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

F1Q10 Earnings Call

September 4, 2009 8:30 am ET

Executives

Scott Dudley – VP IR

Russ Smyth – President and Chief Executive Officer

Becky Shulman – Chief Financial Officer

Charles Elliott (C.E.) Andrews – President, RSM McGladrey

Joan Cohen – Chief of Staff

Robert Turtledove – Chief Marketing Officer

Analysts

Kartik Mehta - FTN Midwest Research

Sloan Bohlen - Goldman Sachs

Andrew Fones - UBS Investment Research

Scott Schneeberger - Oppenheimer

Michael Millman - Millman Research

Bill Carcache – Fox-Pitt Kelton

Operator

Welcome everyone to the H&R Block first quarter earnings conference call. (Operator Instructions) Mr. Dudley you may begin your conference.

Scott Dudley

Good afternoon everybody and thank you for joining us to discuss our first quarter fiscal 2010 results. Presenting on the call today are Russ Smyth, President and CEO and Becky Shulman, Chief Financial Officer. Following their opening remarks we will have a Q&A session. During that time we have other members of our senior management team here to be available during that time.

To start, let me provide our Safe Harbor statement. Comments made on this call may contain forward-looking statements within the meaning of Section 21-E of the Securities Exchange Act of 1934. Such statements are based upon current information and management's expectations 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 actual outcomes and results could materially differ from what is expressed, implied, or forecast in such forward-looking statements. Such differences could be caused by a number of factors including risks described from time to time in H&R Block's press releases and Forms 10-K, 10-Q, 8-K and other filings with the SEC.

H&R Block undertakes no obligation to publicly release any revisions to forward-looking statements to reflected events or expectations after the date of these remarks. H&R Block provides a detailed discussion of risks factors in periodic SEC filings and you are encouraged to review these filings.

Earlier this morning we issued a press release announcing our results and that is available at our website at hrblock.com. 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 one related follow-up if needed.

So with that, let me now turn the call over to Russ Smyth.

Russ Smyth

Thanks Scott and good morning everyone. Thank you for joining us and happy Labor Day weekend. As most of you know the tax business is generally concentrated in the fourth quarter so our first quarter results are not nearly as significant as they become later in the year. However, since our last earnings call we have made several management changes, experienced some changes in our market environmental conditions and we made some great progress on our plans for 2010 and beyond we want to share with you. After all, tax season is now only 118 days away. Later in the call you will also hear from Becky Shulman as she will cover our financial results for the quarter.

I would like to start by briefly highlighting our recent management changes which have strengthened our executive team as we position the company for long-term growth. We are delighted to have Robert Turtledove on board as Chief Marketing Officer to lead our strategic marketing efforts and the execution of our plans this tax season. Robert joined us three weeks ago bringing 25 years of broad consumer marketing experience with some of the world’s best brands and companies including Pepsi, Frito Lay, Pizza Hut and Lever Brothers. H&R Block is an iconic brand and we look forward to Robert’s leadership in leveraging this powerful asset as we pursue growth in clients and in market share.

On Monday of this week we announced Brian Worham as our new General Counsel. For 14 years Brian oversaw all legal and corporate compliance functions at Centex, one of the nation’s largest home builders and a publicly traded company before its recent merger with Pulte Homes. Brian’s breadth of legal experience, his business acumen and leadership skills make him a valuable addition to our team.

With these two additions plus C.E. Andrews having going us as President of RSM McGladrey and the changes we made in May to our existing management team structure, we now have a strong team in place that is working very well together as we prepare for the upcoming tax season.

Before we begin our comments about the state of the business I would like to make a few remarks about the external environment we expect to see this coming tax season. Based on IRS projections and unemployment data we believe the total number of tax returns filed will likely be down 1-2% this coming season. In addition we expect the do-it-yourself category will continue to gain a small amount of market share from assisted tax preparation primarily driven by growth in the digital online space. We don’t believe there will be any real change in trends from within the tax preparation industry as the digital players will expand their advertising and product features and the assisted competitors will continue to expand their network, albeit at a slower pace than last year.

Turning to the regulatory environment, we don’t believe the new tax law provisions resulting from the American Recovery and Reinvestment Act passed earlier this year will significant increase the number of filers as the Economic Stimulus Act did in 2008. However, various provisions such as the Make Work Pay product will increase the complexity of tax returns. Earlier this year the IRS also announced its intention to regulate unlicensed tax professionals and we support this proposal.

