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H&R Block (NYSE:HRB)
Q3 2018 Earnings Conference Call
March 6, 2018 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day. My name is Ian, and I will be your conference operator today. At this time I would like to welcome everyone to the H & R Block Third-Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session. To address your question during that time simply press * followed by the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Thank you.

I would now like to turn the call over to Mr. Colby Brown, vice president of finance and investor relations. Sir, you may begin.

Colby Brown -- Vice President of Finance and Investor Relations

Thank you, Ian. Good afternoon, everyone, and thank you for joining us to discuss our fiscal 2018 third-quarter results. On the call today are Jeff Jones, our president and CEO, and Tony Bowen, our CFO. We posted today's press release on the Investor Relations website at hrblock.com.

Some of the figures that we'll discuss today are presented on a non-GAAP basis. We reconciled the comparable GAAP and non-GAAP figures in the schedules attached to our press release. Before we begin our prepared remarks, I'll remind everyone that this call will include forward-looking statements, as defined under the securities laws. Such statements are based on current information and management's expectations as of this date and are not guarantees of future performance.

Forward-looking statements involve certain risks, uncertainties, and assumptions that are difficult to predict. As a result, our actual outcomes and results could differ materially. You can learn more about these risks in our Form 10-K for fiscal 2017 and our other SEC filings. H&R Block undertakes no obligation to publicly update these risk factors or forward-looking statements.

At the conclusion of our prepared remarks, we will have a Q&A session. During Q&A, we ask that participants limit themselves to one question with a follow-up, after which they may choose to jump back into the queue. With that, I'll now turn the call over to Jeff.

Jeffrey J. Jones II -- President and Chief Executive Officer

Thank you, Colby. Good afternoon, everyone, and thanks for joining us. We're off to a strong start this tax season and I'm very pleased with our results. Before I jump into the details, let me outline the areas we'll cover on today's call.

First, I'll give a brief update on our long-term strategy work. Next, I'll provide our perspectives on what we have seen in the industry, followed by our mid-season results. Then I'll talk about our expectations for the second half of the season. And finally, Tony will review our third-quarter financial results and outlook for the fiscal year.

First, let me provide a few thoughts on our strategy. As we discussed on our Q2 earnings call in December, we're taking a fresh look at our long-term strategy. While we don't have specifics to share today, I can tell you that I've challenged the team to go deeper than we have in the past and to think differently about our business. And they're delivering.

This work will allow us to make informed decisions about ways to continue to improve our assisted and DIY business and to position us for long-term sustainable growth. We expect to provide an update in late fall. Turning to the overall industry performance, the latest results from the IRS showed decline in returns of 0.4% on a day-to-day basis through February 23. While better than last year, these results are fairly consistent with what we've seen in the years prior, as it is typical to see year-over-year decline on a day-to-day basis at this point in the season.

Consistent with prior years, industry results from February show a shift from assisted to DIY. Early season filers are more likely to change tax-preparation methods, so the shift in the early season is typically greater, and then moderates in the second half. Last year, the season ended with an assisted-to-DIY shift of approximately 40 basis points, which is about half of what the industry experienced the previous few years. At this point in the season, we're seeing a shift consistent with last year.

Based on the early season results, we continue to expect total federal filings to increase approximately 1% this tax season, with industry-assisted volumes flat to slightly up, and the remainder of the growth coming from DIY. Turning to our performance. Our goal for the season was to build on our momentum from last year, continuing to improve the client trajectory. We've brought a more client-centric approach to everything we do, which is focused on three areas: 1) improving operational excellence 2) new products and partnerships, and 3) marketing and promotions that drive demand for the H&R Block brand.

In the assisted business, we outpaced the industry in the first half on the strength of our promotions and improved execution. We again offered Refund Advance and free federal 1040EZ. This is the second year for these two promotions, which attract new clients and help us improve retention. Refund Advance is an interest-free loan that is especially relevant to early season filers who faced delays in receiving the refunds due to the PATH Act.

