H & R Block Inc (HRB) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen.

And welcome to the H&R Block third quarter earnings conference call.

I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr.

Scott Dudley, Vice President of Communications and Investor Relations.

Please proceed, sir.

Good morning and thank you for joining us to discuss our fiscal 2008 third quarter results.

Presenting on the call today are Richard Breeden, Chairman of the Board; Alan Bennett, Interim CEO; Tim Gokey, President of Retail Tax Services; and Becky Shulman, Senior Vice President, Treasurer, and Interim CFO.

They will comment on our results and then we will open the call to questions.

Several members of our senior management team are also on the call and will be available during the Q&A session.

Our call today is planned for about an hour.

To start, let me provide our Safe Harbor statement.

Comments made on this call may contain forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934.

Such statements are based upon current information and management's expectations regarding the Company, speak only as of the date on which they are made and are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict.

Therefore actual outcomes and results could materially differ from what is expressed, implied, or forecast in such forward-looking statements.

Such differences could be caused by a number of factors including the risks described from time to time in H&R Block's press releases and Forms 10-K, Forms 10-Q, Forms 8-K and other filings with the Securities and Exchange Commission.

H&R Block undertakes no obligation to publicly release any revisions to forward-looking statements to reflect events or expectations after of the date of these remarks.

H&R Block provides a detailed discussion of risk factors in periodic SEC filings and you're encouraged to review these filings.

In conjunction with today's call there is an accompanying slide presentation which is posted to the investor relation's section of our website at hrblock.com.

In addition, last evening we filed our third quarter 10-Q and issued a press release announcing our results including interim tax season information through the end of February.

These documents are also available on our website.

To give as many participants as possible an opportunity to ask a question, we ask that when you are called upon you limit your query to one initial question and then one related follow-up question if needed.

So with that, I will now turn the call over to Richard Breeden.

Thank you, Scott.

Good morning everyone.

I would like to give a general overview of developments during the quarter and a brief summary of certain longer term issues as well.

The third quarter at H&R Block is less significant for performance in the quarter itself, but rather for the insight it gives into the fourth fiscal quarter that drives Block's annual financial performance.

In that respect, our tax performance during the quarter and in the month of February has certainly been gratifying.

Though the tax season for Block is far from over.

I also believe that this quarter is important in a somewhat broader perspective as it marks the first full quarter of our new team and renewed focus on our basic tax business.

From an earnings perspective, as Alan will go into in greater depth, the quarter showed a slight improvement to the third quarter of 2007.

We had revenues of $973 million, a 4.4% growth from $931 million a year ago.

Adjusted net earnings from continuing operations were $25 million, or $0.08 per diluted share, prior to severance charges.

This compares with $22 million, or $0.07 per share, in the year earlier period.

The net loss from discontinued operations was $57 million or $0.17 per share, compared with $82 million or $0.25 per share in the year-ago quarter.

More importantly, the net loss of $57 million the in the third quarter is down from $366 million or $1.13 per share in the immediately preceding quarter.

As Becky will discuss and as you will see in the slides, our total remaining exposure to Option One's loans held for sale and real estate owned is now only $36 million, net of reserves, down from billions not so long ago.

As previously announced, the Company is in the process of attempting to sell our remaining Mortgage Loan Servicing business.

Initial bids were due in mid-January.

And since that time, we have been refining the specifics of bids and focusing on the highest tier of bid prices.

We are currently in advanced negotiations with more than one party.

Although there can be no certainty in such matters, we are optimistic we will have a signed contract in the near future.

At this time of year, the most important question is expectations for the overall tax season.

Alan Bennett and Tim Gokey will have more detailed comments on various metrics we are seeing as the tax season progresses.

However, there are a few high level observations that may be useful to make at the outset.

We believe as others have noted that the entire tax season got off to a slow start this year as a result of AMP and other issues.

That slow start resulted in a decline of 3.5% in retail clients served through January 31.

However, net tax preparation and rebate fees during the quarter grew 3.3% over the comparable quarter last year, driven by a 7% increase in net average fee per U.S.

retail client.

Aggregate tax services revenues, including digital and commercial markets, were up 5.4% to $662 million, while pretax income fell $14 million to $46 million.

Operations in the month of February were appreciably stronger than January.

The total number of clients grew 6.8% in February, and aggregate tax preparation fees in the month of February grew 12.6% over February 2007.

This brought year-to-date retail client growth to 2.6%, and year-to-date growth in retail tax preparation fees to 8.7% although both numbers must take account of the fact that February this year had one additional day.

Alan and Tim will provide outlook for the results we anticipate for the full tax season.

