Colby Brown - VP, Finance & IR Tom Gerke - President & CEO Tony Bowen - CFO

Kartik Mehta - Northcoast Research Partners Scott Schneeberger - Oppenheimer Anjaneya Singh - Crédit Suisse Mark Savino - Morgan Stanley Jeff Silber - BMO Capital Markets Hamzah Mazari - Macquarie Capital Michael Millman - Millman Research Associates

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the H&R Block First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. I'll now turn the call over to Colby Brown, Vice President of Finance and Investor Relations. You may begin your conference.

Thank you, Mike. Good afternoon, everyone and thank you for joining us to discuss our fiscal 2018 first quarter results. On the call today are Tom Gerke, our Interim 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've reconciled the comparable GAAP and non-GAAP figures in the schedules attached to our press release. Before we begin our prepared remarks, I will 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 2016 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 Tom.

Thank you, Colby. Good afternoon and thanks everyone for joining us. Earlier today we announced the results for our fiscal 2018 first quarter, which ended July 31. As a reminder, given the highly seasonal nature of our business, the first quarter is not indicative of our performance for the full year. Tony will walk you through the first quarter results in greater detail shortly, but overall, they were in line with our expectations. Now I'd like to provide an update on our CEO transition, our overall strategy and our preparation for the upcoming tax season. Starting with our leadership transition. We announced last week that Jeff Jones has been appointed our new President and CEO effective October 09. Jeff brings 27 years of executive management experience, great leadership and operational excellence to H&R Block. Having held key roles at top companies in the retail, consumer products, agency and technology industries. The management team will actively work with Jeff over the next several weeks in advance of his arrival to ensure a seamless transition. We are delighted by the Board's selection of Jeff as our new CEO. And in addition, we would also like to give a final thank you to Bill Cobb for all he did during his tenure at H&R Block. During this time of transition, the leadership team has been and will be continue to be laser focused on delivering a strong tax season '18. We've largely completed our planning efforts and are working to operationalize those plans. While we're not prepared to discuss details regarding our expectations for the upcoming tax season, our long-term goal continues to be achieving client growth in both the assisted and DIY channels and our strategy to get there remains unchanged. So, here's what you should expect from H&R Block this year. We will continue to aggressively go after client growth through compelling promotions and product offers. We'll continue to invest in innovative solutions designed to leverage our ability to serve our clients any way they want to be served and we will continue to improve the value we provide to our clients and we'll effectively communicate that value. Again, while we're not prepared to provide a lot of specifics today regarding our tax season '18 plans, we can talk in a little more detail about our key product and our operating line up the refund advance. After a successful launch in tax season '17, we're excited about this product in place for tax season '18. Last month, we reached an agreement with BofI to be our exclusive refund advance provider this year. This expands our relationship with BofI which also provides our Emerald Advance, Refund Transfer and Emerald Card products and by reaching this agreement in July, we solidified the terms of our Refund Advance program much earlier than last year, giving us more time to enhance our execution of the program as well as to focus on other initiatives. Refund Advance continues to be a valuable product for the early season clients, looking to access their refund faster and it rounds out our Tax Plus product suite, which is the most robust in the industry. Our products combined with the expertise of our tax professionals and Watson, offer compelling value for taxpayers. Beyond Refund Advance, we have many exciting plans for the upcoming tax season as we continue to look for ways to innovate and provide our clients with outstanding promotions and product offerings. We look forward to sharing more details regarding our tax season '18 plans on our second quarter earnings call in December. And with that, I'll hand the call over to Tony.

