H & R Block Inc (HRB) 2004 Q1 法說會逐字稿

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

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

I would now like to turn the call over to Mr. Mark A. Ernst, Chairman and CEO of H&R Block.

Mr. Ernst, you may begin.

Thank you.

Good afternoon and welcome.

Thanks for joining us to discuss our fiscal 2004 first quarter results.

With me today are Jeffery W. Yabuki, our Executive Vice President and Chief Operating Officer.

Frank J. Cotroneo, Senior Vice President and Chief Financial Officer, Becky Shulman, our Treasurer, and Mark Barnett our Director of Investor Relations.

Before I begin my formal remarks, I again need to remind you that various comments we'll make about future expectations, guidance, targets, estimates, assumption, plans and prospects of the company constitute forward-looking statements within the meaning of the Federal Securities laws, and are based on current information and expectations.

These statements speak only as of today, actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our first quarter press release and in H&R Block's reports on form 10K, form 10Q and form 8K, which are on file with the SEC.

In conjunction with today's call, supplemental financial information has been posted to the Investor Relations portion of our website at hrblock.com to facilitate your analysis.

In addition, a copy of our prepared remarks will be posted to our website shortly after the conclusion of this call.

I'm pleased to report very strong financial and operating performance in the first quarter.

Compared to the same period last year, revenues grew 15%, net income increased by $20 million, and we achieved a 11 cent improvement in earnings per diluted share.

Our results this quarter were driven by continued strong performance in our mortgage businesses, improved results in investment services and solid off-season results and cost controls within our tax businesses.

As I mentioned on our year-end call, and it bears repeating, the strength of H&R Block's overall business mix is an at tribute of our company that is often overlooked.

Our financial services strategy and mix of businesses enables us to generate a more balanced revenue and income stream while at the same time building the value proposition to consumers under the H&R Block brand.

There have been questions as the mortgage business growth we have experienced over the past couple of years is sustainable.

Rising rates in recent weeks appear to have highlighted these concerns.

While changing economic conditions may flow our mortgage growth rate, we believe the financial performance of our mortgage business is less dependent upon interest rate cycles than is generally appreciated in the markets.

At the same time, those same factors will likely accelerate growth in other segments, such as our financial adviser's business.

Hence, one of the benefits of our financial services business mix is that when one business faces some moderation following an aggressive up cycle, like our mortgage business may, that moderation could be partially offset by another business coming off of a down cycle.

In fact, H&R Block business model is delivering.

Over the last five years, through both positive and negative economic cycles, including rising and falling interest rate environments, we've delivered strong financial results.

In executing our financial services strategy, we have assembled a very positive mix of businesses with attractive economic characteristics and an overall balance profile of risk and return that we believe will deliver solid results in changing economic cycles.

From the strength of this business mix, we are able to generate even stronger cash flows, which provide an engine for continued growth and value for shareholders.

During today's call, we will first discuss results from the quarter, followed by an update on our major franchise acquisitions, and then concluding with an outlook for the remainder of the fiscal year.

At that time, I will also discuss in some detail our fiscal year expectations for our mortgage businesses.

Also, as we announce today, I'm very pleased to welcome Brad Iversen to H&R Block.

Brad will be joining us next week as Senior Vice President and Chief Marketing Officer.

Brad will focus primarily on the H&R Block branded businesses, and his exceptional marketing background is an excellent fit for our organization.

For the past 20 years, he's held Senior Executive positions leading the marketing functions for some of the country's largest financial services companies.

Recently at Bank One.

This broad experience in the financial services industry will be helpful in differentiating H&R Block as a tax and financial partner to our nearly 20 million U.S. tax clients.

Turning to our first quarter results, reported net income rose $20 million to $11 million or 6 cents per diluted share compared to a loss of $10 million or 5 cents per share last year.

For the quarter, revenues increased 15% to $495 million, compared to $431 million a year ago.

The strong revenue growth is primarily the result of double-digit growth in our mortgage and our U.S. tax segments.

Let me turn to Jeff Yabuki to review financial results from several of our business segments.

Thanks, Mark.

Our U.S. tax operations, which include U.S.-based tax services, payments related to refinance loans and E-solutions, reported first quarter revenues of $30 million.

An increase of $6 million or 27% over last year.

The increase was driven primarily by favorable bad true up provision from last year's waiver agreement, higher off-season average fees and revenues related to our peace of mind service.

The pre-tax loss for the segment increased just slightly to $95 million, versus $94 million last year.

Total expenses for the first quarter were $124 million, up $7 million or 6% from the prior year.

I am particularly pleased with these results.

As our overall spending during the first quarter was below plan levels, even with the addition of over 200 new offices within our retail tax network over last year's comparable quarter.

This solid performance was achieved through effective management of off-season labor and continuing efforts to improve processes and expense structures that ultimately leads to continuing growth in operating margins.

Compared to the year-ago quarter, occupancy and equipment costs increased $3 million, due primarily to a 4.9% increase in the number of offices under lease and a 5.6% increase the current in average rents paid.

All other quarter increased $4 million over last year driven by additional technology projects, increased depreciation and amortization expenses and planned consulting expenses.

Offsetting these increases, compensation and benefits declined $2 million, or 9% due to better management of off-season labor costs.

Since our year-end conference call in June, we continued to analyze the data from the last tax season and confirmed the tentative conclusions we discussed with you at that time.

Our analysis of last tax season indicates two primary factors, the impact of the economy and also a lack of perceived tax-law changes where the drivers of the lower than expected client acquisition result.

The good news is, that we don't see any systemic issues within our business model.

We didn't see unexpected shifts in filing behaviors between the do-it-yourself and paid professional markets.

In fact, the data further reinforces our belief that consumers are continuing to look for advice and professional assistance in managing their tax situation.

During last tax season we once again experienced improvement in the client mix by adding and retaining clients with more complex tax situations which led to better than expected average fees per return.

For the upcoming tax season, we have a number of strategic initiatives underway, geared towards delivering sustainable client growth and enhanced operating margins.

For competitive reasons, I'm not going to provide details at this time.

However, what I will say is that we are continuing to focus on delivering increasing levels of service differentiation, and developing a deeper relationship with our clients, so that over the long term, our clients have a compelling reason to pick H&R Block as their preferred tax and financial provider, and to sustain that relationship over time.

Our international tax operations generated revenues of $5 million, a 28% increase over last year, and a pre-tax loss of $6 million that was essentially flat with last year.

First quarter results were driven by growth in off-season tax returns compared to Canada, offset by a weakened U.S. dollar, creating an unfavorable exchange rate in the quarter.

