H & R Block Inc (HRB) 2003 Q3 法說會逐字稿

Good afternoon, my name is Mitch, and I will be your conference facilitator today.

At this time, I'd like to welcome everyone to H&R Block's third quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period.

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

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

Thank you.

I will now turn the call over to your host for the afternoon, Mr. Mark Ernst, Chairman and Chief Executive Officer.

Mr. Ernst, please begin.

Thanks, Mitch.

Good afternoon and welcome.

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

With me today are Jeff Yabuki, our executive Vice President and Chief Operating Officer, Frank Cotroneo, SVP and Chief Financial Officer, Becky Shulman, our Treasurer, and Mark Barnett, our Director of Investor Relations.

Before I begin my formal remarks, I need to remind that you various comments we may make about future expectations, guidance, targets, estimates, plans and prospects for 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 important factors, including those discussed in our third quarter press release and in H&R Block's filings on form 10-K, form 10-Q, and form 8-K, which are on file with the SEC.

A copy of these prepared remarks will be posted to our investor relations portion of our website at hrblock.com shortly after the conclusion of this call.

So we're going to, again, go through a number of details and you'll have an opportunity to go back and verify some of the things we say to the extent we go too fast.

I'd also mention that as long as you're at hrblock.com, if you haven't done your tax returns yet this year, we'd be happy to serve you.

Before we start, I also want to take a moment to recognize the dedication and hard work of our thousands of associates.

Seasonal tax professionals, franchises, and of course our thousands of H&R Block Option One [INAUDIBLE] and H&R Block financial advisors associates, a large number of whom are shareholders, whose work serving the needs of our clients make the results we'll talk about today possible.

I'd like to personally thank you for your hard work and efforts that lead to the continuing strong performance we have as a company.

Thanks very much.

I'm pleased to report that H&R Block again delivered record results for the third quarter.

Our solid financial performance was achieved through good results in the tax segment and another outstanding quarter in our mortgage operations.

GAAP earnings for the third quarter were $132 million, or 73 cents per diluted share, compared to $30 million or 16 cents per share last year.

This includes a $78 million after-tax gain from sale of residual assets that we announced in early November, for what we have referred to as the RENIM.

Earnings including this sale were -- excuse me, earnings excluding this sale were $55 million, or 30 cents per diluted share, nearly double last year's levels.

Third quarter revenues grew 31% to $958 million, compared to $734 million a year ago, driven primarily by the strong performance of our mortgage operations and solid growth in our U.S. tax businesses.

Our cash flow in the third quarter also continued the trend of strong year-over-year growth.

Our cash earnings as measured by GAAP net earnings and adding back after-tax amortization expense of acquired intangible assets improved $103 million, or 261%, to $142 million, or 78 cents per diluted share.

This compares to cash earnings of $39 million, or 21 cents per diluted share, in last year's third quarter.

Excluding the cash we received from the RENIM, cash earnings from operations were $65 million, or 35 cents per share.

We have a number of highlights that I'd like to point out before we go into the results in depth.

One is the continued strength of the Option One and H&R Block mortgage businesses.

We've been saying that results from these businesses hit record levels every quarter for several years now, and this quarter is no exception.

The business models that we operate are showing consistently strong growth that is resulting in tremendous levels of free cash flow generation to H&R Block shareholders.

In the tax business, January results were again solid this year, despite a very difficult comparison from last year.

Last year, as you will recall, January results were bolstered by the rate reduction credit, which did not exist this year.

Nevertheless, this year's January results included growth in returns prepared and average fees and impressive performance in our e-solutions business that help drive strong revenues and pretax earnings in the quarter.

As Jeff will discuss in a few minutes, tax return growth slowed through mid February.

A series of reasons explain this, including a mid February snowstorm that disrupted operations as it moved across the country.

This effect extended into last week as well, beyond the currently reported period.

For the last several years, we've been building our capabilities to deliver tax services to clients in ways -- the way in which they choose to be served, whether it's retail, online or software.

This multichannel capability is both convenient to client and competitively differentiating, as we're the only company who is able to offer all three services under a single brand in the tax marketplace.

We see these multichannel offerings as an important driver of improving retention, building lifetime client value, and introducing a whole new generation of consumers to H&R Block services.

Having the full suite of do-it-yourself products makes us relevant to the approximately 50 million people who prepare their own tax return each year in addition to concentrating on the available clients in the [INAUDIBLE] operations side of the tax market.

Also, by carefully educating our large client base of retail clients about our proprietary digital capabilities, we may capture clients that would otherwise defect to a different tax service provider.

This year, we're seeing clear indication that our multichannel tax strategy is taking hold.

Let me turn to Jeff Yabuki to discuss more about the tax results.

Thanks, Mark.

Our U.S. tax operations - which includes U.S.-based tax services, payments related to refund anticipation loans, and e-solutions - reported quarterly revenues of $404 million, a $32 million or 9 percent increase over last year's third quarter.

The 9 percent revenue growth was achieved despite a decline in refund anticipation loan, or RAL, revenues of $6 million resulting from the change in our refund anticipation loan participation agreement with Household Tax Masters.

Pretax earnings increased $9 million, or 35 percent, to $34 million, compared to $25 million last year.

Growth in the number of clients served during January, combined with a higher average fee per client, and improved performance in e-solutions, were the primary contributors to the improved earnings this quarter.

Through Jan. 31, returns prepared by company-owned and franchised operations increased 5.1 percent, compared with the same period last year.

