H & R Block Inc (HRB) 2003 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

My name is Matthew.

I will be your conference facilitator today.

At this time, I would like to welcome everyone to H & R Block's fourth quarter and year-end earnings release conference call.

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

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

To ask a question during this time, simply press star, then the number one on the telephone keypad.

To withdraw the question, press the pound key.

Thank you.

I would now turn the call over to Mr. Mark Ernst, Chairman and CEO.

Mr. Ernst, you may begin the conference.

Thanks.

Good afternoon and welcome.

Thanks for joining us to discuss our fiscal 2003 fourth quarter and year-end results.

With me today are Jeff Yabuki, our Chief Operating Officer, Frank Cotroneo, our Chief Financial Officer, Becky Shulman, our 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, guidance, targets, estimates, assumptions, 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.

The 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 fourth-quarter press release and on H & R Block's filings on form 10K, form 10Q, and form 8K, which are on file with the FCC.

For the benefit of those of you who are going to try to catch all the numbers that we'll talk about in today's call, a copy of our prepared remarks including any reconciliation of non-GAAP measures, which is a new item, are now being posted to our investor relations portion of our web site at hrblock.com.

So you can facilitate your analysis after the call.

Before discussing the operating results, I would take a moment to personally thank our thousands of associates, many of whom who are listening or will listen in to our webcast.

We have tax and accounting professionals who have served our clients with real distinction, financial advisors who are working hard in the face of a very challenging market environment, mortgage professionals who are setting the standard for how to serve clients' mortgage needs, and the many people who support these individuals to do their jobs well every day.

I want to thank you personally for your hard work and efforts that lead to our continuing strong performance.

I'm pleased to report that we achieved record financial results for fiscal 2003.

By traditional measures of company performance, this was a very good year for H & R Block.

Revenues from our businesses grew 14%, net income increased 34%, and diluted earnings per share grew 36%.

In a challenging economic environment, these numbers describe a company that has had a very good year.

In addition to record revenues and earnings per share, we managed our capital levels prudently, allowing us to post a return on equity of 45%.

The consolidated results we're reporting today are particularly gratifying given a weak economy that has caused many of our nation's leading businesses to report declining financial results over the last couple of years.

We believe our results this year as well as financial results over the last several years demonstrate the strength of our mix of businesses and our ability to generate solid results even in a relatively tough economic environment.

I think the strength of our overall business mix is an attribute of our company that is perhaps often overlooked.

For example, a frequent concern expressed by some investors is the sustainability of the growth we have seen in our mortgage business over the last couple of years.

While we believe our mortgage businesses are much stronger than generally appreciated, I would agree that at some point changing economic conditions might slow the mortgage business growth rates.

Those same factors will likely accelerate growth in other segments, such as our financial advisor business.

We believe the combination of our businesses positions H & R Block for positive performance through various economic cycles and solid revenue, earnings, and cash-flow growth in the coming years.

A very positive mix of businesses that have attractive economic characteristics, controllable value drivers, and an overall balanced profile of risk and return that offsets changing economic cycles.

Turning to our fiscal 2003 results, reported net income increased 34% to $580 million or $3.15 per diluted share compared to $434 million or $2.31 per share last year.

Our results were primarily achieved through another outstanding year in our mortgage operation, and good operating performance in the tax segment.

Our reported result for the year include several items which in the aggregate dilute operating income for the fiscal year.

These items include a $12 million nondeductible impairment of good will in the business services segment that we took in the fourth quarter; a $24 million nondeductible impairment of good will in the investment services segment, taken in the first and second quarters; a $26 million after-tax litigation settlement reserve taken in the third quarter; as well as a $47 million after-tax gain in the third quarter from the sale of residual assets, net of estimated accretion that would have otherwise occurred.

Excluding these items, net income would have been $3.22 per diluted share.

For the year revenues increased 14% to $3.8 billion compared $3.3 billion a year ago, driven by growth in all of our operating segments with the exception of investment services.

Although we believe cash earnings are an important measure of the strength of our mix of businesses and accentuate our focus on delivering free cash flows, we are no longer permitted under new federal reporting standards to report cash earnings.

But you should know we continue to measure the free cash flow generation of our businesses and focus on managing our businesses in a manner that permits an optimal creation of free cash flow.

During fiscal 2003, cash flow from operating activities were about $700 million.

In addition, we received $283 million in cash from our residual interests.

Reflecting our strong financial performance, the board of directors of H & R Block has increased the quarterly cash dividend 11% to 20 cents per share, effective with the dividend payable October 1 of this year.

The board has also authorized an increase in our share repurchase authority of an additional 20 million shares.

Frank Cotroneo will cover more on our share repurchases in his comments.

Before discussing the financial results of our business segments, let me briefly comment on a couple of points.

U.S. tax operations achieved solid financial results through a combination of margin improvement, pricing power, and better-than-expected performance of our E-Solutions businesses.

Additionally, we achieved an overall increase in total clients served in the year in which total tax filings appeared to have declined for only the second time in the last 26 years.

We also continued to see improvement in the client mix which helped drive slightly higher than expected average fees per return.

However, our results this year in the tax segment were mixed.

We were disappointed by the decline in the number of clients served in our retail offices.

Jeff Yabuki is going to discuss more about the causes of this in comments.

For the last several years, we've stressed the importance of managing operating margins in all of our businesses with particular emphasis on tax services.

I'm pleased to report that in our retail tax operations, excluding the litigation settlement charge, we improved our operating margin a full 90 basis points to 28.7% compared to 27.8% last year.

This was accomplished despite an increase in the number of company-owned offices and the decline in retail office clients served through strict attention to all of our spending.

Including the litigation charge, the operating margin declined 170 basis points.

For the last self years, we've been building our capabilities to deliver tax services to clients in the way in which they choose to be served: Retail, on-line, or software.

While this multichannel capability was developed to better serve clients, we think it's now becoming a competitive differentiator for us.

Today H & R Block is the only company able to offer a full range of tax services direct to consumers under a single brand.

This year we saw clear evidence that this strategy is taking hold.

We see this multichannel offering as an important driver of building lifetime client value.

It maximizes our capability to serve and introduce far more consumers to H & R Block's services.

Having a 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 paid preparation segment of the tax market.

Also, by carefully educating our various clients about our other channel capabilities, we're able to keep clients within the brand that may have otherwise defected to a different tax services provider as their needs change.

Another highlight of the continued strength of the option 1 and H & R Block mortgage businesses.

For several years now, these businesses have delivered outstanding results, and the fourth quarter was no exception.

The business models that we operate have shown consistent strong growth that is resulting in tremendous levels of cash flow generation to H & R Block's shareholders with little balance sheet exposure.

In fact, our level of balance sheet exposure to mortgage residual assets showed a decline over last year despite record levels of growth in this business.

As we believe the value of our mortgage operations and specifically our focus on optimization of cash from these businesses continues to be undervalued by the market, this provides opportunities to create value to shareholder by using that cash flow that's generated by these operations for share repurchase.

Strategically we continue to focus this year on a number of efforts that are important to us for the long term.

Key among them are creating an integrated client experience through our tax, mortgage, and financial advisors business, and using advice as the key differentiator.

We continue to make progress, but this is a long-term focus, and much more work needs to be done against this strategy.

