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10-K 1 c86302e10vk.htm ANNUAL REPORT e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


(Mark One)
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the fiscal year ended: April 30, 2004

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to

Commission File Number: 1-6089

H&R Block, Inc.

(Exact name of registrant as specified in its charter)


MISSOURI		44-0607856
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

4400 Main Street, Kansas City, Missouri 64111

(Address of principal executive offices, including zip code)

(816) 753-6900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Common Stock, without par value		New York Stock Exchange
Pacific Exchange

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, without par value

(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

The aggregate market value of the registrant’s Common Stock (all voting stock) held by non-affiliates of the registrant, computed by reference to the price at which the stock was sold on October 31, 2003, was $8,416,026,893.

Number of shares of registrant’s Common Stock, without par value, outstanding on June 1, 2004: 168,292,888.

DOCUMENTS INCORPORATED BY REFERENCE

The definitive proxy statement relating to the registrant’s Annual Meeting of Shareholders, to be held September 8, 2004, is incorporated by reference in Part III to the extent described therein.

H&R BLOCK, INC.

2004 FORM 10-K AND ANNUAL REPORT

TABLE OF CONTENTS


PART I
	Introduction and Forward Looking Statements	1
Item 1.	Business	1
	General Development of Business	1
	Description of the Business	1
	U.S. Tax Operations	1
	Mortgage Operations	5
	Business Services	7
	Investment Services	8
	International Tax Operations	9
	Service Marks, Trademarks and Patents	10
	Employees	10
	Risk Factors	10
	Availability of Reports and Other Information	11
Item 2.	Properties	11
Item 3.	Legal Proceedings	11
Item 4.	Submission of Matters to a Vote of Security Holders	13
PART II
Item 5.	Market for the Company’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	13
Item 6.	Selected Financial Data	13
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 7a.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 8.	Financial Statements and Supplementary Data	34
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	66
Item 9a.	Controls and Procedures	66
PART III
Item 10.	Directors and Executive Officers of the Company	66
Item 11.	Executive Compensation	68
Item 12.	Security Ownership of Certain Beneficial Owners and Management	68
Item 13.	Certain Relationships and Related Transactions	68
Item 14.	Principal Accounting Fees and Services	68
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	69
	Signatures	70
	Exhibit Index	71
Amended and Restated Bylaws
Employment Agreement for Nicholas J. Spaeth
Severance and Release Agreement for James Ingraham
Termination Agreement of Jeffrey G. Brandmaier
Computation of Ratio of Earnings to Fixed Charges
Subsidiaries of the Company
Consent of KPMG LLP
Consent of PricewaterhouseCoopers LLP
302 Certification of Chief Executive Officer
302 Certification of Principal Accounting Officer
906 Certification of Chief Executive Officer
906 Certification of Principal Accounting Officer

Form 10-K – H&R BLOCK

INTRODUCTION AND FORWARD LOOKING STATEMENTS

This year we have chosen to combine our Annual Report on Form 10-K, which we are required to file annually with the Securities and Exchange Commission (“SEC”), and our Annual Report to Shareholders. Certain portions of our Annual Report to Shareholders, including our consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations, have historically been filed as exhibits to the Form 10-K. We hope that by including all of this information in one document, you will find this year’s Annual Report more useful and informative.

Specified portions of our proxy statement, which will be filed in July 2004, are listed as “incorporated by reference” in response to certain items. Our proxy statement will be printed within our Annual Report and mailed to shareholders in July 2004 and will also be available on our website at www.hrblock.com.

In this report, and from time to time throughout the year, we share our expectations for the Company’s future performance. These forward-looking statements are based upon current information, expectations, estimates and projections regarding the Company, the industries and markets in which we operate, and our assumptions and beliefs at that time. These statements speak only as of the date on which they are made, are not guarantees of future performance, and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in these forward-looking statements. Words such as “believe,” “will,” “plan,” “expect,” “intend,” “estimate,” “approximate,” and similar expressions may identify such forward-looking statements.

PART I

ITEM 1. BUSINESS

General Development of Business

H&R Block is a diversified company delivering tax products and services and financial advice, investment and mortgage products and services, and business and consulting services. For nearly 50 years, we have been developing relationships with millions of tax clients and our strategy is to expand on these relationships. Our tax services segments provide income tax return preparation services, electronic filing services and other services and products related to income tax return preparation to the general public in the United States, and also in Canada, Australia and the United Kingdom. We also offer investment services and securities products through H&R Block Financial Advisors, Inc. (“HRBFA”). Our mortgage services segment offers a full range of home mortgage products and services through Option One Mortgage Corporation (“OOMC”) and H&R Block Mortgage Corporation (“HRBMC”). RSM McGladrey Business Services, Inc. (“RSM”) is a national accounting, tax and consulting firm primarily serving mid-sized businesses.

H&R BLOCK’S MISSION

“To help our clients achieve their financial

objectives by serving as their tax

and financial partner.”

H&R BLOCK’S VISION

“To be the world’s leading provider of financial

services through tax and accounting

based advisory relationships.”

Key to achieving our mission and vision is the enhancement of client experiences through consistent delivery of valuable services and advice. Operating through multiple lines of business allows us to better meet the changing financial needs of our customers. Developments during fiscal year 2004 within our operating segments are described below in “Description of Business.”

H&R Block, Inc. was organized as a corporation in 1955 under the laws of the State of Missouri, and is a holding company with operating subsidiaries providing tax and financial products and services to the general public. “H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.

Recent Developments. We continue to believe share repurchase is one of the best ways we return value to our shareholders. On June 9, 2004, the Board of Directors approved the repurchase of an additional 15 million shares. On June 11, 2003, the Board of Directors approved the repurchase of 20 million shares and we repurchased 10.6 million shares during fiscal year 2004.

During fiscal year 2004, we began operating former major franchise territories as company-owned tax operations, as discussed further below in “Description of Business” and in Item 7.

Financial Information About Industry Segments

See discussion below and in Item 8, note 21 to our consolidated financial statements.

Description of Business

U.S. Tax Operations

General. Our U.S. Tax Operations segment is primarily engaged in providing tax return preparation, filing and related services and products in the United States. Revenues include fees earned for tax-related services performed at company-owned retail tax offices, royalties from franchise retail tax offices, sales of Peace of Mind (“POM”) guarantees, sales of tax preparation and other software, fees from online tax preparation, and fees related to refund anticipation loans (“RALs”). Segment revenues constituted 50% of our consolidated revenues for fiscal years 2004 and 2003, and 56% for fiscal year 2002.

Retail income tax return preparation and related services is our original business. These services are provided by tax professionals via a system of retail offices operated directly by us or by franchisees. In addition to our retail offices, we offer a number of digital tax preparation alternatives.

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H&R BLOCK – Form 10-K

TaxCut® from H&R Block enables do-it-yourself users to prepare their federal and state tax returns easily and accurately. Our software products may be purchased through third-party retail stores, direct mail or online.

Clients also have many online options: multiple versions of do-it-yourself tax preparation, professional tax review, tax advice and tax preparation through a tax professional, whereby the client completes a tax organizer and sends it to a tax professional for preparation and/or signature.

By offering professional and do-it-yourself tax preparation options through multiple channels, we can serve our clients in the manner in which they choose to be served.

We also offer clients a number of options for receiving their income tax refund, including a check directly from the Internal Revenue Service (“IRS”), an electronic deposit directly to their bank account, a refund anticipation check or a RAL.

Block Advantage. When clients have tax returns prepared by our tax professionals or online, they also receive a Block Advantage report and consultation, which provides free, personalized tax and financial-related information and guidance for use throughout the year. This report also includes a summary of their tax return. The service helps identify opportunities for clients to potentially minimize tax liability, maximize tax refunds, take advantage of new savings created by tax law changes, and, in some cases, take advantage of government and other programs that may help the client’s financial situation.

Peace of Mind Guarantee. The POM guarantee is offered to tax clients, whereby we will assume the cost, subject to certain limits, of additional taxes owed by a client resulting from errors attributable to one of our tax professionals. The POM program has a per client cumulative limit of $5,000 in additional taxes assessed with respect to the federal, state and local tax returns we prepare for the taxable year covered by the program. There is an additional charge for the POM guarantee, except at H&R Block Premium offices.

RALs. RALs are offered to our tax clients by a designated bank through a contractual relationship with Household Tax Masters, Inc. (“Household”). An eligible electronic filing client may apply for a RAL at one of our offices. After meeting certain eligibility criteria, clients are offered the opportunity to apply for a loan from Imperial Capital Bank (“Imperial”) in amounts up to $7,000 based upon their anticipated federal income tax refund. We simultaneously transmit the income tax return information to the IRS and the lending bank. Within a few days or less after the filing date, the client receives a check in the amount of the loan, less the bank’s transaction fee, our tax return preparation fee, a system administration fee, if applicable, and/or other fees for client-selected services. Additionally, qualifying electronic filing clients are eligible to receive their RAL proceeds, less applicable fees, in approximately one hour after electronic filing under a product known as Instant Money. For a RAL to be repaid, the IRS directly deposits the participating client’s federal income tax refund into a designated account at the lending bank. See related discussion of RAL participations below.

Software and online clients may obtain an Electronic Refund Advance (“ERA”). ERAs are also loan products, through Imperial, that allow a client to have a RAL deposited directly into his or her bank account, usually within two days after the IRS accepts the taxpayer’s electronically filed return.

RACs. Refund Anticipation Checks (“RACs”) are offered to clients who may not wish to obtain a RAL or do not qualify for the RAL program, but who would like to either (i) receive their refund faster and do not have a bank account for the IRS to direct deposit their refund or (ii) have their tax preparation fees paid directly out of their refund. With a RAC, the IRS directly deposits the client’s refund into an account set up by the lending bank within approximately three weeks after the tax return is electronically filed. A check is then issued to the taxpayer in the amount of the refund, less the bank’s transaction fee and our tax return preparation fee, a system administration fee as applicable, and/or other fees for client-selected services. A RAC is not a loan, but allows our clients to receive their refund faster and allows their tax preparation fees to be paid directly out of their refund.

Additionally, digital tax clients can use a RAC so their federal, state and electronic filing fees can be paid directly out of their refund.

Other Services and Products. We also offer the following services and products:


	▪	If one of our tax professionals makes an error in preparing a client’s tax return or if our online service or TaxCut software causes an error that results in the assessment of any interest or penalties on additional taxes due, we guarantee payment of the interest and penalties, but not the additional taxes, under our standard guarantee.
	▪	Beginning in fiscal year 2004, if due to our error on a return the client is entitled to a larger refund or smaller tax liability than what we calculated, we will refund the tax preparation fee for that return, when claimed within the calendar year, under our maximum refund guarantee.
	▪	Our Double Check Challenge encourages taxpayers to bring previously filed returns, which were not prepared by us, to one of our offices for review at no charge. One of our tax professionals reviews the returns to determine if the taxpayer should file an amended return for a tax refund which otherwise would have been lost due to overlooked credits or deductions or other reasons.
	▪	Electronic filing reduces the amount of time required for a taxpayer to receive a federal tax refund and provides additional assurance to the client the return is mathematically accurate.
	▪	Individual retirement accounts (“Express IRAs”), invested in FDIC-insured money market accounts, are offered to tax clients as a tax savings strategy and as a retirement savings tool. HRBFA acts as custodian on the accounts, with the funds being invested at insured depository institutions paying competitive money market interest rates.
	▪	“EasyPay” revolving loans are offered by Imperial through a contractual relationship with Household to clients whose tax returns reflect a balance due to the IRS. The loan has “same as cash” terms for approximately 90 days.
	▪	We offer income tax return preparation courses to the public, which teach taxpayers how to prepare income tax returns and provide us with a source of trained tax professionals.

Online Tax Preparation. We offer a comprehensive range of tax products and services, from tax advice to complete professional and do-it-yourself tax return preparation and electronic filing, through our website at www.hrblock.com and www.taxcut.com. Our branded websites and partner sites provide clients the ability to purchase digital tax services and products. These products and services allow them to prepare their Federal and state income tax returns using the Online Tax Program (“OTP”), access tax tips, advice and tax-related news and use calculators for tax planning.

In addition to the standard OTP, we offer several other online tax products and services, including Online drop-off, OTP Premium, OTP Signature and OTP Young Adult, as well as Ask a Tax Advisor. We also offer our online and software customers ERAs as discussed above under “RALs.”

Beginning with the fiscal year 2003 tax season, we participated in the newly formed Free File Alliance. This alliance was created by the tax return preparation industry and the IRS, and allows qualified lower-income filers to prepare and file their federal return online at no charge.

– 2

Form 10-K – H&R BLOCK

Software Products. We develop and market TaxCut income tax preparation software, H&R Block DeductionPro^TM, Kiplinger’s Home and Business Attorney and Kiplinger’s WILLPower^SM software products.

TaxCut Standard Edition offers a simple step-by-step tax preparation interview, data imports from money management software and tax preparation software, calculations, completion of the appropriate tax forms, checking for errors and, for an additional charge, electronic filing.

TaxCut EZ Edition offers a simple step-by-step tax interview, data imports from money management software and tax preparation software for taxpayers qualified to file 1040EZ forms and, for an additional charge, electronic filing.

The TaxCut Deluxe Edition offers all the features in the Standard edition plus video tax advice from the experts at H&R Block and Kiplinger Personal Finance magazine, access to IRS publications, a tax and financial planning library, one free TaxCut state program after mail-in rebate and free electronic filing after mail-in rebate.

The TaxCut Premium Edition offers all the features in the Deluxe Edition, plus access to free live professional tax advice from an H&R Block tax professional after mail-in-rebate (through H&R Block’s Ask a Tax Advisor service) and a number of additional features to help users address more complex tax situations.

The TaxCut Premium for Home & Business Edition offers users all the features included in the Premium Edition, plus an additional program to help business owners complete their Federal business returns.

H&R Block DeductionPro helps taxpayers track and accurately value their charitable deductions by providing fair-market valuations for hundreds of commonly donated household goods.

Clients Served. We, together with our franchisees, served approximately 19.2 million clients in the United States during fiscal year 2004, compared to 19.4 million in fiscal year 2003 and 19.5 million in fiscal year 2002. “Clients served” includes taxpayers for whom we prepared income tax returns in offices, federal software units sold, online completed and paid federal returns and paid online state returns when no federal return was purchased, as well as taxpayers for whom we provided only paid electronic filing services. Returns for our clients constituted 15.6% of an IRS estimate of total individual income tax returns filed as of April 30, 2004, compared to 15.9% in fiscal year 2003 and 15.6% in fiscal year 2002.

Owned and Franchised Offices. All offices are open during the tax season. During the rest of the year, only a limited number of offices are open, but H&R Block personnel are available by telephone to provide service to clients throughout the entire year. A summary of our company-owned and franchise offices is as follows:





April 30,		2004		2003		2002

Company-owned offices			4,746		4,672		4,417
	Former major franchise territories(1)		459		—		—
	Company-owned shared locations(2)		947		607		600

Total company-owned offices			6,152		5,279		5,017
	Franchise offices		3,374		3,398		3,373
	Former major franchise territories(1)		—		529		524
	Franchise shared locations(2)		325		95		101

Total franchise offices			3,699		4,022		3,998
Total offices			9,851		9,301		9,015

⁽¹⁾ Impact of company-owned offices in former major franchise territories that commenced operations during fiscal year 2004.

⁽²⁾ Shared locations include offices located within Wal-Mart, Sears or other third-party businesses.

In addition to our regular offices, we offer tax return preparation services and products at H&R Block Premium offices in the United States. Appealing to taxpayers with more complex returns, H&R Block Premium stresses the convenience of appointments, year-round tax service from the same tax professional and private office interviews. The number of H&R Block Premium offices in fiscal year 2004 was 405, compared to 427 and 446 in fiscal years 2003 and 2002, respectively. In fiscal year 2004, the number of H&R Block Premium clients was 455,000 compared to 504,000 and 559,000 for fiscal years 2003 and 2002, respectively.