Despite the slow start and a very uncertain economy, our experience as we head into the second half of the season where expertise clients have a larger impact suggest we are on track for a good year.

Becky will provide further details on financial balance sheet and liquidity matters during the quarter.

However, given the concerns about liquidity that many expressed at the time of our second quarter call, we had several very positive developments.

We were successful in refinancing our $500 million in bridge loans during the quarter with $600 million in medium term notes.

Thereby, eliminating this issue from our balance sheet.

We have reduced our short term borrowings under our bank line of credit from $1.8 billion at January 31, to $950 million as of today and we expect to continue to pay down these borrowings through the end of the fiscal year.

Our search process for a new CEO is proceeding and we are in the process of interviewing candidates.

We anticipate that we will have a new CEO on board by early summer.

The Board and management expect to continue ongoing discussions of longer term strategy over the next few months and we will be considering opportunities to improved focus and profitability in every aspect of our tax services.

There were more than 110 million tax returns that we did not prepare in the United States last year, and we believe improving our market penetration is our foremost challenge.

This is an issue not only for our retail group but also for software and Internet products through our digital channel.

We also recognize the challenges inherent in changing views regarding traditional refund anticipation loans including the pending IRS rule making on this subject.

Block has been a leader historically in reducing prices for these products and we are working on various ideas that may enable us to broaden our market share while providing clients with even better and lower cost financial products.

We are working to identify opportunities to strengthen both revenue growth and profit margins in our McGladrey unit and we recently began initial steps to reduce overhead costs.

We continue to review opportunities to refocus H&R Block Bank on providing low cost banking products to our tax customer base, rather than its previous focus on purchasing mortgage loans.

We are continuing our constructive discussions with the OTS concerning capital requirements related to the bank once our disposition of Option One is complete.

Overall, we have many challenges but we believe we have even greater opportunities for increasing market share and profitability.

The Company has always benefited from our immensely talented tax professionals and we plan to put them to continued good use in the future.

H&R Block has a proud Heritage but I firmly believe our best years lie ahead of us, not behind.

Now I would like to turn the call over to Alan Bennett, our interim CEO.

Thank you, Richard.

I would like to start by taking a moment to thank H&R Block associates throughout the organization including more than 100,000 tax professionals in the midst of the busy season for your dedication, commitment to serving clients with unmatched expertise, and ultimately delivering value for our investors.

Everyone has been working extremely hard and we sincerely appreciate your contribution to our results during this season's first peak.

I will provide a quick summary of the performance of the non tax segments.

Following this Tim Gokey will provide significantly more detailed information on our tax business including clients served, pricing, our Emerald products, client retention, and other information.

Becky Shulman will follow with an update on our financial position including a review of our balance sheet and detail on remaining assets at Option One.

Finally, I'll conclude with our financial outlook for the full year.

Starting with Consumer Financial Services, which consists of our bank and our financial advisory businesses, the segment delivered revenues from continuing operations of $117 million, up 9% from the third quarter last year.

Pretax income was up nearly 19%, from the prior year, to $13 million.

Within the Consumer Financial Services segment, the H&R Block Bank benefited from continued strong demand for the Emerald Card, including demand for our Emerald advanced line of credit, generating revenues of $39 million for the third quarter, up significantly from $22 million a year ago.

Pretax income rose a strong 91% to $12.3 million.

The bank realized an annualized pretax return on average assets of 3.47%.

And a significantly higher net interest margin of 7.28% reflecting the Emerald advanced line of credit balances and Emerald Card account deposits.

The bank's deposits continue to be largely comprised of assets from clients of tax services, and H&R Block Financial Advisors.

We ended the quarter with $1.2 billion in Emerald account deposits which were invested primarily in overnight funds.

Which drove total assets of the bank to $2.4 billion at quarter end.

Due to the short term nature of these deposits we expect the asset base of the bank to be lower during the first quarter.

This increase in total assets required capital contributions totaling 107 million to be made during the quarter.

And we are pleased that the OTS has already approved our ability to dividend excess capital back to the holding company as its balance sheet shrinks in the fourth quarter.

The bank ended the quarter with 1 billion of mortgage loans held for investment.

Our mortgage loan portfolio was reduced by $38.3 million during the quarter, primarily due to scheduled principle payments received.

The mortgage portfolio balance at fiscal year end 2008, 2009, and 2010, is expected to total approximately $992 million, $792 million, and $619 million respectively, as mortgage loans run off and are not replaced.

We recorded allowance for loan losses representing our estimate of credit losses inherent in the mortgage loan portfolio.

The majority of potential credit loss is evaluated on a pool basis, however, we review non performing mortgage loans individually.

And record loss estimates typically based on the value of the underlying collateral.

