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H&R Block, Inc. (NYSE:HRB)

F2Q09 Earnings Call

December 8, 2008 5:00 pm ET

Executives

Scott Dudley – Investor Relations

Richard C. Breeden – Chairman of the Board

Russ Smyth – President, Chief Executive Officer

Timothy C. Gokey – President of Retail Tax Services

Becky S. Shulman – Senior Vice President, Chief Financial Officer

Steve Tait – President, RSM McGladrey

Kathy Barney – President, H&R Block Bank

Sabrina Wiewel – President, Digital Tax Services

Jeffrey T. Brown – Controller

Analysts

Kartik Mehta - FTN Midwest Securities Corp.

Michael Millman - Soleil-Millman Research Associates

Andrew Fones - UBS

Scott Schneeberger - Oppenheimer & Co.

Operator

Good afternoon and welcome to today’s webcast. (Operator Instructions) Welcome to the H&R Block second quarter earnings call for December 8, 2008. At this time, I would like to turn the event over to Mr. Scott Dudley. Please go ahead.

Scott Dudley

Good afternoon and thank you for joining us for our second quarter earnings call. Presenting on our 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.

In addition, several members of our senior management will be available during the Q&A session. They include Steve Tait, President of RSM McGladrey; Kathy Barney, President of H&R Block Bank; Sabrina Wiewel, President of Digital Tax Services; and Jeff Brown, our Controller. After discussing results and our outlook for the remainder of the fiscal year, we will open up the call to your questions. Our call today is planned for about an hour.

To start, let me provide our safe harbor statement. Comments made on this call may contain forward-looking statements within the meaning of the Section 21E of the Securities Exchange Act of 1934. Such statements are based upon current information and management’s expectations regarding the company, speak only as of the date on which they are made, are not guarantees of future performance, and involve certain risks, uncertainties and assumptions that are difficult to predict.

Therefore, after 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 public 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 those filings. In conjunction with today’s call an accompanying slide presentation and earnings press release have been posted to the Investor Relations section of our website at HRBlock.com. We also filed our second quarter 10-Q earlier this afternoon.

To give as many participants as possible an opportunity to ask a question, please limit your query to one initial question and then one related follow-up question if needed. Please remember to avoid using a headset or a speaker phone as this may cause audio problems.

Finally, a quick reminder that we will be hosting our annual Investment Community Conference in New York City on January 13. At that time, we will be providing a more in depth review of our performance, strategy and outlook, including our preview of the 2009 tax season. With that, I’ll now turn the call over to Richard Breeden.

Richard C. Breeden

Thank you and welcome everyone. It’s a pleasure to participate in our fiscal 2009 second quarter earnings call. Besides being the holiday season, this is that truly wonderful time of year when we finally launch back into our early tax season after many months of preparation. Russ and his team will go through the details of our results for the quarter ended October 31 in a few moments. Since those results in and of themselves for a second quarter generally don’t tell too much because of the seasonality of Block’s businesses, I’d like to make a few opening comments regarding how we see Block in terms of our overall position.

It has been just over 12 months since I became Chairman and only 17 weeks or so, give or take a day or so, since Russ took the helm as CEO. Nonetheless, we believe we have made significant strides in repositioning and reinvigorating this company. We completed the disposition of all of our sub-prime mortgage business through a combination of an immediate shutdown of lending and the subsequent sale last April of the mortgage servicing business.

Our debt load is more than $1.2 billion lower today than it was a year ago and that gap should actually increase over the next month or so, even though we spent nearly $280 million to enhance our tax market share through the acquisition of the Texas region. Unlike companies that did nothing in the face of the looming credit market catastrophe, we moved fast to pay down debt and to eliminate demands on our liquidity.

On November 3, we completed the disposition of H&R Block Financial Advisors. FA was a drag on the company for nearly a decade. Its disposition should improve the company’s return on invested capital while eliminating both risk and diversion of management attention.

Also on November 3, we completed the purchase of our Texas regional franchise. We believe that transaction as we said at the time we announced it has very good return characteristics for shareholders. In addition, we’ve already opened 30 new offices in Texas and we believe we will be able to increase market share in several previously underserved communities in that territory.

We completed an equity transaction that raised $141.5 million in net proceeds on October 27. While we had hoped to avoid the need to issue equity in advance of our normal equity build in Q4, the board and management decided that in these turbulent and uncertain markets we should accelerate the rebuilding of net worth that would otherwise have occurred in the fourth quarter.