Total clients served for the quarter - including both retail and e-solutions clients - increased 6.9 percent over the prior year.

Refund anticipation loans, or RALs, processed by Block in January increased 7.7 percent to 1.9 million.

As we previously announced, this year we waived our right to participate in RALs in exchange for direct payments of a waiver fee Compared to last year, this had the effect of reducing revenues in the quarter from RAL participations by $6 million.

For the period Jan. 1 through Jan. 31, tax preparation and related fees of company-owned and franchised operations increased 13 percent, compared to the same period last year.

Consistent with our expectations, the average fee per client rose 8 percent to $124.21, compared to $115.01 last year.

And the average charge per tax return rose 10.4 percent to $103.09 compared to $93.43 last year.

The increase in fees for the quarter includes the impact of demand based pricing that was implemented in late January.

All indications are that demand pricing will deliver the anticipated results with virtually no price resistance by clients.

Demand pricing was removed as planned at the end of the peak period in February and we plan to re-institute demand pricing during the late season peak period.

The period ending Feb. 15 was weaker than expected for our retail offices.

While it is too early to know for sure, it appears that taxpayers have less urgency in filing their tax returns this year.

Information recently released by the Internal Revenue Service indicated that total tax returns filed as of Feb. 14 were up 1 percent from the prior year.

Taking a deeper look at the IRS data, you will see that the relative increase in returns filed so far this year is due to substantial increases in e-filing behavior.

The increase in e-filing dramatically expedites the processing of returns, which would otherwise be mailed to the IRS for processing.

This has the effect of artificially inflating the reported number of returns received by the IRS at a given point in time.

In contrast, our company-owned retail office clients e-filed at an already high 96 percent rate, a 1 percentage point increase over the prior year, which further highlights the difficulty in comparing our retail office results to the market data supplied by the IRS.

Our estimate is that individual tax filings are actually down 2 to 3 percentage points as of Feb. 14.

That said, through Feb 15, the number of tax returns prepared by company-owned and franchise operations declined 0.5 percent compared to the same period last year.

Total clients served - including both retail and e-solutions clients - increased 2.2 percent.

Tax preparation and related fees increased 7.6 percent.

The average fee per client was up 8.7 percent to $125.73, and the average charge per return rose 10.7 percent to $108.41.

While overall unit results through Feb. 15 are below our expectations, we are cautiously optimistic that the lagging consumer filing behaviors of the early season will reverse in the later season.

The lack of a specific catalyst this season, such as last year's rate reduction credit, the later distribution of tax information such as W-2s, and the continuing uncertainty in the geopolitical landscape all appear to be impacting the timing of tax filing behavior.

As Mark mentioned, we also believe that early results are being negatively impacted by the challenging weather in parts of the country that should also reverse later in the season.

On the positive side, we are seeing early indications that our new client retention initiatives are having a positive impact on the business.

Based on the mixed results in the early part of the season and the continuing impact of the environmental conditions, we would encourage investors to model retail tax unit growth at the lower end of our range of 2.5 to 4 percent growth for the full year until there is better clarity about this year's filing patterns.

Let me turn now to our e-Solutions initiatives, which include our TaxCut software and online tax solutions In this line of business, revenues increased $2 million, or 11 percent to $19 million.

The pretax loss for the quarter improved to $5 million, a $7 million improvement over the third quarter last year.

The improved operating performance is related to the increased revenues and also continuing containment of our technology and client support costs relative to revenues.

Again, as we saw last year, the substantial majority of growth in the digital do-it-yourself category is coming from the online tax market.

As Mark mentioned earlier, we believe that our multichannel tax strategy is starting to take hold for us, and we are taking share in the do-it-yourself category.

For context, the IRS issued statistics through Feb. 14, indicated that self-prepared e-file returns were up 1.1 million units versus the same day a year ago.

We are pleased to announce that for the same period, self-prepared returns using H&R Block services represented just over 41 percent of the total growth in this part of the U.S. market.

Through Feb. 15, our paid online clients were up 123 percent over the prior year.

We are also experiencing strong growth in our online attach rates for additional products, such as state tax returns, which serves to increase our online revenue per client.

We also continue to build and develop services to bring tax advice and professional services to online consumers.

Through Feb. 15, we have experienced a 145 percent increase in the number of clients that have purchased an online professional service delivered through one of our tax professionals.

While this is on a relatively small base, we continue to believe that providing customized tax advice to people, regardless of the channel, to be an important point of differentiation for the Company.

In software, we are proud to announce that for the second consecutive year our tax preparation product, TaxCut from H&R Block, received virtually all of the number one ratings awarded to consumer tax software.

The 2003 list includes the prestigious top ratings from PC World, PC Magazine, Wall Street Journal, Barrons and the New York Times.

We also introduced a new higher-end Platinum product that is doing well in its initial year.

Third quarter revenues from TaxCut and other software were down slightly over the same period last year, due largely to the timing of rebates, which we expect will level out later in the season.

Although relative numbers of new users in the software market continue to slow, our federal unit sales have increased by 3 percent over the prior year ,according to published NPD data as of the week ending February 8.

Our international tax operations - which include Canada, Australia and the United Kingdom - generated revenues of $9 million during the third quarter, an increase of 10 percent compared to last year.

A pretax loss of $6 million was $500,000 over last year, and is primarily due to timing of expenses.

Now, let me comment on the investment services business.

The third quarter results for H&R Block Financial Advisors saw a continuation of the challenges faced over the last many quarters.

