H & R Block Inc (HRB) 2004 Q3 法說會逐字稿

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

At this time I would like to welcome everyone to the H&R Block third quarter earnings release conference call.

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

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

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

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

Thank you.

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

Sir, you may begin your conference.

Great, thanks.

Good afternoon and welcome and thank you for joining us to discuss our fiscal third quarter 2004 results.

With me today is Jeff Yabuki our Executive Vice President and Chief Operating Officer, Melanie Coleman our Vice President and Controller, Becky Shulman our Vice President and Treasurer, and Mark Barnett, Director of Investor Relations.

Before I begin our 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.

These statements speak only as of today.

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

In conjunction with today's call, there's some supplemental financial information that's been posted to the Investor Relations section of our web site at hrblock.com to facilitate your analysis.

In addition, a copy of these prepared remarks are going to be posted to our web site shortly after the conclusion of this call.

And during today's call we will discuss results from the quarter and then provide our outlook for the remainder of the fiscal year.

But before I do that, get into the details of the business, I would like to take an opportunity to first of all thank the thousands of associates that are throughout our organization for their efforts that led to the results that we are going to discuss today.

We have truly committed associates who are key to this company's success.

So I thank you for your efforts.

I'm pleased to be reporting very strong financial and operating performance for the third quarter.

Our solid financial performance was achieved through strong financial performance in the tax segment, improved results in both the business services and investment services segment and continued solid performance in our mortgage operation.

Revenue for the third quarter were $977 million, compared to $958 million a year ago.

As you will recall, last year's third quarter included a $130 million -- excuse me $131 million pretax gain from the sale of previously securitized residual assets what we have referred to as a renim transaction.

We also recorded a similar, although much smaller sale in the third quarter this year, that netted a $17 million pretax gain.

If you exclude the impact from these sales of these residual assets, revenue increased 16% and this wasn't due to any one part of our business.

We saw double digit revenue growth in all of our reporting segments.

Reported net income was $107 million or 59 cents per diluted share, compared to $132 million or 73 cents per diluted share last year.

Excluding the impact of the sales of residual assets, net income increased by $43 million an 80% increase over the prior year's operating results and we achieved a 24 cent or 81% improvement in earnings per share.

And this was despite the fact that third quarter results include $7 million this year in stock-based compensation.

In the tax business, the results for the quarter were solid, despite a slower-than-expected start to the tax season.

Growth in average fees, cost efficiencies, and impressive performance in our digital tax solutions businesses all contributed to the strong financial performance in the tax segment through the January period.

The inclusion of former major franchise territories as company-owned operations added to revenue for the third quarter but slightly reduced overall earnings.

As you will recall, last year we experienced a very fast start to the retail tax season with positive client growth through the January period, and weak results the remainder of the year.

This year's results reflect a different and we believe more favorable trend.

After a slower start in January, we are seeing growth on a comparable basis in February, which Jeff will discuss further in a moment.

We believe the early season retail weakness to be a combination of two primary issues.

A somewhat slower start to the tax filing season and changes in our marketing strategies which we believe will attract later filing clients.

As we discussed in January we changed our marketing strategy to be less promotional in our Refund Anticipation Loan advertising, consistent with our brand repositioning and advice messaging in our media campaign.

In addition, we have continued to evolve our settlement products practices to encourage clients to choose lower cost settlement products when it is best for them.

Our primary -- our preliminary results indicate that these changes may have led to a weaker-than-anticipated early season business for clients who are primarily motivated by access to fast refunds.

Over the longer term, we believe our RAL offerings must be consistent with our overall brand repositioning, as it strengthens our competitive position and allows us us to extend value to a broader base of clients and better position us for sustainable long term client growth.

At the same time, we are committed to serving the portion of our client base who is primarily motivated by access to fast refunds and deliver best in class value to that segment.

Although it appears our efforts may not have been entirely successful this year, we will learn from the results and make the necessary adjustments going forward.

Based on current trend, which Jeff is going to discuss, the very early indication is that our repositioning in the market is having a positive impact.

As we discussed in detail in our January investor conference, for the last several years, we've been building our capabilities to deepen client relationships through advice, and deliver tax services to clients in way -- in a way -- the way in which they choose.

Retail, online, or software.

This advice-based multi-channel capability is both convenient to clients, and competitively differentiating as we are the only company that is able to offer a full range of tax services under a single brand.

Based on the limited market information available, we believe that we are outperforming the overall tax market in clients served which is an indication our multi-channel tax strategy is working.

We are seeing very strong growth in our digital business, along with higher revenues per client, continued pricing power in all channels, and preliminary data indicate improvements across all client satisfaction measures.

Lastly, and although it is very early in the year, we are seeing growing strength in our ability to turn advice into action.

Programs that extend our value proposition such as our express IRA and referrals to our -- our -- to our financial advisors and mortgage business are experiencing solid growth rates this year.

While these results are on a relatively small base, we believe that turning advice into action is a critical component in building differentiation and client loyalty.

Let me turn to Jeff who is going to discuss more about our tax results as well as results from some of our other business segments.

Thanks, Mark.

Our U.S. tax operations which include U.S.-based tax services, refund anticipation loan participations, and digital tax solutions reported quarterly revenues of $464 million, a $60 million or 15% increase over last year's third quarter.

Former major franchise territories are now operated directly by the company, contributed $24 million of the increase in revenues.

Revenue growth was also driven by higher average fees per client, increased clients served in our digital tax solutions business, and increased revenues primarily related to timing changes, related to refund anticipation loan or RAL participations.

Pretax earnings increased $34 million or 100% to $68 million, compared to $34 million last year.

The improved results were primarily due to continued progress in off-season expense management.

Partially offset by a larger distribution system.

Which now includes a commencement of company-ownered operations in former major franchise territories and the addition of new offices last year.

For the quarter, we recognized a pretax loss of $2 million related to company-owned operations in former major franchise territories, which includes $4 million of intangible amortization.

Also, excluding those operations in former franchise territories, occupancy and equipment costs increased $7 million, due to a 7% increase in average rents paid.

Stock-based compensation is now being reported within our business segments, and totaled $4 million in the tax segment this quarter, versus no such expense last year.

Through January 31, clients served by company-owned and franchise retail operations decreased two-tenths of one percent, compared with the same period last year.

Total clients served for the quarter, including both retail and digital tax solutions clients increased 4.6% over the prior year.

Refund anticipation loans, processed by H&R Block in January decreased 1.2% to 1.9 million.

As Mark mentioned, the majority of the decline appears to be attributable to the filing season timing changes combined with less aggressive promotional advertising.

However, over the same period we experienced substantial increases in some of the lower cost settlement products which can have the effect of enhancing the price value relationship for our tax clients.

Based on what we currently can see in the tax market, we do not expect to improve on this shortfall in RAL participation units for the year.

For the period January 1 through January 31, tax preparation and related fees of company-owned and franchised operations increased 8.6% compared to the same period last year.

Consistent with our expectations, the average fee per client rose 8.9% to $134.99.

Compared to $123.99 last year.

Through February 15, clients served by company-owned and franchise retail operations, declined 3.9% compared to the same period last year.

Total clients served including both retail and digital tax solutions clients increased one-tenth of one percent.