Thank you, Tom and good afternoon. As Tom mentioned, given the seasonality of our business, first quarter results are not representative of our full year performance. To put it in perspective, first quarter results typically represent less than 5% of our annual revenues and less than 15% of our annual expenses. That said, our results were largely in line with our expectations. With that as a backdrop, I'd like to provide additional context on the quarter. Revenues increased $13 million or 10% to $138 million primarily due to increased U.S. tax preparation fee and revenues from prior year sales and our Peace of Mind product. Turning to expenses, total operating expenses increased $13 million or 4% to $323 million. Increases in amortization expense and occupancy cost were due to acquired franchising in the businesses in the prior year. We also saw inflationary increases in both occupancy cost and compensation expense. Pretax loss increased approximately $2 million to $205 million as increases in revenue were offset by increase in operating expenses. Additionally, other income declined due to the sales in mortgage loan portfolio, which occurred in the third quarter of fiscal 2017. The quarter's income tax benefit was less favorable compared to the prior year due to lower base tax rate as well as lower discrete tax benefits. Finally, loss per share increased $0.07 to $0.62. Approximately half of the increase was due to the reduction in the share count, which will be accretive on a full year basis, but negatively impacts those quarters with a net loss. The remainder of the change in loss per share was due to the decrease in income tax benefit. Turning to capital, we remain committed to our practice to returning excess capital to shareholders through dividends and share repurchases after making appropriate investments in the business. Regarding share repurchases, there are a number of factors that impact the amount and timing of repurchases, including our financial position, market conditions, trading ranges, blackout periods and operational considerations. So, we'll continue to be opportunistic in our approach. There were no repurchases in the first quarter and we currently have approximately $1.2 billion remaining of our $3.5 billion share repurchase authorization effective through June 2019. Turning to dividends, last quarter the Board authorized a 9% increase in our quarterly dividend to $0.24 per share. We remain committed to paying the -- to paying quarterly dividends which we have done every quarter since becoming a public company over 50 years ago. Turning to discontinued operation, Sand Canyon's accrual for contingent losses related to representation and warranty claims was unchanged from the prior fiscal quarter at $4.5 million as of July 30. 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. As Tom mentioned, our plans for fiscal year '18 are well underway and we're still working on certain areas that may impact our financial outlook for the year. Consistent with last year, we'll provide additional details during our second quarter earnings call. That said, I'd like to provide some color around our operating expenses, which is an area many investors have asked about during the past few months. As we stated previously, we do not plan any large-scale cost reductions this year, but you can expect us to diligent about cost management. As we discussed during last quarter's call, fiscal year '17 represents a new baseline for expenses. That said, we had one-time benefits of approximately $15 million last year that will not recur in fiscal year '18. Additionally, expenses will be impacted by variable cost and inflationary increasing in areas such as compensation and occupancy costs. We'll provide details on expenses, margin and other elements of our financial outlook during our second quarter call in December. With that, I'll now turn the call back over to Tom.

Thanks Tony. In summary, we're on the right path to deliver for tax season '18. We're aggressively building up of last year's momentum. We're excited about the arrival of Jeff Jones and are working to ensure a smooth transition. We look forward to sharing more in December on our Q2 earnings call. With that, we'll now open the line for questions. Operator?

[Operator instructions] Your first question is from Kartik Mehta from Northcoast Research.

Hey good afternoon, Tom and Tony. Tony, I think you talked about RAL program or the bank's products programs going with one bank. I am wondering if you anticipate any other changes in the RAL program? It seems like you had some success last year and I'm wondering are you planning to make any changes and anticipate those changes having greater success?

Yeah and Kartik, thanks for the question. Obviously, our goal is to try to improve on the success we had last year for Refund Advance as far as what the specific changes will be. Obviously, we're not going to talk about it for competitive reasons, but we're really pleased with the performance that that product had last year in driving a new client. Open to build on that performance in the second year, but as far as the details, more to come.

And then, what do you anticipate for low tax market growth, both for the total market and the DIY?

So last year as we you know was a bit of an anomaly from our perspective and we think the fraud controls at the IRS put in place both the PATH Act as well as the AGI PIN change that they made in DIY definitely had an impact on industry volume. If you take last year on and you look at over the last 60 plus years, the growth is highly correlated with employment. Right now, the economy is strong, employment is strong. So, we would expect the IRS returns to return to more historical growth patterns of around 1%.

And then, Tony, just your thoughts on the assisted market and DIY market. What do you anticipate growth wise from those two markets? Thank you.

Yes so, sorry I missed the second part of your question, I think last year was a bit of a unusual year. We saw the migration from assisted to DIY be about half of what it was in the prior years. I think part of that had to do with some of the fraud controls I mentioned before. I think part of it had to do with the product offerings that you saw in the assisted side of the business, specifically Refund Advance. We expect that there will be a migration from assisted to DIY next year. Exactly what that is, is really depends on a lot of factors including competition, different offers in the marketplace etcetera. I think overall, we would expect assisted to be relatively flat and see positive growth on the DIY side.

Thank you very much. Appreciate it.

Thanks, Kartik.

Your next question is from Scott Schneeberger from Oppenheimer.

Thank you. Good afternoon. I was curious to hear that no share repurchases in the fiscal first quarter. Just Tony, any commentary on that? Is that something where you're going to hold off before tax season? Or just happenstance? Or any commentary surrounding that?