This has been an extremely competitive season for Refund Advance, with multiple tax-prep providers, including H&R Block, offering larger loans than in previous years. Given our strong offer and execution, our results were positive and we stabilized EITC clients for the second year in a row, an area of significant historical client declines. While promotions help drive filers to H&R Block, we must exceed their expectations at the office. Our clients are now more engaged in the process and our tax pros are providing more value-added expertise, including our People Like Me enhancement, which utilizes machine-learning to provide occupation-specific advice for Schedule C filers.

Additionally, we're offering our clients personalized assessments of the future impact of the new tax law. The many variables in this new law make it difficult for taxpayers to know how they will ultimately be affected. Our clients will learn if they would pay more or less under the new tax law, and then determine how to appropriately adjust their withholding. This is a great example of how our nearly 80,000 tax pros offer value to our clients and provide the personalized advice so many of them need.

Collectively, these efforts have translated into positive assisted results driven by increased retention. Client volume is in line with our expectations and we achieved early season share gains in the overall assisted category, with IRS-assisted e-files down 3.2% on a day-to-day basis this February 23, and comparable H&R Block volume down just 2.1%. And while we were pleased with these results, we do expect our performance to moderate in the second half. Turning to DIY, this year marks the second season for our H&R Block More Zero promotion, which allows a significant portion of the tax-filing population to file both their federal and state taxes for free.

We also strengthened our partnerships to bring H&R Block to more consumers in the places they frequent the most. Additionally, we continue to make enhancements with improved drag-and-drop and further capture capabilities, making it easier than ever to switch to our product and pre-populate information in tax forms, and we're seeing positive results with our new online product for self-employed filers. These efforts have translated to strong results and market-share gains in DIY, driven by new clients. This February 23, IRS DIY e-files increased 2.4% on a day-to-day basis and comparable H&R Block volume increased 6.2%.

Now I would like to provide an update on virtual tax, which includes redesigned Tax Pro Review and our new product, Tax Pro Go. These innovative products have been designed to meet evolving consumer needs and begin to represent the range of ways taxpayers can count on H&R Block, whether they want little to no help, complete in-person assistance, or anything in between. We launched Tax Pro Review, an improved version of an innovative product previously called Best of Both. This is a powerful way for our DIY clients to benefit from the peace of mind of knowing that one of our highly trained experts has identified all available credits and deductions and has also reviewed their return for accuracy.

We also did a soft launch of Tax Pro Go, our virtual assisted offering. This product addresses the needs of consumers who want assistance but don't want or have time to visit one of our offices. Clients get upfront pricing, upload their documents through the secure MyBlock portal, and work virtually with one of our tax pros to have their taxes seamlessly prepared. The focus on Tax Pro Go this year has been to understand the client experience in order to optimize the product going forward.

Initial feedback on both products has been positive. We are forming a more comprehensive view of the types of filers who are attracted to these products. And while we don't anticipate a meaningful volume lift this season, our learnings will assist us in enhancing these products over time. Now that I've covered early season results, I'd like to discuss our plan for the second half of the season.

Last week, we brought back the half-off promotion as we look to drive more new clients to the H&R Block brand. Additionally, in order to deliver more value, we are partnering with Lending Tree to provide our clients easy access to information that can help them improve their credit and financial health. And in the DIY space, we continue to optimize our product to drive conversion and deliver an exceptional client experience. In summary, we are pleased with our results so far.

Our focus on operational excellence, new products and partnerships, and value-enhancing promotions is driving results, and we remain laser-focused on execution for the second half of the season. With that, I'll hand the call over to Tony to discuss our financial results and outlook.

Tony Bowen -- Chief Financial Officer

Thanks, Jeff. Good afternoon, everyone. As Jeff mentioned, we are pleased with our results at the midpoint of this tax season. Our third-quarter financial results were in line with our expectations, and we are on track to achieve the financial outlook we provided in December.