Tax preparation and related fees increased 3.9% for the year.

The average fee per client was up 8% to $135.48.

Although some may find it surprising based on a cursory look at the early season reported data we are relatively pleased with overall performance in our retail business so far.

Let me explain what I mean.

First and foremost, the February 1, to 15, reported volume information is only partially representative performance, given that there were three Sundays in that period this year, versus the prior year when there were three Saturdays.

As many of you know, Saturdays are substantially busier than Sundays, and not surprisingly, on a day to day basis, it is almost impossible to overcome that deficit.

This timing event reverses in the second half of February.

Also as you will recall from our discussion in our January investor conference, we were anticipating slight growth in the overall tax filer market, consistent with the IRS's estimate of a .45% or 45 basis point increase in returns for the year.

While IRS data has not yet been formally released, it is our belief that the tax market is soft, and total tax returns filed may be down so far this year.

Additionally, as IRS tax filing data are released, we expect there to be a fair amount of inter-period movement of the numbers.

Due largely to increases in electronic filing adoption rates.

These swings could result in significant positive and negative variation, in period data.

Which will make forecasting overall tax market growth challenging.

Our current estimate is that individual tax filings are moderately down as of mid February.

While we are treating the IRS estimate cautiously, we have a growing internal bias that the actual results may be less than those originally projected by IRS.

The primary cause of the slow industry start is not entirely clear.

Our own internal data on this point is mixed.

Our early analysis points to a somewhat larger-than-expected number of people not filing returns again this season, which may be connected to the continuing weak labor market.

At the same time, it is early.

And we will learn much more as the season progresses.

However, starting in early February, we began to see much more favorable filing trends on a day to day comparison, over last year's data.

When analyzing the tax business, as in most retail businesses, we look at comparable volumes on a date basis as well as on a same-day basis.

Understanding changes relating to a day of the week, as well as on a date basis allows for better analysis and forecasting.

Slide number five of the supplemental information, this information is available on our Investor Relations web site, shows a snapshot of the day to day percentage change in retail company-owned clients served over the previous year, for the period January 16, the initial date of E-filing through February 22, our last day of complete information.

As you can see on the chart, the day to day trend switches from negative to positive starting on February 3.

For further context, although we reported a 4% decrease in clients served for the date to date period, February 1, through February 15, on a day to day basis, we actually experienced a 2.5% increase, over the prior year.

As we have discussed on previous occasions, date to date comparisons do not necessarily reflect overall filing trends within our tax business.

As any single period may not necessarily be comparable for a variety of reasons, some of which we have discussed today.

Accordingly, we urge caution in trying to extrapolate filing trends based on the date to date comparisons until much later in the season.

Although our interim tax season releases will be on a date to date basis because of the complexity later in the year from a day to day comparison we will continue to provide you with our view of the overall filing trend as the season progresses.

We monitor the nature of the tax filers coming to H&R Block on a regular basis, and we believe that we have a good handle of what we can do to maximize our performance given the environment and the remaining tax filers in the market.

Giving way to a softer-than-expected overall filing season, and the trends that we were seeing through February, we now believe that we will be on the low end of our retail unit growth expectation of 1-4%.

As Mark mentioned, we were disappointed that the less promotional nature of our RAL marketing campaign appears to have negatively impacted our early season retail business.

However, the remainder of the block advantage campaign appears to be working well and based on our overall market repositioning we appear to be seeing a slight shift to later filing higher value clients.

I would also like to share with you some additional insights on the continuing role of our distribution system in achieving growth in the retail tax business.

We've explained the importance of improving our levels of network density.

And also, that our physical distribution system has been at times disadvantaged in terms of achieving significant client growth, given the maturity levels of the majority of our real estate network.

As you may recall, last year we opened over 230 new locations across the country.

In reviewing our office results by tenure, we see that those offices opened in tax season 2003 have experienced client growth at an average rate in excess of 30% over the comparable period last year.

These results have been achieved without deep discounting or other unsustainable economic actions that can distort short term performance.

Admittedly this growth is on a relatively small base compared to our more seasoned offices but we are gaining important insights into a key lever for future growth, and also additional insights into competitive growth plans.

Given the tax market's lack of growth last year and weakness so far this year.

We've also been pleased with the early results in our Wal mart distribution partnership this year.

While it is too early to gauge the entire year, the system in the aggregate is performing within our expectations, and we think represents an efficient client growth opportunity in the future.

Lastly, the performance in the former major franchise territories has been generally consistent with our expectations to date, given the overall tax marketplace and the expected pressure on client retention, given the price increases levied in the prior year.

We will continue to provide visibility into the performance of this important aspect of our business throughout the season.

In our volume releases, and when we share results at the end of the season.

Let me now turn to our digital solutions businesses, which include our tax cut software and online tax solutions.

In this line of business, revenues increased 54% over the prior year's third quarter.

Given the significant operating margins in this business, the revenue growth translated into substantial bottom line improvement, including profits in the third quarter.

As we saw last year, the majority of our growth in the digital do it yourself category is coming from the online tax market, with steady growth in the software category.

As Mark mentioned earlier, we believe that our multichannel tax strategy is starting to take hold.

And that we are building our share in the do it yourself category.

Through February 15, our paid online clients were up 47% over the prior year.

On top of this outstanding client growth we are also seeing growth in attach rates for additional products such as state tax returns which is increasing our online revenue per client and building client value.

Online revenue per client increased 32% over the prior year, to just over $31 per client.

We also continue to develop services that bring tax advice and professional services to tax consumers in any way that they choose.

Through February 15, the number of clients that purchased an online professional service delivered through one of our tax professionals, increased over 200%.

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

In the software market, third quarter revenues from tax cut and other software grew 34%, driven by increased sales volumes and an improving mix to higher priced products.

On a sell-through basis through January 31, our federal unit sales increased by 11% over the prior year.

While we were pleased with our strong early unit sales, category marketing efforts may be pulling sales forward.

Accordingly, we don't necessarily expect unit volume in the software business to continue to grow at the same historical trajectory seen in the typical tax software sales cycle.

In summary, based on tax season results we have seen so far, we now expect pricing growth near the higher end of our 5.5 to 8% range in our retail tax business, retail client growth at the low end of 1-4%, in that business, online growth at the higher end of 20-40%, and software in the mid range of 5-15%.

In total, we expect to be in the lower end of the 2-7% growth range for overall tax clients served.

In our international tax operations, which include Canada, Australia, and the United Kingdom, revenues--generated revenues of $11 million, a 24% increase over last year, and the pretax loss of $6 million was essentially flat compare to last year.

While our international operations achieved improved financial performance on a local currency basis, driven primarily by solid expense management, our reported results were offset by weakness in the dollar exchange rate because we are now experiencing off-season losses in these operations.

Turning now to investment services, we saw significant improvement in the key drivers of that business during the quarter.

Third quarter revenues of $58 million were up 20% compared to the third quarter of last year, and up 10% sequentially.

Investment services profitability also improved recording a pretax loss of $13 million in the third quarter, which is a $19 million improvement over the pretax loss of $32 million in the third quarter of last year and a $3 million improvement over the previous quarter's pretax loss of $15 million.

Each of these quarterly loss figures includes $7 million of intangible amortization.