Now 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 for delayed refund anticipation loans and E-Solutions reported full-year revenues of $1.9 billion, an increase of $29 million or 2% over last year.

Of the U.S. tax operations segments total increase over last year, U.S. tax services retail operations revenues contributed $60 million.

E-solutions contributed $19 million.

Offset by the expected $50 million decline in refund anticipation or R.A.L. revenues, primarily resulting from the change in our R.A.L. participation agreement with [INAUDIBLE], our partner in the R.A.L. business.

Including the $42 million reserve for litigation taken in the second quarter, fiscal 2003 pretax income increased $14 million or 3% to $547 million, compared to $533 million last year.

Excluding the litigation charge, pretax income grew 10%.

Of the total increase in pretax income over last year, e-solutions contributed $22 million.

And the R.A.L. business contributed $7 million.

Offset by decline of $15 million in retail tax operations.

For the tax operations segment, operating margins excluding the impact of the Texas litigation charge increased 260 basis points over the prior year to 31.7%.

Volume and tax preparation related fees and company owned and franchised offices was up &68 million or 3% over the prior year.

The increase was due to a 7.2% increase in the average fee per client, partially offset by a 3.4% decrease in returns prepared.

Total clients served increased .2%, while clients served in company-owned retail offices declined 4.3%.

In our R.A.L. business, total revenues were $110 million.

As we previously announced during fiscal 2003, waived our right to purchase participation interest and receive license fees for R.A.L.'s, in exchange for direct payments of a waiver fee subject to adjustments based on delinquency rates.

Compared last year, this had the effect of reducing revenues and expenses in fiscal 2003 related to R.A.L. participations.

Pretax income resulting from the R.A.L. business was $104 million, compared $97 million last year.

The primary shortfall for tax services growth this year was in the acquisition of new clients.

Although we've not completed the entire analysis of our tax season programs, we have an understanding of the key drivers that negatively impacted the tax business this year.

Our analysis shows two main drivers negatively impacting client growth.

The first, and we believe largest driver, is the impact of the sustained weak economy on the tax filing base generally, and specifically the impact on our client base.

Prior to tax season 2003, there had only been two occasions in the last 26 years, tax season 1983 and tax season 1993, where the I.R.S. reported a decrease in tax filings for the year.

A common element in each of those decline years was a sustained period of growing unemployment in terms of both the actual unemployment rate and also the duration of unemployment for those people affected, as measured by the number of weeks unemployed.

The data for the last couple of years leading into the 2003 tax season looks similar to the two past periods of tax return decline.

And the results of the season are consistent with this view.

We also saw a corroboration of this phenomenon in the data gathered in our nonreturning client study.

This year's results indicate that 14% of nonreturning clients didn't return because they decided not to file a tax return this season.

A 6% point increase over the prior year.

And although clients directly impact retention and not acquisition, the nonfiling behavior of this group corroborates our analysis that acquisition performance was severely impacted.

We have focused on hiring growing demographics of our client base over the past years.

Again there year, we saw favorable results in attracting new clients in these segments.

As these segments are smaller in absolute size than our core base, we continue to overindex in the more economically sensitive demographic groups.

These groups hit the hardest in the current economic downturn are hampering our ability to attract new clients from the traditional core demographic segments.

But for the impact of the economy, we estimate that we would have likely served 2% to 5% more clients in our offices during the 2003 tax season.

The other significant factor weighing on retail client acquisition this year was a look of perception of either substantive tax changes or strong incentive to modify personal filing behavior.

Last year, our retail business was buoyed by a perception of increased tax complexity and more specifically, the impact of the rate reduction credit on our client base.

In 2002, over 930,000 new clients or about 18% of all clients acquired that year had a rate reduction credit form in their return.

We have concluded over time and exhibited again by this year's client numbers the changes to either tax laws or personal complexity built into unit volume.

In the absence of a catalyst to change individual filing behaviors, our marketing programs and messaging needed to work harder than planned to drive business which did not occur.

The challenge magnified by the war in Iraq that rightfully distracted consumers from focusing consumers during from doing taxes during the season.

The two factors -- the impact of the economy and look of perceived tax changes -- combine to give us weaker than expected client acquisition results.

The good news is that we don't see any internal or systemic issues with our business model.

We did not see shifts in filing behaviors between the do-it-yourself and paid professional markets.

In fact, the paid professional market continued to grow faster than the do-it-yourself market.

Further reinforcing our belief that consumers are continuing to look for assistance and advice to help manage their tax situation.

We do, however, believe that we must work to deliver increasing levels of differentiation so that over the long term our target consumers have compelling reason to pick H & R Block as their preferred tax provider year in and year out.

The results on the retention side of the coin were mixed.

This year, we experienced a decline intention of about 140 basis points for a company operation to 70.2%.

Although the decline was larger than we had expected, we anticipated a possible decrease in retention this year due to the 10-year mix of the aggregate 2002 client base.

Also given the substantial increase in the number of nonreturning clients who did not file this year, we believe our retention performance is stronger than the gross numbers indicate.

We were also encouraged by the results of our retention programs that we tested this year.

We've also been tracking shifts between retail and digital channels and did not see any evidence of meaningful shifts that could lead to cannibalization.

In fact, we kept many more consumers in the enterprise both retail and digital by offering multichannel solutions.

When measuring enterprise retention, we show an increase of 59 basis points over the results of retail alone, which indicates improvement in keeping otherwise abiding clients within the brand.

We were encouraged at the number of clients indicating they left to use a competitor actually dropped slightly year over year.

As we have stated previously, we will continue to focus attention on retention in 2004 and beyond.

There has also been noise in the marketplace regarding retail competition and its impact on H & R Block.

We don't have any evidence that shows greater impact from competition this year versus previous years.

Nor can we find a particular impact from a specific retail competitor.

Data shows that the overall pricing and revenue per return is in line with the brand in competition, excluding short-term discounting that our past testing has indicated is not economically rational.

In many cases, the total that we charge is actually less than the competition.

Even though we have a better brand position.

Not surprisingly, we see weaker business results in markets with higher than typical degrees of competitive density and are taking steps to address the issue in the 2004 plan.

We feel confident that this added focus will benefit our longer term business results.

We were pleased with the performance of our pricing strategy this year and specifically our desire to deliver an enhanced value perception through demand and complexity pricing.

Our goal is to have a pricing strategy that allows us to achieve pricing power in all economic conditions while building a claimant's level of price value satisfaction.

This year's 7.2% increase in average charge is a solid indication that we were able to realize pricing power in a difficult economy.

At the same time, our national client satisfaction scores showed meaningful increases in many of the categories that we measured.

Client satisfaction is critical as a leading indicator of loyalty in future retention, likelihood to refer, and the maintenance of pricing power.

We also believe that the increasing level of client satisfaction are a sign of the progress that we are making in delivering relevant advice to our clients.

We will continue to look for opportunities to better align pricing with value and believe we are on track for the long term.

Lastly, we are pleased with the 90 basis-point increase in operating margin performance for retail tax operations this year.

Margins increasing in spite of adding over 240 net new offices this tax season.

While the new offices did not perform to our internal growth expectations, we realized absolute client growth in all locations.

We believe the majority of the shortfall to be environmental, and we gained important information that will improve our expansion plans in the future.

