H & R Block Inc (HRB) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the first quarter 2009 H&R Block Incorporated earnings call.

My name is Eric, and I will be your coordinator for today.

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

We will facilitate a question and answer session towards the end of the conference.

(OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to Scott Dudley, Vice President of Communications and Investor Relations.

Please proceed.

Thank you.

Thank you for joining us this afternoon.

Presenting on the call today are Richard Breeden, Chairman of the Board, Russ Smyth, President and Chief Executive Officer, Tim Gokey, President of Retail Tax Services, and Becky Shulman, Senior Vice President and Chief Financial Officer.

They will discuss our first quarter results, and our outlook for the remainder of the fiscal year.

We will then open the call to questions.

While you may have some detailed questions on information in our 10-Q filed today, we ask that you address those with us after the call.

We are planning our call today to last 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 21-E of the Securities Exchange Act of 1934, such statements are based upon current information and management's expectations regards the Company, speak only as of the date on which they are made, 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 risks described from time to time in H&R Block's Press Releases and Forms 10-K, 10-Q, 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 the date of these remarks.

H&R Block provides a detailed discussion of Risk Factors in periodic SEC filings, and you are encouraged to review these filings.

In conjunction with today's call, there is an accompanying slide presentation, which is posted on the Investor Relations section of our website at HRBlock.com.

In addition, our 10-Q has been filed and our Earnings Release has been posted to our website.

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

When asking your question, please remember to avoid using a headset or a speaker phone, as this will cause audio problems.

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

Thank you, Scott.

Good afternoon, everyone.

I am pleased to be on the call today with our new Chief Executive Officer Russ Smyth, who joined H&R Block on August 1, just about a month ago.

We are delighted to have found someone with Russ' background , his experience, and his personality, that together represent a very good fit with H&R Block.

As we noted when we announced his appointment as CEO, Russ spent 21 years with McDonald's, one of the world's great consumer brands, with over 30,000 retail locations in the United States and across the world.

He spent most of his time working internationally, including President of McDonald's Europe, where he was responsible for more than 6,300 restaurants, that generated 6.7 billion in revenues, or more than a third of McDonald's total.

Russ worked with and motivated a large and diverse workforce.

He also has proven abilities running a significant franchise network.

The Board believes that Russ will help H&R Block utilize more effectively the power of it's brand in growing our market share, and also in improving our efficiency.

During his McDonald's tenure, Russ learned firsthand the importance of focusing on a company's core strengths, and delivering consistent quality across a large retail network.

That is an important need here at H&R Block.

Russ' international experience was also a bonus for many reasons, particularly that Russ had to use the McDonald's brand in new markets, where it wasn't already dominant, but wished to grow significantly.

At H&R Block, we are very strong in some market segments, but not nearly as strong as we intend to be in others.

Russ' selection reflects the Board's desire, to challenge perceived limitations to H&R Block's pace of growth in it's core tax business.

We will be hearing from Russ in just a minute, as we discuss results for the quarter.

While welcoming Russ on Board, I would also like to take just a moment to thank Alan Bennett, who did such an outstanding job as interim CEO.

Alan was a stabilizing force for an organization undergoing significant change, and he provided really excellent leadership, and results during his tenure.

I have been in his shoes and I know how difficult the challenges are as an interim Chief Executive Officer.

We are extremely pleased that Alan agreed to join our Board, where he will bring his long experience with financial markets, as developed as CEO of Aetna, as well as the knowledge of H&R Block's business and it's people, gained from eight months at the helm, we believe that he represents a terrific improvement to our Board.

But thanks very much to Alan for all of his efforts.

The Board and the new leadership team remain focused on repositioning H&R Block for accelerated, long term profitable growth, and delivering shareholder value.

We have taken some recent steps to further our focus on growing our core tax business, and focusing the overall company effort.

Last month, we announced the sale of H&R Block Financial Advisors to Ameriprise, in a transaction that we believe is a win/win for everybody.

Good for us, good for our tax clients, and good for the Financial Advisors, who will be joining Ameriprise.

Our tax clients will continue to enjoy the high quality advice previously provided by our H&R Block Financial Advisors, and in the future, they will have the opportunity to continue to work with these Financial Advisors.

The securities brokerage business increasingly demands size and scale.

And HRBFA simply did not have the size to be able to compete at the highest levels in the future.

This transaction will give HRBFA a parent company with a growing platform and strong technology, so that they can compete effectively and efficiently.

At the same time, the transaction should strongly benefit Block shareholders, as we eliminate what has been a long term drag on returns, and a source of operating and market risk.

When this transaction closes in three to six months, we will have completed the initial phase of H&R Block's strategic realignment.

Earlier today, we announced an agreement to acquire a major Southwest franchise Operator.

We believe the Block Texas acquisition is a very good transaction, that will enhance our client growth and our financial returns.

Block Texas operates a network of 621 tax offices in Texas, Oklahoma, and Arkansas.

385 of these offices are owned and operated by Block Texas, while the remaining 236 offices were operated and owned by subfranchisees.