Within our revenues, total production revenue increased by $10 million from last year and $5 million from the prior quarter.

The increase in production revenue from the prior year was driven primarily by increased asset-based revenue, such as managed money fees, mutual fund and annuity sales.

Third quarter trading volume was up 35% from last year and 19% compared to the previous quarter. 36% of production revenue came from mutual funds, annuities, and fee-based accounts compared with 28% in the prior year, and 37% in the prior quarter, which is consistent with our strategy.

Net interest income of $8 million in the third quarter remained essentially flat, compared to both last year and the previous quarter.

Ending margin balances increased 11% compared to last year, and 10% compared to the previous quarter.

In terms of the growth of our revenue base, we continue to recruit experienced financial advisors as a way to leverage existing capacity.

Our fiscal year 2003 and our fiscal year '04 recruits accounted for 16% of our production revenues this quarter.

We are also enhancing our business model by broadening our distribution capabilities, by aligning tax professionals with financial advisors, to deliver a value proposition unique to H&R Block.

We are now linking small groups of experienced tax professionals with a financial adviser on a local market basis to provide a team-based approach to meeting client's needs.

Through the end of the third quarter we have registered 294 tax professionals in the program, and have another 528 people that are in the registration process now.

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 operations.

Thanks, Jeff.

Mortgage operations, which include option one and H&R Block mortgage, again delivered solid results this quarter.

Excluding the impact of the current and prior year's sales of residual assets, pretax income during the third quarter increased 5% over the year ago period and declined 25% over the previous quarter.

Growth over last year was driven by increased nonprime origination volume partially offset by tighter margins for the loans that we sold.

Decline over the previous quarter was driven primarily by lower origination volume due to fewer funding days in the quarter and a difficult comparable due to the spike in loan application volume that we experienced in the second quarter.

Third quarter loan production totaled $5.4 billion an increase of 18% over the third quarter last year and a decline of 16% from the previous quarter.

Excluding the impact of the current and prior year sales of residual assets, revenues for the third quarter were $315 million, up 18% over last year, and down 10% over the previous quarter.

Third quarter revenues also include $17 million gain from the sale of residual assets, although this gain was largely offset by other expenses, including a break down of $9 million related to the remaining assets of a part of our mortgage business that we had previously discontinued.

As for the gains in the sale of residual assets this quarter, it was largely offset, the reported level of profitability is a pretty good indicator of the true operating profit that we experienced for the quarter.

Within our retail mortgage operations, we've shifted our focus towards higher margin nonprime production, due to the slow-down in prime refinance activity.

Third quarter retail nonprime origination volume grew 66% over last year, and declined 6% over the previous quarter.

Consistent with our expectations, retail prime origination volume declined 68% over last year's comparable quarter and was down 36% sequentially.

Of the total number of retail notes that we originated, more profitable nonprime represents 75% of the total compared to 39% last year, and 68% in the previous quarter.

Overall, our net gain on sales on nonprime originated loans was 408 basis points compared to 460 basis points last year, and 387 basis points in the previous quarter.

Compared to last year, this anticipated decline in our net gain on sale is within our planned levels and is primarily the result of lower loan sales pricing in the secondary markets.

We're focused on managing our costs of origination to allow us to sustain our historic margin advantage in the market.

Weighted average interest rate charged nonprime borrowers, on new originations during the quarter were 7.47%.

Down from 7.94% a year ago.

And 7.51% in the previous quarter.

At quarter end, option one servicing portfolio was $42 billion, an increase of $13 billion over last year and $2 billion over the previous quarter.

In the quarter, the majority of our nonprime loan sales settled through the whole loan sale market versus securitizations due to comparably superior execution in the whole loan market.

Of nonprime loan sales completed during the quarter, 87% were sold to the whole loan market while the remaining 13% was securitized.

This compares to 41% whole loan sales and 59% securitizations over the course of the previous fiscal year.

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

The percentage of cash proceeds we received from our capital market transactions was 72% for the current quarter, compared to 98% last year, and 87% in the previous quarter.

The decline in the percentage of cash proceeds from the previous quarter resulted from a decision that we made to delay the NIM sale from third quarter securitization activities until the fourth quarter.

Based upon our strong third quarter cash position, we decided to push the final disposition of this NIM bond to the fourth quarter, which will allow us to increase the overall cash proceeds that we received from the residual asset.

You should note, this is -- we are now using a new metric that we first provided you in our January 14, investor conference.

This metric is calculated by dividing the cash that we received from capital market loan dispositions during the quarter by the recognized gain from those same transactions.

We believe this is a better measure of cash generated from current quarter capital market activities than cash proceeds, as a percentage of gains, recorded gains at sale which we referenced in previous quarters.

Using the recognized gain from capital market transaction, as the denominator, providing a more accurate reflection of cash generated from current quarter activities, because the recorded gain on sale typically includes other accounting items, that were unrelated to the current quarter activities.

For example, impairment charge -- charges inflate cash as a percentage of the recorded gain on sale.

For the remainder of this fiscal year, we will continue to provide both metrics in our SEC filings.

During the quarter, credit quality remains strong in our nonprime originations.

Our average FICO scores for nonprime originations averaged 607 for the current quarter compared to 611 last quarter and 606 for the year ago quarter.

Average loan to value remains steady at 78%.

Delinquency trends continue to be positive.

Using data reflecting only loans that are 12 months 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 January, 31 days plus delinquency rates were at 12.55%, compared to 14.8% in January of 2002.

We are using data reflecting only loans that are 12 months seasoned 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 are non recourse transactions, it is important to note that our risk as it relates to loan performance is primarily limited to the value of residual assets and mortgage servicing rights on our balance sheet.

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

Our residual interest continues to perform better than expected primarily due to lower than modeled losses , slower prepayments and lower interest rates.

Accordingly during the quarter we realized a net write-up in residual balances of $36 million, which was recorded in other comprehensive income on the balance sheet, net of deferred taxes.

Turning to business services, third quarter revenues increased 12% over last year to $112 million.

The increase is primarily driven by strong revenue growth in our capital markets business and improving performance in our core accounting business.

Pretax income was $2 million compared to a loss of $4 million last year.

The year-over-year improvement was due to increased earnings from capital markets and taxed accounting services, offset by planned losses related to our payroll and benefits processing businesses.

While uncertainties remain in the business climate we are cautiously optimistic as we look to participate in a recovering economy.

This business which has strong seasonality, also earns the bulk of its net profit during our fourth quarter, and we are well positioned to have a good fourth quarter.

Let me now turn and talk about some of our key balance sheet items.

As compared to October 31, there are several notable changes to the balance sheet.

Cash and cash equivalents increased from $261 million to $671 million, this increase was primarily generated through commercial paper issuance to fund RAL participation interest.

Receivables increased $752 million, to $1.1 billion.

The increase is primarily related to seasonal fluctuations typical of the tax season, with the majority of the increase related to purchase interest in refund anticipation loans.

Mortgage residual interest and securitizations decreased $84 million during the quarter to $234 million.

Decreasing the balance were cash receipts of $76 million, impairments of $15 million, cleanup calls of $3 million and an increase in net unrealized holding gains of $3 million, which consists of a $36 million write-up, net of $33 million in realized gains.