In Australia, we are experiencing a strong start to the tax season, while it is early in the season, indications are that we are on track to meet or exceed our growth objectives for our Australian operations.

Turning now to investment services, we saw modest improvement in key drivers of the business during May and June, which moderated a bit in July, consistent with the rest of the industry.

First quarter revenues of $57 million were up 29% sequentially and down 3% the compared to last year.

A pre-tax loss of $14 million in the first quarter, compares to a pre-tax loss of $36 million in the previous quarter, and a pre-tax loss of $33 million in the first quarter last year.

These quarterly loss figures each include $7 million of intangible amortization.

Last year's first quarter results also included a $18 million write-down in goodwill.

Compared to the previous quarter, we saw improvement in trading volume and margin lending balances.

First quarter trading volume was up 48% over the previous quarter, and down 3% from last year.

The related transaction-based revenues increased $8 million quarter over quarter and declined $3 million compared to the year-ago quarter.

Net interest revenue was $8 million in the first quarter, compared with $7 million in the previous quarter, and $10 million last year.

Ending margin balances increased 6% compared to last quarter, and declined 21% compared to last year.

The rate reduction in June had an offsetting impact on interest income and interest expense.

Our third revenue source, those revenues associated with both packaged and E-based products increased in the first quarter by $2 million or 15% from the prior quarter, and increased 34% over the prior year. 68% of retail non-interest revenues for the quarter came from sources other than the sale of direct equity investments, such as mutual funds, annuities and fee-based accounts consistent with our long-term strategy.

Our focus was within this business remains on cost control, balanced against our longer term strategies, are replacing the historic transaction-based equity orientation of the firm, with a broad-based planning in advice orientation that is consistent with our tax and financial partner strategy.

We also continue to recruit experienced advisers as a way to leverage unused infrastructure capacity.

Lastly, we are enhancing our business model by building distribution capability into our qualified tax client base, with programs to align our tax professionals with this business.

This program teams tax professionals with the adviser to provide a more comprehensive view of the client's financial situation.

We are encouraged by the early results from this initiative.

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

Nice job.

In mortgage operations, which, as primarily includes option one in H&R Block Mortgage Corporation, which is the resale Mortgage operation of H&R Block, again, delivered strong results this quarter.

And consistent with our views as the interest rate environment should not have a dramatic effect on our levels of originations.

We continue to experience record pipeline and very strong application activity into August.

Pre tax income during the first quarter rose to $164, an increase of 25% over the previous quarter, and 11% over the year-ago period.

Growth was driven by a solid increase in origination volume, which, as expected, was partially offset by declining pricing in the capital markets.

First quarter loan production totaled $5.3 billion, an increase of 11% over the previous quarter and 57% over the last quarter last year.

Revenues for the first quarter were $303 million, up 9% over the previous quarter and 21% over last year.

Pre-tax income from our retail mortgage business increased 143% in the first quarter, driven by a 64% increase in the number of retail originations over the year-ago quarter.

Growth from our retail mortgage operations, represents more than 18% of our quarter-over-quarter origination growth demonstrating the momentum we are building in our effort to serve H&R Block clients.

The H&R Block client base represents slightly over 50% of our retail originations, and 10% of total original nations within the segment.

Our net gain on sale on originated loans was 442 basis points, compared to 437 basis points in the previous quarter, and 488 basis points last year.

At quarter end, option one servicing portfolio was $34 billion, an increase of $7 billion over last year.

The weighted average interest rate charged to non-prime borrowers during the quarter was 7.5%, compared to 7.8% last quarter and 8.8% a year ago.

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

Cash proceeds from the sale of first quarter loan production were in excess of 100% of the recorded gain on sale.

Cash received exceeded the gain on sale for the quarter due to disposition of pipeline loans that were recorded as gains during the previous quarter.

The high amount of cash relative to our gain on sales is significant, because it means little of our gain on sale revenues dependent on future loan performance.

In the quarter, the majority of our non-prime loan sales settled through the whole loan sale market versus securitizations due to the comparatively superior execution that we saw in the whole loan market.

Of non-prime loan sales completed during the quarter, 57% were sold in the whole loan market, while the remaining 43% were securitized.

This compares to 41% hold home sales and 69% securitization over the course of the previous fiscal year.

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

Credit quality remained strong in our non-prime originations.

Our average cycle score for non-prime originations averaged 607 for current quarter originations compared to 605 last quarter and 598 for the year ago quarter.

The average loan to value remained steady at 78%.

Delinquency trends continue to be positive.

Using data reflecting only loans that are 12-month seasoned and beyond, 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 July, 31+ day delinquency rates were 12.8% compared to 14.8% in January of 2002.

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

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

As we discussed on prior calls, we model our residual interests against historical prepayment experience, cumulative losses and forward interest rates.

We then discount the expected cash flows.

As the value of these assets is based on future performance, we are continuously monitoring the reasonableness of our assumptions relative to actual loan performance and performance in the market.

Our residual interest continue to perform better than expected primarily due to lower than amount of losses, slower prepayments and lower interest rates.

Accordingly, during the quarter, we realized a net write-up in residual balances of $54 million, which was recorded in other comprehensive income on the balance sheet net of deferred taxes.

While we have not previously expected to sell residuals this year as we did last fall in our [inaudible] transaction, the continuing out performance of our residual assets may give us an opportunity to accelerate the realization of cash again this year.

If we choose to do so, it would occur in our third or fourth quarters.

While there is no current plan to do so, the fact the fact that this is even an option for us again demonstrates that there is significant value in these assets that is accruing for the benefit of our shareholders.

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

We are seeing the benefit of building a business that serves the H&R Block tax client base and a small amount of residual interest that we have retained in our balance sheet is fairly valued.

Turning to business services, the first quarter revenues increased 3% over last year to $98 million.

The increase was primarily driven by strong revenue growth in our capital markets business.

The pre-tax loss was $7 million compared with the loss of $4 million last year.

The increase operating loss was due to planned losses related to our payroll and benefits processing business, and increased off-season losses related to tax and accounting services and these are offset from increased earnings from our capital market services.

While we still face a cautious business climate, we did see growth in our core tax and accounting services in the quarter.

The next quarter will be an important indicator of the segment's performance over the remainder of the fiscal year as we look to participate in a recovering economy.

Now let me turn to Frank Cotroneo who's going to review some of the key balance sheet items.

Thank you Mark and good afternoon.

As compared to April 30th, 2003, there are several notable changes to the balance sheet.

Cash and cash equivalents decreased from $875 million at fiscal year-end to $675 million.

The decrease is largely attributable to payments made for share repurchases, dividends, and net changes in quarter end working capital.

Payments for share repurchases during the quarter were $84 million compared to $37 million in the year-ago quarter.