Before I get into the details, as a reminder, we typically report a loss during the fiscal third quarter due to the seasonality of our business. Therefore, third-quarter results are not representative of our full-year performance. Starting with revenues. We saw a year-over-year increase of $37 million, or 8%, to $488 million.

This is primarily the result of an increase in total U.S. client volumes of 4% through January 31 and planned inflationary increases and net average charge in our assisted business. Turning to expense. Total operating expenses increased $9 million, or 2%, to $586 million, primarily due to increased compensation costs, which were partially offset by the timing of marketing and advertising expenses.

The increase in compensation was due to variable labor related to revenue increases in the U.S. as well as planned conversion of higher-cost contractors to lower-cost full-time associates. As Jeff mentioned, we saw positive results from Refund Advance this season. When the program ended on February 28, applications for Refund Advance totaled 1.2 million, a 14% increase over last year.

And while the average loan amount increased 40% due to the addition of the $3,000 loan tier, we were able to maintain the cost per loan at approximately the same level as last year. Moving through the remainder of the income statement. We saw interest expense decrease $1 million due to lower draws on our line of credit compared to the prior year. Putting it all together, pre-tax loss from continuing operations improved by $30 million.

However, loss per share increased $0.67, from $0.49 to $1.16, solely due to changes in the company's effective tax rate resulting from the recently enacted federal tax legislation. The negative impact from these corporate tax rate changes was anticipated and is unique to our fiscal third quarter, as the impact will be favorable on a fiscal-year basis. We now expect our fiscal-year effective tax rate to be in the range of 6% to 9%, which is an update to the range provided in our previously filed 8-K in January. For fiscal '19 and beyond, our effective tax rate is expected to be in the 23%-to-25% range.

As a reminder, we don't anticipate any impact to our core business in fiscal '18 from the recent changes to individual taxes. We will offer more clarity on the potential impact of these changes on our core business when we provide our fiscal '19 outlook in December. Turning to discontinued operations. Sand Canyon Corporation made settlement payments of $4.5 million in the quarter, which were previously accrued and related to a settlement agreement from fiscal '16.

For additional information on Sand Canyon, please refer to disclosures in the company's reports on forms 10- K and 10-Q and other SEC filings. As a reminder, Sand Canyon is, and always has been, operated as a separate legal entity from H&R Block. We continue to believe our legal position is strong on any potential veil-piercing arguments. I'd now like to provide thoughts on our financial outlook for fiscal '18.

Overall, we expect results to be in line with the outlook we provided in December. In assisted, we continue to expect improvement in our client trajectory, driven by promotional offers and client-experience enhancements, and we are on track to deliver moderate inflationary price increases, as outlined in December. In DIY, we anticipate growth in client volumes, with net average charge consistent with fiscal '17. The net result is that we continue to expect overall revenue to increase modestly this year.

Considering the revenue projection and the impact of inflationary costs and investments, we continue to expect EBITDA margin at the high end of the 27%-to-30% range. With respect to capital allocation, consistent with the message we shared on our Q2 call regarding share repurchases, we did not repurchase any shares in Q3. No significant share repurchases are planned for the remainder of fiscal '18. With that, I will now turn the call back over to Jeff.

Jeffrey J. Jones II -- President and Chief Executive Officer

Thanks, Tony. In summary, we're pleased with our performance so far this season, as we've outperformed the industry and are delivering to our clients in both assisted and DIY channels. While we expect our assisted results to moderate in the second half, we are keenly focused on executing our plans for the remainder of the season. We look forward to sharing more when we report our full-year results in June.

With that, we'll now open the line for questions. Ian?

Questions and Answers:

Operator

Ladies and gentlemen, as a reminder, if you would like to ask an audio question, you may do so by pressing * then the number 1 on your telephone keypad. Once again, that's *-1 to ask an audio question. Our first question is from the line of Scott Schneeberger from Oppenheimer.

