H & R Block Inc (HRB) 2010 Q3 法說會逐字稿

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

All participants are in a listen-only mode.

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

(Operator Instructions) At this time, I'd like to turn the call over to your host, Mr.

Derek Drysdale, Director of Investor Relations.

Welcome to the third quarter earnings conference call.

Presenting today are Russ Smyth, President and CEO, and Becky Shulman, our Chief Financial Officer.

Before we get started, I would like to remind everyone that some of our remarks will include forward-looking statements as defined under the Securities Exchange Act of 1934.

Those statements are relating to matters that are not historical facts and such statements are based on current information and management's expectation as of this date and are not guarantees of future performance.

Forward-looking statements involve certain risks, uncertainties, and assumptions that are difficult to predict, and as a result, actual outcomes and results could materially differ.

Please see the risk factors included in our most recent periodic reports and other filings filed with the Securities and Exchange Commission.

H&R Block undertakes no obligation to publicly update such risk factors or forward-looking statements.

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, if needed.

With that, I'll turn the call over to Russ.

Thanks, Derek, and good afternoon, everyone.

While Becky and I will be leading this call, we do have other members of our leadership team in the room to address questions at the end as well.

Earlier today, we announced third quarter net income from continuing operations of $54 million, or $0.16 per share, but clearly the bigger story and really what we plan to discuss with you in more detail today is year-to-date tax return volumes.

As I said in our release, we are disappointed with our volume results during the first half of the tax season.

There appear to be many factors contributing to these results.

Some are external, and some are internal.

Our goal today is to break these down for you and give you a better context for evaluating our results.

Give you a better sense for where we are making progress, as well as areas we need to significantly improve our performance.

And reinforce our longer term views of the industry and our business opportunities.

Of course, a general caveat to this discussion is that we are only halfway through tax season, and we won't be able to fully evaluate all of the trends until we see full-year results and the extent to which any timing issues affected results through February.

In terms of the external environment, there are three main headlines.

First, we believe total IRS filings are down somewhere between 4% and 5% through the end of February.

Second, it appears the shift from assisted to do-it-yourself through February is running between 1% and 2%.

And then, third, economic conditions and the disruption in the RAL marketplace appear to have resulted in a decline of 2% to 3% in industry-wide financial settlement products.

So here's some additional color on each of those headlines.

Although the IRS hasn't published their data yet, we believe that the IRS season-to-date filings are down between 4% and 5% due in part to weather in February.

We also believe that the IRS returns will recover somewhat during the rest of the season but will still finish down between 2.5% and 3.5%.

If this turns out to be accurate, this annual decline would be nearly double our original estimate of the negative 1% to 2%, although it would be a couple points better than where we are at the end of February.

While everyone was aware that unemployment rates would have a negative impact on returns this year, the sustained high levels of unemployment appear to be having a significantly higher effect than anyone predicted.

Many people who don't have a job simply are not filing, and as most of you know, at Block we are over-indexed on low income filers particularly during the first half of tax season.

Unemployment rates within this lower income client segment are substantially higher than today's overall 10% unemployment rate.

Beyond those not filing, others are shifting to online and other forms of do-it-yourself.

This is certainly a trend we've seen in recent years, but one that is clearly accelerated.

We believe most of this acceleration is due to economic pressures as price-conscious consumers try to do it themselves.

And in the early part of the season, the shift has been more pronounced than in previous years.

But if this year follows previous trends, we should see less of a shift in the second half of the tax season with our higher income clients.

Finally, there has been a great deal of change in the settlement product marketplace this season, caused in part by the disruption in RAL funding and availability.

We believe that the combined digital and retail settlement product industry is down 2% to 3% this year, with RALs down 20% to 25% due to a significant decline in availability for RAL funding and approval rates this year at firms other than H&R Block.

The decline in RALs is being partially offset by a 10% to 15% increase in RACs, or refund transfers, and this growth is primarily occurring in the online digital marketplace where RALs are not offered.

For the future, we believe that there will continue to be constraints on the amount of bank financing for settlement products, in part due to supervisory concerns by banking regulators.

We don't think that these constraints will adversely affect H&R Block's ability to offer these products due to the strength of our bank partner and our existing agreements.

Frankly, we expected to see an increase in new clients resulted from the RAL disruption that occurred this year.

We had RAL funding, and many competitors did not.

However, we didn't see any meaningful client growth driven by RAL availability.

And in fact, our performance in states in which competitors either had or didn't have RALs, show no meaningful difference.

We believe some customers at those firms without funding were told that nobody had RAL funding.

In addition, many clients didn't find out that they couldn't receive a RAL until the return was ready to be filed at the end of the process.

So for this season, it appears many people walked into a competitor's office expecting a RAL, but instead walked out with a refund transfer.

This didn't account for our decline in clients, but it prevented gains we thought we could otherwise achieve.

So with those comments on external factors, now I'd like to focus our remaining comments on things that seem to be working and not working at H&R Block.

As I mentioned in the press release, we have finally begun to see improvement in our client retention trends.

Reducing the hole in the bottom of our client growth bucket is a critical step to building market share.

However, the area in which we are falling short is in new client growth.

At our investor conference in December, we outlined the changes in our approach to the business over the next three years.

Many of these initiatives are fundamental improvements around delivering a stronger level of service, a better office experience, a more focused marketing message, and improving our price value proposition.