Although new offices do have the effect of compressing margins in the ramp-up period, we see office expansion as a way to deliver incremental clients and increased profitability for the tax business, while addressing a part of the competitive density issue I talked about earlier.

We are continuing to look for new ways to increase our margins and expect even when adding offices in the future that we will be able to improve our margins each year over the foreseeable future.

Let me now turn to our e-solutions initiative, which include our tax prep software and on-line tax products.

In these lines of businesses, full-year revenues were $88 million, compared with $69 million last year.

A strong increase of 28%.

For the first time, our e-solutions businesses was profitable this year.

Generating pretax income of $9 million compared with a $13 million loss last year.

The improved operating performance is related to a combination of increased revenues, leverage of technology infrastructure, and continuing efficiencies in client acquisition and support costs.

The strong performance of our e-solutions businesses this year had an especially beneficial impact to tax segment margins as these operations are primarily fixed cost businesses.

This year, a total of 3.4 million software units were sold.

An increase of 12% over the year ago period.

Revenues from software sales increased 13% to $61 million.

As a result of higher sales volume.

This increase was partially offset by increases in the number of rebates offered and higher than historic rebate redemption rates.

We are extremely pleased with the progress we have made in our software business, including the launch of our new higher end platinum product, which did well in its initial year.

One of our unique advantages is the integration of Block brand of tax, financial and mortgage advice, into the product experience.

Our ability to offer financial services and customized advice to the tax software user is a differentiating factor that will allow us to build client loyalty and grow in this category.

On-line tax preparation revenues increased 80% to $26 million, as a result of a 96% increase in clients served.

We define on-line clients served as a client who pays for an on-line service.

A client filing a federal and state return on-line is counted as just one client.

The number of paid on-line units rose to 707,000 compared 455,000 last year.

Additionally, our on-line pricing strategy includes a demand pricing component as well as the opportunity for back-end revenues similar to software which combine for a solid increase in the revenue for paid federal clients this year.

A fair amount of the increase in on-line revenues was the result of our participation in the I.R.S.-sponsored free file alliance or F.F.A.

Even though F.F.A.

Even though F.F.A. filers do not pay for their federal return, there were a sizable group of F.F.A. clients who purchased additional services.

A number of companies have agreed to participate in the F.F.A. consortium by offering a free federal return to qualifying taxpayers.

Consumers then choose a provider and enter the tax preparation process.

While we continue to believe that the I.R.S. should focus on tax administration and collection versus tax preparation, it is our intent to continue to participate in the program.

We were pleased that the number of consumers that recognized H & R Block as a company they trust to deliver high-quality tax services via the internet and who decided to embark upon a relationship with the company.

Most importantly, there did not seem to be any material impact in the retail client base this year.

However, given the anomalies of the 2003 tax season, we will continue to closely monitor the impact of F.F.A. on our overall business.

Our on-line products provide clients a range of services beyond digital tax preparation including having a professional review completed by an H & R Block tax professional, view of financial plan, investigate a mortgage or fund an I.R.A., all at their own discretion.

These types of services reinforce the advisory positioning of the company.

Our on-line professionally based products, such as using the on-line channel to have an H & R Block tax professional either review a do-it-yourself return, or do the return for a client, continued to grow.

We experienced a 19% increase in the number of clients that purchased an on-line 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 is an important point of differentiation for the company.

Through our on-line offerings, we continued to attract on-line clients with more upscale demographics and importantly 69% of the new on-line clients were new to H & R Block.

We will continue to focus on providing clients the ability to work with us the way they choose as a key part of our overall distribution strategy.

Our international tax operations which include Canada, Australia, and the United Kingdom, generated full-year revenues of $85 million an 8% increase over last year.

The improvement is primarily due to a relatively strong season in Australia, and favorable exchange rates, offset by a weaker than expected tax season in Canada.

Pretax income improved by $3 million or 48%, to $10 million.

Primarily due better cost management in the U.K., and a favorable comparison resulting from the writeoff of good will in the U.K. in fiscal 2002.

Turning now to investment services, continued low investor confidence and declining stock market valuations combined with the Iraq war in our fourth fiscal quarter continued to suppress retail trading activity.

This negatively impacted commission revenue, net interest margin revenue, and revenue based on assets.

Investment services revenues for the fourth quarter were $44 million.

A decline of 8% compared to the third quarter.

And down 21% compared to the fourth quarter last year.

A pretax loss of $36 million in the fourth quarter compares to a pretax loss of $32 million in the previous quarter, and a pretax loss of $27 million in the fourth quarter last year.

The quarterly loss figure also includes $7 million of intangible amortization.

For the full year, the free tax loss was $128 million, which includes a $24 million good will impairment and $29 million of 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.

Fourth quarter trading volume revenue was down 34% over last year.

The related transaction-based revenues declined by $9 million or 31%.

Net interest revenue was $7 million in the fourth quarter.

Compared with $11 million in the prior year and $8 million in the previous quarter.

Ending margin balances declined 9% compared to last quarter and 39% compared to last year.

Our third revenue source, those revenues associated with both packaged and fee-based products, increased in the fourth quarter by $3 million or 39% from a year earlier and increased 19% from the prior quarter. 68% of retail, noninterest revenues for the quarter came from sources other than the sale of direct equity investments consistent with our developing strategy.

Despite the tough environment, we continue to make progress against our longer term strategies during fiscal 2003.

Replacing the historic transaction-based equity orientation of the firm with a broad-based planning and advice orientation that is consistent with our tax and financial partner strategy.

Through the end of April, HRBFA added new accounts through cross referencing of tax clients.

As we discussed at the January investment community meeting, we are enhancing our business model by building distribution capability into our tax client base with the rollout of the licensed referral tax professional or LRTP program.

This program allows tax professionals to become registered, be teamed with a tax advisor, and share on the compensation generated on business referred to HRBFA.

Each team consists of a financial advisor and five to six LRTP's.

The program creates an opportunity to form a solid relationship with an individual financial advisor and the chance to create a team-based approach to client management.

Through the end of April, the LRTP program had 134 licensed tax pros and there are 360 tax pros in the process of becoming licensed referrers.

We are encouraged by the initial results from this initiative.

For the 2004 planning horizon, we are not assuming any material changes in the financial services landscape.

We have continued to reshape our business model, and on that basis expect improved results in 2004.

We continue to believe in the strategic differentiation that financial services brings to the tax business and the company as a whole.

We will continue to prudently build our capabilities in this business line and deliver improved results.

Let me now turn the call back to Mark for review of the mortgage and business services operation.

Thanks, Jeff.

Our mortgage operations, which primarily include option one and the H & R Block mortgage business, the retail mortgage operation of H & R Block, again delivered strong results this quarter.

While we have certainly benefited from the low interest rate environment, much of the growth coming from these businesses has been achieved by our focus on several controllable drivers, including systematic growth in our distribution capability and channels and significant improvement in the closing ratio and average loan sizes.

Pretax income in the fourth quarter rose to $131 million, compared to $102 million in the year-ago period.

Full-year pretax income more than doubled to $694 million.

But full-year results include the $79 million gain net of accretion that would have accrued from the sale of residual assets in the third quarter.

At quarter end, option one services portfolio was $31 billion, an increase of $8 billion over last year.

