H&R Block, Inc.

Thank you for standing by, and welcome to H&R Block's third quarter fiscal 2023 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. I would now like to hand the call over to Vice President, Investor Relations, Michele Galena. Please go ahead.

Thank you, Lateef. Good afternoon, everyone, and welcome to H&R Block's third quarter fiscal 2023 financial results conference call. Joining me today are Jeff Jones, our president and chief executive officer, and Tony Bowen, our chief financial officer. Earlier today, we issued a press release and presentation that can be downloaded or viewed live on our website at investors.hrblock.com. Our call is being broadcast and webcast live, and a replay of the webcast will be available for 90 days. Before we begin, I'd like to remind listeners that comments made by management may include forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties, and actual results could differ from those projected in any forward-looking statement due to numerous factors. For a description of these risks and uncertainties, please see H&R Block's annual report on Form 10-K and quarterly reports on Form 10-Q, as updated periodically with our other SEC filings. Please note, some metrics we'll discuss today are presented on a non-GAAP basis. We've reconciled the comparable GAAP and non-GAAP figures in the appendix of our presentation. Finally, the content of this call contains time sensitive information, accurate only as of today, May 9th, 2023. H&R Block undertakes no obligation to revise or otherwise update any statements to reflect events or circumstances after the date of this call. With that, I will now turn it over to Jeff.