It's significant to note that due to our strong cash position, we concluded the quarter with no short-term borrowings, whereas in the year ago quarter we had outstanding short-term debt of $156 million.

Cash increased by $90 million to $528 million.

This increase was almost exclusively the result of higher segregated cash balances, being held at our financial adviser businesses, for the benefit of our clients.

Due to customer credit balances growing faster than margin balances, HRBFA maintains balances.

Receivables decreased to $309 million from $403 million at year-end.

The decrease relates to seasonal declines in business services and software receivables.

Mortgage residual interest in securitizations increased $27 million during the quarter to $291 million.

The increase reflects cash receipts of $27 million, impairments of $11 million, clean-up calls of $2 million, offset by a net unrealized holding gains of $33 million, and interest accretion of $34 million.

We continue to focus on cash and minimizing balance sheet risk.

In that regard, it's noteworthy that our current residual business of $291 million is $107 million or 27% less than residuals of $398 million at July 31st, 2002.

During the first quarter, we re acquired 1.9 million shares at a total cost of $84 million, or an average cost of $43.81 per share. 578,000 shares were issued for option expenses, Employee Stock Purchase Plan purchases, and restricted shares.

As of July 31st, there were 179 million shares outstanding.

Starting in the second quarter, a new accounting standard, EITF 00-21, revenue arrangements with multiple deliverables, requires us to separately account for tax-return preparation and piece of mind guaranty revenues which are presently sold for a single fee in our premium tax offices.

Fees and expenses associated with premium office peace of mind guarantees were previously recorded at the time the product was sold.

Under this new standard, the revenues and related expenses will be deferred and recognized over the life of the guaranty.

In other words, revenues and expenses related to peace of mind from our premium network will be deferred in the same manner as if a separate fee were charged for the product as is the case in our regular retail system.

As allowed by the standard, we expect to record a non-operating charge representing accumulative adjustment for the effect of this new accounting principle.

This change in accounting is expected to reduce our full-year earnings by 3 to 4 cents per diluted share and will show up on our reported results showing in the second quarter.

However, you should note the discharge will not be included in our second-quarter results.

Under accounting rules the changes effective at the beginning of our fiscal year, which means the charge will only impact year-to-date and full-year reported results.

Now, I'll turn the call back to Mark.

Thanks, Brian.

I'd like to update you on a couple different items, the first being our major franchise acquisitions.

Tell you, we are making substantial progress toward the transition of the effective major franchises to company-owned operations.

Within the next month, we will have assumed control of most of the major franchise operations.

Transitions going smoothly and most of the franchisees are co-operating in this process.

We also entered into a new modified franchise agreement with one of the parties, the last major franchise agreement involved in the transition is not expected to expire until 2005.

Under the terms of the franchise agreement, the major franchisees are entitled to fair and equitable compensation in the event of contract non-renewal and our discussions continue regarding an appropriate resolution.

During the first quarter, we assumed operations of two of the major franchises.

The payments for these two operations total approximately $9 million and you can see those on our cash-flow statements.

The court has set an October trial date to begin the first case to resolve all the remaining issues in dispute with respect to one major franchise, including the determination of fair and equitable compensation.

Although we expect a positive financial impact to our tax business for the major franchise acquisition this fiscal year, it's a bit premature to assess the full impact to our fiscal 2004 financial results until negotiations or litigation have progressed further.

Therefore, the impact from these transactions is not included in our current full-year guidance.

However, we anticipate that in the second quarter of this year, $7 to $10 million in additional off-season expenses as a result of the integration of the major franchise offices into our company-owned system will occur.

Also in the second quarter, we anticipate higher off-season occupancy costs due to the increased number of company-owned offices compared to last year.

In addition, we're seeing that in our E-solutions business as it grows, an increasing portion of our off-season cost structure is related to technology costs that support our software and our online businesses.

We this year are well ahead of last year in technology and product enhancements, which will result in higher technology spending in this year's second quarter compared to last year, offset by costs in our third quarter.

Also for the full year, we are anticipating that non-cash stock option expense that will flow through our income statement will total about $22 million.

A more meaningful portion of this expense is going to start showing up in the second quarter after just $1 million in this first quarter of this fiscal year.

Let me turn to the mortgage business.

It appears that the rise in interest rates over the last several weeks has heightened concerns that we are likely to see declines and some would say significant declines in our earnings for the mortgage segment.

We believe these concerns are not warranted.

Let me provide perspective on what we are seeing within our business and the industry in recent weeks.

Historical performance indicates that the non-prime market that we serve is much less sensitive to interest rates than the prime mortgage market.

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

The benefit of the low interest rate environment to our financial performance over the last couple of years has been on loan profitability rather than as a primary driver of origination growth.

We've consistently stated our belief that in a rising rate environment, we would expect continued growth in our origination volumes, but at a more moderate pace.

Offset by some margin compression, leading to a flattening out or perhaps a slight decrease in earnings.

We are not seeing anything in the current environment that is causing us to alter that view.

Well into August, we continue to see a record pipeline and very strong non-prime application activity.

The strength in non-prime applications is likely a result of redirected capacity within the broker network, due to now a slowdown in refinancing activity in the prime market.

We continue to focus on the controllable drivers within our businesses and our forecasting origination volume growth for the remainder of the fiscal year against moderating profit margins.

Accordingly, excluding the gain that we had last year from the sale of residual assets, we expect fiscal 2004 operating income to be roughly flat compared to last year.

On a consolidated basis, we continue to expect fiscal 2004 GAAP earnings per share in the range of 13% to 18% and I would note that excludes the impact of EITF 00-21, which Frank commented on.

These expectations assume that interest rates will remain relatively unchanged through the calendar year-end and then rise modestly with growth in employment continuing to be weak but showing improvement over where we were last year.

Lastly, the impact from the change in our major franchise operations is not included in today's fiscal year out look and will be discussed after the terms of those transactions are completed.

I'd like to thank all of you for joining us today.

As I mentioned at the beginning of my remarks, the results reported today are indicative of the strength in our mix of businesses and the quality of our associate to management across the company.

We remain focused on managing our businesses to improve operating performance, strive additional growth through the execution of our longer term strategies, all while managing our capital allocation to reward shareholders.

I personally appreciate the support that we have of our shareholders and our associates for the people that really make these results happen.

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

Your first question is from Michael Millman.

Thank you.

You talked about some of the results from last year, but could you give us a little more detail by separating retention and acquisition and looking at that by income category?

Also, quickly, is the 6% increase in expense sustainable excluding the acquisitions?

Okay.

Let me tell you what, I think we understand about the first, and then I'll have Jeff sort of comment on the expense growth that we've been seeing so far.

