H&R Block, Inc. (HRB) Earnings Call Transcript & Summary

[indiscernible] I work at the Information and Solutions team here at Baird. So like I said, we have H&R Block, with CFO, Tony Bowen. We also have Michaella Gallina and VP of IR in the back. H&R Block is a leading Assisted and DIY tax software provider to help and inspire confidence in its clients and communities through global tax prep, financial services and small business solutions. So I'm going to give it over to Tony for few opening comments, then we'll do Q&A.

I thought you were going to read this. You're not going to? Just kidding. How is everybody doing? Good to see you guys. Thanks for having us. It's great to be in-person for the first time in a couple of years, so. I thought I'd do is just -- we're going to just stay on one slide and talk a little bit about the H&R Block story, and I'm sure a lot of you know the name, but maybe there's a few things on the slide that you don't know about the company. So what you probably know is we're the largest assisted tax provider in the United States. We serve about 12 million customers in our Assisted business. We serve about 8 million customers in our DIY tax software business. And we're actually the second-largest DIY tech software provider, which some of you may not know. That's something that we've been focused on over the last several years. We've grown that business. We're trying to make it essentially a 2-horse race with us and Intuit. They've got a big lead, but we're definitely trying to make it a 2-horse race. In 2020, we announced 3 strategic imperatives as a way to refocus on growth. So the first one was a focus on small business. H&R Block historically has always served small business customers, but it's never really been a concerted effort. It's been more just happenstance. Clients come into the office, maybe they start as an individual, maybe they open a small business, and then we continue filing their tax returns. And it's an asset that's been inside the company that we really hadn't leveraged for a long time. All of our tax pros are trained to handle small business tax returns, but it's not a market that we'd ever marketed to, built specific products and services to, had differentiated pricing to, so it's something that we wanted to really start focusing on. Connected to that, we did an acquisition of a company called Wave, which is a small business accounting and invoicing software. And think of it it's -- the easiest way is to say it's similar to QuickBooks where you can do all of your accounting, invoicing, it's payment-enabled those invoices, so the end customer can pay using their credit card. They also have a payroll offering. And now they've just launched a product Wave Money, which is a small business checking account. The differentiator for Wave though versus QuickBooks is they charge nothing for the main subscription. So there's no monthly fee that you're paying on an ongoing basis. And they only monetize when you, for example, payment enable that invoice or add an employee for the payroll purposes. So small business is our number one strategic imperative. We've been growing that business the last couple of years and something that we think has a lot more upside in the future as well. The second is financial products. So today, we offer a couple of different financial products. We have a Emerald Card, which is our prepaid debit card platform. We have about $8 billion loaded on that platform each year, largely connected to the tax event and have about 2 million customers that take that card. We have a couple of lending products as well. But the focus on this was how do we build a new product that targets our existing customers who aren't happy with their current banking solution? So we just launched a product in January called Spruce that is basically a fully digital mobile banking offering, that's very, very low fees, so no monthly fees, no overdraft fees. We have a large fee-free ATM network. But we monetize through interchange as well as when customers go outside of the network for ATM withdrawals. And our data shows that several million of our existing 20 million customers aren't happy with our current banking solution. So how do we build a product to create year-round engagement and try to get those customers setting up direct deposit where they're using that product on a year-round basis, not just for the tax refund. And then the third strategic imperative is Block experience. And this is all about digitizing our overall business and helping our clients connect to more of that human expertise that we have as a brand. We have a unique asset where we have 60,000 highly trained tax professionals. Even our DIY clients need help along the way. How do we connect them to that help, how do we also allow customers to have their taxes done fully virtually by never coming into an office? So today, most of our 12 million customers come into one of our nearly 10,000 locations. How do we build a product that allows them to upload documents, interact with tax professionals and pay and review their return from the convenience of their mobile phone by not having to visit the office. The benefit is not only the benefit for the client by not having to schedule an appointment, drive to a local location, but also a benefit to H&R Block when we think about the efficiency of our labor and the efficiency of our real estate. Over time, we think we can reduce the size of our locations. We can reduce the number of desks in our locations and potentially reduce the amount of labor that we're spending by having more clients who don't require that face-to-face visit. We just finished our most recent tax season. We had a normal tax season for the first time in a few years. Obviously, the last couple of years, the IRS had moved the tax season deadline. 2 years ago, it was to July. Last year it was up till May. This year, it ended on April 18, thankfully. And it was our second year that we posted really, really strong results. So in our Assisted business, we gained share for the second year in a row. We just increased our outlook for both revenue and EBITDA. And one of the things we've also done in the last year is change our fiscal year. Historically, our fiscal year was April 30. We just moved it to June 30, starting with this year, and that was because of that hangover from last year's tax season, not ending until May. If we hadn't done that, we would have had a kind of incomparable year again. So this is the first year that we're going to have a clean year since fiscal year '19. We guided to the full year results, which are really, really strong. And I think that's part of the reason you're seeing the stock react so favorably is, because people are now seeing that this company still makes a lot of money, generates a lot of earnings and creates a lot of cash flow. With that cash flow, we've been deploying to shareholders. We bought $550 million worth of stock so far this year through the first 3 quarters, average price of about $24 a share, a little less than that, obviously, relative to where the stock sits today, a really, really good use of capital. As part of our Investor Day, we provided some long-term guidance for both revenue and earnings. I mean, H&R Block isn't a high-growth company, but it's a stable industry that can provide nice growth over the long-term. So we said that revenue can grow 3% to 6%. We provided on our Q1 call a view of how we can get there with a combination of holding share in the overall tax category, getting a little bit of moderate price increases, continuing to do franchise buybacks versus a use of capital in the way that we drive revenue and earnings as well as getting growth from Wave. And then if you go back to growing Spruce and additional small business, that's how you get kind of within the top end of that range. We expect that if we grow revenue at 3% to 6%, we can grow EBITDA faster than revenue, and we expect that we can grow EPS faster than EBITDA as we continue to execute share repurchase. So at the bottom there, you can just see, since 2016, we've returned $2.6 billion of capital to shareholders through dividends and share repurchase, which is an incredible amount relative to our current market capitalization. So again, our goal is to have increased cash flow over time, continuing to pay a growing dividend and continue to execute share repurchases. So a quick overview, but you want to jump into some questions?