While it's still early in the season, we are seeing good signs of progress in several areas, but others need improvement.

We also said that we would renew our commitment to the digital business.

Growth in the digital category is part of a broader trend to increase buying online and is not limited just to tax services.

Unfortunately, H&R Block has been a late entrant in this category, and we have a lot of ground to make up.

Particularly in the critically important online tax preparation where we are currently a distant third in terms of market share.

On the retail side of our business, we believed our client service improvements would result in higher levels of satisfaction, reduced walk-outs, improved retention rates, as well as contribute somewhat to new client growth this year.

To achieve this, we increased coverage and quality at our front reception desks.

We moved more clients to our best performing tax pros, increased service levels at our call center, and improved the appearance of our offices.

Since the implementation of these initiatives, our indicators to date have shown progress on all areas except for an increase in new clients.

We are on track to achieve our goal of reducing the walk-out rate by more than 30%.

Client satisfaction is up four points to 81%.

We've also stabilized client retention levels after years of steady declines, and all of our call center metrics have improved significantly.

We have also been successful in moving a large number of clients to our highest performing tax professionals which is clearly helping to improve perception of the knowledge of our tax pros.

And our higher performing tax pros consistently have better retention levels.

So we expect the combined effect of these changes will result in improved retention levels in subsequent years.

Additionally, we're pleased with our improvements in our call centers where handle rates, issue resolution rates, and satisfaction have all improved.

Since each of these metrics have been declining for several years, turning them around fairly quickly is very encouraging.

But the progress is either not significant enough or hasn't had the time to take root yet to drive short-term business results.

We need to continue to build on this momentum, and then translate these improvements into results.

In terms of our marketing strategy, growing brand consideration and trial was key to re-engaging consumers with the H&R Block brand.

We had to improve our advertising tone, our value proposition, and change perceptions about our brand expertise.

And with the shift to do-it-yourself, it was imperative we communicate with consumers about the multiple channels we had to serve them.

There are early signs that our marketing has improved consideration in several key brand perceptions.

Our biggest challenge and our biggest disappointment has been new trial.

The conversion rate from improving brand consideration to new client trial has not happened as fast as we had hoped and planned.

We know that we're in a share war, so we're making real-time adjustments to our marketing in the second peak, including more pointed messaging, stronger calls to action that give clients reasons to try us, and a clearer communication of the unique benefits and value that H&R Block delivers to retail and digital clients.

Several of these initiatives are in test markets as we speak.

And we're prepared to move the right programs to market quickly to impact the second half of our tax season.

An important piece of making the brand more relevant to a younger generation of taxpayers is to connect with them in ways we've not done before.

And although just the tip of the iceberg, our social media program has engaged over 110,000 community members asking tax questions.

We introduced a favorably reviewed iPhone Tax Answers application that is now a leading tax app in the Apple online store, and we'll continue to innovate in ways that engage and contemporize this brand with this key audience.

We're also pleased that during the third quarter we entered into a new strategic alliance with Yodlee which promises to open up significant new opportunities, connect with clients in the online personal financial management space.

With these initiatives and ongoing learnings, we remain committed to our multi-year plan of strengthening brand relevance and client attraction.

We believe that many of the branding initiatives are the right ones and will resonate well with second half clients.

We just need them to be even more right and for consideration to move to trial faster.

Regarding digital.

Given the marketplace trends we described earlier and category growth of approximately 8%, our digital results are extremely disappointing.

Overall, our digital business is down nearly 4% in clients served versus last year.

In the online, non-FFA channel, which is the primary battleground in digital, we are up 2.5% year-over-year.

But frankly, this is unacceptable in a category growing at double digits.

As I mentioned earlier, Block was late to the digital game.

Our product historically has lacked some of the features and capabilities of other competitor offerings.

And until last year, we didn't even offer free services online.

An offer which has driven much of the growth in this category.

Over the past year, we've redesigned our product to improve its ease of use by clients and added the ability to import W-2 data and financial records.

These changes have improved the fundamental competitiveness of our digital products, and as a result, we have fared significantly better in head to head product reviews this year.

Regarding free online services, we now offer this as an online option.

This offer is helping to grow our online business, and we have had success monetizing those clients that start on our website in the free category.

However, based on our results through the end of February, we appear to have lost two points of market share in the digital space, rather than chipping away at the market leader.

This is a priority for me to fix, as we believe it is just as important for the long-term health of our business to become fully competitive in the digital space, as it is to improve the service, quality, and price value proposition in our retail business.

To improve our performance this year in digital, our marketing message has to be more crisp and aggressive in communicating the free message.

To date, our messaging has been too subtle, and as a result, hasn't cut through in an extremely competitive category.

In addition, when our marketing has been effective in driving more traffic to our website, we've not been successful in converting this traffic to actual clients.

So we are redesigning our web pages to increase conversion of visitors to clients.

These changes for the second half of the season are already in progress, and we will continue to work on improving our marketing message in the digital space, in order to be more competitive and gain market share.

From a longer term perspective, we no longer look at the digital market as a secondary priority to our retail tax business.

Strategically, we'll fight to build share in retail while competing equally hard in the tax digital business.

Because we believe to be the leader in the tax preparation business, we have to offer clients choices that best fit their needs.

And we know that when digital clients switch to retail tax providers as their taxes become more complex, they are a lot more likely to choose H&R Block if they use our digital products and services.

Now, I'd like to turn to pricing in our retail channel.

