Earnings Call Transcript - HRB Q4 2023

Michaella Gallina, Vice President, Investor Relations

Thank you, Latif. Good afternoon, everyone, and welcome to H&R Block's full year 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, which can be downloaded or viewed live on our website at investors.hrblock.com. Our call is being broadcast and webcast live, and a replay of the webcast will be available for 90 days. Before we begin, I'd like to remind listeners that comments made by management may include forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties and actual results could differ from those projected in any forward-looking statement due to numerous factors. For a description of these risks and uncertainties, please see H&R Block's annual report on Form 10-K and quarterly reports on Form 10-Q as updated periodically with our other SEC filings. Please note, some metrics we'll discuss today are presented on a non-GAAP basis. We've reconciled the comparable GAAP and non-GAAP figures in the appendix of our presentation. Finally, the content of this call contains time-sensitive information accurate only as of today, August 15, 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.

Jeff Jones, President and CEO

Thanks, Michaella. Today we'll provide an update on our fiscal year '23 results, then I'll share more on the progress we continue to make within our Block Horizons strategy, provide initial thoughts on fiscal year '24, and Tony will discuss our financial performance and outlook in more detail. Starting with 2023 results. We had a good finish to the year and delivered revenue growth, material EBITDA growth, and adjusted EPS growth of 9%. As we discussed at the beginning of the year, we knew we were facing headwinds due to the rollback of the advanced child tax credit payments that were loaded onto the Emerald card. During the year, we also had foreign exchange impacts, stimulus filers that returned to the sidelines, and California's deadline extension. Overall, I'm pleased with the results we produced despite these challenges. Our DIY strategy delivered this year, resulting in meaningful share gains. We demonstrated pricing power in the Assisted channel and saw positive customer satisfaction metrics, small business tax continued to be a growth driver, and we also added about 150,000 new sign-ups to our Spruce mobile banking platform. In addition, our capital allocation story is driving ongoing value for shareholders. We completed another $200 million of share repurchases in Q4 alone, and today announced a 10% increase to the dividend. Entering fiscal year '24, we are well positioned and expect a return to ordinary industry growth, which Tony will discuss in more detail later in the call. Before that, let me share more about our Block Horizons' progress. Let's start with our Small Business imperative that includes tax and Wave. Small Business Assisted Tax continues to be a growth driver. This business delivered 6% revenue growth for the fiscal year on top of strong growth last year, led by net average charge, or NAC, which grew 5%. We also see a nice runway of longer-term opportunities in services. While early, bookkeeping and payroll are gaining traction, and this year, we launched a business formation tool. Our new internal sales team more than doubled appointment to sale conversion rates, accelerating growth in services. All in all, we are pleased with the trends in the Small Business and continue to see significant opportunity ahead. Turning to Wave, our top priorities are driving revenue growth and improving profitability. For the full year, revenue increased 12%. In the fourth quarter, we grew average revenue per user while also becoming more efficient with our customer acquisition spend. We also launched a new feature for receipt processing that scans and imports data in seconds, reducing manual bookkeeping. Its uptake has been faster than anticipated and we are now working on a robust roadmap of other new features to roll out in the coming months. Moving on to our financial products imperative. Regarding Spruce, our mobile banking platform, we've been utilizing learnings from its first year in the Assisted channel to address and solve the needs of our clients. Since launch through June 30, we have had 300,000 sign-ups and $334 million in customer deposits. Spruce is committed to helping customers be good with money, and we're seeing progress toward that impact goal. A higher percentage of users are now saving money and the balances accumulating in savings accounts continues to grow. These savings accounts allow users to customize goals in order to save for the things they want in their lives, whether it be emergency savings or a new car. Our newest feature, a budget watchlist, utilizes flexible guardrails to help build healthy spending habits. Feedback from users indicates that these tools give them the visibility and control that they've been missing in their financial lives. From here, we are focused on acquiring clients both in and out of the tax season. Now let's turn to Block Experience, which is all about blending digital tools with human expertise to serve clients however they want to be served, fully virtual to fully in-person and everything in between. In DIY, we delivered on what we set out to do and we were especially pleased with the results. As you recall, our goal was to return to share growth by increasing awareness that we offer a DIY product, by improving the product, and by making it easier to switch from TurboTax. This multifaceted strategy worked, and as we reported last quarter, we saw online client growth of 2.5% through April 30, and 35 basis points of share growth. We are looking forward to continuing this momentum in fiscal '24. In Assisted, through April 30, we successfully increased company NAC by 4% while receiving strong customer satisfaction metrics. We also attracted higher-income clients and saw over 10% growth in those with more than $100,000 of income. And as we shared last quarter, we continue to see progress in the adoption of virtual tools. Although we saw stimulus filers return to the sidelines, the data shows that dynamic is now behind us, and we're focused on bringing more new clients into the Assisted channel next year. As you may have seen from our recent announcement, we entered into an industry-leading partnership with Microsoft to leverage its Azure OpenAI services and leading genAI technology to fuel faster and better experiences for taxpayers. While we have been building in-house capabilities for some time, we believe we can further accelerate our progress by leveraging the most advanced AI models in the world while continuing to keep data security a top priority. We will initially be focused on two areas: first, using genAI to reduce expenses and increase productivity; and second, to deliver enhanced customer experiences. We have dedicated teams working on these efforts and we are excited about the possibilities for H&R Block. Looking back over the last few years, we've made significant strides in our products, services, and features within our Block Horizons strategy, and we're looking forward to what lies ahead. Now, let me turn it over to Tony to discuss our financials and outlook.