After this transaction, the subfranchisees locations will become regular H&R Block franchise offices, with a direct franchise relationship to H&R Block parent.

The Block Texas operated locations will become H&R Block Company operated offices, at least initially.

Longer term we will look hard at opportunities to refranchise offices in Texas and elsewhere, as part of normal efforts to shift the total proportion of offices, in the direction of a greater mix of franchises.

Block Texas is a unique opportunity, based on the retirement of the key operator of this business, and it removes a current barrier to significant expansion of franchising, and the growth in Company owned offices in the Texas region.

We believe this acquisition brings us two primary benefits.

First it is financially attractive, at a purchase price of 5.8 times projected FY09 EBITDA, it is immediately accretive.

We expect it to add approximately $0.05 per share to our earnings in FY09, and somewhat lower amounts indefinitely in the future.

The transaction also represents a strong long term return on invested capital, even before any synergies or incremental growth.

It does not affect our ability to repurchase shares in the future, and it is low risk, because it is an operation that we know well, with minimal integration risks.

More importantly this transaction opens up important growth avenues.

The Block Texas markets are growing strongly, and have a significant Latino presence.

Our current penetration in the key Block Texas operated metro market is 20 to 40% lower than in our comparable company-operated markets.

Owning Block Texas will give us the ability to open new H&R Block branded offices, and it will create additional Express Tax, Latino, and other franchise opportunities.

We believe that over the next several years, we will be able to add more than 400 locations in the region, and our goal is to add at least 250,000 new clients over time.

So while our first fiscal quarter is not usually a focal point, because we report a pre-season loss every year, we obviously feel good about the many positive steps we have taken, and the momentum we believe we are sustaining, as we prepare ourselves for tax season 2009.

With that, I would like to turn the call over to

Thanks Richard, and thanks to all of you who joined us on the call today, to discuss our first quarter results, as well as our outlook for fiscal year 2009.

Before I start I should mention that there are several members of our Senior Management team here, in addition to those of us that are presenting, and they will be available during the Q&A session, and that group includes Kathy Barney, President of H&R Block Bank, Joan Cohen, President of H&R Block Financial Advisors, and Jeff Brown, our Controller.

Obviously this is my first earnings call, and I welcome this opportunity to start a dialogue with our investors and our analysts, and even more importantly, I am looking forward to meeting many of you personally in the coming months ahead.

So in a month, it has been fairly busy as Richard mentioned.

We announced the sale of HRBFA, as we continue to focus on our core businesses.

We appointed a new President of Digital Tax, as we begin to refine our digital strategy, and better coordinate growth opportunities with Retail Tax.

This morning we announced a large acquisition that will contribute positively to earnings and shareholder value immediately, as well as give us further opportunity for growth over the next several years, and we are doing earnings today, and tomorrow is our Annual Shareholder Meeting.

So in between all of this activity I have spent the rest of my time getting educated about H&R Block's businesses, and meeting with people throughout the organization, to get their views on how we can best leverage our strengths, and accelerate growth in our core businesses of H&R Block and RSM McGladrey.

As I have spent time within the organization, to be honest there has been no real big surprises in terms of the Company, the way it operates compared to my initial perceptions coming in.

There are clearly some things about H&R Block that I believe are important to our success in the future, and those have been reinforced by what I have learned to date.

I believe in both H&R Block and RSM McGladrey, we have brands with great potential, that we can better leverage, with targeted messaging to our diverse customer segments.

We have strong values and ethics.

where how you do things is just as important as what you get done.

And we have market leadership positions in both our tax services and business services segments, that give us a unique competitive advantage.

But most importantly, we truly have the best people in the business.

They are clearly our greatest strength, and when it comes to our tax pros at H&R Block, I really believe they are perhaps our best kept secret, but not for long, I promise you that.

So those are just some of the reasons why I am excited and our future, as we lead H&R Block back to being a great company again.

And just so you understand what I mean by a great company, I think great companies do three things exceptionally well.

First, they consistently exceed their clients expectations.

Second, they provide superior returns to shareholders, and third, they create a challenging, yet supportive work environment for employees, and because they do those three things well, they grow.

So as we do those three things better, we will grow faster.

We will grow our client base by improving client satisfaction and retention for existing customers.

We will also attract new customers with market leading services and products, communicated in a compelling and relevant manner in our advertising.

We will open new locations to meet the increased demand in underserved markets.

And we may even acquire businesses that add to both client growth and shareholder returns.

And while we are growing, we will keep a close eye on our cost structure, investing where it is needed to drive growth, but quickly eliminating costs that don't improve either customer satisfaction or shareholder value.

So those are the things that we will be focusing on during my watch here at H&R Block, and that is what you will see reflected in our future business results.

Now while it is still early days, I can tell you we plan to enhance our marketing efforts this year, and to further utilize franchising as a growth driver, particularly in Latino and our expertise market groups.

This year we will also focus on doing fewer things, but doing each of them better, because at the end of the day, great execution will ultimately be the biggest reason for our success.