Our analysis would suggest that we saw better retention as income levels were higher in our client base from last year.

And clearly we were also seeing better acquisition activity at higher income levels relative to where we had been historically.

So I think both of those are consistent with the strategy and the strategic direction we've had, which is to move our client base slightly upscale or slightly higher income from where it has traditionally been.

And the experience we had this past year is fully consistent with that.

Jeff, on the expense side?

Mike, and I'm not sure if you're asking me do we expect to see that kind of an expense growth going forward, is it sustainable?

The answer is, is I think, from a combination of being able to continue to find process opportunities, opportunities to improve our processes and just tightly control expenses that we will manage our expenses down to that kind of a level, excluding things that are variable on the basis of revenue where those will of course change.

So I think the answer is, yes, and that really links into how we believe we'll continue to sustainably grow margins over time.

Just have one thing to your question on the retention and the acquisition.

One of the things that we saw this year was that we believe that our retention programs that we introduced last year were helpful to our results that, that they made a difference, although they were diluted by the kind of the fall-off that we saw in what we referred to previously as these economically sensitive clients.

And so we did see some growth, they performed about where we expected them to grow, and that's really where we're focusing a lot of energy moving forward, how can we continue to improve retention?

And let me just make sure, because I think we tried to make it clear in the script, but it people may have missed it.

On the expense side, while I think Jeff is right, we think we can manage our spend level cautiously throughout the course of the year.

The one thing that we are expecting is that there's going to be a bit of lumpiness between the second and third quarters, and that is being driven by two things.

One is that as the major franchises are now starting to be operated as part of the company operations, both that have been taken over and others that will come in this quarter, we are expecting some additional spend that will be going through the upcoming quarter in advance of the coming tax season.

The other thing that's happening, which is in general in my view a good thing, is our technology spend is moving up in our off-season from the third quarter into the second quarter a bit, and that's really being driven by better planning and better sort of product design well in advance of the off-season, which allows us to get a jump-start on the product enhancements that we'd like to make.

So a combination of those is that we're getting some lumpiness in this.

All right, thank you.

Your next question is from Michael Hodes.

Yeah, hi.

Good afternoon, guys.

A couple questions on the mortgage side and then a few on tax.

On the mortgage side, I'm interested in getting a sense of how far into the future have you locked in pricing as you look to sell loans into the secondary market, that's question number one.

Question number two, on mortgage, I guess this is for Frank, I'd like to know what the total residual gains are in other comprehensive income at this point.

And then I just wanted to confirm, thirdly, that you're expecting mortgage volumes to increase from the level that you saw the $5.3 billion level that you saw in Q1 as you moved through the balance of the fiscal year.

Yeah, let me start with the two, how far forward we're locked.

We're locked into -- I believe it's into October.

So we are locked for the production that's being sold now in August and September and into I think maybe partway into October.

So essentially this upcoming quarter is pretty much set.

So the variations now will be sort of not the ability to sell it, but much is actually produced.

And you're right, we are expecting that we're going to continue to see an increase in the origination levels off of where we have been.

I tell you, the pipeline that we had at the end of July, was at an all-time high, it was about $3.5 billion, I think, $3.5, $3.6, something like that.

And we have been running now, during August, application levels that are about 10% to 11% higher than the levels we were running in July.

So while we had always anticipated or we believe that when the refinance boom sort of started to moderate, that it was going to help us, we are now seeing clear evidence that that is occurring on the origination side.

On the OCI level --

$131.

Total unrealized gains, Michael, is $131.

If you take the year-end, which is the $98 and we're adding $32 to it, $33 to it this quarter.

And then on the tax side for Jeff, how big was the RAL with Household in the quarter?

About $4 million.

I'm sorry, $4 million.

About $4 million.

Yeah.

Michael, I think -- and to confirm that, as I noted earlier, Mark Barnett is posting a series of information on our website in association with this call.

And we've got the detail of sort of the major line items of revenues and expenses by line of business and you'll be able to see that in that detail.

That's terrific.

I look forward to it.

And, lastly, I'm just trying to think through the change in the marketing side of the business that was announced today.

When you look back on last year, I guess in addition to kind of fallout from the weak economy and the some other anomalous aspects I take it implicitly you're disappointed with the brand positioning of the company?

Well, no.

Let me comment on that because frankly, I think, the addition of Brad Iversen who we're delighted to have joining us.

I think he brings some very, very strong experience and will be a great addition to the management team here.

So I'm really happy with that.

But that is not to take anything away from the quality of work that people have done up to this point.

I think we are in much better shape today than we have been over the many years.

The nuance that I would highlight is that if you go back and look at the way in which we have positioned the brand of the last several years, while we talked here about our tax with financial partners strategy, we have been hesitant, at my insistence we've been hesitant to go out and position the company in the market that way in a very strong way.

And the reason for that is that we need to be able to deliver in a substantive way against a brand positioning that talks more about financial partnering and giving people a connection between tax to something that they can relate to their financial lives, and I have not been confident before that we were executing sufficiently across our system to be able to go out and use that as a reposition way for the brand.

Frankly, in the last five years, certainly, the data would suggest that as we have continued to focus our branding efforts against the branding of tax category, there's a lot of good things that have happened, but our level of differentiation, the degree to which people say H&R Block offers something really unique in the market, has declined.

And I think that that is attributable to a lot of different things, but probably the one thing that we have not done is we have not taken the brand to a new place from a positioning perspective.

I am now, I think, almost there.

Jeff is going to throw something at me.

But I think we are almost there.

I'm confident that we have sufficient ability to execute on delivering financial advice as a component of what we do across our system, so that we can use that in our brand positioning beginning next year.

And our research would suggest that is a much more compelling value proposition than simply just tax preparation.

So we're now looking at how far we can go with that concept, how we can make that into a sort of evolving part of our brand and how we think that can further our efforts to take our client base more upscale, to create more value in the client relationships that we have and to attract more clients, which we think that that value proposition more effectively does.

But that's all work in process.

What do you want to add?

I would just say I think I would certainly agree with all of that and add that we think there is a unique opportunity to modify.

Our messaging has been fairly consistent over the last couple of years and one of the things that we indicated during the season or at the end of the season is we did not believe our messaging worked as hard for us or our programs as we would have liked them to have worked.

And it's a unique opportunity this year with the tax changes and we think the focus that people, consumers will have on their tax situation to begin to introduce this enhanced version of who H&R Block is, continuing to be rooted in our tax expertise and knowledge that we're known for today.

Okay, guys.

Thanks a lot.

Thank you.

Your next question is from Christopher Gutek with Morgan Stanley.

Thanks, good afternoon.

