H&R Block Beats Expectations

Yesterday, H&R Block Inc. (HRB - Analyst Report), the market leader in tax preparation services, posted better-than-expected results for the fourth quarter of fiscal 2009. The results were prompted by higher fees that offset the decrease in tax returns prepared by the company.

Net income for the fiscal fourth quarter ended April 30 increased to $706.9 million, or $2.09 per share on a diluted basis, from $543.6 million, or $1.66 reported a year ago. This was above the consensus estimate of $2.05 per share. Though revenue for the quarter was down 3%, H&R Block’s cost containment initiatives have benefited the bottom line.

Consolidated net income for fiscal 2009 was $485.7 million or $1.45 per share, compared to a loss of $308.6 million or $0.94 per share in the prior-year period.

Overall tax returns prepared in retail offices fell 5.8% in fiscal 2009, which was partially offset by a 21.1% increase in returns prepared through its online products and TaxCut software. Management believes that “online is the key battleground of the future”. However, net average retail fee per return increased 7.2% due to higher complexity of tax returns in addition to a shift towards clients with higher income levels. Returns prepared online grew 45.2% while software-prepared returns were up 1.7%.

Pretax margin for the Tax Services segment improved 320 basis points over the prior year while margins in the Business Services segment were up 130 basis points.

For fiscal 2010, H&R Block expects an EPS of $1.60 to $1.80, supported by a single-digit revenue growth and a 100 basis point improvement in operating margin. Its 2010 strategic initiatives include margin expansion coupled with improving brand awareness and loyalty so as to drive client growth and expand services to existing clients. The company intends to rely less on fee increases in the coming years. It also intends to maintain its current dividend rate in fiscal 2010.

H&R Block’s rival company, Jackson Hewitt Tax Service Inc. (JTX - Snapshot Report), posted a 28% decline in its profit last week. The company also witnessed a significant decline in the number of tax returns prepared.

Although H&R Block has closed its mortgage business the company may continue to feel the negative financial impact from the mortgage industry meltdown going forward. H&R Block remains exposed to losses that it previously originated via its Option One business. However, we believe that the steps taken by the management to refocus the company on its core tax businesses and emphasize on expense reduction should result in improved margins going forward. Hence, we continue to view the shares of H&R Block a hold.