So now I would like to turn to our first quarter.

I would like to give you a brief summary of our overall performance and results from the non-tax Continuing Operations areas, and then I will turn it over to Tim Gokey, who will cover our results for Tax, and then Becky Shulman will review Discontinued Operations, as well as key items from a financial perspective, and then I will conclude with some comments about our outlook for fiscal year '09, and we will open it up for your questions.

As you know, this is the time of year when tax services and RSM McGladrey businesses are really preparing for the upcoming busy season, and in the meantime we are also managing the residual risk from having been in the mortgage business.

Our net loss from Continuing Operations was $129 million, or $0.40 per share, compared with a loss of $110 million, or $0.34 per share in the prior year.

The increase in loss was primarily due to higher loan loss reserves for the bank, and operating loss from our Financial Advisors business, and a write-down of residual interest in securitizations associated with our former mortgage business, all of which were somewhat offset by improved pre-season results from our Tax Services group.

We had significant improvement in our Q1 consolidated net loss over the same period last year, as there were no additional reserves taken on Option One mortgages.

Whereas in the quarter a year ago, there was a total of more than 260 million in residual impairments, losses on loan repurchases, and losses on the sale of loans.

Inclusive of Discontinued Operations, our net loss for the quarter was $133 million, or $0.41 per share, compared with the net loss of 303 million, or $0.93 per share in the prior year.

In Business Services, RSM McGladrey achieved a slight improvement in earnings, despite some softness in the overall market.

Reported revenues declined 9%, primarily due to reduced leased employee revenues, reflecting the integration of the AmEx TBS acquisition.

Employees that had been leased to the AmEX TBS attest firms, have now been transferred to RSM McGladrey, to the separate attest practices, so as a result we no longer record the revenues and expenses associated with the leasing employees to the attest firms.

This change however, had no impact on earnings.

Given the seasonal nature of tax and accounting business, RSM normally reports a loss in the first half of the fiscal year.

This segment reported a small pre-tax loss of $300,000 in the first quarter, compared to a loss of 2 million the same period last year.

And this improvement reflects savings and ongoing operating expenses, and the recent cost reduction efforts that occurred company-wide.

Our Consumer Financial Services segment, which comprises our bank and financial advisory businesses, continues to be negatively impacted by interest rates, and difficult conditions in financial and housing markets.

The bank recorded a pre-tax loss of 14 million, compared with pre-tax income of 5 million a year ago.

The decline in profitability was due to quarterly mortgage loan and related loss provisions totaling 20 million.

Although our delinquency rate during the first quarter was consistent with our previous assumptions, underlying collateral values on the mortgage loan portfolio continued to decline, resulting in additional reserve requirements.

We continue to work toward shrinking our mortgage loan portfolio and related assets, which declined by a further 34 million during the quarter, as a result of net principal repayments, and Becky will have more to say about the Bank's loan portfolio during her remarks.

At July 31 we held approximately $520 million of deposits on behalf of H&R Block Financial Advisors clients, and slightly more than 250 million of deposits for our tax services clients.

The sale agreement with Ameriprise provides for the bank to continue to have access to HRBFA customer deposits for more than two years after the closing date.

At HRBFA, first quarter revenues fell 22% compared to the prior year quarter, to 68 million.

The revenue decline is due to the absence of underwriting activity this year, and a challenging market environment in general.

HRBFA reported a pre-tax loss of 3.6 million, compared with pre-tax income of 1.4 million a year ago.

This entire variance from the prior year is due to the revenue reduction, but was partially mitigated by cost savings initiatives enacted at FA.

Now as a result of the recent sale to Ameriprise, FA's results current and historical will be reported in Discontinued Operations beginning in our fiscal second quarter.

With that, let me turn the call over to Tim for a review of Tax Services.

Thanks, Russ.

Our Tax operations reported improved results for this pre-season quarter.

Revenues increased 8% over the prior year to 75 million, primarily due to a 16% increase in US retail clients served.

About 7 percentage points of the increase was attributable to one-time economic stimulus tax filers, although these filers had only a minor revenue impact, due to the lower charge on these relatively simple returns.

Our client increase also reflects the success of our second look product.

Our Canadian operations also had a strong quarter, reflected in client growth of 13%, and pricing growth of 5%.

The pre-tax loss in our tax segment of 164 million, represents a 5% improvement over the prior year.

This is the first time in nearly a decade that our first quarter loss is less than the prior year, largely due to overall better management of expenses, including our recent cost reduction efforts.

While the sum of this result is due to timing, our expense control in the first quarter gives us increased confidence in our planned margin increases for the year.

As you can imagine, we are deep into planning for the upcoming tax season.

We intend to build on the momentum from this past tax season, in which we grow retail client growth and retention, to continued product superiority, service quality, and the expertise of our tax professionals.

Our plans in retail tax will focus in particular on extending our leadership in the important early filer segment, while aggressively pursuing the large opportunity we have among expertise filers.

In Digital Tax Services, our goal is to build our market share and maintain profitability.