No, I appreciate it. If there is client, who'd like to ask a question, you could e-mail at [email protected]. I'll be moderating in the iPad here. But maybe I just want to start. As just talked about, it's been sort of a hectic tax season last couple of years, extensions, you talked about your fiscal year change. So maybe help us just understand better, so where are you in the market? Now you talked about market share gains, what's driving that? Maybe just help us reset the picture just given the amount of moving pieces.

Yes. It has been tough to kind of understand the results, and we've tried to normalize them over the last couple of years. But again, this is the first year we'll have a really clean view at what the business looks like. And again, tax season ended on time made a huge difference in that. Like I said, in the Assisted category, we've grew market share last year. Part of that benefit was driven by people entering the category who we call first-time filers. We knew some of those first-time filers were going to likely go back to the sidelines this year. And we thought that we may lose a little bit of market share as a result. When you gain market share when they came in, maybe you'll lose a little bit on the way out. The fact that we actually just held market share is a really, really positive sign. And we shared on our Q3 call that over the last 2 years, we're up in Assisted clients, versus 2020. So we're in fiscal year '22. So versus fiscal year '20 we're up about 300,000 Assisted clients. We're up about 5% in net average charge. We're up about 10% in Assisted revenue. Assisted, obviously, is the biggest part of our company and just an incredible sign that we're on the right path. If you go back to fiscal year '18, our business had been losing market share for a long, long time. When we kind of diagnosed what was causing that, we thought pricing was a key part of that. The company has been raising price 5%, 6%, 7% for a lot of years. So we've made a change to how we price. We now do it upfront. We call it upfront and transparent, so clients know the price before they ever start. And we also lowered pricing for millions of our customers. And the feedback has been really, really positive. Our client satisfaction scores continue to be really high since that change. Our tax professionals' feedback about how clients are feeling continues to be really, really positive. And I think that was a core catalyst to put us where we are today, which is holding market share. We just haven't been able to prove it until we could have a clean year, which is what this year is. So I feel like now we have a solid base to grow from. Again, getting that 3% to 6% range allows us to grow our EBITDA faster than revenue, grow EPS even faster than that. And one fact. If you go back to 2016, our EPS that year was $1.50 and change. This year, we'll be well above $3. So we're up over 100% over that period. And up until a month ago, our stock essentially hadn't moved. Our stock was in the 20s in 2016. It was in the 20s a month ago. And Michaella and I were sitting around like why is our stock not moving? It doesn't make any sense, because our EPS has grown so much. But I think it was, again, just the confusion of those changing tax seasons and not being able to post a clean year and show the ongoing profitability of the business.