Three consecutive years of highly volatile and down investment markets, combined with the current geopolitical uncertainty, continue to plague the retail investment industry.

Investment Services revenues for the third quarter were $48 million and were stable compared to the previous quarter, and declined $13 million compared to the third quarter last year.

This quarter's pretax loss of $32 million compares to a pretax loss of $22 million in the previous quarter, excluding the impairment charge taken last quarter and a pretax loss of $12 million in the third quarter last year.

With revenues remaining essentially constant in the second and third quarters, the increased sequential loss is primarily related to investments for the future of the business.

Initiatives to replace our back-office system, and strategically expand our tax professional referral program, among others, resulted in some additional third quarter costs.

With the new system and related products in place, we anticipate a return to expense levels generally consistent with that of the first two quarters of the fiscal year.

These quarterly loss figures also include approximately $7 million of continuing intangible amortization.

As in the previous several quarters, and consistent with the prior year, we continue to see weakness in two of our main drivers of revenues: trading volume and margin lending.

Third quarter equity trading volume was down 39 percent over last year.

The related equity transaction-based revenues declined by $8 million, or 35 percent Net interest revenue was $8 million in the third quarter, compared with $12 million in the prior year.

On a sequential basis, however, these sources of revenues were essentially flat, and margin balances have remained nearly constant for the last three months.

Our third revenue source, those revenues associated with both packaged and fee-based products, increased by $7 million, or 49 percent, from a year earlier, and decreased 7 percent from the prior quarter. 60 percent of retail, non-interest revenues for the quarter came from sources other than the sale of direct equity investments, consistent with our developing strategy.

Based on what we see in the short-term environment, we don't expect results to improve in our fourth quarter.

Now, let me now 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 One and H&R Block Mortgage Corporation, the retail mortgage operation of H&R Block, both delivered exceptionally strong results again this quarter.

We continue to benefit from three well-performing origination platforms and a solid reputation for client service that allows us product pricing that is generating strong margins

Pretax earnings rose to $262 million, compared to $77 million in the year ago period and $154 million in the previous quarter.

Excluding the pretax gain of $131 million from the ReNim transaction, pretax earnings from operations were $131 million.

My remarks will focus on operational results, and accordingly, the impact of the ReNim is excluded unless I note otherwise going forward.

At quarter end, Option One's servicing portfolio was $29 billion, an increase of $6 billion over the same period last year.

Third quarter loan production totaled $4.5 billion, an increase of 17 percent over the previous quarter and 57 percent over last year.

Revenues, excluding the ReNim gain, for the third quarter were $266 million, up 48 percent over last year and down 3 percent sequentially.

Compared to last year, revenue growth was primarily driven by an increase in both conforming and nonconforming originations, resulting in additional gain-on- sale revenues of $68 million.

Revenues from our servicing business experienced a $9 million increase.

Originations volume in our retail mortgage operations were up 42% compared to last year, demonstrating the momentum that we are building in our effort to serve H&R Block clients.

Our net gain-on-sale was 4.60 percent, compared to 4.78 percent in the previous quarter and 3.82 percent last year.

Compared to last year, the increase in net gain was driven primarily by higher execution on securitizations, which by the way were driven primarily by lower CAP costs in those transactions.

The weighted average interest rate charged to non-prime borrowers during the quarter was 7.94 percent, compared to 8.24 percent in the previous quarter and 8.82 percent a year-ago.

The decline in the rate that we charged to borrowers is a result of sustained low interest rates and a flattening of the yield curve.

Although the decline has the effect of narrowing our spreads, pretax profit margins on loans originated are still strong and are well within our planned expectations.

We continue to manage our mortgage business to optimize cash earnings from originations.

Cash proceeds from the sale of third quarter loan production (excluding the ReNim) were about 80 percent of the total gain-on-sale, compared to 84 percent in the second quarter.

The fact that such a high percentage of our gain-on-sale is cash is significant, because it means only a small portion of our gain-on-sale revenue is dependent on future loan performance and related prepayment and loss assumptions, which I will discuss in detail in just a moment.

In the quarter, the percentage of our non-prime loan sales settled through securitizations increased due to comparatively superior cash execution in the securitization market versus the whole loan sale market.

Of non-prime loan sales completed during the quarter, 75 percent were securitized, with the remaining 25 percent sold in whole loan sales.

This compares to securitizations of 28 percent in the second quarter and of 99 percent in the third quarter of last year.

The mix between whole loan sales and securitizations is dependent upon a number of factors, but is highly dependent on our assessment of how to best optimize the level of cash received for production in any given quarter balanced against the value we receive for it.

The operating profit margin within our mortgage operations was 2.70 percent for the quarter, compared to 2.28 percent in last year's third quarter and 299 basis points in the previous quarter.

Compared to third quarter last year, the increased operating profit margin is primarily attributable to increased gain-on-sale proceeds.

Credit quality remains strong on our non-prime originations.

On a FICO score basis, our average FICO scores for non-prime originations continue to improve and averaged 606 for the current quarter originations, compared to 604 last quarter and 597 for the third quarter a year ago.

Average loan-to-value remains steady at 79 percent.

It should be noted that our loan-to value has remained at the 78 to 79 percent range for several years now.

As you know, in early November we announced the completion of the sale of some of our mortgage residual assets.

In this transaction, we monetized part of the value of the write-ups that we have taken in our residual assets over the last year.

We sold residual cash flows from 12 previous net interest margin transactions, or NIMs, that paid off sooner than expected because they generated cash flows higher than originally anticipated.

