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

Okay. Good afternoon, everyone. Thank you all for joining us today. I'm Scott Schneeberger, the Senior Business and Consumer Services Analyst at Oppenheimer. It's our pleasure to have from H&R Block, Chief Executive Officer, Jeff Jones; and Chief Financial Officer, Tony Bowen. H&R Block is the largest store front tax repair in the U.S., it also offers digital do-it-yourself tax preparation solutions, financial products and small business services. We're using a fireside chat format. I'll ask management some high-level questions upfront to get us an overview of the business. And later in the session, I'll -- throughout the session, I'll be checking for questions. But at the end, I'll ask the questions from you in the audience. So please feel free to send those into me. And without any further ado, I'm going to get started. So Jeff, thanks very much. H&R Block has been a leader in part preparation for over half a century and it's a highly recognized brand. If you could please provide us with background of how H&R Block serves American individuals and families by providing the company's tax services and the corresponding financial products.

Yes, Scott, thank you. I mean, at the highest level, our block horizon strategy is about evolving H&R Block from being a seasonal consumer tax business to a financial platform for Main Street America that does consumer tax, small business services and financial products. Small business is our #1 strategic imperative and that is to serve small business owners from 0 to 9 employees with tax, bookkeeping and payroll. We offer entity formation, and we're building the capabilities through a sales team and a partnership team to drive greater lead generation for that part of the business. And then finally, part of our Block Horizons, small business strategy is our subsidiary way, which is a fully integrated banking bookkeeping and payroll platform for DIY small business owners. Financial services is all about spruce and products such as Emerald Card, Emerald Advance and Refund Advance. And then our legacy brand and really our history is in consumer tax. And everything we're doing in consumer tax is about modernizing and increasing the relevance of the brand by driving greater quality and value and integrating digital and technology into everything we do to serve clients, whether you're an assisted client or you're a DIY client and that's kind of the broadest way to think about our strategy and the 3 strategic imperatives.

Let's focus first upon the core business, the assisted tax preparation business at H&R Block, if you please share an overview of how the company's assisted volume has trended over the recent tax seasons. This one that just ended and those leading up to it all relative to the industry, if you could put it in that frame. And then also, highlight the key drivers of the performance and hence provide perspective on what you expect going forward?

Yes. Over a multiyear period, we've seen continuous improvement in our assisted tax business. Obviously, navigating many external factors, including the pandemic, the most recent tax season, tax season '23, we saw a volume decline in our assisted tax business for 3 really clear reasons. We think we understand this quite well. And it starts with the industry performance. The industry this year was softer than anyone anticipated. We expected a 1% growth rate. The industry actually declined 1%. That naturally creates some headwinds. And then specifically to our business, we saw 3 different factors. The first is stimulus filers that make under $5,000 a year in income, left the industry. We see in the data that they've returned back to 2019 levels. We saw the extension that happened in several states, but specifically California, which is a very large state. That extended past our fiscal year. That's really a timing dynamic. Those 2 factors impacted our volume. The most controllable thing that impacted our volume was our performance with EITC filers. And as we've dissected this, we think we have a pretty good handle on what we need to do better and different for next year. And it really has to do with how we communicate the value proposition of H&R Block much earlier in the season as these filers are looking for great value, but they're also valuable clients to us. They tend to be complex filers. And then there's a decision we'll face about the Refund Advance product, what we offer, what the market offers and a decision we have to make about do we want to offer a higher dollar amount that comes with interest and fees. And generally, that's been something we did not want to do. So those 3 reasons explain our volume decline this year, one, is behind us, once timing and one is clearly work ahead.

Just to clarify. So our earned income tax credit is EITC, as Jeff referenced, everyone. And Jeff, could you delve in a little bit more about -- you mentioned maybe something strategically you may or may not want to do next year based on what you saw this year. If you can just take us one level deeper in there, I think just it would be informative.

Yes. So specifically, what I'm talking about is a Refund Advance product. And we know this year, we lost market share to competitors that offered larger Refund Advance products. So our product is 1/3 up to $3,500 with no fees and no interest. The very strong value proposition. We saw with the macro backdrop of this year, the season starting faster, people clearly demonstrating their need for cash. We saw them move to products with the refund advances up to $6,000 as one example. Those products came with interest and fees. The consumer doesn't generally know that. They're lured by the high dollar amount, and then these are trailing expenses that come. And that's something that we have stayed away from. It obviously introduces regulatory pressure. But more importantly, we just think it's the wrong product for the consumer. So we don't believe we want to play in that space, which means we have to get more clear on how we demonstrate our value proposition to a customer that really cares a lot about price and value and refund and that's the work ahead for the team before next tax season.