Mark, if I could follow up on the franchise repurchase opportunity.

I know you don't want to get real specific at this point but you did talk about some of the near term integration expenses.

Can you clarify whether you expect the net effect of the franchise repurchases to be positive or negative for your earnings?

We clearly expect that the net effect through the course of the year will be positive.

I'm hesitant to get too far ahead of this for a couple of reasons.

One is we are still in discussions with the franchisees themselves about the specific terms of the transactions.

So for that reason, I'd prefer not to get into what we model internally.

Probably as importantly, maybe more importantly, it's not clear to us yet, based upon the -- sort of the way in which the purchase price will be accounted for, how much amortization we will have, and therefore the net bottom-line impact still isn't finally determined.

We have work going on that's helping us to shape that and know the answer, but we don't know the answer to that yet.

Clearly, I would tell you it will be net positive.

We would clearly not be going into this if we thought it was net negative.

Great.

And on the mortgage business, from a high-level perspective, you guys continue to be very bullish on the earnings outlook for that business.

Just recognizing that the origination of volumes seems likely to grow given it's sub prime business but also looking at the pre-tax margin you had in this business was less than 26% in fiscal 2000 and was almost 58% in fiscal 2003, you're obviously assuming that the margins will hold towards the high end of that range.

Could you just explain a couple reasons why you're so confident the margins can hold both at the current peak levels?

I would tell you.

I'm not sure I would say that they're going to hold at the current peak levels.

What we have been modeling internally is, a net margin, so sort of a net margin in the 175, 200 basis point range.

So, from our perspective, that is not dissimilar to where we were several years ago.

What's happened in this business for us in the last couple years, we've gotten a lot more leverage in the business, our scale is giving us an acquisition cost position that is much better than where we were, and clearly the level of margins that we are seeing in the last couple of years, we never, I guess, believed were sustainable.

We enjoyed them while they were there, but how fast they'll come down, we're not sure.

But I think that competitively, we're well-positioned from a cost perspective and when we are operating the business for 175 to 200 basis points, based on our leverage and the way in which we operate the business, it probably means our competitors are operating the business for substantially less.

We think that that means that from a market competitive position, we're in really good shape at this point.

What extent. if at all are you assuming that you will be able to continue to write up the residual values and that therefore you'll have fairly high accretion values going forward, is that entered into your model?

Yeah, we clearly look at that and I think it's always a little dangerous to kind of project write-ups because they're a --we think the valuation today is fair.

What we have been seeing and we saw very, very clearly this quarter, are a couple different key drivers for the valuation increases.

One was the decline in the short end of the rate curve, and because that's the thing that gives us our, we're using the short end of the curve for the credit rate on the underlying bonds, is that those rates have come down, we're crediting less, and as a result, the back bond or the back part of the cash flows which we will receive are becoming more valuable, because they're more likely to occur at higher levels.

So that's one piece.

The other piece, which is about half of this quarter's write-up, which I think is significant, because, it's probably the more sustainable piece.

You're not going to see another drop in rates.

Maybe we are but we're not betting on it.

But perhaps the more sustainable pieces, we are seeing out performance on the underlying performance characteristics against the model levels.

We are seeing -- and it really comes in two forms.

We're seeing fewer delinquencies.

Now, our models still assume it's sort of an increase in delinquencies over time.

But we're seeing not occurring yet and as a result the cash flows early are better than what our models have formerly called for and we're seeing prepayments actually be later or be less than what we had anticipated.

Both of those increased cash flows, as in the current period and because of the very high discount rates we use in creating values or assessing value of these, some movement up in the cash flows because of just the sort of timing of the performance of the delinquencies and prepayments, fairly dramatically shifts the value up.

Okay.

Thanks.

And one final quick question.

Looking at the capital structure, the company's much stronger capitalized versus a year ago and one could argue the company's overcapitalized.

Can you give us a quick update on your thoughts on use of cash?

Yeah, I'll let Frank kind of chime in with this as well.

We had been targeting a particular capital level.

I think we got very close to the level we feel very confident at at the end of the fiscal year we just ended.

We are still managing our capital levels very prudently in the off-season.

As a result, we had no short-term debt outstanding at the end of this quarter, like for the first time.

I think maybe ever.

We have been a little more cautious in the use of our capital so far this year as we are sort of working through the transaction structures for the franchise acquisitions.

Were it not for that, I would tell you we would probably be much more aggressive at this point in using that per share repurchase.

But because we have those kind of teed up and sort of working their way through the process, we have gone a little bit slower in the allocation of our capital to share repurchase.

Great, thanks, Mark.

Your next question is from Jeff Neff with William Blair.

Hi, John, just two quick questions here.

I know you said this on the call, but if you could just repeat the gain on sales on the mortgages for the last four quarters, and also are you seeing yet any impact in the secondary market in terms of securitizations due to the elimination of the prepayment penalty in some states?

John, can you give me your first question again?

I know the parity act question, but I didn't catch the first one.

Sure.

If you could repeat the gain on sale on the mortgage business for the last four quarters.

I'll have to have somebody pull that in just a second.

Let me tell you what we are seeing on the parity act.

I'm sorry, I do have the gain on sale numbers.

The gain of sale was 442 basis points this quarter.

That was compared to 488 basis points for all of last year.

So we're down about 40, 40 some odd basis points versus all of last year.

At least so far this quarter.

Parity Act, we are beginning to see the effect of -- on valuation, or on sort of gains, uh, we are estimating that this decline has caused about a 20-basis point decline in our overall lended gain on sale.

You're getting prepayment penalties to a level, but they are less than what we were getting before.

The estimate that we have is that that's going to have a pre-tax impact to us, to our business of about $35 million this year, overall.

And so far probably the other thing that we are watchful of is whether or not competitively people reprice in those states that are affect by the Parity Act.

Our experience so far is that is that repricing has not occurred and therefore the full effect of the sort of loss in value is flowing through our gain on sale.

Great.

Thank you.

Your next question is from Joe LaManna with William Blair & Company.

You had another question on the mortgage business.

I talked about this a little bit, but I'm trying to reconcile the very strong growth in origination volume in the quarter, 57% with only 11% increase in pre-tax earnings from the mortgage business.

And I know you started mortgage interest rates and the capital markets but I'm trying to figure out -- I mean, to any extent did you sacrifice margin on the lending side in order to maintain the origination volume?

Or if it was just something in the capital markets in terms of when you went to securitize if the spreads narrowed?

A couple things on that.

We do not think we are sacrificing something on our -- sort of the quality of what we're originating to maintain origination levels.

Not quality in terms of credit card, quality in terms of pricing.