We also restructured the onbalance sheet NIM transaction that we mentioned on our call last quarter which decreased residual interest by $40 million.

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

In that regard, it is noteworthy that our current residual balance of $234 million is $41 million less than residuals of $274 million at third quarter end last year.

Goodwill during the quarter increased $118 million, to $949 million, primarily as a result of the final payments that were made in connection with the settlement with our former major franchisees.

You will note that the current portion of our long-term debt is now being carried an increased $252 million, reflecting our 6 and 3/4 senior notes that are due in November, now being treated as current.

Our long-term balance, debt balances reflect a corresponding decrease.

Notes payable increased to $1.4 billion.

The increase in borrowings is related to commercial paper issuance in connection with this year's RAL, and the other tax season requirements, we expect to fully repay all of our short-term borrowings now in the fourth quarter.

During the quarter, we reacquired 3.7 million shares at a total cost of $192 million or an average cost of $52.61 per share. 1.6 million shares were issued for option exercises, employee stock purchase plan purchases, and restricted shares.

For the fiscal year to date, we reacquired 7.8 million shares at a total cost of $371 million, or an average cost of $47.49 per share.

As of January 31, there were 176 million shares outstanding, a decline of 4 million shares, from the end of the last fiscal year.

Let me now talk about how we see things looking forward to the remainder of the year.

In a tax segment, we expect to be at the lower end of our range for tax unit growth.

Overall revenues and financial performance are expected to be within the range that we've previously shared.

We remain confident in our long-term ability to drive growth in the tax business, offset to some extent currently by the challenges of a difficult economic and jobs environment.

This year's early results are consistent with the view we have how to grow our tax business for the long term, by delivering differentiated value to all of our clients.

Our mortgage businesses continue to perform as we expected, and we are now -- we are not seeing anything in the current environment that is causing us to alter that view.

As I've said for some time now, while we have certainly benefited from the low interest rate environment, much of our mortgage business growth has been achieved by our focus on controllable drivers within the business.

Including systematic growth of our distribution system and improvements in our closing ratio and 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 continue to focus on the controllable drivers within our mortgage businesses, and are forecasting origination volume growth against moderated profit margins.

The progress within H&R Block Financial Advisors has been good and I expect us to continue to make progress with our financial performance giving way to the continuing improvements in overall market conditions.

Business services is showing improvement in all the key lines of business.

And therefore on a consolidated basis we continue to expect fiscal 2004 GAAP earnings per share to be in the range of $3.65 to $3.85.

Which would again be above our long-term growth target of 13-18%.

Revenue growth is likely to be at the high end of our target range of 10-15%, included in these expectations, is about $24 million or 8 cents per share of noncash stock-based compensation expenses flowing through our income statement during this fiscal year at the segment level.

In conclusion, let me thank you first of all for joining us today.

We continue to be pleased with our performance.

Given the challenges and uncertainty facing businesses today, we remain confident in H & R Blocks ability to create sustained growth and additional value for our shareholders.

And with that Operator we would be happy to open the line for questions.

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

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

Your first question comes from Michael Hodes with Goldman Sachs.

Hi, good afternoon, guys.

A couple of questions around retail client growth.

First off, I just wanted to get some clarification, is it your view that thus far in the season, Block has lost share, held share steady or gained market share?

Second, in terms of the retail client growth, I think so far through the 15th, it is negative 3.9%, my calculations, to get the retail client growth into the low single digits, let's say 2% for the full season, implies 4% growth for the back half of the season.

February 15, through mid April.

I just want to get some clarity around what your guidance is in terms of client growth.

And then, you know, lastly on client growth, you know, are we right in assuming that we are, you know, 50% plus through the retail tax season?

At mid February?

I think last year we were 51% through the season at February 15.

Thanks.

Those are my questions on tax and I have one on mortgage.

Let me -- I think I can handle these without looking to Jeff to see if he -- if he sees it differently.

On the retail share, the share questions, our estimate right now is that on the retail filing side, that we are holding share, we may be down slightly but only slightly because of the focus of the early season filers this year versus historically.

And we think there has been a timing shift and from the data that we are getting informally, out of the industry, it appears that we are essentially holding share but we are shifting that share between the early season speed of refund kinds of filers to what we think is a more higher value client that comes in the--in the later part of the season.

I see your point, I think that is correct, we would say that we are probably 50% of the way through the year.

To reach the target that we believe we are trending toward, you would have to see somewhere in the 3 to 5-- 3 to 4% range through the back half of the season, and we think that is what is happening.

In fact that is consistent with what we've been seeing now, as the month of February has been developing, and we think that as we look inside the mix of clients that have been coming to us this year, and where we are seeing growth in the segments, the segment growth, you know, the client segment growth that we are benefiting from are those clients who are typically later season filers.

That is consistent with the overall marketing strategy that we have had for the company, and the positioning strategy that we've had for the brand, throughout this year, as we talked about, so you know, while I would tell you, I think we are disappointed that we did not hold more of our share of the early season kind of speed of refund filer, we're pleased that we're seeing that the marketing strategy that we have is, you know, is starting to attract the kind of client that we had expected it to attract.

The other thing I will tell you, and then I'm going to have Jeff, you know, sort of chime in on the pieces that I missed, we think we're gaining share in the other category, the digital category, I think there is no question we have seen better revenue growth than the industry overall, we've seen better unit growth, for sure on the online and a little bit hard to tell on the software side, but we are pretty pleased with what we're seeing in the digital market, so far this year, and think that our multi-channel, in effect, strategy under the Block brand and our blended channel through strategy of offering sort of -- this unique blend of professional access through a digital channel is really starting to work in the market.

What do you want to add, Jeff?

The only other thing I would say, Mike, is in the early parts of the season, we tend to -- we tend to lose share and then we will come back, because of the nature of our business, a lot of the ERO paid professional market, especially the fast refund centric market does a lot of business and then falls off.

You kind of hold on through the end of the year which was similar to the old -- the older Block business.

And what we are seeing this year and we have seen it in other -- at other times and we're seeing it on a very pronounced way this year, is that growth after, what we would call the traditional first peak period, and as we mentioned in the call, our growth for the first -- for the first 15 days of the month on a day to day basis was about 2 1/2%, and as you can see in the attachment, the -- we continue to experience growth over the prior year on a day to day basis, which we think is the right proxy.

And while we certainly can't -- we can't say that it is going to continue throughout the season, the indications that we've seen are that the client patterns, and the clients that we're attracting are a little bit different than we've seen historically, so the growth, the growth, we're actually pleased with on that side.

And I'm just -- just to be clear here, when you think about the second half of February, and the trends into March, are you making adjustments for the deceleration last year, I mean is that really the right baseline to use, given the way last year broke?

Well, certainly what we're looking at is both the pattern of sort of timing, which I think is what you're describing, but probably more importantly, we're also looking at the segment, the types of clients that are coming to us this year, you know, we -- we have a relatively sophisticated -- for those of you who have been around the business for a long time, you all recall, you know, back in 2000, filing season 2000, we were disappointed when we, you know, -- we were surprised at the end of the year that we didn't have as many clients as we had expected, and we, since that time, have put a fairly sophisticated tracking mechanism in place that allows us to not just see the filing patterns themselves but to be able to see the characteristics of the clients that are coming to us and to be able to segment those clients and then to look at the traditional filing patterns of the segment clients and it is within that that we are seeing that we are attracting a different character of client this year, than what we have, you know, on balance, somewhat different character of client than what he what we have on balance in the past and that those clients that are -- that we are seeing the greatest amount of growth in are the kind of clients who file at the second half of the season and they are also the kind of clients who our marketing campaign is specifically targeted at.