The acquisition of Block Texas will add approximately 102 million to FY09 tax segment revenue, and $38 million to pre-tax profit.

Including Block Texas we now anticipate high single-digit revenue growth for the segment, with margins increasing in excess of 200 basis points.

We look forward to sharing more details about our plans just prior to the tax season.

With that, let me turn call over to Becky Shulman.

Thank you, Tim.

I will start with a discussion of our corporate segment, and the banks mortgage loan portfolio, both of which are part of Continuing Operations, followed by a review of our Discontinued Operations.

I will also cover the balance sheet, and other items related to our financial statements.

The first quarter pre-tax loss in Corporate Operations was 33 million, compared to a loss of 16 million a year ago.

The increased loss reflects a $12 million increase in net interest expense, as interest on borrowings incurred to cover losses of our former mortgage operations were reported in Discontinued Operations last fiscal year, but in Continuing Operations in the current year.

The larger loss is also due to a $5 million impairment of residual interest.

Although first quarter corporate losses are larger year-over-year, enterprise-wide expenses of our Continuing Operations are $15 million lower in fiscal 2008.

We remain on-track to fully deliver our previously committed expense savings.

The bank ended the first quarter with more than 4,100 mortgage loans held for investment, representing an aggregate net principal balance of 869 million.

In addition at July 31, the bank had 246 properties classified as Other Real Estate Owned, or REO, totaling 48 million net.

Our mortgage loan and REO portfolio was reduced by 50 million since the fourth quarter, due primarily to net principal payments of approximately 34 million, and additional loss reserves taken during the quarter.

Primarily as a result of declining collateral values during the first quarter, we increased our loan loss allowance by 15 million, and wrote down other Real Estate by 5 million, for aggregate loss provisions of 20 million during the quarter.

Our loan loss allowance totaled 47 million at July 31, 5.1% of our total mortgage loan portfolio, up from 4.5% at the end of the fourth quarter.

During the quarter, we continued to observe sharply lower property values across the country, in particular certain areas where we have loan concentrations including California , certain communities in Florida, and select states in the Northeast.

As a result, we increased our expected weighted average loss severity used to estimate loss reserves on loans less than 60 days past due, from approximately 22% at April 30, to approximately 30% at July 31.

It is important to note that the original loan to value on the banks portfolio was approximately 76%, and therefore our current loss severity assumption implies a nearly 50% decline in property value, from the appraised value at origination.

At July 31, our mortgage loan 30 plus day delinquency rate in REO, was a combined 16.9%, or 153 million, which is up from 11.7%, or 117 million at the end of our fiscal fourth quarter.

Within this total, loans delinquent by more than 90 days were 113 million, or 12.5% of the portfolio, up from 74 million, or 7.4% of the portfolio at the end of the fourth quarter.

We continue to actively manage the loan portfolio to minimize losses.

In the first quarter the bank modified 146 loans totaling 42 million, of which 72 loans totaling approximately 20 million were previously delinquent.

Our loan loss reserve at April 30 assumed an overall delinquency rate during fiscal 2009 of 14%, with higher delinquencies early in the year, and a declining delinquency rate throughout the year.

Actual delinquencies during the first quarter were consistent with our expectations.

We believe that we have established an adequate reserve based on current conditions, however market conditions remain volatile, and future increases in the loan loss reserve may occur, particularly if pressure on the housing market persists.

We estimate that a 100 basis point increase in our current delinquency rate assumption would result in an additional loan loss provision of approximately $2 million, and a 100 basis point increase in our current loss severity assumption would result additional loan loss provisions of approximately $1.6 million.

Our net loss from Discontinued Operations of $3 million during the quarter, was down significantly from a net loss of $193 million in the prior year.

The relatively small loss for the first quarter of this year, reflects the continued wind-down of our former mortgage operations.

There were continue to be a minimal amount of shutdown expenses incurred throughout the year, as well as some expenses related to the small long term staff, in place to handle the remaining wind-up activities.

We repurchased just $4 million in mortgage loans in the quarter with respect to [reprimorant] related repurchase obligations, and new claims were consistent with our expectations.

Repurchase activity during the quarter did not give rise to recording of additional repurchase reserves, and accordingly, the repurchase reserve remained relatively unchanged from year-end.

Residual interest in securitizations from our former mortgage operations declined by $8 million during the quarter, of which 5 million went through the Income Statement and Continuing Operations, with the remaining change resulting from cash received and write-downs recorded as a direct adjustment of equity.

Due to the current mortgage market, the Company has decided to retain the residual interest, and is reporting all activity related to residual interest through Continuing Operations.

Turning to the Balance Sheet, at quarter end our unrestricted cash position decreased to 356 million, from 727 million at April 30, primarily due to our off-season working capital requirements and dividend payments.

Our total outstanding debt of $1 billion was essentially flat compared to the fourth quarter.

Net receivables declined to 383 million for more than 550 million at fiscal year end 2008, reflecting the normal pattern of collections, primarily at RSM McGladrey.