We maintain sort of a competitive price slightly above some of our core competitors that we think is very sustainable.

So that has not changed.

We've not widened it per se, but we've also not shrunk it at all, to my way of viewing that kind of stuff.

The margin shift that we're seeing is primarily driven by one factor in the capital markets, and that's cap costs.

While we did more of our loan sales this quarter as whole loan sales, so it's not directly visible as a cap cost, implicit in even the whole loan prices are cap costs.

And as market conditions are changing and people are putting higher probability on rising rates, the cost to cap rising rates is costing more in our deals, and that's the primary driver of the decline in our gain on sale numbers.

And then therefore now that you have this knowledge, though, are you raising prices in the origination side to make up for that?

Yeah, we are doing it -- I guess I want to say selectively.

We are looking at our competitive position in a variety of different markets, we're looking at sort of where we can do, the right thing, sort of to maintain our profitability and our profit ranges while maintaining the kind of broker relationships that have created long-term, value in this business.

So we are doing some of that.

We've begun repricing and I think this quarter will probably end up having been -- the one we just finished, having been the lowest level of weighted average coupons that we will report.

Our expectations you are going to start seeing those going up going forward.

Okay.

Thank you.

Your next question is from Kim Vinsko with Financial Stock.

Had I, Sean Rine here at Financial Stocks.

Just a quick question.

I just want to double-check, is it the case that none of the $53.5 million in net write-ups is reflected on the income statement?

Yeah.

It's generally right.

I believe about $3 million of that would have gone through accretion starting this quarter, because it's one month of it, so $3 million out of the $53 has now been accreted in.

But the --

Okay.

The balance is not, that's correct.

Okay.

Great.

Thank you.

Your next question is from Sloan Swindal with Cove Asset Management.

Thank you.

I appreciate the presentation materials and I was looking at the mortgage operations and just wanted to know sequential quarter basis you've had a fairly significant drop in compensation benefits, as well as occupancy and equipment, but then you had kind of a steep climb in bad-debt expense, I wondered if you could provide a little color on that?

And then I have some other questions as well.

Yeah.

On the compensation line item, that is essentially a reflection of the accrual of compensation that we booked in the last quarter.

All right.

So that's sort of the key reason why that would have declined and I think it was primarily a reflection of the fact that we had not accrued as much as we ultimately were intending to pay out, and caught that up in the fourth quarter.

You said the other ones were occupancy and --

Occupancy and equipment was down about a couple of million and bad debt was up.

This is Frank.

The occupancy was -- last year and the prior quarter we had additional start-up costs with the servicing platforms that opened up in Jacksonville that wasn't recurring, so you'll see some benefits there with respect to the quarter-over-quarter and year-over-year on the occupancy costs.

And on the bad debt, we, I think, began this quarter -- because we had as much whole loan sales as we did this quarter, we set aside a reserve against sort of likely loan kickouts, returns that could happen due to first-payment default, that is an incremental two basis points, and that's why you're seeing the bad-debt number go up.

Again, to reiterate, the occupancy piece that Frank was talking about, we opened up a second site for our servicing last year in Jacksonville, Florida and that's now fully operational and we're not recurring the start-up costs.

Okay.

Thank you.

Now, the other thing I wanted just to reiterate to make sure I understand it.

Did I understand you to say that the price at which you're going to sell loans that you originate is pretty well locked in until October, is that what you said?

Or did I misunderstand that?

You got that pretty much right.

We have sort of commitments for the sale of the loans and the terms of those commitments.

Now, as we originate the sort of -- the weighted average coupons may affect that.

But about 75% of all of our production is already going forward through October.

And you know what price you're getting for it?

Yes.

And then did I also hear you say that in the full-year fiscal 2004, you expect the operating income line flat for the mortgage operation?

Well, included in last year's operating income line was our remin transaction where we booked $125 million gain.

When I say flat, -- we are not anticipating a recurrence of that type of a transaction.

We may, but we aren't currently planning on one.

So exclude that, we think that flat is not far from what we think is likely to occur here.

So if we take out the gain from last year, and look at your full-year results then, you're thinking operating income for the mortgage operation will be about the same.

Yeah.

I say it's sort of plus or minus.

Clearly this is a very big number and secondary markets are going to ultimately answer the, how big the gain on sale number can ultimately be, but I think within a range that of plus or minus, say, $20, $25 million, that's right.

But still on a consolidated basis on your net income for the full year, you think that can be up 13 to 18%, did I miss that? 18 --

That's correct.

Okay.

So if the operating income for mortgages is fairly flat, then what do you anticipate making up the difference for sort of the flat results in mortgage?

Yeah, there's a couple of things that I would say to make sure that we are fair about it to begin with.

There's in my mind, there's three major non-recurring last year.

There was the renim, which we just talked about, there was a charge that we took related to settlement of the litigation in Texas that was about $42 million that we took in our second quarter of last year and then there was an impairment charge that we took against goodwill for our investment services group of about $24 million.

So the net of those was a positive number, but in general it sort of gives us something that we have to overcome.

Over and above that there's probably one other moving part that you need to keep in mind for this year and that we expect to have about $22 million of expense related to options.

We began expensing options this quarter, a small amount went through this quarter but the bigger apples are going to start coming through.

So among all those moving pieces we have sort of those kind of unusual items.

Key things after that is all said and done we're expecting performance to improve in our business services line, we're expecting substantial improvement in our investment services and we're seeing that happen now through our first quarter and again into August.

And we are expecting continued sort of steady growth as we have seen over many years in our tax business.

So I think it's a combination of a whole series of things.

The 13 to 18% earnings growth that we talk about is a GAAP number but it's the earnings per share growth and, another key element that drives earnings per share growth for this company is how we reallocate our capital.

We continue to dedicate excess capital share repurchase and reducing our share count.

So a combination of a lot of things and I say it's the way we manage all the businesses together.

So the 13 to 18 does eliminate some of those extraordinary items from --

No.

The 13 to 18 --

Would leave those in.

Is inclusive.

Okay.

So we're doing an EPS GAAP-to-GAAP comparison.

That straightens that out.

And then one last question.

You've been very patient, but I think I understood you to say that when the refinancing boom moderates, that helps your business, that was a little bit counterintuitive to me.

I'm obviously missing something.

Can you explain that?

Yeah.

Because I think this is, as we started out, we think this is one of the misunderstood aspects of our business.

You got to understand how our business is done.

We do a lot of our retail business in H&R Block mortgage is done a traditional way and I think we're going to see a reduction in the level of traditional loans that we do or the conforming loans that we do through H&R Block mortgage.

The other side of the our business and the bulk of our business is done through mortgage brokers.

