H & R Block Inc (HRB) 2003 Q1 法說會逐字稿

Good afternoon.

My name is Allison and I will be your conference facilitator today.

At this time I would like to welcome everyone to the H and R Block first quarter earnings release conference 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 period.

If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad.

If you would like to withdraw your question, press the pound key.

At this time I would like to turn the conference over to Mark Ernst, president and chief executive officer of H and R Block.

Thank you, Mr. Ernst.

You may begin your conference.

Thank you.

Good afternoon and welcome.

Thanks for joining us to discuss our fiscal 2003 first quarter results.

With me today are Jeff Yabuki, executive vice-president and chief operating officer, Frank Cotroneo, our senior vice-president, chief financial officer, David Byers, our senior vice-president and chief marketing officer, Becky Schulman, vice-president and treasurer, and Mark Barnett, director of investor relations.

Before I begin my formal remarks, I need to remind you that various comments we may make about future expectations, targets, estimates, plans and prospects of the company constitute forward looking statements within the meaning of the federal securities laws and are based on current information and expectations.

These statements speak only as of today.

Actual results may differ materially from those indicated by these forward looking statements as a result of various and important factors, including those discussed in our first quarter press release and in H and R Block filings and Form 10(k) and Form 10(q) which are on file with the SEC.

Before reviewing results, I want to also take a moment to thank all of our associates who have worked hard in a challenging environment.

These results we're going to talk about today are the results of the individual efforts of very large number of very talented people all across our various businesses and for that I thank you.

I'm pleased to report today that in a difficult economic environment and with instability in the equity markets, we achieved very strong operating performance in the first quarter.

Achieving an 18 cent per share improvement in operating performance over last year.

Excluding an impairment charge related to investment services which I'll talk about, our consolidated earnings from operations were $1.3 million or 1 cent per share compared to a loss of 17 cents in the first quarter of last year.

Our improved operating results were primarily related to the exceptionally strong results in our mortgage business though performance in all of our other businesses was consistent with our plans for the year.

Our reported gap results for the first quarter included a noncash charge of $18 million.

This charge is the result of the valuation of our investment services segment in accordance with FAS-142. the $18 million reflects our best estimates of the potential good will impairment in the investment services segment.

As discussed in prior conference calls, we established our annual review period for good will as February 1st of each year.

We also monitor conditions that could have a material effect on good will or other intangible assets throughout the year.

Because of the unsettled market conditions of the investment industry and particularly in light of the severe decline of comparable business valuations in July, we felt it would be prudent to valuate the fair value of good will related to the investment services segment and to the end of our first quarter in accordance with FAS-142.

This evaluation requires a two step process.

Step 1 evaluates the fair value of the entire segment versus its carrying value.

Should fair value be above carrying value, no indication of potential good will impairment is determined to exist, then the valuation is concluded.

This has been indicated from the past when we periodically reviewed the carrying value for this business.

However, as was the case in July 31st, should the fair value be below carrying value, this would be an indication that good will impairment may exist and step 2 of the evaluation is required.

Step 2 is a comprehensive valuation of all assets of the business versus their carrying value on the day date of the analysis.

This process will determine the fair value of good will and will be the basis for our final determination of impairment of good will, if any.

We engaged a third-party to assist us in the valuation of investment services to provide an independent view of our methods, our models and our final step 1 determination.

Step 1 indicated that the fair value of the investment services segment was below its carrying value by $18 million.

While the ultimate value of good will will be determined during the step 2 analysis, the $18 million reflects our best estimate of the potential good will impairment as of July 31st, 2002 and our decision to book this charge reflects our commitment to take a prudent approach to both our valuations and the timing of any charges. the second step of the analysis is underway which we expect to complete before October 15th. the ultimate amount of the impairment will be determined in this step 2 analysis and may be more or less than the $18 million recorded in first quarter results.

We will report any material change in our estimate when they are known.

In total for the quarter our reported results including this charge improved by $21.2 million to a loss of 9.$5 million for the first quarter or 5 cents per share compared to a loss of 30.8 million dollars or 17 cents per share last year.

Revenues in the quarter increased 31 percent to 43 $1.4 million compared to $329 million in the year ago quarter. the strong growth in revenues is primarily attributable to mortgage operations with double digit growth in our U.S. tax and business services segment also contributing to the growth.

Our cash flow in the first quarter also tend to trend a strong year over year growth.

Cash earnings as measured by gap nets loss and adding that after tax amortization expense of acquired intangible assets as well as the good will charge improved $40 million to 18.$6 million or ten cents per share compared to a loss of $21.4 million or 12 cents per share in last year's first quarter.

Now I'm going to ask Jeff Yabuki, our chief operating officer, to review the financial results from several of our business segments.

Thanks, Mark.

Our U.S. tax operations reported an increase in revenues for the quarter of $3.8 million or 20 percent to $23 million.

The increase was driven primarily by revenues related to our peace of mind service.

Pretax loss for the segment increased $12.8 million to $94 million versus $81.2 million last year. the primary drivers of the increased expenses were 4 million in additional personnel costs, mostly related to changes in the field organization. $3 million in field occupancy expenses or increases in rent and systems costs, and about $2 million of expenses related to product development and consulting fees.

We also incurred about $2 million of expenses in the first quarter that in the previous year were incurred in the third and fourth quarters.

While our total spending during the first quarter was higher than last year, we were within plan levels and is typically the case in the first quarter represent preparations for the upcoming tax season. with respect to spending, we continue to be prudent in the light of the current economic environment.