We believe the $142 million in cash we received from this ReNim transaction is very solid evidence that the assumptions we use in valuing our residual assets reflect real market value.

Net of accretion that would have otherwise been recorded, the ReNim contributed an additional 33-cents per diluted share of income in the quarter.

For those who are tracking the numbers behind this ReNim, you may recall that we indicated the gain would be about $122 million when we announced the ReNim in early November.

Our estimate of the fair value of residual assets at that time was based upon second quarter interest rate assumptions.

Approximately concurrent with the closing of the ReNim transaction, the Fed lowered rates by 50 basis points, which ultimately increased the fair value of our residual assets and our reported final gain by $9 million.

On a full year basis, the ReNim transaction will contribute about 26 cents per share of incremental income.

The reason that the full-year incremental contribution is lower than the third quarter contribution is because this transaction had the effect of eliminating accretion and unrealized gains from residual write-ups of about $21 million or 7-cents that would have otherwise been recognized in the fourth quarter In a moment, Frank will discuss the balance sheet impact of the ReNim transaction.

We remain highly confident of our mortgage operations.

Originations remain very strong across all of our origination channels.

Loan performance continues to exceed modeled expectations.

As both our whole loan sales and securitizations are non-recourse transactions, it is important to note that our risk, as it relates to loan performance, is essentially limited to the valuation of residual assets and mortgage servicing rights on our balance sheet.

We model our residual interests based on a very cautious outlook against historical prepayment experience, cumulative losses and forward interest rates.

We then discount the expected cash flows.

As the value of these residual assets is based on future performance, we continuously monitor the reasonableness of our assumptions relative to actual loan performance.

Actual non-prime loan performance remains well within our modeled assumptions.

We are currently using a weighted average 4.75 percent cumulative loss assumption.

Our worst performing vintage year is 1995, and with 96 percent of the pool paid off, cumulative losses are 390 basis points.

Cumulative losses for all other vintage years are less than 3 percent, compared to our 4.75 percent total loss assumption in our evaluation model.

Our forward interest rate assumption is that 1-month #LIBOR will rise from its level at the valuation date, which was then 1.38 percent, to 5.00 percent over the next 12 months.

Our weighted average discount rate is 16.5 percent.

With respect to loan prepayments related to our production, prepayment rates are very predictable as about 80 percent of our non-prime loans include a prepayment penalty during the first two years.

Accordingly, we see relatively low prepayments while the penalty is in effect, and very predictable prepayments once the penalty expires Even in this sustained low interest rate environment, we are not experiencing any unusual change in prepayment rates, which remain within our modeled expectations.

As actual overall performance has been better than our modeled expectations, we have experienced net write-ups in valuations over the last five quarters, and Frank will talk about the write-up that we are experiencing this quarter as well.

Delinquency trends continue to be positive.

Using 12-month seasoned data, delinquency rates have been decreasing slightly since January of 2002.

At the end of January, 31-day plus delinquency rates were 13.79 percent, compared to 14.82 percent in January 2002.

We are using 12-month seasoned data to factor out the positive effect that increased origination volumes would have on the overall delinquency rate that would be reported.

Let me just conclude by saying that we continue to manage the business to optimize cash, our originations remain very healthy, we are seeing the benefits of building a business servicing the H&R Block tax client-base, and the small amount of risk that we have retained on our balance sheet is appropriately - yet conservatively - valued.

Turning to business services, revenues in this segment declined 6 percent over last year to $101 million.

Mid-single digit revenue growth in our core tax and accounting services was partially offset by declining revenues in consulting services due to selective downsizing of unprofitable service lines.

The continued recession in manufacturing and the cautious business environment are the primary contributors to the slowdown in consulting services.

The pretax loss was $4 million compared to pretax earnings of $2 million last year. $7 million of the decline in operating performance was due to planned start-up losses related to building the payroll and capital markets/valuation businesses, offset by operating efficiencies realized through improved productivity and decreased operating costs.

The additional losses in our capital markets business reflect a weak quarter, while the additional losses in the payroll business reflect the fact that we had a significant increase in clients during the quarter - which incur up front costs when they are set-up.

The fourth quarter will be a key period for this business, just as we experience in our tax businesses, as it is highly seasonal.

Now I'll turn the call over to Frank Cotroneo who will review some of the key balance sheet items.

Thank you, Mark, and good afternoon.

As compared to October 2002, several notable events have occurred that impact the balance sheet.

Residual interests in securitizations decreased $113 million during the quarter, from $387 million to $274 million at quarter end.

The decrease reflected a reduction of a net $148 million from the November ReNim, cash receipts of $16 million, write downs of $1 million offset by a net unrealized write-up in the fair value of residuals by $41 million, and interest accretion of $11 million.

The $41 million write-up of residuals was recorded on the balance sheet net of deferred taxes ($16 million) as an increase in accumulated other comprehensive income, OCI, of $25 million.

Notes payable increased from $482 million at the beginning of the quarter to $587 million at quarter end.

The increase in borrowings is related to working capital requirements during the quarter.

The notes payable are expected to be repaid in full in the fourth quarter.

During the quarter, we repurchased 100 thousand shares at a total cost of $4 million, or an average cost of $39.67 per share.

Fiscal year to date, we repurchased 6.6 million shares at a total cost of $317 million, or an average cost of $47.94 per share. 4.4 million shares were issued for option exercises, employee stock purchase plan purchases and restricted shares, of which, 2.6 million were related to seasonal tax professional stock option exercises.