Fourth quarter loan production totaled $4.8 billion, an increase of 6% over the previous quarter and 46% over the fourth quarter last year.

Revenues for the fourth quarter were $279 million, up 23% over last year.

Revenues declined 30% sequentially due to the inclusion of the sale of residual assets in the third quarter.

Compared to last year, revenue growth was primarily driven by an increase in both conforming and nonconforming originations resulting in addition gain on sale revenues of $65 million.

Revenue growth was also driven by an increase in the gain on sales percentages for prime and nonprime production.

Origination volume in our retail mortgage operations for the fourth quarter increased 60%, demonstrating the momentum that we are building in our effort to serve H & R Block clients.

Our net gain on sale was 4.4% compared to 4.6% in the previous quarter and 4.4% last year.

The weighted average interest rate charged to nonprime borrowers during the quarter was 7.8% compared 7.9% in the previous quarter, and 8.8% a year ago.

The decline in the rate charged to borrowers is the result of the lower interest rates and the 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 origination.

Cash proceeds from the sale of fourth-quarter loan production were approximately 92% of the gain on sale and for the full year, 83%.

The percentages exclude impairments of residual interest which is a change in the way we have calculated it in the past.

Reflecting this change, cash proceeds in the fourth quarter and in fiscal 2002 were 81% and 83% respectively.

The high percentage of cash relative to our gain on sale 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 second.

In the quarter, the majority of our nonprime loan sales settled through securititizations due to comparatively superior execution price in the securititization market versus the whole load sale market.

Of nonprime loan sales completed during the quarter, 72% were securitized with the remaining 28% sold in the wholesale market.

Over the course of fiscal 2003, 59% of our nonprime loan sales were securitized and the other were whole loan sales.

This compares with 89 % securitizations and 11% whole loan sales in the previous fiscal year.

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

Credit quality remains strong in our nonprime originations.

On a FICO score basis, our average FICO score for nonprime originations remains strong and averaged 605 for current quarter originations compared to 606 last quarter and 601 for the year ago quarter.

Average loan devalue remained steady at 79% for the year.

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

We remain highly confident in our mortgage operations.

Originations remain very strong across all origination channels.

Loan performance continues to exceed modeled expectations.

Both the whole loan sales and securitizations are non-recourse transactions, it's important to note that our risk as it relates to loan performance is primarily limited to the valuation of residual assets and mortgage interest rates on the balance sheets.

As we discussed on prior calls, we model our residual interest based on a 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.

As part of our fourth-quarter evaluation process, we further refined our modeled assumptions to better reflect the current economic and interest rate environment.

As interest rates are likely to remain low through the end of the calendar year, we modeled our forward interest rate assumptions using a spread that rises over the next 12 months to 100 basis points over the forward yield curve.

Our loan loss assumptions have been revised to more accurately -- accurately reflect the timing of losses over the life of the loan pools.

Loss rates typically are lower in the early years, and increase as the loan pools age, then fall in later years.

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

Accordingly, we see relatively low prepayments while the fee is in effect, and very predictable prepayments once the fee expires.

Even in this sustained low interest rate environment, we are not experiencing any unusual changes in prepayment rates, which remain well within our modeled expectations.

The effect of the changes in our modeling assumptions was to write up the value of our newer residuals and to write down the value of more of our seasoned residuals.

Accordingly, during the fourth quarter, we realized a net writeup in residual balances of $28 million, which was -- which are recorded in other comprehensive income on the balance sheet, net of deferred taxes.

In addition, impairments through income of $29 million in the fourth quarter were recorded to reflect the changes.

The refinements to the valuation assumptions resulted in decreased valuations primarily on specific residual interests from 1999 and earlier pools.

Most of the impairments we took are related to borrower and loan profiles that represent a significantly smaller portion of our current production.

While current losses on these specific residual interests are in line with our previously modeled assumptions, we expect economic conditions within this specific group may result in higher loan -- loss percentages as these loan pools age.

Delinquency trends continue to be positive.

Using data reflecting only loans that are 12 months seasoned and beyond, the delinquency rates have been decreasing slightly since January of 2002, which represents the period of highest delinquency rates in the current economic cycle.

At the end of April, 31 days plus delinquency rates were 12.71%, compared to 14.82% in January of 2002.

We are using data reflecting only loans that are 12-month seasoned to factor out the positive effect that increased loan resignation volumes would otherwise have on the overall delinquency rate.

Let me conclude by saying that we continue to manage this business to optimize cash, our originations remain very healthy.

We're seeing the benefit of building a business serving the H & R Block tax client base and the small amount of risk that we have retained on our balance sheets is fairly valued.

Turning to business services, full-year revenues increased 4% over last year to $434 million.

The increase was primarily driven by full year of operations from our valuation and capital markets business in the current fiscal year, compared to only five months in the prior year as the business was acquired in December of 2001.

Additionally, growth in our core accounting and tax services was partially offset by declining revenues in consulting services.

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

In addition, our fourth-quarter revenues were negatively impacted by a deferral in $12 million in revenues in fiscal 2004 due to a backlog of projects resulting from staff shortages in our valuation business.

This deferral reduced what would have otherwise been reported as revenue and income.

For fiscal 2003, we experienced a pretax loss of $14 million compared to pretax income of $23 million last year.

A good will impairment charge related to my benefit source, our payroll processing business, accounted for $12 million of the decline.

Our entry into the payroll business continues to be a key strategic move for us.

However, the business is taking longer to show results on the bottom line and, as a result, we have chose tonight write off any good will that was associated with this business.

Also contributing to the decline were $33 million due to anticipated losses related to initial build-up of the payroll and the capital markets and valuation businesses, offset by operating efficiencies that we realized through improved productivity and decreased operating costs.

The additional losses in our capital markets business reflect a soft economy for business acquisition activity, while the additional losses in the payroll business reflect slower ramp up of our operations and our client base.

Finally, we've made a key change in the management of our business services operation.

Steve Tait, a long-time executive with the Gardner Group, a technology consulting firm, has joined us as the leader of this business unit.

Steve brings a strong business development and performance orientation to this role that is already being felt from the business.

I've got a great deal of confidence in Steve and look forward to many of our investors having the opportunities to meet Steve.

Of now, let me turn the call over to Frank, who will review the key balance sheet items.

Thank you, Mark.

Good afternoon.

We concluded our year with a very strong balance sheet, in line with our operating performance.

Cash balances increased significantly.

And we achieved our targeted debt-to-capital ratio while reducing shares outstanding by 1.5 million shares.

As compared to April 30, 2002, there are several notable balance sheet changes.

First, our cash increased $439 million to $875 million.

The year-over-year increase is the result of cash flow from operations, the sale of mortgage assets, being -- and those two being offset by purchases of treasury stock.

The increasing cash contributed to achieving our total target debt to cap ratio of 35%.

Restricted cash increased by $286 million to $438 million.

The increase was almost exclusively the result of higher segregated cash balances being held at HRBFA as collateral for securities purchased under agreements to resell.

As customer debt of balances have declined, H & R Block financial is required to maintain certain reserve balances for the exclusive benefit of customers with the credit balances pursuant to S.E.C. regulations.

Receivables from customers, brokers, dealers, and clearing organizations decreased by $328 million to $517 million during the year due to continued declines in margin lending.