Thank you, Michaela. Good afternoon, everyone, and thanks for joining us. Today I will share highlights from the third quarter and discuss our tax season performance in context of the unusual market dynamics this year. Tony will share our financials in more detail later in the call. Then we'll open it up for Q&A. As you'll recall, we and others expected this to be a normal tax filing year with the pandemic largely behind us, no new federal programs, a large number of stimulus filers having left the industry, and strong employment. Generally, tax return volume was expected to grow about 1%, which is in line with its historical average. But after an initial peak, the industry volume in fact declined about 1% year over year, which was about 200 basis points below our expectations. While we are still analyzing results, we believe a number of factors contributed to this outcome, including more stimulus filers rolling off than anticipated, a decrease in average refund size, and an increase in balance due returns, which may have driven low-income filers to the sidelines, and the IRS filing delay in several states, including California, which we estimate to be about 100 basis points of the impact. As a result of industry volume declines and our own assisted performance and the impact of foreign exchange, we have updated our full year outlook. Tony will share more detail later in the call, but I'm pleased that we still expect to deliver EBITDA and EPS growth this year despite these headwinds. Let's dig deeper into our performance starting with DIY. As you recall, our goal was to return to share growth by increasing awareness that we offer a DIY product, by improving quality, and making it easier to switch from TurboTax by creating a customized experience in the product user flow. We also introduced new innovations, like our industry-first use of artificial intelligence that finds tax refunds that may have been missed on TurboTax returns. This multifaceted strategy worked. Through April 30, we grew DIY online clients by 2.5%, with many of them switching from TurboTax. We also improved unaided awareness by 200 basis points, which is a significant move year over year. Our online net average charge was about flat. Our largest segment of new clients was Gen Z, between the ages of 18 to 25. And finally, our service quality scores were strong. These metrics are historically a good forward-looking indicator and confirm our progress and the prospects of our DIY business. We also continue to see clients that begin in DIY choosing to upgrade by adding expert help with one of our two products, Online Assist and TaxPro Review. OnlineAssist offers on-demand access to an H&R Block tax expert. Clients can access this help before starting their return or while completing it. And AI is helping us get smarter about anticipating when the client may be struggling and needs this help. TaxPro review provides the benefit of having our tax experts check the entire return for accuracy, ensuring clients get their maximum refund and then we file the return on their behalf. TaxPro Review continues to grow double digits, which it has done nearly every year since we launched this capability more than a decade ago. Of course, both online assist and TaxPro Review enable the client to access one of our tax experts without needing to visit an office. Now let's discuss our assisted business. Since I joined H&R Block, we've made numerous changes with the goal of improving relevance and driving growth among clients with greater lifetime value. For example, we introduced upfront transparent pricing, eliminated free assisted tax prep, and eliminated nationwide 50% off promotions, to name a few. These efforts are paying off, and this year we experienced client growth among each segment above $50,000 in income, with our fastest growing segment being clients over $100,000 in income. However, this year, the growth in higher value clients wasn't enough to offset the volume decline in the lower income segments. While we'll continue to learn more in the coming months, three factors are clear. First, as I shared earlier, we were impacted by the overall industry decline. Specifically, as a result of very low-income filers, likely stimulus filers who had less than $5,000 in income going back to the sidelines. This group likely made up a little more than one-third of our client loss this year. And as we look to the data, it appears they have returned to pre-pandemic levels, and we believe this headwind is now behind us. Second, we saw a decline in earned income tax credit filers. We simply did not do a good enough job attracting them with the right message at the right time. And I know that we can better focus marketing messages on relevant value propositions such as refund advance in the early part of the season. This group likely made up almost half of our client loss this season. And third, the IRS filing deadline extension in multiple states impacted the industry and our volumes. We estimate that the California delay likely made up about 15 to 20% of our volume declines. All of these factors led to about a 3% decline in our assisted volume. When the fiscal year ends, we'll conduct a full review and make decisions about changes and improvements for next year. But we believe we have a strong grasp on what drove the declines. Assisted net average charge across the company and franchise offices increased 4% year-over-year as we successfully offset the two-point headwind due to the rollback of the child tax and earned income tax credits. We feel great about our pricing approach as client satisfaction scores improved, including notable moves in price for value, intent to return, and other service quality scores. Considering refund sizes declined and more clients were balance due, these are especially strong results. Not only did we see this significant growth I already mentioned in TaxPro review, but we also saw continued improvement in virtual tool adoption, which enabled clients to exchange documents with their tax expert, check the status of their return, and approve and pay online. More than 30% of assisted clients leveraged a virtual tool during their tax prep experience within our company-owned footprint. Overall, the transformation of our assisted tax preparation business has made more progress this year. Turning to small business assisted tax, volumes were down slightly with the broader industry, but we demonstrated pricing power that drove incremental revenue. NAC increased 5%. alongside positive client satisfaction metrics, demonstrating our value proposition versus local CPAs. We're also focused on serving entity clients, which grew 6%, and company entity revenue increased by double digits. We recently launched an entity formation tool to allow small business customers to take advantage of benefits that may come from incorporating. We're also pleased with the trends in our bookkeeping and payroll services in the early stages of its strategic focus. Our new dedicated internal sales team has meaningfully increased conversion rates, and we feel good about the value we're creating for clients through year-round services. These are strong signals about how we are helping small businesses beyond tax. At Wave, revenue growth was 10% in the quarter. Wave's new CEO has made a lot of progress in his strategic review of the business to accelerate revenue growth and drive long-term profitability. We have already taken initial steps by restructuring the organization, and we look forward to sharing additional detail in the coming months. In January, we introduced Spruce, our mobile banking platform, to our assisted clients for the first time. Since launch through April 30, we had 291,000 signups and $288 million in customer deposits. When I view the performance of Spruce relative to the initial launch of today's leading challenger banks, we have outperformed in account signups. However, given our client base, we had higher expectations. Some tax pros were successful in introducing Spruce to their clients, which provides great insight about our value proposition and selling model. But on balance, our TaxPro community focused on serving the tax needs of our clients. That being said, Spruce clients are utilizing it to help them be better with money. This season, tens of thousands of users deposited over $100 million of refunds to their Spruce account up to five days early. which is a meaningful benefit, especially at a time when every dollar matters. We are also seeing clients make their first purchase at a much faster rate than earlier customers. Recently, we launched a new feature enabling clients to easily set up direct deposit within the app with just a few clicks. Thousands of clients have engaged with this new tool, and of those, more than 80% have chosen to direct their entire paycheck. All in all, SPRUCE demonstrated that it has value to clients, and we had important learnings which are already informing some shifts we'll make moving forward. Before I turn it over to Tony to discuss our financials, let me just say that overall, while this was not the industry context we expected, and we didn't land where we wanted and assisted, our DIY strategy was very successful. Tax Pro review, again, grew double digits. We attracted higher value assisted clients. Small business continues to progress. And Spruce demonstrated signals of its potential. These important wins are a reflection of our block horizon strategy and are evidence of the progress we continue to make in transforming H&R Block. Now, we are focused on finishing out the year and integrating these key learnings into plans for our next fiscal year. Tony, I'll turn it over to you.