Loss rates are based on historical experience, our assessment of economic and market conditions and loss rates of comparable financial institutions.

Based upon our analysis conducted during the second quarter of this year, a substantial increase in mortgage loan delinquencies was projected for the upcoming 12 months and accordingly, we adjusted our loan loss reserve adding approximately 10 million in loan loss reserves at that time.

As expected from that previous analysis our 30 day plus delinquent loans have risen during the quarter.

The mortgage loan portfolios 30 plus day delinquency rate at quarter end was 7.1% or $75 million worth of loans, which is up from the previous quarter but in line with our second quarter projections and the loan loss reserve actions taken.

Mortgage loans delinquent by more than 90 days were $24 million at year end or 2.3% of the portfolio.

At quarter end or loan loss reserve as a percent of all delinquent mortgage loans was 21.25%.

The loan loss reserve as a percentage of all mortgage loans was 1.49% at quarter end.

The tendency for borrowers reaching 60 or more days past due to proceed tort foreclosure is showing a slight increased trend over the past quarter.

Consequently, ongoing monitoring of collateral valuations and the continued analysis of portfolio performance and trends may result in future increases in the loan loss reserve.

H&R Block Financial Advisors reported results that were lower than a year ago quarter, in what has clearly become a very challenging market and interest rate environment.

Third quarter year-over-year revenues fell 9% to $78 million, pretax income declined 85% to $670,000, compared to $4.5 million in the prior year.

The current period benefited from a $6 million reduction in amortization of intangible assets as these assets were fully amortized in November 2007.

Results for our Financial Advisors business were negatively impacted by the recent Fed rate cuts since in response we lowered the rates on margins and other asset balances which led to a decline in interest income.

Despite difficult market conditions, average productivity per advisor increased 3% over the second quarter of fiscal 2008 and positive trends in recruiting and retention of higher level producers continued.

Furthermore, amortized revenues as a percentage of total production are ahead of plan as we continue to emphasize long-term advisory relationships with our clients, and focus on fee-based annuity and insurance products.

At quarter end we had $31.8 billion in assets under administration, which is essentially flat with the prior year.

Business services revenues of $192 million were flat compared with the same quarter last year.

Pretax income for the quarter was $7 million, compared to income of $1 million last year, reflecting efficiencies gained from integration of businesses.

Discontinued operations which are essentially all Option One, recorded a pretax loss of $97 million during the quarter.

This loss consisted of the following.

$28 million of restructuring charges related to the shutdown of our mortgage originations unit and this was $19 million lower than previously announced.

$67 million of losses on the sale of mortgage loans including impairment of residuals.

$32 million of other operating losses, offset somewhat by the reversal of the $30 million valuation allowance.

Becky will discuss the discontinued operations' balance sheet in detail in just a moment.

During the quarter we took a severance charge for corporate staff reductions and executive severance of $26 million pretax.

This charge was due to the elimination of 325 filled positions and we have also eliminated 180 open positions.

These reductions represent about 23% of corporate support staffing, and will reduce annual compensation expense by approximately $50 million.

Our next phase of cost reduction is to thoughtfully reduce our spending and overhead expenses such as consulting, travel, real estate and IT.

As Richard mentioned, McGladrey has a program under way to reduce expenses by $15 million, bringing our total cost reduction effort to $125 million.

Our goal is to instill a better and sustained cost culture throughout the organization, in order to improve the Company's competitive position, its operating margins and overall value to shareholders while maintaining or improving outstanding customer service.

I will now turn the call over to Tim who will talk in more detail about tax season to date.

Thank you, Alan.

Before describing more deeply the results in different parts of the tax segment, let me comment on several market factors.

The IRS is projecting total filer growth of about 1.1% after adjusting for telephone excise tax filers.

It seems likely that the impact of the economic stimulus package may move this growth upward but how much remains to be seen.

The season saw an unusually slow start due primarily to publicity related to the ANT patch.

Most of this delay corrected itself by mid-to late February.

Finally, the market saw an early season shift in share toward do it yourself methods from assisted preparation.

This shift appears to be moderating as the season progresses.

It is too early to say if the shift is timing related or due to the significant growth in marketing spend against so-called free tax preparation by some competitors in the digital space.

Our in season market research suggests H&R Block Retail has lost relatively few clients to free digital options to date but this is an important metric that we will continue to monitor.

After a slow start, our retail tax business grew strongly in the month of February.

Driven by gains in client retention, our retail tax clients served excluding lending products only clients, increased 6.8% and net tax preparation and related fees grew 12.6% in February.

Retail clients served gained 2.6% year-to-date through February 29, 2008 compared to February 28, 2007.