Accordingly, we are exercising discipline cost management, balanced against funding longer term strategic initiatives.

At the same time we are maintaining our target of the 60 basis point improvement in operating margin for the full year.

For the upcoming tax season we have a number of strategic initiatives underway.

For competitive reasons, I won't yet be specific about this year's focus.

However, I do want to address the Internal Revenue Service's recent announcement of Freon line federal income tax filing.

The IRS recently announced that a consortium of private firms have tentatively agreed to provide free online tax preparation to qualified taxpayers.

Government's main objective is to make electronic filing more accessible to the public.

We have been and will continue to be a significant supporter of electronic filing.

Although we believe our participation in this program to be a net positive for our business, as we expect to introduce many new taxpayers to the H and R Block brand, we do not expect any material impact to our operating results for the year. the primary benefits to us from this program are that the IRS has no incentive to creep into the tax preparation business and we benefit from free marketing of our on line serves and referral of on line traffic to our web site.

Our revenues associated with this service will be built through individuals who are directed to our site, but do not meet the federal tax - the federal tax qualifications.

State tax preparation and filing and the delivery of advice and other ancillary services to on line consumers, we are pleased to be a key member of the consortium.

Our international tax operations which include Canada, Australia and the United Kingdom, generated revenues of 4.$3 million during the first quarter, down $500,000 compared to last year.

Pretax losses of $6.5 million increased from $5.7 million last year primarily driven by normal increases in operating expenses in Canada.

In Australia the tax season is in full gear and while it is too early to know for sure, indications are that we are on track to achieve our client growth objectives.

In investment services the first quarter operating results for H and R Block financial advisors saw a continuation of the challenges base over the last two years.

Steep declines in equity valuations coupled with high volatility and a weak economic outlook have kept retail investors on the side lines.

Revenues for the first quarter were up $2.9 million to 58.$7 million compared with 55.8 million dollars in the last quarter of fiscal 2002 reflecting slightly better sequential results.

Revenues in the first quarter last year were 68.$9 million.

Investment services had a pretax loss of 32.8 million dollars including the $18 million charge compared to a pretax loss of 27.3 million in the prior quarter and a loss of $6.1 million in the first quarter last year.

Excluding the good will charge, the improvement in operating performance over the prior quarter is largely attributable to an increase in revenues and one time expenses incurred in the fourth quarter for advisor retention and closing our equity trading operation.

As in the previous several quarters we continue to see weakness in the two main drivers of revenues, trading volume and margin lending.

First quarter trading volume was down by 4 percent compared to the prior year, but up slightly in terms of average daily trades over the previous quarter.

Equity transaction based revenues declined $2.9 million or 14 percent from last year and $356,000 or two percent from the previous quarter.

Total revenues, excluding margin interest, were up $3.9 million or 9 percent over the previous quarter and $1.8 million or 4 percent over the prior year.

While equity based transaction revenue saw declines, total revenues related to fee based accounts introduced in October 2001 were nearly $1.6 million for the recent quarter representing a $567,000 improvement over the previous quarter.

This is reflective of the shift from transactional revenues to fee based and packaged products.

Indicative of the shift in product mix 63 percent of retail noninterest revenues for the first quarter came from sources other than the sale of direct equity investments.

These revenues are concentrated in fee-based accounts, mutual funds and a rapidly rising base of annuity and closed and fund offerings.

Transition from a transaction base organization to that of consultative and planning oriented sales continues to progress, albeit in a challenging environment.

Interest income on margin accounts decreased $12.1 million or 52 percent from last year.

At the end of July margin balances totaled $680 million compared with 845 million at the end of the previous quarter and $1.26 billion a year ago.

One of our key initiatives this year is to build revenues through the addition of experienced financial advisors to the organization.

Through the end of the first quarter we've added 72 experienced advisors and it is our expectation that we will continue at a similar pace through the remainder of the fiscal year.

We believe that the combination of the challenging financial services environment, existing leverage in our field structure, and the unique opportunities with our tax client base provide us an excellent economic opportunity that will build scale for future results.

At the same time we are experiencing little or no attrition of our veteran financial advisors.

We had a total of 1,780 advisors as of July 31st.

Now let me turn the call back to Mark for a review of our mortgage and business services operations.

Thanks, Jeff.

Our mortgage operations which primarily include option 1 and H and R Block Morgan corp. our retail mortgage operation delivered exceptionally strong results again this quarter.

We continue to benefit from the unusual environment in that interest rates are remaining at low levels which are generating historically high margins.

Revenues for the first quarter rose 69 percent to $250.3 million compared to the same period last year and we're up 11 percent over the previous quarter.

Compared to last year revenue growth was driven by by an increase in nonprime production resulting in additional revenues of $41.3 million, increased gain on sale of our mortgages for $19.7 million, increased interest income of $46.4 million, and increased servicing income of six and a half million dollars.

Revenue growth was partially offset by associated higher origination expenses of $12 million due largely to the increase in production volume.

Revenue growth from our retail mortgage operation continues to grow nicely and was up 76 percent over last year.

Pre-tax earnings rose $147.1 million compared to $66.8 million in the year ago period and $102 million in the previous quarter.

Costs associated with the strong revenue production performance included an $11.2 million increase in compensation expenses as a result of the higher volume, increased servicing costs of three-and-a-half million dollars related to the increased size of the servicing portfolio, and increases in all other expenses of $7 million.

As of this quarter option 1 servicing portfolio was 26.8 billion dollars, an increase of 7.$6 billion over last year.