This eliminated any risk of losing access to our main line of credit facility, which has very attractive pricing. In addition, the transaction helped us contribute more capital to H&R Block Bank which enhanced the strength of the Bank considerably. This in turn gives us the capacity to raise approximately $1 billion in new deposits, which the Bank can use to fund Emerald Advances for our tax customers.

We have realigned and strengthened our management team over the past year. Most notably, with the appointment of Russ as CEO, Becky Shulman as CFO and several other key appointments. I believe Russ is well on his way to making a strong, positive impact on the company and the team is working well together.

We have strengthened our Board of Directors. We have six new members since the annual meeting in 2007 and today 60% of the members of the Board are new within that timeframe. The Board has been extremely active in monitoring risks and developing the many new initiatives to improve accountability and performance.

While our total return to shareholders under performed the S&P 500 significantly in recent years before our turnaround, to date in calendar year 2008 we have significantly outperformed the broader market. Of course, that only counts if it is sustained over time, which we are deeply committed to doing.

We’ve increased the dividend by $0.03 or approximately 5% to put greater discipline around our return of cash to shareholders. While earnings can be reported from accruals, dividends can only be paid from cash, so this has a disciplinary effect beyond mere dollars involved. We set a target of $2 billion in share buybacks during the next four fiscal years. From the beginning, these buybacks were to commence only after restoring prudent levels of net worth after the mortgage losses of the last two years.

The recent equity offering accelerated the timetable for rebuilding the balance sheet but did not change at all our commitment to returning cash to shareowners or our view of the overall magnitude we can achieve during this time period. We have not made any decisions regarding the timing of repurchases since that involves market price levels and other factors, including overall economic conditions. However, we will have the ability to begin purchases in the fourth quarter of this year and the Board has not altered our long term plans regarding share buybacks.

We’ve begun an aggressive program of mortgage loan modifications to help the Bank’s borrowers avoid foreclosure wherever possible. We’ve made blanket offers to segments of our loan portfolio to modify adjustable rate mortgage resets, modify actually to eliminate ARM resets and to offer conversion from ARMs into 30 year fixed rate mortgages at an average interest rate of approximately 5%.

These offers have been made to roughly 25% of the total number of loans in our portfolio. In some cases, these changes have cut monthly payments for the borrowers by as much as 25%. Early results are quite encouraging, although it is too soon to see what our rate of re-default will be over the next six months. This program we believe this program is the right thing to do for our customers and it helps the Bank reduce the rate of defaults and expensive foreclosures as well.

We have implemented cost cuts and hope to create a new cost culture. This both improves profit margins and gives room for reinvesting in the business. We’ve established stiff targets for margin improvements in both Tax and McGladrey and managers will be held accountable for meeting those targets.

We believe we can grow the tax business faster than was true in the past, although we are not unrealistic about the challenges in doing so. We will not easily give up any of the market share gains we made at the expense of competitors in retail tax last year and of course we are aiming for more. Our ability to offer financial products with significantly superior returns to those offered by competitors is only one part of that strategy. We also plan to enhance quality for clients, and shift the overall mix of offices more in the direction of franchise locations over time.

We have enhanced corporate governance through improved transparency, greater communications and stronger mandates in our governing documents. This year we put in place director term limits, say on pay provisions and made the separation of Chairman and CEO permanent without a shareholder vote to alter this structure. We will continue to work on overhauling our compensation programs for senior executives to more tightly link pay and performance. We think our practices in this regard compare to some companies in the marketplace are notably superior.

As the saying goes, however, so much done but so much left to do. We know we have our work cut out for us but we believe this quarter’s results show our trend lines continuing to improve and we are very pleased at our posture for this tax season about to begin. With that, let me turn the call over to Russ. Thank you.

Russ Smyth

Thanks Richard and thanks to all of you who have joined us on the call today. I’m looking forward to meeting many of you personally at our Investor Conference next month and sharing my thoughts on how we expect to accelerate the profitable growth trends in both our Tax Services and RSM McGladrey business segments beyond fiscal 2009.

But for today, we’re going to focus on Quarter 2 results. As you know, due to the seasonal nature of our business the second quarter has a limited impact on overall fiscal results since we make almost all of our earnings during our fiscal fourth quarter. Having said that, we reported improved year-over-year results from continuing operations that were in line with our own expectations and slightly better than Wall Street’s.

Our loss of $0.40 per share from continuing operations was better than prior year results by $0.02 per share and reflects improved results in both Tax Services and at RSM McGladrey, our two primary business segments. Partially offsetting these improvements was a larger loss in consumer financial services, which consists solely of our retail Banking activities since the results of our former financial advisor business are now reported in discontinued operations.