Yeah, so thanks Scott. Obviously, we remain committed to returning capital to shareholders through both share repurchase and dividends. We've returned over $2.3 million over the last couple years through share repurchases. In that two consecutive years of raising the dividends. So, we definitely feel like we've returned a significant amount of capital. As a matter of practice, we don't comment on the levels or timing of share repurchases either in the past quarter or in what we're expecting in the future, but we really think about it as trying to be opportunistic for our shareholders, not programmatic. So, we'll continue that approach in the future, but I can't speak too detailed about why we did or didn't buy during this last quarter.

All right. Thanks, and a primary competitor recently mentioned kind of three thematic focus areas for the upcoming tax season and number one was the focus more in early season segment and compete effectively in the free segment. How clearly, you're bringing back the RAL 1040 EZ was the first time the -- for free was the first time this past year. Should we anticipate that that would likely perpetuate and that's question one and part two of it is just taking a step back, what do you see what regard to the competitive environment you can approach that however you like for the upcoming tax season, thanks.

Thanks Scott. So, I think your question was do we plan on continuing for EZ as well as Refund Advance. So, Refund Advance is EZ, one of the answer is yes. We've already announced that. So that will definitely be in the assisted channel. 1040 EZ was a program we introduced last year. We had some good success bringing clients and driving trial to the assisted brand and I think it just provide a nice offer for us to bring clients and then ultimately monetizing in future years. As far as what competition does, obviously the tax maker is highly competitive right now especially on the DIY side with new entrants like Credit Karma and others. So, we would expect that competition to continue. That being said, competition was pretty fierce last year and we were able to outpace the market on the DIY side, gain market share, outpace TurboTax for example. So we feel like we're well positioned to do that again next year. We're focused on continue product innovation, being aggressive in the space and having an offer that we think competes effectively.

Thanks. I'll turn it over.

Thanks Scott.

The next question is from Anjaneya Singh from Crédit Suisse.

Hi. Thanks for taking my questions. So, the first one, last summer you guys had focused on developing a strategy around arresting the client decline. Fully realizing you share more details on your 2Q call. We're curious to see if you can share any high-level thoughts on direction of strategy you have in place for fiscal '18, is it more about getting flattish volumes in assisted, is volume growth in assisted that is something that you can try and achieve in '18? I'm asking because I know in the past you've been pretty upfront that assistant volume growth wasn't likely in the foreseeable future declining volumes are a bigger focus in arresting those or the biggest focus. So just trying to get a sense of how your targets are evolving there thanks.

What I would say is we obviously had good progress in changing our client trajectory last year and at this point, we're planning to improve from that level. I am not going to say whether or not that's plus one client or zero or minus one, but there is definite an improvement from last year as our expectation on the assisted side. In DIY, we gained market share. We outpaced the market. We had positive growth. We will continue to do the same on the DIY side as well.

This is Tom. The things that I would add is we had a lot of things this last year that are things that we can clearly built upon. So, we talked about the Refund Advance. We announced the Watson relationship and enhanced the client experience by drawing them into that experience with a devoted monitor for them and those are just a couple of examples of some things that you're going to see us built upon. Also, a thought on cost, but also just operational effectiveness. We made some improvement is efficiency effectiveness and we had a senior league team where every member of the senior lead team is back at what they were doing last season and in many cases for many seasons before that. So, despite transition at the CEO office, we got a pretty incredible degree of stability as we prepare and plan for execution of the upcoming season.

Okay. That's helpful. Appreciate it. As for second question, I wanted to just ask on the hire of Jeff Jones, clearly his experience in retail, consumer, digital all speak volumes, but curious to see if you can share any thoughts on why the Board didn't pursue someone with more tax industry experience? Is it simply a matter of wanting fresh eyes on the business? Is it something else? Aby thoughts you can share there. Thank you.

Sure, well just taking it up a little bit of a high level, the Board had the opportunity, took the opportunity to do a very disciplined broad search. We retained recruiter and then looked at all of the attributes. Given the size of the tax industry, at least as Block plays in at both assisted and digital and again at the level of expertise that we operate at. I think you look at all the different attributes and you touched on a couple of them, but proven leadership, the broad retail and digital experience, a comfort level with innovation, probably driving emerging technologies both into the client offering but into your operations. And I think when you look -- look at us and the available pool of people's to even tax, that probably recedes and some of these other attributes are far more important and then you can get up to speed on the nuances of the tax industry and especially when you get somebody of Jeff's proven talent to do that.