And you talked about the net average charge and some of the pricing adjustments you've made, but yet you still grew net average charge -- you said it 5%, I think it was 8% in the first quarter. What's driving some of that improvement in average charge?

Yes. So when we made that pricing change 3 years ago, we essentially decided we weren't going to change pricing for the foreseeable future. So we went in 3 years in a row essentially no price increases. And this is the first year where we felt like the claim satisfaction scores were in a positive enough place. And clearly, with cost of things continuing to go up, we felt like we were going to return to modest price increases. So we took about a 3% price increase. But for us, price -- what we talk about is net average charge, which is a combination of price changes plus mix. And we had a lot of mix favorability this year as we had more people filing, who qualified for additional credits, earned income credits, child tax credits. We also had more people who did crypto and retail trading, which obviously you have to get a 1099, we file that on the Schedule D, that's additional complexity that we charge for. So all of that drove an increase in our net average charge of that 8%. The 5% I was quoting was over on a 2-year basis it's up, because we actually were down last year in net average charge due to a negative mix as we have those first-time filers come into our business who are more simple and a lower complexity. This year we offset that as some of those first time filers went the other way, net average charge end up increasing 8%. Over the long-term, I still think net average charge mix will wash itself out on -- you may have year-on-year variability, but over the long-term, it will wash itself out. We think about pricing being in that 2% to 3% zone. Obviously, the inflationary environment today could justify a little bit higher price in the near term. But over the long-term, I think it's at 2% to 3% is what we're targeting.

And I said maybe in inflationary environments to go point to on the opposite side of prices, obviously, costs, you have a sort of more labor-based model, I guess, you call it that. What are you seeing with wage pressures? How are you managing personnel size, things like that? So just help us understand that side of the model.

Yes, it's kind of 2 different categories. So one is from a corporate perspective, we have kind of full-time positions, all of our corporate staff -- me, Michaella, others. And you're going to see higher than normal merit increases and definitely a little bit of wage pressure there. We've had to make some comp adjustments for certain positions like software engineers, for example, to make sure we're retaining the best talent. But that's the kind of smaller part of our comp. The bigger part is what happens in our offices, and that's tax professional, labor, that's largely commission-based. So if they do a $200 tax return, they essentially get a portion of that revenue as compensation. And the nice thing about that model is as revenue goes up or down, it obviously adjusts automatically. We haven't seen a big issue with retaining and attracting talent in our Assisted business. And we -- our tax professionals know that if they want to make more money, they essentially do more business, drive more revenue. They work more hours. They do more tax return. So it automatically adjust with things like our pricing increases that we're taking, tax professionals are getting the benefit because it's driving up the average charge that makes them make more. So we aren't happen to adjust the core compensation system, and it will just flow through as a variable percentage of revenue. It runs about 25% to 30% of revenue, but we aren't happen to do anything special in the current labor market.

Okay. And sort of post COVID, one of the, I think, broader trends that's happen is this increase in digitization, maybe just start to go -- move into the DIY side of things. But maybe try to straddle that middle ground, what's your real estate footprint look like? Are you sort of readjusting the size and locations, things like that?