As a leader in the industry we are actively participating in this discussion with the IRS, have already submitted our viewpoint in writing and will be represented from both a company and franchise perspective in an upcoming panel discussion with the IRS leadership. H&R Block has provided industry leading tax and ethics training for many years and we require annual continuing education for all of our tax professionals. We believe these practices have provided us and will continue to provide us with a distinct competitive advantage in the marketplace.

As you know there has been some discussion surrounding potential reductions in RAL pricing by various banks that provide the product widely in the marketplace. We believe we have the best-in-class RAL product to offer and H&R Block has a great track record for leading the industry in RAL pricing having initiated the 36% APR RAL back in 2007. We do not expect these changes to materially impact the economics for our clients or for us as a company given our historical pricing and our long-term relationship with one of the world’s largest banks. However we will continue to monitor the situation as competitive details become more clear.

There are also important market dynamics impacting RSM McGladrey. The auto market remains soft due to the current economic climate and billable rates and hours are under pressure. However, it is important to note that RSM McGladrey’s tax consulting businesses have not been impacted as our core revenues were up nearly 6% over the prior year. I know many of you are interested in an update on negotiations with McGladrey and Pullen (M&P). As previously disclosed on July 21st we were notified by the board of M&P, partner owned attest firm we have worked with for 10 years that they intend to terminate the administrative services agreement under which the two firms work together to serve clients.

We have been quite clear in our communications that we believe the firms are better off together and that this course set in motion by the ten member board of M&P is risky from both a business and a financial perspective and is not in the best interest of our partners, employees and clients. With the exception of the complete independence and professional responsibilities and judgments relating to audits, RSM provides all significant strategic and operational leadership. In addition, all financing and infrastructure support is provided by RSM.

By leveraging our industry position as the fifth largest full-service accounting firm, we have access to significant capital. We see great opportunity for RSM and are fully committed to growing and improving this business. The negotiations between M&P and RSM are being led by both C.E. Andrews and myself. C.E. as you may remember is a 29 year veteran of Arthur Anderson and recently joins our company as our new President. His extensive industry background and leadership experience are invaluable and he will play a critical role in taking full advantage of the opportunities that lay ahead.

C.E. and I are working together to resolve this situation in a quick and favorable manner by taking three parallel approaches. First, we have exchanged proposals with M&P to address their concerns in an effort to keep the firms together and that dialogue continues.

Second, since we are not dependent on the relationship with M&P there are other audit and attest firms we can affiliate with to replace M&P should the need arise and we are pursuing those additional relationships at the same time we are in discussions with M&P.

Lastly, as the dialogue continues RSM and M&P are engaged in a legal arbitration process concerning certain provisions of our operating agreements. This arbitration process is likely to continue well into November. So we will continue to evaluate our alternatives as we move forward and work towards bringing this matter to resolution in the best interests of the long-term shareholder value.

While this is certainly taking up some of my time and even more of C.E.’s time, the rest of the H&R Block management team is squarely focused on the upcoming tax season. Having just completed an on-site review of the business plan in each of our geographic regions I am very pleased with the progress we are making to prepare for a strong 2010 tax season. We believe there are three keys to our success; operational excellence, leadership marketing and strong financial discipline.

In terms of operational excellence, we are working to attract and retain more clients by improving the quality and consistency of the client experience and delivering greater value to all of our clients regardless of whether they visit our offices, use our online software or choose some combination of both. As we have mentioned previously one of our largest opportunities for growth in our retail offices is reducing client walk outs. Situations where people check in at the front desk but never sit down with a tax professional. This is clearly low-hanging fruit in terms of client growth opportunity.

In addition we also know we have a significant opportunity to improve our client retention rates and we believe we can address both of these opportunities by making a stronger first impression with our clients. Many of our walk outs are a result of poor service or lack attention when they enter our offices. Although we can’t quantify the number we also know there many clients who enter but don’t check in or call on the phone but don’t come in due to service issues.

We also know that the first impression we make on our clients impacts their decision to return next year. Our research tells us that when clients give our front desk associates a high service rating their overall satisfaction rating is twice as high. So we plan to reinvest funds and effort into improving the first impression we make on our clients this season and we are confident this initiative will help drive a stronger 2010 and beyond.

This initiative breaks down into three main parts. First, we will get more of our clients in front of our best performing and our more experienced tax professionals. We have already identified the tax pro’s that best serve our clients. We will schedule them for more hours wherever possible and we will adjust our client scheduling process to ensure that they get priority when clients walk in or call for appointments.