Offices in shared locations include 742 offices in Sears stores operated as “H&R Block at Sears” and 553 offices operated in Wal-Mart stores. We are a party to license agreements with both Sears and Wal-Mart relating to the operation in these locations throughout the United States. The Sears license agreement expires on December 31, 2004 and the Wal-Mart agreement expires on May 30, 2005, both subject to termination rights.

We have primarily granted two types of franchises — franchises, formerly called “satellite” franchises, and major franchises. Our franchise arrangements provide us with certain rights designed to protect our brand; however, these arrangements do not provide us with the right to make significant decisions regarding franchise activities or control over the day-to-day operations of the franchise.

Major franchisees cover larger cities and counties and provide for payment of franchise royalties based upon a percentage of gross revenues of their offices. At the end of fiscal year 2004, we only have one remaining major franchisee. Under the agreements, we granted to each franchisee the right to use the name “H&R Block” and provided a policy and procedure manual and other supervisory services. We offer to sell furniture, signs, advertising materials, office equipment and supplies to major franchisees. Each major franchisee selects and trains the employees for its office or offices. Since March 1993, HRB Royalty, Inc. has been the franchisor under the major franchise agreements.

We have also granted other franchises in smaller localities. These franchisees receive signs, designated equipment, specialized forms, local advertising, initial training, and supervisory services, and consequently, pay us a higher percentage of gross tax return preparation and related service revenues as a franchise royalty than do major franchisees. Many of our franchises are located in cities with populations of 15,000 or less. Some major franchisees also grant franchises to sub-franchisees in their respective areas. Of the total 3,699 franchise offices in fiscal year 2004, 304 were operated by major franchisees, 230 were operated by franchisees of major franchisees and 3,165 were operated by other franchisees.

It has always been our policy to grant tax return preparation franchises to qualified persons without an initial franchise fee, although we do require a deposit to secure compliance with franchise contracts.

From time to time, we have acquired the territories of existing franchisees and other tax return preparation businesses, and will continue to do so if future conditions warrant and satisfactory terms can be negotiated.

During fiscal year 2000, we placed most of our major franchises on notice that we would not be renewing their respective franchise agreements as of the next renewal date. The related major franchise agreements accordingly expired in fiscal year 2004, and we began operating the tax preparation businesses as company-owned operations in the former major franchise territories. The major franchise agreements required us to pay the franchisee a “fair and equitable price” for the franchise business. During fiscal year 2004, we made payments of $243.2 million related to the acquisition of assets and stock in the franchise territories of ten of our former major franchisees. Two former major franchises entered into new franchise agreements. One franchisee is continuing litigation

3 –

H&R BLOCK – Form 10-K

challenging the post-expiration restrictive covenants and also disputing the payment due under the franchise agreement terms.

RAL Participations and 2003 Tax Season Waiver. Since July 1996, we have been a party to agreements with Household and others to participate in RALs provided by a lending bank to H&R Block tax clients. The 1996 agreement was amended and restated in January 2003 and again in June 2003. In the June 2003 agreement, we obtained the right to purchase a 49.9% participation interest in RALs obtained through company-owned offices and a 25% interest in RALs obtained through major franchise offices. The current agreement continues through June 2006. Our purchases of the participation interests are financed through short-term borrowings, and we bear all of the credit risk associated with our interests in the RALs. Revenue from our participation is calculated as the rate of participation multiplied by the fee paid by the borrower to the lending bank. During fiscal year 2002, we participated in RALs in substantially the same manner as the current year. Our RAL participation revenue was $168.4 in fiscal year 2004 and $160.0 million in fiscal year 2002.

In January 2003, we entered into an agreement with Household, whereby we waived our right to purchase any participation interests in and to receive fees related to RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights, we received a series of payments from Household, subject to certain adjustments based on delinquency rates for the 2003 tax season. We recorded revenues totaling $138.2 million during fiscal year 2003. The initial payments were recognized as revenue over the waiver period. We recorded an additional $6.5 million in revenues in fiscal year 2004. The waiver agreement only covered the 2003 tax season.

Seasonality of Business. Because most of our clients file their tax returns during the period from January through April of each year, substantially all of our revenues from income tax return preparation and related services and products are received during this period. As a result, our tax segment generally operates at a loss through the first two quarters of the fiscal year. Historically, these losses primarily reflect wages of year-round personnel, training of tax professionals, rental and furnishing of retail tax offices, and other costs and expenses relating to preparation for the upcoming tax season. Additionally, the tax business is affected by national economic conditions and unemployment rates.

Competitive Conditions. The tax return preparation and electronic filing businesses are highly competitive. There are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services. Many tax return preparation firms and many firms not otherwise in the tax return preparation business are involved in providing electronic filing and RAL services to the public. Commercial tax return preparers and electronic filers are highly competitive with regard to price, service and reputation for quality. In terms of the number of offices and personal tax returns prepared in offices, online and via our software, we are the largest company providing direct tax return preparation in the United States. We are also, in terms of the number of offices and tax returns electronically filed in fiscal year 2004, the largest provider of electronic filing services in the United States.

The Digital Tax Solutions businesses compete with a number of companies. Intuit, Inc. is the dominant supplier of tax preparation software and is also our primary competitor in the online tax preparation market. There are many smaller competitors in the online market, as well as free state sponsored online filing programs.

Government Regulation. Primary efforts toward the regulation of commercial tax return preparers have historically been made at the federal level. Federal legislation requires income tax return preparers to, among other things, set forth their signatures and identification numbers on all tax returns prepared by them, and retain all tax returns prepared for three years. Federal laws also subject income tax return preparers to accuracy-related penalties in connection with the preparation of income tax returns. Preparers may be prohibited from further acting as income tax return preparers if they continuously and repeatedly engage in specified misconduct. With certain exceptions, the Internal Revenue Code also prohibits the use or disclosure by income tax return preparers of certain income tax return information without the prior written consent of the taxpayer. In addition, the Gramm-Leach-Bliley Act and Federal Trade Commission regulations adopted thereunder require income tax preparers to adopt and disclose consumer privacy policies, and provide consumers a reasonable opportunity to “opt out” of having personal information disclosed to unaffiliated third parties for marketing purposes. Some states have adopted or proposed strict “opt-in” requirements in connection with use or disclosure of consumer information.

We believe the federal legislation regulating commercial tax return preparers and consumer privacy has not had and will not have a material adverse effect on the operations of H&R Block. In addition, no present state statutes of this nature have had a material adverse effect on our business. However, we cannot predict what the effect may be of the enactment of new statutes or adoption of new regulations.

The federal government regulates the electronic filing of income tax returns in part by requiring individuals and businesses to be accepted into the electronic filing program. Once accepted, electronic filers must comply with all publications and notices of the IRS applicable to electronic filing, provide certain information to the taxpayer, comply with advertising standards for electronic filers, and be subjected to possible monitoring by the IRS, penalties for disclosure or use of income tax return preparation and other preparer penalties, and suspension from the electronic filing program. States that have adopted electronic filing programs for state income tax returns have also enacted laws regulating electronic filers and the advertising and offering of electronic filing services.

Federal statutes and regulations also regulate an electronic filer’s involvement in RALs. Electronic filers must clearly explain the RAL is a loan and not a substitute for or a quicker way of receiving an income tax refund. Federal laws place restrictions on the fees an electronic filer may charge in connection with RALs. In addition, some states and localities have enacted laws and adopted regulations for RAL facilitators and/or the advertisement and offering of RALs. There are also many states that have statutes regulating, through licensing and other requirements, the activities of brokering loans, providing credit services and offering “credit repair” services to consumers for a fee (“Loan Activity Statutes”). We believe the procedures under which we facilitate RALs are structured so our activities are not included within the scope of the activities regulated by these Loan Activity Statutes. There can be no assurances, however, that states with these Loan Activity Statutes will not contend successfully that these statutes apply to the RAL business and that we will need to become licensed under the Loan Activity Statutes, otherwise comply with statutory requirements, or modify procedures so that the Loan Activity Statutes are inapplicable.

Many states have statutes requiring the licensing of persons offering contracts of insurance. We have received from certain state insurance regulators inquiries about our POM guarantee program and the applicability of the state insurance statutes. In states where the inquiries are closed, the regulators affirmed our position that the POM guarantee is not a contract of insurance and is therefore not subject to state insurance licensing laws. In the few states where inquiries are pending, we believe there are no insurance laws under which the POM guarantee constitutes a contract of insurance. There can be no assurances, however, that the product, or other similar products we may offer in the future, will not be scrutinized as potential insurance products and held to be subject to various insurance laws and regulations.

Many of our income tax courses are regulated and licensed in select states. Failure to obtain a tax school license could affect our revenues and limit our

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Form 10-K – H&R BLOCK

ability to develop interest in tax preparation as a career or obtain qualified tax professionals.

We believe the federal, state and local laws and legislation regulating electronic filing, RALs and the facilitation of RALs, loan brokers, credit services, credit repair services, insurance products, and proprietary schools have not, and will not in the future, have a material adverse effect on our operations. We cannot predict, however, what the effect may be of the enactment of new statutes or the adoption of new regulations pertaining to these matters.

As noted above under “Owned and Franchised Offices,” many of the income tax return preparation offices operating in the United States under the name “H&R Block” are operated by franchisees. Certain aspects of the franchisor/franchisee relationship have been the subject of regulation by the Federal Trade Commission and by various states. The extent of regulation varies, but relates primarily to disclosures to be made in connection with the grant of franchises and limitations on termination by the franchisor under the franchise agreement. To date, no such regulation has materially affected our business. We cannot predict, however, the effect of applicable statutes or regulations that may be enacted or adopted in the future.

See discussion in “Risk Factors” for additional information.

Mortgage Operations

General. Our Mortgage Operations segment originates mortgage loans, services non-prime loans and sells and securitizes mortgage loans and residual interests in the United States. Revenues consist of proceeds from sales and securitizations of mortgage assets, accretion on residual and beneficial interests, servicing fee income and interest received on loans. Segment revenues constituted 31% of our consolidated revenues for fiscal years 2004 and 2003, and 21% for fiscal year 2002.

Prime mortgages are those that may be offered through government sponsored loan agencies. Non-prime mortgages are those that may not be offered through government-sponsored loan agencies and typically involve borrowers with impaired credit. Even though these borrowers have impaired credit, they also tend to have equity in the property that will be used to secure the loan. We offer both types of loans and conduct business through four channels:


	•	Option One’s wholesale origination channel works with brokers throughout the United States to fund mortgage loans through a national branch network. Wholesale originations represent the majority of Option One’s total loan production.
	•	Option One’s national accounts channel forms partnerships with financial institutions, including national and regional banks, to allow them to offer non-prime loans.
	•	Option One’s bulk acquisitions channel specializes in the purchase of performing non-prime mortgage loan pools.
	•	HRBMC originates residential mortgage loans directly to retail consumers.

The following table details our originations by channel for fiscal years 2004, 2003 and 2002:



(in 000s)



	2004		2003		2002

Wholesale	$	16,828,138	$	11,434,138	$	8,078,192
National accounts		2,642,944		1,814,092		1,219,080
Bulk acquisitions		679,910		411,013		160,059
Retail		3,105,021		2,918,378		1,995,842

	$	23,256,013	$	16,577,621	$	11,453,173

Option One. Option One, headquartered in Irvine, California, operates in 49 states by serving more than 32,500 mortgage brokers and through its network of 33 wholesale loan production branches and six national accounts branches.

Loan Origination. We originated $20.2 billion in non-prime mortgage loans in fiscal year 2004, compared to $13.7 billion in fiscal year 2003 and $9.5 billion in fiscal year 2002. The average non-prime loan during fiscal year 2004 had a $155,000 principal balance, compared to $146,000 in fiscal year 2003 and $127,000 in fiscal year 2002, and was secured by a first lien on a single-family residence. The weighted-average loan-to-value ratio was 78.1%, 78.7% and 78.6% in fiscal years 2004, 2003 and 2002, respectively.

Wholesale loan originations involve an independent broker who assists the borrower in completing the loan application, gathering necessary information and identifying a lender who offers a loan product best suited to the borrower’s financial needs. Brokers are free to submit an application to one or more non-prime lenders, such as Option One. No one broker originates more than 1.2% of our total non-prime production.

Each applicant completes an application, which includes information regarding his or her assets, liabilities, income, credit history, employment history and personal information. We require a credit report on each applicant from an industry recognized credit reporting company. In evaluating an applicant’s credit history, we utilize credit bureau risk scores, generally known as a FICO score, which is a statistical ranking of likely future credit performance developed by Fair, Isaac & Company and provided by the three national credit data repositories. Our weighted average FICO score on our non-prime production was 608 and 604 for the years ended April 30, 2004 and 2003, respectively. Qualified independent appraisers are required to appraise mortgaged properties that are used to secure mortgage loans.

Upon receipt of an application from a broker, a credit report and an appraisal report, one of our branch offices processes and underwrites the loan. Our underwriting guidelines require mortgage loans be underwritten in a standardized procedure that complies with federal and state laws and regulations. The guidelines are primarily intended to assess the value of the mortgaged property, evaluate the adequacy of the property as collateral for the mortgage loan, and assess the creditworthiness of the related borrower. Based upon this assessment, we advise the broker whether the loan application meets our underwriting guidelines and product description by issuing a loan approval or denial. In some cases, we issue a “conditional approval,” which requires the submission of additional information or clarification. The mortgage loans are underwritten with a view toward resale in the secondary market.

Sale and Securitization of Loans. Substantially all non-prime mortgage loans we originate are sold daily to qualifying special purpose entities (“Trusts”). See discussion of our loan sale and securitization process in Item 7, under the heading “Off-Balance Sheet Financing Arrangements.”

Servicing. Mortgage loan servicing involves collecting and remitting mortgage loan payments, making required advances, accounting for principal and interest, holding escrow for payment of taxes and insurance and contacting delinquent borrowers. We receive loan servicing fees monthly over the life of the mortgage loans. We only service non-prime mortgage loans. At the end of fiscal year 2004, we serviced 324,364 loans totaling $45.3 billion, compared to 246,463 loans totaling $31.3 billion at April 30, 2003 and 209,594 loans totaling $23.8 billion at April 30, 2002.

5 –

H&R BLOCK – Form 10-K

The following table summarizes our servicing portfolio by origin and includes related mortgage servicing rights (“MSRs”) and the rate we earn on each type of servicing as of April 30, 2004:

(dollars in 000s)

Type of servicing

Principal Balance

MSR Balance

Rate Earned

Originated

36,131,752

112,800

0.43%

Purchased

353,576

1,021

0.50%

Sub-servicing

8,782,775

–

0.30%

Total

45,268,103

113,821

0.41%

When non-prime loans are subsequently sold or securitized, we generally retain the right to service the loans. The resulting MSR assets are recorded at allocated carrying amounts based on relative fair values when the loans are sold. The fair values of MSRs are determined based on the present value of estimated future cash flows related to servicing loans. Assumptions used in estimating the value of MSRs are discussed in Item 7, under “Critical Accounting Policies.” In addition to servicing loans we originate, we also service non-prime loans originated by other lenders. MSRs are recorded only in conjunction with our originated or purchased loan servicing portfolio.

Geographic Distribution. The following table details the percent of origination volume of our non-prime loans for fiscal year 2004 and our loan origination branches by state.





State	Percent of Volume		Number of Branches

California		18.8%		5
New York		14.4%		2
Massachusetts		10.2%		0
Florida		6.4%		4
New Jersey		5.1%		1
Texas		4.5%		3
Illinois		3.6%		3
Virginia		2.9%		2
Connecticut		2.6%		1
Pennsylvania		2.6%		1
Michigan		2.3%		1
Georgia		2.2%		2
Colorado		2.1%		1
Rhode Island		2.0%		2
Ohio		1.9%		2
North Carolina		1.7%		1
Arizona		1.5%		2
New Hampshire		1.3%		1
Washington		1.3%		1
Nevada		1.0%		1
Wisconsin		.8%		1
Other		10.8%		0

H&R Block Mortgage Corporation. HRBMC, a wholly-owned subsidiary of Option One, is a retail mortgage lender for prime, non-prime and government loans and is licensed to conduct business in all 50 states. HRBMC is an approved seller/servicer for Fannie Mae and Freddie Mac and is HUD authorized to originate and underwrite FHA and VA mortgage loans. Through HRBMC, we originated retail mortgage loans from various sales channels, including 41 loan production offices and nine regional offices in 26 states in fiscal year 2004. During fiscal year 2004, approximately 49% of HRBMC’s loans were made to clients of our other affiliates compared to 54% in fiscal year 2003.