As I had mentioned previously, we needed to take actions this year to improve the value perception of our retail services.

We took a two-pronged approach to move us in the right direction.

First, we did not increase the price on any of our forms this year.

And second, we created some targeted value offers.

While we chose to hold the line on forms price increases, we did allow complexity to flow through to a higher net average charge.

However, we reinvested some of the increase by creating various value offers targeted to certain client segments with the largest offer being a reduced 1040EZ price.

While it is still too early to discuss the specific results of this action, or any of our other price tests that we have in market, we do believe the new 1040EZ pricing has reversed the trend of significant market share losses within this category and continues to gain momentum as the tax season progresses.

Clearly, these pricing efforts have not driven client growth as we had hoped so far this year.

However, we believe holding pricing flat is the right approach for our clients given the current economic environment.

We also believe this year's actions will help improve our retention rates and preserve our pricing flexibility over the long run.

It would be all too easy to resort to price increases to boost revenue as the Company has for the past decade.

However, we believe holding the line on price this year is the right step given the overall economic situation.

We continue to test different pricing approaches actively and will carefully evaluate what we learn as we formulate pricing strategies for next tax season.

We know we have a large degree of pricing flexibility, but we have to use that prudently to maximize both our competitiveness and our profitability for the longer term.

Regarding our financial discipline, it's clear to this management team that continued aggressive cost reductions are critical in delivering value to both our clients and our shareholders.

We are delivering as planned on our cost reduction activities for this year, and we believe that we can continue to drive significant costs out of the system over the next several years.

So that is a quick recap of this year's initiatives to date.

We have not had the initial success we wanted to see and understand we need to redouble our efforts in those areas that need to be improved.

With that, I'll turn the call over to Becky.

Thanks, Russ.

I'd like to begin with an overview of our third quarter results.

In Tax Services, pre-tax income declined less than 2% to $131 million despite a more than 6% decline in revenue which was driven by fewer tax returns prepared.

Total expenses fell about 7%, or $47 million, primarily due to lower compensation and other operating expenses.

In the third quarter, we also recorded a $12 million gain on the sale of Company-owned offices to franchisees under the re-franchising initiatives we've shared with you previously.

Despite the investment we made to improve our client experience and better staff our retail offices, total fixed expenses are down slightly from the prior year.

Specifically, we have been able to reduce our occupancy, supplies, and other administrative expenses.

We have also reinvested a portion of our cost savings into the client-facing initiatives Russ mentioned earlier which included better front desk coverage and more clients being seen by higher performing tax professionals.

We will continue to eliminate expenses aggressively and believe we still have significant opportunity to do so in the future.

Optimizing our office footprint is a key component of our cost reduction efforts.

Selectively closing offices enables us to reduce occupancy expense.

It also takes advantage of the proximity of our remaining offices and helps us both improve our execution and facilitates moving more of our clients to higher performing tax professionals.

As you are aware, we had a sizable reduction in our office count this year.

We closed more than 400 Company-owned locations, nearly 100 offices in Sears, and approximately 1,000 offices in Wal-Mart.

To date, we have been very successful retaining the clients from these offices even more than what was required from an earnings perspective to justify the exit of these locations.

We currently estimate that by the end of the tax season, the closed offices will cause a client decline of nearly 1% and reduce our market share in the assisted market by approximately 10 basis points to 15 basis points.

We will continue our efforts to identify underperforming offices, and we anticipate being more aggressive in optimizing the network in the years ahead.

When the Company aggressively increased the number of offices beginning in 2002, it added approximately $300 million in expenses without adding to overall client counts.

As we have further optimized our network, we should be able to reduce or infrastructure costs significantly.

In Business Services, we are very pleased that on February third, RSM McGladrey and McGladrey and Cohen entered into new definitive agreements which renewed the longstanding business relationship between these two firms.

This ends an uncertain period that had adversely affected our ability to participate in proposals for new client engagements.

Throughout the negotiations, we incurred more than $6 million of legal and consulting expenses, fiscal year to date, that have impacted our margins.

Happily, we don't believe the negotiations significantly impacted our current client base, although it did temporarily impede growth initiatives.

With these internal issues now behind us, we will focus our full attention and energy on taking RSM to a new level.

You will recall in June we hired C.E.

Andrews to serve as President of RSM.

C.

E.

is a talented industry veteran who we firmly believe will make a major impact in strengthening RSM.

Now that C.

E.

is able to commit 100% of his time to operations, we expect RSM to pursue opportunities to grow the business, increase share in the middle market, and improve our margin.

RSM's total third quarter revenues were down $7 million, or 4%.

The current economic climate is hurting the accounting and tax industry as a whole, and we have not been immune to these important market dynamics.

The audit market remains soft, and billing rates are under great pressure.

The tax market usually follows audit which is evident in RSM's tax business revenues which were down 7%.

While we are seeing less discretionary spending on consulting services overall, a large engagement helped our consulting revenues grow 14% over the prior year.

Total expenses increased $15 million, or 9%.

This increase was largely driven by a $15 million goodwill impairment to RSM's capital markets business, which now has remaining goodwill of about $14 million.

Given the soft economic conditions, our Capital Markets division has experienced declining revenues and profitability.

RSM's pre-tax loss for the third quarter was $11 million compared to income of $11 million in the prior year, largely driven by the impairment and soft market conditions.

In our corporate operations, third quarter losses of $23 million were nearly $20 million lower than the prior year.