That's helpful. Thanks so much.

Thanks, Anjaneya.

Your next question is from Mark Savino from Morgan Stanley.

Hey, good afternoon, guys. Just on the expense side, with the 4% cost growth in the quarter, wondering if -- I know you guys had mentioned you plan to be diligent on cost management, but is that level of growth indicative of what we should expect for the full year?

Yeah thanks Mark. What I would say is we're going to provide more clarity on what our full-year margin impact would be given all of our financial plans for this upcoming year. On our Q2 call, I wouldn't read too much into Q1. It's obviously not a large quarter for us especially on the revenue side, but we'll provide more clarity once we get to Q2.

Understood, thanks. And just following up on that a little bit, you did talk about occupancy cost as being a bit of a headwind, given the retail environment is generally weak, is there an opportunity for you guys to potentially renegotiate some of your leases across the own store base?

Yeah, we have about 20% of our leases that come up for renewal every year typically execute those in the spring and their early summer timeframe and we got a lot of people ask us about the weakness in the retail space and if we're benefitting from that. And the reality is there are some, but not a lot. I think a lot of that weakness is happening more in the big box retailers, maybe the more anchor tenants and the places that we operate in more strip centers, for example, we're not seeing a lot of weakness. We're not seeing a high level inflationary increase. It's more on the 1% range. Part of that occupancy costs you saw increase this year, probably the bigger chunk was due to the fact we have more locations on the company side due to buybacks. So, we're moving from franchise to company and we're now paying the full year of rent expense that's probably the bigger chunk. There is a little bit of just inflationary increase in there as well.

Very helpful. Thank you.

Thanks Mark.

Your next question is from Jeff Silber from BMO Capital Markets.

Thanks so much. Actually, just a quick follow-up from that last question. Are you still in process of repurchasing franchises on a relatively fast scale compared to prior years?

Yes Jeff, it's happening at lower rates. Remember we had peak debt over 300 offices in 2015. That number has continued to come down. I think last year we did about 170 offices, expect that number to come down even more this year, but we are continuing to repurchase franchise locations that make sense.

Okay. Great. And then going back to the discussion on the refund advance loan, I'm just curious was this your conscious decision just to go with one bank? Are you comfortable that BofI can handle it? I think give a little bit more color in that decision, that will be great.

Sure, well we're very comfortable that BofI can handle it and we believe based on our range that we'll have ample funding for the upcoming tax season. I also think about the other products that we have and just the complexity of having multiple parties involved and so we were satisfied to go this route. Meta was a good partner and played a great role last year, so we have lot of respect for them, but we have this existing relationship with BofI and we're very comfortable with how we've extended it and that it will allow us to do what we want to do with that product offering.

One more. Are you planning an Investor Day in December like you typically do?

No Jeff. We're going to plan to do the same thing we did last year, which is do an extended Q2 call including slides and additional financial outlook information.

Okay. Great. Thanks so much.

Thank you.

The next question is from Hamzah Mazari from Macquarie Capital.

Good afternoon. Thank you. The first question is just if you could maybe update us on what you're hearing on potential tax reform in terms of simplification of the tax score or anything else you may be hearing on the regulatory front positive or negative, just update us there?

Sure. Thanks for the question, this is Tom. I guess I'd probably start by saying it's always difficult to predict if anything is going to happen in the legislative process and that's especially true now frankly probably buried by the weak. And the only thing that's merging is that there's definitely a lack of consensus around any single proposal. But I then go back to what do I know? What did we know at H&R Block? We know we've been doing taxes for 60 plus years and the tax code had all different degrees of complexity and what not during that and people have consistently needed help and people have consistently wanted help. So, if something happens here, it's conceivable I guess. It could be simpler, but there's no scenario where it would be simple, the U.S. tax code. And then their credits under discussion, there is child care credits, there are other things like that, that are being discussed. So, it's not just that. It's like every time we get into one of these reform processes, we can't resist adding to it as well. So, there is certainly those kinds of additions that are being considered. The other thing is that any time there is change, change equals uncertainty, uncertainty equals a desire for certainty that they're maximizing the refund, maximizing taking advantage of a new credit or any change in the way the tax law works. So that can often and will materialize and desire for assistance. So, and again I'd probably finish that comment on these taxes about where I started 60 plus years people need help, people want help. I guess that's why I finish on individual taxes. On corporate taxes. I think it's really important to remember that a 25% or lower corporate rate would result a substantial reduction in H&R Block's taxes and provide us a considerable tailwind and you asked your question more broadly used the word regulation. I guess the other thing that I would say is that we're just not seeing new regulation come out of DC at the pace we have in the past and I think we probably benefit from that the way everybody who has a broad consumer offering products benefits. So, it's businesses what I would probably sum it up.