We originated $3.1 billion in retail mortgage loans in fiscal year 2004, compared to $2.9 billion in fiscal year 2003 and $2.0 billion in fiscal year 2002. In fiscal year 2004, we originated $1.3 billion in prime loans and $1.8 billion in non-prime loans.

Substantially all of our retail prime mortgage loans are sold to Countrywide Home Loans, Inc. (“Countrywide”). The majority of mortgage loans sold to Countrywide are underwritten through an automated system under which Countrywide assumes our representations and warranties, which comply with Countrywide’s underwriting guidelines. This agreement allows us to achieve improved execution due to price, efficiencies in delivery, and elimination of redundancies in operations. We do not retain servicing rights related to the prime mortgage loans we sell. Non-prime mortgage loans are sold to Option One. See discussion of our prime warehouse line in Item 7, under “Capital Resources and Liquidity by Segment.”

Competitive Conditions. Both the prime and non-prime sectors of the residential mortgage loan market are highly competitive. The principal methods of competition are in service, product differentiation and price. There are a substantial number of companies competing in the residential loan market, including mortgage banking companies, commercial banks, savings associations, credit unions and other financial institutions. There are also numerous companies competing in the business of servicing non-prime loans. No one firm is a dominant supplier of prime and non-prime mortgage loans or a dominant servicer of non-prime loans. We believe we are one of the top originators and servicers of non-prime loans in the industry.

Seasonality of Business. Residential mortgage volume is not subject to significant seasonal fluctuations. The mortgage business is cyclical, however, and directly affected by national economic conditions, trends in business and finance and is impacted by changes in interest rates.

Government Regulation. Mortgage loans purchased, originated and/or serviced are subject to federal laws and regulations, including:


	•	The federal Truth-in-Lending Act, as amended, and Regulation Z promulgated thereunder;
	•	The Equal Credit Opportunity Act, as amended, and Regulation B promulgated thereunder;
	•	The Fair Credit Reporting Act, as amended;
	•	The federal Real Estate Settlement Procedures Act, as amended, and Regulation X promulgated thereunder;
	•	The Home Ownership Equity Protection Act (“HOEPA”);
	•	The Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended;
	•	The Home Mortgage Disclosure Act and Regulation C promulgated thereunder;
	•	The federal Fair Housing Act;
	•	The Gramm-Leach-Bliley Act and regulations adopted thereunder; and
	•	Certain other laws and regulations.

Under environmental legislation and case law applicable in certain states, it is possible that liability for environmental hazards in respect of real property may be imposed on a holder of a deed to the property, which may impair the underlying collateral.

Applicable state laws generally regulate interest rates and other charges pertaining to non-prime loans. These states also require certain disclosures and require originators of certain mortgage loans to be licensed unless an exemption is available. In addition, most states have other laws, public policies and general principles of equity relating to consumer protection, unfair and deceptive practices, and practices that may apply to the origination, servicing and collection of mortgage loans.

In recent years, there has been a noticeable increase in state, county and municipal statutes, ordinances and regulations that prohibit or regulate so-called “predatory lending” practices. Predatory lending statutes such as HOEPA, regulate “high-cost loans,” which are defined separately by each state, county or municipal statute, regulation or ordinance, but generally include mortgage loans

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Form 10-K – H&R BLOCK

with interest rates exceeding a (1) specified margin over the Treasury Index for a comparable maturity, or (2) designated percentage of points and fees. Statutes, ordinances and regulations that regulate high-cost loans generally prohibit mortgage lenders from engaging in certain defined practices, or require mortgage lenders to implement certain practices, in connection with any mortgage loans that fit within the definition of a high-cost loan. We believe that we do not originate loans falling under the definition of high-cost loans under any law.

Certain state laws restrict or prohibit prepayment penalties on mortgage loans, and we relied on the federal Alternative Mortgage Transactions Parity Act (“Parity Act”) and related rules issued in the past by the Office of Thrift Supervision (“OTS”) to preempt state limitations on prepayment penalties. The Parity Act was enacted to extend to financial institutions, other than federally chartered depository institutions, the federal preemption that federally chartered depository institutions enjoy. However, in September 2002, the OTS released a new rule that reduced the scope of the Parity Act preemption effective July 1, 2003 and, as a result, we can no longer rely on the Parity Act to preempt state restrictions on prepayment penalties. The elimination of this federal preemption requires compliance with state restrictions on prepayment penalties. These restrictions prohibit us from charging any prepayment penalty in six states and restrict the amount or duration of prepayment penalties that we may impose in an additional eleven states. This places us at a competitive disadvantage relative to financial institutions that continue to enjoy federal preemption of such state restrictions. Such institutions can charge prepayment penalties without regard to state restrictions and, as a result, may be able to offer loans with interest rate and loan fee structures that are more attractive than the interest rate and loan fee structures that we are able to offer.

See discussion in “Risk Factors” for additional information.

Business Services

General. Our Business Services segment offers middle-market companies accounting, tax and consulting services. We have continued to expand the services we have to offer our clients by adding wealth management, retirement resources, payroll services, corporate finance and financial process outsourcing. Segment revenues constituted 12% of our consolidated revenues for fiscal years 2004 and 2003, and 13% for fiscal year 2002.

This segment consists primarily of RSM, which was formed in August 1999 to acquire substantially all of the non-attest assets of McGladrey & Pullen, LLP (“M&P”). RSM has more than 90 offices in 23 states and offers services in 18 of the top 25 U.S. markets.

Services are also provided by the following wholly-owned subsidiaries:


	▪	RSM McGladrey Retirement Resources administers retirement plans, helps clients design the best plan for their needs, and also provides retirement plan investment advice, year-end compliance, tax reporting and consulting.
	▪	RSM EquiCo, Inc. is an investment banking firm specializing in business valuations, acquisitions and divestitures for private middle-market businesses.
	▪	RSM McGladrey Employer Services, Inc. (formerly known as “MyBenefitSource, Inc.”) is a provider of payroll and benefits administration services to middle-market businesses.
	▪	PDI Global, Inc. provides marketing, communications and visibility programs, tax and financial planning guides, and marketing and management consulting services to accountants, consultants, lawyers, banks, insurers, and other financial service providers.

Relationship with McGladrey & Pullen, LLP. By regulation, we cannot provide audit and attest services. M&P, a public accounting firm, provides audit and review services and other services in which M&P issues written reports on client financial statements to their clients. Through an administrative services agreement with M&P, we provide accounting, payroll, human resources and other administrative services to M&P and receive a management fee for these services. M&P is a limited liability partnership with its own governing body and, accordingly, is a separate legal entity and is not an affiliate. Some partners and employees of M&P are also our employees.

Seasonality of Business. Revenues for this segment are largely seasonal in nature, with peak revenues occurring during January through April.

Competitive Conditions. The accounting and consulting business is highly competitive. The principal methods of competition are price, service and reputation for quality. There are a substantial number of accounting firms offering similar services at the international, national, regional and local levels. As our focus is on middle-market businesses, our principal competition is with regional accounting firms. We believe we have a competitive advantage in the geographic areas in which we are currently located based on the breadth of services we can offer to these clients above and beyond what a traditional accounting firm can offer.

Government Regulation. Many of the same federal and state regulations relating to tax preparers and the information concerning tax reform discussed above in the “Government Regulation” section of “U.S. Tax Operations” apply to the Business Services segment as well, except accountants are not subject to the same prohibition on the use or disclosure of certain income tax return information as tax professionals are. Accounting firms are also subject to state and federal regulations governing accountants, auditors and financial planners. Various legislative and regulatory proposals have been made relating to auditor independence and accounting oversight, among others. Some of these proposals, if adopted, could have an impact on RSM’s operations. We believe current state and federal regulations and known legislative and regulatory proposals do not and will not have a material adverse effect on our operations, but we cannot predict what the effect of future legislation, regulations and proposals may be.

Independence rules established by the SEC, American Institute of Certified Public Accountants (“AICPA”) and the Public Company Accounting Oversight Board (“PCAOB”) apply to M&P as a public accounting firm. In applying its auditor independence rules, the SEC views us and M&P as a single entity and requires that we abide by its independence rules for M&P to be deemed independent of any SEC audit client. The SEC regards any financial interest or business relationship we have with a client of M&P as a financial interest or business relationship between M&P and the client for purposes of applying its auditor independence rules.

We and M&P have jointly developed and implemented policies, procedures and controls designed to safeguard M&P’s independence and integrity as an audit firm in compliance with applicable regulations and professional responsibilities. These policies, procedures and controls are designed to monitor and prevent violations of applicable independence rules and include, among others, (i) informing our officers, directors and other members of management concerning auditor independence matters, (ii) procedures for monitoring securities ownership, (iii) communicating with SEC audit clients regarding the SEC’s interpretation and application of relevant independence rules and guidelines, and (iv) requiring RSM employees to comply with M&P’s independence and relationship policies (including M&P’s independence compliance questionnaire procedures). We believe these policies, procedures and controls are adequate, although there can be no assurances they will ensure compliance with applicable independence rules and requirements. Any noncompliance could cause M&P to lose the ability to perform audits of financial statements filed with the SEC.

See discussion in “Risk Factors” for additional information.

7 –

H&R BLOCK – Form 10-K

Investment Services

General. Our Investment Services segment provides brokerage services and investment planning through HRBFA. Products and services offered to our customers include traditional brokerage products, as well as annuities, insurance, fee-based accounts, online account access, equity research and focus lists, model portfolios, asset allocation strategies, and other investment tools and information. Segment revenues constituted approximately 5% of our consolidated revenues for fiscal years 2004 and 2003 and 8% for fiscal year 2002.

HRBFA is a registered broker-dealer with the SEC and is a member of the New York Stock Exchange (“NYSE”), other national securities exchanges, SIPC, and the National Association of Securities Dealers, Inc. (“NASD”). HRBFA is also a registered investment advisor, offering financial advice with traditional products.

Our integration of investment advice with the tax client base allows us to maximize an already established relationship. In the past two years, new product offerings have allowed us to shift our focus from a transaction-based client relationship to a more advice-based focus.

Customer trades in fiscal year 2004 totaled approximately 1.5 million, compared to approximately 1.2 million in fiscal year 2003 and approximately 1.5 million in fiscal year 2002. We had 863,116 active accounts at April 30, 2004, compared to 752,903 at 2003 and 695,355 at 2002. Margin balances decreased to an average of $545.0 million for fiscal year 2004 from $577.0 million and $1.0 billion for fiscal years 2003 and 2002, respectively.

Financial Services Offerings. We provide a full range of financial services to our clients in the United States.

As previously discussed in “U.S. Tax Operations,” we offer our tax clients the opportunity to open an Express IRA through HRBFA as a part of the tax return preparation process. Clients funded approximately 215,000 Express IRAs during tax season 2004, approximately 126,000 in tax season 2003 and approximately 130,000 in tax season 2002.

We also offer account holders a service that makes it possible for clients to transact all of their investment activities from one convenient, flexible brokerage account with cash management features. The cash management features include no-minimum checking, unlimited check writing, a credit interest program, a variety of tax-exempt money market fund options, an FDIC insured deposit account, a VISA® Gold ATM/check card with a 1% cash rebate on card purchases and an airline miles program, one consolidated monthly statement and a year-end account summary. HRBFA offers college savings products – called 529 Plans – through state-sponsored investment programs that allow clients to make tax-free withdrawals for qualified education expenses and a comprehensive line of insurance products. Clients may also open professionally managed accounts.

We act as a dealer in fixed income markets including corporate and municipal bonds, various U.S. Government and U.S. Government Agency securities and certificates of deposit.

Financial Advisors and Their Compensation. Our financial advisors receive compensation based on several different factors. They receive commissions from individual customer transactions as well as a percentage of quarterly fees for certain products based on asset levels. In addition, they can receive salaries, draws against commissions and bonuses based on the level of assets they transfer and production achieved.

Key to our future success is retention of our financial advisors and recruitment of new advisors. One of our key initiatives is to build revenues through the addition of financial advisors. During fiscal years 2004 and 2003, we added 255 and 260 advisors, respectively. These additions were offset by attrition of 230 and 487 advisors, respectively. Our overall retention rate for fiscal year 2004 was approximately 77%, but the retention rate for our more experienced, higher-producing advisors was approximately 93%. The retention and recruitment of experienced advisors will continue to be a key initiative in fiscal year 2005.

Advisor productivity by recruitment class is as follows:



	(dollars in 000s)



	Revenue		Total Production
	Per Advisor		Revenues

Fiscal year 2004:
Pre-2003 class	$	216	$	135,949
2003 recruits		84		17,717
2004 recruits		61		7,664

Fiscal year 2003:
Pre-2003 class	$	135	$	126,176
2003 recruits		34		4,604

Licensed Referral Tax Professional Program. The Licensed Referral Tax Professional (“LRTP”) program encourages a cooperative relationship between Investment Services and U.S. Tax Operations by helping tax professionals become licensed to sell securities, teaming them with a financial advisor and providing a commission to the LRTP for business referred to Investment Services. The LRTP program began in fiscal year 2003 and, as of April 30, 2004 there were 461 LRTPs with total customer assets of $72 million compared to 126 LRTPs with total customer assets of $2.0 million as of April 30, 2003. We will continue to increase the number of LRTPs in the coming year.

Integrated Online Services. We have an online investment center on our website at www.hrblock.com. Online users have the opportunity to open accounts, obtain research, create investment plans, buy and sell securities, and view the status of their accounts. Through April 2004, over 145,000 accounts had been web enabled, compared to approximately 143,000 through April 2003 and April 2002. In fiscal year 2004, 229,211 securities transactions were completed online compared to 126,055 in fiscal year 2003, and 107,308 in fiscal year 2002.

Office Locations. HRBFA is authorized to do business as a broker-dealer in all 50 states and the District of Columbia. At the end of fiscal year 2004, we operated approximately 358 branch offices, compared to approximately 600 offices in fiscal years 2003 and 2002. The reduced number of branch offices is primarily due to the evolution of our tax-partnering program, which now locates financial advisors with tax professionals. Some HRBFA offices offer, in addition to financial products and services, tax preparation and mortgage services year-round to clients.

We believe the existence of retail locations contributes to our growth and client satisfaction. The existence of retail locations generally results in an increase in unsolicited customer transactions in the geographic area near the office. Many clients prefer to conduct business in person in local offices rather than in distant offices or online. Clients may also use retail locations to deliver checks and securities.

Competitive Conditions. HRBFA competes directly with a broad range of companies seeking to attract consumer financial assets, including full-service brokerage firms, discount and online brokerage firms, mutual fund companies, investment banking firms, commercial and savings banks, insurance companies and others. The financial services industry has become considerably more concentrated as numerous securities firms have been acquired by or merged into other firms. Some of these competitors have greater financial resources than HRBFA and offer additional financial products and services. In addition, we expect competition from domestic and international commercial banks and larger securities firms to continue to increase as a result of legislative and regulatory initiatives in the U.S., including the passage of the Gramm-Leach-Bliley Act in November 1999 and the implementation of the U.S.A. Patriot Act in April 2002. These initiatives strive to remove or relieve certain restrictions on mergers between commercial banks and other types of financial services providers and

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Form 10-K – H&R BLOCK

extend privacy provisions and anti-money laundering procedures across the financial services industry.

Discount brokerage firms and online-only financial services providers compete vigorously with HRBFA with respect to commission charges. Full-commission brokerage firms also offer more product breadth, discounted commissions and online services to selected retail brokerage customers. Additionally, some competitors in both the full-commission and discount brokerage industries have substantially increased their spending on advertising and direct solicitation of customers.

Competition in the online trading business has become similarly intense as recent expansion and customer acceptance of conducting financial transactions online has attracted new brokerage firms to the market.