Thanks, Jeff. Good afternoon, everyone. Today, I'll review results from the third quarter, provide additional color on our updated outlook, and discuss capital allocation. In the third quarter, we delivered approximately $2.1 billion of revenue, an increase of 1.5%, or about $32 million to the prior year. The increase was primarily driven by net average charge in the assisted category, partially offset by lower software sales and a decline in online paid returns during the quarter compared to the prior year. Total operating expenses were $1.2 billion, an increase of 4.5%, primarily driven by higher field wages and the timing of advertising, partially offset by lower bad debt, legal fees, and consulting and outsource services. EBITDA was approximately $910 million, a decrease of 1.3% or $11.7 million to the prior year. Interest expense was $22 million, a decrease of 6%. As we have shared, this savings is the result of the $500 million notes we issued in June of 2021 at about half the rate of those that we replaced, which were paid off in early in May of 2022. While we have seen higher interest expense on short-term borrowings, we expect a greater benefit from interest rates while we are in a positive cash position. Pre-tax income was $855 million compared to $862 million in the prior year, and our effective tax rate was 24.5% compared to 21.7% last year. We did not execute any share repurchase in the third quarter. Given our narrow trading windows, we have historically executed most of our share repurchases in the early part of the year. In the first half of 2023, we completed $350 million of share buybacks, or another 5% of shares outstanding. Earnings per share from continuing operations increased from $4.06 to $4.14, while adjusted earnings per share from continuing operations increased from $4.11 to $4.20. Note that the only adjustment we are currently making to adjusted earnings per share is amortization-related acquisitions. On that note, franchise acquisitions are a core part of our Block Horizon strategy and our longer-term revenue growth target of 3% to 6%. We expect to acquire approximately 125 locations per year, though this year we were able to complete 195. We will continue to be opportunistic and believe this is a great use of capital. Turning to our outlook, as Jeff mentioned, due to industry volumes as well as the lighter-than-expected assistant client volumes this season and an expected foreign exchange impact of about $20 million, we are updating our estimates. We now expect revenue to be in the range of $3.44 to $3.465 billion, EBITDA to be in the range of $895 to $910 million, Adjusted earnings per share to be in the range of $3.65 to $3.80. And we continue to expect our effective tax rate to be approximately 22%. In a year with the industry declining and headwinds from the rollback of the Earned Income Tax Credit and Child Tax Credit, including its impact on the Emerald Card, I'm encouraged that we still expect to grow EBITDA and deliver solid EPS growth. Our longer-term shareholder return algorithm remains unchanged. We believe we can deliver 3% to 6% long-term revenue growth, EBITDA to grow at 1.5 times revenue, and double-digit adjusted earnings per share growth annually through 2025. As I've said, despite year-to-year nuances, the strength of our capital allocation story remains the same. We produce significant cash flow, pay a growing dividend, and buy back a meaningful amount of shares each year. We are committed to and confident about driving ongoing value for shareholders with these practices. With that, I will now turn things back over to Jeff for some closing remarks.

Thank you, Tony. While this isn't how we expected the season to play out, I'm pleased that despite the many factors we have discussed, we still expect to grow EBITDA and EPS year over year. We're focused on finishing the year strong, analyzing fiscal year results, and creating action plans for next year. I look forward to sharing more with you on our next call in August. Now, operator, we will open the line for questions.

As a reminder, to ask a question, you will need to press star 1 1 on your telephone. Again, that's star 1 1 on your telephone to ask a question. Please stand by while we compile the Q&A roster. Our first question. comes from the line of George Tong of Goldman Sachs. Your question, please, George.