Appreciate that. In -- I want to talk pricing now in the Assisted category. Bunch of years ago, you reset assisted pricing lower and introduced it as a pre-pandemic, reset pricing or where you introduced upfront transparent pricing in the assisted business. And then after a few years of subsequently holding assisted price steady in fiscal '22, last year, you began again to moderately increase pricing. You perpetuated that most recently in the fiscal '23 season. If you could talk a little bit about the pricing trend and your approach from a strategic perspective of what we may expect in coming tax seasons. That would be appreciated.

Yes. I'll rewind just a little bit first and remind people that the reason why we reset in 2018 was because we had seen a pattern of raising prices pretty dramatically over a long period of time, and we were hearing loudly from the consumer, but also from our tax professionals that our prices have just gotten too high. We knew that the value, the quality and the price, that relationship was not in sync. And so we made the hard decision, the financially hard decision, the easy decision from a consumer standpoint to lower pricing for millions of Americans, but importantly also simplify how pricing happens, including the idea of upfront transparent pricing. It was one of the frustrations that we heard from consumers was it's one of the few things in my life that I buy, that I have no idea what I'm going to pay until it's done. So now we have full transparency on what pricing is, the customer can know that before they start. And we watch that very carefully as we focus on improving quality, retail operations, standard operating procedures, introducing more digital tools into the equation and overall, just building a greater relevance of the H&R Block brand. And when you put all that together and we saw our volume continue to improve year-over-year, we recognize that we have gotten to a place where we can start taking low single-digit price increases again, which we've started to do, and we watch very carefully, not only volume and performance, but customer and tax pro feedback, and we have 1 metric called price for value, and we continue to see that metric grow and hold very strong. So we're getting the right signal from the consumer. And when we look at the growth algorithm that we've laid out of 3% to 6% revenue growth, a component of that is assuming low single-digit price increases in the Assisted business as we move forward, and we continue to believe we can do that going into next year.

Great. Let's head over for now to Do-It-Yourself. And the Do-It-Yourself tax preparation business please talk to how H&R Block's volume has trended in recent tax seasons relative to the industry. Please discuss the main drivers of the performance and provide a perspective on this category going forward as well, please.

Yes. So for a few years in a row, we were not pleased with our DIY market share performance. And it really caused us to regroup leading into taxes in '23 and just more deeply understand what the issues are and 3 issues really emerge loudly from the consumer. One is just very broad and simply we're not known for having this kind of product. We're so well known as an assisted brand that we knew we just had to simply remind people and drive awareness that we're in the DIY business. We also knew that there are more people that leave TurboTax every year than we had as clients at H&R Block and DIY. So to understand better about why are they leaving? And one of the biggest frustration points is this feeling that they are lured into the product with marketing that tells them it's free or low price, they're upgraded in the background without knowing it. And by the time they finish, the price is completely different, and they're very frustrated by that. And then the third barrier was this belief that's very difficult to switch providers. And so this year, fully-integrated product experience and marketing experience to make an aggressive promise about what we can do in the DIY business. And then we paid that off when we drove traffic to our website and then ultimately into our product. And the punchline from all that work is -- we had a really nice year in DIY this year. And so we think we have a good handle on what it takes to help people understand the value of our product that we offer the product, and it's very, very easy to switch from another provider. And like I said, those are 3 clear things we understand and applying that this year led to a nice season.

Great. And congrats, it was a strong season for you and do it yourself relative to the industry. I want to speak on pricing and do it yourself now. Can we just talk about how that's trended in recent tax seasons, and what we may expect from your net average charge over coming years.

Yes, because it's a digital product, we can just simply be more dynamic in how we think about pricing and that starts with the list or base pricing in the SKU lineup. And we do benchmark ourselves here against the competitive set. We strive to maintain a $10 price gap with us in TurboTax. And we pay close attention to that. We test a lot of different pricing scenarios. And then in addition to base list pricing, more and more DIY filers are choosing to upgrade to human health. And that might be something like Online Assist where they just get their questions answered, or Tax Pro Review where they turn over the work to us and we finish and sign and file their return. Those obviously have prices. As we see the competitors' performance, we see them relying more and more on raising prices. And so that creates opportunity for us to still be a fast follower in pricing, but close the gap from what we see today. On lower SKUs, that might be a $10 price delta. On higher SKUs or attached products, that could be as much as a $50 price delta. So as more people understand we're in this business, they see the quality of the product, that gives us more confidence that there is a price gap to close more than there has been in the past in DIY. And again, because it's digital, we can test into that and be more dynamic in how we make those changes.