Proceeds from issuance of stock related to these option exercises totaled $113 million.

Finally, we expect the effective tax rate for the full year to be approximately 40.6 percent.

The increase over last year's rate is primarily the result of the non-deductible goodwill impairment charges taken in the first and second quarters.

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

Thank you, Frank.

Before I do that, let me briefly comment regarding the RAL litigation.

As I'm sure you know, it is our overriding objective to do what in our opinion is in the best interest of shareholders with respect to any of this litigation.

I ask that you understand that it is not in the best interests of our shareholders for us to disclose our litigation strategies in these matters and that we are not able to offer speculation as to the outcomes or effects of our strategies.

In the Zawikowski class action case in Chicago, the judge has not yet ruled on the fairness of the pending nationwide settlement.

The Green case in Maryland has been stayed pending the outcome of the Chicago fairness decision.

In the Haese case in Texas, the settlement agreement has not yet been filed and the plaintiffs have not yet filed motions for preliminary approval of the settlement or for approval of attorneys' fees.

Plaintiffs' counsel did file a motion asking the Texas court to direct that $26 million of their attorneys' fees be paid to plaintiff class members.

The court must approve any attorneys' fees, but the defendants in the Haese case have jointly agreed to pay up to $49 million in fees to the plaintiff class counsel.

Let me also briefly comment on an article in this morning's Wall Street Journal that incorrectly compared the proposed Texas and Chicago class action settlements.

These two settlements have entirely different structures, and therefore, comparing them is not only inappropriate, but will lead to inaccurate conclusions about the value of the settlements.

While we do not have standing to object to the Texas plaintiffs' attorneys giving part of their legal fees to their clients, we have opposed attorneys' attempt to make this part of the settlement.

And although we can't predict what the courts will do, we remain firmly committed to our belief that both settlements are fair to members of each class.

Let me now turn to the expectations for the fourth quarter and the full fiscal year In U.S.

Tax operations, based on the results we have seen through Feb. 15, we are modeling the lower end of our revenue guidance of 9 -11.5 percent for the full year.

Our cost control efforts are on track and we continue to believe we will achieve our targeted margin increase of at least 50 basis points within the segment.

Within our mortgage businesses, we expect strong performance through the remainder of our fiscal year.

We can now see that interest rates are likely to remain at or near current levels.

We expect the fourth quarter to be similar to the third in terms of origination levels and margins.

We remain highly cautious in our outlook for the Financial Advisors business.

While we are taking what we feel to be prudent actions on both the cost and revenue generation side of this business to address our weak financial performance, we aren't planning for this business to show meaningful improvement until our next fiscal year.

We expect fourth quarter results to be similar to third quarter performance.

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 very attractive and well aligned businesses that will create value for shareholders in the long-term.

Combined with the recession in manufacturing and a cautious business environment, we continue to expect flat to slight earnings growth within the business services segment.

On a consolidated basis we expect fiscal 2003 revenue growth to be at the high end or slightly above our target range of 10 to 15 percent.

Our current expectation is for fiscal 2003 GAAP earnings per share in the range of $3.10 to $3.25.

This includes the incremental 26-cents from the ReNim, less the 14-cent charge for the Texas litigation settlement and 13-cents in goodwill impairment charges.

We also ought to note that these are non-deductible for tax purposes and therefore raise our overall reported tax rate).

Excluding the impact of the ReNim, the Texas litigation and goodwill impairment charges, we expect cash earnings from operations to be in a range of $3.33 to $3.48 per share, which reflects the additional 22 cents of intangible amortization that we incur.

We will continue to share our tax season results semi monthly with the next report scheduled for March 12.

As we gain better insight into the second half of tax season, we will share any changes that we can see in the full year effect of tax filing patterns.

I want to thank you for joining us today.

We continue to be pleased with our performance given the challenges and uncertainty facing business today.

We remain confident in H&R Block's ability to create sustained growth and additional value for shareholders.

Operator, we'd be happy to open the lines for questions.

Ladies and gentlemen, if you would like to ask a question, please press star then the number one on your telephone keypad.

We will pause for just a moment to compile the Q and A roster.

Your first question comes from the line of Michael Millman with Salomon Smith Barney.

Thank you.

One, maybe you can reconcile your guidance, the 310, to 325 to 290 to 310 previously.

Secondly, maybe you can talk a little bit about how -- why the timing difference and maybe snow so affected February 1 to 15, but the W-2 effect and the strains last year didn't seem to affect and, in fact, did you particularly well in the January period, and then three, on the mortgages, because your sales were so much greater than your originations, does that distort some of the margins in the third quarter?

And should we apply different margins to the fourth quarter?

Let me -- I'm going to -- I'll try to take the guidance question first of all, sort of what's driving this approximately 15 to 20-cent increase in guidance for the full year.

It's a combination of different things, I think partially we are feeling confidence in the tax season that we're in the middle of, and that that will give us more confidence that some things that we believe will happen in that business financially are delivering the way we expected.

We are also seeing continued strength in our mortgage business which is in excess of what we had previously been sort of cautiously modeling.

As we are now entered into already the fourth quarter, we can see both our pipeline, we can see the, you know, the level of originations that are continuing now through February as well as where the pipeline is, and that gives us a lot of confidence that this is going to be a very solid quarter.

Those are probably the two things that I would point to that are, you know, kind of driving that.