People who are more focused on a relationship as opposed to just some simply the speed of refund.

So it is for that reason that we think that, you know, we're looking at something that is sustainable.

Okay.

And then actually I got to switch my last question, instead of being on mortgage, I have one more on tax.

Jeff, I think you mentioned some timing differences in terms of -- I don't know if it is revenue or expense recognition, influencing the quarter, I was hoping maybe you could, you know, isolate for us where the upside came from in terms of earnings impact.

It seems like, you know, just looking at the franchise and owned office revenue trends, we come to some differing conclusions on what the bottom line would be than what we actually saw.

I was hoping you could flesh it out a little bit better for us.

And you're talking about in the third quarter?

Yeah I'm talking about the third quarter versus the third quarter a year ago.

I understand the major franchise purchases are skewing both the royalty revenues and the tax prep and fees, but I'm just wondering what else is going on.

Well, the royalty revenues wouldn't be dramatically affected by that, because the major franchises were generally low franchise -- or low royalty -- a lower royalty group.

Some of this is, you know, this is a little bit based on timing.

You know, both the January 31 cut-off data, and the first half of February data are skewed somewhat, because of the day of the week that January 31, falls on this year versus last year, as well as February 15, where it falls this year versus last year.

And January 31, this year I think fell on a Saturday, instead of last year a Sunday.

As I recall.

And that difference means that we had stronger volume on the last day of the month this year than we did last year.

And that would be affecting both our reported revenues our reported clients, as well as ultimately the royalties that we receive or we have, because of the timing of the business that we get from -- in our franchise organization as well.

At the same time, that is reversing somewhat in the first half of February, where we have -- in the reported period for these clients, we have three Sundays now in the reported period, unlike last year, when we had three Mondays, which are historicalcally the strongest days of the week for us.

So I think that has to explain it.

Okay.

I appreciate it.

I will get back in the queue for my other questions.

Thanks.

Thanks.

Your next question comes from Chris Gutek with Morgan Stanley.

Yeah, thanks, good afternoon, Mark and Jeff.

A couple of questions.

Focusing on the taxes, specifically the volume growth with the lower income type clients, one of the concerns we had last year, was the competitive intensity in the industry might be picking up a bit, and I'm curious, how much of an effect do you think that is having with some of your low income clients going to Jackson Hewitt, Liberty tax, relative to the effect that you're seeing because of your own strategy change in regarding marketing?

Well, Chris, you know, we -- we have continued to see the number of competitive locations increasing, which is why when we spoke in January, and really what we've been saying for almost a year now, is it's crucial for us to do two things.

And that is, increase our level of density, which is really why I talked about the fact that the offices that we had this year, picked up a 30% growth rate over the prior year in those 230 offices, which we think is a little bit indicative of why some of our competitors show higher growth rates.

So that's one thing.

The second thing that we -- that we said is that it is critical for us to have a differentiated service, and that we -- we have got -- once we get the clients in the door, by showing that we have a little bit better of a value proposition, we will be able to keep them longer.

The third thing, and the thing that we did not -- we did not anticipate as clearly as we probably should have, in hindsight, is that driving people into the door takes a higher dose of promotion than we probably thought.

We had believed the differentiation would bring clients into the door, and our evolving belief is that differentiation is crucial when the client is sitting at the desk, but you may need the promotional elements combined with better levels of network density, to ensure that we both not just keep share, but take share, and that's what we've learn so far.

And I think I would add that, you know, in particular the point about, you know, -- maybe to be more promotional, probably reflects in particular on speed of refund and refund lending.

You know, we chose consciously this year, consistent with what we're trying to do with our brand for the long term, to reduce the level of promotion around refund lending.

And our marketing efforts clearly did that and I -- you know and our competitors did not.

And we think that, you know, the lack of promotional activity that, you know, relative to where we've been in the past, probably hurt us with that early January filer.

And you know, for the long term, if you look at the pattern of filing that we're seeing this year, we would much rather see our growth come in the second half of the year because this is a higher value, probably more loyal client base, who is driven by the relationship that we can have, not by how fast we get them their money.

But clearly, we have a very, you know, a very large position in the early season filing market as well, and we're not, you know, we're not looking to lose that segment of the market, you know, Jeff's right the answer to that we believe ultimately is you know we have to have more competitive density and we're seeing that our competitors are out there in larger numbers as more traditional competitors and electronic filing and other access to refund lending, not just kind of, you know, brand names that you've talked about, and we are seeing, you know, more sort of aggressive promotional activity for that early season filer, who is less brand loyal.

Right.

The only other -- I would add one other thing, because what we are finding as--and it is obviously very early, Chris and so we're trying to kind of temper our conclusions or our desire to jump to a conclusion, is that -- is that we are not -- and you will see this later on in the year, when we get at the year-end and we do our retention analysis, the issue does not appear to be as strongly on the retention side as it is on the new client acquisition side.

I believe that at the end, what we will see is our retention continues to improve or stay strong, including at the lower end of our client base, in the bank product client specifically.

But on the new client side, people who have not yet experienced us, they may not -- and I hate to say this, may or may not wait an hour to get in to see us, which raises an interesting engineering question, on staffing, and that's one of the things we're looking at now to ensure that we have the right levels of staffing across the -- across the network as well, that staffing is obviously just as important as the number of locations.

That's great.

Thanks and my second question, final question, look at the effective complexity, both from because of tax law changes as well as a shift towards hiring compliance you should be seeing more complex average returns for your customers which should have an impact both in the terms of the timing as well as the volume growth.

Last year by contrast we didn't really see the volume growth accelerate in spite of the shift toward more complex returns.

We saw the opposite.

Is there anything specific for this season that gives you more confidence.

We should see the complexity effect and the mix shift in the client base drive an acceleration in volume growth as the season progresses.

For example the mailing of the 1099 forms; or any other technical factors that might shift the timing later in the season?

Well, I will give it a shot, and then I will have Mark fill in.

Clearly, the season itself started a bit later this year for the more complex clients with -- with the 1099 issues that were in the marketplace and we've been able to see, when we look at the level of forms incidents which is the number of forms that are attaching to a 1040, we've seen -- we saw an early decline in things like schedule B, and now we're seeing that rebuilding, and I think something like that is very attributable to the late delivery of tax information.

We are also seeing this year a more direct complexity in the returns than we even anticipated.

So we -- we take some -- some comfort in that.

And then the last thing that I would say is, is as we take a look at our pricing model every -- every -- on a regular basis, we're seeing changes in the makeup of the returns as we move through the season.

So we are seeing a more complex client, both coming in on a retained basis, as well as on a new client basis.

We can actually look at the mix of clients across -- in any -- in any given time frame or time horizon, and we can see how that mix is changing.