Our Banking results were negatively impacted by the continued decline in residential home prices. As Richard mentioned in looking ahead, driving a cost conscious culture continues to be a key priority for the company. We recently initiated an enterprise wide review of our procurement and real estate programs in an effort to eliminate redundant and unnecessary expenses, and to reduce our overall occupancy costs. We look forward to sharing more details on these efforts and quantifying our future savings on our next earnings call.

With that, I’d like to provide a more detailed assessment of our second quarter results by segment. In Business Services, RSM McGladrey achieved an 11% year-over-year improvement in pretax income this off season quarter, despite a 2.5% decline in revenues. Most importantly, core accounting tax and consulting revenues increased 8% over the prior year quarter. Those gains were offset by declining capital markets revenues stemming from fewer transactions.

Also, amounts previously reported as leased employee revenue have been eliminated in the current period due to an operational change. This change had no impact on earnings as related costs were also eliminated. And excluding this change, revenues at RSM would have been up nearly 2% year-over-year.

Pretax income for the fiscal second quarter was $13.1 million compared to $11.8 million a year ago, reflecting additional savings in ongoing operating expenses and previously committed cost reduction programs. The McGladrey team is working hard to drive revenue growth by focusing on those business segments less impacted by the current economic downturn. In addition, we believe our low cost operating model gives us the ability to provide a rate structure that results in significant competitive value for our clients.

Along with these revenue growth opportunities, we’re working equally hard to drive ongoing improved business productivity and cost efficiency. Operating costs are down year-over-year and our previously announced cost reduction plans are well on track.

In Consumer Financial Services, which is now comprised only of H&R Block Bank, we continued to expand the Bank’s role in supporting the growth of our tax business through the Emerald Platform. The Emerald Advance line of credit and the Emerald Card have proven to be very popular and give us a great competitive advantage in the marketplace. We’ve enhanced our Emerald Advance line of credit product this tax season, making it available to both new and existing clients and increasing the amount available to existing clients up to $1,000.

With annual percentage rates between 9 and 36%, the Emerald Advance is a far more affordable option than the other financial services clients might use for short term credit. This year round line of credit was created with the FDIC’s proposed approach for consumer friendly, small dollar lending in mind. And given these tough economic times, we expect this compelling product to drive more tax clients in a safe and affordable manner.

We also continue to work towards minimizing losses and managing the risks associated with the Bank’s mortgage loan portfolio. These loans are held for investment and as such these loans are not mark-to-market. Since December, 2007, the Bank has been actively pursuing modification agreements with its borrowers. As of October 31, 2008, the Bank has modified approximately 25% of the loans it purchased from Option One.

About half of these loans were delinquent at the time of modification and as Richard mentioned, based on performance of these modified loans, it’s having an excellent impact for us and we estimate that this program has already reduced our losses by approximately $20 million. The balance of our mortgage loan portfolio and related assets declined further as expected during the second quarter, down 6.5% to $812 million, primarily due to net principal payments and further loan loss reserves.

The Bank’s pretax loss for this off-season quarter increased to nearly $19 million, compared with the pretax loss of $4 million a year ago, mostly due to a $13 million increase in mortgage loan loss provisions. Becky will have a lot more to say about the Bank’s loan portfolio during her remarks.

In Digital Tax, the market is approaching 32 million taxpayers and we view this as a significant growth opportunity. We’ll continue to invest to capture pencil-and-paper do-it-yourselfers who migrate to a digital solution and introduce them to the H&R Block brand. It’s important to note that we are the only company that offers our digital clients access to a one-of-a-kind, national network of certified and trained tax professionals.

We plan to grow both market share and profitability by enhancing the consumer experience, offering a competitive free product, expanding software distribution, and increasing awareness by leveraging the Block brand and our associated expertise. At the same time, we have lowered our price points by up to $20 on last year’s comparable products. On the other hand, Turbo Tax has raised its prices by $15 in some cases and added an additional user fee of $9.95 in Turbo Tax software.

Our product lineup features consumer friendly bundles, comparable to what we offered last year. Although we have reduced prices, we have also made product enhancements, adding more features and functionality to further improve our products for customers. We did not sacrifice quality to deliver greater value to our customers.

Every single product in our do-it-yourself lineup is packed with expertise, represented by more than 50 years of tax experience and our national network of tax professionals. Our H&R Block TaxCut software is already on store shelves for the start of the season, and H&R Block software and online products are now available to purchase online as well.