That's very helpful. Just a follow-up question and I'll turn it over. Any sense of how you're thinking about your non-tax related revenue? I guess it's 15% or so of your book of business? Is the Block Advisors' initiative still alive? How do we think about their Tax Plus strategy or is that something we wait for the new CEO to figure out whether there is a focus on nontax related book of business?

Yeah, So Block Advisors would be reported tax prep revenue, just as a clarification, and it definitely is still a focus. It's now in its third year of having that brand out in the marketplace. We knew it would be a slow build to get that to a place where it was adding significant contribution to the business, but still positive things happening and more to come on that front. As far as Tax Plus products, we feel like we made a lot of progress over the last several years from both in a cash perspective as well as best functionality and features in the marketplace. We include refund advance and that said, even though it's not directly attributable from a revenue perspective, it brings clients into the door. They get to experience their product and we think that's an overall benefit to H&R Block.

Thank you.

Thanks, Hamzah.

Your next question is from Michael Millman from Millman Research Associates.

Thank you. I guess a couple questions regarding some of the costs, you said 4% in the first quarter. Just wondering, however, if the $15 million cost benefit from the end of the year isn’t somehow included in that or that was a one-time deal related to cost also, both the -- will they be charging the same $32, $34 to do RA's? And…

Go ahead Michael. Did you have another part, just go ahead?

That was that part, separate question might as well get it out. I'm not sure I heard your answer to Scott's question and to its talk about going after Assisted and then you mentioned tax reduction. What is your actual cash tax rate?

Yeah, we got a lot of questions. So, we'll try to take these one at a time. First one on expenses, so the $15 million, so we reduced expenses, a significant amount last year, we view most of that expense reduction to be essentially permanent in nature. There was $15 million approximately a benefit that we got last year that we don't expect to recur in FY '18. So that's $15 million. So, part of that reduction last year will be coming into the P&L as essentially a headwind or increase in expense over the next four quarters. So that's kind of that piece. As far as BofI and what we're paying them, we're not sharing the specific details at this point. At the end of the day, the key number to think about is what is the total amount we're spending in origination cost to offer the Refund Advance program and that's both a combination of what we're paying on a per loan basis as well as the total volume of loans that we're giving out to our customers and then ultimately how many customers we're driving in as a result of offering that product. We feel like we're in a good place, but we're not sharing specific details on each of those buckets at this point.

I'll jump in. On Intuit, there really isn't anything new to the industry trying to have various hybrid models or have assisted as part of DIY. We expect that to continue frankly especially in the light of the fact that you saw even less than half of the 70 to 90 basis points of shift we've seen in the prior two seasons. I'd just focus, and I think Block for a long time now has been talking about and I think is well positioned to serve our customers anywhere, anyhow, any way they want and we've got the experience of 70,000 plus tax pros to provide and have ample base to provide any assisted whether that's on its own or in a blended fashion. And we look forward to continuing to bring those offerings forward and enhance then and so we'll continue to fair quite well, it's our belief in that space and back to Tony.

Yeah, and so I think Michael your last question was on cash taxes versus essentially GAAP taxes, our effective tax rate last year was around 33%. Our cash taxes were less than that. We put some things in place that we haven’t fully realized from a GAAP perspective, obviously booking some provisions along with those benefits. So, it is less than our 33% of our effective tax rate.

So, a 25% tax rate you wouldn't get the difference between that and the 33% in effect.

Yeah, well first of all there is state taxes implied in the 33%. So that's another factor to take into effect, but part of the difference between the cash and the GAAP basis is some timing and things that are yet to be realized. So, there's obviously a lot of complexity that go into exactly what the changes are from a corporate perspective before we realize what the full benefit would be. I think Tom's point is that anything south of 25% and really under any scenario be a positive for H&R Block. Definitely from a GAAP perspective, but even from a cash perspective.

Great. Thank you very much.

Thanks Michael.

That was our last question. At this time, I'll turn the call back over to the presenters.

All right. Thanks everyone for joining us. This concludes today's call.

This concludes today's conference call. You may now disconnect.