S&P Global Ratings revised its ratings outlook on H&R Block Inc. (NYSE: HRB) to negative from stable. At the same time we affirmed all ratings on the company, including the 'BBB' corporate credit rating and 'A-2' short term rating.

"The negative outlook reflects our downward revision to our performance forecast because of Block's weaker-than-anticipated earnings for the 2016 tax year, and our belief that the increasingly competitive tax preparation industry, as well as continuous shift in the industry from assisted tax filing to DIY services, will continue to weigh on the company's performance, leading to only modest profit growth during the 2017 tax season," said S&P Global Ratings credit analyst Mariola Borysiak. "The ratings affirmation incorporates our view of the company's strong market position in the retail tax preparation services segment, its well-recognized brand, above-average operating margins, good cash flow generation capabilities, and strong credit metrics."

The tax preparation industry is highly competitive and Block competes with many independent tax providers, as well as online and software companies that offer similar services. With about 15% market share, Block is the world's largest consumer tax service provider with brick and mortal locations that assist customers with tax preparation services. The company's DIY online business is relatively small and generates only about 10% of revenues from tax preparation fees. The DIY segment is dominated by Intuit Inc.’s Turbo Tax, which has steadily captured a growing share of the overall tax return market as the number of self-prepared tax returns filed electronically has expanded. We expect Block to promote its DIY online business more in the coming years and believe it will modestly increase as a portion of its sales over the next few years.

Block's performance during the past tax season was below our previous expectations. Revenues declined about 1% during fiscal 2016 because of lower client volumes in the company's assisted and DIY tax preparation segments, and, to some extent, due to foreign currency market conditions. In our view, Block has lost some market share to other independent tax return preparation service providers, and to Intuit's Turbo Tax, whose aggressive pricing strategy allowed it to gain share in DIY space. We believe the industry dynamics will continue to change, with ongoing migration of the consumers to
DIY service.

Block stated that it is undertaking aggressive steps to address declining client volumes and acquire new customers. The company plans to review its product offerings and pricing strategy, and intends to use resources from its cost savings program to invest in business ahead of the 2017 tax season. In our view, these efforts should help the company stabilize its revenues and margin during 2017 tax season, and we believe the majority of taxpayers will still use assisted tax preparation services.

S&P Global Ratings could consider a lower rating if we believe the company is unable to increase its U.S. tax volumes and its profitability continues to erode. In our opinion, this would indicate that Block continues to lose its market share to other tax preparation providers in the industry. A negative rating action could also result from more-aggressive financial policies, such that the company issues debt to finance shareholder-friendly initiatives and we believe debt leverage will remain above 2x at end of the fiscal year.

A revision of the outlook to stable would be predicated on our belief that the company has stabilized its market share and could deliver profitable revenues growth over the next one to two years. We would expect the company to demonstrate modest revenues growth and EBITDA margin expansion as an indicator of turnaround performance trends.