We will continue to run our businesses to minimize the capital necessary, to deliver the returns and cash flow we require of our operations, while keeping with our historical view that any excess capital should be returned to our shareholders.

As we have noted before, our Board has authorized the purchase of $2 billion worth of stock over the next four years.

As a reminder, our share repurchase activity won't begin before the fourth quarter of this fiscal year.

During the first quarter, we issued 2.3 million shares from our Treasury for option exercises, the employee stock purchase plan, and restricted shares.

As a result the weighted average shares outstanding for the quarter increased to 327.1 million.

The effective tax rate from Continuing Operations for the first quarter was 40%.

And throughout this year we have taken several steps to streamline and strengthen our Company, and these efforts have been recognized by external parties.

On July 31, S&P upgraded H&R Block's counterparty credit rating to BBB/A2, with a positive outlook, reflecting the changes we have made and our overall improved liquidity positions.

I will now turn the call back over to Russ to conclude with our outlook for the remainder of the

Thanks, Becky.

As we have said, we announced earlier today the acquisition of the Block Texas franchise, and that transaction is accretive to us this fiscal year.

But we are keeping our fiscal 2009 earnings guidance at $1.60 to $1.70 per share.

It is important to keep in mind that this is just the first quarter of the year, and we generate almost all of our earnings for the year in the fiscal fourth quarter.

In deciding to leave the guidance unchanged, we also consider the higher loss reserves for the bank that we booked in the first quarter, as well as the anticipated earnings contribution from HRBFA, which we originally included in setting our guidance, but now will be reported in Discontinued Operations starting in the second quarter of this year.

Overall, we remain very confident in our ability to build on the underlying momentum in our core businesses from last year, and find new ways to aggressively grow our business through improved client satisfaction and retention, new client acquisition, and maintaining a lean and mean organization, while we invest wisely in our people and our businesses for future growth.

So with that Scott, I will turn it back to you to open up the floor for questions.

Operator, we are ready for questions.

Thank you very much.

(OPERATOR INSTRUCTIONS).

Your first question comes from the line of Kartik Mehta with FTN Midwest.

Please proceed.

Thank you.

Richard, I wanted to just make sure, I think you made a statement earlier in the conference call that I just wanted to better understand, I thought you indicated that the tax margins were to improve more than 200 basis points, and I believe last, if I remember you said 200 to 300 basis points, and it is just a technicality, but I just wanted to make sure that things haven't changed, and that doesn't change your perception on the margins for the business?

Tim, do you want to take that one?

Yes, absolutely.

Our expectation continues to be to increase margins in excess of 200 basis points this year, and a little bit in excess of 100 basis points in each of the two years after that.

So there isn't really a change then from what you said in Q4 '08, to what you are saying today?

That is true.

There really isn't a change, actually the acquisition of Blue will be a little bit of an addition to margins, but we are just staying with the plus 200 for now.

And that kind of would also be true not only for retail tax business but for the RSM McGladrey Business, as well as what we promised in the past on cost reductions.

All of the messages that you have heard before on cost reduction and margin improvements, there is no change from what we have seen so far in the first quarter.

Perfect, and just one last question for you, Tim.

I think you talked a little bit about the digital tax business and growing market share for that business, and I am just wondering, what maybe if you could elaborate a little bit?

Is that more of a pricing issue that you will price more aggressively compared to Turbo Tax, or is it marketing, or is it something else, that will allow you to gain more market share in that business?

I think it is a little bit early for us to go into any detail regarding our plans for 2009.

I would just suffice it to say that we will be competing very aggressively.

We are very excited about our plans for the year, and we look forward to talking more about it in January.

All right, thank you very much.

Your next question comes from the line of Michael Millman with Soleil Securities.

Thank you.

It looks like that Jackson Hewitt and Liberty will have a pre-loan product this year, and a military product this year, and therefore, it looks like a level playing field.

Can you talk about what you think that means about your ability to gain share, and increase profit in the retail end of the business, tax business?

Yes, absolutely.

We expect to be very competitive with Jackson Hewitt and Liberty this year, even more so we expect to be very competitive with the independent preparers, who really control the largest part of the market, and who do not have any pre-file product or military product, so I think we feel very good about it.

I would also note that our products, the Emerald Advance for the pre-season is modeled on the FDSE's guidelines for small dollar lending, and was really hailed by Consumer Advocates last year, as a healthy alternative for consumers needing short-term credit, so we feel good about our product.

We feel good about it's attractiveness, and we feel very good about our ability to compete aggressively amongst early filers.

When you say you expect to be competitive, or aggressively competitive, could you give us some color?

Are you talking about pricing?

Are you talking about servicing?

Are you talking about offering additional products, higher levels of loans, a pay stub equivalent product?

Generally, I am looking for some definition of how you expect to be more competitive.

Michael, I think all I really feel comfortable saying at this point, is that we have always had product superiority, and we intend to maintain that this year.

We believe our bank gives us an ability to tailor products that are a better fit for this segment than others might have, so we believe we will have the best product in the market, and that we will be able to promote it more aggressively than our competitors, and that we will do very well.