Scott Schneeberger -- Oppenheimer -- Managing Director

Thanks. Hey, just to start off, if we could have a clarification. Jeff or Tony, if you could just rehash the 2/23 versus 2/28 IRS versus HRB performance in assisted and DIY? And also any commentary on what we might expect to see from the industry results at the end of this week when the IRS reports it? And then, I have a follow-up, please.

Tony Bowen -- Chief Financial Officer

Yes. So going back to Jeff's opening comments, in the assisted category, the IRS-assisted e-files are down 3.2%, and our business was down 2.1%. And then, in DIY, IRS is down 2.4% -- or excuse me, increased 2.4%, and we increased 6.2%. And those are both day-to-day through February 23.

Scott Schneeberger -- Oppenheimer -- Managing Director

Just following up, it looks like you guys were strong out of the gate, obviously, throughout February and congratulations for that. January looks very strong as well, and it was a little later start to the season this year versus past. So if you guys could comment, please, on what you'd attribute to that initial strong start, be it marketing, the products? Just a little bit more honing the feel for that immediate strong start?

Jeffrey J. Jones II -- President and Chief Executive Officer

Scott, it's Jeff. So I'll kick this off, and Tony may add in as well. So I think, starting in early January, our network was opened and ready for business despite the delay in the e-file open date, and we did come out strong early season with great promotions. And so we see that play itself out in changing the trajectory of EITC clients as an example.

Refund Advance, we came in this year with a higher loan tier than we had in the past. And so as I traveled around the country, I also saw just really solid execution in the offices, so I think the combination of those things did really help us get off to a good start in the assisted business.

Tony Bowen -- Chief Financial Officer

Just to add to that, Scott. I think, the Refund Advance product definitely pulls clients in earlier than we saw last year. I think, by having that product for two years in a row, we're seeing prior clients take advantage of it. It's obviously driving new clients, but really, a lot of the benefit is coming from retention lift and just clients coming in earlier.

So knowing that we have the product for the second year, tax pros being comfortable offering it, I think, definitely got us off to a strong start early.

Operator

And our next question is from the line of Jeff Silber from BMO Capital Markets.

Jeff Silber -- BMO Capital Markets -- Managing Director

Thanks so much. In your comments, you talked about expectations for some moderation in the second half of tax season, specifically focused on assisted, but if you want to talk about DIY, that would be fine as well. But is assisted solely because you're not offering Refund Advance in the second half of the season, or is there anything else we need to understand?

Jeffrey J. Jones II -- President and Chief Executive Officer

Jeff, it's Jeff Jones. I'll do the same and let Tony chime in as well, too. Obviously, we feel really good about how we started the season. In DIY, I think, what I'd say is we expect to see the continued positive momentum as we move through the season.

When we look at our second-half performance last year, we kind of consider what we're seeing the last couple of weeks in terms of assisted performance. Even when we factor in the 50%-off promotion that just launched last week, we factor all that in, we see our results moderating as we move through the balance of the season. Obviously, we're about halfway through so there's still a lot of business to come, but based on what we know, that's really our best estimate.

Tony Bowen -- Chief Financial Officer

I don't think I have a lot more to add. I mean, as Jeff said, I think, we've got a lot of tax season to go, so we're trying to forecast a fairly small range here. But if you look at the second half of our performance last year, even though it improved from the first half, we were still down slightly in clients and we also lost a little bit of share. And while we added 50%-off running this year in March, which we didn't have last year, we do think that we will get back a little bit of the gains we've seen in the early part of the tax season on the assisted side.

Jeff Silber -- BMO Capital Markets -- Managing Director

OK. And just to clarify a few things in terms of the promotions that are available now, Refund Advance is no longer available, is that correct? And if you can just describe the half-off promotion, is this just for assisted clients?

Jeffrey J. Jones II -- President and Chief Executive Officer

Yes. So Refund Advance and the free 1040EZ promotion are both ended on February 28. So those are done. Fifty percent off is essentially, clients pay half of whatever they paid last year at a competitor.

So they bring in their receipt from an independent, for example, and we will do their taxes for half. And really, it's a trial offer to get them into the store to experience our tax pros, experience our expertise, and it's only available to new clients.