In addition, we are continuing to benefit from the better than expected cash flows associated with our residual interest.

As we have mentioned on previous calls, due to the low interest rate environment many of our net interest margin bonds are paying off 12 to 15 months early which has translated into increased cash collections and write ups in residual valuations. the continued low interest rate environment has positively impacted the expected cash flow to the point where it was appropriate to write up the value of the residual securities.

In the first quarter our residual balances increased $32.4 million.

This increase reflected accretion of $16 million and new additional write uptake enthis quarter of $77.9 million, cash receipts of $41.3 million, and write downs of $20.4 million.

We continue to manage our mortgage business no, sir maximize cash earnings from originations.

Cash proceeds from the sale of first quarter loan production were 88 percent of the total gain on sale.

It is important to note that for nonprime production the percentage of pure rate and term refinancing to total loan originations or those types of refinancings that are driven by the rate environment has not changed significantly despite the continued decline in interest rates. the operating profit margin within our mortgage operations increased to 368 basis points compared to 255 basis points last year and 297 basis points in the previous quarter. the increased operating profit margin is primarily attributable to higher spreads due to the low interest rate environment combined with improved productivity.

Operating profit margin is defined as pretax earnings before amortization and accretion on residual write ups provided by our mortgage fundings. with respect to loan performance, our losses and prepayment rates generally remain at or below our expectations, or better than our expectations, reflecting the quality of our servicing operation and the conservatism we apply in this business.

Specific information regarding loan performance including losses, delinquencies and prepayments is available at our option 1 web site.

Turning to business services, revenues rose 12 percent over last year to $95.3 million primarily as a result of the increase in revenues associated with our acquisitions and [inaudible] evaluation and corporate finance firm, and my benefit source a payroll processing company which were acquired in December 2001.

Partially offset by declining revenues and consulting services due to selected downsizing of unprofitable service lines. a recession in manufacturing in the cautious business environment are the primary contributors to the slow down in consulting services.

Pretax loss was $4.3 million compared to $2.2 million last year.

The increased operating loss was due to planned start up losses related to my benefit source and RSM EquiCo [phonetic].

Partially offset by increased earnings from tax and accounting sever says. the increase in tax and accounting earnings is primarily attributable to operating efficiencies realized through improved productivity and decreased operating costs.

As I mentioned previously mentioned we we are not planning any significant acquisition activity within our business services segment in fiscal 2003, though we will likely conduct some smaller acquisitions.

Our focus for the next year will be on execution of our growth strategy to ensure that we are appropriately integrating products and services such as wealth management, payroll evaluation services into the business model.

Although we expect RSM EquiCo to break even by fiscal year-end, losses related to the payroll business will continue throughout the remainder of this fiscal year and into fiscal 2004.

Now let me turn the call over to Frank Cotroneo who is going to review the balance sheet and some corporate items.

Thank you, Mark, and good afternoon.

As compared to April 30th, 2002, several [inaudible] impact the balance sheet.

Our cash decreased from $436 million to $378 million at the end of the first quarter. the decrease is largely attributable to payments made for share repurchases and dividends during the quarter and net changes in quarter end working capital. [inaudible] cash increase from 152 million to 242 million primarily as a result of 106.9 million of higher segregated cash balances being held at HR B.S.

A for the benefit of clients.

Residual interest increased 32.4 million from 365.4 million at year-end to 397.8 million at July 31st, 2002 as Mark previously noted.

As you may recall from our fourth quarter call, accounting for write ups is different than accounting for the initial residual so the valuation methodology is the same.

Fair market value [inaudible] credited to other comprehensive income and deferred tax liability on an approximate 60/40 split.

Both are then amortized into earnings over the remaining life of the securitization.

In this case the first quarter $77.9 million write up [inaudible] as increased in other comprehensive income of 48.1 million.

Receivables from customers, brokers, dealers and clearing organizations decreased $164 million to $680 million during the quarter due to continued deterioration of market conditions.

Accounts payable to customers, brokers and dealers decreased by $62 million to 841 million.

Notes payable increased from zero at the beginning of the quarter to 156 million at quarter end. the increase in borrowing is related to funding share repurchases, dividend payments and other working capital requirements during the quarter.

During the quarter we repurchased 7 86,000 shares at a total cost of 36.6 million or an average cost of $46.57 per share. 6 30,000 shares were issued for option exercises, employee stock purchases and restricted shares.

Beginning September 1st, and continuing through November 30th, our seasonal tax associates have the opportunity to exercise their stock options.

There are a total of 4.7 million seasonal options outstanding.

These options carry a two- year life and are granted seasonal tax associates based on productivity and represent an important element used in seasonal associate retention.

Given the strong performance of the stock, we anticipate the majority of those options will be exercised and accordingly we expect heavy trading volume during the beginning and end of the eligibility period.

I'll now turn the call back to Mark who will discuss our earnings outlook.

Thanks, Frank.

Before discussing our outlook for the remainedding quarters let me comment on a couple issues related to corporate governance.

Our deadline for filing of the CEO CFO certification associated with our first quarter Form 10(q) is September 16th.

We certainly plan to meet this deadline and execute the certifications without exceptions.

With respect to expensing stock options, we're studying this issue and expect to announce our position at our annual shareholders meeting which will be held on September 11th. with respect to the litigation that's been going on involving our major franchises, the trial court ruling that H and R Block has the right to terminate the major franchise agreement at the end of the current renewal periods is currently on appeal.