Tony Bowen, Chief Financial Officer

Thanks, Jeff. Good afternoon, everyone. Today, I'll review results for fiscal year 2023, provide detail on our outlook, and share more on our strong capital allocation practice. We delivered nearly $3.5 billion of revenue, an increase of $9 million over last year. The increase was due to higher U.S. Assisted tax preparation revenues, partially offset by a decrease in Emerald card revenue. As a reminder, the impact from the Emerald card was over $30 million due to the rollback of the advanced child tax credit. We also had a negative foreign exchange impact of $19 million. Given these variables, I'm pleased that we were able to grow the top-line this year. Total operating expenses were $2.7 billion, an increase of approximately $5 million, primarily driven by higher field wages and partially offset by lower consulting and outsourced services. We saw about $5 million of savings from our footprint optimization efforts as we continued to eliminate unnecessary square footage. Interest expense was $73 million, a decrease of $15 million, or about 17%, due to lower interest expense on our notes compared to last year, partially offset by higher interest expense on our line of credit due to higher interest rates and higher draws. Other income increased $33 million, primarily due to higher interest income. As we've discussed, higher interest rates were a net benefit given our cash position throughout the year. Pretax income was $711 million, an increase of $52 million, or about 8%. Earnings per share from continuing operations increased from $3.26 to $3.56, and adjusted earnings per share from continuing operations increased from $3.51 to $3.82, or 9%. This is meaningful growth despite the aforementioned headwinds as well as our effective tax rate increasing from 15% to 21%. Lastly, we acquired just over 200 franchise locations in '23. We feel great about franchisees' willingness to sell to us and are pleased with how this opportunity supports our longer-term revenue growth. As you can clearly see in our results, our capital allocation story remains strong. We completed another $200 million of share repurchases in the fourth quarter at an average price of $30.94 after already completing $350 million of repurchases in the first half of the year. In fiscal year '23, we retired 9% of shares outstanding at an average price of $37.59. Over the last five years, we have reduced shares outstanding from 209 million to 146 million, or approximately 32% of float. We continue to believe share repurchase is a great use of capital. As Jeff mentioned earlier, today we also announced a 10% increase to the dividend. Over the last five years, we've increased the dividend by about 30%. What is great about the capital allocation approach is that despite increasing the dividend, the total dollars paid has been decreasing because we have acquired so many shares, which has created a nice flywheel. As we've consistently shared, we produce significant and stable cash flow, pay a growing dividend, and buy back a meaningful amount of shares. Our goal is to return 100% or more of free cash flow to shareholders annually. This year alone we generated over $700 million of free cash flow and returned a similar amount to shareholders. For fiscal year '23, our free cash flow yield, calculated as free cash flow divided by market cap, was over 16%, which is more than three times the S&P 500. Now turning to our fiscal year '24 outlook. First, let me share more about the assumptions we've made: We believe next year will return to typical industry growth of about 1%. This is in line with the historical average, and we do not foresee any industry dynamics that would change this assumption. Data shows that stimulus filers are now behind us, there are no major tax law changes anticipated, and employment has remained strong this year, which is usually correlated to filers in the next year. We are also assuming we maintain overall U.S. tax market share, but our goal is always to increase share. We expect to continue to take low single-digit pricing, as we successfully executed in FY '23. Our customer satisfaction scores specific to price for value have remained strong. Additionally, we continue to see value in repurchasing franchise locations, and remain committed to our capital allocation strategy with ongoing, opportunistic share buybacks. As a result, our fiscal year '24 outlook is for: revenue to be in the range of $3.53 billion to $3.585 billion; EBITDA to be in the range of $930 million to $965 million; our effective tax rate to be approximately 23%; and adjusted earnings per share to be in the range of $4.10 to $4.30. In summary, we feel great about how we are positioned. With that, I will turn it back over to Jeff for some closing remarks.