Yes. So we are looking at that, especially over the next several years. So today, we have about 9,500 total locations. About 70% of those are company locations remaining in our franchise. Obviously, the franchisees pay their own rent and are responsible for that side of it. So that 70%, we're thinking about as we become more digital in the Assisted business, can we reduce the square footage of our real estate. We don't necessarily want to reduce the number of locations because it's important to have those points of presence. It allows clients to just walk in, who want to walk in. It's also a marketing billboard in every strip center in America. But if we can go from an office that has 2,000 square feet to an office that has 1,000 square feet, that's obviously a considerable saving. So we're starting to execute against that strategy now. We're in the early days, because to do that, we need to get a meaningful portion of our clients who aren't visiting offices will allow us to reduce that real estate any further. So I think it's a multiyear strategy, but we think it's definitely a tailwind from an earnings perspective as we can reduce the amount of square footage we utilize.

Great. And as far as the straight DIY then, what's your strategy in the market? How are you competing? May be just help us understand that better?

Yes. So in DIY, our strategy is a few key things. Number one, we have to have a great product. So we've invested in the product over the last several years. And if you look at independent reviewers of the product, it's gotten better and better reviews every year. So we feel like the product is now really, really good. In some cases, we actually beat Intuit head-to-head. In some cases, they still beat us, but overall, the product is in a really good place. Two, we make sure that the product is properly priced relative to Intuit. So they're the market leader. We know that they kind of are the 800-pound gorilla, and they're almost the Kleenex of the tech software market, and we're still fighting an awareness game. So we need to make sure that people even know we make tax software. Everyone knows H&R Block for Assisted, but not everyone knows H&R Block for tax software. And then we have to go out and tell them. So we've got a good product. We appropriately market it and we need to go out and then make sure we're telling about that aggressive price. And that's where I think if you look at last year's results, we did lose a little bit of share. Business still was really, really healthy. We actually grew revenue because we got some positive benefit from a mix perspective on the pricing side, but we didn't hold share. And if you go back in history, we'd actually gained share about 3 years in a row in the last couple of years we haven't. So this summer, we're essentially going back to the drawing board, thinking about what do we need to do to make sure that we're getting awareness out there. And I think over the last couple of years from a marketing perspective, we've tried to highlight H&R Block has lots of ways to file. And when you do that, everyone immediately thinks about the Assisted side, but DIY tax software kind of gets lost in the shuffle a little bit. So how do we build marketing that's directly targeting against TurboTax. Again, we think our message is strong, the value prop is there, but you've got to go out and tell them. And you've got to do it with a marketing budget that's less than Intuit, because they're obviously outspending this, especially on the DIY side exponentially. But we're not trying to bring in as many clients as they are either. I mean every year, they've got to bring in millions just to offset their churn. From our perspective, given our base of 8 million total DIY clients, we're not trying to fight the same battle. But we can be more aggressive on the marketing side and try to bring in clients to grow market share, which is absolutely our goal.

Cool. And like I said, we cover tax, but obviously, you're more than just tax. You have financial products side of your business as well. What's that portfolio, again, and then how does that fit with H&R Block and sort of what you're trying to do for the consumer?

Yes. I mean a lot of our financial products are tied to the tax event. Like I said, our prepaid debit card, which we call Emerald Card essentially a way for customers to load their tax refund onto that card. Think of a $3,000 load that goes on there and most of those customers spend those dollars down in the next few weeks. So they either do ATM withdrawals or they go to Walmart and buy a new TV, whatever it is. But that money goes down really, really quickly. We have a small percentage that use that card on a year-round basis, but most of them only use it for the tax event. So then when we launched Spruce, it's really about how do we build a product that's a year-round banking offering. Again, we surveyed our customers. They're not happy with their current bank offerings. A lot of them are getting charged monthly fees, they're getting charged overdraft fees. Our product has none of that. And the way we make money is through interchange. And then like I said, if you go out of network ATM, we do charge revenue for that. So it's a low-cost option. We're trying to create more engagement year-round relationships with our customers. And given the sizable benefit we can get from a revenue perspective by offering the tax services, we don't have to make a ton of money on the banking products, but we do think it's going to be additive to revenue and earnings over time. So we again launched that product in January. At the end of April, we had 150,000 sign-ups. We've had $16 million loaded. It's continuing to grow every single day. This year, we only focused on our DIY channel. We did even launch it in our Assisted channel. That's what we plan to do next year. But now the game is how do we get people to actually use it year-round. We got 150,000 clients to sign up through tax season, how do we get 150,000 clients to actually set up direct deposit and use it a year-round banking option. So it has a lot of the similar functionality you would see in a Chime or a Varo or Dave. It has integrated credit scores, for example. It has savings wallets where you can set up savings goals and to set a certain amount of money aside each paycheck. And then we're launching several new features in the coming months. Again, it's only been up for about 4 months. So we'll continue to offer products like our prepaid debit card. But again, this product is about building year-round banking relationships.