We compete based on quality of service, breadth of products and services offered, prices, accessibility through delivery channels, technological innovation and expertise and integration with our tax services relationships.

Seasonality of Business. The Investment Services segment does not, as a whole, experience significant seasonal fluctuations. The securities business is cyclical, however, and directly affected by national and global economic and political conditions, trends in business and finance and changes in the conditions of the securities markets in which our clients invest.

Government Regulation. The securities industry is subject to extensive regulation covering all aspects of the securities business, including registration of our offices and personnel, sales methods, the acceptance and execution of customer orders, the handling of customer funds and securities, trading practices, capital structure, record keeping policies and practices, margin lending, execution and settlement of transactions, the conduct of directors, officers and employees, and the supervision of employees. The various governmental authorities and industry self-regulatory organizations that have supervisory and regulatory jurisdiction over us generally have broad enforcement powers to censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees who violate applicable laws or regulations.

The SEC is the federal agency responsible for the administration of the federal securities laws. The SEC has delegated much of the regulation of broker-dealers to self-regulatory organizations, principally the Municipal Securities Rulemaking Board, NASD, Inc. and the NYSE, which has been designated as HRBFA’s primary regulator. These self-regulatory organizations adopt rules, subject to SEC approval, governing the industry and conduct periodic examinations of HRBFA’s brokerage operations and clearing activities. Securities firms are also subject to regulation by state securities administrators in states in which they conduct business.

As a registered broker-dealer, HRBFA is subject to the Net Capital Rule (Rule 15c3-1) promulgated by the SEC and adopted through incorporation by reference in NYSE Rule 325. The Rule, which specifies minimum net capital requirements for registered brokers and dealers, is designed to measure the financial soundness and liquidity of a broker-dealer and requires at least a minimum portion of its assets be kept in liquid form. Additional discussion of this requirement and HRBFA’s calculation of net capital is located in Item 7, under “Capital Resources and Liquidity by Segment.”

See discussion in “Risk Factors” for additional information.

International Tax Operations

General. Our International Tax Operations segment provides tax return preparation, electronic filing and related services to the general public, principally in Canada, Australia and the United Kingdom. We also offer tax preparation of U.S. tax returns and related services in company-owned and franchise offices in nine countries and U.S. Territories. We offer electronic filing of U.S. income tax returns at offices located in Europe, and the electronic filing of Canadian, Australian, and United Kingdom income tax returns at H&R Block offices in their respective countries. Segment revenues constituted approximately 2% of our consolidated revenues for fiscal years 2004, 2003 and 2002.

This segment served 2.3 million taxpayers in each of fiscal years 2004, 2003 and 2002. Returns prepared at 1,334 company-owned and franchised offices in countries outside of the United States in fiscal year 2004 constituted 12.8% of the total returns prepared by H&R Block, compared to 12.4% in fiscal year 2003 and 11.9% in fiscal year 2002. A summary of our company-owned and franchise offices in countries outside the United States is as follows:





April 30,	2004		2003		2002

Canada		891		910		955
Australia		378		362		362
Other		65		62		59

Total offices		1,334		1,334		1,376

Canadian Operations. H&R Block Canada, Inc. (“Block Canada”) and its franchisees prepared approximately 1.7 million Canadian regular and discounted returns filed with Revenue Canada in each of fiscal years 2004, 2003 and 2002. Of the 891 offices in Canada in fiscal year 2004, 489 were owned and operated by us and 402 were owned and operated by franchisees. We operated 133 offices in department stores in Canada in fiscal year 2004, including 79 offices in Sears’ facilities.

We offer a refund discount (“CashBack”) program to our customers in Canada. Canadian law specifies the procedures we must follow in conducting the program. In accordance with current Canadian regulations, if a customer’s tax return indicates the customer is entitled to a tax refund, we issue a check to the client. The client assigns to us the full amount of the tax refund to be issued by Revenue Canada and the refund check is then sent by Revenue Canada directly to us. In accordance with the law, the discount is deemed to include both the tax return preparation fee and the fee for tax refund discounting. This program is financed by short-term borrowings. The number of returns discounted under the CashBack program in fiscal year 2004 was approximately 552,000, compared to 531,000 in fiscal year 2003 and 525,000 in fiscal year 2002.

During fiscal year 2004, we contracted with Intuit Canada, Inc. to provide online tax preparation services under the H&R Block brand to Canadian consumers. Users could print and mail their return, or download their return and file electronically.

Australian Operations. The number of returns prepared by our company-owned and franchise offices in Australia, was approximately 519,000 in fiscal year 2004, compared to 505,000 in fiscal year 2003 and 489,000 in fiscal year 2002. Of the 378 offices in Australia in fiscal year 2004, 278 were company-owned and 100 were franchise offices.

Seasonality of Business. Revenues in this segment are seasonal in nature with peak revenues occurring during the applicable tax season, as follows:

Competitive Conditions. The tax return preparation business is highly competitive, with a substantial number of firms offering tax preparation services. Commercial tax return preparers are highly competitive with regard to price,

9 –

H&R BLOCK – Form 10-K

service and reputation for quality. We believe we operate the largest tax return preparation businesses in Canada and Australia.

Government Regulation. We seek to determine the applicability of all government and self-regulatory organization statutes, ordinances, rules and regulations in the countries in which we operate (collectively, “Foreign Laws”) and to comply with these Foreign Laws. We cannot predict what effect the enactment of future Foreign Laws, changes in interpretations of existing Foreign Laws, or the results of future regulator inquiries regarding the applicability of Foreign Laws may have on our segments, any particular subsidiary, or our consolidated financial statements.

Statutes and regulations relating to income tax return preparers, electronic filing, franchising and other areas affecting the income tax business also exist outside of the United States. In addition, the Canadian government regulates the refund discounting program in Canada, as discussed under “Canadian Operations,” above. These laws have not materially affected the International Tax Operations segment.

See discussion in “Risk Factors” for additional information.

Service Marks, Trademarks and Patents

We have made a practice of selling our products and services under service marks and trademarks and of obtaining protection for these by all available means. Our service marks and trademarks are protected by registration in the United States and other countries where our products and services are marketed. We consider these service marks and trademarks, in the aggregate, to be of material importance to our business, particularly our business segments providing products and services under the “H&R Block” brand.

We have no registered patents that are material to our business.

Employees

We have approximately 15,300 regular full-time employees. The highest number of persons we employed during the fiscal year ended April 30, 2004, including seasonal employees, was approximately 111,300.

Risk Factors

In this report, and from time to time throughout the year, we share our expectations for the Company’s future performance. The following explains the critical risk factors impacting our business and reasons actual results may differ from our expectations. This discussion does not intend to be a comprehensive list and there may be other risks and factors that may have an effect on our business.

Liquidity and Capital. We use capital primarily to fund working capital requirements, pay dividends, repurchase our shares and acquire businesses. We are dependent on the use of our off-balance sheet arrangements to fund our daily non-prime originations and the secondary market to securitize and sell mortgage loans and residual interests. See “Off-Balance Sheet Financing Arrangements” in Item 7. We are also dependent on commercial paper issuances to fund RAL participations and seasonal working capital needs. A disruption in such markets could adversely affect our access to these funds. In order to meet our future financing needs we may issue additional debt or equity securities.

Litigation. We are involved in lawsuits in the normal course of our business related to RALs, our Peace of Mind guarantee program, electronic filing of tax returns, Express IRAs, losses incurred by customers in their investment accounts, mortgage lending activities and other matters. Adverse outcomes related to litigation could result in substantial damages and could adversely affect our results of operations. Negative public opinion can also result from our actual or alleged conduct in such claims, possibly damaging our brand and adversely affecting the market price of our stock. See Item 3, “Legal Proceedings” for additional information.

Privacy of Client Information. We manage highly sensitive client information in all of our operating segments, which is regulated by law. Problems with the safeguarding and proper use of this information could result in regulatory actions and negative publicity, which could adversely affect our results of operations.

U.S. Tax Operations

Competitive Position. Increased competition for tax preparation clients in our retail offices, online and software channels could adversely affect our current market share and limit our ability to grow our client base. See clients served statistics included under “U.S. Tax Operations” in Item 7.

Refund Anticipation Loans. Changes in government regulation related to RALs could adversely affect our ability to offer RALs or our ability to purchase participation interests. Changes in IRS practices could adversely affect our ability to utilize the IRS debt indicator to limit our bad debt exposure. Changes in any of these, as well as possible litigation related to RALs, may adversely affect our results of operations.

Mortgage Operations

Competitive Position. The majority of our mortgage loan applications are submitted through a network of brokers who have relationships with many other mortgage lenders. Unfavorable changes in our pricing, service or other factors could result in a decline in our mortgage origination volume. A decline in our service ratings could adversely affect our pricing and origination volume. Increased competition among mortgage lenders can also result in a decline in coupon rates offered to our borrowers, which in turn lowers margins and could adversely affect our gains on sales of mortgage loans. Additionally, changes in legislation relating to our industry can adversely affect our competitive position.

Asset Valuation Assumptions. The valuation of residual interests and mortgage servicing rights includes many estimates and assumptions surrounding interest rates, prepayment speeds and credit losses. If actual experience differs from our estimates, we would be required to record write-ups or write-downs to the related assets, which could either positively or negatively affect our results of operations. See “Critical Accounting Policies” in Item 7.

Legislation and Regulations. Several states and cities are considering or have passed laws, regulations or ordinances aimed at curbing predatory lending and servicing practices. The federal government is also considering legislative and regulatory proposals in this regard. In general, these proposals involve lowering the existing federal HOEPA thresholds for defining a “high-cost” loan and establishing enhanced protections and remedies for borrowers who receive such loans. If unfavorable laws and regulations are passed, it could restrict our ability to originate loans if rating agencies refuse to rate our loans, loan buyers may not want to purchase loans labeled as “high-cost,” and it could restrict our ability to sell our loans in the secondary market. Accordingly, all of these items could adversely affect our results of operations.

– 10

Form 10-K – H&R BLOCK

Business Services

Alternative Practice Structure with M&P. Our relationship with M&P requires us to comply with applicable auditor independence rules and requirements. In addition, our relationship with M&P closely links our RSM McGladrey brand with M&P. If M&P were to encounter problems concerning its independence as a result of its relationship with us or if significant litigation arose concerning M&P or its services, our brand reputation and our ability to realize the mutual benefits of our relationship, such as the ability to attract and retain quality professionals, could be impaired.

Investment Services

Regulatory Environment. The broker-dealer industry has recently come under more scrutiny by both Federal and State regulators and, as a result, more focus has been placed on compliance issues. If we do not comply with these regulations, it could result in regulatory actions and negative publicity, which could adversely affect our results of operations. Negative public opinion about our industry could damage our reputation even if we are in compliance with such regulations.

Integration into the H&R Block Brand. We are working to foster an advice-based relationship with our tax clients through our retail tax office network. This advice-based relationship is key to the integration of Investment Services into the H&R Block brand and deepening our current client relationships. If we are unable to successfully integrate, it may significantly impact our ability to differentiate our business from other tax providers and grow our client base.

Availability of Reports and Other Information

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website at www.hrblock.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC.

Copies of the following corporate governance documents are posted on our website: (1) The Amended and Restated Bylaws of H&R Block, Inc., (2) The H&R Block, Inc. Corporate Governance Guidelines, (3) the H&R Block, Inc. Code of Business Ethics and Conduct, (4) the H&R Block, Inc. Audit Committee Charter, (5) the H&R Block, Inc. Governance and Nominating Committee Charter, and (6) the H&R Block, Inc. Compensation Committee Charter. If you would like a printed copy of any of these corporate governance documents, please send your request to the Office of the Secretary, H&R Block, Inc., 4400 Main Street, Kansas City, Missouri 64111.

Information contained on our website does not constitute any part of this report.

ITEM 2. PROPERTIES

We own our corporate headquarters, which are located in Kansas City, Missouri. We have leased additional office space for corporate, U. S. Tax Operations and Investment Services personnel, as necessary, in Kansas City, Missouri.

Most of our tax offices, except those in retail outlets, are operated under leases throughout the United States.

Option One’s executive offices are located in leased offices in Irvine, California. HRBMC is headquartered in leased offices in Lake Forest, California. Option One and HRBMC also lease offices for their loan origination and servicing centers and branch office operations throughout the United States.

The executive offices of HRBFA are located in leased offices in Detroit, Michigan. Branch offices are operated throughout the United States, in a combination of leased and owned facilities.

RSM’s executive offices are located in leased offices in Bloomington, Minnesota. Its administrative offices are located in leased offices in Davenport, Iowa. RSM also leases office space throughout the United States.

Our Canadian executive offices are located in a leased office in Calgary, Alberta. Our Canadian tax offices are operated under leases throughout Canada.

We will begin construction of new corporate headquarters during fiscal year 2005, which will allow us to consolidate the majority of our Kansas City-based personnel into one facility. The new building will be located in downtown Kansas City, Missouri.

All current leased and owned facilities are in good repair and adequate to meet our needs.

ITEM 3. LEGAL PROCEEDINGS

The information below should be read in conjunction with the information included in Item 8, note 20 to our consolidated financial statements.

RAL Litigation. We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). Plaintiffs in the RAL Cases have alleged, among other things, that disclosures in the RAL applications were inadequate, misleading and untimely; that the RAL interest rates were usurious and unconscionable; that we did not disclose that we would receive part of the finance charges paid by the customer for such loans; breach of state laws on credit service organizations; breach of contract; unjust enrichment; unfair and deceptive acts or practices; violations of the Racketeer Influenced and Corrupt Organizations act; violations of the Fair Debt Collection Practices Act; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program. In many of the RAL Cases, the plaintiffs seek to proceed on behalf of a class of similarly situated RAL customers, and in certain instances the courts have allowed the cases to proceed as class actions. In other cases, courts have held that plaintiffs must pursue their claims on an individual basis, and may not proceed as a class action. The amounts claimed in the RAL Cases have been very substantial in some instances.

We have successfully defended against numerous RAL Cases. Of these RAL Cases, some were dismissed on our motions for dismissal or summary judgment and others were dismissed voluntarily by the plaintiffs after denial of class certification. Other cases were settled, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”).

We believe we have meritorious defenses to the RAL Cases and we intend to defend the remaining RAL Cases vigorously. We have accrued our best estimate of the probable loss related to the RAL Cases. However, there can be no assurances as to the outcome of the pending RAL Cases individually or in the aggregate, and there can be no assurances regarding the impact of the RAL Cases on our financial statements. The following is updated information regarding the pending RAL Cases that are class actions or putative class actions:

Lynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et al., (formerly Joel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block,

11 –

H&R BLOCK – Form 10-K

Inc., Block Financial Corporation, et al.) Case No. 98 C 2178, United States District Court for the Northern District of Illinois, Eastern Division, instituted on April 18, 1998. On April 15, 2003, the District Court judge declined to approve a $25.0 million settlement of this matter, finding that counsel for the settlement plaintiffs had been inadequate representatives of the plaintiff class and failed to sustain their burden of showing that the settlement was fair. The judge subsequently appointed new counsel for the plaintiffs who filed an amended complaint and a motion for partial summary judgment. On March 29, 2004, the court either dismissed or decertified all of the plaintiffs’ claims other than part of one count alleging violations of the racketeering and conspiracy provisions of the Racketeer Influenced and Corrupt Organizations act. We intend to continue defending the case vigorously, but there are no assurances as to its outcome.

Sandra J. Basile, et al. v. H&R Block, Inc., et al, April Term 1992 Civil Action No. 3246 in the Court of Common Pleas, First Judicial District of Pennsylvania, Philadelphia County, instituted on April 23, 1993. The court decertified the class on December 31, 2003. Plaintiffs have appealed the decertification.

Levon and Geral Mitchell, et al. v. H&R Block and Ruth R. Wren, Case No. CV-95-2067, in the Circuit Court of Mobile County, Alabama, instituted on June 13, 1995. Plaintiffs’ motion for class certification was granted, and defendants have filed a notice of appeal of the certification.

