H&R Block, Inc. (HRB)

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H&R Block, Inc. (HRB)

F2Q10 Earnings Call and Investment Community Conference

December 8, 2009 8:30 am ET

Executives

Derek Drysdale – Investor Relations

Russ Smyth – President & CEO

Robert Turtledove – Senior Vice President & Chief Marketing Officer

Sabrina Wiewel – Chief Tax Network Officer

Phil Mazzini – Senior Vice President Tax Services Support

Becky Shulman – Senior Vice President & CFO

Analysts

Andrew Fones - UBS

Vance Edelson – Morgan Stanley

Mary [Inaudible]

[Sam Buddrick] - UBS

John Fox – Fenimore Asset Management

Joe Capone – Credit Suisse

Sloan Bohlen – Goldman Sachs

Michael Millman – Millman Research Associates

Michael Chapman – Private Capital Management

Presentation

Derek Drysdale

Let me cover our safe harbor statement. This presentation and various comments made in connection with it including certain estimates, projections, and other forward looking statements. These statements speak only as of the date on which they are made and are not guarantees of future performance. Actual results may differ materially from those expressed, implied or forecast in the forward looking statements.

H&R Block undertakes no obligation to publicly release any revisions to forward looking statements to reflect events or expectations after the date of today’s presentation. H&R Block provides a detailed discussion of risk factors in its periodic SEC filings and you are encouraged to review those filings.

To start our program today and set the tone for the entire morning we’ll begin with a brief video. Welcome and thank you for your interest in H&R Block.

Russ Smyth

That video was developed for us by our advertising agency after we had reviewed our long term business plans with them. It was a way they were kind of doing a check to make sure that they captured the spirit of what we’re trying to accomplish with our long term business plans. I think they’ve captured that spirit extremely well in that video.

We’ve shown this a few times already internally and the question that we always get: “So is this your new brand campaign, is this your first commercial?” The answer to that question because I’m sure you’re going to ask me anyways if I don’t tell you what the answer is, not quite.

You will see, I think, when Robert shows you some of our early work later on this morning you’ll see many of the individual components from that video in our new brand campaign. We’ve chosen those elements that we’re confident that we can actually deliver against in our tax offices and with our digital offerings. However, the reality is we’ve got some work to do over the next few years so that we’re going to be able to deliver on all of the promises that we showed in that brand video.

Directionally I think that gives you a good sense of where we’re headed and we are excited about where we’re taking the brand. As we’ve tried to put that into words, the words we chose, where our journey is and our mission is to become the most trusted state of the art tax preparation experience at a great price for everyone.

A lot’s happened since we met here last January both in the marketplace and at H&R Block. I’m pleased to share our progress with you as we head into now our 55th tax season and my officially second tax season. Before we get started this morning I wanted to introduce you to our leadership team. We’ve got several new members on our senior management team this year. I want to take a chance to introduce them to you. For those of you that are here, please stand up when I introduce you.

First, Robert Turtledove who joined us this summer as our Chief Marketing Officer, although he’s new to the role, Robert is already deeply engaged in helping us build our brand consideration trial and really is working hand in hand with our new ad agency DDB to work on the new brand campaign. You’re going to see the early results of those efforts later this morning. In fact, Robert and the team just finished shooting commercials about a week ago and you’re going to see some of the early product that they’re coming out with this morning.

Also joining our leadership team is Kate Fulton who is leading our Government Relations and Public Policy efforts in Washington DC. Brian Worum our new General Council, I think Brian is here. We’ve also added C.E. Andrews to the team. C.E. is the President of RSM McGladrey. C.E. is unable to attend today.

I need to off script here a little bit. I’m reminded that last year at this meeting we didn’t have our President of RSM here at that time. About 10 days later we announced that we were making a change. I don’t want you to assume that because C.E. is not here that that is the reason that he is not here. We are very happy with C.E. but as you can all imagine he has a few issues to work out at RSM McGladrey so that’s the reason he’s not in attendance.