Just a quick one, on the digital where I think you have indicated you expect to be in the free business this year, do you expect that product to allow you to increase profits this year, or expect that to be a net expense this year?

We believe that net/net, given the market share we anticipate, or the overall growth we anticipate that we will be able to maintain our current profit level, so while there certainly our investments we will be making in that business, we believe we will be able to offset that within the business within other areas of growth.

Thank you.

Your next question comes from the line of Vance Edelson with Morgan Stanley.

Please proceed.

Hi.

Thanks a lot.

Could you elaborate on the synergies you can derive from taking on the Texas franchises as company-owned?

Any challenges involved in integrating those franchises and creating those synergies, or would you say it should be a relatively smooth process?

Thanks.

Yes, we expect it to be relatively smooth.

The Texas franchise is structured very, very similarly to our current Company operations, so on the Texas franchise owned side, they have a regional and divisional structure very similar to ours.

We have worked closely with them over the years, and so we expect that to be a very smooth transition.

In terms of synergies, there are some synergies.

We really see the primary motivation for this deal to be around growth, while the Block Texas operators are very good operators, they have been somewhat constrained in investment in recent years, and we think there are opportunities to invest in that area, and also to unleash some new growth tactics that we have been pursuing elsewhere in the country, but haven't pursued there yet, so we are very excited about the growth opportunity, and think it should be a very smooth transition.

Okay.

And as a quick follow-up could you give us an update on where you would say you are in terms of overall cost savings initiatives companywide, has most of the heavy lifting been done at this point?

Yes, it has.

So, we announced our targets last year.

We are tracking it very closely, and we expect to come in with the margin improvement that we told you to expect, so so far so good.

We are seeing everything come through.

I think a good way to think about it, when you look at our overall corporate expenses, historically you have probably seen those increase about 10% a year.

This year, you will probably see those be up around 1 to 2, and so remember when we put those out there, we basically said that it would not all fall through to the bottom line, because we were going to be doing some reinvestment into the business, and that is exactly what we are seeing happen.

And this is Russ.

I just want to add that while the heavy lifting was done on the one-time cost, big cost saving initiative last year, I think that there is an ongoing process of always looking at our costs, and finding ways to get more efficient that we need to do on an ongoing basis, as part of the way we run the business.

And if we do that we will never have to go through another one-time cost saving initiative again.

So I think that has got to be a part of the discipline and process that we learned from last year, that we have now added to what we do on a day-to-day basis.

Okay that is helpful.

Thanks.

Your next question comes from the line of Scott Schneeberger with Oppenheimer.

Please proceed.

Thanks very much.

Going back to the activity in Texas today.

Just curious, what is the view now on your franchise versus company-owned split?

Are you looking to significantly alter that mix of about one-third franchise, two-thirds company-owned, over the coming few years, just the strategic thoughts there, and then as a follow-up, how many HRB offices do you anticipate having a year from now, three years from now, five years from now?

Thanks.

Scott, this is Richard.

Let me take a crack from a policy perspective, and then let Russ and Tim comment.

I think that Texas transaction, first of all we see it as a one-off opportunity.

It was initiated really by the seller, not by us.

The person operating that, the principal operator there had a desire to retire, so I wouldn't, we see that as a growth story, more than a story about reengineering the franchise network.

Now the reason we see it as a growth strategy and a growth opportunity, is in part, because of the fact that instead of having an exclusive franchisee with a large three state territory, we are now going to have that territory, and we can flood it with Latino franchises, Express Tax franchises, as well as normal Block branded franchises, or company-owned stores, so it is simply in the nature of removing somebody with an exclusive territory, it gives us an opportunity to redesign that territory, if you will, and I think management has indicated, and intent to utilize products we are utilizing other places in the country in that region, to a greater degree than they have been doing.

So we see that as adding to growth numbers in that region, as well as I indicated that it is a financially attractive transaction on it's own merits.

More broadly, I think there is a policy desire to look hard at franchising as one member of the Board only, speaking only for myself personally, I would like to see us move to a 50/ 50 split of franchise & company-owned locations, and once we get there, to then look and see how we like that and consider where we go in the future, and I don't know and I don't think any of us know whether that is a three year project, a five year project, a 10 year project, or a never get there project.

We are going to look hard at franchising.

Now what we know is that some of the new growth in Express Tax and Latino are going to be essentially 100% franchisee, and so to the extent those non-Block branded parts of the business grow, it will of necessity dilute, increase the overall companywide percentage of total franchisees.

I think we would be beyond our limits to wisely predict, let alone our ability to do it, to try and give you a store count breakdown of what things are going to look like two or three years from now, but we all recognize the financial benefits of franchising, the fact that franchisees know their communities traditionally, have entrepreneurial spirit, and lots and lots of good advantages from franchising, and at the same time we generate really significant earnings from a good network of company-owned locations, and we are not going to turn our back on that.