Appreciate that. Let's talk now about Hybrid products. Assisted solutions for do-it-yourself filers such as Online Assist and Tax Pro Review. If you can just provide a background of what these offerings are as well as perspective on their contribution to volume and net average charge for you now and what that could become in the future.

Strategically, we are intentionally blurring the lines between traditional DIY and traditional assisted. And what that means is we want to offer the consumer choice from a fully assisted in-person offering to a fully literally do-it-yourself software offering and these combinations in between. So that means if you're an assistant client, there are multiple ways today that you can work with and engage with a tax professional without going to an office. MyBlock is our authenticated portal, and that's the key entry point. Share documents, collaborate with your tax pro, exchange information and then approve and pay online. That can be a fully virtual experience if that's what the consumer chooses. What we tend to see is the consumer opting to want to spend time at some point in the process with their tax pro in person but then rely on something like MyBlock if they forgot documents or they leave for the tax pro finishes and then they approve and pay online, and they don't have to do that in the office setting. The other side of that is the consumer starches a DIY filer and then chooses to need an upgrade for human help. And we currently offer 2 versions of that product, again, Online Assist is simply saying, "I want to pay to get unlimited access to a tax professional to get all my questions answered." And that can be a robust experience. They can take over and drive for you on your screen, help you navigate or they can just be a resource to answer your questions. What we actually see more people doing is upgrading to Tax Pro Review. And that's essentially the consumer doing a lot of the work, but lacking the confidence to push the button to file. So they turn it over to us and one of our tax pros reviews all of the source documents, their work and then signs and files the return on their behalf. That product, Tax Pro Review has been growing double digits for more than a decade. That's how long we've offered a version of this product. And it just speaks to us of the power of expertise and our ability to leverage help when people need it. And so we think this is a really important merging or converging of these 2 businesses that have always been very separate, we just see them blending more and more.

Yes, a lot going on there. Speaking of a lot going on, what's going on recently in the news about the IRS coming out with a new e-filing pilot where the IRS is getting into tax preparation itself. I think a lot of misperception about what this is and what this could become. So I guess, Jeff, if you can just share your view of this industry situation and where you think it goes next.

The pilot that's planned to launch in January of 2024 is a very simple portal exchange basically. It does not -- it's not full tax preparation software. It does not consider EITC as one important customer segment. We talked about them earlier. It does not do state returns. It does not do assisted tax preparation. And the jury is still out, literally because Congress would still have to approve moving from a pilot of a portal like product to the IRS being in the tax preparation business. And what I hear directly from my trips to Washington, D.C. is an understanding that, first of all, the IRS doesn't want to be in the tax preparation business. This is really a topic that's being pushed from the extreme left. And when people start to realize that what it takes to serve customers, to provide customer support, to answer technical questions about the product, answer technical tax questions. These are things that we've been doing for decades and get tens of millions of calls every year. And the IRS knows. They can't answer basic calls today on where is my refund. So the idea of now competing against the private sector and spending without exaggeration, hundreds of millions of dollars here to build a product, maintain a product, market to acquire customers, provide customer support. We just don't see that happening. But I -- just for giggles, I always like to assume -- let's assume they do, do it. Let's assume they actually get this done and Congress approves it and all these other things happen. It's important to remember, they're focused on serving low-income consumers who pay $0 for tax preparation. So if we were to lose 3 clients to this product, yes, we would be losing market share because it would be a client and they all count the same in market share, but there's no financial impact because we're trading free to free. And by the way, there are over 30 providers company and nonprofits today that offer free tax preparation.

Right. Yes, we'll put there. Let's move on back to H&R Block specific. You've been targeting 3% to 6% total company revenue growth long term. If we could delve a little bit into the drivers of that, I don't know if you have any different view now that this tax season has occurred but just kind of the componentry of what's going to drive that? And where you think you can be high and low end over the near term going forward.

Yes. So when we introduced that financial algorithm, we said 3% to 6% revenue growth, EBITDA growing 1.5x to 2x faster and EPS growing faster than EBITDA. And inside the 3% to 6% revenue growth, it really begins with our performance in the core consumer tax business and simply holding market share. In addition to that, we see opportunity with pricing. We've talked about what we think we can do in low single-digit price increases. We know that franchise buybacks are a great use of capital, and that's a component of the 3% to 6% revenue growth. And the final piece is Wave. And so the work we're doing on small business services and financial products, are really, in our mind, a free option that are upside to the core revenue growth that we see as possible. And so that's how we view the financial algorithm for revenue growth, and I'll let my partner jump in here and talk about how we see that translating on EBITDA performance and our capital allocation strategy to drive EPS.