Due to the effect of the extra day due to leap year, our best estimate is that this is equivalent to an increase of 1.3% in clients served on a comparable basis.

Net tax preparation and related fees grew 8.7% year-to-date over the same period.

This strong performance which has continued into early March is a result of many factors, and reflects many initiatives we have been pursuing for some time.

Turning to pricing, our net average tax preparation and related fees per retail client rose 7%, for combined Company owned and franchise operations, as of January 31, Through February 29, the year-to-date increase was 6.1%.

The lower rate of pricing increase in February reflects a higher mix of low complexity clients including those not normally required to file but who have done so due to the economic stimulus package rebate.

Excluding this latter group, we expect pricing for the season to be in line with our expectations of an increase of 6 to 8%.

As Richard noted earlier, we are working to increase our market share in every segment of the market.

Last quarter, we described our approach for growing in speed of refund, building a stronger position among expertise filers and building a great organization.

Let me briefly recap our progress in each of these areas.

In speed of refund, we had a very solid early season based in large part on our Emerald suite of products.

We made nearly 900,000 Emerald advances with total credit extended of over $400 million.

We are monitoring these advances carefully and we are experiencing client return and repayment generally in line with our expectations.

Our 36% APR Emerald (RAL) backed by our lowest cost guarantee, proved popular.

This drove a nearly 5% increase in refund anticipation loan applications to date and what we believe is a measurable share, a gain in share of the RAL market.

Importantly, this product continued H&R Block's tradition of being a leader in delivering high quality, less expensive financial products to our clients.

More than [2.3] million clients have chosen an Emerald Card to date, putting us on track to serve more than 2.5 million clients with Emerald cards for the year.

This represents more than 25% growth over the prior year.

The Emerald Card enables an important segment of our client to avoid expensive check cashing and gives clients that may not have a traditional bank account the safety and convenience of a MasterCard.

This year we have seen important retention gains from clients that took the Emerald Card last year.

Beyond the strength of our product innovation, we have also seen increased client service levels, minimal client wait times, improved marketing effectiveness and significant growth in our new express tax franchise business.

Excluding parts of the business we closed down after last tax season, we are currently seeing a gain of nearly 50% in express tax year-to-date.

While currently small, we believe express tax can be an important contributor to speed of refund growth in the future.

We anticipate expanding express tax considerably in coming years.

We're now into the second half of the season when expertise filers become more important and when H&R Block has a competitive advantage.

We have seen good growth in the second half the past two seasons and leading indicators are good for this year.

The typical Block client is served by a tax professionals with more than eight years experience and more than 450 hours of training.

Building on this depth of tax knowledge, more than 35,000 tax professionals chose to enroll this year in special training on building their client base which is more than triple the number that did the previous year.

As a result, we are seeing a significant increase in referrals year-to-date.

We have also seen an increase in the matching of clients with their tax professional from the previous year which positively impacts retention both this year and next.

When XPs clients and potential clients see the skills and tax knowledge of our tax professionals it is very compelling.

Year-to-date, our tax professionals have completed more than 10,000 public speaking engagements on topics ranging from rental property to the impact of the tax rebate.

We believe these efforts, along with our new second look product, strong local marketing, and continued growth in referrals will set us up for a strong second half.

Across both these client segments, we continue to make progress, strengthening our organization.

This year we have rolled out new training and new tools designed to build on H&R Block's lead as the best place to be a tax professional.

Last year we increased our tax professional retention by over 2 percentage points and this year it is trending 1 percentage point above that.

These are significant gains.

Client retention is also up year-to-date and client satisfaction is up 2 percentage points.

Notably, they receive and possession of price value is also up nearly 4 percent damage points from last year.

These indicators give us confidence that the important changes we have undertaken are bearing fruit in more satisfied and committed clients, tax professionals, and associates.

While these moves are difficult and not glamorous, they are the important work of building a truly high performing Company that attracts the best in the profession.

The entire digital market has seen a shift from software to online and the composition of online is increasingly made up of free services.

Although growth in digital E-files is coming from both increases in the free file alliance and some competitors offering free online tax products backed by significantly increased marketing spending.

During the quarter, our digital operations were negatively impacted by these factors and slower start to this year's tax season.

Digital clients served were down 10.8% through January 31.

While our digital clients served, which includes only tax returns for which we have been paid a fee, were down for both the quarter and through February 29, we have participated in the overall growth of the online market.

At the end of February, our digital E-file growth was 5.5% year-to-date.

This growth was driven by gains in FFA as well as online paid returns, offset by a decline in software.

As with the expertise market, there's a great deal of the filing season left for the digital business.

In the meantime, we are successfully executing on a plan to meet higher earnings objectives through a combination of optimizing our costs, based on targeted price increases and improving client retention which is up nearly 10 points to date.