Operator

And our next question is from the line of Michael Millman from Millman Research Associates.

Michael Millman -- Millman Research Associates -- Analyst

Could you talk a little bit more about the RAs, to what extent was it existing -- I think you mentioned it broadly -- and what was new, the number that was new? And could you do the same thing for Free EZs? In particular, how much book were Free EZs this year? How many? And what kind of repeat business did you get and what kind of upgrade did you get from last year's Free EZs business?

Jeffrey J. Jones II -- President and Chief Executive Officer

Michael, just to kick us off on your RA question, I think, what was especially new this year was the new loan amount, the higher loan tier of $3,000. So this year, we offered $500, $750, $1,250, and then $3,000. We saw increases in applications in loans and believe that as awareness grows about this product and clients understand its value, that it really is interest-free, no fees, quick access to funds, all that value proposition, that it will continue to be a solid product for us. And whether it was on national advertising or in local office execution, I just think we did a really nice job of executing in all channels to make sure that value was clear to our clients.

Tony Bowen -- Chief Financial Officer

Yes. And just to add to that. I think, specific, Michael, to your question about drive new clients or priors. I think, I'll talk about both programs together, both Refund Advance and Free EZ, really did a nice job of lifting prior clients.

They obviously brought in new clients. But we were a little disappointed with the volume of new clients we saw from those two programs, and I think it's still an opportunity for us when we think about how we get better in out years, specifically focused on new clients. As far as how many we've upgraded and things, that's detail that we don't want to share at this point, but programs overall did a nice job of bringing in clients, but like I said, more skewed toward prior clients than new.

Michael Millman -- Millman Research Associates -- Analyst

Could you give us a rough idea of the size of the Free EZ program last year and this year?

Tony Bowen -- Chief Financial Officer

Yes. We're not sharing by form at this point, Michael

Michael Millman -- Millman Research Associates -- Analyst

Can we assume it was bigger or smaller this year than last year?

Tony Bowen -- Chief Financial Officer

I mean, we -- well, I think, you said for Free EZ. So for Free EZ, we're not going to share the specifics because I think that provides too much information from a competitive perspective.

Michael Millman -- Millman Research Associates -- Analyst

OK. Thank you. I tried.

Tony Bowen -- Chief Financial Officer

Thanks, Michael.

Operator

And our next question is from the line of Alex Perez from Barrington Research.

Chris Howe -- Barrington Research -- Analyst

This is Chris Howe sitting in for Alex Perez. I had a question in regard to the increase of 6.2% you saw on DIY as it relates to the additional partnerships that you announced last quarter. How have those partnerships been going versus your internal expectations? And I guess, what is the structure of these partnerships? Is it possible to, I guess for my knowledge, push it to a multiyear agreement? Or is that something that comes up for rebid or proposal each tax season?

Jeffrey J. Jones II -- President and Chief Executive Officer

Chris, it's Jeff. I'll kick this off. So I think, overall, in the DIY business, I think, if we keep it very simple, what we're seeing is a very good product at a great value, and we're starting to tell people about it. And not to oversimplify it but, I think, those three things are helping us drive a lot of the DIY growth.

Now in the partnerships, Amazon and Walmart were two partnerships that we announced this year, and we're not going to break out individual customer channel performance but in both cases, we're seeing improvements in the units sold. And I think we believe it represents a way that we can just continue to bring the H&R Block brand to more consumers than all the places where they shop. So we feel good about those partnerships. In the DIY business overall, we feel good about its performance.

Tony Bowen -- Chief Financial Officer

And this is specific to your question about structure, we've had long-term relationships with both Amazon and Walmart, but typically, you negotiate those each year as they determine what products they want to promote in their various stores and online sites.

Chris Howe -- Barrington Research -- Analyst

OK. That's helpful. And then, one last question in regard to Review and Go. You mentioned that Go has had a soft launch, and it will be more of a material contributor later on.