As technology has made it easier for consumers to file their returns electronically, we’re committed to maintaining our position as the industry leader and supporter of E-filing. We’re setting the standard for the industry with 100% of our products and services now offering federal E-file at no additional cost to the consumer. Our pricing is simple. TaxCut software customers have the ability to choose, prepare, print and E-file multiple federal returns at no additional cost. A key consumer dynamic in this software category is that many consumers purchase the initial product for their own use, and then prepare several additional returns for other family members.

So, as an example, I may file my own return then complete and submit a return for my children. With our offering, consumers can prepare and print unlimited returns at no charge, using our software. They can also E-file up to five returns, and it’s limited to five because it’s a constraint on the number of E-files from one computer that’s dictated by the IRS.

TurboTax, however, is charging $9.95 federal tax prep fee on any additional federal returns after the first return, regardless of whether it is E-filed or printed. As a result of this season’s unique pricing dynamics, we believe TaxCut provides an even better choice for our customers and will result in additional unit growth, which in turn will further drive our earnings in the Digital segment.

Finally, another opportunity moving forward that will be a clear and distinct advantage for our brand is the ability to more effectively move between our Retail and Digital services. Due to our superiority and our expertise in technology and the size and scope of our retail network, we see this as a clear and distinct advantage over the competition. We recently changed leadership and restructured our Digital organization to add greater purpose and greater focus around developing new products and services that will further integrate these two businesses.

With that, I’ll turn the call over to Tim to discuss our retail tax and our outlook for the upcoming tax season.

Timothy C. Gokey

Thanks Russ. As I start, I want to thank our tax professionals and all of our associates who are doing so much to get us ready for a strong ’09 tax season. It’s the experience, skills and efforts of these professionals that make Block truly distinctive.

Our tax operations delivered improved results for the second consecutive preseason quarter. Revenues increased 9% over the prior year, driven by a 6% increase in core U.S. retail clients served or 12% including one time economic stimulus acts filers, as well as strong results from our Australian operations.

The pretax loss in the Tax Segment improved by $15 million or 7% over the prior year, due to increased revenue and a $6 million reduction in expenses. Expenses were lower due to our cost reduction efforts initiated earlier this year, effective management of ongoing expenses, and lower bad debt, offset by one time expenses in our Digital business including an adverse litigation judgment and write off of goodwill related to previously acquired businesses.

Looking ahead to the tax season, we see a number of changes from last year. We expect the season to start somewhat faster because there will not be a delay caused by the A&P issues of last year, and because taxpayers will be seeking refunds earlier given the economic environment. Due to job losses in calendar 2008, we are currently expecting overall growth in IRS tax filings, excluding one time economic stimulus act or ESA filers to be near zero. As you recall, we reported our growth last year, excluding one time ESA filers and we will continue that approach this year.

Excluding these filers, we feel confident about delivering positive client growth and market share gain, despite the slower growing market, complemented by pricing growth in the 5 to 7% range. Key uncertainties that could be positive upsides include higher overall market growth, the potential for another economic stimulus package through the tax code, and the possibility that banks supplying our competitors with refund anticipation loans will be unable to competitively match H&R Block’s funding for these products.

Planning and preparations for the upcoming tax season are substantially complete. Over 95% of our offices are set up and ready for business, which puts us four to six weeks ahead of last year in terms of readiness. Our tax class enrollment and recruiting has been strong and we are pleased to be partnered with one of the world’s strongest banks to insure full funding for our refund anticipation loan program.

Finally, integration of our recent Texas franchise acquisition has gone smoothly. Let me take just a moment to comment more on the Texas franchise acquisition. The integration has gone exceedingly well and we expect to be right in our financial plan for the acquisition. Even though we did not close until November 3, we are, as Richard mentioned, opening 30 additional offices in the territory of our former franchisee, in line with our expectations for this year when we signed the deal.

We continue to see this as an important growth opportunity over the next few years, especially in the Latino market. Our retail tax plans target stronger growth and higher margins, as we build on the momentum from last year’s tax season. Our core U.S. retail clients grew 1.9% excluding ESA filers. Both revenue and pretax earnings increased by 11%, while client retention and tax professional retention grew by more than 1%.

For tax season ’09, we expect to continue to deliver in three categories; growth in market share and tax clients served; growth in profits and margins; and other long term growth initiatives. Let me briefly touch on each of these areas.

Growing our share of later season filers seeking expertise remains Block’s biggest opportunity. This market is won through referrals, word of mouth, and direct contact with tax professionals who have the expertise clients need. We plan to build on last year’s success in helping tax professionals build their client base with enhanced training, more public speaking in the community, more referrals and continuing to give potential clients direct access to the expertise of our tax professionals through our online tax special finder introduced last year.