Great. So I do want to go back to the, I guess, small business side of the things. But with Wave, so that's, I guess, for lack of a better way, a competitor to QuickBooks. Again, what -- so what is the strategy there? How do you compete, I guess, the market? What's the competitive advantage there?

Yes. The biggest competitive advantage is the core product of accounting and invoicing is completely free, versus QuickBooks or FreshBooks or Xero that you would pay a monthly subscription. So if you think about a small business owner who's starting out, obviously, they're strapped for cash, so giving them a product that there's 0 barriers to try is a really, really good acquisition vehicle. So Wave doesn't do a lot of marketing today. Most of it is word of mouth. They do SEO. They do just a little bit of SEM, but most of it is word of mouth. So that's how they're growing the business. They're getting clients to appreciate the benefits of payment enabling those invoices so that their end clients can pay with credit card, which is where Wave makes revenue, which is the same thing that QuickBooks does, for example. So we both monetize the same way, but again, with Wave, there's not a monthly subscription fee. They just launched last year a small business checking account. So it's all integrated in the same platform. So all of your banking, your invoicing, your accounting is all on the same platform. So that's a new growth vehicle as well. They would make money from interchange, ATM fee, similar to what we would do on Spruce. But the biggest opportunity for Wave is continuing to just grow awareness and let more small business owners know that the product is out there. The stat that we share, there's about 30 million small businesses in North America, but only about 5 million to 7 million use any kind of a software to manage their business when you think about accounting, invoicing, et cetera. So there's a huge untapped market. Now most of the small businesses, they're using something. So what are they using? Well, they're using Excel, they're using a checkbook, they're using a shoebox. They're essentially not keeping books like you should be as a small business owner. And it's only when you get to the end of the year for tax purposes and you realize you have to pay tax on all that revenue and the way to offset that is to track all of your expenses, and that's what Wave exactly do. So that's where it has the connection back to H&R Block, where we do some referrals between the 2 brands, but has a ton of upside in just attacking that 25 million small businesses who aren't using any software today. It definitely competes with QuickBooks, but in a lot of ways, it doesn't, because we're really competing against Excel and just a checkbook.

And you -- it's had really strong growth and your saying there is no marketing, it's word of mouth based, but it's growing pretty high double-digit rates.

Yes.

How sustainable is that growth? What do you think is driving it? Help us understand that.

Yes. I mean, again, it's -- there's so many small businesses that are being generated and created every day. There's obviously some churn in the small business space. But because the value prop is so strong, it's -- and there's no barrier to try it, because it's completely free product, I think that's what's driving a lot of the growth. The other part that's driving the revenue growth is getting deeper penetration within their existing base of payment enabling those invoices that's also driving it. They're also seeing growth in payroll. They're seeing growth in Wave Money. So all those pieces together are working in concert to deliver there. It's been running about 25% to 30%. When we bought the business in 2019, it did a little bit less than $40 million of revenue. This year, it will be $80 million plus, and we think it will continue to grow on that path for the foreseeable future.

Great. So you're the CFO, so I want to make sure I get some financial questions in there as well. The 3% to 6% revenue growth target, what drives that? Help us kind of break down the pieces and the areas there?