Second, we will also welcome clients warmly with more and better trained front desk service associates. We will be much more selective in recruiting this personnel and address adequate training to assure they are well prepared when our offices open. Finally, we are improving our office appearance by making sure they are clean, neat and well organized.

We are also hard at work making improvements to our digital products and features. Our clients will see a dramatic difference in the overall look and feel of the products this year and they will be able to utilize a new suite of smart import capabilities. For the first time we also plan to fully leverage the Block brand on all of our digital products.

While the online space is growing rapidly by itself, we are taking bigger steps to take advantage of our unique opportunity to seamless integrate our retail offices and digital products to serve our clients in ways that no other competitor can. We will provide more details on this exciting opportunity in December.

Beyond these operational improvements which will enhance long-term client growth, marketing will play a critical role in successfully growing clients and market share. Improving consideration and trial are critical opportunities for us especially given we have not moved the needle on consideration over the last several years. With Robert’s leadership as our new CMO, and the help of our new agency, DVB, we are working on a number of initiatives to build consideration.

First our marketing message will be more credible and serious in tone and more consistent in addressing key client priorities. Second, we will focus on the expertise of our tax professionals. They have been a well kept secret for far too long. Third our brand messaging will be broader and delivered across multiple media channels. Fourth, we will become more effective in national advertising and messaging about H&R Block and its brand promise to become the most trusted, state of the art tax preparation experience at a great price for everyone.

Part of this effort will center on building and promoting the Tax Institute at H&R Block as the most trusted source of tax law interpretation. Finally, we will place greater emphasis on reaching consumers in key strategic or geographic segments where we have identified significant growth potential.

We also know the economy impacted certain client segments last year. Solving the price value equation is an important opportunity that we will take initial steps toward improving this year. We are working on the specifics of our pricing strategy and will not go into detail for obvious competitive reasons right now. As I mentioned earlier our net average charge will benefit this year from the greater complexity that is expected for most tax payers. We will also provide targeted value offers this year for client segments most affected by the current economic situation. Over the long-term our goal is to have quality revenue growth driven by client and market share gains.

To help fund the investments in the initiatives I have just discussed we plan to continue our strong financial discipline. We will continue to aggressively renegotiate real estate leases and close down or consolidate low profit margin locations. We also plan to manage our marketing spend more efficiently, better leverage our field support infrastructure and focus on eliminating non-value added costs.

Lastly, I want to update you on where we are on our franchising efforts. As we have noted in the past franchisees historically have grown clients faster on average than company-owned offices. Due to geographic differences it is difficult to compare the operating and financial performance between the two. We will become an active franchisor again and we are starting by refranchising up to 300 company offices.

In the coming months we will also create a pipeline of quality franchise candidates to support this long-term initiative. To this end we have launched a national advertising campaign to target opportunistic entrepreneurs. We believe we have a very compelling offer given our market leadership position, our strong support structure and unit economics that are far superior to other branded tax franchisors.

With that I will now turn the call over to Becky Shulman.

Becky Shulman

Thank you Russ. To start I would note we changed our segment reporting starting this fiscal year to reflect the way we are currently managing our businesses. We eliminated the Consumer Financial Services segment which was comprised solely of H&R Block bank. Net interest, margin and other gains and losses associated with the bank’s mortgage portfolio are now incorporated in corporate operations and the Emerald Suite of products and the remainder of the bank operations are reported in the Tax Services segment.

We will continue to provide transparent disclosure with respect to mortgage loans held on our balance sheet and we believe this change will provide a more transparent view of operating results for our Tax segment now inclusive of the results of our bank provided Emerald products. We will make ourselves available all day to walk you through any changes or answer any questions you may have and I welcome your feedback.

As you know, we reported a loss in our fiscal first quarter primarily due to the seasonality of tax services. Our net loss from continuing operations was slightly better than our expectations, coming in about $2 million lower than last year and flat on an EPS basis at $0.39. While our tax rate for the quarter was 38.1% we still expect that our effective rate for the full year to be higher and closer to our original guidance of 40%.

Tax services revenues rose nearly 8% primarily due to improved results from our Australian operations. RSM McGladrey’s core revenues including tax and consulting were nearly 6% but those gains were partially offset by a decline in capital markets revenue due to a decrease in the number of transactions closed.

On the expense side in the Tax Services segment we incurred the expected incremental pre-season costs of $9 million from the Southwest Franchise operation we had acquired last November. The net impact of the acquisition including revenue was $7 million. In addition we incurred an incremental $4 million of severance costs related to the various tax leadership changes we announced in June and $3 million of incremental but planned and front-loaded IT costs to ready for the upcoming tax season in digital and retail.