I would say that's also a little bit offset by we've seen continued weakness in the financial advisers' business even more so as sustained weakness than what we thought maybe three, four months ago.

We thought by the spring, we would start to see some more strength and we're not really seeing that.

So those would be the things I would point to.

I'll have Jeff take the, you know, little discussion about the tax results.

Let me comment on your mortgage question.

Because we use a warehouse facility for funding mortgages, the level of originations versus sales don't make a difference in the reported results.

We are reporting results every quarter based on originations, and as those originations go into the warehouse facilities, the gain is estimated as it goes in.

So you wouldn't expect to see a big variation in results based on sales versus originations.

So from a margin perspective, looking into the fourth quarter, we think that it's probably similar to the kind of margins that we've been seeing, we saw it now during the third quarter.

Mike, on the tax question, the W-2 issue is an issue that -- let me just step back.

We have a number of clients who come in in the very early time frame, who don't necessarily receive formal W-2s.

They get tax information from other sources, from government sources, unemployment from states and localities.

Some of that was, people can file without necessarily having the W-2s.

The W-2 issue is obvious for people who have employment earnings, and with the 31st landing on a Friday, it is our belief that that most employers give their W-2s out, especially smaller employers, on the last Friday of the month, which in this case happened to be the 31st.

How that factored in, what we believe, and it's really speculation and anecdotes at this point, in January, is we had a lot of people who came in who are what I would call our hardcore, long tenured loyal clients.

They were coming in in January in a relatively healthy way.

With the W-2s coming in later and the weather starting to come in in the early part of the February, that with not having any catalyst for acquisition this year, as we mentioned, we had the rate reduction credit, which drove, and really which drove business, but without having a catalyst this year, it really just weakened overall kind of urgency around tax filing.

And we continued to see that through the first half of February, and actually a little bit -- as the weather continued to stretch out after the 15th, we continued to see weakness there.

So Jeff are you saying that the W-2 effect really was more fourth quarter -- would be fourth quarter effect that last year's 25th didn't really help January and despite all these negatives, January still was extraordinary strong?

You know, we, you know, we had a very good, solid, January.

And the key thing that is happening, which is inside -- we can see inside these numbers, we are seeing real strong evidence that our retention numbers have been improving this year compared to prior year.

And that was what helped drive our results in January.

At the same time, our new-client acquisition is a little bit weaker than we expected and that, you know, is possibly associated with this rate reduction credit point that, you know, the year-over-year comparisons were very tough because last year early season we had -- and early season meaning early February, you had a lot of new client growth last year because people sort of discovered they didn't understand this, and they then came to H&R Block.

This year's comparative first half of February was a very tough comparison in that sense, and we saw a lot of those first new clients from last year pushed into January this year.

That is a very clear trend that we can see inside the numbers.

So we know we've got a number of sort of odd things going on here that we're trying to sort out.

We actually thought we had, you know, started to see more sort of intelligence of what the trends were all about, and Jeff knows this, I hate to talk about this weather point, but it really messed up our ability to see the numbers and understand what's going on because it just modified a lot of consumer behavior at a crucial time when we were -- we thought we were starting to glean what was going on and what shifts were going on.

It just threw all of our numbers off.

And that, unfortunately, continued in the last week where, in fact, we saw even a bigger impact last week.

So you should now -- know, our next reporting period, it's not over yet, but I would expect we'd be surprised if, you know, you don't see weak numbers again in this next round reporting period because the whole East Coast from Philadelphia, DC, up to Boston, were, you know, closed down for a couple days.

So we have a whole bunch of moving parts, I think is the real point.

What we can see inside the numbers is retention is showing up to be stronger and we're pleased about that.

New-client acquisition is a little bit weaker so far this year than what we had expected and our expectation was driven off of last year's performance.

Last year's performance we can now see, we knew then, but we thought there were other mate gating factors, but last year's performance was very much impacted by the rate reduction credit at this point in the cycle.

And this year we have no comparable to the rebates as we had last year.

Yet you're still saying that your guidance is up partially because of better tax expectations?

Yeah, and that's, you know, that's I guess our internal numbers and our internal models where we have, you know, we went into the season very cautiously and, you know, we can see that things, most notably, our ability to control costs and our margins are, you know, coming in very good.

We are also seeing very strong good performance in our average prices.

You know, we've done a number of things this year around pricing that are proving to work very well.

We're seeing the uptick in average price that we had expected related to complexity.

The mix of clients we're getting is consistent with what we had expected.

Demand-based pricing worked the way we expected it to.

In fact, it maybe worked even better than we expected it to so all in all, you know, we think that we've got much or visible now and confidence in our ability to deliver the bottom line.

Thank you.

Your next question comes from the line of Michael Hodes with Goldman Sachs.

Good afternoon.

A few questions on tax and a few questions on mortgage.

First, on the tax side, just looking at the client growth trends, I was hoping you could comment on the differential between the franchise performance and a company-owned performance.

This appears to be the second year in a row where the franchises seem to be noticeably ahead of the company-owned offices.

And then secondly, I'm trying to back out the impact of the demand-based pricing on the price increase.

I just want to confirm that that price is up, were up roughly 5% absent the demand-based pricing.

And then just lastly on tax I was hoping you could just give us a backdrop of perhaps another tax season or two in the last 10 years where you really had a particularly strong finish, just so we have some more context around the kind of late-break to the season.

And then I want to know after that, when you answer that, I have a quick question or two on mortgage.

Okay.

Well, on the franchise growth rates versus company-owned, we've been studying that issue, trying to get underneath of it for some time.