Deandra D. Cummins, et al. v. H&R Block, Inc., et al., Case No. 03-C-134 in the Circuit Court of Kanawha County, West Virginia, instituted on January 22, 2003. Defendants’ motions to dismiss and to compel arbitration were heard in part in December 2003, during which the judge discontinued the hearing and ordered the parties to mediation. Mediation occurred in February 2004 during which the parties were unable to reach agreement. Defendants’ motion to dismiss and compel arbitration was subsequently denied.

Roy Carbahal, et al. v. Household International, H&R Block Tax Services, Inc. et al., Case No. 00C0626 in the United States District Court for the Northern District of Illinois, instituted on January 31, 2000. Defendants’ motion to compel arbitration was granted and the case was dismissed. Plaintiffs appealed such dismissal. On June 24, 2004, the Seventh Circuit Court of Appeals affirmed such dismissal.

Abby Thomas, et al. v. Beneficial National Bank, H&R Block, Inc., et al., Case No. 4:03-CV-00775 GTE in the United States District Court for the Eastern District of Arkansas, Western Division, instituted on August 12, 2003. Defendants moved to dismiss and compel arbitration, and plaintiffs thereafter filed an amended complaint and a motion to remand the case to state court. On December 8, 2003, the federal court denied plaintiffs’ motion to remand.

Lynn Becker v. H&R Block, Case No. CV-2004-03-1680 in the Court of Common Pleas, Summit County, Ohio, instituted on April 15, 2004. Plaintiffs filed an amended complaint on May 3, 2004, containing class allegations.

Peace of Mind Litigation. Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Civil Action 2002L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2002, as to which the court granted plaintiffs’ first amended motion for class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the defendants’ Peace of Mind program under which the applicable tax return preparation subsidiary assumes liability for the cost of additional tax assessments attributable to tax return preparation error. The plaintiffs allege that defendants’ sale of its Peace of Mind guarantee constitutes statutory fraud by selling insurance without a license, an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it and/or did not want it), and constitutes a breach of fiduciary duty. In August 2003, the court certified the following plaintiff classes: (1) all persons who were charged a separate fee for Peace of Mind by “H&R Block” or a defendant H&R Block class member from January 1, 1997 to final judgment; (2) all persons who reside in certain class states and who were charged a separate fee for Peace of Mind by “H&R Block,” or a defendant H&R Block class member, and that was not licensed to sell insurance, from January 1, 1997 to final judgment; and (3) all persons who had an unsolicited charge for Peace of Mind posted to their bills by “H&R Block” or a defendant H&R Block class member from January 1, 1997, to final judgment. Among those excluded from the plaintiff classes are all persons who received the Peace of Mind guarantee through an H&R Block Premium office and all persons who reside in Texas and Alabama. The court also certified a defendant class consisting of any entity with the names “H&R Block” or “HRB” in its name, or otherwise affiliated or associated with H&R Block Tax Services, Inc., and which sold or sells the Peace of Mind product. The trial court subsequently denied the defendants’ motion asking the trial court to certify the class certification issues for interlocutory appeal. Discovery is proceeding.

There is one other putative class action pending against us in Texas that involves the Peace of Mind guarantee. This case is being tried before the same judge that presided over the Texas RAL Settlement and involves the same plaintiffs attorneys that are involved in the Marshall litigation in Illinois and substantially similar allegations. No class has been certified in this case.

We believe the claims in these Peace of Mind actions are without merit and we intend to defend them vigorously. However, there can be no assurances as to the outcome of these pending actions individually or in the aggregate, and there can be no assurances on the impact of these actions on our consolidated results of operations or financial position.

Other Claims and Litigation. As with other broker-dealers that distribute mutual fund shares, HRBFA is the subject of an investigation by the NASD into activities characterized as “market timing” and “late trading” of mutual fund shares by HRBFA. The NASD staff has notified HRBFA that on the basis of its investigation it has preliminarily determined to recommend a disciplinary action against HRBFA for violating various federal securities laws and NASD rules in connection with market timing activities that took place primarily in one of HRBFA’s offices. HRBFA has provided the NASD a written response to its allegations. HRBFA is cooperating with the NASD and has conducted its own internal investigation. While we cannot provide assurance regarding the ultimate resolution of this matter, we believe the resolution of this matter will not have a material adverse effect on our operations, consolidated results of operations or financial position.

As part of an industry-wide review, the IRS is investigating tax planning strategies that certain RSM clients utilized during fiscal years 2000 through 2003. Specifically, the IRS is examining these strategies to determine whether RSM complied with tax shelter registration and listing regulations and whether such strategies were appropriate. If the IRS were to determine that these strategies were inappropriate, clients that utilized the strategies could face penalties and interest for underpayment of taxes and may attempt to seek recovery from RSM. While there can be no assurance regarding the outcome of this matter, we do not believe that its resolution will have a material adverse effect on our operations, consolidated results of operations or financial position.

As reported in current report on Form 8-K dated December 12, 2003, the United States SEC informed outside counsel to the Company on December 11, 2003 that the Commission had issued a Formal Order of Investigation concerning our disclosures, in and before November 2002, regarding RAL litigation to which we were and are a party. There can be no assurances as to the outcome and resolution of this matter.

We have from time to time been party to claims and lawsuits not discussed herein arising out of our business operations, including additional claims and lawsuits concerning RALs, the Peace of Mind guarantee program, the Express IRA program and claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of customers’ tax returns, the fees

– 12

Form 10-K – H&R BLOCK

charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage foreclosures, other aspects of the mortgage business, intellectual property disputes, and contract disputes. Such lawsuits include actions by individual plaintiffs, as well as cases in which plaintiffs seek to represent a class of similarly situated customers. The amounts claimed in these claims and lawsuits are substantial in some instances and the ultimate liability with respect to such litigation and claims is difficult to predict. We consider these cases to be ordinary, routine litigation incidental to our business, we believe we have meritorious defenses to each of them, and we are defending, or intend to defend, them vigorously. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these other matters will not have a material adverse effect on our consolidated results of operations or financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2004. Information regarding executive officers is contained in Item 10 of this report.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

H&R Block’s common stock is traded principally on the NYSE and is also traded on the Pacific Exchange. The information called for by this item with respect to H&R Block’s common stock appears in Item 8, note 22 to our consolidated financial statements. The remaining information called for by this item relating to “Securities Authorized for Issuance under Equity Compensation Plans” is reported in Item 8, note 14 to our consolidated financial statements. On June 15, 2004, there were 31,063 shareholders of record and the closing stock price on the NYSE was $46.62 per share.

A summary of our purchases of H&R Block common stock during the fourth quarter of fiscal year 2004 is as follows:

(shares in 000s)

Total Number of

Maximum Number

Total

Average

Shares Purchased as

of Shares that May Be

Number of Shares

Price Paid

Part of Publicly Announced

Purchased Under the

Purchased⁽²⁾

per Share

Plans or Programs⁽¹⁾

Plans or Programs⁽¹⁾⁽³⁾

February 1 – February 29

781

55.28

780

13,367

March 1 – March 31

1,460

53.81

1,460

11,907

April 1 – April 30

575

46.75

575

11,332

⁽¹⁾ On June 11, 2003, our Board of Directors approved the repurchase of 20 million shares of H&R Block common stock. This authorization has no expiration date.

⁽²⁾ Of the total number of shares purchased, 1,202 shares were purchased in connection with funding employee income tax withholding obligations arising upon the exercise of stock options or the lapse of restrictions on restricted shares.

⁽³⁾ On June 9, 2004, our Board of Directors approved the additional repurchase of 15 million shares of H&R Block common stock. This authorization has no expiration date.

ITEM 6. SELECTED FINANCIAL DATA



		(in 000s, except per share amounts)



April 30,		2004		2003		2002		2001		2000

Revenues		$	4,205,570	$	3,746,457	$	3,285,701	$	2,965,405	$	2,420,923
Net income before change in accounting principle			704,256		580,064		434,405		276,748		251,895
Net income			697,897		580,064		434,405		281,162		251,895
Basic earnings per share:
	Net income before change in accounting principle	$	3.98	$	3.23	$	2.38	$	1.50	$	1.28
	Net income		3.94		3.23		2.38		1.53		1.28
Diluted earnings per share:
	Net income before change in accounting principle	$	3.90	$	3.15	$	2.31	$	1.49	$	1.27
	Net income		3.86		3.15		2.31		1.52		1.27
Total assets		$	5,380,026	$	4,767,308	$	4,384,640	$	4,166,044	$	5,700,146
Long-term debt			545,811		822,302		868,387		870,974		872,396
Dividends per share		$	.78	$	.70	$	.63	$	.59	$	.54

13 –

H&R BLOCK – Form 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We are a diversified company with subsidiaries delivering tax, financial, mortgage and business products and services. We are the only major company offering a full range of software, online and in-office tax solutions, combined with personalized financial advice about retirement savings, home ownership and other opportunities to help clients build a better financial future.

Overall for fiscal 2004, we achieved strong financial results and generally executed well against our strategic priorities. We were able to increase our tax and financial advice offerings, strengthen our multi-channel offerings and continued to cross-sell our financial services and products across segments, which we believe all help increase brand loyalty and client retention. However, we saw a decline in our retail tax clients served in our offices. Additionally, we again saw Mortgage Operations deliver strong financial results. Our key strategic priorities can be summarized as follows:


	▪	U.S. Tax Operations – expanding our office network, working on service and product differentiation and focusing on advice that supports client growth, increased brand loyalty and business extensions with a tax and financial connection.
	▪	Mortgage Operations – developing a diversified source of originations, distinguishing our service quality, minimizing risk and volatility in performance and using secondary markets to optimize value.
	▪	Business Services – developing a national accounting, tax and consulting firm, adding extended services to middle-market companies and enhancing our client service culture.
	▪	Investment Services – serving the broad consumer market through tax-based advisory relationships, brand differentiation through relevant advice and multi-channel access and providing services clients can use to readily implement that advice.

The analysis that follows should be read in conjunction with the tables below, the consolidated income statements and the information contained in Item 1 under “Description of Business.”

Overview

A summary of our fiscal year 2004 results is as follows:


	▪	Diluted earnings per share before change in accounting principle were $3.90, an increase of 23.8% over fiscal year 2003.
	▪	Revenues grew 12.3% over the prior year, primarily due to revenues from operations in former major franchise territories and growth in our Mortgage Operations segment. We achieved revenue growth in each of our segments.
	▪	Clients served in company-owned retail tax offices grew 5.2%, and the average fee per client served increased 6.7%. The increase in clients served is due entirely to company-owned operations in former major franchise territories. Excluding the former major franchise territories, clients served decreased 2.5%.
	▪	Software and online revenues increased 11.4% and 70.6%, respectively, compared to fiscal year 2003.
	▪	Mortgage originations totaled $23.3 billion for the year as a result of increases in the sales force, average loan size, loan applications and the closing ratio.
	▪	Gains on sales of mortgage assets reached $726.7 million, including $40.7 million realized on the sale of previously securitized residual interests.
	▪	The Business Services segment reported pretax income of $19.3 million, an improvement of $33.4 million over the prior year. Fiscal year 2003 includes an $11.8 million goodwill impairment.
	▪	The Investment Services segment reported a pretax loss of $64.4 million, an improvement of $63.8 million over prior year. Fiscal year 2003 includes a $24.0 million goodwill impairment.
	▪	We began expensing stock-based compensation as of May 1, 2003. We recorded $25.7 million in expense related to the issuance of stock options, restricted stock and our employee stock purchase plan during fiscal year 2004.




Consolidated Results of Operations (in 000s)



Year ended April 30,	2004			2003			2002

REVENUES:
U.S. Tax Operations	$	2,093,617		$	1,861,681		$	1,831,274
Mortgage Operations		1,281,399			1,165,411			702,333
Business Services		499,210			434,140			416,926
Investment Services		229,470			200,794			250,685
International Tax Operations		97,560			85,082			78,710
Corporate Operations		4,314			(651	)		5,773

	$	4,205,570		$	3,746,457		$	3,285,701

INCOME (LOSS):
U.S. Tax Operations	$	627,592		$	547,078		$	533,468
Mortgage Operations		678,261			693,950			339,388
Business Services		19,321			(14,118	)		22,716
Investment Services		(64,446	)		(128,292	)		(54,862	)
International Tax Operations		11,097			10,464			7,093
Corporate Operations		(107,668	)		(122,005	)		(130,963	)

Pretax income	$	1,164,157		$	987,077		$	716,840

CRITICAL ACCOUNTING POLICIES

We consider the policies discussed below to be critical to securing an understanding of our financial statements, as they require the use of significant judgment and estimation in order to measure, at a specific point in time, matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, we caution that future events rarely develop precisely as forecast, and estimates routinely require adjustment and may require material adjustment.

Revenue recognition: We have many different revenue streams with different revenue recognition policies. We record retail and online tax preparation revenues when a completed return is filed or accepted by the customer. RAL participation revenue is recorded when we purchase our participation interest in the RAL. Commission revenue is recognized on a trade-date basis. Business Services revenues are recognized on a time and materials basis.

We recognize interest income on customer margin loan balances daily as earned, based on current rates charged to customers for their margin balance. Accretion income represents interest earned over the life of residual interests using the effective interest method.

We record sales of software when the product is ultimately sold to the end user. POM revenues are deferred and recognized over the term of the guarantee based upon historic and actual payment of claims.

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Form 10-K – H&R BLOCK

Franchise royalties, which are based upon the contractual percentages of franchise revenues, are recorded in the period in which the franchise provides the service.

Gains on sales of mortgage loans: We sell substantially all of the non-prime mortgage loans we originate to the Trusts, which are qualifying special purpose entities (“QSPEs”), with servicing rights generally retained. Prime mortgage loans are sold in whole loan sales, servicing released, to third-party buyers. We record the gain on sale as the difference between cash proceeds and the allocated cost of loans sold.

We determine the allocated cost of loans sold based on the relative fair values of loans sold, MSRs and the beneficial interest in Trusts, which represents the ultimate expected outcome from the disposition of the loans. The relative fair value of the MSRs and the beneficial interest in Trust is determined using discounted cash flow models, which require various management assumptions (see discussion below in “Valuation of residual interests” and “Valuation of mortgage servicing rights”). Variations in these assumptions affect the estimated fair values, which would affect the reported gains on sales. Gains on sales of mortgage loans totaled $716.7 million, $663.6 million and $455.4 million for fiscal years 2004, 2003 and 2002, respectively.

See discussion in “Off-Balance Sheet Financing” related to the disposition of the loans by the Trusts and subsequent securitization by the Company.

Valuation of residual interests: We use discounted cash flow models to arrive at the estimated fair values of our residual interests. See Item 8, note 1 to our consolidated financial statements for our methodology used in valuing residual interests. Variations in our assumptions, including loss, prepayment speeds, discount rate and interest rate assumptions, could materially affect the estimated fair values, which may require us to record impairments or unrealized gains. In addition, variations will also affect the amount of residual interest accretion recorded on a monthly basis. Residual interests – available-for-sale valued at $211.0 million and $264.3 million were recorded as of April 30, 2004 and 2003, respectively. We recorded $167.1 million in net write-ups in other comprehensive income and $30.7 million in impairments in the income statement related to our residual interests during fiscal year 2004 as actual results differed from our assumptions. See Item 8, note 6 to our consolidated financial statements for current assumptions and a sensitivity analysis of those assumptions. See Item 7a for sensitivity analysis related to interest rates.

Valuation of mortgage servicing rights: We generally sell non-prime mortgage loans with servicing retained. MSRs are recorded at allocated carrying amounts based on relative fair values when the loans are sold (see discussion above in “Gains on sales of mortgage loans”). Fair values of MSRs are determined based on the present value of estimated future cash flows related to servicing loans. Assumptions used in estimating the value of MSRs include discount rates, prepayment speeds (including default) and other factors. The prepayment speeds are somewhat correlated with the movement of market interest rates. As market interest rates decline there is a corresponding increase in actual and expected borrower prepayments as customers refinance existing mortgages under more favorable interest rate terms. This in turn reduces the anticipated cash flows associated with servicing resulting in a reduction, or impairment, to the fair value of the capitalized MSR. Many non-prime loans have a prepayment penalty in place for the first two to three years, which has the effect of making prepayment speeds more predictable, regardless of market interest rate movements. Prepayment rates are estimated using our historical experience and third-party market sources. Variations in these assumptions could materially affect the carrying value of the MSRs.