Reduced expenses including reductions in self-insured liabilities, lower interest expense on corporate borrowings, and reduced loss provisions on mortgage loans held for investment.

Our third quarter tax rate was 45% due to $5 million of discrete quarterly adjustments.

We expect favorable discrete items that will offset the impact of this in the fourth quarter.

And it's important to note that year-over-year fluctuations in our quarterly tax rate contributed $0.03 to the $0.04 decline in EPS from continuing operations.

Our balance sheet continues to strengthen despite a slow start to the first half of the tax season, we still expect considerable cash flow and equity generation in fiscal 2010.

We ended the quarter with $936 million in equity, compared to $804 million at the end of the comparable quarter last year.

As you know, nearly all of our equity generation comes in the fourth quarter each year.

Our liquidity position is also very strong.

At quarter-end, we had no outstanding balance on our committed lines of credit, primarily as the result of our being able to reenter the commercial paper market.

Total debt, including our RAL participation secured line of credit, was essentially flat compared to a year ago at $2.7 billion.

Since the end of the third quarter, all of our short-term borrowings, including our lines of credit, RAL participation secured line of credit, and commercial paper have been entirely repaid.

Also, I'd like to note our Emerald suite of products continues to be very popular.

We ended the quarter with just over $920 million in Emerald Card deposits and approximately $670 million of Emerald Advances.

By the end of February, Emerald Advance balances have paid down by $600 million to approximately $70 million.

Since our previous committed line of credit was set to expire in August, we have been working diligently with our banks to reach a new agreement.

On March fourth, we entered into a new $1.7 billion credit facility, maturing in July of 2013, and that completely replaces the old facility.

Initially, the Company was seeking a $1.5 billion facility, but we increased the size at the end of the negotiations because the facility was oversubscribed.

The $650 million quarter-end net worth covenant remains unchanged, and additionally, no incremental covenants were added.

And the upfront and facility fees of the new [C lock] are consistent with the current market.

I'm very pleased with the execution of this facility and the support of our bank group, particularly given the tough lending environment that currently exists.

This new bank facility, coupled with our successful reentry into the commercial paper market, removes considerable uncertainties surrounding our liquidity planning for the next three years.

We remain committed to returning excess capital to our shareholders through both dividends and share repurchases.

During the third quarter, we repurchased and retired 6.8 million shares at an aggregate cost of $150 million.

As you know, we're subject to windows of when we're allowed to be in the market and to maximum volumes we can purchase on any given day under SEC rules.

As a result of the third quarter purchases, the weighted average fully diluted shares outstanding decreased to 334.3 million at quarter-end.

Notwithstanding the early tax season results this year, we have not changed our long-term view of the business and its ability to generate free cash flow.

Therefore, we have not changed our intention to utilize all, or nearly all, of our $2 billion share repurchase authorization on a opportunistic basis through June of 2013.

With that, I'll turn the call back over to Russ.

Clearly, we've got a lot of work to do, but I continue to believe we are focusing on the right things to improve our business, and that we are up to the challenge.

We have proven that when we get squarely focused on the right priorities, we can improve our performance.

We've demonstrated that in terms of our proving our ability to reduce our operating costs without negatively impacting client experience.

Over the last two years, we've taken out more than $340 million of our fixed overhead costs and used it to fund service improvement and value initiatives, or allowed it to fall to the bottom line.

And we will continue to find ways to reduce costs aggressively that do not directly help us grow our business.

While it is still early, I am encouraged by the progress we have made on improving client satisfaction and retention levels to date.

But we have to do much better.

And every member of this management team understands the need for a greater sense of urgency in making improvements.

Continued improvement will result in higher retention levels of prior clients, as well as an increase in new client growth through word-of-mouth referrals, which is truly the best advertising that we can ever create.

And new client growth is the area where we have to take our game up several notches.

We're learning a great deal this season about what works or what doesn't work, and we're using this time to test a variety of approaches to attract new clients so we can have greater confidence in what the right strategies and tactics are for the future.

We're making some adjustments already mid-season, and we'll even make more for next year.

Now I'll be the first to admit we won't find all of the answers on the first attempt, but we will keep getting better, and that will translate to better client growth and more market share.

I also ask to you keep in mind that we're in the first year of a turnaround plan, and we're only at halftime of that first year.

We still have millions of clients left to serve this year, and we expect to serve them better than we ever have before.

But we understand we can't sit and wait for the economy to rebound.

We know that we're in a war for market share, and we need to be more aggressive and move the needle and client count quickly despite the difficult operating environment.

We will be bold, yet thoughtful.

Because this is not the time for desperate acts or Hail Mary passes.

We are focused on the right initiatives for long-term growth, and we will sustain that focus.

I know there are those who look at industry trends last year and the first few weeks of this tax season and predict the death of the assisted tax preparation business, and that in just a few years, everyone is going to be using digital methods exclusively.

The reality is the facts just don't support that argument.

There has been and will likely continue to be some real shift to digital as a result of changing demographics and consumer behaviors.

There's also no doubt that this shift looks like it has accelerated due to the disproportionate impact that unemployment is having on the assisted tax preparation segment.

So, while there is some shift that is secular, there is also a component of that shift that appears to be driven by economic conditions.

Through improved marketing and better client service levels, we hope to persuade clients of the many benefits of assisted tax preparation utilizing an in-person visit with an H&R Block tax professional.