In Missouri court of appeals heard the case in April and we expected a decision some^time this summer.

It's our understanding that all decisions of the appellate court have been delayed and the decision is not likely until some^time this fall.

Now looking forward, we believe the outlook for fiscal 2003 continues to be very positive for our company.

As we said in our last call, historically H and R Block has benefited from significant tax law changes.

Since the recently past tax legislation use the approach, we believe changes will continue to positively affect our tax business. for planning purposes however we use cautious assumptions for setting spending levels knowing that once tax season arrives there is little chance to reduce costs if revenue growth isn't what we had expected.

Overall, within U.S. tax we are using a 9 percent revenue growth rate in setting our spending levels and targeting a 60 basis point margin improvement.

This will allow us to again see double digit earnings and cash flow growth from this business.

Within our mortgage businesses we expect 2003 to be another very good year.

On our last call we indicated full year pretax earnings growth for our mortgage segment to be in a range of 10 to 15 percent based on the planning assumption that rates would move significantly higher later over our fiscal year.

Moderating our profit growth as the year progressed.

We can now see that interest rates are not likely to rise as fast as our original planning assumptions anticipated and we now believe that pretax earnings growth will be more likely to be in the range of 35 percent to 50 percent.

In addition, we continue to manage this business to optimize the cash generation from the business over time.

This year we expect that we will generate more cash than the businesses earnings, about $100 million more resulting in a reduction in our residual interest balances by year-end. with interest rates at 30- year lows and cash flow receipts are far exceeding initial projections on new residuals, we have recorded increases of approximately $229 million in our residual assets over the last year.

We are evaluating the potential to money ties a significant portion of this buildup in residuals as early as the coming quarter.

If this occurs, we would generate cash that could be dedicated to our share repurchase program while reducing our residual assets on the balance sheet.

This could also give rise to a significant amount of nonrecurring gains as the write ups that have been previously been recorded as other comprehensive income are realized through a sale transaction.

If this occurs, we will provide more information at that time.

We remain highly cautious in our outlook for the financial advisors business.

Our revenue outlook is for a slight increase year over year. for planning purposes we factored into our assumptions little change from the current operating environment.

We expect to maintain this cautious view until we see a sustained improvement in market conditions.

While we're taking what we feel to be a very prudent actions on both the cost and revenue generation side of this business to address our weak financial performance, we don't expect this business to show meaningful results until our next fiscal year.

For the current year I'm expecting some improvement as the year progresses, but still a significant operating loss.

As I mentioned earlier, we are investing in a number of start up businesses within our business services segment that will moderate our reported results.

However, we believe these to be a very attractive and well aligned businesses that will create value for our shareholders in the long term.

We expect a very - excuse me.

We expect a few small additional acquisitions this year, but primarily focus on execution.

I'm looking for solid earnings growth [inaudible] from a relatively small base from this business.

On a consolidated basis we expect revenue growth to tall within our target range of 10 to 15 percent.

Our current expectation is fiscal 2003 earnings per share growth of 21 to 30 percent targeting a range of $2.8 0 to $3.

This includes the effect the 10 sent effect of the impairment charge that we have reported this quarter.

Any impact from the sale of residuals would be in addition to this amount.

In conclusion, we are pleased with the strong results we are reporting today.

Overall fiscal 2003 is off to a great start.

As always, we are prudently managing the off season losses in our tax operations with preparation for the upcoming season well underway.

In addition, we continue to invest in growth initiatives that we believe will create shareholder value over the long term.

I look forward to updating you on our progress again next quarter.

And with that, Allison, we'd be happy to open the lines for questions.

At this time I would like to remind everyone, in order to ask a question, please press the star then the number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q and A roster. [Pause.] Your first question is from Michael [inaudible] of Goldman Sachs.

Good afternoon and congratulations on the [inaudible] showing in the quarter. a couple questions on the mortgage business.

First, given the guidance that you just gave, Mark, am I understanding it right that mortgage will be - could be at the high end of that range, roughly as big as tax?

And then secondly and perhaps this is for Frank, could you go through in perhaps a little bit more detail the components of the [inaudible] there was a write up as well as a write down?

I'm kind of curious what drove the write down portion.

And then lastly [Write down] given the IO write up last year, maybe you could give us a sense of what portion of that IO write up flowed through earnings [inaudible].

Thanks.

Sure.

I think the forecast that we would have on mortgage for the full year is not as large - assuming we don't have a residual sale, which we are exploring, the earnings that we would have for mortgage would not be as large as the earnings that are coming out of tax.

They are getting to a point where they are very large. and as we have been managing the business to generate significant amounts of cash flow out of that business and really managing the business to optimize cash, that we think is a good thing.

So in general I think your estimate or your initial numbers on how big that is likely to be for the year is probably accurate.

Frank can talk as far as the residuals and write downs are concerned?

Sure.

Mark went through the numbers in the script.

Let me give it to you once again. the total balance of residuals increased 32.4 million there was some component pieces there.

First the increase coming in which we'll talk about in a Minute, you had an additional write up in the quarter of 77 million, cash receipts that we've been talking about strong cash flow performance or cash receipts coming down are reducing those residual balance and write downs are approximately 20 million.

Now, when we talk about the process that's employed for the write ups and the write downs, it's important to understand that each transaction or each tranche of residuals and/or NIMs need to be revalued based on interest rate forward curves, based on losses and based on prepayments having to do with the respective pool.

We have pools of loans going back as far as 1999 all the way through 2002.