MSRs are carried at the lower of cost or market and are reviewed quarterly for potential impairment. Impairment is assessed based on the fair value of each risk stratum. MSRs are stratified by: the fiscal year of the loan sale date (which approximates date of origination) and loan type (6-month adjustable, 2-to 3-year adjustable and fixed rate). Fair values take into account the historical prepayment activity of the related loans and our estimates of the remaining future cash flows to be generated through servicing the underlying mortgage loans. If actual prepayment rates prove to be higher than the estimate made by management, impairment of the MSRs could occur. MSRs valued at $113.8 million and $99.3 million were recorded as of April 30, 2004 and 2003, respectively. There were no impairments to MSRs during fiscal year 2004. See Item 8, note 6 to our consolidated financial statements for current assumptions and a sensitivity analysis of those assumptions.

Valuation of goodwill: We test goodwill for impairment annually or more frequently whenever events occur or circumstances change which would, more likely than not, reduce the fair value of a reporting unit below its carrying amount. We have defined our reporting units as our operating segments or one level below. The first step of the impairment test is to compare the estimated fair value of the reporting unit to its carrying value. If the carrying value is less than fair value, no impairment exists. If the carrying value is greater than fair value, a second step is performed to determine the fair value of goodwill and the amount of impairment loss, if any. In estimating each reporting unit’s fair value using discounted cash flow projections and market comparables, when available, we make assumptions, including discount rates, growth rates and terminal values. Changes in the projections or assumptions could materially affect fair values. Our goodwill balances were $959.4 million and $714.2 million as of April 30, 2004 and 2003, respectively. No goodwill impairments were identified during fiscal year 2004.

In fiscal year 2003, a goodwill impairment charge of $24.0 million was recorded in the Investment Services segment due to unsettled market conditions. Also during 2003, our annual impairment test resulted in an impairment of $11.8 million for a reporting unit within the Business Services segment. No other impairments were identified.

Litigation: Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical experience in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” and related pronouncements. Therefore, we have recorded reserves related to certain legal matters for which it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, we have concluded that a loss is only reasonably possible or remote and, therefore, no liability is recorded. In addition, there are certain gain contingencies for which we have not recorded an asset.

Stock-Based Compensation: We record compensation expense for the issuance of stock options, restricted shares and our employee stock purchase plan (“ESPP”). The expense is calculated based on the fair value of the options/shares and the number of options/shares that vest. We use the Black-Scholes model to calculate the fair value for stock options and ESPP shares using the following assumptions: stock volatility, expected life, risk-free interest rate and dividend yield. The fair value of restricted shares is the stock price on the date of the grant. We also estimate, based on historical data, the percent of options/shares that we expect to vest. The total expense is recognized on a straight-line basis over the vesting period. Variations in the assumptions used to calculate fair value could either positively or negatively affect the recorded expense. Variations in the estimate of vesting could result in timing adjustments recorded at the end of the vesting period.

We began expensing all stock-based compensation grants issued beginning on May 1, 2003. Therefore, our income statements do not fully reflect the expense related to all of our stock options and restricted shares outstanding. We recorded

15 –

H&R BLOCK – Form 10-K

$25.7 million and $2.1 million in stock-based compensation expense during fiscal year 2004 and 2003, respectively.

Additionally, changes in accounting rules related to stock-based compensation could result in changes to our assumptions of fair value and expense recognition.

Other significant accounting policies: Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. These policies require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standards setters and regulators. Although no specific conclusions reached by these standard setters appear likely to cause a material change in our accounting policies, outcomes cannot be predicted with confidence. Also see Item 8, note 1 to our consolidated financial statements, which discusses accounting policies we have selected when there are acceptable alternatives.

– 16

Form 10-K – H&R BLOCK

RESULTS OF OPERATIONS

Our business is divided into five reportable segments: U.S. Tax Operations, Mortgage Operations, Business Services, Investment Services and International Tax Operations.

U.S. TAX OPERATIONS

This segment primarily consists of our income tax preparation businesses – retail, online and software.




U.S. Tax Operations – Operating Statistics (in 000s, except average fee)



Year ended April 30,				2004		2003⁽¹⁾		2002⁽¹⁾

Clients served:
	Company-owned offices ⁽²⁾				9,811		10,058		10,513
	Former major franchise territories ⁽³⁾				775		**		**

	Total company-owned				10,586		10,058		10,513

	Franchise offices				5,413		5,629		5,785
	Former major franchise territories ⁽³⁾				16		830		850

	Total franchise				5,429		6,459		6,635

	Digital tax solutions:
		Software ⁽⁴⁾			2,027		1,963		1,825
		Online ⁽⁵⁾			1,207		920		481

					19,249		19,400		19,454

	Average fee per client served: ⁽⁷⁾
	Company-owned offices ⁽²⁾			$	147.38	$	137.36	$	128.69
	Former major franchise territories ⁽³⁾				135.52		**		**

	Total company-owned				146.51		137.36		128.69

	Franchise offices				128.02		117.42		108.82
	Former major franchise territories ⁽³⁾				126.13		122.96		112.31

	Total franchise				128.02		118.14		109.27

				$	140.24	$	129.84	$	121.18

	RALs: ⁽⁶⁾
		Company-owned offices ⁽²⁾			2,521		2,758		2,844
		Former major franchise territories ⁽³⁾			185		**		**

		Total company-owned			2,706		2,758		2,844

		Franchise offices			1,501		1,595		1,573
		Former major franchise territories ⁽³⁾			**		188		189

		Total franchise			1,501		1,783		1,762

		Digital tax solutions:
			Software		5		—		11
			Online		57		75		33

					4,269		4,616		4,650




U.S. Tax Operations – Financial Results (in 000s)



Year ended April 30,			2004		2003		2002

Tax preparation and related fees			$	1,519,238	$	1,378,733	$	1,364,673
Royalties				173,754		163,519		154,780
RAL waiver fees				6,548		138,242		—
RAL participation fees				168,375		874		159,965
Software sales				69,474		62,368		54,823
Online tax services				44,860		26,290		14,606
Peace of Mind revenue				75,025		47,677		44,387
Other				36,343		43,978		38,040

		Total revenues		2,093,617		1,861,681		1,831,274

Compensation and benefits				662,326		577,545		598,355
Occupancy and equipment				235,469		207,366		186,998
Depreciation and amortization				54,879		39,456		39,871
Supplies, freight and postage				39,666		39,579		35,989
Cost of software sales				25,274		20,085		19,947
Bad debt				44,155		17,358		38,235
Legal				7,645		69,783		7,641
Other				126,338		105,456		137,884
Allocated corporate and shared costs:
	Marketing			110,807		90,142		99,560
	Information technology			91,158		77,285		77,230
	Finance			19,675		22,367		13,270
	Supply			21,607		19,724		19,508
	Other			27,026		28,457		23,318

		Total expenses		1,466,025		1,314,603		1,297,806

	Pretax income		$	627,592	$	547,078	$	533,468

⁽¹⁾ Company-owned and franchise numbers for fiscal years 2003 and 2002 have not been restated for franchise acquisitions during fiscal year 2004.

⁽²⁾ Excludes company-owned offices in former major franchise territories, which commenced operations during fiscal year 2004.

⁽³⁾ Impact of company-owned offices in former major franchise territories, which commenced operations during fiscal year 2004.

⁽⁴⁾ Includes TaxCut federal units sold.

⁽⁵⁾ Includes a) online completed and paid federal returns, and b) state returns only when no payment was made for a federal return.

⁽⁶⁾ Data is for tax season (January 1 – April 30) only.

⁽⁷⁾ Calculated as gross tax preparation and related fees divided by clients served.

17 –

H&R BLOCK – Form 10-K

Fiscal 2004 compared to fiscal 2003

U.S. Tax Operations’ revenues increased $231.9 million, or 12.5%, to $2.1 billion for fiscal year 2004.

Tax preparation and related fees increased $140.5 million, or 10.2%, for fiscal year 2004, compared to fiscal year 2003. This increase is due to a 6.7% increase in the average fee per client served in company-owned offices, coupled with a 5.2% increase in clients served in those offices. The average fee per client served increased to $146.51 in fiscal year 2004, due to increases in our pricing and the complexity of returns prepared. Clients served increased to 10.6 million from 10.1 million as a result of the former major franchise territories. Excluding the impact of our acquisition of former major franchises, clients served declined 2.5%. We believe this decline is due to a combination of factors including a lack of office network density in some key areas of the country. Given the competitive environment and lack of density in key areas, we believe some potential clients, who are primarily motivated by convenience and who do not want to wait for service in our office or drive as far to our office, will instead go to a competitor who is perceived to be more convenient. This is an indication that, for certain consumers, we have not been able to effectively differentiate our services from the competition. See discussion of our future strategy in “Fiscal 2005 Outlook” below. We also believe our marketing campaign, which focused primarily on our brand, did not effectively drive clients, particularly early season filers, into our offices.

The average fee per client at our franchise offices increased 8.4%, while clients served declined 15.9%. The decline is due to the former major franchise territories being operated as company-owned for the majority of fiscal year 2004. These changes, coupled with the re-franchising of certain former major franchise territories at higher royalty rates, resulted in an increase in royalty revenue of 6.3%.

Revenues earned during the current year in connection with RAL participations totaled $168.4 million. These revenues are approximately $30.1 million higher than waiver fees earned during fiscal year 2003 and $8.4 million higher than participation fees earned in fiscal year 2002. See discussion on the waiver below. Our RAL participation revenues are benefiting from the new company-owned operations in former major franchise territories. We participate in RALs at a rate of nearly 50% for company-owned offices compared to 25% in major franchise offices. This increased participation rate has allowed our revenues to increase, although the number of RALs has declined 8.2% since fiscal year 2002.

During fiscal year 2003, we entered into an agreement with Household, whereby we waived our right to purchase any participation interests in and receive license fees for RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights we received a series of payments from Household in fiscal year 2003, subject to certain adjustments in fiscal year 2004 based on delinquency rates. See discussion in Item 1, “RAL Participations and 2003 Tax Season Waiver.”

A total of 3.8 million software units were sold during fiscal year 2004, an increase of 11.2% compared to unit sales of 3.4 million in 2003. Software units include TaxCut Federal, TaxCut State, DeductionPro, WillPower and Legal Advisor. Revenues from software sales of $69.5 million in fiscal year 2004 increased 11.4% as a result of the higher sales volume.

Online tax preparation revenues increased 70.6% to $44.9 million primarily as a result of an increase in the average price and a 31.2% increase in clients served. Increases in software and online unit sales have an especially beneficial impact to our earnings, as these operations have relatively low variable costs.

POM revenues for fiscal year 2004 increased $27.3 million, or 57.4%, primarily due to a change in accounting principle. Prior to the adoption of EITF 00-21, revenues related to POM guarantees in premium offices were recorded within tax preparation revenues. With the adoption of EITF 00-21, the revenues are deferred and recognized over the guarantee period. The increase over the prior year is a result of the amortization of larger deferred revenue balances established as part of the cumulative effect of a change in accounting principle. The cumulative effect will increase revenues this year and in future years, but is offset by the $6.4 million reduction to consolidated net income in fiscal year 2004.

Total expenses for fiscal year 2004 were up $151.4 million, or 11.5%, from 2003. These increased expenses were partially attributable to the operation of former major franchise territories as company-owned. Compensation and benefits increased $42.6 million as a result of the former major franchises and $20.2 million due to field wages during the later part of the tax season. Additionally, $12.9 million was incurred for the expensing of stock options awarded to seasonal tax associates. Occupancy and equipment costs increased $28.1 million due primarily to a 5.7% increase in the average rent and a 3.4% increase in the number of offices under lease. Depreciation and amortization increased as a result of $9.0 million in intangible amortization from the acquisition of assets of former major franchisees and additional equipment purchased for new office locations opened during the period. Bad debt expense increased $26.8 million as a result of bad debt expense associated with RAL participations, which was not recorded in the prior year due to the waiver agreement. Allocated marketing costs increased $20.7 million as a result of additional marketing directed toward our brand repositioning and raising consumer awareness of our advice offerings via the Block Advantage Campaign. Allocated information technology costs increased $13.9 million as a result of additional technology projects.

These increases were partially offset by a $62.1 million decrease in legal expenses, which is primarily a result of the Texas RAL litigation settlement and other cases in the prior year. See discussion in “RAL Litigation” below.

Pretax income for fiscal year 2004 increased $80.5 million, or 14.7%, over 2003. The segment’s operating margin improved sixty basis points to 30.0% in fiscal year 2004.

Fiscal 2005 outlook

For us to successfully grow our client base in future years, we must improve the convenience of our services through office expansion and differentiate the value of our services through advice and multi-channel access. In fiscal year 2005, we plan to expand our company-owned office locations by 500-600 offices. We believe by investing in our office network, we can attract potential clients who are primarily motivated by convenience. Although, we expect the additional tax offices to result in incremental revenues during fiscal year 2005, due to the cost of expansion, we do not expect any growth in pretax income from this office expansion.

Over the past few fiscal years, we have focused on integrating actionable advice into our relationships with our tax clients. We continue each year to add new areas of free advice targeted at the individual client based on information provided during the preparation of their tax return. We believe our advice-based strategy is a key point of differentiation and strengthens our competitive position. In addition, our Licensed Referral Tax Professional (“LRTP”) program, which provides referrals to HRBFA financial advisors, is key to bringing financial advice and services to the portion of our client base where more sophisticated investment services are appropriate. Our fiscal year 2005 goal is to have 2,500 LRTPs. We believe this advice relationship, as well as our ability to offer retail mortgage products to our client base increases our tax client retention.

We will also continue to enhance our digital tax solutions. We believe our multi-channel strategy not only allows clients to choose how they want to be served, but also allows us to appeal to a different client base than we do through our offices.

Fiscal 2003 compared to fiscal 2002

U.S. Tax Operations’ revenues increased $30.4 million, or 1.7%, to $1.9 billion for fiscal year 2003.

– 18

Form 10-K – H&R BLOCK

Tax preparation and related fees increased $14.1 million, or 1.0%, for fiscal year 2003, compared to fiscal year 2002. This increase is due to a 6.7% increase in our average fee per client served, partially offset by a 4.3% decrease in clients served in company-owned offices. The increase in the average fee per client served is primarily due to an increase in the complexity of returns prepared. The decrease in clients served in company-owned offices during fiscal year 2003 was driven primarily by the impact of the sustained weak economy. Additionally, due to the absence of substantive tax law changes, the marketing programs failed to attract as much new business as in the previous year.

Royalty revenue increased $8.7 million, or 5.6%. The average fee per client served at franchise offices increased 8.1%, while clients served declined 2.7%.

RAL waiver fees of $138.2 million were recognized during fiscal year 2003. We participated in RALs in fiscal year 2002 and recognized revenues of $160.0 million.

A total of 3.4 million software units were sold during fiscal year 2003, an increase of 12.1% compared to unit sales of 3.0 million in 2002. Revenues from software sales of $62.4 million in fiscal year 2003 increased 13.8% as a result of the higher sales volume. This increase was partially offset by increases in the number of rebates offered and customer rebate redemption rates.

Online tax preparation revenues increased 80.0% primarily as a result of a 91.3% increase in clients served.

Total expenses for fiscal year 2003 were up $16.8 million, or 1.3%, from 2002. These increased expenses were primarily attributable to a litigation reserve of $41.7 million recorded during the second quarter of fiscal year 2003 relating to Texas RAL litigation. Other legal costs increased $20.4 million due to various legal proceedings.

