Q3 2023 H&R Block Inc Earnings Call
Thank you for standing by and welcome to the H&R Block's third quarter fiscal 'twenty to 'twenty three 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 one one on your telephone.
I would now like to hand, the call over to Vice President Investor Relations Mcculloch Galena. Please go ahead.
Thank you Latif and good afternoon, everyone and welcome to H&R block 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 don't HR block Dot 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 will 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 nine 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 Mikael 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 and then we'll open it up for Q&A.
As Youll recall, we and others expected this to be a normal tax filing year with the pandemic largely behind us now.
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 the 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 assistant 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 am 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 and the product user flow.
We also introduced new innovations like our industry first use of an artificial intelligence defined tax refunds that may have been missed on turbotax returns.
This multifaceted strategy worked.
Through April 30, we grew DIY online clients by two 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 with 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.
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 tax Pro review.
Online assist offers on demand access to at H&R block tax expert.
Clients can access this help before starting their return or while completing it.
AI is helping us get smarter about anticipating when the client may be struggling and need this help.
Tax Pro review provides the benefit of having our tax experts check the entire return for accuracy.
Ensuring clients get their maximum refund and then we filed a return on their behalf.
Tax Pro 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 tax Pro review enabled our clients 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 in this year, we experienced client growth among each segment above $50000 in income with our fastest growing segment being clients over $100000 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.
Specifically as a result of very low income filers likely stimulus filers, who had less than $5000 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 and the early part of the season.
This group likely made up almost half of our client lost 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 will conduct a full review and make decisions about changes and improvements for next year, but.
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 size has declined and more clients who are balanced do these are especially strong results.
Not only did we see the significant growth I already mentioned and tax Pro review, but we also saw continued improvement in virtual tool adoption, which enable 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.
We demonstrated pricing power that drove incremental revenue.
<unk> increased 5%.
Alongside positive client satisfaction metrics, demonstrating our value proposition versus local cpas.
We are 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.
Waves, 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 Bruce our mobile banking platform to our assisted clients for the first time.
This launch through April 30, we had 291000 sign ups 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 sign ups.
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 tax pro 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 a $100 million of refunds to their <unk> account up to five days early.
As a meaningful benefit, especially at a time when every dollar matters.
We're 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.
The 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 will 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 in assisted.
Our DIY strategy was very successful tap.
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 our results for 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 one 5% or about $32 million to the prior year.
The increase was primarily driven by net average charge in 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 four 5%, primarily driven by higher field wages and the timing of advertising, partially offset by lower bad debt legal fees and consulting outsource services.
EBITDA was approximately $910 million, a decrease of one 3% or $11 7 million for 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 will be 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.
Pretax 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 repurchases 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 are another 5% of shares outstanding.
Earnings per share from continuing operations increased from $4 six to $4 14.
While adjusted earnings per share from continuing operations increased from $4 11.
The $4 20.
Note that the only adjustment we are currently making to adjusted earnings per share is amortization related to 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 assessing 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 344 to $3 $4 $65 billion.
EBITDA to be in the range of $895 million to $910 million.
Adjusted earnings per share to be in the range of $3 65 to.
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 credits and child tax credit, including its impact on the Emerald card I am 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 one five times revenue.
And double digit adjusted earnings per share growth annually through 2025.
As I 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 buyback a meaningful amount of shares each year.
We are committed to and confident about driving ongoing value for shareholders with these practices with that ill 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 in 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 one one on your telephone again Thats Star one one on your telephone SaaS question. Please standby, 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.
As 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 slipped from fiscal <unk> fiscal <unk> and how much of the volumes might flipped in fiscal 2024 because of the filing extensions and then perhaps comment on what the impact from the other state.
Following 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% 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 is going to come in next fiscal year, frankly closer to the filing deadline.
October .
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 what we've been focused.
Got it that's helpful and then 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 wise, yet we're digging into that but.
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 T SEC filers that we think we can do better at with respect to refund advance about half.
And then the 15% to 20% of California and timing.
As we showed in the slide in our presentation.
In 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.
Okay.
Our next question.
It comes from the line of Kartik Mehta.
Northcoast research your question please.
Thank you.
Jeff maybe on the neck, you said you gained about 4% Mack on the assisted side and I'm wondering we've.
We've got partially related to inflation and as you move forward. What do you think is a reasonable.