Expense increases were partially offset by savings in occupancy and other costs stemming from the renegotiation of real estate and office closures. In corporate operations our quarterly pre-tax loss totaled $40 million compared to a loss of $49 million a year ago. The improvement reflects impairments of residual interest and other real estate owned in the prior year of $9 million which did not recur in the current year.

Turning to the balance sheet I am pleased to note that we continued to strength our overall financial position which enhances our operational flexibility and reduces our overall risk profile. We ended the first quarter with over $1 billion in non-restricted cash and no borrowings outstanding under our $2 billion committed lines of credit. The cash decline of approximately $650 million compared to April 30th was primarily due to normal off-season expenses, income tax payments, quarterly dividends and seasonal fluctuations at H&R Block Bank.

Net receivables declined to $379 million or more than $512 million at year-end 2009 reflecting a normal pattern of collections primarily at RSM McGladrey. Total debt was essentially unchanged at $1.1 billion. Our equity remains strong at $1.2 billion and that is after the normal pre-season loss in the first quarter.

As expected, the net mortgage loans helped our investments decreased further to $708 million down more than $37 million from year end and more than $160 million year-over-year. Our loan loss reserve allowance at the end of the first quarter was approximately $92 million up from $84 million at year end.

Finally with regard to the RSM McGladrey situation some of you may be wondering if Block will need to report an impairment if the differences are not resolved. Although some level of impairment is possible depending on the outcome of a number of variables we are actively pursuing mitigating actions in event of the separation including alternate attest partners. It is important to note we do not expect the RSM situation to have any impact on our debt covenant.

Overall we are pleased with our quarterly financial performance as we were able to absorb the planned incremental costs in our Tax Services segment and we continue to achieve the cost efficiencies we had targeted in the areas of corporate overhead and non-client facing activities. We remain on track to achieve earnings for the full year within our previously established range of $1.60 to $1.80 per share from continuing operations. We continue to expect an improvement in Tax Services margins totaling 100 basis points over two years.

I will now turn it back over to Russ for final comments.

Russ Smyth

Thanks Becky. As you have just heard we feel good about our financial results in the quarter and more importantly we are optimistic about the progress we are making so far this year on our operational excellence plans, our marketing strategies and our continued financial discipline. We believe these initiatives will not only drive improved client and profit growth in fiscal 2010 but also establish a strong foundation for growth in fiscal years 2011 and 2012.

So that concludes our prepared remarks and we are now ready to take your questions. As always, after we finish Scott and Derek will be available through the rest of the day in case we are unable to address all of your questions within our allotted time.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Kartik Mehta - FTN Midwest Research.

Kartik Mehta - FTN Midwest Research

I wanted to ask you about your comments about the tax business. You said the IRS anticipates tax returns to be down about 1-2% and you also indicated you thought the software business would take some market share. Obviously H&R Block specific issue is maybe the loss of some clients because of WalMart. If you put all that and look at the numbers it sounds like for H&R Block you are starting at negative 3 or possibly negative 4 and I am wondering from your perspective would you anticipate this year to be a negative client growth year because of all the headwinds or are there other things you think you will be able to do to have a positive client growth year for the upcoming tax season?

Russ Smyth

As you know when we gave our guidance on last quarter’s call we mentioned our guidance was based on low single digit revenue growth. We specifically don’t want to repeat what we have done in the past which is to say how much of that is coming from net average charge and complexity, how much of it is coming from our tax form pricing or how much of it is coming from client growth. In the economic environment we are dealing with and with the headwinds you mentioned we need the flexibility to be able to manage and balance all those three factors during the course of tax season.

So for that specific reason we think there are a number of different ways we can get to low single digit revenue growth. We will manage it in a way that gives us the best result for 2010 consistent with our guidance but even more importantly also positions us strongly for growth beyond 2010 as well. I am not trying to avoid that client growth question. There are headwinds but we think we have a lot of good operational things like the walk outs we talked about earlier that should help us gain market share and hopefully potentially offset a lot of the headwinds we face.

Kartik Mehta - FTN Midwest Research

Switching gears a little bit asking about McGladrey Pullen, can you talk about if things don’t work out with McGladrey Pullen and aligning yourself with another attest firm, if that happens, any thoughts or any comments you can provide in terms of the revenue you would be able to keep as a result of having a new attest firm and losing McGladrey Pullen? Any thoughts on what the impact could be to the business?