And it has been changing to date a positive way which gives us some comfort that we are seeing a little bit more complex client and you can see that in our pricing data where currently complexity is on the higher side of even what we anticipated when we got together in January.

Great.

Thank you very much.

Your next question comes from Joe Lamanna with William Blair.

Yeah, on the mortgage business, you made a comment about fewer days, counting for part of the reason why the pretax profit excluding the nonrecurring gains were up only 4.5%.

Is there a way you are going to adjust for the fewer days, and if so, what would that percentage increase be?

Because you made also a comment that you thought the growth in the mortgage business was consistent with your expectations, and I'm surprised 4.5% pretax growth would be consistent with your expectations for that business.

Well, you know, there are -- the idea is -- the number of sales days in effect is what we're referring to because you have the holidays over the course of the third quarter, and this year, because of the way in which those days fell, being on Thursday, we also viewed the Friday after the, you know, Christmas and New Year holiday as sort of nonproductive days, so a combination of those, compared to the second quarter, is why we sort of referenced fewer workdays.

There is no question.

We saw a slow-down in the level of originations, and I don't have it off the top of my head but I'm sure we can get it for you, on the number of -- at the level of the origination activity or the number of applications that we are receiving in the mortgage business in the third quarter compared to the second.

Now the second was a abnormally active quarter.

And I'm not sure that we would conclude that that was normal either.

But there may have been some business that was somewhat pulled forward into the second from the third quarter, and we saw in November and December and somewhat into January the level of origination activity and application activity had slowed down.

Now, during February, that is reversing again, and we are now seeing I think the number through yesterday would say we were seeing the fourth most productive month on an applications per day basis that we had seen in the company's history, so the application activity is back up to kind of the levels that we suspected or expected that we were going to see for the rest of the year.

So you know, I know that is more subjective and not putting hard data on it, but we can get you more hard data on the level of originations if that would be useful.

That's sufficient.

Thank you.

Thanks.

Your next question comes from Michael Millman with Millman Research.

Thank you.

I guess a couple of questions, primarily, on -- maybe beating this tax issue even more, is it looks like the actual number of RAL declines year-over-year was about the same as client declines in company-owned offices.

I don't know if that is coincidental.

Or if there is something to it.

Also, maybe you could talk to us, talk about what generally RAL, attrition might be, in the past, and if that seems to have changed, to say, acquisition seems to be the problem, also last year, in February, you were down 6.1%, and so as the comparisons are probably pretty easy in the second half of February, particularly towards the end of the period, when the snows hit, and that's where you show your greatest strength, so I'm not sure we're looking at necessarily an apples-to-apples and maybe you can comment on that.

And then, you know, I guess maybe it was last year, that you -- I don't know if it was motion but you did open some trailers, you had trailers in Canada to handle some of these crowds, why don't you do those kind of things here?

Trailers in Canada?

Anyway, well, on the -- your point about the number of refund participation loans, I tell you there is a couple of things happening there.

One is our overall tax rate, if you will, the number of people who are clients who are taking a refund loan is down year-over-year.

And we believe that is based upon -- or that is the result of some actions that we have specifically taken around our process, and the way in which we describe to clients the alternative choices they have for receiving their refund.

We have adopted what we believe to be industry best practices that have the effect of showing clients the sort of full cost, ensuring that they understand the full cost and what the lower cost alternatives are, before they are able to choose a refund loan.

And we think that consistent with our overall market strategy, brand strategy, of being more of a financial advocate with our client, that's both the right thing to do, and the consequence is something that we will just simply, you know, accept, and we do see that -- it is a little bit early, Jeff described it, and I think he is right, it is a little bit early for us to fully judge the retention year-over-year differences.

But the data that we have so far would suggest that for the segments of the client base that are down year to year, primarily those who are the traditional "I want my money fast" segments of the population, we are not losing from a retention perspective.

We are not gaining the number of new clients.

And I think that goes specifically to the heart of the issue that we have discussed before, which is the lack of -- when all you are is a source to get money fast, you don't have the differentiation, and that lack of differentiation is a, you know, a longer-term problem, and, you know, you can solve it through density, as we think we can, but more importantly, we think the right answer is to solve it through greater value, and to the extent clients, there is a segment of the population out there who, you know, for whom speed of refund is really all that matters, we will not, you know, you know, we will not, as we suspect, be able to build our longer term business off of continued growth in that segment of the population.

So, you know, your observation that the number of refund loans is down and the number of clients down year to date is sort of similar.

I think goes specifically to the issue which is, you know, we are not attracting the number of clients within our base that are interested in sort of quick refunds.

You know, on the point about the comparisons year over year, we included in the supplemental information and hopefully by now everybody has pulled that data that they will look at it , we've included certain supplemental information through Sunday what our year-over-year, day to day comparisons are.

And your point about whether you will be able to see in that--the weather hit on a Monday, this year by comparison, we grew 35% on a day to day basis, it was a wonderful day, we all felt good, but we also all knew better, and much of the weather effect from last year was made up through the course of the rest of that week.

And we now think that, you know, sort of that effect or the bulk of that has now played through our numbers.

Not the ones that have been reported but the ones that we can see, and the trend that we were seeing in early February has continued and has gotten a little bit stronger in the last half of February, in terms of our overall client growth.

So you know, that's a little bit of a, you know, giving you some data that you are going to see reported in a couple of weeks ahead of time, but we're seeing the continued strength in the second half of February.

Also, could you talk a little bit on the expenses, are those -- is the current level of expenses sustainable?

Or do you need to accelerate them at some point?

You mean I assume you mean from a long-term perspective, long-term business model perspective?

Yes, looking into next year.

You know, the primary -- I mean the two key drivers of the business, maybe three, but you know, for this segment, I think it is really two that are worth discussing are tax professionals and our real-estate costs.

Those are the two big ones that go specifically to the size of the system.

We believe that, you know, the variability or the variable cost nature of our seasonal employee base is something that we can sustain, and we think that, you know, we are seeing sort of levels of costs associated with our revenue drivers that are sustainable.

On the real estate side, we actually, you know, a little bit of this was discussed in January but maybe not this articulately.

We -- we think that there is opportunity in reducing the number of moves that we make to reduce our cap ex, and then in the process, that will have the effect of allowing it to expand the size of our distribution network without dramatically increasing or as dramatically increasing the overall real estate costs associated with that.

So, you know, we think there is more leverage in the real estate, interestingly, than what -- than what might be implied from our discussion about a density strategy.

Thanks, And could you answer one question on the mortgage, and that's, one of the things you talked about in the past, is I guess an efficiency rate, a closing rate.

How do you increase a closing rate?

Well, you know, this quarter, I guess it is not quarter, we have some of this in there, too our year to date, closing ratio is up from 54% in '03, through -- and this year, the fiscal year to date, it is up a little bit over 58%.

You know, you do that through a variety of things.

You do that by being more selective about the way you target business.

You do that through the types of loan structures that you use.

You do that through -- or do that through the way -- or underwriting process operates.

You do that through the relationships that we maintain with the brokers.

I mean there is a whole range -- it is not any one thing.

It is a series of sort of operational improvements that we have been making throughout that business and studying what causes a loan to fall out.