Yes. You guys are doing such a great job. I don't want to jump in, but -- and Jeff said the industry is a core component of that. I mean over the long term, Scott, you know this, but the industry grows about 1% a year. This year, it declined 1%. Obviously, everyone was surprised by that, not typical. We've got a chart going back 60 years and essentially grows 1%, 1.5% almost every year. There's, a few years of an anomaly, maybe it grows 2.5% or 3%. And really bad year, maybe it declines 1% or 2%. But we feel pretty confident that as employment grows in the U.S., more people working, more people paying taxes, more people doing taxes. So that number is going to grow 1%. If we hold with that, that's kind of the foundation that allows us to get into that 3% to 6% zone. And that outlook hasn't changed. I mean this tax season, obviously, we didn't get there. It's really rooted in the foundation of the industry not being in line with what we thought. Obviously, a few other things that we don't think are going to be persistent. But over the long term, we still think 3% to 6% is very doable. And to Jones' point, we don't need everything to fire on all cylinders to get into that zone. We think we can get there with a solid industry, moderate price increase. You got franchise buybacks. That essentially gets you in the zone right there and then there's upside from spruce and more in small business and other things. From a core operating perspective of growing EBITDA, we've been doing that even this year with a really soft industry, our recent guidance that we just provided, still has EBITDA growth, and has a really solid EPS growth. I mean, capital allocation is a core part of what we do. The business generates $500 million plus of free cash flow a year. A lot of years, it's north of $600 million. The variability in that is a lot of times around taxes. So we do a lot of things to try to minimize our cash taxes over time. And in some years, that means our cash tax rate is a little bit different. But over the long term, we've been averaging 15% to 20% over the last several years, which is a great outcome because that obviously lower taxes you pay out and maximizes free cash flow. And it's allowed us to pay an increasing dividend and then opportunistically buy back stock. And if you look at what we've done over the last 5 years, we essentially returned all of our free cash flow to shareholders through those capital allocation methods. And we like the one, two punch of buying back shares because it allows us to increase the dividend without increasing dollars paid to the dividend. So our dollars paid to the dividend payment have actually gone down from $200-plus million to about $175 million because we've been repurchasing shares every year. So the guidance we provided this year is going to, again, be solid EPS growth. We -- I think we've proven that we're opportunistic. I mean in FY '22, we bought $550 million worth of stock. In Q1 and Q2 of this year, we really bought $350 million. And we try to take advantage when obviously the stocks at a lower trading point when we have open windows to go in and create value from that method. So the industry can be up or down 1% or 2%, but the reality of the cash flow generation is the same. And that's why we've essentially said over the long term, we think we can deliver double-digit EPS growth. Whether the industry is flat or up on, that really won't change that outcome a lot. I think we've proven that. We talked about last year that from fiscal year '16 through fiscal year '22, we've essentially taken EPS from $1.50 and change to about $3.50. I mean it's material growth. And that's not only driven by reduced share count. We've grown revenue. We've increased clients, we've grown EBITDA, but share count is a huge part of it. I mean we trust shares outstanding, and that's an approach that we think is going to continue for a long time.

Great. We're getting close to opening up. Just I wanted 2 qualifying questions on a couple of those -- of what you went over just now. Yes. You've targeted growing EBITDA at about 1.5x revenue long term. Just -- could you address -- I think people don't fully understand or appreciate the fixed and variable cost structure at H&R Block. And what might we see as far as margin expansion going forward? Should we see more of the same in the mid-20s level? Or is there an opportunity to expand?