Jeff Jones, President and CEO

Thank you, Tony. As I reflect on the passing of another year, I'd like to thank our tax professionals, franchisees, and associates, who embody our purpose every day to provide help and inspire confidence in our clients and communities everywhere. I am looking forward to all we will accomplish in the next year and sharing our results for the first quarter in November. Now, operator, we will open the line for questions.

Operator, Operator

Our first question comes from Kartik Mehta of Northcoast Research.

Kartik Mehta, Analyst

Hey, Jeff. Hey, Tony. Jeff, I know you and Tony both said that you anticipate next year going back to kind of that normalized 1% total growth for tax returns. I'm wondering what do you anticipate in terms of Assisted and DIY changes or growth?

Jeff Jones, President and CEO

Hey, Kartik. Yes. I mean, when we work through our assumptions for the year, we always go through the normal, what do we think about employment, what do we think about potential changes from the IRS, what do we see in trends, by channel. And obviously, it hasn't been a normal year for a while. But as we look on the horizon and anticipate, employment has been strong, we've seen some general trends in the industry, we are not aware of any potential changes coming from the IRS. And really, those are the things that we put together about what we see the industry doing next year. Do you want to add anything, Tony?

Tony Bowen, Chief Financial Officer

Yes. I mean your question about Assisted versus DIY, Kartik, I think we believe Assisted is going to be fairly flat. Even though we had an unusual year in DIY this year, we think over the long term, DIY continues to grow a couple percent. So probably a slight migration from Assisted to DIY.

Kartik Mehta, Analyst

Jeff or Tony, you've been returning a lot of capital to shareholders, including a 10% dividend growth this year. Was the dividend increase this year unusual and is it sustainable?

Tony Bowen, Chief Financial Officer

Yes, I can take it. I think it's definitely sustainable. I mean we talked about our adjusted EPS growing 9%. We raised the dividend 10%, so essentially in line. Obviously, it's a bigger dividend increase than we've been doing over the last few years, even though we've been increasing the dividend. I think all else being equal, we prefer to do share buybacks, given the flexibility and the advantage we can take when we see volatility in the stock price. But the fact that we can buy back shares, which is obviously reducing shares outstanding, and as I mentioned in my opening comments, we've actually been reducing dividends paid in total amount. So, even though we've been increasing the dividend and even this amount going up 10% this year, I think you'll see dividend dollars being flat to even slightly down, which, as I mentioned, is creating that nice flywheel effect, which we think is very beneficial for shareholders.

Kartik Mehta, Analyst

Perfect. Thank you. I appreciate it.