You know, I tell you, when we, you know, the data shows where we were at three years ago, which was about 45%, you know, we don't think there is another 20 percentage points of close ratio available to -- in the market, practically speaking, but you know, 60% close ratios is, you know, getting to be a very, very nicely efficient business.

And you know, final, when you say there was some slow down in the rate during the Christmas -- during the holidays, was that because people -- you didn't have the applications, the industry didn't have the applications, is it -- if you would have added more people, you might have done better?

Maybe a little bit more color around what the industry looks like, and how that may differ from what your experience has been.

Yeah, you know, you only see the industry information with a little bit of a lag so the only thing I would tell you about the industry is going to be an estimate of what we thought -- think was going on in the industry.

But you know, there was -- there were a couple of things that were going on, I think in that fourth quarter, which -- or in that, you know, the fourth quarter in January of the calendar year.

Most notably, there were a number of players out there who have become, you know, more aggressive in their loan pricing, and as a way of growing their -- maintaining growing origination, but I think that they have, you know, different objectives in doing that, most notably, you know, their share prices are dependent upon continued, you know, high growth rates and originations.

We have always believed that we should operate the business, you know, sort of for the long term, and not necessarily to try to drive earnings in the short term necessarily.

I think we got a little bit complacent in how hard we pushed our pricing, where we looked at how to leverage our broker network, and as we have identified that, we started to, you know, see improvement again in our level of submissions, so you know, it is probably -- it has more to do with how aggressive we've been in going out and working our sales and distribution network than anything else.

Okay.

Great, thanks, Mark.

Your next question comes from John Neff with William Blair.

Hey, guys.

Three questions here.

And first one, I realize it is early, but I was wondering if you could comment on the retention trends that you're seeing this year so far, versus last year, and specifically, I know you've -- you've alluded to the fact that some of the major franchisees, the price increases year-over-year to last year were pretty significant.

I was wondering if you could -- if there is any, at this point, difference that you've been able to see in the retention rates with the company-owned locations versus the major franchisees this year.

Well, John, I would say that the -- it is too -- the too early to tell answer is probably the best one I can give you right now on retention, but for two things, because it dances around an awful lot this early in the season but one of the things that we had seen for the last three years that we did not see this year was a significant move forward of clients, from, for instance February to January, or April to February, we are seeing much less of that, and people -- people coming back into a more normal filing pattern, which gives us some level of comfort.

We -- our early concern was that because people weren't moving forward at the same pace, that it would end up -- we could end up seeing an issue but that has not been the case and then the second piece of data that I would see is, as we look at -- as we look at retention across the segments and across the tenure bands of our client base, we are not seeing any material shifts.

And right now, what we really look for is do you have any big outliers which would indicate there is an issue.

Now conversely, we don't have any significantly positive outliers that I can advocate for right now, but I will tell you that everything is looking stable, and solid on the retention front.

And I suspect that based on what we're seeing right now, the things that we have been doing, which we had always said were long term, are making a difference.

On the major franchise side, we won't be able to measure that until the end of the year.

Unfortunately, the major franchisees used a different -- different methodology of tracking clients, they tracked it more by the return than by the client, and so we -- we're having to reconstruct the prior year's data to really understand retention.

So we will have some data at the end of the year, it will be directional, it won't be as precise as the data we have in the company, and then come '05, we will have a much better sense for retention.

But we're not seeing anything disastrous there.

We are seeing a couple of things that have us kind of be cautious, but right now, we think it is generally doing what we thought it would do.

Great.

Next question, the newer office retail growth, 30%, obviously off a small base but pretty impressive, how does that reconcile with your contention that fewer moves of existing older locations is going to be required?

Does it speak to a problem in terms of those older locations, the location?

No, actually I think it goes to the overall density point that we've tried to make, which is, you know, as we -- what we're finding in the market, and I think this explains some of the competitive response that we've had in the last number of years, and where we maybe should have caught it sooner, is you know, there is -- for the early season filer, there isn't -- there is increasingly a lack of differentiation between our -- how fast we can get them their refunds and how fast our competitors can, and for the early season filer, that is the primary motivation.

And to the extent that our system or our -- our offices are either less convenient or the convenient office is -- as busy as can be, and there is an hour or two wait, that overflow, based on the fact that, you know, there is no differentiation between our service and the speed of refund than somebody else's, people will go go to the place where they can get served as conveniently or as quickly as possible.

I think that is the point and what we believe we have to do is ensure that we have the size of operation and the convenience of location that blunts any opportunity for competitors to come in and capture that part of the business.

And so it is not about moving existing offices, we're not moving them, as the case may be.

It has more to do with the absolute number of locations.

I would also say that we have seen an interesting phenomena in the relocated offices, where the -- kind of the I will say the urban lore was that when you moved an office, it ended up performing better, but unfortunately, it doesn't end up performing better for a year or two.

And by the time you get that, you're working off a little bit of a lower base, and you've invited incremental competitive presence, and so what we believe is to the extent that we limit the number of relocations, we will actually be able to get a higher level of overall growth, because what we need, as Mark talked about, are additional locations, shifting one location from location A to location B, if you have 10 clients and 9 of them show up, show back, you've actually inadvertently detrimented yourself and yes you start growing at the new location level in year two and three but not nearly as richly as you do with the 30% that we talked about earlier in the call.

The other pragmatic thing that we've seen happening in the market which we just have to stop is quite often if we leave a location for a preferred location, one of our competitors comes in right behind us to the location we just left.

And you know, there is a certain amount of--people remember that there was a tax office in that spot and they go back to that same spot.

And we just need to stop leting that be a competitor in that location.

Great.

Thank you.

Your next question comes from Mark Albert with Centurion.

Hi.

Just a couple of quick questions.

Well, one is quick.

One isn't.

In the U.S. tax operations, under revenues, what was the change between the RAL waiver fees and the RAL participation fees?

I think the amount was approximately --

I have the amount.

I just don't understand --

Oh, you don't understand.

Okay, I'm sorry.

Last year, in lieu of participating in the loans themselves, we signed a one-year agreement with then Household, now HSBC, to forgo our participation in those loans, in exchange for a waiver fee.

And this was, you know, it was a -- it was sort of the financial equivalent of participating without actually participating.

This year, we have the full -- the continued the traditional relationship where we are actually a co-owner or a participant in the loan itself and we also participate in the expenses, the servicing, and the bad debts associated with it.

That is why you have higher revenue and you also have higher expense attached to that same thing and the economic effect is about the same.

Okay.

And thank you.

And the next question, I mean I'm just wondering, if the early season filers aren't -- you know, are they more profitable than later -- than later season filers?

And if so, by how much?

You know, relative, like on a scale of, you know, like one and a half to one or 1.2 to one?

We actually look at our value of clients by a segment by segment basis.

The early season filers are not the least profitable but they're also not the most profitable.

They would be, sort of, somewhere in the middle of the pack in terms of overall clients.

It really depends on a number of things.

In terms of their overall behavior.

But in general, you know, the most valuable clients are actually the later season filers.

Because they tend to be greater complexity, and more loyal so there's a greater lifetime value.

The early season filers are the ones who want the RALs I thought more often than not.

That's correct.