Mortgage servicing rights increased $17 million to $99 million reflecting the increase in production during the fiscal year.

In addition, residual interest and securititizations increased $101 million during the fiscal 2003 to $264 million.

This decrease reflects cash receipts of $283 million, writedowns of $54 million, offset by a net unrealized writeup in the fair value of residuals by $178 million, and interest accretion of $58 million.

As discussed on prior conference calls, management conducts its good will impairment testing annually in the fourth quarter.

As Mark mentioned earlier, as part of our year-end analysis, an impairment charge of $12 million was recorded related to my benefits source.

No other good will impairments were determined to exist in the annual tests.

An impairment totaling $24 million related to investment services was taken in the first and second quarter.

During fiscal 2003, we repurchased 6.6 million shares at a total cost of $318 million.

Or an average cost of $47.94 per share. 5.2 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.

This is compared to $6.4 million last year in the last fiscal year.

Proceeds from issuance of stock totaled $126 million.

As of April 30, there was 179.6 million shares outstanding.

We remain committed to share repurchases of primary capital allocation tool.

We continue to purchase other alternatives to maximize return on invested capital and shareholder returns.

Earlier today the board of directors approved an increase to our share repurchase authorization by an additional 20 million shares.

This is in addition to the 1.9 million shares remaining under the previous authorization as of April 30.

Finally, the effective tax rate for the full year was 41.2%.

The increase over last year's rate is primarily the result of nondeductible good will impairment charges taken during the course this fiscal year.

Now we'll turn the call back to Mark.

Who will discuss the earnings outlook.

Thanks, Frank.

Before I talk about the outlook for the upcoming year, let me comment on just a couple of things that -- that some of you may have an interest in.

Although I'm probably not going to tell you as much as you'd like to know.

With regard to the R.A.L. litigation, you know, there's really nothing to add at this point, as I'm sure you know.

It's our overriding objective to do what is in our opinion in the best interests of shareholder with respect to any of this litigation.

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

So that the litigation continues and there's not a lot we're going to be able to talk about with regard to that.

With respect to the major franchise operations, you may be aware we have exercised our right to terminate the franchise agreements that were subject to termination.

Under the terms of the agreements, the major franchisees are entitled to compensation in the event of termination.

We're in the midst of conversations with them regarding appropriate resolution of the evaluation.

We expect a positive financial impact to the tax business this fiscal year, but until the negotiations are completed, it's a little premature to assess what the full impact of that will be.

Let me talk about expectations for the fiscal 2004.

Looking to the next year, we believe the outlook to be very positive for the company, even after we adjust or allow for an estimated six cents per share effect from expensing and stock options.

Within the tax business, we believe we are well positioned for growth next year, for planning purposes we use -- we will use cautious assumptions for setting spending levels, knowing that once tax season gets here, there's little chance to reduce costs, if revenue growth isn't what we expected.

We believe the recent tax law changes combined with an improvement in the economic environment will positively impact our tax business.

In the mortgage business, we expect fiscal 2004 to be another good year.

While the interest rate environment does not appear to have a dramatic effect on our level of originations, it does affect our profit margin and performance of retained interest.

We can see that interest rates are likely to remain low through our second quarter, but our current planning assumption is for rates to move higher later in the fiscal year, and will moderate our profit growth as the year progresses.

We remain highly cautious in our outlook for the financial advisors business and for planning purposes, we've assumed market conditions stay essentially flat in fiscal -- in fiscal 2004.

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 prudent actions on the cost and revenue generation side of the business to address our weak financial performance, we don't expect this business to show significant improvement in results until our next fiscal year.

For the current year, I'm expecting some improvement, but still an operating loss.

As I mentioned earlier, we are investing in a number of startup businesses within the business services, and that will continue to moderate our reported results.

Fiscal 2003 should be an easy comparison as we are not expecting any further impairments in fiscal 2004, nor are we expecting the effects of the change in revenue recognition that occurred in that segment.

On a consolidated basis, we expect fiscal 2004 revenue growth to be within our target range of 10% to 15% and GAAP earnings per-share growth of 13% to 18%, even after the estimated six cents per-share effect of expensing of stock options.

The expectations assume that interest rates will remain stable for the next six months, and then see strengthening, while growth in U.S. employment will be weak.

But we do expect improvement.

With that, thanks for joining us today.

As I mentioned at the beginning of my remarks, the results that we have are indicative of the strength of our mix of businesses.

There is also considerable opportunity within our businesses to improve operating performance and to drive additional growth through our longer term strategies.

I appreciate personally the support that we have from our shareholders and the many associates who are the people that make these results happen.

We'll remain focused on achieving our objectives for the next fiscal year and into the future.

With that, operator, we will be happy to open the line for questions.

Thank you.

At this time, I would like to remind everyone, in order to ask a question, please press star 1 on your touchtone phone.

We'll pause for just a moment to compile the Q&A roster.

The first question is from Michael Hodes from Goldman Sachs.

Hi.

Good afternoon.

Thanks for the detailed run down on the call.

Three broad questions.

First pertains to guidance.

Mark, I wanted to make sure I'm on the same page as you.

The 13% to 18% E.P.S. increase, what E.P.S. base are you using?

You know, with the new Reg G, whatever it is, we are trying to be very disciplined and only talk GAAP to GAAP.

So we are talking about our GAAP reported number of $3.15 compared to a fiscal '04 outlook of GAAP now with the option expense item.

Okay.

And then the -- the 13% to 18% earnings growth, should we assume that that's what you're expecting for the tax unit, as well?

You know, I think our tax unit -- yeah, we're going to get into sort of the nuances of where the growth is coming from.

You know, my sense is that I don't know that the tax will be that high.

We're managing margins carefully in that business.

We are taking a cautious view of the business in general.

I think it's going to be, you know, for planning purposes, we're looking at segment clearly to be double digit.

But, you know, you can remember we had the Texas litigation that we wouldn't expect to be a charge into next year.

So you know, if you do GAAP to GAAP, within that segment, I would say certainly we'll be in that range.

Okay.

And then did -- does your outlook include any additional renim transactions?

No, it does not.

That's it for guidance.

On tax, I want to make sure I'm following the -- you know, the rationale that you're giving for the softness on client growth.

On the one hand it seems that you're saying, you know, there was no real step up in competitive activity.

You're also saying that paid preparation, gain share versus self-preparation, and at the same time, we know that the I.R.S. returns were down, but they were down something like 40 to 50 basis points year over year, according to the I.R.S.

Yet when I look at your data, as far as in-office client growth, you know, you're down something like 3.7%, and there was 2% to 3% more stores.

The central reason for the softness is --

Yeah, let me sort of take my version of that.

Then I'll have Jeff weigh in, as well.

You know, we're trying to I guess do a number of things with sort of sharing with you what we have been able to determine as we have analyzed this tax season and really gotten to the heart of what -- what happened or what has been happening in the environment.

What's happening competitively.

And where do we fit with that.

The overriding thing that we can see that is impacting our results is an economic phenomena where in times of sustained unemployment, coupled with, say, longer term people being out of work, you see numbers of people fall out of the filing system.

This has occurred in -- in a number of different times over history, and H & R Block has experienced a decline in the number of filing clients, much like we did this year in all of the different cases.

In -- and Jeff referred to the other two circumstances in the last 25 years or so.