Are there any trends that you're seeing that you would be able to share or perhaps attach rates in regard to these new offerings?

Jeffrey J. Jones II -- President and Chief Executive Officer

I think, both of those products, we love the role they play in the portfolio, it's starting to fill in the gaps between full-assisted business and DIY. They're fundamentally about providing help and leveraging our tax pros to do that. So we think we're incredibly well-positioned to provide that kind of service versus our competition. Tax Pro Review, it's a redesigned product from Best of Both.

Tax Pro Go, brand-new. Tax Pro Review, we're marketing. Tax Pro Go, we're not. And in both cases, we're really trying to understand more about the kind of clients that we attract and more about the user experience, just trying to keep it as easy as possible for people who engage with us on whatever terms they choose to engage.

So not large volume contributors this year but really important products in the portfolio, and we're getting some very positive learnings that I expect us to integrate and improve for what we do next.

Chris Howe -- Barrington Research -- Analyst

Thank you for the color.

Jeffrey J. Jones II -- President and Chief Executive Officer

Thank you.

Operator

And our next question is from the line of Hamzah Mazari from Macquarie.

Mario Cortellacci -- Macquarie -- Analyst

Hi, guys. This is Mario Cortellacci filling in for Hamzah. Could you walk us through how we should think about your pricing strategy and your current customer-retention rates versus targets?

Tony Bowen -- Chief Financial Officer

Yes. I mean, I think, our pricing strategy, obviously, very different in assisted and DIY, you're probably asking more about assisted. We went into the year expecting inflationary, kind of modest price increases, and that's exactly what we're delivering. I think over the last couple of years we've tried to be much more targeted in our pricing approach, and that includes not only the price, but the value we're delivering.

Refund Advance, for example, is additional value that we're delivering to that early season client who wants a refund quickly. It's a no-cost, no-fee loan, and there's definitely been a change in trajectory for those clients. But we know we've got to be nimble from a pricing perspective. We've got to figure out places where we're not bringing in enough new clients or incremental clients and think about how do we adjust our pricing model going forward.

So it's definitely a living, breathing thing, but we feel good that we made significant progress over the last couple of years with changing our client trajectory.

Mario Cortellacci -- Macquarie -- Analyst

And just one more, and I'll turn it over. Could you update us on any changes that you might be seeing from a competitive-dynamic perspective in the DIY side?

Jeffrey J. Jones II -- President and Chief Executive Officer

I think, generally, we feel like we're well-positioned relative to the market leader in DIY. As I mentioned earlier, we have a really good product, we're starting to see more and more third-party reviews celebrating our DIY product. We've got a very competitive value proposition in price versus TurboTax, and we're starting to tell that story. So relative to TurboTax, that's how we'd assess it.

I think, beyond that, it's kind of hard to tell for sure at this stage who else might be doing what. But what I'm most excited about for us is that we continue to improve the product and we're seeing good results from that work.

Mario Cortellacci -- Macquarie -- Analyst

Thank you, guys.

Jeffrey J. Jones II -- President and Chief Executive Officer

Thanks.

Operator

And at this time, I'm showing there's no other audio questions. I'll now turn it back to Mr. Colby Brown.

Colby Brown -- Vice President of Finance and Investor Relations

OK. Thanks again, everyone, for joining us. This concludes today's call.

Operator

Ladies and gentlemen, this does conclude the H&R Block third-quarter earnings conference call. We thank you for your participation. You may now disconnect.

Duration: 32 minutes

Call Participants:

Colby Brown -- Vice President of Finance and Investor Relations

Jeffrey J. Jones II -- President and Chief Executive Officer

Tony Bowen -- Chief Financial Officer

Scott Schneeberger -- Oppenheimer -- Managing Director

Jeff Silber -- BMO Capital Markets -- Managing Director

Michael Millman -- Millman Research Associates -- Analyst

Chris Howe -- Barrington Research -- Analyst

Mario Cortellacci -- Macquarie -- Analyst

More HRB analysis

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