Estimate for Mac.
Yes, great Great question Kartik, so that this year that 4% was <unk>.
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 and feedback.
So this year, we feel especially good about the 4% in light of the fact that obviously inflation was much higher.
And given the refund dynamics, where fewer people that a refund more people switched to Bal do.
The customer told us we deliver great value.
And so we saw that show up in several metrics so.
So I don't want to sit here today and predict what nack might be next year will 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 are 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 really wasn't I think the.
The three macro things, we talked about that impacted volume.
The stimulus filers, the ITC filers and the timing in California.
Those things really applied across the system company and franchise.
Yes, the only thing I would call out Kartik is as you look at the volume table, it's actually in the appendix slides for the presentation that we have uploaded you will see company looking a lot better thats largely due to the franchise buybacks as we obviously buy franchise locations. Those are now reported as company locations as well as the return.
Showing up on that side versus franchise. So that explains most of that that dynamic.
And there's one last question Jeff.
What do you attribute kind of shift in share from DIY to assisted or maybe that's just the difference in performance in the two.
Yes that is definitely a question that we've got more work to do to understand better obviously, we see what's happened.
We have an understanding of our performance.
But 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 there's a lot more learning there.
Perfect. Thank you.
Thanks Kartik.
Thank you.
Our next question.
Comes from the line of Scott Schneeberger of Oppenheimer <unk> Company. Your question. Please Scott.
Thanks very much.
Jeff You May have the same response to this question I just had the card X but.
Where do you think the share wins in.
In assisted do you think it was a rise in your and your competitors' digital assistant that maybe took share.
Within the industry this year.
Yes, I do.
Don't want to just say repeat what I said to Kartik, but I think we just don't understand all the while yet.
We don't know any competitive information at this point, we'll obviously hear more wind turbo announces in a couple of weeks, what they saw and what they experience but at this point, we just don't know where share may have gone to.
Anything you'd add or.
When we look at the type of clients Scott that we have loss, which we talked about the stimulus related filers, we define them as less than five K of income.
ITC related filers, obviously, California, 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 the stimulus a lot of them properly and 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 an <unk> question about market share, it's hard to understand the DIY and assisting dynamics, we focus frankly more this year on total because I think it's just a clear story and there is 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 5%. So we had really good performance, but but we know that there are some other factors at play, but when we look at our own data. It doesn't appear that we are the type of clients, where leasing losing would be going to a digital competitor.
I appreciate you guys.
Thanks, Tony that was that was some helpful information I know I understand it's early and we need to hear more.
Following up there.
You mentioned the timing of marketing was was a bit of a headwind. This year could you elaborate on that.
Yeah. So specifically when we look at those three reasons why we lost assisted volume that second reason about the ITC filer in particular.
When we look at not just timing Scott, we actually spent more money this year to year over year and 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.
Advanced size that may come with interest or fees.
Its 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 I think that just explains.
So much about the state of the consumer early in the year and how badly they needed to get access to cash.
Thanks, and kind of a follow on to that Jeff.
You guys called out that there were.
A lot of people that may have received a refund I think it was two $5 million to $3 million I'd have to go back and look.
We also believe that some customers didn't take that product because their refund was lower.
When you're 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 this year, we did see a reduction in product attach kind of across the board.
Think it is connected back to not only how many were getting refunds, but the size of the refunds being lower.
Thanks has one 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 put in the demographic that you cited that's a that's a that's a lower revenue generating often a free product demographic it's <unk>.
Right that you captured them and and the goal would be to retain them, but am I right in that assessment can you kind of bifurcate.
Your your DIY paid versus your DIY not <unk>.
You're exactly right you know attracting <unk> 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 wanted to start attracting a younger demographic into the brand just.
Just like in the assistant business, we've intentionally been trying to migrate to higher value clients in terms of lifetime value. So those those are intentional goals and your instinct is right that they tend to start free.
Okay, great. Thank so I'll turn it over I appreciate you taking all my questions.
Thank you.
Thank you [noise].
Now like to turn the conference back to mackellar, killing enough for closing remarks.
Thanks for teeth, and thanks, everyone for joining US today. This concludes our third quarter physical 20th twenty-three earnings conference call.
Oh. This concludes today's conference call. Thank you for participating you may now disconnect.
Mmm.
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