Based on these actions, our digital tax business is on track to nearly double its profitability, despite significant competitive actions.

Results from our continuing international operations were in line with our expectations.

We recorded a third quarter pretax loss of $8 million which is essentially flat when compared to the prior year.

Now I'll turn the call over to Becky Shulman to discuss our financial position and balance sheet items.

Thanks, Tim.

As we did last quarter, I want to take a moment to summarize our remaining Option One exposure.

The shut down of Option One's origination platform is essentially complete.

All of our on balance sheet and off balance sheet warehouse facilities have either matured or been terminated, consistent with our exit from the origination business.

We entered the quarter with $135 million in gross amount of loans in real estate owned on the balance sheet.

We originated $43 million of loans of which two-thirds were prime loans.

We repurchased $100 million, $18 million of which were rec and warrant repurchases and $82 million of which were early payment default repurchases.

We sold $189 million of loans, resulting in a loan balance on a growth basis of $89 million at January 31.

After netting a $53 million valuation allowance, we ended the third quarter with $36 million of loans in real estate owned held on the balance sheet.

We began the quarter with $57 million of off balance sheet exposure in subprime loans.

All of these loans were sold during the third quarter and we no longer have any off balance sheet exposure.

Our remaining Option One loan exposure at January 31, is as follows.

Loans held for sale and real estate owned on the balance sheet totaled $36 million net of reserves.

Residual interest and securitizations were valued at $26 million, down from $38 million in the prior quarter.

We also have a reserve for potential rec and warrant repurchases of $69 million, reflecting assumed loan repurchases of $138 million, at a 50% loss severity.

At the end of the third quarter, the net book value of discontinued operations which is essentially all option one, was approximately $500 million, inclusive of a $305 million valuation allowance.

As Richard noted, since our last earnings call we completed a number of important financing actions, in particular, we issued $600 million in medium term notes in a difficult market with a coupon rate of 7 7/8%.

We have fully repaid the $500 million bridge loan as of February 15.

We successfully increased our servicing advance facility capacity from $750 million to $1.2 billion, and we believe this will provide sufficient capacity.

As a result of these actions and seasonal cash inflows from our tax business, we have paid down our lines of credit from $1.8 billion to $950 million as of March 5.

By the end of the fiscal year, we expect these lines to be substantially paid off.

Also, the line HSBC line of credit for financing wealth participations has reduced from $1.7 billion at January 31, to $152 million through yesterday.

This line is expected to be paid to zero by fiscal year-end.

Our consolidated cash position increased $332 million, compared to last January, primarily due to increased Emerald card balances at H&R Block Bank.

Receivables increased $340 million year-over-year, largely due to tax season timing differences as it applies to RAL and the increased Emerald advanced lines of credit relative to the decline in [IMEL].

Compared to the second quarter, the discontinued operations balance sheet reflects higher servicing advances, up $336 million, and an increased use of the servicing advance facility, up $468 million.

The balance sheet also shows an increase in the repurchase option loans and offsetting liability, up $700 million to $1.63 billion.

These are the loans within the securitizations that have reached repurchase triggers and are required to be recorded in the asset and liabilities sections of the balance sheet per GAAP.

We will not be exercising the option to repurchase these loans.

Now I'll turn the call back to Alan for our conclusion.

Thanks, Becky.

Let me briefly comment on our outlook for the remainder of the tax season and our fiscal year.

For full year 2008 we remain confident about the operating performance of our continuing businesses.

As a result, we are affirming our previous guidance range of $1.30 to $1.45 per share.

We continue to expect that we will finish the year towards the low end of that range, after absorbing the current quarter's severance charge.

Specifically to the tax business, we are pleased with our year-to-date results.

However, the season is far from over and our work is not finished.

We anticipate growth in the number of domestic retail clients of up to 2%.

We believe we will achieve high single digit revenue and earnings growth in the tax segment.

Thank you.

We are now ready to take your questions.

Thank you.

(OPERATOR INSTRUCTIONS) Our first question comes from Scott Schneeberger from Oppenheimer.

Please proceed.

Thanks and nice work on your early season in the retail tax segment.

I guess if I could ask really quick one little housekeeping question, Richard, you said that the EPS guidance of 1.30 to 1.45, does that include the severance charge or not?

I wasn't clear when you mentioned that.

That's after the effect of the severance charge.

So net of it, it's in there.

Correct.

Thanks.

And then for tax services, I guess Tim it looks like really good at retail but a little weak in digital.

Could you take us a little deeper, with regard to the competition offering a lot of free, perhaps seeing some down volume as a result of that and your discussion of doing a little bit of pricing this year, where you will double profit but at the same time you are losing a little bit of -- little share there.