Mortgage brokers during the refinance boom have been, very busy doing refinance.

And once that slows down, we are in a position to get more of their attention as they are doing more of the kinds of mortgages that we specialize in.

We specialize in debt consolidation, we do a substantial share of our loans, our purchase money loans, and only about 8% of our mortgage originations last year were rate and term refinance.

So we think that as mortgage brokers have less demand for traditional rate and term refinance, they will continue to work hard, but they'll focus more on the more difficult loans and loans where people are doing debt consolidation, which is really our specialization.

So a combination of that, we think -- and other things that we can control in our business model, leads us to believe that net-net we're going to be in a better position from an origination perspective.

Thank you so much.

Thank you.

Your next question is from Rick Ludwig with John A. Levin.

Yeah, hi, I had a couple questions.

First of all, with respect to second-quarter earnings, I mean, maybe you gave a specific guidance here, but you gave a lot of potential [inaudible] to that relating to the expenses of the sort of the franchisee buybacks and that type of thing.

I mean, are you going to have sort of flat year-over-year earnings in Q2, or is there potential that they could be down 5 or 10 cents from where they were last year?

We obviously have a lot of different moving parts.

Our estimate is that the tax business between the acceleration -- the real moving number I think in this one is the tax business.

I think the other lines of the business, at least the estimates that I've seen from the sell side of the street, are pretty close to what we would internally be modeling as well.

It's really tax where because of $7 to $8, $9 million of additional expense related to taking over some of these franchisees and more offices which will account for several million, $4 or $5 million of additional expense and the additional technology that's moving from our third quarter.

I would say all in, there could be a $15 to $20 million additional spend over and above what --the traditional levels would be for that quarter.

Now, you can remember last year's second quarter number has the legal settlement in our litigation in Texas.

So I'm certainly not anticipate that's going to occur again.

Okay.

And then I also had a quick question.

I -- if you look at the cash flow statement, the accretion of the residual interest $34 million for the quarter and on total mortgage income of -- whatever $163 million for the quarter as well.

Is that about the ratio we're going to see for the rest of the year in terms of the accretion of residual income compared to securitizations sort of as a percentage of the income that comes out of the mortgage operations?

Let me let Frank take that.

I'd say the answer to that question is yes.

If you go back and look at the last four to five quarters the write-ups have been approximately consistent quarter over quarter so the accretion would reflect that consistently in a level of the write-ups.

So for the net rest of the year that would be the appropriate ratio going forward.

Just one other question.

Michael Hodes asked a question about the true up with respect to household and I didn't see that anywhere in the press release, what was that relating to?

As part of the arrangement that we had with Household for this past year only in terms of the waiver agreement that we had with them where we did not participate, there was an agreement in part of that that based upon actual performance of some of the underlying loans, we would have sort of additional revenue coming to us, and that was reported.

Mark A. We think it's fully recorded now, but it was realized in the first quarter and that was about $4 million.

That was $4 million in the operating income in the tax operation?

That's correct and again I'll reiterate so everyone is aware of it.

We've now begun this quarter posting supplemental information from this call on our website, and there's a schedule in there that will obviously be in our queue when we finally file it but it shows sort of the makeup of this quarter's revenues and we'll see a $4 million item in there.

Thank you very much.

Your next question is from Steve Tazo with Tazo Capital.

Hi, this is actually Eric for Steve.

I was curious, what percentage of the loans that you originated were refi, and I guess of the refi how many of those would be a rate only and how many were cashout?

I'm not going to have the exact number but I can give you sort of pretty close numbers.

A little over 30% of our originations would have been purchased money.

Less than 10% would have been strict rate in terms, so no cashout.

And the balance would be -- which is going to be about 50 -- almost 60%, a little over 60%, would be debt consolidation cash-out.

Thank you.

Your next question is from Dan Kerrs with DK Equity.

Good evening.

I had a follow-up question concerning your forecast of the tax business in fiscal year '04 in terms of the pieces of growth that an earlier caller mentioned, how we get the 13 to 18% GAAP.

Now, I mean last year tax operations was a little under 50% of pre-tax, and we did have a relatively weak '03 relative to I guess earlier expectations and you explained those.

But frankly, I was a bit surprised to hear that you don't sound more bullish for taxes as prospects this year and perhaps I misunderstood you, but given a firmer economy and hopefully higher workforce participation, tax changes coming at tax payers and hopefully higher retention rates at tax associated with your retention efforts and a move to greater one-stop financial service shopping, I would hope that tax might act better than perhaps up steady as she goes.

Am I missing something?

I'm not sure I would disagree with your perspective.

It's just early and we are trying to be prudent in how far ahead of ourselves we get.

Now, we're working very hard and I'm feeling very good about the way the programs for next year and our targets are coming together, but as we saw last year, the level of impact that the economy had on our business, sort of caught us by surprise.

We are paying very close attention to those things that we think will affect us this year while economy appears to be improving, how it does for the rest of the year and in particular the employment market is something that we're very cautious of.

So, and the other good it news I think out of all of that is that cautiousness about looking forward is reflected in our spending levels, because, again, we don't want to get ahead of ourselves and spend money that we can't recover once tax season gets here.

Frank, could I ask a follow-up on that, can you give us any idea where you see retention rates possibly going this year, any broad brush stroke, any couple hundred basis points better, or where are we at currently, can you tell me?

Yeah, we have our models and we're kind of working those and looking at what we both know and what programs we think we can do to affect that.

But we're getting ahead of ourselves, if I get too far out there on this one.

We will clearly share as much of this as we can when we get closer to tax season.

Generally speaking, the 50 basis points or more improvement would already have quite a substantial leveraged impact on the bottom line, right, so --

Yeah.

And the other key thing, I mean a little secret about retention is the retention rate itself is really very dependent upon how many new clients came in the year before, because the place where we have the greatest challenge with retention is first-year clients.

So since we acquired fewer first-year clients last year, not happy about that, but it should have a -- a corresponding improvement in the optics, at least, the retention rate for next year.

Thank you very much for your answers and for the call.

Thanks, Dan.

Your next question is from Mike Christodoulu with Enwood Capital.

Yes, Mark, in terms of your whole loan sales, would you think that the 60/40 whole loan sales versus securitization ratio of the first quarter, should we assume that'll be the case for the balance of the year, given current conditions?

Yeah, well if you qualified it by saying given current conditions I'd say yes, the thing that we do is we are constantly kind of checking where we think the value levels are and what's available to us either through securitizations plus sales or whole loan sales and we move where the market is giving us what we believe to be the best long-term value for our shareholders.

That more recently has been in the whole loan market and given what I think we understand about how the secondary markets are functioning today, I wouldn't be surprised that that ratio would hold for some time, because of the sort of factors that are driving the whole loan market to be strong.