That -- that is sort of the overriding thing that we think is occurring in the market this year.

The people affected by that economic phenomena are people in demographically lower incomes, which is where we're clearly overindex.

In terms of our poor client base and who the brand has traditionally appealed to.

So we are being disproportionately impacted by that phenomena relative to the I.R.S. data So the I.R.S. is still seeing growth at higher income levels, but they're not seeing growth, like we suspect they're seeing shrinkage.

Most of the shrinkage at lower income levels, where H & R Block has traditionally, you know, had its greatest strength.

And as a result, we, you know, we are seeing, you know, a loss of clients in our our lower income demographics.

Saying that, the comment about competition, you're right.

The number of filers who use paid preparation increased again this year.

We think that is part of a longer term trend that is not reversing.

We wouldn't expect it to reverse.

To the extent that people are going to other forms of paid preparation, our data suggests they are going to C.P.A.'s.

It does not suggest that they are disproportionately going to other branded retail tax providers, who talk about their business models more publicly.

You know, we cannot see in our data -- in fact, our data would suggest we lost fewer clients to those forms of competitors this year than we do in the past.

To the extent we lost clients to competitors, we're losing them to people who will continue to move up to the C.P.A. brand as an alternative brand.

Jeff --

You know, Mike, I would say that just to clarify, I do think that we are impacted by competition generally.

And we've been impacted by competition generally ever since -- probably ever since the company was started.

So we don't see any incremental impact of kind of the larger branded retail competition.

And that in fact, we think that in some cases the other companies that may have been publicly talking about this are showing growth not -- they're showing comparative growth because of the tenure of their offices and the size of their system.

We have a more mature system because, as you know, for the last several years, we did not make distribution kind of the addition of locations, an important part what have we were doing.

And as I mentioned, although our new offices didn't perform up as high as we thought they would, they performed pretty well.

And next year, I feel very confident that those new offices will show a very high percentage of increase in returns relative to a very small population of new offices.

And I think -- I think if you took a look at kind of the universe of offices by tenure you would see that to be the case.

So I -- I would say that the competition in general isn't any different than it's been.

Your next question is from Joe LaManna with William Blair.

Another clarification question.

The 33 cents in charges for the full year you talk about in the first page of the press release.

I'm having trouble reconciling that.

I would imagine others are, as well.

Would you list the items that make up the 33 cents.

Sure.

They are -- they are the good will impairment charges.

We we had the investment services impairment charges, and we had the impairment charge that we took fourth quarter of six cents related to our payment business.

Right.

And the -- and the after-tax cost of the R.A.L. settlement that is about 14 cents after tax.

Okay --

33 cents --

Impairment charges for the investment services I thought added up to eight cents.

Well, it was -- I think it may have been eight cents the first quarter.

Then we took an additional -- we took $18 million in Q1 and another $6 million in the step-two analysis in Q2.

So $24 million.

And that's both -- that is an after-tax number.

So okay.

So it's six cents impairment charge in the fourth quarter, litigation settlement of 14 cents, and the other eight cents comes from the investment services?

The other --

The other 13 cents --

The other 13 cents.

Yes. 13 cents investment services.

Six from payroll. 14 cents from litigation.

You're not including the -- the mortgage right down in the fourth quarter?

No.

I'm not.

I mean, you know -- I suppose certainly from our perspective, that is, you know -- you know, from my perspective, you know, what you have going on there is we have, you know, sort of looked in depth at the assumptions and sort of honed in on all of the assumptions that we were using.

And, you know, moved toward what we think are really tight market-based drivers of those assumptions.

In the process of doing that, we, you know, we had both, you know, on business, we had about the same valuation as we had before.

The difference is that, you know, within the different pools, there were some writeups and writedowns.

We took the writedowns from the income statement and took the writeups through O.C.I., so that there is about nine cents I think of additional expense, if you will, going through that segment in the fourth quarter related to that sort of offset which is not offset by the increase in O.C.I.

Uh-huh.

Okay.

We did not include that in the 33 cents, no.

Okay.

Thanks for the clarification.

That's all I had.

Thanks.

Your next question is from Chris Gutek from Morgan Stanley.

I wanted to dig a little deeper into some of the reasons as to why the growth was disappointing.

You said a couple of times you didn't get as much revenue from the new offices as you expected but you didn't say why you didn't get as much revenue.

And what do you expect to do differently in fiscal '04 to correct that?

You know, Chris, the -- the general answer on that is -- is we had set targets that were based on the -- our historical performance of opening new locations.

And we saw what we believed was a bit of anomaly in the performance this year, and the new offices performed disproportionately -- sorry, proportionately the way the rest of the system did.

So they were a little bit less.

And in out years, we had -- until we can understand the anomaly, we have decreased what we think the new offices will do.

But -- but for example, you know, instead of getting to full kind of capacity in -- I'm using this as an adjective, in four years, it may take five years to get there.

They were not significantly under.

They were just under a bit where we thought they would end up.

In the aggregate, they performed pretty well, and they did what we thought they would do in that they brought in new clients, more new clients, more retained clients, in the places where we put them.

And then in -- in many cases, they created capacity in the offices where they were close -- they may have been located close to other offices which opened up capacity in what we call the feeder office.

So that was -- that worked out well.

You know, Chris, one of the things Jeff commented on was a concept that we have been studying for some time now.

And it was really related to the opening of new offices.

Is the idea of competitive density.

And it is becoming more apparent that, you know, it doesn't matter who the competitor is, the level of competition that surrounds a trade area that our operation is -- is serving will have an impact on our able to both retain and attract clients.

So our ability to open up new offices sort of creates our own form of density that -- that, you know, has an effect on, you know, both our business but also more importantly, you know, forestalling competitors.

And I think that's what we are seeing pretty clearly with this.

Great.

Thanks.

And a second question if I could.

If you look at the new tax law bill that was signed a couple of weeks ago, on the surface it looks like it would add significant complexity.

In fact, some of the changes, for example the marriage penalty modifications, could actually reduce complexity of some of your clients' returns.

How do you see this tax bill having an impact on your volume growth?

How specifically do you expect to change your advertising and marketing strategy to capitalize on the tax law change?

You know -- you know, you're going to hear different views because right now we are studying that question.

We don't know fully the answer yet.

You know, my read on the bill itself is -- is that it -- it, you know, will benefit us from a volume perspective.

It will probably hurt us from a pricing perspective or complexity pricing perspective.

Because as you point out, the marriage penalty relief really comes in the form of greater standard deductions.

Which -- which is -- will reduce complexity for some people.

So, you know, that said, the refundability of some of the child credits, the increases, the use of advance refunds, are all as we have seen with the rate reduction credit a couple of years ago, they -- they may drive a lot of people looking to understand how to handle this.

So I think we will have an opportunity to use that as a volume driver, not necessarily -- however that will have to offset some -- some pricing issues or pricing pressure that will come with the reduction in complexity.

And we're still studying now how our advertising and marketing strategies will -- will, you know, reflect that.

Okay.

Great.

Thanks, Mark.

Your next question is from analyst Mike Millman.

Thank you.

I guess a couple of questions.

One, you give us some detail on looking at retention by income debt style and two, I suppose with what's happened with F.R.E., deserves question and maybe to put this this way.