You know, the estimate that we have, or the impact that we think we are seeing is that many of our franchises operate in suburban territories that surround or ring some of the larger cities.

And so as you've seen more and more population growth continue to push out into the suburbs, versus the inner city, that growth, population growth, is increasingly occurring on the, you know, sort of outer rings where our franchises operate.

Versus many of the company operations, again, this is all relative at the margin, our company operations tend to be more dominant in larger, metropolitan areas where you're seeing less population growth and, therefore, you're seeing less sort of, you know, absolute growth in the company versus franchise.

So that's, you know, one of the hypotheses that we had heard, was that it had something to do with pricing and pricing differentials, can't see that at all.

In fact, you'll see, I think, this year, the average price that we're seeing in the franchise operation is every bit as large, if not larger than what we're seeing in the company.

So that doesn't explain it.

You know, as best I can tell or we can tell, this continues to be sort of a structural aspect of where the company operations are versus where the franchise operations are.

Jeff, the impact the demand-based pricing had on the price increase so far this year?

It represents about $2.50 a return for the first 15 -- for the first six weeks of tax season.

So the average price per return is up 10.7%, and about 2.5% of that.

So we're seeing about an 8% increase absent the demand pricing so far.

It reflects some of the complexity shifts we knew were out there.

The price we put into the system reflected, I think, the 4% price increase that we had expected across the board.

As well as the first of the clients who come in the first half have a little bit more, we think, room in a price-value relationship.

So we've skewed a bit more of the price increase to the first-half clients as opposed to to the second-half clients.

We don't think it will stay up at that eightish% level.

One thing I'll add here that I think is important, is that we are seeing clear evidence in our numbers thus far this year that client satisfaction with the price-value relationship is up fairly strong this year.

And that's really good new his for the long-term and is something that we paid very close attention to this year with the delivery of advice the way we do, we've been doing this year, and some other changes in operations trying to drive consumer perception of value, satisfaction with value to ensure that we have long-term sustained ability to move price.

And so far, so good.

We're seeing very good performance there.

Last question you had was, you know, could we point to a year, even in the last decade, where, you know, sort of the pattern was as this one is, where, you know, you start slow and finish strong.

You know, my sense is, you know, I think we're hearing this across our organization, most everybody whose been in the business many, many years, are saying we are experiencing a very unusual filing pattern this year.

Something that people have not seen maybe since the early '90s.

Unfortunately, our data doesn't go back and doesn't really do a good job of breaking out for us what the pattern was back then.

So I'm not sure that we could look at, you know, the place where we have relevant and useful data in the last three, four, five years, and use that as a guide because it's unlike anything that we've seen in that period of time.

Okay.

And then just quickly on mortgage, I want to make sure, the appropriate adjustment for the ReNIM transaction is 33 cents net of the accretion that you otherwise would have recorded if you had not done the sale?

That's right.

And then you will see another seven-cent decrease in the fourth quarter net of what we would have otherwise recorded had it not been done.

The 33 cents is the net number for the third quarter.

The mention of 40 cents is a gross number?

Yes.

That was the absolute gain recorded.

But had that transaction not occurred, 7 cents of that would have occurred as accretion this quarter.

And then a basic question on mortgage, I apologize, then I'll get off the call, it looks like versus the third quarter, loan sales were, you know, up, I think you said 17%, gain on sale margin compressed a little bit, yet the number that you're showing for operating income versus the third quarter was down.

And without getting the detail or maybe you could just offer us the detail on a breakout of the quarter, it's a little bit surprising just how it pencilled out.

Maybe it has to do with the loss of the accretion income, but there's something the way you're presenting it that doesn't quite --

Yes.

One of the elements is the loss of the accretion income.

I'd have to go back to the detail to be -- I know that one is part of it off the top of my head.

We saw a little bit of shrinkage in the margin quarter over quarter, but it wouldn't be a lot to explain it.

I'd have to go back to the detail to give you a specific answer.

Maybe, Frank --

Michael, just give us a call, we can circle back with you on that.

Okay.

Thanks a lot.

Your next question comes from the line of Chris Gutek with Morgan Stanley.

Hi, Mark, I wanted to follow up on some of the timing questions with the tax business, not to beat a dead horse, if these various issues, if they were purely timing issues, you wouldn't necessarily have to reduce the volume growth guidance for the full fiscal year.

I'm curious, is the reduction on your part purely an increased conservatism, given the uncertainty or are you basically saying the better than expected retention is not enough to offset the weaker than expected new client acquisition rates?

Two things I'd say, then I'll get to the specific question, but I point out, we're not saying there's a reduction, we're saying from our internal modeling purposes, we're using the lower end of the range that we've had out there.

And I tell you, that is, you know, being prudently conservative at this point in the cycle with what we're seeing in the sort of noise that we have in the numbers, it would be not responsible for me to talk about the numbers, you know, other than conservatively.

So he I'd say that's a significant piece.

You know, the things that are going on are really kind of hard for us to read.

We know that retention is showing good performance, you know, the problem with any of that is that, you know, to look at intraseason retention at any one point in time is a little bit dangerous because you can, just like we're seeing shifting in overall market filing patterns, we might be experiencing shifting in our client retention numbers as well.

So you know, it's a little dangerous to, you know, fully extrapolate that and say that's the full-year effect.

Also when it comes to the new client, we know that our sort of complex, higher value clients are typically later-season clients.