Jeff Jones, President and CEO

Thanks, Kartik.

Operator, Operator

Thank you. Please standby for our next question. Our next question comes from the line of George Tong of Goldman Sachs.

George Tong, Analyst

Hi. Thanks. Good afternoon. I wanted to dive into some of your market share assumptions for next year. Can you talk a little bit about what you're assuming for share performance in the Assisted and DIY categories? And with a particular focus on the Assisted side, this past year, you had lost some share in the lower income category. What are some internal initiatives to help improve that performance? Thank you.

Jeff Jones, President and CEO

George, great question. Thank you. This is Jeff. I'll kick us off. Yes, I think the starting point is the clarity about what happened this year. We talked on the last call about the three reasons why we lost business in Assisted this year. The low-income filers, EITC in particular, being a real focus for the teams as we prepare for next year. In simple terms, we think we have to do a better job of communicating our value proposition earlier in the year when those consumers are most in the market looking for their refunds. And I feel good as we sit here in August that the teams are very clear about what has to happen. In terms of looking to next year and our share expectations, as we said in our opening comments, we expect Assisted share to be flat, but we're always trying to grow share in Assisted. So, it doesn't change our plans, it's just tempering our expectations. And in DIY, we feel very good about the three-pronged strategy that we took this year, and we anticipate being able to continue to improve our performance and take share again in DIY next year.

George Tong, Analyst

Got it. That's helpful. There are several factors at play in the broader tax preparation industry, including the IRS' Free File program and generative AI. Can you discuss any internal strategies you are implementing in response to these changes? Additionally, how do you evaluate the potential impact of these two developments on the industry?

Jeff Jones, President and CEO

Yes. Excellent again. So, I mean, first of all, we're very excited about the opportunity with Gen AI, and I want to start at there. We talked a little bit in our prepared remarks about this, but we have dedicated teams who are absolutely leaning in in building integrations. Given our partnership with Microsoft and OpenAI, those initial two use cases, one on the expense side, one on the customer experience side. Obviously, a lot more detail to share as we're ready to make those public specifically. The technology is generally well understood, the customer adoption is not. And so, we're very excited to begin that learning journey by deploying two very specific use cases. We've identified a number of use cases. And so, based on that learning, we see real opportunity for the business in various parts. More to come in detail, but I think the punchline is we're very excited about what it could mean both in cost savings and customer experience, and teams are leaning in and moving fast to get ready for the year. On the IRS Free File option, in simple terms, we do not see it as a material threat to the business. We know that there is a real concern about the IRS' ability to ultimately market and support a product like this, the ultimate cost to taxpayers of what that would entail, and we've seen consumers make it clearer that there really isn't a problem here. There are over 30 organizations, tax prep companies and not for profits that are already offering free tax prep. And so, we stand by those remarks and are very focused on building great experiences to continue to do what we do. And with respect to Gen AI, like I said, we're very excited about that opportunity.

George Tong, Analyst

Got it. Thank you very much.

Jeff Jones, President and CEO

Thanks, George.

Operator, Operator

Thank you. Please standby for our next question. Our next question comes from the line of Scott Schneeberger of Oppenheimer & Company.

Scott Schneeberger, Analyst

Thank you. Good afternoon. For my first question, I want to discuss the revenue forecast for next year. It appears to suggest a growth of about 2% to 3%, which seems to be a bit lower than your long-term target of mid-single digits. So, I would like to ask what factors you see influencing this outlook, including any challenges and advantages for the upcoming year that might have contributed to this expectation. Additionally, Tony, referring to your Slide 17, you mentioned several assumptions related to revenue: industry growth, market share, low single-digit pricing, and ongoing franchise acquisition. Could you prioritize these factors to help us understand which ones are the most significant drivers for revenue growth next year? Thank you.