Do you see the fact that you're cashing out a lot of mortgages reducing the subjectivity of how you handle derivative accounting?

Finally to clarify more your earnings assumption.

Looks like you're suggesting 355 to 370, and that would compare what looks about 305 on an ongoing basis.

You know, I'm going let Jeff think about whether we have the -- I've not seen yet the retention data by income debt style .

I'm sure we've analyzed it.

It could well be.

I'll refer for a second to Jeff on that one.

On the -- on the F.R.E. situation, yeah, you know, we obviously, you know, follow those -- what's going on there pretty carefully.

You know, I would tell you I think that, you know, this is an example of why we try to, you know, highlight that we run this business to optimize cash.

And in the process of running the business to optimize cash, you cannot question the valuation of cash.

And so, you know, in that sense, we're not trying to judge, you know, very much.

We are judging some, but we're not judging very much the valuation of various different future cash flows that come in various different forms.

And I would tell you I think that reduces our risk profile substantially, and that is why we operate the business the way we do.

We have very little, you know, in the way of valuation issues.

We are -- are, you know, very studied now in the way in which we go about that valuation.

We have honed that even further in the last year.

And in particular, we've, you know, made some changes or taken, you know, some adjustments both up and down in the fourth quarter to reflect that, you know, sort of tighter band of assumptions different pools.

Where we do have assets on the balance sheet that have subjective valuations, we think we are doing a very good job of sort of being very tight on how we approach that.

And we continue to sort of manage down the level of exposure.

I mean, our -- our residual values are down $100 million year over year to $240 million. $245 million, $246 million at year end.

And at the same time, we've built our capital base by something approaching $500 million.

So in general, we think we are doing all the right things from a risk mitigation perspective.

On the -- on the issue of guidance, the math is right.

You know, I would say our guidance is somewhere in the three, you know -- by the math specifically, it's 356 to 372.

And I'd say that's, you know, a pretty reasonable range for us on a GAAP basis for next year.

On an equivalent basis, you would, you know, for all my non-GAAP friends out there, you would add six cents for the option expense that we are -- we are adjusting for in that guidance.

At the same time, you have a bunch of these, you know, quasi--one-time things, depending how you treat the re-N.I.M., other things, some up, some down.

Last year.

And, you know, our view would be sorted of a non-Gaap kind of adjusted number for last year would have been about 322, which is, you know, adding back re-N.I.M., subtracting good will charges and subtracting the R.A.L. litigation If you adjust for all of those things, you know, the reported GAAP number and sort of a normalized GAAP number I would say is pretty close, 315 versus 322.

You know, Jeff retention --

Yeah.

The retention was actually down across all of the -- all of the income deciles.

And it is absolutely consistent what we saw across the economy.

We -- we were -- we got segment growth, Mike, across all -- the segment growth that we got was exactly what we've gotten the last couple of years.

Our higher income segments grew the way we wanted them to grow.

And so the trend line looks identical.

It just moved down a little bit.

And that's actually one of the validation points that we saw where we saw kind of this across-the-board reduction in retention.

And it was proportionate.

But we -- but we also saw at the same time significant increases in price value and other -- other measures of value on our satisfaction survey that gave us comfort, that it was more external than internal.

In fact, we didn't see things internal.

Okay.

Thank you.

Good to hear from you, Mike.

I can walk.

The next question is from John Neff with William Blair.

Hi, two questions I think for Frank.

First, what if any impact do you expect from N.I.M. 46 on your financials?

We're still -- still in the process of evaluating that, the variable interest entities.

At this point we don't expect any effect.

Okay.

Secondly, why the -- what accounted for the increase in cap-ex in fiscal '03 from fiscal '02?

Didn't hear that.

Sorry.

What accounted for the increase in cap-ex?

I would suspect that it is the increase in adding offices and tax --

That's right.

We added 246 net new offices, and those, you know, would have had cap-ex attached to it, you know, we were doing some technology upgrades.

In various different field offices that had cap-ex attached to them.

You know, there's -- there's -- there's certainly nothing that I can recall that stands out that's really unusual related to that.

You know, we added --

Capitalized software increases of $10 million over --

Yeah.

We added a new, you know, changed out our trading system or our back office system as financial advisors.

That occurred during the year.

You know, so I think we had a hodge-podge of different projects that came on that related to that.

And we have a variety of things coming in the upcoming year.

There's nothing, you know, major that is on the horizon.

Great.

Thank you.

Thanks, John.

Your next question is from Steve Farley.

My question's been answered.

Thank you.

Thank you.

Your next question is from Mitch Lester with L.R.L. Capital.

Congratulations on a good quarter, gentlemen.

Question -- obviously it's an unusual circumstance when an auditor chooses not to stand for re-election.

As given the recent woes at Freddie Mac which you touched upon a moment ago.

Can you give us some comfort that your auditor's decision not to stand for re-election had nothing to do with the assumptions used internally in your mortgage division versus what they were suggesting.

Thank you.

I -- I will tell you categorically that that had nothing to do with their decision.

You know, as we stated, I think, you know, it's sort of in the 8K and we stated in other sort of places, this was, you know, their decision based upon an assessment of the engagement and, you know, the rewards they received for the engagement for the, you know, relative exposure they felt they had in the engagement.

And it -- you know, we have no disagreements.

We have no accounting issues, where they disagree with -- with our treatment of those accounting issues in our financial statements.

So this -- this is not a -- an audit scope problem.

I mean, there just is nothing here.

This is a risk/reward decision on their part.

Okay.

Could you also share your internal model for unemployment for, you know, '04 given that we're about 6.1% now through the middle of June.

You know --

Are you expecting an improvement between now and year end?

Right.

Our guidance, our guidance assumption is that there will be stabilization and then slight improvement as we head into the tax season.

So nothing dramatic.

Don't get me wrong.

So as a result, we are -- we are sort of paying attention closely to this.

You know, the index that we used is -- you know, that we find correlating with the overall performance of our business on the tax side as well as the I.R.S. filing side has shown an increase even further.

Sort of, you know, the level of severity of the indexed version of this that we're looking at has shown a slight increase beyond where it was at December 31.

And, you know, that may obviously change somewhat before the end of the year.

There are things that will mitigate it like the change in the tax laws that are coming with -- with Congress taking action against the soft economy.

But frankly, we don't know.

We are -- we're at this stage in the game, we are being cautious in our plans.

We're being cautious in our spend.

We are being -- we are developing a view on how we will approach our marketing efforts for next year, with this in mind.

We are, you know, very comfortable that the revenue guidance we've talked about is -- is sort of taking into consideration a relatively cautious approach to this.

But frankly, I can't tell you that, you know, the world will look better come January 1 next year.

But I can tell you that unlike this year frankly, this management team, we didn't see it coming.

We did not understand the relationship between, you know, filers and the unemployment rate and the duration of people's unemployment because, you know, we just had never, you know, really tracked and seen the data and the analytics that's backed it up have never been looked at before.

We have studied the phenomena in depth.

I think we will be if not better prepared, we're certainly going to know who we're walking into better come next year.

And we'll be able to sort of, you know, moderate expectations to go along with that.

And hopefully we'll also be better prepared and we'll be able to address the environment with our marketing in a much more effective way.

Last question, gentlemen.

Has your branded competition, as you mentioned, they're more mature and smaller in size.