But, again, this is the kind of thing that has the ability to shift and we actually feel better that we have the ability to access in a variety of different markets at different times based on where we see the greatest value but right now I'd say that's probably right but the world changes.

Your next question is from Bob Coleman with Gardner.

Yes, good afternoon.

Mark, could you put some insight on your warehousing facilities and how, if any, increased costs have been derived from that with the recent activity in Fannie and Freddie Mac?

And more importantly, with your loan activity running at $5.2 billion dollar on a quarterly basis, do you have to put up more capital against that because of the possibility of more default risk in the future?

Yeah, I'll do the capital and I'll tell you what I know about the warehouse facility and I'll have Frank also chime in on this.

Capital levels, we do look at our capital levels not necessarily against current originations, although that has an affect, we look at the overall level of outstandings against everything that we've ever originated and we maintain a capital target, I believe it's about 1% of all that that's outstanding, consist with what we think is an appropriate level and the way the rating agencies look at this business.

So, indirectly there's probably additional capital that we will hold and I'd say that what we're seeing is that the level of originations and the level of capital that we're holding is very consistent with what our overall plan is for this year so there's nothing unusual happening there.

On the warehouse facility, no, the warehouse facility's actually been a very stable source of funding for us, our costs have not modified.

I mean there is a float with rates in the market, obviously, so they've come down a bit.

But in general, that has not really been much of a factor.

Then as a follow-up, I've been told that some sub prime mortgage brokers have left the market in the last two or three months, and I'm wondering if you picked up any incremental volume from them leaving the market and having the brokers consolidate versus expand?

My personal sense of that is that that's a -- if you're hearing that people are starting to do that, I have not seen that directly in the market unless they're very small players, and I think there's some very small players, but we would conclude that with a variety of things that are happening, you're going to see some of the more marginal players in the market be hurt certainly, and that's why we think that our cost structure's an important advantage for us in maintaining not just our profitability but the ability to continue to service brokers very effectively, which is what it takes to be a long-term player.

I've heard it on a very small basis, but not a lot more.

And if you allow me two questions on the tax business, when dealing with the expectation of the refunds for '03, average refunds per household and then against that refund, what will be your pricing for '02 or a '03 tax product?

And then a follow-up on marketing.

Yeah, we don't price based upon the size of the refund.

We are still working on what our pricing strategy for next year will be.

But we clearly do not price based upon refund levels.

Now, having said that, there is client satisfaction implications based on the size of refund, which we either benefit or are hurt by unnecessarily.

So we think that'll have an affect.

We also tell you that -- the legislation that passed this year and what that's doing with the child credit, the advance payment of the child credit, a myriad of things that will relate to that we think will be good for business, as we saw with the rate-reduction credit.

But again, I think it's just a little bit ahead of the time for us to be sort of describing how much we think that'll impact us.

And then finally on the marketing side, what should we expect from the change in personnel at the marketing levels for this tax season?

Will there be a dramatic change, will there be any affect of the programs already in place that we shouldn't expect any change at all?

Oh, yeah.

I think the programs are very much close to being.

So while there may be some capital margin modification based on a new chief marketing officer coming in, I tell you, for a seasonal business like ours, we started probably in January planning next year's marketing campaigns and it was supplemented by the analysis that occurred at the end of the season and has really been driving through the programs.

We do not anticipate a change in marketing strategy per se, we're looking at modifications and in our marketing message and our brand positioning, but the strategy itself isn't dramatically going to be different.

So should we expect an increase in overall marketing promotional costs for the rest of '03?

I think that's too early to know.

We'll talk about that as we get closer to the filing season.

Okay.

Thank you very much.

And you have a follow-up from Mike Christodoulu

Yes, Mark, in terms of your whole-loan sales, you had been getting I think 106% of face in the last couple of quarters, given that you've got some, commitments for originations through October, do you still expect to see premiums over the next three to four months?

We certainly haven't seen 106.

If you can tell me where I can find that I'd like to talk to you. 106 is a little strong.

But we have, a variety of different forward commitments on loans that, we'll -- by current trends in our current sense for the upcoming quarter is it's going to be slightly below where we've been -- somewhat below where we were for this quarter and as we sort of see in the margins moderate a business.

So, in the 104, 10, 20 range, that kind of range.

And just a follow-up on cross-selling, how should we think about the 3500 retail mortgages out of the 7,000 that came from existing H&R Block customers and how should we look at that versus the 20 million customers that you have?

Are there any -- any quantifications you could offer us just in terms of greater opportunities for cross-selling in the future?

Yeah, I tell you, we still believe that there's a very, very big opportunity.

Our estimate is that within the H&R Block client base on an annual basis you're seeing about a million clients a year who are doing something with their mortgage, either moving or refinancing to take cash out or something, so out of a million loans a year that we think are occurring inside the Block-branded client base we're seeing about 3500 of those.

So obviously, those are the kinds of numbers that can get me in trouble, because I see a huge opportunity in the complications of how you actually execute against that will quickly get in the way.

I think we're making really good progress on doing this and we're now seeing sort of sequentially better and wetter performance out of your retail business.

I think we have a very solid management team, they've got a good game plan for how we're attacking the opportunity that exists here, but we're going to be growing into this opportunity for a number of years.

But clearly, the lower costs that we have in acquiring a loan because of the relationship we have with clients and because of the process we are using, we think gives us a distinct competitive advantage for the long term.

Those 3500 customers were they tax customers?

They were predominantly tax customers.

Thanks very much.

And your final question is a follow-up from Michael Millman.

Thank you.

Mark and Jeff, this year, assuming that the economy is flat to some improvement, do you think that you will outpace the IRS return numbers?

In theory, if you look back at historically what's happened as the economy has affected the number of tax filers in this country, at times when the economy is negatively affecting the number of filers, H&R Block has been disproportionately negatively affected.

And at times when the economy is recovering, H&R Block has disproportionately benefited.

So in years in transition years, which is what I'd say this one is, it's kind of a push.

So, all things being equal, I would say it really depends on what kind of strength we see now in the second half of the year with employment, but I'm not ready to say we're going to outperform sort of the market until we have a much clearer sense of both the economy as well as some of the programs that we're trying to put in place.

Thank you.

Thanks.

At this time, there are no further questions.

Gentlemen, do you have any closing remarks?

Yes, let me just close by saying again, thank you to all of you for joining us.

As always, if you want further clarity about anything that we've discussed, please feel free to call.

We appreciate you joining us.

Thanks.

This concludes H&R Block's first quarter earnings release conference call.

Thank you for your participation.

You may now disconnect.