H&R Block, Inc. (HRB)

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H&R Block, Inc. (HRB)

F4Q10 (Qtr End 04/30/10) Earnings Call Transcript

June 24, 2010 4:30 pm ET

Executives

Derek Drysdale – Director, IR

Russ Smyth – President & CEO

Jeff Brown – Interim CFO

Kate Fulton – SVP, Government Relations & Public Policy

Analysts

Scott Schneeberger – Oppenheimer & Co.

Michael Millman – Millman Research Associates

Sloan Bohlen – Goldman Sachs

Vikram Malhotra – Morgan Stanley

Bill Carcache – Macquarie Research Equities

Vishnu Lekraj – Morningstar

Michael Chapman – Private Capital Management

Presentation

Operator

Good day and welcome to today’s web conference. During today’s event for those dialed into the audio bridge, all lines have been muted to prevent background noise. This event is being recorded. There will be a question-and-answer session after the formal comment.

At this time, we would like to welcome everyone to today’s web event titled, “Fiscal 2010 Earnings Conference Call.” At this time, it is my pleasure to turn the floor over to Mr. Derek Drysdale. Mr. Drysdale, you have the floor.

Derek Drysdale

Thank you for joining us today. This is to discuss our fiscal 2010 results. Presenting on the call are Russ Smyth, President and CEO; and Jeff Brown, our Controller and Interim Chief Financial Officer. Other members of our senior management team will be available during the Q&A session.

I would like to remind everyone that today’s remarks will include forward-looking statements as defined under the Securities Exchange Act of 1934. Such statements are those relating to matters that are not historical facts and 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 and as a result, actual outcomes and results could materially differ.

Please see the risk factors included in our most recent periodic reports and other filings with the Securities and Exchange Commission. H&R Block undertakes no obligation to publicly update such Risk Factors or forward-looking statements.

Following our prepared remarks, we will open the call to Q&A. To give as many participants as possible an opportunity to ask a question, we ask that you limit your query to one initial question and then one related follow-up if needed.

With that, I’ll now turn the call over to Russ.

Russ Smyth

Thanks, Derek, and good afternoon everyone. Earlier today, we announced our fiscal 2010 results. We generated consolidated net income of $1.43 per share this year, which is a slight decline of 1.3% from last year, despite the IRS suffering its largest decline in total filings in nearly 40 years. And while these IRS results reflect the impact of an overall unemployment level of nearly 10%, for many in our core client base, unemployment was in the 15% to 30% range.

Given our overall performance this year, our financial position and liquidity base remained very strong which enables us to make the right strategic choices for growing our business and returning value to shareholders.

Here’s a quick recap of our fiscal 2010 results. We prepared 20.1 million U.S. tax returns this season, down about 4% from a year ago. We did a better job of retaining our existing clients.

In fact, our retention to the brand increased 130 basis points to 71.6%, but our marketing and pricing initiatives did not generate adequate new client growth to compensate for the loss in clients due to record levels of unemployment. We lost 65 basis points of share in the assisted market and 100 basis points in the digital online category.

At McGladrey, we successfully resolved the dispute with McGladrey & Pullen and created a new operating agreement that resolves the nagging issues of the past and positions the partnership for growth. However, there was a one-time drop in income as a result of this dispute and it adversely affected RSM’s ability to participate in proposals for new client engagements and we incurred more than $6 million of related legal expense.

Despite a difficult operating environment, we generated strong free cash flow of nearly $500 million. We returned substantially all of our earnings to shareholders in the form of share repurchase and dividends. In the past two quarters alone, we repurchased nearly 13 million shares, ending the year with $1.4 billion of equity and just $1.1 billion of total debt. These repurchases reflect our confidence in the future of our business.

So with that overview, our goal today is to talk about the areas in which we saw progress and then in those in which we need to improve. And I’ll also share some of our plans to address both the opportunities and the challenges that we expect to see in the tax industry next year.

But the headlines are this; we’ve got three key challenges for fiscal 2011. First, we’ve got to reduce the early season client loss in our retail business. Second, we need to significantly change our approach to be more competitive in digital. And third, we need to ensure that the McGladrey business is back on track, growing top line revenues, partner income and bottom line profits.

I’ll talk more specifically about the actions we plan to take for each of these later on the call. But, first, I’d like to start by sharing our analysis of the tax season 2010. We saw very clear and pronounced contrast between the first and second half of this tax season. Our results were directionally consistent with the trends in IRS filings, which were down significantly in the first half but recovered in the second half of tax season.

More than 90% of our client loss this year was among lower adjusted gross income first half filers, particularly those who file the 1040A Form and those who take settlement products. As you can see on the slide, unemployment rates within this client segment are up two to three times the national average.

Many were not required or chose not to file, while others went to an independent tax preparer. Some may have chosen a digital alternative, but based on our performance improvement in the second half, we believe many of these lost returns went unfiled.

We estimate that the total industry shift from assisted to DIY was about 75 basis points or approximately 1 million returns this year. The shift was significantly lower than our original projection of 100 to 125 basis points and it occurred predominantly in the first half of the season.

Frankly, we believe that the challenging economic conditions would lead to a larger shift. More recent data indicates that even during hard times and with changing demographic trends, the assisted tax prep category remains both resilient and relevant. In fact, the assisted category currently represents 61% of total IRS filings compared to 39% for do-it-yourself. These are the exact same percentages that they were back in 2002.

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