As they continue to grow -- and I assume try to look at some of your territories, what programs do you have in place not for customer retention only, but for employee retention?

Well, you know, I'll tell you.

The amount of -- of -- at least the information that I have seen would suggest that the amount of attrition of our key employees, number of, you know, both middle management people, but most importantly our frontline tax professionals is they have client relationships and a client following that is shared between them and H & R Block.

And, you know, for them -- and all of these people have noncompete agreements that we actively work to enforce.

So we see relatively little movement of our more tenured and most valuable tax professionals to this brand competition.

Certainly, that's not true -- people who have not billed much of a client following, you know -- having said that, we are working on a variety of different programs that we think will address a more fundamental issue than just how do you keep tax professionals from leaving us.

More importantly, how do you better engage them to help us grow the business, help us serve clients really effectively.

And how do we align our compensation systems in ways that -- that both reward them for the things that will create value for shareholders and for the company overall.

We're working on that now.

We expect to have some of those things to share with our field organization.

In the fall, and, you know, I think we've got a good handle on how we can help the really -- better leverage the really quality people that we have throughout the system.

Thank you for your time and continued success.

Thank you.

Your next question is from Kurt Muller with Dresner.

Good afternoon, ladies and gentlemen.

Can you please kind of help me out with the investment services arm for a minute.

You have roughly three quarters of a million active accounts there.

How many of those are block tax-paying clients, too?

Oh, about I think the estimate -- the number is about 350,000.

Okay.

Can you kind of -- I'm just still puzzled as to that business and strategic value because, you know, we're in a market environment where the business keeps losing money.

I mean, a significant amount of money.

Is there some kind of test that it's going to have to pass as far as profitability at a certain point?

To become -- to remain a member of the Block family?

Absolutely.

You know, here's the context that I guess I would put this in.

And, you know, the screen you just -- you know, sort of suggested we ought to have, we have for absolutely everything we engage in.

So, you know, we're not into losing money because, you know, it's because its businesses we're enamored with.

What I would tell you is strategically we believe that for the long term the way in which we can differentiate H & R Block from our various forms of tax competition is to be more of a financial partner, more of a financial advocate with our clients.

And that gives rise to what we refer to as our tax and financial partners strategy.

As part of that, there's a whole series of things that we are doing with our business to help drive toward a different position in the market, beyond just filling out tax forms in, you know, a relatively compliant kind of business.

That strategic direction we believe, you know, has us becoming more of a financial partner, financial advocate for our clients, through the services that we offer.

To do that, we can't just claim that position.

We really have to be able to deliver on it in a meaningful way to our clients.

H & R Block financial advisors, the business of investment services, is a piece of how we really deliver on that valuable proposition change.

And as a result of that, sort of strategic fit that I think it can help us move where we want the brand to go for the long term, I am -- we will be probably more patient to get the business to a point where it is playing that role and playing that role profitably for us than we might be with something that didn't fit as well strategically for the long term.

Having said that, you know, nothing is forever.

I mean, if we cannot make the business work within the system or the economy or the, you know, the markets just never really sort of give us a viable alternative that we think can work for the strategy but for the shareholders in the bottom line, you know, we will aggressively rethink that.

You know, we study whether we are pursuing this in the right way all the time.

I'm -- I'm personally convinced that we are doing all the right things.

But, you know, those right things have who to turn into bottom line.

I don't think they're going to turn into bottom line.

I don't think they're going to turn into bottom line this year on a positive basis.

I think as we look into '05, if we aren't seeing really meaningful progress toward profitable, we will be rethinking it.

Also, on the mortgage services side, what are the possibilities of some kind of disposition of that either as a spinoff to shareholder, tax bill would be a big hit because it's increased so much since you bought that and it's a great purchase.

What's your thinking about that right now?

Well, the way we look at that business, you know, first of all, it has been a wonderful business.

And we operate it in all the right ways, we think, to optimize it within the kind of ways we see H & R Block able to create value for our shareholders.

And that is, you know, optimize it for cash, optimize the cash, redistribute the cash back to shareholders.

So from that perspective, I think that the business is run and is operating really well.

I would tell you I think it is underappreciated by -- by the investment community.

But you know, that's not my job necessarily to, you know, convince you what it should be worth.

Your question about would we, should we, could we dispose of the business or have it create value for shareholders?

In some other form, you're right.

To sell the business, there is a big tax hit that would in along with it -- that would come along with it.

It's not terribly economically viable to create value for shareholders through an outright sale.

We've looked at -- you know, not recently, but we have in the past looked at what the consequences of a spinoff would be.

As we look at the capital requirements that we think that kind of a business would need to have as a stand-alone entity, as opposed to a part of the Block group of companies, it really comes down to a capital allocation choice.

You know, we would estimate that you would have to capitalize that business on a stand-alone basis by about another $200 million to $250 million.

That's the capital allocation choice.

We could choose to do that.

But frankly, you know, the alternative is to buy back shares with the $250 million and create value that way for shareholders.

And that's a tradeoff that we, you know, we study and consider all the time.

I would tell you, you know, as we look at valuations today, my sense is that, you know, using $250 million, we're -- we will create far more value using that in the share repurchase program than we would to recapitalize a sub.

Right.

I apologize for taking so long with my questions.

One last thing.

You said you thought you lost people shifted toward C.P.A.'s as opposed to your other branded competition.

Given that C.P.A.s are more expensive than you our the competition and we're in a recessionary environment, I'm having a hard time reconciling the two.

Why do you think that?

Well, I mean, you know, we know that to be the case.

When we study our lost clients and -- and sort of get at where they are going and what are they telling us that they're choosing as alternative means.

You know, I wouldn't say accountants are a big change, you know.

And they are down from where it was a couple of years ago when Block used to lose more clients to C.P.A.'s or accountants.

We've actually decreased that through our brand repositioning.

We continue to lose far more clients when they leave us.

They leave us to go to accountants or C.P.A.'s than they do to branded competition.

That we believe through our research is because, you know, for people who think that their tax situation has become more complex, they conclude that if they're a H & R Block client and their situation has become more complex, they need a more sophisticated form of tax prep, and C.P.A.'s have a brand advantage over us when it comes to that.

And this is speculation now.

My hypothesis would be in a tough economic time, a fair number of people say I can't afford to not be paying as little as possible.

So I'm going to, you know, make the best that a C.P.A. is going to find more deductions than what H & R Block did.

Now, we know -- or I know that that's probably not a rational, you know, thing.

That's a brand fact.

And that's brand advantage that C.P.A.'s have.

Jeff, anything to add?

Yeah.

I would just say that I think the point we were trying to make is that we view all of the options that people have to -- to do something other than Block, C.P.A.s, accountants, on-line, web, software, friends and family, great market, all of those different options as competition in that we don't want to view the scope just as a branded retail competitor, but looking at the entire competitive space when we look at the notion of density.

Thank you very much.

Thanks.

Ladies and gentlemen, we've reached the end of the question-and-answer session.

Gentlemen, there any closing remarks?

Yes.

I guess I just want to conclude by thanking you for joining us today.

As always, if you have further questions or we can clarify anything, please feel free to call.

And thanks for giving us some of your time today.

Appreciate it.

This concludes today's H & R Block fourth-quarter and year-end earnings release conference call.

You may now disconnect.