Each one of those has been revalued relative to the assumptions that were put up at the time that the original securitization was done and so they agree there is a change in value, that value is marked in.

So what we've got is a situation of over 20 different tranches, each of them revalued representing in large part the increase in value because of the change in interest rates, and some of those decreases because of performance and some of the older loans with respect to losses.

To the degree that those older loan pools had losses, we do not expect that that will be a significant trend to be continued through the next [inaudible] for this year.

You had another question as to of the 77 million or 78 million write up we took this quarter, how much of that was reflected in the earnings for this quarter?

No, no, the question was there was a 150 million write up if I remember correctly last year.

I was just curious how much of that flowed through earnings in the July quarter.

You can see [inaudible] the press release we have our cash flow statement.

On the cash flow statement you can pick these numbers up specifically, but basically we have accretion of residual of 38.7, 38.8 million dollars and then we have a write down of residuals coming through the income statement of $20.4 million.

Those are the two sort of relevant numbers.

I thought, though, the accretion was just adjusting for just the present value of the cash flows.

Mike, the exact answer to your question is $23 million of the 10 $5 million write up we took in the fourth quarter, took the P and L in the form of accretion in the first quarter.

Thanks a lot.

You're welcome.

Your next question comes from Michael mill man of Salomon Smith Barney.

Thank you.

I guess a couple questions some relating to the mortgage as well.

It looks like the first quarter increase in mortgage was probably 15 cents, at least better than most of us expected, a share and maybe you as well when you had originally given your guidance.

So I was wondering if you're being super conservative in just taking into account the first quarter improvement in mortgage and not the rest of the year.

Secondly, and maybe this relates to that, could you maybe repeat again, if you had this residual sale, I believe you're talking about, I'm not how much are we talking about that you might realize, and to what extent would that take away earnings that would have been amortized over some future years?

And then maybe you could also tell us on the tax business, do you expect '04's tax - U.S. tax business to show a better than or less than increase than in '03?

Let me try to get those.

Are we being conservative?

Certainly the first quarter - the mortgage business in this first quarter was substantially stronger than what we had expected when we first gave guidance early this year.

We had anticipated, as I think we said at that time, that by now we would begin to be experiencing a declining rate environment and therefore, you know, a lot of things that have been driving these results would not be occurring.

Most notably we're seeing real strength in secondary market for [inaudible] securities and for whole loans that's allowing us to generate substantial amounts of cash out of this business.

Our current expectation is that while the current quarter will continue to be very strong, that the rate environment will start to push - rates will start to push up later this calendar year and that by the - our third and fourth quarters we will not be seeing the kind of strength that we have in the mortgage business right now.

So - and if you can tell me where rates are going, we can tell you whether that's conservative posture or not.

So, you know, we clearly are trying to avoid getting ahead of ourselves with where these numbers could be, but I think clearly we can see into the next quarter that we are continuing to see real strength, probably not as strong as we just finished with, but we're seeing real strength in the business.

On the notion of selling residuals, we think that, you know, from an environmental perspective, given the strong cash flows that are now coming out of these, if we had the opportunity to monetize those assets, it would be a smart thing for us to do, although I'm not saying we will absolutely do that we really are testing the market to see whether or not it's an attractive thing for us to do or not.

In the event we did it, we would estimate that there is something in the order of $100 million worth of residuals that could be mono advertised.

If that happens, we would bring those earnings or the amount of that as a gain out of OCI and into our gap reported earnings and that would be a separate item from what we have - we've talked about in terms of guidance.

That would have the effect of reducing the earnings for the balance of the year by about 16 cents so you would bring in something in the order of 40, 45, 50 cents something like that of earnings, and then it would reduce future earnings for the balance of the year by about 16 cents.

So, yeah, that's our, you know, sort of very, very high level estimate at the moment.

Those sound like the sales of the second coming of the NIMs.

That's what they are, other yes. and basically for those people who aren't familiar with this, basically we normally would secure ties and then in a secondary transaction we sell the net interest margin bond to the degree we can, and we keep just a very, very small sliver of the transaction.

Those loans, those loan pools have performed so much better than we had modeled that we are now starting to receive the cash flows from those transactions, even after the residual holders, the NIM holders are paid off. and we believe that given the strength of those loan pools, we have the opportunity to again resell those residual cash flows and take that out in the form of cash. and that's what we're exploring in the market.

Obviously, we don't know if it's going to get done. and pricing is going to drive, you know, both whether we do a deal as well as what impact it has on our earnings per share.

That's part of the reason why we are not including it in the guidance that we have right now because, again, until we know better, the opportunity that exists in the market, we won't know whether we'll do something here.

On the tax question, whether we will see sort of better '03 results growth versus '02, Jeff maybe wants -

Actually '04 versus '03.

You're jumping ahead of me here, another year ahead?

We're in a hurry.

We're in '03 now.

So -

I'm asking about '04 when some of the initiatives that you didn't want to talk about start to affect '03 and then maybe to a greater extent '04 what that might mean.

Well, you know, what I can assure you is we will give you as much visibility as we have on that when we get into January and some of the current year plans get better developed. the key thing that we know will not affect us this year that we believe we can have some impact on is the retention rate of our client base.

We know also that sitting here today we can't have much affect on that for the cup uming fiscal year, current upcoming tax filing season. the things that we could have done or should have done or might have done to effect retention for the upcoming year had to have happened by now.

So, you know, the real focus that we have on improving the retention rate is going to be a multi year process, something we're working very hard on.