We expect more than 25,000 of our tax professionals who have completed the advanced portion of training and client base building by the start of the season, an increase by 50% over last year. Since May, we have already spoken in the community nearly 10,000 times, gathering more than twice the number of contacts than we did all last year. And we expect to continue to grow referrals, which last year were up 30%, yielding 150,000 new tax clients.

We believe Second Look, which we introduced last year, will become an even more important product for H&R Block, symbolizing our expertise and enabling us to win clients for life as we uncover errors on returns prepared by others. We find more money for clients on over half of the returns we check and when we do, the savings average more than $1,300. At $29, this product is a compelling value and another great way for tax professionals to demonstrate their expertise and further build their client base. We will be supporting this product with additional marketing this year.

For early season filers who are seeking quick access to money, Block’s superior Emerald suite of products is a significant, competitive advantage. In its inaugural season last year, the Emerald Advance proved to be a valuable retention tool. Of the approximately 900,000 clients who obtained an Emerald Advance, more than 91% returned for tax preparation. This year, our Emerald Advance product is significantly improved, including being available for new clients and being available in amounts up to $1,000 compared to $400 last year.

This product is superior to competitive products and should be an important lever to retain prior clients and to gain new ones. We began offering Emerald Advance in mid-November and while it is very early, results are in line with our expectations. At 36% APR, our core refund anticipation loan remains 4% cheaper than our nearest competitor for the average size loan when taken on the Emerald card. The number of clients who deposited their refunds onto an Emerald card last year grew 30% to 2.6 million. Demand for the Emerald card continues to grow and we expect to end the season with more than 3 million Emerald card holders.

Finally, we have strong strategies in targeted markets including Latino and military filers. We are increasing our investment in Latino marketing this year and we will significantly increase our bilingual staffing. As we’ve previously announced, we will not offer a military RAL this year. Partly as a result, we have secured a presence on 29 additional military bases this year. The military RAL was not a significant business driver for us last year and we do not expect this change to have a material impact on the size of our military client base.

Another key growth objective for us this year is to significantly drive profit and margin. We identified substantial cost reductions to the tax business in our corporate cost reduction effort announced last year, and we are on track to fully capture those savings. Our results for the first two quarters give us strong convictions that we will meet or exceed our stated goal of increasing margins by 200 basis points this fiscal year.

Going forward, we have developed a multi-year program to improve the efficiency of our field operations, including optimizing our office network, improving productivity, and optimizing field management’s span of control. These initiatives will yield additional savings of

$100 million over the next five years. As a result of optimizing our office network this year, we expect to add fewer than 30 net new locations overall.

In summary, becoming more efficient and cost conscious, as well as achieving a better balance of franchise and company owned operations, will be important parts of our strategy going forward.

Turning to longer term growth initiatives, we believe the Block brand can be leveraged significantly more and we are planning to reinvest a portion of the savings we have achieved in additional marketing to support our client growth initiatives. We are increasing our investments in new media behind our Latino clients and in testing new approaches, it can yield additional opportunities in the future.

Our marketing this tax season will continue to communicate the expertise of our tax professionals and encourage consumers to experience that for themselves. As we continue to invest for the future, we start with the belief that we have the best people in the industry. Recruiting, developing and retaining our tax professionals continue to be a top priority. Last year, tax special retention increased to 74%, a 1.6 point improvement. This was a significant gain and we expect this to lead to improved productivity, client service and client retention over time.

This year, we have seen a significant increase in the proportion of experienced tax professionals involved in our upper level courses, which bodes well for continued gains in tax special retention. We are also continuing to support our tax professionals with updated technology, products, training and software.

Finally, we are investing to continue to grow the expertise of our tax professionals. As you know, the average H&R Block client is served by a tax professional with more than eight years of experience and the equivalent of six university courses of tax training. Our overall training hours are up 21% this year, which will continue to build our ability to serve clients seeking the right expertise for them. We look forward to sharing more details about our Retail and Digital Tax plans at next month’s Investor Conference.

And now I’ll turn the call over to Becky Shulman.

Becky S. Shulman

Thank you Tim. I’ll start with a discussion of our corporate segment and the Bank’s mortgage loan portfolio, both of which are part of continuing operations, followed by a review of our discontinued operations. I’ll also cover balance sheet and other items related to our financial statements.

For the second quarter of fiscal 2009, corporate expenses were $37 million compared with $30 million a year ago. The increased expenses reflect lower investment income and the inability to allocate expenses to our discontinued operations. These unfavorable changes were partially offset by benefits resulting from the company’s cost reduction program previously discussed. We expect FY ’09 total operating expenses from continuing operations to be flat to the prior year, excluding the Texas acquisition and the Bank loan loss reserves.