Russ Smyth

At this point until we really get closer to understanding who those potential attest partners would be and it does not necessarily need to be one. It probably likely would not be just one to be able to replace as many of the clients we currently have with M&P. I can’t tell you. What I can say is our hope would be if we do end up aligning with different attest firms we would be able to keep as many of our M&P attest partners with RSM McGladrey and our new affiliated attest firm as we possibly can. Our plan would not be to try to give up our existing M&P audit partners or their clients but be able to realign them with our new attest firm partner.

Operator

The next question comes from the line of Sloan Bohlen - Goldman Sachs.

Sloan Bohlen - Goldman Sachs

Another question on RSM, could you give us a sense of what the overlap is for those clients using the audit services at M&P and also using you for a consulting basis?

C.E. Andrews

The breakdown of the way our client base is about 14% of our clients are attest only. Then where we have those joint non-attest and attest services is about 35% as we look at that and that leaves about 51% that provide non-attest only services to them.

Sloan Bohlen - Goldman Sachs

Switching gears, you mentioned potential new geographies. Is it possible we could see something as big as the Southwest acquisition you did last year or are you looking to do something a little bit smaller?

Russ Smyth

I talked about new geographies not in terms of acquiring franchisees because as we mentioned when we did the Southwest acquisition last year that is really the last large independent franchise network in the system. Clearly our focus is really on going the opposite way and re-franchising offices as opposed to focus on purchasing locations from franchisees. My reference to geographic opportunity is we have a couple very large urban markets where we have significant market share opportunities where they are running at about half of our national market share averages. Houston is one of those and that was part of our strategic purpose in acquiring the Southwest franchise. The other two are New York and Los Angeles where we think we have tremendous opportunities to grow our clients in those two large urban centers.

Sloan Bohlen - Goldman Sachs

So that was more of a marketing related comment?

Russ Smyth

Marketing and operational as opposed to an acquisition strategy. Absolutely.

Operator

The next question comes from the line of Andrew Fones - UBS Investment Research.

Andrew Fones - UBS Investment Research

I was wondering if you could tell us what tax revenue would have been reported on the old basis if you can for this quarter.

Becky Shulman

I’m sorry, I didn’t quite understand you. Can you repeat the question please?

Andrew Fones - UBS Investment Research

I was wondering what tax division revenue would have been in Q1 if you had reported it on the old basis, excluding any revenue you had from the Emerald product in the quarter and so forth.

Becky Shulman

I think there was minimal impact. We intend to file the Q later today and we have restated all of the periods in there in a like manner so you will be able to get visibility to that but it is minimal.

Andrew Fones - UBS Investment Research

I think you said the loan loss provisions were up about $8 million from Q4 to Q1 is that right?

Becky Shulman

It was $13 million in the quarter. Again while we are still adding to reserves we are adding at really overall a decreasing rate so if you look year-over-year we definitely expect to be down this year.

Andrew Fones - UBS Investment Research

So the expense was $13 million but the increase was $8 million to the financial reserves. I was wondering if you could give us a sense of the number of stores you expect to have this year on a company-owned and franchise basis and then the break out between shared locations and regular offices.

Russ Smyth

You were cutting in and out a bit. I heard a piece of the question on where we think we are going to be in terms of number of office locations and then what we think the mix is going to be by the end of the year. Is that right?

Andrew Fones - UBS Investment Research

Yes. That is right.

Russ Smyth

In terms of office locations we will probably close another 300 locations prior to this tax season. In terms of the mix between company and franchise as I mentioned we are looking to refranchise another 300 company offices to qualified franchisees this year. We did 37 right before last tax season in terms of selling them to refranchises. I’m sorry that was 43. So you will get the full-year benefit of those as franchise operations this year. We will continue to refranchise really as many of the 300 as we can based on the quality of the franchisee pipeline we are able to create.

Andrew Fones - UBS Investment Research

I was wondering what we should assume in terms of the impact, the list of initiatives you mentioned that should impact market share gains for you this year in the retail business. I was wondering which of those initiatives you think are going to have the most impact?

Russ Smyth

Again, we believe that reducing the number of clients that walk out of our offices after having checked in is the biggest and best opportunity to try to impact client growth for this year. It is something that is directly under our control and is based solely on our ability to execute better and do a better job of greeting and welcoming those clients when they walk in. In addition to that, as I mentioned in my prepared remarks, there are a number of people that walk in but don’t check in and many, many more who call us on the phone but don’t get good service and we miss the opportunity to bring them into our offices.