Could you just speak a little bit deeper on that?

Thanks.

Yes, I will comment briefly.

I'm going to ask Tom Allanson to comment also.

We did take a variety of moves to better strengthen our digital position from a profitability standpoint, both on the cost side and on the pricing side.

We think those moves are being very effective.

We do not believe that the volume changes we've seen in the business are related to our pricing actions.

As we feel very good about those.

We did, however, see a very significant increase in, particularly marketing spending behind free offers.

As you know, our major competitor is offering free on your home page and on TV.

We felt that was not the right strategy for us and we'll see how that plays out going forward, but that certainly has had an impact on our volume in this early part of the season.

I'm going to just ask Tom to expand on that.

I think Tim answered the question very well.

If I could ask one quick follow-up in the tax space, I was a little confused by the pretax income line, just the clarification of that in the press release.

If you guys could clear up a little bit about why that was down year-over-year?

Thanks.

The major factor that caused that to be down year on year was a sort of a one-time impairment to our increase in our bad debt reserves related to refund anticipation loans.

We changed along with our lending partner, HSBC, our collections practices to eliminate cost collections and we basically make an estimate of what is the future impact of that on all future collections and that resulted in a net one-time charge of about $14 million.

Okay.

Thanks very much.

Our next question comes from Andrew Fones from UBS Securities.

Please proceed.

Yes.

Thank you.

I was just wondering if you could walk us through the EPS impact of some of the one-time items that you're including in your full year guidance.

I think that the severance charges were by my estimate about $0.05.

Can you confirm that, and also this impairment for bad debt for the tax business in Q3, is that also included in the guidance?

Thanks.

This is Alan.

Both of those items are included.

What I would say, though is that some -- even though the severance cost in the third quarter was around $0.05, that we will have some benefit in the fourth quarter for that, those actions, but the guidance we gave you includes the net impact of the severance charge as well as the one time item that Tim just spoke of.

Okay.

Thanks.

Then in terms of the expense in the corporate line, I had expected perhaps a little bit of a decline there in the third quarter.

Should we expect the impact of these cost cuts to be fully recognized in the fourth quarter or would you say that it will be the first quarter before we see the full impact there?

Thanks.

You will see -- first of all, most of the benefit that you will find will not but a the corporate line because we allocate those costs primarily to our businesses.

So the benefit really will go into the businesses.

What I would say with respect to the compensation issues, you'll see those immediately, since we've taken the severance charge in the third quarter.

With respect to the savings on spend, it really depends on the pace and success we have on engineering some of those costs away over time.

Thanks.

Just one final one, if the I could.

You mentioned that the profitability of the digital tax business had doubled year-over-year, can you tell us what that profitability was?

I'm sorry, could you repeat that question?

You mentioned that the profitability of the digital tax business I think had doubled year-over-year.

I was wondering if you could tell us what the income from that business is, approximately.

Thanks.

Now I understand the question.

We do not disclose separately the financial results of digital.

As we view those as proprietary.

Okay.

Our next question comes from Michael Millman from Soleil Securities.

Please proceed.

Thank you.

Regarding shareholder value, could you give us a very rough, as you see it now road map, how you're going to increase the shareholder value from the segments if -- closing some of those segments and timing and that's assuming that in the very near future.

Michael?

Yes.

Michael, for some reason you're cutting out.

I don't know if you're on a head set.

Can you maybe repeat the question?

Sure.

I was asking for a road map of increasing shareholder value and looking at some of the different businesses you're in?

This is Richard.

We have, as I indicated, we are approaching these issues in what we believe is a systematic fashion.

Clearly, the primary challenge facing the Company in returning to a sustained culture of shareholder value increase was to deal with Option One.

That remains our number one challenge.

And I indicated where we are on the status of that.

Once that is accomplished, the Board and management will continue our ongoing discussions of looking at other parts of our business.

And I think it would be a fair road map to say that each and every area of our business will be considered for its profitability and for opportunities to increase market share and drive profitability to the Company.

We expect to do that.

You've seen some actions already in our cost cutting initiatives, both at corporate central and also in McGladrey announced this quarter and those efforts will continue.

Obviously, individual segment realignments are among the subjects that we will consider.

But those will come as we unfold on the sequence I've described.

Could you give us some sort of estimate for when you expect?

Michael, we're cutting in and out.

We can hardly hear you here.

I heard you say the date.

We're not going to predict any dates.

We'll let you know when we've done it.

Sort of related, with the digital business growing, better than retail, does this suggest that you might think of rather than opening new stores, closing stores or selling stores to franchisees?