Hi, thanks. Good afternoon. You noted that the delays in California account for about 15 to 20% of the volume declines. Can you estimate how much of the volumes flipped from fiscal 3Q to fiscal 4Q and how much of the volumes might flip to fiscal 2024 because of the filing extensions? And then perhaps comment on what the impact from the other state filing extensions can be besides California. Thank you.

Hey, George. Thanks for the question. So, for California, that's right, we said about 15 to 20 percent of our impact. Obviously, that's timing. And about 100 basis points to the industry impact. And based on what we're seeing with filing behavior, We really think that most of that's going to come in in next fiscal year, frankly, closer to the filing deadline next October. And when you look at all the different states where there has been an extension, the lion's share, that's California, and that's really where we've been focused. Got it.

That's helpful. And as a follow-up, you mentioned that industry-assisted volume declines contributed to your updated guidance. Can you also elaborate on how market share performance factored into your updated guidance? How did market share perform in this category versus the overall industry?

Yeah, obviously with so many unique industry dynamics, we know our performance, we know industry, we don't know a lot of the whys yet, we're digging into that. But we believe that we lost about 10 basis points of total share in the year. We estimate we gained about 40 basis points of DIY share, and we estimate we lost about 50 basis points of assisted share. And again, in the assisted business, really clear on the three reasons. The stimulus filers, about a third of the volume loss. The EITC filers that we think we can do better at with respect to refund advance, about half. and then the 15 to 20% of Californian timing. And, you know, as we showed in the slide in our presentation, that first third, we see those levels going back to pre-pandemic, so we believe that headwind is behind us.

Very helpful. Thank you.

Thanks, George.

Thank you. Our next question. comes from the line of Karthik Mehta of North Coast Research. Your question, please, Karthik.

Thank you. Jeff, maybe on the NAC, you said you gained about 4% NAC on the assisted side, and I'm wondering, was that partially related to inflation? And as you move forward, what do you think is a reasonable estimate for NAC?

Yeah, great, great question, Kardig. So that this year, that 4% was, you know, almost all price. And as we talk every year, we're paying very close attention to the macro environment, how much we think we can move and what the customer tells us in feedback. So this year, you know, we feel especially good about the 4% in light of the fact that obviously inflation was much higher. And given the refund dynamics where, you know, fewer people got a refund, more people switched to Baldu, the customer told us we delivered great value. And so we saw that show up in several metrics. So I don't want to sit here today and predict what NAC might be next year. We'll obviously factor all that in. And as we get ready to launch, talk about what price we think we can take next year. but we do feel good given what we're seeing from the client and the quality and value we're delivering that we can take low single digit increases.

And then Jeff, was there much of a difference in terms of performance from company owned stores versus franchise stores in terms of volume?

No, not there. There really wasn't. I think, you know, the, The three macro things we talked about that impacted volume, you know, the stimulus filers, the EITC filers, and the timing in California, you know, those things really applied across the system, company and franchise.

Yeah, the only thing I would call out, Cardick, is as you look in the volume table, it's actually in the appendix slides for the presentation that we've uploaded, you will see company, looking a lot better. That's largely due to the franchise buybacks as we obviously buy franchise locations. Those are now reported as company locations as well as the returns showing up on that side versus franchise. So that explains most of that dynamic. Perfect.

And just one last question, Jeff. What do you attribute kind of the shift in share from DIY to assisted or maybe that's just a difference in performance in the two?

Yeah, that is definitely a question that we've got more work to do to understand better. Obviously, we see what's happened. You know, we have an understanding of our performance. But, you know, as we hear competitors talk about their performance, we get later in the summer and see broadly what happened competitively. I think that will help us understand more about the why. It's obviously a dynamic that we haven't seen for a long time. And, you know, there's a lot more learning there.

Perfect. Thank you.

Thanks, Cardick.

Thank you. Our next question comes from the line of Scott Schneeberger of Oppenheimer & Company. Your question, please, Scott.

Thanks very much. Jeff, you may have the same response to this question as you just had to Cardick's. Where do you think the share went in assisted? Do you think it was a rise in your and your competitors' digital assisted that maybe took share within the industry this year?