Tony Bowen, Chief Financial Officer

Thank you, Scott. There’s a lot to consider here, so I’ll break it down. Looking ahead to 2024, you’re correct that our guidance aligns with our long-term target of 3% to 6%. However, I think it may be a bit more conservative this time. Unlike in 2023, we don’t see any specific headwinds impacting us now. Last year, we anticipated challenges from the Emerald Card due to the rollback of the Child Tax Credit and other factors. We faced an unusual tax season in 2023, which we expect will normalize. That said, we don’t have perfect foresight. I believe we’ve set achievable revenue expectations, and our EBITDA forecast indicates growth outpacing revenue, while our EPS outlook anticipates a 10% growth. Combined, I feel very positive about these projections. To reach the upper end of the 3% to 6% revenue range, we must ensure that our growth initiatives, such as Spruce and service expansion in Small Business, are effective. Even without these initiatives, we have a healthy top-line growth. Our EBITDA is growing faster, and our EPS is set to grow in double digits, which is impressive, especially considering this year's 9% growth. Additionally, I mentioned earlier that we're facing a significant tax rate change; our effective tax rate was about 15% in 2022 and rose to 21% in 2023. Despite this, we achieved a 9% EPS growth, which I find very encouraging. In terms of prioritizing these factors, I don’t have a definitive ranking in my mind, as I view them as all contributing positively. It all begins with strong client volume in both Assisted and DIY, which forms the foundation. Next, we layer on low single-digit pricing as discussed. Our franchise buybacks can contribute to revenue growth as well, serving as the primary factors driving revenue. There are minor variations, but these are the key elements. We’re also ensuring our expense management allows EBITDA to grow faster than revenue. Lastly, executing our share repurchase program is crucial for improving EPS. It’s a complex situation with many elements at play, but achieving double-digit EPS growth is a significant accomplishment that I feel good about.

Scott Schneeberger, Analyst

Thanks, Tony. Good answer. You covered what I was looking for. As a follow-on to that, what are you expecting for expense inflation? You're obviously guiding EBITDA growth faster than revenue growth. Just technology, labor, rent, overhead, marketing, anything changing dramatically year-over-year there? And how are you thinking about the inflation year-over-year? And you mentioned pricing of low-single digits. So just curious what the inflation assumption is on the cost side?

Tony Bowen, Chief Financial Officer

We are factoring in inflation, but it appears to be more moderate compared to last year. Our largest expense, which is tax professional labor, is variable with our revenues, so it isn't directly impacted by inflation. However, we are observing more moderate costs for full-time team wages compared to last year. Additionally, there is less turnover and fewer employees leaving, which indicates reduced competition in the labor market. While costs for items like supplies and utilities are expected to rise, we have planned for a more moderate increase than what we experienced last year. Therefore, while inflation is present, it should be somewhat less severe than in the past. We will also need to consider factors like bonus accruals. Ultimately, our goal remains to grow earnings at a faster pace than our revenue, and we are aiming for that this year.

Scott Schneeberger, Analyst

Thanks. If I could also get Jeff's input, I'm curious about your observations from the extension season. I'm aware we haven't reached the deadline yet for California, but since our last public call, what trends have you noticed? I assume they are somewhat better than expected. You also performed better than your guidance, so I would like to hear your thoughts on how this extension season compares to last year. Thank you.

Jeff Jones, President and CEO

Thank you. I appreciate that, Scott. Regarding extensions in California this year, we know that overall extensions were down, and we experienced that as well. We still anticipate that most of the volume will come right before the October 15 deadline. We are keeping additional offices open to capture that volume. However, as Tony always reminds me, we are not fully operational everywhere. We are trying to balance our expenses with our revenue, aiming to capture our fair share and grow. Most importantly, our teams are focused on preparing based on this year's learnings to be ready for the 2024 tax season.

Scott Schneeberger, Analyst

Thanks very much.

Jeff Jones, President and CEO

Thank you.

Operator, Operator

Thank you. I would now like to turn the conference back to Michaella Gallina for closing remarks. Madam?

Michaella Gallina, Vice President, Investor Relations

Thanks, Latif, and thanks, everyone, for joining us today. We look forward to speaking with you again next quarter.

Operator, Operator

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