I'm not sure I -- while the profitability of digital is up in percentage terms, greater than the profitability in retail, we believe we're doing extremely well in the retail sector, certainly in aggregate profitability.

We will, hopefully on a regular basis examine our operations in every sector, including retail tax, for opportunities to groom our office network and other ways of improving profit margins.

I've tried to indicate in the past and I think our team is fully engaged in the idea that we are not as a one-time basis but on a sustained basis going to look at every opportunity to both increase share and increase profit margins in every nook and cranny of the tax business.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question comes from Larry Schumacher from Oppenheimer.

Please proceed.

Hi, guys.

Couple of questions.

Does H&R Block have any exposure to this auction rate security stuff?

Hello?

This is Joan Cohen with H&R Block Financial Advisors.

Our clients hold just north of $100 million of auction rate securities but the firm itself does not include it, does not hold any.

Okay.

And just back to the Option One, how long has that been carried as discontinued ops and how much longer can it be if there's no sale announced?

It can be carried for discontinued ops for one year.

And how long is it been being carried as discontinued ops.

Larry, this is Jeff Nachbor, I'm the SVP, Corporate Controller.

In theory, it should be carried for one year but what happens is, as you know, we went through a transaction where we were selling the entire business and that transaction actually fell through and so that one year basically started kind of at that point in time.

So we have had on our books a discontinued operation, this is the fourth quarter.

We fully expect to have that resolved within the next at least couple of quarters.

So we feel like we're within the accounting guidance.

And is there a contingency plan if that is unable to be sold?

This is Alan.

Again, I think if you look at the balance sheet, the originations business is gone.

And as Becky pointed out, we have very little exposure left.

We have a servicing platform left and a servicing operation that continues to provide positive cash flow every month and we are in, as Richard described, very active negotiations with multiple bidders on this business.

So I think we feel very optimistic that this will resolve itself in the very near term.

Thanks.

Our next question comes from Kartik Mehta from FTN Midwest.

Please proceed.

If you were able to quantify the improvement you had in the tax business because of the Emerald card and (inaudible) maybe if going forward, how much you think that could help?

Yes, this is Tim Gokey talking.

The Emerald card did contribute materially to improved retention year-to-date.

For competitor reasons, I don't don't want to say exactly how much that is.

Year-to-date for clients that we have -- had seen by this time last year, our overall client retention is up just about a percentage point over last year.

There are many factors contributing to this of which the Emerald card is one.

As you look at the Emerald card and maybe everything that's happened, do you believe you still -- do you believe that you need a bank to offer this?

Are there banks that offer this (inaudible - audio difficulties) that allow you to accomplish?

I think we do not believe that ownership of a bank is mandatory and operating in partnership with independently owned banks is definitely an option for the future and it's one that as we review strategy, we will consider.

At the same time, we have a bank.

We believe that ownership of the bank carries with it certain flexibilities and cost savings, so long as the regulatory cost and the impact of any balance sheet and financial inflexibility caused by bank regulation are not in excess of the benefits.

So that is a cost benefit analysis that we are looking at and will continue to look at.

Our principle focus as we described on last quarter's call and mentioned again this time is working with the OTS to see if we can reach agreement with them on changes in the, principally in the 3% tangible holding company capital requirement which was designed quite specifically to deal with the risks of Option One and once Option One is gone, is a rule which we believe could be safely confined to the annals of history.

But that's a discussion that goes on with our regulator and obviously they have the final say on that, though it will affect our calculations of whether we move forward owning a bank or partnering with third party banks.

Last year you indicated that (inaudible - audio difficulties) to be able to dividend back up to the holding company.

So are we just talking a net zero.

Are you going to be able to dividend back what you put into the bank or will you be able to dividend more than you put into the bank out.

We'll be able to dividend out to the bank's capital requirement which is currently 12%.

Thank you.

Our next question comes from Scott Schneeberger from Oppenheimer.

Please proceed.

Thank you.

Could you just speak a little bit to -- I mean, you touched on liquidity.

Could we talk a little bit about CapEx and what the horizon looks like for that?

If we will be adding more or less tax stores going forward and just a broader, what other things might be included in that so we can get an idea of operationally what might go through to free cash?

Thanks.

Okay.

We expect CapEx to be somewhere in the neighborhood of 94 million, $95 million for the year.

And I'll let Tim speak to stores or.

We would expect our plans for expansion of tax offices to be roughly in line with what we have done this past year.

As you know, we have significantly moderated the pace of office openings and we would expect to be in that range or slightly lower this coming year.

Could you just remind me where -- you're net positive this year, just a lot lower than in past years; correct?

That's correct.

We opened on the Company side about 120 new offices this year.

Okay.

Thanks.