Yes, I'll start with your last question. I mean, obviously, if EBITDA is growing faster than revenue, which is what we think we can do, that will cause margin to expand. We haven't focused as much on a specific margin target because our goal is to grow EBITDA dollars. That's ultimately what we want to do. And I'd rather have EBITDA dollars growing and margin expanding while revenues detract. That's not obviously a good outcome. When you think about the core business of assisted and DIY, when we serve an incremental plan in either channel, it's very, very profitable. So you think about it in the software channel, if we serve an incremental client, and there's a little bit of customer support, a little bit of IT back in cost, but it's very, very minor. Most of that is dropping to the bottom line as incremental profit. In our assisted channel, it's a similar outcome where if we get an incremental $100 of tax rep revenue, there's about 30% of it that goes to variable labor, but 70% of it essentially would drop to the bottom line. And that's why we're able to take advantage of that fixed cost leverage. And as we're able to grow revenue at 3-plus percent, that allows that EBITDA to grow 1.5x. And that 3% number is important because that's obviously over the long term, been above inflation. You think about inflation being 2% to 2.5% of the long term, that 3% is above the inflation rate. Obviously, we have things like rent and utilities and supplies and salaries that are going to continue to go up with inflation over time. But if we can hit that 3-plus percent revenue number, we're confident that we can outpace the cost increases, which is going to allow EBITDA to grow faster. You layer on share repurchases on top and that allows EPS to grow even faster, which we think can get into the double digits over the long term.

And then wrapping up this segment, the -- you spoke earlier a pretty steady $0.5 billion of free cash flow generation a year and that's proven quite resilient over time. You also quantify in dollars the buyback amount. If you could speak maybe to historically, what percent of the shares outstanding you bought back. And how you expect to allocate capital in the future? I imagine it's more of the same. You discussed the dividend. But should we continue to expect this stock buyback approach?

Yes. I mean when you think about our $500-plus million of free cash flow generation, like I said, we think about investing in the business, but we've been doing that by, as Jeff said earlier, funding our future is what we call it and taking out cost to essentially fund those investments. So we've been able to maintain our cash flow to essentially deploy all of it to shareholders. So $175 million or so going to the dividend with the remainder is available basically for share repurchase. And I think, like I said, we've done that in Q1 and Q2 of this year, buying back $350 million. I think we'll continue with that approach going forward. We don't kind of guarantee the share repurchase because it is opportunistic. I mean if the stock happened to get into a zone or if we happen to be in into blackout period for whatever reason, there may be a window when one particular quarter that we're not buying. But I think over the long term, we've proven that we're essentially returning all capital to shareholders. And we bought back about 1/4 of the company in the last 5 years. And I think that approach will continue. I think the cash flow generation is there. Obviously, at the valuation that we're trading at, we think that's very attractive. I think we've proven that. Like I said, last year, we bought back $550 million at $24, I think Q1 and Q2 of this year. Obviously, the stock had went up given the strong performance, and we were buying back in the low 40s. Stock is trading now at $32. So I think it's obviously a really solid opportunity based on where we're trading.

Yes, we're going to wrap. That's the formal part of the fireside chat. Now I'm going to go to the questions. And again, feel free to send them my way. We're going to start off, Jeff. One, I'm sure you've never heard this one before. Generative AI, how much that influence your business going forward? And what is Block's position?

I mean we're excited about Generative AI. I mean -- if you've seen any of our news over the last couple of years, you've seen that we've been investing in deploying AI and machine learning models into the business actively already, and we see real potential with ChatGPT and Generative AI. We'll have some announcements that are coming in the coming days that I think will bring even more clarity to my broader comments, but there are many, many use cases of potential that we see in the business. We're trying to be disciplined to focus on the highest value use cases first. Obviously, there's lots of predictions about what things could be, but this is very, very, very early in actually implementing it for any company. And so we see opportunity on both the efficiency and cost side, and we see opportunity, for example, in our DIY product and improving the customer experience and potentially monetizing that better customer experience. So we're leaning into what we know and look forward to making some important announcements relatively soon about it.

All right, switching gears here a little bit. And we're maybe the last question we're running up on time. But California, some weather there and it affected this tax season. That state in many, many counties, many populated counties as extension into October, where you don't have to file. You just automatically get the extension. How is that influencing your tax season?

Yes. I mean we believe that, that business will not happen in this fiscal year, which obviously just ends in a couple of weeks. We haven't provided outlook yet for fiscal '24, but that's something we'll be considering is the impact in fiscal '24 broadly in the business and then specifically what upside we might see from California. So we'll be providing outlook on '24 when we do our year-end call in August. But when those things happen in the business, we've demonstrated great operational flexibility to deal with it. Obviously, we can't control when an extensions made and it moves across the fiscal year. So we just do our best to respond to those things and plan accordingly in the next year.

It's -- we are bouncing up against time here. So I'm not going to be able to fit any more in. But thank you both. Very good overview. I appreciate it. And thanks for being here and sharing with us the H&R Block story.

Thanks, Scott. Take care.

Thank you, Jim. Thanks, Tony. Thank you, guys.