And some of our growth is expected to come from the new offices that we would expect are going to perform better in the second half because of our placement of those in locations that are designed to attract that kind of caliber of client.

We have shifted a lot of our marketing efforts against higher value clients, and again, those are later filing season client.

So there's a lot of different things that are kind of moving here, and just from a prudence perspective, we're, you know, approaching this thing a little bit cautiously.

Fair enough and, Mark, you referred to the increasing average income levels and moved towards increasingly more complex returns, could talk about that, and maybe compare that to the, I guess it's less than 1% addition to the growth and revenue based on demand based pricing but complexity above and beyond baseline price increase was that a contributing factor?

We started going down the path actually to do the analysis to answer that question and we stopped it because there was so much noise in the numbers that we didn't have the confidence.

If I were to tell you the answer to at that question with what -- the analysis we were doing, that would be 100% accurate, so I don't know precisely what we'd say.

You know, the complexity number is a difficult thing to sort of ascertain in this base, because as you recall, last year, a lot of early filers had the rate reduction credit, the rebate.

That contributed complexity that went away this year.

So we actually, for a large share of the client base, had a net reduction in complexity.

And so we have that as a moving part inside this overall base.

Knowing that there's so many different things that are happening to us, we chose to, I guess, say we're going to have to wait to see how it all plays out.

Finally if I could, the RAL volume was flat, the revenues were down I think more for accounting reasons.

Could you comment on the change?

It's comparable to a year ago, which is what we would have expected it to be.

The big driver in RAL profitability, or profitability of that line item for us, will be the bad-debt levels that occur in that product line.

While we aren't participating in the loan directly, we do have some adjustments in our agreement with household related to the overall performance of the loans that they own.

And so far, so good.

We've used a cautious estimate loan losses for the third quarter, and we think that those numbers are coming in pretty good -- pretty well.

But for the quarter, you know, which is a small part of the overall total, we've used a pretty cautious number.

Great, thanks Mark.

Thanks.

Your next question comes from the line of John Neff with William Blair.

Hi, most of my questions have been answered, just one quick question in terms of why the lower cash realized in terms of the percentage of the gain on sale in the third quarter versus the second?

In the mortgage business.

Yeah, you know, that number is -- moves for a couple of different reasons.

Probably one of the more significant, which is sort of a net positive, is that we had no write-downs or we had very little, I think a million dollars or something in some of the overall residuals.

That write-down traditionally would boost the percentage of the total gain that was coming from cash just because it reduces the gain itself.

We didn't have as much in terms of comparable write-down that go through the income statement.

Overall, what we're seeing in the secondary market is that the NIM transactions, the key to making the cash gain numbers be solid for us, are still holding up very well.

We are getting good, solid execution, we're seeing our NIMs move fairly well.

There's a real strong pool of buyers for that out there.

So, you know, net-net, we're not seeing a lot -- I probably tell you, it's more noise in the overall number than what happens on any given quarter than something that would indicate a trend as far as we can tell.

Great, thank you.

Again, ladies and gentlemen, I would like to remind everyone, in order to ask a question, please press star, then the Number 1 on your telephone keypad.

Your next question comes from the line of Rick Lodrick~(ph.) with John A. Lebanon and Company.

You had a fairly substantial increase both sequentially in prepaid expenses and other current assets.

What does that relate to?

Hang on, I'm going to have -- Frank's looking for the specific number.

You have increase in primarily the services advances and relating assets from Option One of about $44 million is the primary driver of that number.

That change.

Okay.

It was up about a hundred and three sequentially, so 44 of that was was --

Right and the balance of that would be receivables and it's the IO strip, the interest only receivables of about $#155 million.

Okay.

The balance of those two numbers.

Yep.

Okay.

Thank you.

Gentlemen, your final question is a follow-up from Chris Gutek with Morgan Stanley.

A couple quick ones.

Would you guys expect to do another ReNIM.

We are exploring that.

The answer is, we would if it was the appropriate thing to do.

As you know, we have said and we will continue to say, we manage this business to optimize cash coming out of the business and when we can monetize some of these assets, we will do it.

We are exploring that right now now.

We might do something as early as late in the fourth quarter, early in the first quarter of '04.

So we're studying that issue.

Okay.

And then finally: Is the IRS prefiling initiative having any impact either way on your software or website business?

Yeah, it's interesting, you know, of all the things we have going on, the online business is the one where we can get the fastest insight into exactly what's happening.

We can see the numbers as they come in on a minute-by-minute basis almost.

The prefiling alliance is not having any effect at all on our retail office numbers.

We are seeing, you know, that there's no cannibalization, virtually none, of business out of the retail business.

We can see a little bit of that out of our previously paid online service.

We're seeing virtually no transfer of clients from software into the free filing alliance.

So overall, this looks to us to be very much new category entrants, at least for H&R Block, people who have never used one of our other services before who are now using are being introduced to H&R Block.

We think net-net, this is turning out to be a good thing, not because we're making any money at it, which we're not, but because it will allow us to have thousands and thousands, if not more than that, of people who will sort of now be a client of H&R Block, or at last have experienced services from H&R Block for the first time in all likelihood in their lives, and we think it will extend to longer term lifetime value.

Great, thanks, Mark.

Thank you.

With that, let me thank everybody for joining us today.

And as always, if you want further clarification about anything we discussed, please feel free to call us.

Thanks very much.

Ladies and gentlemen, this concludes today's H&R Block third quarter earnings conference call.

Thank you for your participation, you may now disconnect.