And I guess that question was broader too.

Thank you.

It was specific on the tax business.

But also Richard, maybe if you could add anything on, are you looking to spend CapEx elsewhere in the business or are we more in a disposition mindset?

Thanks.

Well, I don't think it's -- we certainly would not rule out the expenditure of capital in initiatives to increase our business, but when we look at what we're doing now, lack of capital spending has not been the problem over the last couple years.

It has been lack of discipline on allocation and spending of capital and so our primary focus is to stop throwing away capital on loss making operations or on operations that generate unacceptably low levels of return.

So I think, while I would never rule out the opportunities to make investments in any of our businesses, I think you will see a consistent, very strong focus from us on discipline in the expenditure of capital.

(OPERATOR INSTRUCTIONS) Our next question comes from Andrew Fones from UBS Securities.

Please proceed.

Yes, thank you.

I had a just a quick question on the Option One balance sheet.

I see that the deferred tax assets fell from I think it was about $427 million in Q2, to about $200 million this quarter.

Were you able to use that at the parent level and then the $200 million that remains, what are your thoughts on that?

Thanks.

Yes, this is Scott Austin.

The reduction in the net DTA in discontinued operations from Q2 to Q3 included a reclassification of $286 million from the deferred tax asset of Q2 to a long-term tax receivable at Q3.

This reduction was partially offset by increases to the book of tax timing differences of about $59 million.

The $200 million that's remaining, we expect to receive approximately 75% or $150 million monetization of those benefits in the next 12 months with the remaining standing out for a roughly five to seven year period.

Okay.

Thanks.

And then just in terms of the potential timing of the sale of the mortgage servicing business, can you just kind of explain what remains in terms of the process towards the sale and perhaps if you're able to give us some approximate sense of timing there.

I've said anything we're going to say on this subject.

I think we'll leave it where it is.

Our bidders are listening to this call as well as you and I think we've said enough.

Okay.

Our next question comes from Janice Davies from Ivory Capital.

Please proceed.

It's actually Ed Shen here with Janice.

I just had a quick question on the guidance.

The 1.30 to 1.45 that you are reaffirming.

Just wanted to understand what assumption you're making for some of the cost reduction activities you've already announced?

It sounds like you've achieved 50 of the 100 plus that you had already announced.

So wanted to know how much of that is included.

In addition you had $15 million that you announced today from the RSM business, is any of that included in this year's guidance?

Thank you.

First, with regards to RSM, I don't think any of that will impact this effort at all.

As a matter of fact, we may have a small severance charge there which we'll absorb as well.

With regard to the $15 million, that's an annual savings rate so we will realize up to a quarter of that, depending on the timing of the actions, in the fourth quarter that somewhat offsets the $26 million charge we took and is included in the guidance as well.

Okay.

But the remaining half or so of the previously announced reductions are not included in the guidance?

We are making immediate gains.

There's some low hanging fruit that we're taking advantage of right away.

So there is some I would say very modest run rate savings that we will accrue in the fourth quarter, fourth fiscal quarter, but I would say most of the -- of that will really benefit next year.

Okay.

And then to be clear, the severance from this quarter is included in that guidance, and also it sounds like some additional severance from the other actions, or some other charges from some of your actions, are going to be included in that in Q4.

Yes, we are.

We're going to absorb that into the guidance that we've we've.

Okay.

Thank you.

Our next question comes from Michael Millman from Soleil Securities.

Can you talk a little bit more about digital, where the competition has been very aggressive on free, to what extent license fee from that (inaudible - audio difficulties), to what extent do you think that your rate from the (inaudible) so-called digital.

Michael this is Tom Allanson I got the first part of the question which had to do with what some of the competitors are doing.

What we're seeing in advertising, national advertising, is advertising for free.

If you go on websites for some of our competitors you'll find that they're offering online federal products for free and some of the shift that we believe we've seen in online is a result of advertising for free and that product being available for free.

We're also-.

I guess my question was really what you're doing.

Well, we participated in the free file alliance which is a product which is essentially free federal and we're seeing nice growth there.

But our focus this year going into the year was to focus on earnings growth and we feel like we've achieved that and that's pretty much the path we've stayed on through the course of this year.

And your competition claims that free is profitable and not centralize the full service product.

It sounds like you disagree.

We went into this year with the philosophy of growing earnings and we've been testing a number of different free option that we're exploring for future years.

But we did not go into this year thinking that free was a good strategy for us, based on our plans.

Thank you.

I would now like to turn the call over to Mr.

Scott Dudley for closing remarks.

Well, thanks everyone for joining us today.

If you have any follow-up questions or issues please give us a call in Investor Relations.

Thank you.

Thank you for participating in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.