This is a dramatic change to the almost 10% year-over-year growth over the last five years. The Bank ended the second quarter with $812 million of net mortgage loans held for investment. Our second quarter delinquency rate was relatively consistent with our previous assumption. However, underlying collateral values on the mortgage loan portfolio continued to decline. As a result, we increased our expected loss severity used to estimate loss reserves on loans less than 60 days past due to 37.5% at October 31. That compares to approximately 30% at July 31.

Because the original loan to value on the Bank’s portfolio was approximately 76%, our current loss severity assumption covers a more than 50% decline in property values from the appraisal and origination. During the second quarter, 30 to 89 day delinquencies held flat at 4.4% compared to the end of July. Loans more than 90 days delinquent increased to 7.2% in October from 5.2% in the prior quarter.

With the additions this quarter of $23 million, our loan loss allowance was approximately $64 million at October 31, representing 7.3% of our total mortgage loan portfolio, up from 5.1% at the end of July.

Our net loss from discontinued operations of $3 million during the quarter was down significantly from a net loss of $367 million in the prior year. The reported results for the second quarter of this year include H&R Block’s Financial Advisors and the continued wind down of our former mortgage operation. A small profit realized from the sale of Financial Advisors on November 1 will be reflected in our third quarter results.

Activity related to loan repurchase obligations was relatively benign for a second consecutive quarter. We made just $15 million of loan repurchases and indemnification payments during the second quarter. Repurchase activity during the quarter did not give rise to recording of additional repurchase reserves, and accordingly we ended the quarter with $225 million in reserves. We believe that this reserve is adequate.

At quarter end, our unrestricted cash position in continuing operations was $694 million, up about $450 million from July 31. Our total outstanding debt of $1.7 billion reflects nearly

$700 million of draws on our committed lines of credit to fund just our normal, preseason working capital needs. The ongoing credit crisis has not materially impacted our see lock availability. As a reminder, we have $1.95 billion as capacity on our see lock and we only intend to use approximately half of that through January when we become cash flow positive.

Consolidated non-bank debt of the company, both on and off balance sheet, has decreased

$1.2 billion in year-over-year from $2.9 billion to $1.7 billion. Consolidated non-bank interest expense consistent with the decreased balance is also down significantly for the first half of the year about $30 million or 43%. We ended the second quarter with equity of $833 million, which is substantially above our $650 million see lock net worth covenant.

In late October, we sold 8.3 million shares of our common stock at a price of $17.50 per share and a registered direct offering through subscription agreements with selected institutional investors. Because the additional shares are weighted on a daily basis and the equity offering was completed on October 27, the weighted average shares outstanding increased only modestly during the second quarter to $329.8 million.

Our capital expenditures are anticipated to be about $100 to $110 million this fiscal year, which is slightly lower than the $112 million guidance we provided earlier this year. We also believe that our continuing operations full year effective tax rate will be approximately 40%.

Moving to our financial outlook, we are reaffirming our FY ’09 earnings guidance at $1.60 to $1.70 per share from continuing operations and expect overall mid single-digit revenue growth. We must be mindful that we are just halfway through the year and we generate almost all of our earnings in our fiscal fourth quarter. Overall, we remain confident in our abilities to build on the underlying momentum created last year in maintaining a lean and mean organization, all while we invest wisely in our people and our business for future growth.

And with that, I think we’re now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kartik Mehta - FTN Midwest Securities Corp.

Kartik Mehta - FTN Midwest Securities Corp.

I wanted to ask you a little bit more on the guidance. Obviously the loan loss this quarter was something that I don’t know if you were expecting or not, so I was wondering one, if that was anticipated in the early guidance. If it was not, maybe what part of the business is doing better than you thought so you’re able to maintain your guidance?

Russ Smyth

Well, I guess I’ll take that. You know, Tax Services, this is the second consecutive quarter in a row where our Tax Services business has performed very strongly, and even though it’s not the largest part of our off-season business, it’s done really well. And that’s helped mitigate some of the loan loss reserves that we’ve taken on the Bank, which are a little bit higher than what we thought we were going to be when we started the year.

So that’s provided us some cushion. The other thing that is helping us is the acquisition of [Blue], which we’ve now completed, also is going to help contribute quite a bit to profitability in quarters three and quarter four.

Kartik Mehta - FTN Midwest Securities Corp.

I think, Richard, in your statements earlier and the fall you had said that you’d seen more franchises than company owned, and I was wondering if you believe this is a business that’s better run franchise or if that’s just a strategy you want to follow going forward with the new stores.