So there is a balancing exercise that goes on here, and over time I think the Board is very interested, and as I indicated at the outset, it was one of the reasons, one of the things that was an element in Russ's selection, but one of many things that franchising is an opportunity for us to continue to grow market share and grow financial returns, but we see that as a long term opportunity, not an overnight kind of change.

Yes, Scott, I will just echo what Richard said, in terms of we have not put a hard pencil to paper yet to give you a number of how many of the new locations will be franchise versus company operated.

We need to do that on a market by market basis, in terms where are our growth opportunities down in Texas, but we certainly see franchising as the primary driver of our growth, and further expansion down in that geography, and then I think based on what we learn and our success down there, that is going to help us answer the bigger strategic question of what the overall mix would look like in three, five, seven, 10 years from now, so this acquisition is really an opportunity to kind of put some fuel on the fire on the franchising question, and get some better answers around it, so we can better launch a better long-term strategic direction for ourselves, and Tim if you could answer the question about the number of openings by when?

Yes, absolutely.

So our openings this year will be rather modest.

We are doing this acquisition late in the year, so we will do some, but not a huge number this year.

I would expect to see on the order of 75 to 100 in each of the next five years.

I mentioned an overall goal of around 400 over that timeframe, and obviously we need to build a pipeline of people that would be franchisees in these areas, so that will be one of the factors that will go into our pace of openings in that territory.

Great.

Thanks.

That is a really informative answer from all of you.

I appreciate that.

I guess Tim following up on your part, a goal of roughly 400 new over the coming call it five years, you had also mentioned before to potentially calling 300 underperforming Company owned stores over the next three years, so is that 400 number a gross or a net number?

That 400 is a gross number that refers to the territories that Block Texas has only.

It is not a national number.

The other part was really more of a national project, to make sure we are getting the best out of every office.

Okay, thanks.

That is helpful.

I appreciate that.

One more if I can sneak it in.

I guess Russ or Richard, any update on your strategic thoughts on we just saw you disposition Financial Advisors.

Any update you care to provide on what you view as core and non-core business going forward?

Thanks.

Well, I think we have tried our Annual Report tried to lay out pretty clearly that the two core businesses we see ourselves having are the tax business and business services through McGladrey, and of course McGladrey is, when we call that a separate segment, it is not entirely divorced from tax, since McGladrey does about $400 million plus of tax services every year, so it is an area where as we think about growing the retail tax business in what we call the expertise segment, the higher income individuals and more complex tax returns, McGladrey is actually one of the leading providers of services to exactly that marketplace.

So we see these as strategically related activities, and clearly, the two core businesses we will be pursuing going forward.

Now I don't mention the bank in describing that.

Number one, we don't see the bank as a core independent area of business.

That doesn't mean the bank will be disposed of, or that it isn't important.

It is just that we see the repositioned bank as really a factory for creating products that will be used in support of the tax business.

So I personally think of the bank as if it is part of the tax business, though of course legally, it is an independent institution with it's own Board, but it is the provider of the Emerald Card, the Emerald lines of credit, all of the things we have been talking about and rolling out over the last couple years, that are used every single day in every one of our tax offices, so it is just intellectually, I consider that part and parcel of the tax business, rather then a freestanding independent banking business uncorrelated to our tax business.

Great.

Thanks so much for all of the color.

Your next question comes from the line of Andrew Fones with UBS Securities.

Please proceed.

Yes.

Thanks.

To the extent you are able to give us any color, I was hoping you could help us understand how you plan to attack the complex, the CPA hiring tax market if you could?

Thanks.

Yes, sorry, Andrew?

Could you repeat that one?

You were cutting in and out on this end.

Okay.

I am sorry.

Yes, to the extent you could, could you help us understand how you plan to attack the complex CPA tax market?

Thanks.

Absolutely, Andrew.

This is Tim.

I think there are really two aspects to this, the biggest is just further growth within our core Block brand.

We actually grew fastest amongst expertise filers last year, as Russ mentioned our tax professionals have an incredible amount of expertise that is not well known at this point.

Our typical client is seen by a tax specialist with over eight years experience, and as we expose clients and prospects to the expertise that our tax specialists have, they are surprised and are consideration amongst expertise filers goes up significantly, so we think that just doing more with basically our current business model under the Block brand, is a big opportunity for us in expertise.

Beyond that, we have alternative value propositions that we are testing, we have a couple, a number of different small businesses that we think could be interesting, new business models for us, probably franchised, and we think that could be an additional area of growth for us over time.

We don't have any of those perfected far enough along at this stage, to be in sort of a full rollout of them, but we believe that we are getting promising initial results.

Thanks.

That was helpful.

And then just as kind of a follow-up to your answer there as well, you have kind of given us a good understanding of where you are earmarking most of your cash flow, and the use of that with the share buyback, but in terms of what could be spent on acquisitions, do you have anything budgeted there, or what is your appetite, and is there anything you are looking at currently?

I think generally, this is Richard, we are focused on, and the Board deliberated it at some length, Andrew, before we announced the long term buyback target, and we could have picked a shorter term target, and then changed it as we went along.