Occupancy and equipment costs increased $20.4 million due primarily to a 5.2% increase in the number of offices under lease and increases in related utility and other support charges. Allocated finance expenses increased $9.1 million, or 68.6%, primarily due to increased insurance costs. These increases were partially offset by a $20.8 million decrease in compensation and benefits. This decrease was due to better management of support staff wages, a decline in payroll taxes related to seasonal stock option exercises and changes in the tax preparer compensation plan. Bad debt expense declined $20.9 million as a result of collections of RAL receivables, which were written off in prior years, and the elimination of bad debt expense associated with RAL participations. Other expenses decreased $32.4 million from 2002 primarily due to reduced servicing expenses associated with prior year RAL participations.

Pretax income for fiscal year 2003 increased $13.6 million, or 2.6%, over 2002. The segment’s operating margin improved thirty basis points to 29.4% in fiscal year 2003.

RAL litigation

We have been named as a defendant in a number of lawsuits around the country alleging that we engaged in wrongdoing with respect to the RAL program. In particular, the plaintiffs in these cases have alleged that disclosures in the RAL applications were inadequate, misleading and untimely; that the RAL interest rates were usurious and unconscionable; that we suppressed the fact that we would receive part of the finance charges paid by the customer for such loans; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program. In many of these cases, the plaintiffs seek to proceed on behalf of a class of similarly situated RAL customers, and in certain instances the courts have allowed the cases to proceed as class actions. In other cases, courts have held that plaintiffs must pursue their claims on an individual basis, and may not proceed as a class action. See Item 3, Legal Proceedings for additional information.

On November 19, 2002, we announced a settlement had been reached in the cases Ronnie and Nancy Haese, et al. v. H&R Block, Inc., et al., Case No. CV96-4213, District Court of Kleberg County, Texas (Haese I) and Ronnie and Nancy Haese, et al. v. H&R Block, Inc., et al., Case No. CV-99-314-D, District Court of Kleberg County, Texas (Haese II), filed originally as one action on July 30, 1996. As a result of that settlement, we recorded a liability and pretax expense of $43.5 million during the 2003 fiscal year. This represented our best estimate of our share of the settlement, plaintiff class legal fees and expenses, tax products and associated mailing expenses. Our share of the settlement is less than the total amount awarded due to amounts recoverable from a co-defendant in the case.

We believe we have strong defenses to the various RAL cases and will vigorously defend our position. Nevertheless, the amounts claimed by the plaintiffs are, in some instances, very substantial, and there can be no assurances as to the ultimate outcome of the pending RAL cases, or as to the impact of the RAL cases on our financial statements.

19 –

H&R BLOCK – Form 10-K

MORTGAGE OPERATIONS

This segment is primarily engaged in the origination of non-prime mortgage loans through an independent broker network, the origination of prime and non-prime mortgage loans through a retail office network, the sale and securitization of mortgage loans and residual interests, and the servicing of non-prime loans.

We believe offering retail mortgage products to other segments’ clients results in added value to the total client experience. During fiscal year 2004, 48.9% of our retail loans were made to other segments’ clients. We estimate, for those clients who purchase these products, their retention as a tax client improves by more than six percentage points.




Mortgage Operations – Operating Statistics			(dollars in 000s)



Year ended April 30,			2004		2003		2002

Number of loans originated:
	Wholesale (non-prime)			130,356		93,497		74,208
	Retail: Prime			9,763		12,361		7,935
		Non-prime		15,220		9,983		7,190

		Total		155,339		115,841		89,333

Volume of loans originated:
	Wholesale (non-prime)		$	20,150,992	$	13,659,243	$	9,457,331
	Retail: Prime			1,258,347		1,697,815		1,179,137
		Non-prime		1,846,674		1,220,563		816,705

		Total	$	23,256,013	$	16,577,621	$	11,453,173

Loan sales:
	Loans originated		$	23,234,935	$	16,591,821	$	11,440,190
	Loans acquired			–		633,953		–

	Total		$	23,234,935	$	17,225,774	$	11,440,190


Weighted average FICO score ⁽²⁾				608		604		600

Execution price – Net gain on sale ⁽¹⁾
	Loans originated and sold			4.09%		4.63%		4.30%
	Loans acquired and sold			–		.18%		–

	Total			4.09%		4.46%		4.30%


Weighted average interest rate for borrowers ⁽²⁾				7.39%		8.15%		9.09%

Weighted average loan-to-value ⁽²⁾				78.1%		78.7%		78.6%

⁽¹⁾ Defined as total premium received divided by total balance of loans delivered to third-party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses).

⁽²⁾ Represents non-prime production.




Mortgage Operations – Financial Results			(in 000s)



Year ended April 30,			2004			2003			2002

Components of gains on sales:
	Gains on mortgage loans		$	716,690		$	663,573		$	455,388
	Gains on sales of residual interests			40,689			130,881			–
	Impairment of residual interests			(30,661	)		(54,111	)		(30,987	)

	Total gains on sales			726,718			740,343			424,401
Loan servicing revenue				211,710			168,351			147,162
Interest income:
	Accretion-residual interests			168,029			145,165			50,583
	Accretion-beneficial interest			167,705			103,294			70,668
	Other interest income			5,064			5,421			6,609

	Total interest income			340,798			253,880			127,860
Other				2,173			2,837			2,910

		Total revenues		1,281,399			1,165,411			702,333

Compensation and benefits				297,441			242,143			171,084
Servicing and processing				107,538			74,774			86,146
Occupancy and equipment				49,231			42,626			30,700
Other				148,928			111,918			75,015

		Total expenses		603,138			471,461			362,945

Pretax income			$	678,261		$	693,950		$	339,388

Fiscal 2004 compared to fiscal 2003

Mortgage Operations’ revenues increased $116.0 million, or 10.0%, compared to the prior year. This increase was primarily a result of higher servicing income, increased production volumes and accretion.

The following table summarizes the key drivers of gains on sales of mortgage loans:



	(dollars in 000s)



Year ended April 30,	2004		2003

Number of sales associates ⁽¹⁾		2,812		2,228
Total number of applications		269,267		216,492
Closing ratio ⁽²⁾		57.7%		53.5%
Total number of originations		155,339		115,841
Average loan size	$	150	$	143
Total originations	$	23,256,013	$	16,577,621
Non-prime/prime origination ratio		17.5:1		8.8:1
Loan sales	$	23,234,935	$	17,225,774
Execution price – net gain on sale ⁽³⁾		4.09%		4.46%

⁽¹⁾ Includes all direct sales and back office sales support associates.

⁽²⁾ Percentage of loans funded divided by total applications in the period.

⁽³⁾ Defined as total premium received divided by total balance of loans delivered to third-party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses).

– 20

Form 10-K – H&R BLOCK

Gains on sales of mortgage loans increased $53.1 million to $716.7 million for the year ended April 30, 2004. The increase over last year is a result of a significant increase in loan origination volume, an increase in the average loan size and the closing ratio, partially offset by a decrease in the loan sale execution price and increased loan sale repurchase reserves. During the year, the Company originated $23.3 billion in mortgage loans compared to $16.6 billion last year, an increase of 40.3%. The execution price on mortgage loan sales decreased primarily due to lower mortgage rates as the non-prime industry adjusted rates to reflect changes in the market interest rates. The loan sale repurchase reserves, which are netted against gains on sales, increased $25.5 million over the prior year. This increase is primarily a result of an increase in loan sales coupled with the increase in whole loan sales compared to securitizations, for which higher reserves are provided at the time of sale for estimated repurchases. Whole loan sales accounted for 76% of total loan sales, compared to 41% in the prior year.

In November 2002, the Company completed the sale of previously securitized residual interests and recorded a gain of $130.9 million. This sale accelerated cash flows from these residual interests, effectively realizing previously recorded unrealized gains included in other comprehensive income. Two smaller transactions were completed in fiscal year 2004, which resulted in gains of $40.7 million.

Impairments of residual interests in securitizations of $30.7 million were recognized during the year compared with $54.1 million in the prior year. The impairments were due primarily to loan performance of older residuals and changes in assumptions to more closely align with the current economic and interest rate environment.

The following table summarizes the key drivers of loan servicing revenues:



(dollars in 000s)



Year ended April 30,		2004		2003

Average servicing portfolio:
	With related MSRs	$	32,039,811	$	23,858,490
	Without related MSRs		6,481,069		3,883,980

		$	38,520,880	$	27,742,470

Number of loans serviced			324,364		246,463
Average delinquency rate			6.04%		7.08%
Value of MSRs		$	113,821	$	99,265

Loan servicing revenues increased $43.4 million, or 25.8%, this year. The increase reflects a higher average loan servicing portfolio, which was partially offset by the reduction of certain of our ancillary fees previously charged to borrowers. The average servicing portfolio for fiscal year 2004 increased 38.9%.

Total accretion of residual interests increased $22.9 million over the prior year. This improvement is the result of write-ups in the related asset values in fiscal years 2003 and 2004. Increases in fair value are realized in income through accretion over the remaining expected life of the residual interest.

For the majority of fiscal year 2004, our residual interests continued to perform better than expected primarily due to lower interest rates during the first part of the year and due to lower credit losses than assumed during the later part of the year. As a result of this performance, our residuals have produced, or are expected to produce, more cash proceeds than projected in previous valuation models. We recorded favorable pretax mark-to-market adjustments, which increased the fair value of our residual interests $199.7 million during the year. These adjustments were recorded, net of write-downs of $32.6 million and deferred taxes of $63.8 million, in other comprehensive income and will be accreted into income throughout the remaining life of the residual interests. Future changes in interest rates, actual loan pool performance or other assumptions could cause additional favorable or unfavorable adjustments to the fair value of the residual interests and could cause changes to the accretion of these residual interests in future periods. Additionally, sales of previously securitized residual interests results in decreases to accretion income in future periods.

Accretion of beneficial interest in Trusts increased $64.4 million, or 62.4%, in 2004. The balance of loans held by the Trusts and the interest margin earned impacts our accretion. The average balance of loans held by the Trusts increased to $3.2 billion from $1.8 billion in the prior year. The interest margin is the difference between the rate on the underlying loans and the financing costs of the Trusts. The interest rate margin decreased to 5.40% during fiscal year 2004, from 5.76% in 2003.

Total expenses increased $131.7 million, or 27.9%, over the prior year. Servicing and processing expenses increased $32.8 million, or 43.8%, as a result of a higher average servicing portfolio and the acceleration of amortization of certain MSRs. Compensation and benefits increased $55.3 million as a result of a 22.9% increase in the number of employees, reflecting resources needed to support higher loan production volumes. Other expenses increased $37.0 million, or 33.1%, for the current year, primarily due to $10.4 million in increased marketing expenses primarily for retail mortgage direct mail advertising, $13.5 million in increased allocated corporate and shared costs and $7.2 million in increased consulting expenses. Allocated costs increased due to higher insurance costs and the expensing of stock-based compensation. Occupancy and equipment expenses increased $6.6 million due to nine additional branch offices opened since October 2002, continued expansion of a second servicing center that opened in August 2002 and additional administrative office space.

Pretax income decreased $15.7 million, or 2.3%, for fiscal year 2004.

Fiscal 2005 outlook

We believe fiscal year 2005 will generally be a rising interest rate environment. In a rising interest rate environment, we expect our profit margins will narrow due to less favorable loan execution pricing compared to the sustained period of declining rates over the last two fiscal years. Actual execution pricing for the fourth quarter and full fiscal year 2004 was 3.96% and 4.09%, respectively. As of April 30, 2004, we have forward loan sale commitments at an average execution price of 4.38%.

With the rising interest rates we have raised our coupon rate since year-end. Although the timing and magnitude of changes to non-prime mortgage interest rates may differ from changes in other market interest rates, we will be utilizing various strategies in fiscal year 2005 to manage our pricing in a competitive rate environment.

Additionally, we believe we can grow our originations at a modest level by continued expansion of our retail business and focusing on controllable drivers in our wholesale business. These drivers include geographic expansion, growing our sales force, increasing our penetration of existing broker relationships and continuing to improve our closing ratios.

Based on these assumptions, we expect our mortgage segment pretax income to be flat to slightly down from this year, excluding the gain on sale of previously securitized residual interests.

Fiscal 2003 compared to fiscal 2002

Mortgage Operations’ revenues increased $463.1 million, or 65.9%, compared to fiscal year 2002. This increase was primarily a result of increased production volumes and related sales execution pricing, gains on sales of previously securitized residuals and accretion on residual interests.

Gains on sales of mortgage loans increased $208.2 million to $663.6 million for the year ended April 30, 2003. The increase over the prior year is a result of a significant increase in loan origination volume, an increase in the average loan size, the closing ratio and the loan sale execution price. During 2003, the Company

21 –

H&R BLOCK – Form 10-K

originated $16.6 billion in mortgage loans compared to $11.5 billion in 2002, an increase of 44.7%. The execution price on mortgage loan sales increased primarily due to declining interest rates during the year, offset by a decline in the weighted-average coupon rate charged to borrowers.

In November 2002, the Company completed the sale of previously securitized residual interests and recorded a gain of $130.9 million.

Impairments of residual interests in securitizations of $54.1 million were recognized during fiscal year 2003, due primarily to loan performance of older residuals and changes in assumptions to more closely align with the current economic and interest rate environment.

Loan servicing revenues increased $21.2 million, or 14.4%, over fiscal year 2002. The increase reflects a higher average loan servicing portfolio. The average servicing portfolio for fiscal year 2003 increased 39.4%.

Total accretion of residual interests increased $94.6 million over fiscal year 2002. This improvement is the result of increases in the related asset values in fiscal years 2002 and 2003. Increases in fair value are realized in income through accretion over the remaining expected life of the residual interest.

We recorded favorable pretax mark-to-market adjustments, which increased the fair value of our residual interests $203.8 million during fiscal year 2003, and write-downs of $19.1 million. These adjustments were recorded, net of write-downs and deferred taxes of $70.5 million, in other comprehensive income and will be accreted into income throughout the remaining life of the residual interests.

Accretion of beneficial interest in Trusts increased $32.6 million, or 46.2%, in 2003, due to the average balance on loans held by the Trusts increasing to $1.8 billion from $1.2 billion in fiscal year 2002. Also contributing to the increase was higher interest margin earned. The interest rate margin increased to 5.76% during fiscal year 2003, from 5.58% in 2002.

Total expenses increased $108.5 million, or 29.9%, over fiscal year 2002. This increase is primarily due to a $71.1 million increase in compensation and benefits as a result of a 23.2% increase in the number of employees, reflecting resources needed to support higher loan production volumes. Occupancy and equipment expenses increased $11.9 million due to the opening of an additional servicing center and expansion of the servicing and information technology facilities to support the higher overall activity levels. Servicing and processing expenses declined due to an impairment of $11.6 million on servicing assets recorded during fiscal year 2002, while only $866 thousand was recorded in fiscal year 2003. Other expenses increased $36.9 million, or 49.2%, primarily due to increased consulting, depreciation and marketing expenses.

Pretax income increased $354.6 million, or 104.5%, for fiscal year 2003.

– 22

Form 10-K – H&R BLOCK

BUSINESS SERVICES

This segment offers middle-market companies accounting, tax and consulting services, wealth management, retirement resources, payroll services, corporate finance and financial process outsourcing.

Business Services – Operating Statistics





Year ended April 30,		2004		2003		2002

Accounting, tax and consulting:
	Chargeable hours		2,598,397		2,583,505		2,675,704
	Chargeable hours per person		1,414		1,388		1,399
	Net collected rate per hour	$	124	$	120	$	113
	Average margin per person	$	102,496	$	97,117	$	94,052
Capital markets:
	Platforms delivered		1,293		655		⁽¹	⁾

⁽¹⁾ Not comparable due to mid-year acquisition of capital markets business.




Business Services – Financial Results (in 000s)



Year ended April 30,		2004		2003			2002

Accounting, tax and consulting		$	372,423	$	352,102		$	365,194
Capital markets			73,857		35,626			10,756
Payroll, benefits and retirement services			21,107		20,578			17,048
Other			31,823		25,834			23,928

	Total revenues		499,210		434,140			416,926

Compensation and benefits			336,073		292,291			265,960
Occupancy and equipment			25,277		24,428			19,957
Depreciation and amortization			23,002		23,044			21,339
Impairment of goodwill			–		11,777			–
Other			95,537		96,718			86,954

	Total expenses		479,889		448,258			394,210

	Pretax income (loss)	$	19,321	$	(14,118	)	$	22,716

Fiscal 2004 compared to fiscal 2003

Business Services’ revenues for fiscal year 2004 improved $65.1 million, or 15.0%, over the prior year. This increase was primarily due to a $38.2 million increase in capital markets revenue resulting from a 97.4% increase in the number of platforms delivered.