Richard C. Breeden

Well, Block has a long history of mixing both company operations and franchise locations, and I don’t think we believe there is a one size fits all. Markets can be very different. Rural markets versus metropolitan markets, more generalized offices versus those in a intensely ethnic community. And in some locations franchisees who bring their own capital and their own commitment to and typically have deep roots in their own communities can do a very effective job and oftentimes better than a company owned store might do.

But in other locations where experience shows us, overall profitability is higher through company operations. So what we’ve said is that the current mix, which is about two-thirds company owned and one-third franchisee, we expect to see shift over time. And it will shift over time in the direction of a more even balance between company owned and franchisees. We don’t see that happening overnight, but we do see that as a gradual progression that will be sustained.

Kartik Mehta - FTN Midwest Securities Corp.

I would assume then that you’re anticipating converting some of the company owned to a franchisee to stick into that mix.

Richard C. Breeden

There could be. I think when we acquired Blue, we indicated that we expected to do some re-franchising, that in the aggregate across the country would offset the effect of that. We in essence brought about 300 franchise, what were franchise locations, into company owned and that we probably will offset that in, but we don’t have to do it all in taxes. We can offset that anywhere. And we expect to do that.

Operator

Your next question comes from Michael Millman - Soleil-Millman Research Associates.

Michael Millman - Soleil-Millman Research Associates

I guess, I think last year HSBC lent you the money for your piece of the RAL funding. Could you talk about whether they plan to do that again this year? And what the terms might be? And sort of related, on the credit, I guess the Emerald Advance, can you give us an idea of how many of those advances you expect to make, to date how many have gone for $1,000 or higher than had been, and how you prevent double-dipping since Jackson Hewitt also has a program that they are promoting heavily?

Timothy C. Gokey

Yes, Michael, this is Tim Gokey talking. Thanks for the question and we do anticipate that the whole area of RAL lending could end up being a distinctive competitive advantage for us this season. We do have a contractual obligation from HSBC who, as you know, is one of the world’s largest and best capitalized banks, to fund RAL. And we have had obviously ongoing discussions with them, and have every reason to believe that that is going to be the case this year. We are feeling very good about that. So we do anticipate that they will be funding that for us again this year.

Michael Millman - Soleil-Millman Research Associates

So they will be funding your piece of that?

Timothy C. Gokey

That’s correct.

Michael Millman - Soleil-Millman Research Associates

Your 50%.

Timothy C. Gokey

That’s correct.

Michael Millman - Soleil-Millman Research Associates

And can you talk about the terms compared with last year?

Timothy C. Gokey

The terms are a something that are a matter of ongoing discussion, but we do not anticipate that they will change our financial results in any material respect.

The other question you had was around Emerald Advance. I don’t think we want to go into forecasts at this time. We are expecting the program to be noticeably larger than last year, both as we continue to ramp the number of prior clients that take it and because we are offering the program to new clients this year. In terms of how we control double-dipping between ourselves and Jackson Hewitt, you know, both ourselves and Jackson Hewitt offered such a program in 2006 so we have that experience to fall back on.

And while we are offering it to new clients, it is primarily for both of us based on lending to prior clients and we see a very high return rate back of those prior clients, so we feel pretty comfortable about that particular risk.

Michael Millman - Soleil-Millman Research Associates

How many did you do last year and what was the average loan?

Timothy C. Gokey

Last year we did 887,000 and the loan size was a little bit under $400.

Operator

Your next question comes from Andrew Fones – UBS.

Andrew Fones – UBS

I was just wondering how many new offices you’ll have open this tax season versus last year. I think you mentioned that there’d be 30 new offices in Texas. I was just wondering how many overall, and then also how many new Express Tax locations are going to open this year. Thanks.

Timothy C. Gokey

Yes, this is Tim Gokey again. We are, I think I mentioned in the script, really taking a comprehensive optimization of our overall office network and so we are closing over 150 offices that are not sort of at the top of our performance range. We are adding about 100 new offices, both company and franchise. We are also re-franchising some of our more [disin] geographic offices. We’re doing about 40 of those this year.

On the Express Tax item I had the exact number in front of me, but I think we are expecting just under 90 additional Express Tax locations. And so between that and all the other changes, with alternative channels and other things, when you add that all together that’s where you get to the sort of 15 to 30 number that I mentioned in the script.

Andrew Fones – UBS

And then my second question, if I could, kind of what do you expect the size of the Bank to reach at the height of the tax season? Perhaps Becky and the assets you’d expect to buy with those deposits. Thanks.