Those combined areas are our single biggest opportunity for growing clients by improving operations this year. At the same time, from a marketing perspective consideration I cannot overemphasize the importance of our need to grow consideration. We are not going to be able to grow trial or new clients unless we get more people to consider us so that is a critical factor for us. We know if we can grow consideration by a point and get any kind of reasonable conversion rates through actual trial and client usage that will grow our client base rapidly and significantly.

So I really think it is based on how well we execute in those two areas in terms of our ability to offset some of the headwinds we talked about earlier. We think on the client walkout piece we have opportunity to get between 400,000 to 500,000 additional clients this year that we did not get last year by better executing. So I think that gives you a sense of the order of magnitude those kinds of operational improvements may have. Then consideration could be significantly higher depending on how quickly we are able to move the needle on that metric.

Andrew Fones - UBS Investment Research

Given the potential for regulatory changes here for the tax preparers, I think in California and perhaps in Oregon there are already rules relating to tax preparers. I was wondering if you could give us a sense of your market share in those states relative to other states where there is no regulation.

Russ Smyth

Generally the comments we have heard, I want to state clearly I am not stating our opinion but feedback from others, the initiatives on regulating tax preparers in California has not worked particularly well in terms of accomplishing the objectives they set out to do. Oregon seems to be a better working model and I will tell you that up in the Pacific Northwest we have some of our highest market share rates as we do across the rest of the country.

Operator

The next question comes from the line of Scott Schneeberger – Oppenheimer.

Scott Schneeberger - Oppenheimer

Following up on the tax location question you mentioned 300 would be closed this year. Is there any intention to add new stores for 2010?

Russ Smyth

We will add some in areas where we have opportunities as I mentioned part of our opportunity in New York City in particular is likely to include some real estate expansion but not a significant amount of new office growth is planned for this year.

Scott Schneeberger - Oppenheimer

So that 300 is safe to say a net number and maybe a little less than that would be the net number?

Russ Smyth

Probably a reduction of about 500 including the WalMart’s too. Don’t forget we are not going to be in WalMart locations this year.

Scott Schneeberger - Oppenheimer

Can you give us a feeling for timeframe for resolution on the RSM McGladrey matter? Do you think next quarter call that will be something that is concluded and we will know the ongoing structure or will that play into early 2010?

Russ Smyth

It is really hard to tell at this point. As we mentioned we are pursuing three parallel paths. Some of them could move more quickly than others. Our hope is we can find some type of amicable solution to this with M&P. We think that is in their best interest and we think it is in ours. It takes two parties to come to an agreement. I really don’t want to lock ourselves into a timeframe. We certainly want to resolve this as quickly as we can but we also need to make sure we resolve this in the right manner and have a solution that is a permanent solution or at least a longer term solution and not rush to quickly resolve it now but have to be dealing with the same challenges and issues one, two or three years from now.

Scott Schneeberger - Oppenheimer

Minimal share repurchase activity in the quarter and I noticed you didn’t tap the CELOC. I don’t recall what your historical trend has been in the fiscal first quarter but as you enter the tax season generally in a typical year you would have drawn about $1 billion on the CELOC. Can you give us a feeling of how you are managing the balance sheet as you go through this tax season or head into this tax season?

Becky Shulman

I will separate that into two questions. We definitely have the balance sheet and we definitely have the liquidity. As I said we don’t have anything drawn on our committed lines of credit at this point. We still are operating under the $2 billion board authorization for share repurchase so that is available to us certainly this year as we think about.

From a cash perspective, again we look really good. We expect we will begin borrowing at some point in December but again those borrowings will be outstanding for probably less than a month all in. So really no change to our strategy on share repurchase at this point and liquidity and balance sheet look really strong.

Operator

The next question comes from the line of Michael Millman - Millman Research.

Michael Millman - Millman Research

Can you give us your opinion to what extent the tax preparation business particularly for the speed of refund filers has become or is becoming commoditized?

Russ Smyth

If you could do me a favor and get a little bit closer to the microphone, you are cutting out. It sounded like the question was about our view of refund filers and something about being commoditized?

Michael Millman - Millman Research

You got it.

Russ Smyth

I’m not sure what you mean by that. Can you be a little bit more specific?

Michael Millman - Millman Research

I was asking you to be specific to talk about whether you think the tax preparation industry particularly for the speed of refund filers or RAL participants is becoming commoditized.