But even if you take a contrarian view and believe the shift to digital will continue at accelerated rates, there is still a tremendous opportunity for us to grow in retail tax.

In that scenario in five years over half the returns, or over 70 million tax returns, would still be done with the help of a tax professional.

It is a huge category with plenty of opportunity to grow as we learn best how to grow our market share.

No doubt we are more adversely affected by the shift to digital if we are not holding market share as that shift occurs.

And our goal is not to hold share in digital, but actually to pull share from the market leader over time which we aren't currently doing.

As I stated earlier, from the longer term perspective, we no longer look at the digital market as a second priority to our retail tax business.

We will fight to build share equally in both channels in order to maintain our leadership position in the tax preparation business.

So we continue to be optimistic about all our opportunities because we have many strengths that will better leverage for future success.

On the retail side of the business, we have the most well respected brand and more, well trained tax specialists than anyone else in the category.

We're a distant third in the digital online category today, and we will attack this business segment even harder in the future.

We have restored our financial strength and liquidity base, which will enable us to make the strategic choices for growing our business and returning value to shareholders, as well as providing confidence to our growing base of entrepreneurial franchisees.

We continue to generate very significant free cash flow and will do so under almost any conceivable set of circumstances.

And then externally, continued complexity of the tax code and title regulations on the tax preparation industry should strengthen our business and competitive position in the marketplace.

So we're still bullish on our future, but recognize there is much work to do -- and quickly.

With that, we'll open it up for questions.

(Operator Instructions) Your first question comes from the line of Andrew Fones with UBS.

Thank you.

I need to ask about guidance.

I guess you removed guidance when you gave the interim update.

I was wondering your thoughts around guidance here, and perhaps if you could give us your thoughts around the tax rate going forward.

Thanks.

Hey, Andrew, I'll take the guidance piece, and then, Becky, I'll turn it over to you about tax rate going forward.

Andrew, you are right.

We did pull guidance, and we are not re-establishing it now.

The reasons are actually fairly straightforward.

As I mentioned in my remarks, IRS returns appear to be down a lot more than any -- anyone, us or others in the category, expected going into the season.

We believe that it will improve.

Some of it we think is due to timing.

But frankly, the high unemployment rates are having a much bigger impact than any of us thought, and I think there is still a fairly high level of uncertainty around how the rest of the season will play out overall for the industry.

So that's uncertainty number one about why we pulled guidance and haven't reinstituted it.

Uncertainty number two is, as I mentioned, there was a bigger shift to the do-it-yourself category in the early season, and there is still a lot of uncertainty about where it might end up by the end of the year in the current economic climate.

So that is piece number two.

Third, our early season initiatives that we thought would drive new client growth clearly did not have the impact that we thought they would have, at least in the early part of the season.

We're testing a number of different things in the marketplace today to find out what we can do to better grow our business both in the second half and from a longer term perspective.

But until we have more insight into what kind of impact those programs could have -- that is a third level of uncertainty.

And so really for a combination of those three reasons -- that's why we decided to pull guidance for this year.

It has nothing to do with cost savings.

Those are tracking on target, if not slightly better than what we have said we would do.

Becky, you want to address the tax rate?

Sure.

So I agree that the 45% looks high.

Then again, that's driven by $5 million of discrete items -- largely state tax reserves related, over a small base.

And again, it was $5 million the other way a year ago.

So we expect for the full year that it will be roughly in line with what we have been talking about.

Although I will say that we are looking at tax planning strategies, and we hope to be in a position to drive it even lower in the future.

Okay.

So about 40%, something in that kind of a range would be a reasonable expectation for the year, or 41%?

I would say 40% or a little bit lower.

Okay.

Thanks.

And then in terms of the -- you mentioned in your comments that you expect potentially a little bit of a rebound in the second half of the tax season in terms of the number of IRS tax returns filed.

What brings you to that conclusion?

Thanks.

Well, there's no doubt that weather had a pretty significant impact on industry results in the month of February.

Both through the 15th and even some of that continued through the second half of the month.

And ultimately, we know those timing differences have to true-up themselves by April 15th.

So that's probably the single biggest factor in terms of why we think there will be some rebound.

Okay.

Thanks, then one final one.

On pricing, we've seen a little bit lower revenue per client than we have been used to seeing.

Is this a number that you think is reflective of what we should see for the full year?

Or will we see any change in the second half?

Thanks.

I'm sorry, Andrew, your question was about whether we would see that number for -- the full year?

2.4% growth -- yes, the 2.4% growth in revenue per client.

Should we expect something in that kind of a range for the full year?

I would say that where our net average charge and our pricing -- the impact of our pricing decisions this year is about where we thought it would be at this point, and it's probably a good surrogate for where we think we'll continue to stay throughout the rest of the year.

Obviously, some of this depends on our success in attracting more clients in the second half of the season.

Those are typically higher income clients, and that can -- that could move the net average charge a bit, but I think where we're at is probably a good indication for what our expectations are for the full year.

You typically have fewer 1040EZs in the second half?

Actually, the EZs are a little bit less in the second half although they are more balanced than I thought they would be.

We see a lot less 1040As and more 1040s.

So we see more complicated returns in the second half in terms of other additional forms.

But then partially offsetting that, we see less forms around credits.

Particularly the earned income credit is more seasonal in the first part of our tax season.

Okay.

Thank you.

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

Hello, Scott.

Hello.

