H&R BLOCK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
Amounts in thousands, except share amounts

H&R BLOCK, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
Unaudited, amounts in thousands, except per share amounts

H&R BLOCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited, amounts in thousands

1.		Basis of Presentation

		The condensed consolidated balance sheet as of January 31, 2004, the condensed consolidated income statements for the three and nine months ended January 31, 2004 and 2003, and the condensed consolidated statements of cash flows for the nine months ended January 31, 2004 and 2003 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at January 31, 2004 and for all periods presented have been made.

		Certain reclassifications have been made to prior year amounts to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders’ equity as previously reported.

		Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s April 30, 2003 Annual Report to Shareholders on Form 10-K.

		Operating revenues of the U.S. Tax Operations, Business Services and International Tax Operations segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.

		The Company files its Federal and state income tax returns on a calendar year basis. The condensed consolidated income statements reflect the effective tax rates expected to be applicable for the respective full fiscal years.

2.		Business Combinations

		During the nine months ended January 31, 2004, cash payments of $243,257 were made related to the acquisition of assets and stock in the franchise territories of ten former major franchisees. The preliminary allocation of the purchase price to assets acquired is as follows: property and equipment of $2,697; goodwill of $194,883; customer relationships of $18,167; noncompete agreements of $17,069; and $10,441 related to legal reserves for franchise litigation. The customer relationships will be amortized in conjunction with the estimated retention curve over ten years. The noncompete agreements will be amortized on a straight-line basis over three years. The weighted average life of the intangible assets is approximately seven years. Goodwill recognized in these transactions is included in the U.S. Tax Operations segment and all but $3,901 is deductible for tax purposes. Results related to these ten former major franchise territories have been included in the accompanying condensed consolidated financial statements since the respective dates company-owned operations commenced. See discussion related to

The condensed consolidated balance sheet as of October 31, 2003, the condensed consolidated income statements for the three and six months ended October 31, 2003 and 2002, and the condensed consolidated statements of cash flows for the six months ended October 31, 2003 and 2002 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at October 31, 2003 and for all periods presented have been made.-4-

Financial results for the three months ended July 31, 2003 have been restated as a result of the adoption of Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). See note 13 to the condensed consolidated financial statements for additional information.

Certain reclassifications have been made to prior year amounts to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders’ equity as previously reported.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s April 30, 2003 Annual Report to Shareholders on Form 10-K.

Operating revenues of the U.S. Tax Operations, Business Services and International Tax Operations segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.

The Company files its Federal and state income tax returns on a calendar year basis. The condensed consolidated income statements reflect the effective tax rates expected to be applicable for the respective full fiscal years.

During the six months ended October 31, 2003, cash payments of $118,828 were made or accrued related to the acquisition of assets in the franchise territories of ten former major franchisees. See discussion related to litigation involving major franchisees in note 11 to the condensed consolidated financial statements.

~~Results related to the ten former major franchise territories, from the dates company-owned operations commenced, have been included in the accompanying condensed consolidated financial statements.~~

Due to pending litigation, the purchase price allocations have not been finalized. The preliminary allocation of the purchase price to assets acquired is as follows: property and equipment of $4,168; goodwill of $83,267; customer relationships of $21,362 and noncompete agreements of $10,031. The customer relationships and noncompete agreements will be amortized over ten years and three years, respectively, and the weighted average life of the intangible assets is approximately eight years. Goodwill recognized in these transactions is included in the U.S. Tax Operations segment and all but $3,304 is deductible for tax purposes. The preliminary purchase price allocations will be adjusted upon determination of the final purchase price.
litigation involving major franchisees in note 12 to the condensed consolidated financial statements.
3. Earnings Per Share
Basic earnings per share is computed using the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share. The computations of basic and diluted earnings per share are as follows:


	Three months ended				Nine months ended
	January 31,				January 31,
(in 000s, except per share amounts)	2004		2003		2004		2003
Net income before change in accounting principle	$	106,726	$	132,313	$	128,621	$	85,422

Basic weighted average common shares		176,732		178,770		177,964		179,620
Dilutive potential shares from stock options and restricted stock		4,251		3,402		3,516		4,757
Convertible preferred stock		1		1		1		1

Dilutive weighted average common shares		180,984		182,173		181,481		184,378

Earnings per share before change in accounting principle:
Basic	$	.60	$	.74	$	.72	$	.48
Diluted		.59		.73		.71		.46

3. ~~Earnings (Loss) Per Share~~Diluted earnings per share excludes the impact of shares of common stock issuable upon the exercise of options to purchase 283 shares and 3.7 million shares of stock for the three and nine months ended January 31, 2004, respectively, as the options’ exercise prices were greater than the average market price of the common shares during those periods and therefore, the effect would be antidilutive. Diluted earnings per share for the three and nine months ended January 31, 2003 excludes the impact of 4.7 million shares and 2.1 million shares, respectively, issuable upon the exercise of stock options as they are antidilutive.
The weighted average shares outstanding for the three and nine months ended January 31, 2004 decreased to 176.7 million and 178.0 million, respectively, from 178.8 million and 179.6 million last year, respectively, primarily due to the purchase of treasury shares by the Company. The effect of these purchases was partially offset by the issuance of treasury shares related to the Company’s stock-based compensation plans.
During the nine months ended January 31, 2004, the Company issued 3.8 million shares of common stock pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares, in accordance with the Company’s stock-based compensation plans. During the nine months ended January 31, 2003, the Company issued 4.4 million shares of common stock