Russ Smyth

Absolutely not. I don’t think it is being commoditized. I think it is going the opposite way. The reason I know that is the case is look at the complexity of the tax code and how that is reflected in the increases in net average charge from returns being more complicated. The IRS continues to pass additional refundable credits and other tax law changes that make it more critical than ever for people to have a tax specialist to help them with this very complicated and unsettling time that occurs once a year.

So I really think it is getting less commoditized. We believe it will continue to do so and I think that is a big part of our growth opportunity in the years to come.

Michael Millman - Millman Research

I guess I was thinking from a standpoint at least when we look at the numbers for the last year or two people again early season filers seemingly to be agnostic as to whether they go to Block, Jackson, Hewitt, Liberty or some mom and pop independent.

Russ Smyth

As we said before, certainly last year and the economic situation people were more price sensitive than ever before when it came time for tax prep. We saw the impact on that in our client base where most of our biggest client losses were in the lower adjusted gross income client segments. That is why we have said we will have some targeted price value offers for those client segments most impacted by the current economic situation. I think that is a temporary occurrence. I don’t think that is a permanent shift in how people are going to file their tax returns permanently. We are seeing a lot of clients come in the off season having done their returns digitally last year that are now having second thoughts or concerns about whether they did it right or not. I think a lot of this is incumbent on how we market our brand or tax expertise relative to the other competitors both branded and independents in the category to make it clear to our clients why they ought to choose H&R Block as their preferred tax preparation solution.

Michael Millman - Millman Research

I have a follow-up on the pricing issue; I think you indicated that it was likely more complexity this year. Last year I think your price increase if I recall was very minimal and it sounds the same this year. All in all revenue per return should we assume similar to the 7% of last year given the complexity?

Russ Smyth

Again what we have said and what we will continue to say is included in our earnings targets for this year we based it on low single digit revenue growth. I am not going to get into the specifics of how we are going to manage complexity, which we think could be worth a couple of points on net average charge relative to regular forms pricing, relative to targeted value offers, relative to client growth numbers. As the situation evolves and we find out what works or what isn’t working we will continue to react during tax season to find the best balance that drives results for this year and gives us a strong foundation for future years as well.

Operator

The next question comes from the line of Bill Carcache – Fox-Pitt Kelton.

Bill Carcache – Fox-Pitt Kelton

Can you speak a bit more about the changes to your marketing message this year? You talked about it having a more serious tone but can you give a bit more color on how you plan to target expertise filers and maybe have what media channels you might focus on to do that?

Russ Smyth

I’m going to turn that over to Robert Turtledove. Even though Robert has only been here three weeks he is fully engaged in all of these discussions. Robert?

Robert Turtledove

Swamped is a better word. I think a couple of things. What is so important is we are putting on what we call our consumer forensic goggles and we are digging very deeply into the customer and category and behavior and looking at it from their shoes. What we have discovered is a tremendous number of insight into their attitudes, behaviors, perceptions, how and why they chose to do what they choose. Those insights and learning’s are going to show up not just in our messaging and our marketing but they are going to show up in our products and the way we take those products to markets.

I think there is a confidence we have informed knowledge about how consumers want to see and use our products and how they want to hear about us. I think you will see that. People take their taxes seriously and what they will see is that we take them seriously too. So these are the first points of the overall tone and messages.

I think the second piece is we intend to spend smarter, not necessarily more. What does that mean? If you have a good message and you spend, I am making up a number, you spend $100 million on it you will get a good message at $100 million. If you have a very powerful message and you spend the same money you are going to get a multiplier factor on that. $100 million could seem like $120 million or $130 million. So spending in the right places with a more powerful message is another key to us doing more with the same amount.

I think the final piece is a recognition that consumers are consuming tax products and services in a lot of different ways. We are going to look like and reflect the ways those are being consumed. That means a balanced focus on our great retail offerings as well as our digital and online and any other ways they want to consume their taxes. So at a broader level those are the marketing changes or marketing strategies we are bringing to bear and we are going to have a lot more of that over the next quarter. Hopefully that addresses some of your questions.

Bill Carcache – Fox-Pitt Kelton

Based on your experience can you talk how comfortable you feel the marketing message can have an impact this year or is that something that would maybe take a little bit longer?

Robert Turtledove

Again a good question. I am actually pretty confident we will definitely get some traction. Now things like consideration, perception and attitudes do change over time and while we certainly believe that this is a longer-term building process of re-establishing certain brands, regard and credibility we believe pretty strongly we have a good shot at changing some of those considerations and perceptions in this upcoming tax season.