So, Russ, you're thinking IRS returns down 4% to 5%.

Year-to-date through the end of February and probably negative 2% to 3% for full-year.

Am I correct in that statement?

I think we said 2.5% to 3.5% for the full year.

Okay.

And obviously at storefront, you're down a good bit more than that through February 28th.

How should we think about you?

Should we think of a similar parallel to the IRS numbers that you anticipate?

The question embedded in here is, how much can you grab back at the end of the year?

What do you think is the best case for a volume decline year-over-year?

Okay.

So I want to be careful, Scott, because we're not giving guidance.

So if you want to pick us off on individual assumptions.

With three or four assumptions, you'll quickly have guidance.

So I'm not going to tell you where I think we're going to end up in terms of client count for the rest of the year.

A lot of that is based on how we perform, frankly.

We have lost -- when you look at what has happened with the overall category through February -- being down 4% to 5% in the industry.

And then with the shift of another 1% to 2% on digital.

You can do the math on that and figure out assisted is down somewhere in the 6% to 7% range, and we're down worse than that.

We've lost one point of market share.

Our best estimate is that we have lost a point of market share on the assisted side.

As I said in my comments, we believe a chunk of that is because we had substantial market share in the first part of the season.

We have 30% of the assisted market share during February.

Many of which are lower income clients, which are more heavily affected by the current economic situation in unemployment.

So, we believe we are going to fight like crazy to get more clients -- to attract more clients and to gain share during the second half of the season.

And that is what we are all focused intently on, is improving our performance from a market share perspective through the second half.

We do believe that a lot of the action steps we're taking are going to continue to build momentum as the season progresses.

We think the marketing and the branding changes that we have made are probably more relevant to the second half clients who are typically -- have higher income levels, and that was intentional.

And so I think for those reasons -- internally -- we think we're under -- we continue to believe we're on the right track.

We're going to learn a lot more in the next six weeks, though.

Okay.

Fair enough.

Thanks.

Another question, following up along the theme.

Sounds like in your response to Andrew that you're going to look to keep your pricing strategy fairly consistent in the second half of the season as was in the first.

Couple questions in here.

One, how flexible would you be with that to go up or down with pricing in the second half?

And, then, two, it looks with this performance in the early season that for the overall season -- obviously, you're going to be ending down in revenue in the tax segment.

So, A, would be the pricing flexibility.

B would be, can you speak to us, please, on the incremental margin decline of that lost revenue year-over-year, and how that might impact you?

In the past, I believe you've quantified -- hey, 60,000 returns would equate to $0.01.

If you could -- is there a rule of thumb that you're tracking on question B?

And I'll get back in queue.

Thanks.

I'll ask Becky to handle the second part of that -- the incremental loss revenue piece.

In terms of the pricing flexibility, we are very flexible.

We want to do what's the right thing to do for our clients and to build our business for the long-term.

I mentioned in my comments, we're looking at a lot of different things.

So far, we haven't found anything on the pricing side that has been successful in moving the needle quickly in terms of new client growth.

But we have got some new things that have been in the marketplace for the last few weeks.

We're tracking them daily.

If we find the right thing that we think moves our business directionally the right way and is consistent with our long-term strategy for building the business, then we are very prepared to do that in a big way including nationally for the second half of our tax season.

Becky, you want to handle the incremental loss revenue piece?

Sure.

So we have had margin guidance out there, or where we thought we can improve margins in the tax business.

100 basis points over the course of the next two years.

So it is a two-year target.

We definitely believe we will be down this year.

And I think if I give you those numbers where we think we'll be down -- to Russ's point, we'll be backing you into guidance which I don't think we want to do.

There is just one other point on this topic that I would like to make.

As we think about this, this really is a short-term versus a long-term question.

Could we raise prices?

Absolutely, we could.

We believe that the elasticity or price sensitivity is relatively unchanged.

We're choosing, as we have said.

to hold the base prices flat because we believe that this creates a lot more long-term flexibility for us.

So with that, we're remaining focused on improving the service levels, better articulating our value proposition, and we think that right now that is the better place to be.

But are we going to be flexible?

Sure.

Okay.

Thanks, Becky.

And just to clarify, because I know I just threw out the 60,000 returns equals something of EPS.

And if you're not comfortable giving any guidance on that, I understand.

Is there a rule of thumb we can go by as it equates to a number of returns to EPS?

And if not, that's fine.

But I just -- I don't want to know -- what I'm curious is, that rule, I think, if I have it right, is what we -- what people have looked at you as before.

And it is kind of putting it into a sticky situation, but I want to see -- is that no longer a good way to look at it?

Or is that, perhaps fair?

Or simply, no comment?

I don't think it is too far off.

I think it is a little bit less, but I'd prefer the simply no comment.

Thanks.

I'll hop back in queue.

Your next question comes from the line of Kartik Mehta with Northcoast Research.

Good afternoon, Russ.

Becky.

Becky, I just want to understand the answer you gave to the last question before I ask mine.

You started talking about incremental margins, and then you said you would be down this year with the goal of raising your margins 100 basis points in the tax business over two years.

Was the down comment about margins for this year just because there will be a loss of enough incremental revenue that it would be hard to have similar or increase in margins in FY 2010 compared to FY '09?

Again, I want to be really careful.

As you all know, this has to do really with the clients that walk in the door over the course of the next few months.

So what I will say, though, is that when you look at our total operating expenses.