We have a lot of research underway, both - and we are developing some tests of things that we think could have an effect, but until we get through at least one more cycle, I'm not sure I really know how to answer that question.

It's possible, if you want to be optimistic on some of these initiatives, that you could be getting the benefit in '04 and that's kind of where my question was.

Yeah.

No question about it that, you know, we are - many of the things that we're working on right now will only start showing up in '04.

So depending how much confidence you want to have in us and our ability to figure those things out, it would be out in '04.

Thank you, Mark.

Your next question comes from [inaudible] of Morgan Stanley.

Congratulations on a strong quarter, guys.

Maybe I'll start with Mark with a quick follow-up question on the mortgage business then jump over on the tax side.

But on the mortgage side, assuming you don't engage in the monetization transaction I'm curious what schedule you would set for today for the value of the gains to be accreted into earnings from the mortgage business over the next three quarters of this current fiscal year.

They're worth about 20 cents a share.

Would that be fairly evenly spread over the next three quarters or front loaded to some extent?

It would only be slightly front loaded, but a little bit.

Okay, great.

On the tax business, Mark, can you give us a better sense of the revenue and earnings coming from the peace of mind warranty product and how that compares with the year ago?

This is Jeff.

It's up about - the peace of mind itself is up maybe 60ish percent, but as you remember from the program, we basically take those revenues into income over a 39-month period.

So you have a compounding effect of last few years and that will continue to compound as you continue to see peace of mind sales grow.

As they grow or change, you'll see an out year effect on that.

We're now seeing the out year effect [inaudible] strong performance for the last two years.

That's right.

We've seen the penetration of that product, I think it was 21 percent two years ago, 27 percent last year.

Would you expect that to go materially higher in the last year?

No.

In fact, we're really taking a look at the product and finding out what are the next iterations, if any, of that product.

But we think we're getting very close, if we're not already at a ceiling for the penetration rate on that product.

What would determine the ceiling?

Probably more - most importantly is how many of our clients really, really would benefit from having that product and what it represents given their personal financial situation.

The other thing I I think you have to factor in when you think about a ceiling is because of the seasonality of our work force, there are a series of challenges that you have any time you do a product introduction and this is in its third, fourth year and this is about the time where you start to hit to what you can actually do or what you can - how much you can actually put through to the clients and have it make sense in the interview period.

So it's getting up to the time where we're at its natural level of penetration.

Okay. and then final question if I could also on the tax business, I think the last two years we've seen you guys close a few of the offices on average over the last two seasons.

And the context I guess I was a little surprised to see the occupancy cost and the personnel cost up even though the dollar amounts weren't that significant.

Could you give us a little more detail in terms of what's happening with the cost structure and why the occupancy and personnel costs are up from last year?

Yeah, a couple of things going on, Chris.

Probably the - even though we have been not necessarily closing offices, but basically staying relatively flat for the last couple of years, along with our upgrade work, we've been changing our locations.

So while you don't have any necessarily any material net growth, what you do have is new locations and in some indication cases those locations are more expensive.

The other thing is frankly over the last several years real estate prices in the strength of the economy, real estate prices are up and most of our locations rotate on a three to five- year lease and we're just kind of in the middle of those leases, kind of the ones that we were renewing over the last three or four years, those are kind of catching up.

Again, it's a little bit like peace of mine.

It has that compounding effect.

This time it's somewhat of a negative as it relates to the cost structure.

On balance, we probably renegotiate anywhere from ten to 25 percent of our leases every year.

So, again, even if you don't have - even if you don't have the net new, you still have changes to your occupancy costs. the other big driver in the occupancy costs, we're looking at that somewhat globally.

As we talked about on several occasions, we've made a number of changes to our systems and a number of those changes included increases in our infrastructure cost around connectivity.

So we have some fairly significant increases in our connectivity expense line.

All that together leads us to have the increase in occupancy, and I would reiterate that that was a planned expense.

We knew that was coming; no was surprise there.

On the labor cost side, the biggest driver to that is that we've had some changes in our kind of field employee structure where more of our employees are now entitled to benefits and really other ancillary add on costs as opposed to having more people on staff.

That's really driving a lot of our cost structural change. and again planned for, Chris.

Okay. and just to be very clear, what you're saying is with 9 percent organic revenue growth in the tax business you would expect a 60 basis point margin improvement but if you got more man the 9 percent revenue growth based on the cost structure you modeled out the margin improvement would be greater than 60 basis points is that a fair statement?

Incrementally speaking yes.

Okay.

Great.

Thank you.

Next?

Your next question comes from Rick I sand letter of M and imminence capital.

Hi, guys.

Two questions somewhat related.

First question, you talk a lot about why you've had such great success in the mortgage business and I keep hearing, you know, rates have stayed very, very low.

Could you kind of talk about your performance relative to your own expectations on the pools on both losses and then maybe prepayments and sort of rates what you guys thought, what would happen given to each of those individually, and then secondarily to the extent that we're in a historically low interest rate environment, maybe things can't get better and you guys are putting huge increases on numbers that people didn't think were sustainable any^way, any thoughts on whether we should expect let's say '04 to be a down year in the mortgage business and you just can't repeat it, not that it's necessarily bad, but if you could talk about that?

Sure.

On the underlying performance of the loans in these loan pools, there are several - I'd say, you know, it varies so I would speak generally about them because we look at each pool individually.

But as a general rule, on virtually every measure that we look at, delinquencies, prepays, the levels of loss that are in the pools as well as the credit rates, we are outperforming on virtually every single measure.