We thought the market would benefit from having some visibility into what the Board saw as a really permanent opportunity to return cash to shareholders, and certainly at the time we were deliberating it, and even today we would regard the share price as an attractive use of our capital, a very attractive use for our capital, so we tried to put a long term target out there, with the understanding that we really meant it, and that that is a view of the Board of a very desirable use of our capital.

Now we have said at various times, in the Annual Report and other places, that notwithstanding our interest, and our belief that share repurchases offer us compelling long term value, that we are not going to be afraid to reinvest in the business, and we have tried to speak with equal emphasis, that building market share and increasing the total number of clients is a major priority for the Company.

We think it is a realistic and attainable opportunity to grow our market share consistently over time, and to do so at a somewhat more rapid pace than we have done in the past, as a number of initiatives we have been talking about come online here, so we would look at acquisition opportunities in an opportunistic way, as we did at Block Texas, something that we didn't have on the radar screen came along.

We evaluated it, decided it was really a great opportunity and good value for the shareholders, and so we moved on it.

It happened that the purchase price was a little less than the sales proceeds we are going to be receiving from FA, but that wasn't critical.

We would have done the Blue transaction even if we hadn't had the FA sale, I believe, so I think you will see us willing to look at areas in which we can expand market share, historically there have been acquisitions in McGladrey of other local accounting firms across the country.

I see no reason to expect that that activity will cease, but we are going to at the same time, I think we have an extremely disciplined approach, to doing only acquisitions that are going to build those core businesses, and do so in a financially attractive way, and offer us both attractive returns on capital, and opportunities to grow market share.

Thanks.

That was really helpful.

The following question comes from the line of Michael Millman with Soleil Securities, please proceed.

Thank you.

I guess two questions.

One, can you compare the expertise, the profitability on expertise clients, with those on the bank product buying clients, and secondly, regarding franchisees, growth from the franchisees, do you expect that you have to subsidize franchisees, just like some of your competitors have to do currently, and to what extent do you expect to do that, and regarding the Latino, can you talk about what kind of subsidies you might get from the government for having Latino franchisees?

Michael, this is Tim.

Let me see if I can take those in order.

First of all, with respect to comparing the profitability of expertise clients versus early filers, we really don't see a lot of difference.

The components of that and our expertise filers tend to have larger, more complex tax returns, some of the early filers might have somewhat simpler tax returns, but then some product revenues associated with it, and when you add all that up, there are not really material differences between the two segments.

With respect to franchise growth and the need to potentially subsidize new franchisees, I think we spent a lot of time thinking about our Express Tax model, and how we would have a model that is differentiated for prospective franchisees from those of our main competitors, and one of the difference between us and them is that we are a tax company, not a franchise sales company, and so while our key competitors have a significant up-front fee to become a franchisee, and then lower ongoing royalties.

Our Express Tax expense is structured with a much smaller up-front fee, and then a little bit higher royalties over time, so we think that really makes it a lot easier for people to get into the business with us, and obviously we believe that when they do that, they then have access to our superior products and other things that are benefits of part of being the H&R Block family.

Michael, I will let Tim take a break before he answers the Latino piece.

This is Russ.

Having spent some time in the franchisee business, what I can tell you is that any time somebody is subsidizing a franchisee, it is because the underlying unit economics of the business are weak.

And so when you guys see that, you should recognize that there is something broken with the economic model, and that is not the case with H&R Block.

And then this is going to be a short answer on Latino.

We are at this point as we model this out and think about the opportunity, we not anticipating any government subsidies related to that, certainly to the extent we were able to obtain those, that would be interesting to us.

Tim, you ought to mention the role we play as it is, not solely in Latino and delivering EITC and other benefits, and that certainly is something we expect over time.

What Richard just commented on, is certainly, we are certainly the Earned Income Tax Credit, which is an important benefit from the government is an important part of our business, and many parts of the early filer segment, including Latino filers.

We currently help those who receive almost 25% of Earned Income Tax Credit in the US today, and as we experience more success with Latinos, and other early filers that would increase.

Thank you.

Appreciate it.

Your next question comes from the line of Brian Lester.

Please proceed.

Yes.

Just for some clarity, on the HRB Houston acquisition, was the 140 million in revenues net of paying corporate a 6% royalty, or does that 6% royalty come off of that 140?

That 140 was system revenue so that is the revenue that their network received from clients, irrespective of any payments to us.

Okay, so they will then reduce, they will then pay you on top of that, or out of that 140?

They did pay us out of that 140 previously, yes.

What is the royalty that they were receiving from their subfranchises?

They were receiving 30%.

So they were receiving 30%, and you all were receiving 6?

That is correct.

Great.

Thank you.

There are no more questions in queue at this time.

I would like to turn the call over to Mr.

Scott Dudley for closing remarks.

Great.

Well thank you all for joining us, and if you have any additional follow-up questions, please give us a call in Investor Relations.

Thank you.

Thank you for your participation in today's conference.

This concludes our presentation.

You may now disconnect.

Have a good day.