We do think that those will be down about 5%.

So about $150 million or so.

We think about one third of that is very variable.

About two thirds of that is fixed.

And then, we have what happens on the revenue line.

So the operating expenses for the whole Company should be down $150 million in 2010 -- fiscal 2010 compared to fiscal '09?

And again, that's an estimate that they will be down about 5% or so.

No, I appreciate that, Becky.

Russ, one of the comments you made, obviously, is that now you would like H&R Block not only to be in the retail office business, but also on the digital side.

And I'm just wondering, is there any conflict?

Or are you seeing conflict from your franchisees who are concerned that you're still continuing to advertise the digital side?

Or continuing to have a digital business?

Or is there a better understanding that you need, or do you believe you need both things to really make the Company work well?

Kartik, you talk to a broad enough sample of our franchisees, and I'm sure you have heard two different viewpoints on this.

What I will tell you is, overwhelmingly, our franchise base understands that strategically we need to be in both businesses from a longer term perspective.

It is good for the brand.

It is going to be better for their business -- from a medium and long-term perspective if we play in both.

You get certain franchisees that -- they're not happy with their results, and they want to blame it on cannibalization.

The reality is the smart franchisees understand that if we're not in the digital business, that other digital competitors are going to take those clients away.

And if they take them away, we have less chance of getting them back than if we keep them within our brand and have them use our digital products and services -- because we've got the facts and historical information that say when they switch back to assisted tax prep, if they're coming from our digital products, we have significantly higher retention rates on those clients than if they're using one of our competitors' digital products.

So, there's always some noise about it.

There always has been.

I suspect that there always will be .

That is the nature of being in the franchise business.

But again, overwhelmingly, our franchisees are good business people overall.

They know it is good to play in this base for their business as well as for the

And then, just the last question on digital business, Russ.

In your opinion, do you think -- is it a price issue?

Is it a marketing issue?

Or is it a brand issue that's causing the loss in the market share for you in the digitals business?

Yes, it's clearly not a price issue.

Because we're at a price competitive advantage in the digital space.

I think it's we're late to the game, and our brand awareness was some 40% last year in terms of even people that knew the H&R Block brand were not aware that we had digital products.

That's why Click, Call, or Come Over was added to our ads this year.

It has worked effectively.

It is driving more people to our digital website.

I think our website traffic is up over 20% through February.

Our challenge is -- we're not converting those website visitors to actual clients.

Our conversion rate needs to be improved.

That is why, as I mentioned, we're making some significant changes to our web pages to better take advantage of it.

I really think it is more of a marketing and tenure and presence in the digital space.

Some of which needs a little bit more time, but other of it needs to be better website conversion and more aggressive and focused messaging from a marketing perspective.

So those are the reasons why.

I think our product is closer to parity.

Still not where we'd like it to be, and we'll continue to make it better.

We have made a lot of progress in the last year.

If you look at the independent reviews that have been done, last year, we didn't win any of them.

This year, we have won a couple, and we're kind of -- head to head, or pretty close on all of the rest of them.

So good progress there, I think.

But more of it short-term is marketing.

I think the digital space -- a lot of it is about marketing and marketing messaging and relevance of the brand.

Thank you very much.

I appreciate it.

Thank you ,

Your next question comes from the line of Michael [Millan] with [Nomen] Research.

Hello, Michael.

Thank you.

Is it your assumption that RALs will not be available next year other than from HSBC and Chase?

I think there's -- it is going to be interesting, Michael, to see the way this plays out.

I think there is certainly a lot more pressure on these smaller banks who are in the RAL business -- from the regulators.

And I haven't seen anything that would indicate that that will lessen over the coming months.

I wouldn't necessarily go so far as to say that it's only going to be Chase and HSBC left providing RALs.

There may be others that may be able to do it, but I think the competitiveness of that supply side is going to be -- is going to shrink from where it has historically been.

And do you think that by next year, then, given that you will be able to take advantage of that situation to a greater extent than you did this year?

We had better be able to.

Part of it is -- part of it, as I said, is -- there was a lot of confusion in the marketplace this year.

And this is a complicated thing to discuss with a lot of those clients in a clear, concise way.

I think a lot of folks that now went through the process this year and wound up getting a RAL instead of a refund transfer -- better understand it because they didn't get what they wanted.

But we've also got to get much better with how we communicate with that client base with a clearer, concise message.

And that will be built into our business plans for next year.

And sort of related, what's the typical or the average revenue for return on a RAL, and what is it on a RAC?

We typically don't break that out, Michael.

Well maybe you can tell, is there a difference?

Yes.

Yes.

And so, can we assume that the less RALs you do, then -- that hurts your revenue for return as well?

Yes.

Okay.

Regarding the IRS numbers that you gave out, was the 4% or 5% total?

Or is that just the EROs with do-it-yourself up double digits?

No, we think -- that's our best estimate of total.

So then, what -- how would you break out the ERO and the digital, then?

Well, I think I also said that we think that the shift from assisted to digital is somewhere between 1% and 2%.

So, if you got 4% to 5%, and 1% to 2%, it is 5% to 7% is where we think -- probably assisted ends up being.

Just, did you say 7% for the assisted currently?

Yes, probably it's in the broader category of 5% to 7%.

Okay.

I thank you.

Thanks ,

Thank you.

Your next question comes from the line of Sloan Bohlen with Goldman Sachs.

Yes, thanks.