Now, you know, some of that is we think attributable to our natural conservatism and how we try to look at that business. and a big part of it we also believe is the quality of the servicing platform that we have in the way in which we service those loans creating real incremental value through the way we actively manage the loan pools or the loans themselves through our servicing business.

So in general, it's a little bit of all those things, and there's no one answer to that. the primary thing, quite frankly, though, that is leading to this significant out performance in these underlying loan pools and what's driving our residual values is the credit rate and the interest rate environment.

We have in many cases a loan pool where the underlying bonds are tied to a floating rate or a livor rate, livor based rate and the loans themselves don't reprize for many 18 months or 24 months. and as a result of the decline in rates that we saw in 2001, we are benefiting because those cash flows from allowed us to pay down those bonds dramatically faster than what we had expected.

That is, you know, the primary thing that is leading to us having this significant out performance that we're now talking about.

So that I wouldn't expect that could last forever and that's part of the reason request we're talking about money advertising these things and turning that into a share repurchase program.

We believe that that is a prudent thing for us to do when we get sort of a windfall of cash flows to give that back to our shareholders in that form.

In terms of terms of how you look at '03 versus '04, '03 is clearly shaping up to be a dramatic, you know, another very, very good year for us.

We have put in place measure that will allow us, we believe, to continue to grow our origination volume, so our internal models would have us continuing to grow originations into '04 and '05.

We don't think that either our business or our industry is really at a point as is the nonprivate industry is at a point where we are going to be constrained in terms of our ability to continue to grow origination. the things that are a little bit unique that we don't think will continue into '04, the significant gains on sales that are being realized today are somewhat a factor of the rate environment.

With the low rate environment, it allows us and as we originate some of these loans, these nonprime loans, to get better gain on sales than what we would think is sustainable.

So as we look into '04, you're probably looking at some kind of shrinkage in the gain on sale while we continue to expand the loan origination levels.

I would have told you three months ago that we think that we would show some small growth in '04 off of the plan for '03, with '03 turning out as strong as it is I'm not sure that's still the case, but it's primarily not because '04 is looking any weaker to us but just that '03 is looking strong.

Okay.

That helps.

Is it safe to say if rates aren't exactly what you thought they would do they would be at least in line with your plan maybe a little better because of the performance of the other stuff, obviously the vast majority is because of rates?

The things that are going on inside the business right now, I think our originations are a little bit stronger than we had expected. the gains on sale are substantially stronger than we had expected, and that's really what's driving the variance from our internal plan.

Okay.

Thanks a lot.

Congrats on a great quarter.

Thanks.

Your next question comes from Gregory Hall of hunter global investment.

Thanks, guys.

Actually that last line of questioning covered everything I had.

Great.

Your next question comes from David Duganberry [phonetic] of Deonis Capital.

Hi, good afternoon.

I'm trying to get my hands around your last answer to the questions which were the gain on sale is much stronger than you expected.

So if you could, if you can give me a sense for how much stronger, what did they look like - what were the gains as a percent of the loans and basis points last quarter and then last year versus what you have this quarter?

Sure.

Let me make sure I'm clear about how we define gains on sales so when we talk about this - and we look at them both on a growth level and on a net level. the current environment, what we're seeing is that we're getting about, oh, 5, 580 to 600 basis points of growth gain and in fact this quarter much of that came through home loan sales.

So it's not, you know, that's not our accounting gains. the accounting gain is the cash gain.

Netted against that is our cost to originate so that we look at what the net value is.

We are looking at a net value this quarter of 368 basis points.

That compares to a year ago 255 basis points and last quarter 297 basis points.

So those are the numbers that are driving this. the 368 is - that is almost entirely or the increase over last quarter, the 297 up to 368 is almost entirely driven by higher gains on sale, and that we would attribute to strong secondary markets that - where there's a strong demand for asset backed securities today and in fact again, we're seeing strength in the demand for this kind of a product throughout the industry.

We're actually finding home loan Byers where their bids are in excess of 600 basis points.

And then in terms of on a gross basis last year, you were seeing bids in excess of 600 basis points.

Were they half last year?

Last year we were probably looking at bids in the 480 range.

Okay. and then in terms of resize, you just kind of quickly stated that resize weren't a large percentage - were they as a part of the 3.3 billion as they originated this quarter?

I'm not sure I have that number real handy.

If you were to put call into Mark Barnett our director of investor relations he can get you the specifics on that.

Okay.

Are we talking half or one-third?

No, it's less than 10 percent.

Less than 10 percent. and that holds true as far as your pipeline right now?

Yes, our pipeline is looking the same in terms of the mix of - now, let me be clear.

We look at purchase money loans, we look at rate and term refi.

People looking to lower their rate and we talk about cash out refuse.

People looking to take equity out of their home.

When I said it's less than 10 percent refi, that's less than 10 percent refi.

We still do a substantial portion of our business maybe 40 percent of our business which is cash out refi.

If I put them together between cash net and [inaudible] half the business.

I think that is generally right.

But again, we can get you the specific numbers. and then the reason we make that distinction is our experience is that rate and term refi [inaudible] is more volatile based on rates, but cash out refi at least in our part of the industry, they occur in low and high interest rate environments and they're driven more by events, where people are in need of cash than they do driven by the interest rate environment.

If we were to see a slow down in home price appreciation, what kind of impact would that have on the cash out business?

Well, it certainly would have an impact.

There are so many factors that are going through my head on that, I'm not sure I can quickly answer that.