So are you facting in the economics of the --

We look at the full range of the client relationship, both the add-on product incidents and the profitability of the add-on profit incidents, as well as the expected sort of retention of that client year over year, when we look at both -- we look at two different cuts, a lifetime value cut as well as a current year profitability cut and in general, again, the early season filer would be kind of middle of the pack, that segment of the client base would be more middle of the pack in terms of its overall value.

So the RALs clients aren't that much more profitable or even maybe less profitable than the nonRALs clients?

You know, you can't necessarily segment--pot the world into those two categories, I guess.

We don't.

We really look at the underlying characteristic of the different clients and there is a segment of the client base that is more likely to take a bank product, and that segment of the population, or the client base is not more profitable, than, for example, many other segments that are not likely to take a bank product.

And then my last question, is you know, as I look at the consensus numbers, this quarter beat by 15 cents, but you're keeping the guidance relatively the same.

And I'm just wondering, does that imply -- obviously, well, versus consensus, that it would imply that consensus was too low for this quarter, too high for next quarter, but also, is there a -- does that also imply a mixed shift, between what you thought the contribution would be from tax versus mortgages?

Actually it doesn't.

My sense is that, you know, the--when--when I've looked at what the overall street estimates are if I can understand it by segment, you know, I think they are reasonably close to what we would have expected at this point.

Our, you know, our not -- nonchange of guidance given the fact that we just outperformed in the third quarter has more to do with the, you know, we're sitting here now, we're in the fourth quarter in the tax business, as well as the business services business, very seasonal businesses, are there -- you know, absolute peak of their cycle and it is just not prudent for us to sort of get outside the range in which we talked about at this point.

And when will we hear guidance for the following year?

We usually talk about that in June.

Okay.

Thank you.

Your next question comes from Dan Curt with DK Equity.

Yes, good evening.

May I follow-up with a RAL question?

And it is simply this.

If part of the broader H&R Block strategy is to slowly ween people off of RALs, if you will pardon my way of saying it, both in terms of people using the product, or the service, as well as the sensitivity or exposure of your P&L, at least as a percent of total profits, I understand how that is set to position H&R Block better as a -- as a defacto or evolving financial advisor, in broader sense of the word, and lesser moving away from being viewed primarily as a tax return provider or as you said, Mark, the fastest refund providing firm and while this creates surely a positive halo effect for the brand and the future client base and the services, I just wonder whether you're going to simply end up losing potential RAL business, potential RAL profits, and at the same time, risk not getting a full offset elsewhere.

And in other words, aren't those people that are looking for RALs in the first place not the types of customers that will necessarily be able to do investment business with you or mortgage business with you, even as those that you can envision in higher tax complexity, IRAs and mortgages, wouldn't be interested in a RAL in the first place.

I think -- I think I understand your -- I'm not not sure if it is a question or a point, but you know, it is certainly a strategic issue that we discuss and debate, and kind of, you know, are trying to find the right balance of as we think about our business for the long term.

I should be clear.

You know, if we've left the impression that somehow we are trying to either not serve the part of the population that is interested in speed of refund, I -- you know, I shouldn't leave that impression, because we think that that is clearly a part of the market that we can serve and serve well.

And serve responsibly, and so we are not trying to abandon or walk away from that part of the market.

We just simply see that there is greater upside growth.

We think, given the size of the other segments of the population.

If we can also grow our brand and our access to other parts of the market.

So it is more of a shift in terms of where do we think our growth in the future will come from as opposed to moving and replacing one segment of the population with another.

And that is a -- we have to do that very carefully and we think that the increasing level of sort of competitive locations is in fact something that has caused us to realize we need to look at the density of our system as a result, and in particular, as it relates to people who are not going to see H&R Block uniquely differentiated because then what they're looking for is speed of refund.

The other thing that you've said, which I take by implication was for those people who come to Block, we will try to keep them from acquiring or taking a refund loan, our view on that is that we should make sure clients understand what the product is and what it isn't, what the cost is and what the alternatives are and offer is very responsibly as a product but we should not put ourselves in a position where we're telling clients that they should make a choice that they don't want to make if the refund loan is what they really want and they have motivation or reasons to choose it.

You know, so I would tell you, we don't think that either serving people who want refund loans or offering refund loans is inconsistent with our longer term strategy for serving clients.

It probably just simply is the place where the company has gotten the greatest amount of growth and the greatest amount of penetration in its history in the past, and it is unlikely to be the place where we will get that same level of growth and penetration in the future.

But it is not a trade-off per se.

It just has more to do with, you know, kind of moving the positioning of the overall brand and the company to a place that allows us to be -- to continue our growth.

Okay.

Thank you.

And if I can revisit one thing you said then, and Jeff said about having to be more promotional, in addition to density and differentiation, how does the RAL piece of this puzzle fit into that being more promotional?

Is that -- would that also have a heightened profile, perhaps next year at this time?

Or would that in fact not play a role in the greater promotional posture that you might want to take?

You know, I think, you know, that is a, you know, a -- you know we are just beginning to have that discussion based an what we just saw from the early season here.

We would tell you, you know, we believe that a less promotional, and this year, we did not push as hard about the product features, and the product benefits per se of refund lending, as a reason to come to block, believing that our other brand attributes that we were highlighting would be as compelling, and we think that what we're seeing is that for at least for a segment of the population, not the bulk of the population, but for a segment of the population, that has historically come to us at tax time, there are some people for whom that promotional element of speed of refund really does matter.

And so I think we're debating now how can you be promotional for that segment of the client base and at the same time make the brand transition that we're trying to make broadly.

I don't have a full answer to it.

But one thing to be clear about, you know, we are not -- we are not, you know, in a position where we believe it is prudent for us as a company to be moving away from the traditional speed of refund client.

We just think it is a matter of where we are focusing more of our growth efforts.

Thank you.

And one last thing, if I may, an earlier caller mentioned this, is if you're expecting a firming tax business, as a result of all the things that you mentioned, it would not be wrong to say that that might more than offset the first half?

Of support.

Certainly our kind of current view is that you know, we should be, at least the trends that we are seeing would have us believe that we're in the range of the lower end of our overall growth range, for clients, and that means that we will have, you know, stronger second half.

Thank you very much.

Once again, I would like to remind everyone in order to ask a question, please press star, then the number one on your telephone key pad now.

We do have a follow-up question from Mr. Michael Hodes with Goldman Sachs.

In the interest of time, I will bow out.

Thanks, guys.

Thanks.

At this time, Mr. Ernst there are no further questions.

Do you have any closing remarks.

You know, just reiterate that we appreciate people, you know, joining us to understand what is happening.

Clearly, you know, there is a lot of complexity in this quarter.

We -- this is the -- the third quarter is always the most difficult quarter to conduct this discussion, because of the various moving parts, and what we do and don't know at this point in the year.

But if anything you've heard, if we can further clarify it, we encourage you to call.

Thanks for joining us today.

Thank you for participating in today's H&R Block conference call.

This call will be available for replay beginning at 7:00 p.m. eastern time today.

Through 11:59 p.m. eastern time on March 9, 2004.

The conference I.D. number for the replay is 5141529.

Again, the conference I.D. number for the replay is 5141529.

The number to dial in for the replay is 1-800-642-1687.

Or 706-645-9291.

Thank you.

You may disconnect your lines at this time.