Good afternoon.

Most of them asked and answered.

But Russ, if you could touch a little bit on your results to date and whether that changes your mind on your push to do more re-franchising going forward.

Whether you're going to get some push-back, and maybe just start with that.

Well, as we talked in December, the re-franchising effort -- we were going to probably need an 18 to 24-month period to get a really good read on how the operating results really change after we take a Company office and sell it to a franchisee.

As all of you know that have followed our business for a while, historically franchisees have outperformed the Company from a client growth perspective.

That continues to be true through February of this year.

But a lot of that is a question of they're operating in different geographies because we typically haven't franchised within the same territory.

So we think that the results of our re-franchising efforts this year, and the 45 or so we did last year will give us a good read -- a little bit by the end of this tax season.

But probably more into next tax season that will help us then decide what we think the right mix of our retail offices ought to be between Company-operated and franchised.

So we're going to learn a lot this tax season and into next, and I think at that point in time, we'll be better positioned to be able to find out what the right answer about ownership mix should be from a longer term perspective.

That's helpful.

On a separate topic, could you comment a little about the Best of Both product, and then how successful that has been?

And whether that has been rolled out nationwide?

Or is it still being tested.

It was never intended to be rolled out nationwide.

We said we were going to do it this year -- as a first year, as a pilot program.

It is in a couple geographies.

It's year one in a pilot program.

I know everybody gets excited about that product, and we think it's really interesting.

And we hope it is going to turn out to be exciting, but I don't want to oversell anything at this point in time on Best of Both.

And we need to let it -- it is a pilot program, and we need run it.

We need to see how it does.

If it works well, we'll continue to expand it in terms of its availability to more clients across the country.

But probably nothing more than the current pilot program planned for this year.

Okay.

All right.

Thanks.

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

Thanks.

I'll start with my follow-up.

Given that you would rather not speculate on what is going to happen over the next five weeks, which I understand.

Just given what you have already experienced, any ballpark as to what that has meant already from an earnings standpoint versus last year?

Or better yet, if tax season just continued the way it has through February 28th, any feel for what it would mean for earnings?

We have got all the same models that you have and run.

Essentially, this sounds to me like you're asking me to give you some guidance on where I think it will be -- I'm sorry, Vance, as I said, we're not going to give guidance.

So we're not going to give guidance.

Okay.

Do you feel that greater complexity has helped at all on a market share basis?

It has obviously helped on the pricing front and probably will continue to do so.

But do you feel complexity has slowed the shift to do-it-yourself and played out for you on the retention front so far this season?

I would say no, not on the first part of tax season.

I think we'll get a really good read for that as we get into our second half clients.

Okay.

Thanks.

Your next question comes from the line of Bill Carcache with Macquarie Research.

Hello, Bill.

Focusing on the digital space, can you give us a little bit perspective on how many digital returns you would need to capture to make up for the loss of a retail return, on average?

You are talking about from a profitability component?

Yes, we have not historically broken out the profit of a retail client versus a digital one.

And again, if we gave you that ratio I'm sure you are smart enough you would be able to figure it out.

So we don't disclose that information.

Sorry, Bill.

Okay.

And separately can you talk about on the M&P dispute -- can you discuss the financial implications of the resolution?

And when the new terms will become effective?

Sure.

We've got C.E.

Andrews here who is the President of RSM.

I'll turn that one over to C.E.

The financial terms -- there really are no significant financial effect for fiscal 2010.

Most of the elements of the agreement go into effect as of May first.

And directionally, the terms of the agreement was such that the intention is to facilitate really the growth and success of the business that financial terms are fairly modest.

It's a slight change in the sharing, if you will, of the compensation for the partners and managers and directors from 65% to 67%.

We also put in place -- are in the process of putting in place -- again, it will be effective for next fiscal year what we would believe is a long-term, wealth-building situation for the partners and managing directors that is different than we've had in the past.

But that is approximately $10 million a year -- but it simply -- it also replaces the stock program that we had in place in the past.

And so, it's not a major incremental increase, but the idea there is to retain talent and to gear it toward retention of people and longer term wealth creation.

Again, similar to what you would find in other firms of similar nature in the marketplace.

So those are the major turns, but really almost all of it goes into effect starting May first, or the beginning of the next fiscal year.

All right.

So is it the compensation and benefits line item of the Business Services P&L that would see a bit of an uptick there from that 65% to 67% partner-sharing change that you described?

Yes.

Okay, and then the other line item -- is there another line item that would be affected from the other change that you were describing about -- just trying to understand what parts of the Business Services P&L will be affected as a result of the changes?

Well, I'll look to Becky to clarify that, but I believe all of that runs through the Business Services line.

Right, Becky?

It is all in Business Services.

Yes.

In addition to what C.E.

mentioned, historically, RSM has also contributed to other -- what I'll call longer term business-building expenditures.

Marketing growth in international, and they have done that solely out of what was historically RSM's 35% share of the profitability.

Part of the change in this agreement, in conjunction with the move from 65% to 67% for the partners, is that the partnership would share in their proportionate amount for those types of expenditures going forward in the future.

So there wouldn't be any -- what I'll call off-book expenses paid solely by RSM under this agreement.

Okay.

Thank very much.

And at this time, there are no further questions.

Okay.

Everyone, thanks for your time, and we'll talk to you again in a little bit.

Thank you.

And this does conclude today's conference call.

You may now disconnect.