Okay. and just briefly, looking to increase originations into '04 and '05 as you see the year at this point in the mortgage cycle, sounds like a big statement.

I mean, are you looking to dramatically increase your stable of brokers?

How will you increase your penetration?

We're doing a number of things.

We have probably the elite, you know, group of account executives in the wholesale industry today, and we believe that there is an opportunity for us to gain more of the share of the business, the nonprime business from the brokers that we do business with today, and that's really about how well we serve them, how well we design our products to meet the needs of their client, how well we communicate with them.

We're putting in technology in place to allow us to work more closely with the brokers, we're putting in marketing programs and communication programs with our top client brokers to, you know, serve them better and get a bigger share of their business.

So we don't - certainly you wouldn't - we are not predicating our business plan on the industry itself continuing to expand.

We're pen - we're looking at better penetrating the market and gaining share.

Thanks very much.

Thanks.

Your next question comes from Jim Agaw [phonetic] of Millennium Partners.

Hi, guys.

One question on the investment services. the write down and the independent valuation firm that's going to take a second step or a second look at.

It did you say that that was going to be concluded by September of this year?

No, our current expectation is that work will be finished roughly by the middle of October. and current indications are that the $18 million that we booked is a pretty good estimate, but clearly there's a lot of moving parts there.

Our expectation is that it's going to take us probably at least five or six weeks to finish that work so that we would not - I mean the key, a key date in there is we file our queue on the 16th of September.

Our expectation now is that that work can't be finished by that time [Q] so it's going to have to be booked - the update to this number if there is an update is going to have to be booked in the second quarter.

Okay.

So any additional impairment, should there be one, would likely be next quarter?

That's correct.

Okay. and then is any of the valuation of the business or the fair value, if you will, based on margin lending balances and the net interest income that comes off those?

Yeah, effectively it is because we look at you know, a key component of the asset or the intangible value of the client list or the client relationships that we have, and we look at the revenue extremes that are coming off those accounts and clearly the revenue stream for margin balances is down substantially from where it was when they were first valued.

Right.

Not just for you, but for the industry?

That's right.

And then on the mortgage [Streams] someone was asking about the write up versus the write down and the gentlemen was talking about the different tranchees, each one has to be analyzed independently.

Can you tell us a little bit about the credit quality and the age or the vintage of the tranches that were written down?

Was it substantially different than - like was it old vintages versus new - what was the result - what was it resulting from , prepayments or credit losses on those different tranches?

There was a difference that's causing that. the biggest share of that write down that's going through our earnings this quarter through gap earnings this quarter is on some old product that we have not produced or we have not really had now for about three years. and we have some residual interest in that, those old products that we have been writing down and we, you know, do write down. 75 percent of the write down occurred from loans that originated prior to 1999.

So this is not recent vintage stuff, it's old vintage stuff.

The credit quality, I don't know the answer to that whether there's different why credit quality or not.

I know the loan sizes are quite a bit different. the write downs that we're seeing are on smaller loan sizes and in the last several years we've been driving toward larger loan sizes, more A minus kind of production versus the stuff we used to write, that would be a big part of it.

Okay.

Thanks.

Thanks.

Your next question comes from Richard Steinman of Lynwood Capital Partners.

Yes, good afternoon. to what extent have you revamped your process for making assumptions for your securitization?

Is it sort of fair to say that maybe you were too conservative and therefore there was income that should have been realized in previous quarters that's being brought forward or I guess more specifically what can be done to be more on target with your assumptions?

Well, I certainly wouldn't say that the assumptions we used were inappropriate when we originally booked these.

We certainly don't, you know, unlike companies who have gotten in trouble with this kind of accounting, we try - have tried very hard to be, you know, accurate but prudent in our assumptions and be fair with what we're using, but not to stretch to generate earnings in the process.

And I think that continues to be our view of this, that, you know, investors are far more interested in the predict ability and the cash characteristics of this business which we work really hard at.

If you go back and look at the underlying assumptions, the primary assumption that we sort of got wrong, if you will, with the interest rate environment, that is the big thing that is driving this.

Now, clearly we continue to perform at or better than our models on delinquencies, on prepays, on loan losses, but I wouldn't say that we are substantially - that we substantially mismodeled those elements.

What we really are getting the benefit of now that we didn't anticipate was the low interest rate environment.

I guess my concern comes from how you value your servicing rights.

My understanding is that you do the calculations, you're at 50 basis points.

Country Wide is at 160, and WaMu and some of the other thrifts are at 121, 130. and I'm wondering whether 50 basis points is the appropriate servicing benchmark.

In terms of valuing service rights, the key thing is the comparison you're talking about Washington Mutuals and if you look at Country Wide, they're primarily conforming loans versus nonconforming loans are substantially more expensive to service.

So I think that - and if you look at the subprime or the nonprime industry, how they value mortgage servicing rights are 50 basis points is not far out of line with anybody else in the industry [Our 50 basis points].

So from that perspective, I don't think that's the case.

Now, clearly we think there is a real competitive advantage in being in the servicing business but we think it occurs through the loan performance as opposed to booking a lot of value in the mortgage servicing rights themselves.

Thank you very much.

Thanks, Richard.

At this time there are no further questions.

Well, thanks again for joining us for this call.

We appreciate it particularly late in August before Labor Day.

If you have any questions, follow-up questions, please feel free to contact us, and we will talk to you again in the quarter.

Thanks.

Thank you for participating in today's teleconference.

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