Becky S. Shulman

So the size of the H&R Block Bank during the tax season similar to last season where we have a doubling of our balance sheet. This year we expect to peak around $2.6 billion in total assets for a very short period of time, and then we’ll start shrinking back down the balance sheet as we begin to normalize our total assets.

Andrew Fones – UBS

And what do you expect to buy with the deposits?

Becky S. Shulman

Well, because these are very short term deposits during the tax season, most of our investments will be overnight, so it’ll be such things as fed funds investments and similar investments such as that.

Operator

Your next question comes from Scott Schneeberger - Oppenheimer & Co.

Scott Schneeberger - Oppenheimer & Co.

I guess my first question, and I heard two things that sounded incremental on potential cost savings. The first was on procurement and real estate initiatives that I believe you said you would quantify later, and then I think I heard $100 million over five years of tax field operations, cost cuts. Could you confirm A, these are both incremental and then B, any additional color on both or each or whatever?

Russ Smyth

Yes, Scott, this is Russ. I’ll take the piece on procurement and real estate and then I’ll ask Tim to take the piece on tax. The answer is these are all incremental. In addition to the previous kind of E3 cost reductions efforts that were announced several months ago, the work on the procurement and real estate, what we’re really doing is rather than just looking at individual business segments, looking across the entire organization.

So H&R Block business segments as well as RSM McGladrey and looking for opportunities where we can use our size and scale to more effectively buy any number of things, from mundane everyday expenses like pencils and papers and pens to looking at advertising, media buys, looking at how we’re spending our legal spend as well. So a lot of opportunity we think in looking at this on a broader based approach than what we historically have done.

Regarding real estate, you know we’re seeing the effects of the real estate market on our mortgage business. That hurts us. We need to take advantage of a down real estate market. We’ve got a lot of locations, whether it’s tax offices at H&R Block or corporate offices with RSM McGladrey that we’ve got we think a unique opportunity right now to go in and aggressively re-negotiate those leases with our landlords.

We have a great payment history. We’re a very reliable tenant, and we’re going to be much more aggressive in terms of looking at cost savings opportunities in our real estate portfolio. So that process has just begun and that’s why we’re not quantifying either one of these two for you at this point, but we plan to have some harder numbers for you by the time we have our next earning call.

With that, Tim, do you want to address the tax?

Timothy C. Gokey

Yes. On the field productivity initiative, this is something we have been working on for a while and we want to give a bit more details of it because it is - it’s really sort of what supports the thing we said a couple of times before about increasing margins by 100 basis points each year over the next several years. And so we wanted to provide some support for that. So we think there’s an opportunity to optimize our office network over time to improve productivity in a number of areas, and we are getting a start on that this year and see that as a continuing opportunity over time.

Scott Schneeberger - Oppenheimer & Co.

For a follow-up, I’d like to ask, too, on your initial $125 million cost savings plan, how are you progressing against that? How – I assume from the comments that you’ve made you think you’ll achieve that this year. How far along are you? And how are you re-allocating some of the savings you have there as far as putting it back into the business?

Becky S. Shulman

We are tracking right according to plan on the original $125 million that we said we would achieve. And again, keep in mind that that original $125 million was prior to reinvestment in the business, prior to annualization, merit, that kind of thing. So we’re tracking. We’ve already realized about $45 million of it so far this year. And again before we announced that we were going to hit that, we had already taken the measures to hit it. So we knew that those were realizable.

The challenges we’ve talked about is creating the cost culture and continuing it and making sure that we don’t rebuild those expenses that we already cut. So Russ do you want to talk about the reinvestment?

Russ Smyth

Yes. In terms of reinvestment, Scott, you know we have intentionally not specifically given specific dollar numbers to each of the initiatives for competitive reasons. We have said that some of the money is going to reinvest in an additional marketing spend for this year. We’re also reinvesting in some technology that’s going into our retail tax offices, which we think is going to help our client’s experience this year, but we’re not putting specific numbers to it.

But what you can take away from Becky’s part of our previous comments was that year on year, just looking at annual ongoing operating costs, our G&A is going to be flat to slightly down this year. So clearly we’re absorbing any other normal cost increases like payroll, merit increases, and other normal course of business things, and still having net investment available and still being at or slightly below where we were at spend wise last year.

Operator

And at this time there are no further questions. Are there any closing remarks?

Scott Dudley

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

Operator

And this does conclude today’s conference call. You may now all disconnect.

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Source: H&R Block, Inc. F2Q09 (Qtr End 10/31/08) Earnings Call Transcript
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