Those are the new folks on the leadership team. In addition, we’ve got some of our existing folks that are in new roles. Sabrina Wiewel, who you met last year when she was leading our Digital team and Phil Mazzini. Phil and Sabrina are deeply tenured leaders who have taken on new roles leading our Tax Network. Sabrina kind of leads the integrated side of our field retail offices and the digital channels and Phil leads the operational support team that makes sure that our tax season runs smoothly.

Other tenured members of our leadership team are Becky Shulman our CFO who you will hear from later this morning. We’ve also got Rich Agar who is our Chief Information Officer, Ken Treat who is responsible for franchise development efforts, I’m sorry Tammy Serati, who is in charge of Human Resources and Joan Cohen who rejoined the H&R Block as our Chief of Staff after she successfully transitioned our financial advisory businesses over to Ameriprise.

With this group of folks I believe we’ve got a very strong leadership team that has a really good balance of deep knowledge and experience within H&R Block as well as some external experience in leadership that really gives us a fresh perspective on our business. Our goal today is to give you of our plan for long term sustainable growth as well as a lot of specific details about what that plan is going to look like for this tax season. In particular we’re going to focus on specific initiatives that we think are critical to renewing our focus on our client and to really improve on our ability to execute.

Each of the presenters today is going to outline the changes that have taken place this last year that we think demonstrate the comprehensive approach we’re taking as an organization to really improve client growth over the next three years.

Before I talk about our plans and preparations for tax season 2010 I know many of you from the cocktail reception last night are very interested in an update on our negotiations with McGladrey & Pullen. The news as you saw if you read the press release this morning are that we have recently received a final and binding ruling from the arbitration panel. For now, the rulings of that panel are subject to a confidentiality agreement. We continue to have very positive and productive conversations with the McGladrey & Pullen Board and we are very optimistic that this is going to be settled within the next few weeks.

I did see there was at least one headline this morning that used the word that this situation was resolved and I want to reinforce we chose the words in our release very carefully. While we’re very optimistic that this will have a good outcome, we are not across the finish line yet. I want to make sure that that is clear to everyone because I don’t want anyone to leave with a misunderstanding of exactly where we’re at in this situation.

These negotiations have been taking up some of my time and all of C.E.’s time and then some. I can tell you that the rest of the H&R Block management team has been squarely focused on this upcoming tax season. I’m very pleased with the progress that we are making over the past several months to deliver a strong foundation for this tax year as well as for a strong foundation for future years. You’re going to hear this morning about our plans to attract, retain, and convert a lot more clients over the next three years.

Before I get into specifics about why I’m so optimistic about our position and about our future, I do want to take a second to show you a quick overview of broader trends within the tax industry. Keep in mind these are things relative to the tax industry itself, not specifically how we think it impacts us at Block which we’ll get into throughout the rest of the morning.

A few key market challenges that we think everybody faces as a result of the current economic climate: First, our assumption going into this tax season is that we expect IRS filings to be down about 2% this year and that’s really a result of the fact that unemployment has now reached double digits. Second, we expect to see a continued shift to the do it yourself category from assisted prep, primarily driven by the growth in the digital online space.

We believe that with continued economic pressures and some additional marketing spend from some of the larger branded companies that we expect that free filing is going to plan an even bigger role in the industry this year then it did last year. New tax law changes add a lot of complexity to the code. We don’t expect that these changes are likely to significantly increase the number of filers but we do expect them to have a significant increase on the net average charge.

At the same time, from an overall market perspective what we’ve been seeing for the last few years is that prices across the board for many retail tax preparers have continued to increase while the perceived value by the clients for that tax prep service has not kept pace. Overall when we look at the marketplace footprint the number of assisted tax preparation offices has increased pretty significantly, in fact by more than 40% since 2005 but that rapid office growth rate has decelerated in the past couple years to where it was just 4% last year. We expect that this trend will continue and that the growth rate will continue to decelerate for the next several years.

We also expect to see some progress probably in the next month regarding the IRS recommendations to regulate tax return preparers and increasing taxpayer compliance. However, we don’t expect that these changes are going to have a significant impact on our tax results this season but more likely have an impact on us in 2011 and then 2012.