Yeah, I don't want to just say repeat what I said to Cardig, but I think we, you know, we just don't understand all the why yet. You know, we don't know any competitive information at this point. We'll obviously hear more, you know, when Turbo announces in a couple weeks, you know, what they saw and what they experienced. But at this point, we just don't know where share may have gone. Tony, anything you'd add?

When we look at the type of clients, Scott, that we've lost, which we talked about, you know, the stimulus-related filers, we define them as less than 5K of income, EITC-related filers. Obviously, California is just purely timing. We have a hard time believing that they left to go pay the same or higher price at a competitor. We believe stimulus, a lot of them probably went back to the sidelines. So based on the data that we've looked at, it doesn't seem like it's an impact on all on our performance. To you and Kardec's question about market share, it's hard to understand the DIY and assisting dynamics. We focus, frankly, more this year on total. Cause I think it's just a clear story and there's clearly something that's unusual. I mean, I don't know if the DIY categories ever declined and to see it declining 2% is obviously unusual. Our online business grew two and a half percent. So we, we had really good performance, but, but we know that there's some other factors at play, but when we look at our own data, it doesn't appear that we are the type of clients we're losing, losing would be going to a digital competitor.

I appreciate you guys, and thanks, Tony. That was some helpful information. I know I understand it's early, and we need to hear more. Following up there, you mentioned timing of marketing was a bit of a headwind this year. Could you elaborate on that?

Yes, so specifically, you know, when we look at those three reasons why we lost assisted volume, that second reason about the EITC filer in particular, you know, when we look at not just timing, Scott, you know, we actually spent more money this year year over year in refund advance, but I just don't think we did as good a job as we can in connecting that value proposition to that filer. We also know that we lost to people who offer a larger refund advance size that may come with interest or fees. And it's mattered a lot to us to keep our product interest and fee free. But we know we did lose some to those kind of competitors. And, you know, I think that just explains so much about the state of the consumer early in the year and, you know, how badly they needed to get access to cash.

Thanks. And kind of as a follow-on to that, Jeff, you guys called out that there were, you know, a lot of people that may have received a refund. I think it was $2.5 to $3 million. I'd have to go back and look just at the IRS data. But people who received a refund last year who did not receive a refund this year, how detrimental to you was that of not being able to perhaps offer an additional product to some of those folks? And it was Is that quantified and where would we see that appear in the income statement? Thank you.

Yeah, you know, we don't break that out specifically, but I can tell you in our own business, we saw customers that in the moment learned the status of the refund and decided not to file. You know, we know that from sitting across the table from them, but I can't quantify exactly how many that is.

The one place that it does show up a little bit, Scott, is in the refund transfer line. You know, that's how customers pay for tax prep taken out of the refund. And if you're not getting the refund, you obviously can't pay that way. So given the number of refund customers down is impacted, we also believe that some customers didn't take that product because their refund was lower. You know, when you're kind of playing with house money a little bit and you're getting a larger refund, I think clients are more willing to take some of those products and And this year we did see a reduction in product attached kind of across the board. And I think it is connected back to not only how many we're getting refunds, but the size of the refunds being lower.

Thanks guys 1 more if I could sneak it in impressive that you grew in DIY and that was good. You had some marketing there, so it shows it was effective, but in the demographic that you. That's a lower revenue generating, often a free product demographic. It's great that you captured them and the goal would be to retain them. But am I right in that assessment? Can you kind of bifurcate your DIY paid versus your DIY not paid?

You're exactly right. You know, attracting a Gen Z customer is valuable to the brand over time. despite the fact that many of them start for free this year. You know, we don't actively try to look for clients who are necessarily just free or paid, but we did intentionally want to start attracting a younger demographic into the brand. Just like in the assisted business, we've intentionally been trying to migrate to higher value clients in terms of lifetime value. So those are intentional goals, and your instinct is right that they tend to start free.

Okay, great. Thanks. I'll turn it over. I appreciate you taking all my questions.

Thank you.

Thank you. I would now like to turn the conference back to Michaela Galena for closing remarks.

Thanks, Lateef, and thanks, everyone, for joining us today. This concludes our third quarter fiscal 2023 earnings conference call.

This concludes today's conference call. Thank you for participating. You may now disconnect.