Russ Smyth

Just to touch on something that happened here last year prior to Robert’s time at the end of tax season we changed the tone of several of our ads. We have a measure for our ads called “Made you want to buy” which is probably our best surrogate metric in the short-term for what is otherwise a longer-term consideration pipeline. With the simple change in the tone and messaging of that ad we improved the “Made you want to buy” rating of that commercial by 45% from where we had been running with previous H&R Block ads. If that is a broader indicator of the ability with the right messaging to change perception then we are very encouraged.

Bill Carcache – Fox-Pitt Kelton

Going back to a separate issue you spoke about earlier on the business services and the RSM relationship with McGladrey and Pullen, can you talk a little bit more about to the extent you start heading down the path for the sake of argument of alternative attest partners, don’t most attest firms typically also offer tax services and therefore they would typically have to give up that revenue stream if they were going to partner with you and would that involve some kind of upfront payment? How do you think about that?

C.E. Andrews

Let me just comment on that. Any attest firm would bring with it not just the attest practices but whatever their full scope of services would be. Normally in all cases it would be at a minimum include audit and tax site services and obviously some consulting services as well. So it just depends on the firm. If you acquire those businesses just like we did with RSM a few years ago all of those would come with them. With it would come their personnel, their clients, and their mix of services? Then our challenge would be and what we would do is integrate the components of the RSM business we retained which would be the consulting and tax services into those organizations as best we could so that we end up with more of a combined outcome if you will of the firms we acquire combined with the services we retained and that is what we would manage in some fashion as an integrated business going forward.

Russ Smyth

Obviously as I mentioned earlier one of our objectives would also be to have the high quality audit partners from M&P stay with RSM McGladrey and our new attest firm partner with the goal of not only keeping those great employees but hopefully keeping their audit and attest clients as well.

Bill Carcache – Fox-Pitt Kelton

Would there potentially be any upfront payment with any potential new attest partners?

Russ Smyth

There could be but we are exploring a lot of different creative ways of partnerships going forward.

Bill Carcache – Fox-Pitt Kelton

Finally, I appreciate your answers, on international businesses does your recent announcement about adding new tax professionals in Canada signal a push towards increasing the contribution of international revenues to the business and should we expect a similar push in Australia? What drove the improved results in Australia?

Russ Smyth

I will take a high level international piece and then turn it over to Joan Cohen for the specifics on Australia. Our businesses in Australia and Canada have performed extremely well for us for the past several years and this year is no exception. As we mentioned in our comments and in the press release part of the reason for our first quarter performance was due to Australia’s strong results. Keep in mind their seasons are opposite ours so while first quarter is slow for us in the fiscal year that is their peak season. Those businesses have done extremely well for us.

I think down the road we see continued opportunity for greater contribution in our international business both in Canada and Australia as well as some other markets we would potentially penetrate over the coming years. I think that is a longer term piece of our strategy and obviously more critical importance for us in 2010 and 2011 is growing our clients here in the U.S. tax business as well as our market share. Joan do you want to cover a couple quick highlights from Australia’s results this year?

Joan Cohen

Australia had better than expected results because there was an economic stimulus package that was done in Australia that while it related to the prior tax season the tax filer needed to file by June 30th of this year .So we had some great early season results. We were able to put those clients in front of our best tax professionals in Australia because they are year-round tax professionals there. We are expecting to have great client retention around those new clients.

Both Canada and Australia have been charged with increasing their market share over the next five years and they are in the process right now of putting those plans together and we expect that to be hugely successful.

Russ Smyth

Before we end I want to clarify on a question that was raised earlier regarding expected office count level. In addition to the 300 or so traditional offices that we mentioned we are going to close prior to next tax season, the count on the WalMart closings is a reduction of 700 offices. In addition we probably got another 200 or so offices in what we consider alternative channel locations like Sears and other types of places that we are also likely to close. It is more likely to be a total reduction of around 1200 locations of which most of those other than the 300 traditional offices are considered alternate channel locations. I hope that helps clarify the question asked earlier about office count expectations.

Thanks for your time everyone. As we mentioned Scott and Derek will be available during the rest of the day to answer any questions we didn’t get a chance to cover today. Have a great holiday weekend.

Operator

This concludes today’s conference. You may now disconnect.

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Source: H&R Block, Inc. F1Q10 (Qtr End 07/31/09) Earnings Call Transcript
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