Revenues in accounting, tax and consulting also increased $20.3 million over the prior year as a result of newly acquired tax businesses and increased productivity. The acquisition of U.S. Tax Operations’ former major franchises allowed us to acquire the tax businesses associated with the original M&P acquisition. We were previously unable to acquire and operate these businesses in direct competition with major franchise territories. The acquired tax businesses contributed $13.0 million in revenues in the current fiscal year. The remainder of the increase was driven primarily by a 3.3% increase in the net collected rate per hour.

Total expenses increased $31.6 million, or 7.1%, over the prior year. Compensation and benefits costs increased $43.8 million, primarily as a result of increased activity in the capital markets business and increased costs in traditional accounting. A goodwill impairment charge of $11.8 million was recorded in the prior year. No such impairment was recorded in fiscal year 2004.

Pretax income for the year ended April 30, 2004 was $19.3 million compared to a loss of $14.1 million in fiscal year 2003.

Fiscal 2005 outlook

Our focus for fiscal year 2005 is growing the business within our current markets by expanding our services to existing clients and by targeting other mid-size companies in those areas. To achieve this goal, we began the development of a national sales force in fiscal year 2004 and we plan to continue to roll this initiative out in fiscal year 2005. Additionally, in May 2004 we initiated new marketing efforts designed to promote brand awareness and the services we offer. We have no major acquisition plans for fiscal year 2005.

Fiscal 2003 compared to fiscal 2002

Business Services’ revenues for fiscal year 2003 improved $17.2 million, or 4.1%, over fiscal year 2002. This increase was primarily due to the acquisition of Equico Resources, LLC (“EquiCo”) in December 2001, which contributed an increase of $24.9 million over fiscal year 2002. Revenues from traditional accounting services declined $13.1 million over fiscal year 2002 as a result of a 20.0% reduction in tax planning services sold and lower revenues per unit sold. This decline was somewhat offset by growth in core accounting and tax services, driven primarily by an increase in the net collected rate per hour. Additionally, fiscal year 2003 was the first year there was no significant year-over-year growth related to new acquisitions. In fiscal year 2003 we acquired only a few businesses to add scale to existing offices and only one new location was added, resulting in an increase of $1.7 million in revenues.

Deferred revenue increased $12.2 million in fiscal year 2003 due to a backlog of scheduled capital markets platforms resulting from staffing shortages.

Total expenses increased $54.0 million, or 13.7%, over fiscal year 2002. Compensation and benefits costs increased $26.3 million and occupancy and equipment costs increased $4.5 million, primarily as a result of the EquiCo and MyBenefitSource, Inc. (“MBS”) acquisitions in December 2001. Other expenses increased by $9.8 million primarily due to increased legal and travel expenses, both related to EquiCo and MBS. As part of our annual goodwill impairment testing, an impairment charge of $11.8 million was recorded related to MBS in fiscal year 2003.

The pretax loss for fiscal year 2003 was $14.1 million compared to pretax income of $22.7 million in fiscal year 2002.

INVESTMENT SERVICES

This segment is primarily engaged in offering advice-based investment services and securities products. Our integration of investment advice and new product offerings have allowed us to shift our focus from a transaction-based client relationship to a more advice-based focus.

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H&R BLOCK – Form 10-K

Investment Services – Operating Statistics





Year ended April 30,		2004		2003		2002

Customer trades ⁽¹⁾			1,514,969		1,218,092		1,536,930
Daily average trades			5,918		4,853		6,123
Average revenue per trade ⁽²⁾		$	119.36	$	120.15	$	106.42
Active accounts			863,116		752,903		695,355
Assets under administration (billions)		$	26.7	$	22.3	$	27.3
Average assets per active account		$	30,970	$	29,616	$	39,261
Ending margin balances (millions)		$	608	$	486	$	801
Ending customer payables balances (millions)		$	1,007	$	848	$	825
Number of advisors ⁽³⁾			1,009		984		1,211

Included in the numbers above are the following relating to fee-based accounts:
	Customer accounts		6,964		4,680		3,339
	Average revenue per account	$	1,572	$	1,442	$	449
	Assets under administration (millions)	$	1,494	$	789	$	512
	Average assets per active account	$	214,537	$	168,522	$	153,323

⁽¹⁾ Includes both trades on which commissions are earned (“commissionable trades”) and trades for which no commission is earned (“fee-based trades”). Excludes open-ended mutual fund redemptions.

⁽²⁾ Calculated as total commissions divided by commissionable trades.

⁽³⁾ Fiscal year 2003 and 2002 advisors have been adjusted to exclude sales assistants.




Investment Services – Financial Results (in 000s)



Year ended April 30,			2004			2003			2002

Transactional revenue			$	101,634		$	93,422		$	123,990
Annuitized revenue				59,696			37,358			25,677

	Production revenue			161,330			130,780			149,667
Other revenue				34,732			32,714			33,169

	Non-interest revenue			196,062			163,494			182,836
Margin interest revenue				33,408			37,300			67,849
Less: interest expense				(1,358	)		(4,830	)		(14,744	)

	Net interest revenue			32,050			32,470			53,105

		Total revenues ⁽¹⁾		228,112			195,964			235,941

Commissions				53,851			41,748			46,490
	Other variable expenses			3,866			4,234			9,266

	Total variable expenses			57,717			45,982			55,756
Gross profit				170,395			149,982			180,185
Compensation and benefits				97,151			92,978			93,314
Occupancy and equipment				29,054			30,323			29,106
Depreciation and amortization				45,129			51,791			49,866
Impairment of goodwill				–			24,000			–
Other				44,426			63,933			48,067
Allocated corporate and shared costs				19,081			15,249			14,694

		Total fixed expenses		234,841			278,274			235,047

Pretax loss			$	(64,446	)	$	(128,292	)	$	(54,862	)

⁽¹⁾ Total revenues, less interest expense

Fiscal 2004 compared to fiscal 2003

Investment Services’ revenues, net of interest expense, for fiscal year 2004 increased $32.1 million, or 16.4%, over the prior year. The improvement is primarily due to the increase in annuitized revenues.

Transactional revenue, which is based on transaction or trade quantities, increased $8.2 million, or 8.8%, from the prior year due to a 24.4% increase in trading activity, partially offset by a slight decline in average revenue per trade. Annuitized revenues increased $22.3 million, or 59.8%, due to increased sales of annuities and mutual funds. The increase in production revenues is also due to an increase in advisor productivity. We added a net 25 advisors this year and advisor productivity continues to improve. Productivity averaged approximately $166,000 per advisor compared to $122,000 last year.

Margin interest revenue declined $3.9 million, or 10.4%, from the prior year primarily as a result of a 5.5% decline in average margin balances coupled with lower interest rates. Margin balances declined from an average of $577.0 million in fiscal year 2003 to $545.0 million in the current year. Accordingly, interest expense for fiscal year 2004 declined $3.5 million, or 71.9%, from fiscal year 2003. Margin balances, which steadily declined during most of 2003, have steadily increased in the last several months of fiscal year 2004 and averaged $600.0 million for the fourth quarter.

Total expenses decreased $31.7 million, or 9.8%, primarily due to the $24.0 million goodwill impairment charge recorded last year. Other expenses decreased $19.5 million primarily as a result of a reduction in consulting and legal expenses. These decreases were partially offset by a $12.1 million increase in commissions expense due to the increase in customer trading and higher average commissions paid.

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Form 10-K – H&R BLOCK

The pretax loss for Investment Services for fiscal year 2004 was $64.4 million compared to a loss of $128.3 million last year.

Fiscal 2005 outlook

We believe the key to segment profitability is the recruitment and retention of experienced financial advisors. See additional discussion of our advisor production in Item 1, “Description of Business.” Our goal is to hire 250-300 experienced advisors in fiscal year 2005. We are also partnering with the U.S. Tax Operation segment in the LRTP program, which focuses on adding advice to our tax client relationships through licensing and aligning tax professionals with financial advisors. See additional discussion above in U.S. Tax Operations outlook section.

Although we expect to see continued improvements in our financial performance, we still expect to report an operating loss for fiscal year 2005.

Fiscal 2003 compared to fiscal 2002

Investment Services’ revenues, net of interest expense, for fiscal year 2003 declined $40.0 million, or 16.9%, compared to fiscal year 2002. The decrease was primarily due to lower net interest income and lower transactional revenues.

Transactional revenue decreased $30.6 million, or 24.7%, from the prior year due to a 20.7% decline in trading activity, partially offset by an increase in average revenue per trade. Additionally, syndicate fee revenues of $6.7 million were included in Other revenues for fiscal year 2003 and in fiscal year 2002 they were included in Transactional revenue. Annuitized revenues increased $11.7 million, or 45.5%, due to increased sales of annuities and mutual funds.

Margin interest revenue declined $30.5 million, or 45.0%, from fiscal year 2002 primarily as a result of a 42.3% decline in average margin balances coupled with lower interest rates. Margin balances declined from an average of $1.0 billion for fiscal year 2002 to $577.0 million in 2003. Accordingly, interest expense for fiscal year 2003 declined $9.9 million, or 67.2%, from fiscal year 2002.

Total expenses increased $33.5 million, or 11.5%, primarily due to a $24.0 million goodwill impairment charge recorded during fiscal year 2003. During the first quarter of fiscal year 2003, in light of unsettled market conditions and the severe decline of comparable business valuations in the investment industry, we engaged an independent valuation firm to perform the goodwill impairment test, in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” on the Investment Services segment. As a result, the $24.0 million impairment charge was recorded.

Additional expense increases resulted from various new initiatives to expand products and the business, including the installation of a new back office brokerage operating system, relocation to new offices and advisor recruitment initiatives. These increases were partially offset by a decrease in commissions expense due to the decline in customer trading and cost containment measures.

As a result of meeting certain three-year production goals established in connection with the acquisition of OLDE Financial, certain long-term advisors were eligible to receive a one-time retention payment. The retention period was through December 31, 2002. Retention payments under this plan of approximately $17.0 million were accrued through the third quarter of fiscal year 2003. The retention payments were paid out in February 2003.

The pretax loss for Investment Services for fiscal year 2003 was $128.3 million compared to the prior year loss of $54.9 million.

INTERNATIONAL TAX OPERATIONS

This segment is primarily engaged in providing local tax return preparation, filing and related services in Canada, Australia and the United Kingdom. In addition, International Tax Operations includes Overseas operations, which consists of company-owned and franchise offices preparing tax returns for U.S. citizens living abroad.

Operations in this segment are transacted in the local currencies of the countries in which they operate, therefore the results can be affected by the translation into U.S. dollars. The weakening of the U.S. dollar during the current year had the impact of increasing reported revenues, income and losses.




International Tax Operations – Financial Results (in 000s)



Year ended April 30,	2004			2003			2002

Canada	$	64,238		$	57,985		$	55,753
Australia		26,577			20,614			17,701
Other		6,745			6,483			5,256

Total revenues		97,560			85,082			78,710

Canada		8,888			8,108			7,728
Australia		4,609			3,802			2,912
Other		(2,400	)		(1,446	)		(3,547	)

Pretax income	$	11,097		$	10,464		$	7,093

Fiscal 2004 compared to fiscal 2003

International Tax Operations’ revenues for the year ended April 30, 2004 increased $12.5 million, or 14.7%, compared to the prior year. This improvement is due to results in Canada and Australia. Revenues in Canada increased $6.3 million, or 10.8%, entirely as a result of favorable foreign exchange rates. Revenues in Canadian dollars declined 0.4% primarily due to a 3.5% decline in the average charge per return, somewhat offset by an increase in company-owned tax returns prepared, most of which were discounted returns. The decline in average charge resulted from our current year marketing program, which was designed to attract students and younger filers. Of the $6.0 million increase in Australian revenues, $4.9 million was due to favorable foreign exchange rates. Additionally, tax returns prepared in company-owned offices in fiscal year 2004 increased 3.7% compared to the prior year and the average charge per return increased 2.0%.

Pretax income improved $0.6 million, or 6.1%, primarily due to exchange rates, as earnings in local currencies were similar to the prior year.

Fiscal 2003 compared to fiscal 2002

International Tax Operations’ revenues for the year ended April 30, 2003 increased $6.4 million, or 8.1%, compared to fiscal year 2002. This improvement is primarily due to results in Australia, where tax returns prepared in company-owned offices in fiscal year 2003 increased 3.7% compared to 2002 and the average charge per return increased 3.0%. Revenues in Canada increased $2.2 million, or 4.0%, entirely as a result of foreign exchange rates. Revenues in Canadian dollars declined 2.3% primarily due to the sale of certain operations during 2003 and a decline in the number of returns prepared. Tax returns prepared declined 3.7% as a result of increased competition in the major metropolitan areas.

Pretax income improved $3.4 million, or 47.5%, primarily due to cost savings in the United Kingdom as a result of business restructuring and the write-off of intangible assets in the prior year, which is included in “Other” in the above table.

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H&R BLOCK – Form 10-K

CORPORATE OPERATIONS

This segment consists primarily of corporate support departments, which provide services to our operating segments. These support departments consist of marketing, information technology, facilities, human resources, executive, legal, finance, government relations and corporate communications. Support department costs are generally allocated to our operating segments. Our captive insurance, franchise financing and small business initiative subsidiaries are also included within this segment.




Corporate Operations – Financial Results (in 000s)



Year ended April 30,	2004			2003			2002

Operating revenues	$	12,532		$	6,448		$	12,603
Eliminations		(8,218	)		(7,099	)		(6,830	)

Total revenues		4,314			(651	)		5,773

Corporate expenses:

January – April

July – October


⁽¹⁾	Impact of company-owned offices in former major franchise territories that commenced operations during fiscal year 2004.
⁽²⁾	Shared locations include offices located within Wal-Mart, Sears or other third-party businesses.


ITEM 5.	MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES


⁽¹⁾	On June 11, 2003, our Board of Directors approved the repurchase of 20 million shares of H&R Block common stock. This authorization has no expiration date.
⁽²⁾	Of the total number of shares purchased, 1,202 shares were purchased in connection with funding employee income tax withholding obligations arising upon the exercise of stock options or the lapse of restrictions on restricted shares.
⁽³⁾	On June 9, 2004, our Board of Directors approved the additional repurchase of 15 million shares of H&R Block common stock. This authorization has no expiration date.


⁽¹⁾	Company-owned and franchise numbers for fiscal years 2003 and 2002 have not been restated for franchise acquisitions during fiscal year 2004.
⁽²⁾	Excludes company-owned offices in former major franchise territories, which commenced operations during fiscal year 2004.
⁽³⁾	Impact of company-owned offices in former major franchise territories, which commenced operations during fiscal year 2004.
⁽⁴⁾	Includes TaxCut federal units sold.
⁽⁵⁾	Includes a) online completed and paid federal returns, and b) state returns only when no payment was made for a federal return.
⁽⁶⁾	Data is for tax season (January 1 – April 30) only.
⁽⁷⁾	Calculated as gross tax preparation and related fees divided by clients served.


⁽¹⁾	Defined as total premium received divided by total balance of loans delivered to third-party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses).
⁽²⁾	Represents non-prime production.


⁽¹⁾	Includes all direct sales and back office sales support associates.
⁽²⁾	Percentage of loans funded divided by total applications in the period.
⁽³⁾	Defined as total premium received divided by total balance of loans delivered to third-party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses).


⁽¹⁾	Not comparable due to mid-year acquisition of capital markets business.


⁽¹⁾	Includes both trades on which commissions are earned (“commissionable trades”) and trades for which no commission is earned (“fee-based trades”). Excludes open-ended mutual fund redemptions.
⁽²⁾	Calculated as total commissions divided by commissionable trades.
⁽³⁾	Fiscal year 2003 and 2002 advisors have been adjusted to exclude sales assistants.