Yes. So it starts with holding share in the overall tax category, as I mentioned, getting a little bit of modest price from the Assisted business, continue to do those franchise buybacks, growth at Wave, all of those pieces can get you into 3% to 6% just with what we've already been doing. And then what we haven't been doing, which is new things like Spruce, continuing to grow in small business in new ways, would get you more in the top end of the range. So we laid that on our Q1 call just to show that it's not like we're trying to do something brand new. What we've already been doing over the last several years will get us within that range. And again, 3% to 6% isn't high growth. I know a lot of you guys probably cover fintech and other things that have much higher growth like our Wave business does. But at this rate and the way that we can leverage our fixed cost, grow EBITDA faster than revenue, continuing to do share buybacks, it can be a model that can grow EPS double digits. And if you do that every year, continuing to raise the dividend, obviously, it provides a really nice shareholder return.

And I want to come back to the share buyback, but maybe just think about EBITDA specifically, growing faster than revenue. Is there -- well, I guess, what's the operating leverage of the business? Is there cost efficiencies and takeouts that you're sort of assuming within that target?

Yes. I mean it's really because -- I mean, it's a high EBITDA margin business. So our EBITDA margin runs 25-plus percent. But when you think about -- like if we can grow in the Assisted tax business, for example, for every $100 of revenue, your core variable expense is labor that I mentioned is 25% to 30%. So you're getting a very high contribution margin based on every incremental dollar. Wave is a similar business that once you get to scale, you can obviously add a lot of leverage, because it's basically a SaaS platform, similar to Spruce, where -- I mean, those are all very, very profitable businesses once they get to scale. So that's where we aren't assuming a big cost takeout to grow our EBITDA faster than revenue. It's essentially just growing in our existing lines of business, and then that will allow EBITDA to grow at that faster rate.

Okay. And is the EPS growth, is that primarily a share buyback program? Or is there like --

Correct. Yes. So it's EBITDA growth, growing faster than revenue and then layering on share buybacks, which based on our history, it's a pretty consistent practice.

Okay. And so let's talk about that, I guess. So you've retired a 1/3 of your shares since 2016 through the share buyback. You have great free cash flow. What are your capital allocation priorities? What does the outlook look like for the share repurchase going forward?

Yes. I mean we always think about what's required to invest in the business for growth, but we have been offsetting cost reductions to fund those investments. So we rolled out the investments for Spruce, for example. Spruce was done this year. So we basically built that product in fiscal year '22, but you could see from our EBITDA guidance that EBITDA is really at a healthy level. So we're funding those with other cost reductions. But then we think about pain and maintaining and increasing our dividend and then the excess cash essentially deploying to share repurchase. So we've shared that on average, we generate about $500 million of free cash flow. About $180 million or so will go to the dividend. That number continues to go down, even though we've been raising the dividend per share because we bought back so many shares that it's a nice flywheel effect. And that leaves the remaining $300 million plus for share repurchase. Obviously, this year, we did $550 million. We tried to be ultra-aggressive given the stock price. But we've always got a little bit of excess liquidity that we can take advantage of volatility in the stock when we see those opportunities. But on a run rate basis, we typically think about it of $175 million, $180 million of dividend and the excess going to share buybacks.

Okay. Great. And then we have a couple of minutes left, so maybe I'll just hit on this one. So you recently hired a new chief marketing experience officer from PayPal. Is there something we can look forward to for new marketing or new messaging?

Yes. I mean, Jill Cress is our new CMO. She started a couple of months ago. So she's kind of hitting the ground now. And I think she'll do an awesome job. We're just kind of looking at everything we're doing top to bottom. We definitely need to be efficient with how we go to market. We are competing against competitors like Intuit, for example, so we need to make sure that we're getting the return on every dollar. And I will -- I do think she'll look at things like DIY, for example, what can we do differently to be more competitive. So there's always an opportunity to be better, and I think Jill will bring that.

Okay. Great. I think with that we'll end it there. So I'd thank you for your time.

Yes. Thank you for moderating. I really appreciate it. Thanks guys.