Lastly, while consumer demand continues for settlement products they do appear to be more price sensitive then they have been in the past. We’ve been seeing a trend not only at Block but more importantly within the industry of people switching from refund anticipation loans to refund anticipation checks which we think is an indicator that taxpayers are really for the first time more willing to wait a little bit longer for their refunds in order to pay a reduced rate. We think the overall effect of this is that the profitability on financial sentiment products is likely to continue to decline over the next few years.

When we look at the situation that we’re dealing with I think the reality is that economic conditions are shrinking the marketplace to a certain extent. We do believe that this is temporary and the industry will return to its historical low single digit growth rates. We have modified our business plans to leverage our competitive advantages which we think are many, and to take advantage of this opportunity in the marketplace and capture additional market share.

With only 11% of the retail and digital market share space we think we have significant market share opportunities ahead of us as the use of paper and pencil segment continues to decline and digital continues to grow. Now admittedly I think we’ve created some of our own market dynamics internally that have impeded our ability particularly to significantly increase our 11% market share in retail.

However, I do want to point out, as you see on this slide, that from a market share perspective what we saw happen last year in our retail business was not meaningfully different in terms of market share change then what we had seen in previous years. The client count looked different and the client loss in 2009 looked different but that was really more of a result of the positive impact of the economic stimulus act on our results in 2008.

While the Digital segment is growing I will tell you we’re not satisfied with our results because we don’t think we’re growing at a fast enough rate in Digital and we don’t think we’re getting our fair share of the growth in the Digital category. I’m happy to tell you that a lot of work has been underway these last several months to try to reverse these trends and so we’re going to walk you through some of the changes that we’ve made in our approach and our business to position us for growing our market share in growing our profitability.

When I was here with you a year ago I talked about the reasons I was intrigued by the opportunity to lead H&R Block. In addition to the strength of the brand and the strength of our people the market opportunity was really one of the key factors that brought me here. Now that I’ve been here a little bit more than a year I continue to see tremendous opportunity despite some of the short term industry challenges that we face.

At H&R Block we’ve been spending the past year making changes that we really believe are going to differentiate our brand in the marketplace. Beginning this tax season we intend to fully leverage our size and scope and the strength of our brand.

Internally I will tell you we have not pointed to the economy or the unemployment rates as the root cause for our performance last tax season. In fact, in my message to all of our employees at the end of last year I talked about the state of our business. I really said the economy just put a magnifying glass on some of the internal challenges that we’ve had which have frankly been brewing since about 2002. What have we done about it? We’ve spent a lot of time this last year actually listening to what our clients have to say.

Listening to what our clients have actually been telling us for the past several years and in that process of listening we’ve learned a lot about ourselves. We’ve learned a lot about what we need to do better, to better serve our clients. We’ve learned our clients want choices in tax preparation. They want to be served in a variety of different ways. We’ve learned younger taxpayers joining the market have very specific preferences about how they want to interact with the brand and what they’re willing to pay.

We learned that taxpayers aren’t just looking for tax preparation; they’re looking for tax relief, because they have very complicated tax and financial implications that change over time. We’ve got to view this relationship with our clients as more then just tax preparation. We need to build a deeper partnership with our clients that provide the piece of mind that really comes with providing tax relief.

I was also clear when we listened to our clients that we’re missing out on some key opportunities as we interacted with them. In the past, we rapidly expanded our office footprint which stretched the capabilities of our tax professionals and our people and had a negative impact on our training and our cost structure. As we focused on a narrow segment of client service which was really focused on converting clients at the tax desk, rather then capturing opportunities in the broader market space that really focused on full end to end client experience.

As you can see from this chart, historically we focused our efforts and energy on opportunities at the tax desk so even if we performed really, really well the maximum opportunity we probably had for growth was about one million clients because that’s what was defined as the opportunity we were missing at the desk itself.

As we listen to our clients we learned that there were some other missed opportunities and they were bigger then what we were missing at the tax desk. In fact, more than two million people who interacted with the front desk when they walked in but never got to see a tax professional, that’s a huge growth opportunity for us.

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