Basic earnings (loss) per share is computed using the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share. The computations of basic and diluted earnings (loss) per share are as follows:-5-

(in 000s, except per share amounts) Three months ended Six months ended

October 31, October 31,

2003 2002 2003 2002

Net income (loss) before change in accounting principle $ 10,376 $ (37,347 ) $ 21,895 $ (46,891 )

Basic weighted average common shares 177,828 178,880 178,616 180,045
Dilutive potential shares from stock options and restricted stock 3,282 — 3,348 —
Convertible preferred stock 1 — 1 —

Dilutive weighted average common shares 181,111 178,880 181,965 180,045

Earnings (loss) per share before change in accounting principle:
Basic and diluted $ .06 $ (.21 ) $ .12 $ (.26 )

Diluted earnings per share excludes the impact of shares of common stock issuable upon the exercise of options to purchase 6.5 million shares of stock as of October 31, 2003, as the options’ exercise prices were greater than the average market price of the common shares and therefore, the effect would be antidilutive. Diluted loss per share as of October 31, 2002 excludes the impact of 19.0 million shares issuable upon the exercise of stock options and the conversion of 1,216 shares of preferred stock to common stock, as they are antidilutive.

The weighted average shares outstanding for the three and six months ended October 31, 2003 decreased to 177.8 million and 178.6 million, respectively, from 178.9 million and 180.0 million last year, respectively, primarily due to the purchase of treasury shares by the Company. The effect of these purchases was partially offset by the issuance of treasury shares related to the Company’s stock-based compensation plans.

~~-5-~~

During the six months ended October 31, 2003, the Company issued 2.2 million shares of common stock pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares, in accordance with the Company’s stock-based compensation plans. During the six months ended October 31, 2002, the Company issued 3.6 million shares of common stock pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares.

During the six months ended October 31, 2003, the Company acquired 4.2 million shares of its common stock at an aggregate cost of $178,847. During the six months ended October 31, 2002, the Company acquired 6.5 million shares of its common stock at an aggregate cost of $313,603.
pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares.
During the nine months ended January 31, 2004, the Company acquired 7.8 million shares of its common stock at an aggregate cost of $371,242. During the nine months ended January 31, 2003, the Company acquired 6.6 million shares of its common stock at an aggregate cost of $317,608.
4. Receivables
Receivables consist of the following:


	January 31, 2004			April 30, 2003
Participation in refund anticipation loans (RALs)	$	562,974		$	12,871
Business Services accounts receivable		153,322			185,023
Mortgage loans held for sale		152,668			68,518
Receivables for tax related fees		79,287			1,500
Loans to franchisees		46,729			33,341
Royalties from franchisees		39,898			83
Software receivables		25,995			36,810
Other		72,521			87,471

		1,133,394			425,617
Allowance for doubtful accounts		(22,020	)		(17,038	)
Lower of cost or market adjustment – mortgage loans		(18,323	)		(5,382	)

	$	1,093,051		$	403,197

4.5. ~~Receivables~~Mortgage Banking Activities

~~Receivables consist of the following:~~

Activity related to available-for-sale residual interests in securitizations for the nine months ended January 31, 2004 and 2003 and the twelve months ended April 30, 2003 consists of the following:

October 31, 2003 April 30, 2003

Business Services accounts receivable $ 154,143 $ 185,023
Mortgage loans held for sale 100,174 68,518
Loans to franchisees 39,370 33,341
Refund anticipation loans (RALs) and related receivables 17,200 12,871
Software receivables 1,522 36,810
Other 50,886 89,054

363,295 425,617
Allowance for doubtful accounts (12,678 ) (17,038 )
Lower of cost or market adjustment (9,823 ) (5,382 )

$ 340,794 $ 403,197


	Nine Months Ended						Year Ended
	January 31, 2004			January 31, 2003			April 30, 2003
Balance, beginning of period	$	264,337		$	365,371		$	365,371
Additions from NIM transactions		1,604			753			753
Additions from NIM secured financing, held as collateral		40,196			—			—
Termination of NIM trust		(40,196	)		—			—
Cash received		(127,997	)		(117,522	)		(140,795	)
Cash received from sale of previously securitized residuals		(17,000	)		(142,486	)		(142,486	)
Accretion		118,389			113,146			145,165
Impairments of fair value		(26,048	)		(25,589	)		(54,111	)
Exercise of call options		(5,875	)		—			—
Changes in unrealized holding gains arising during the period, net		26,441			80,680			90,440

Balance, end of period	$	233,851		$	274,353		$	264,337

-6-

5. ~~Mortgage Banking Activities~~The Company sold $16,940,590 and $12,412,587 of mortgage loans in whole loan sales to third-party trusts (Trusts) or other buyers during the nine months ended January 31, 2004 and 2003, respectively, with gains totaling $590,941 and $497,457, respectively, recorded on these sales.
Residual interests valued at $199,021 and $326,395 were securitized in net interest margin (NIM) transactions during the respective nine-month periods. Net cash proceeds of $197,417 and $325,642 were received from the NIM transactions for the nine months ended January 31, 2004 and 2003, respectively. Total net additions to residual interests from NIM transactions for the nine months ended January 31, 2004 and 2003 were $1,604 and $753, respectively.
At January 31, 2004, the Company had $52,564 of residual interests classified as trading securities. These residual interests are included in marketable securities – trading on the condensed consolidated balance sheet. There were no such trading securities recorded as of April 30, 2003.
In the second quarter of fiscal year 2004, the Company completed a NIM transaction with a special purpose entity (SPE) that did not meet the criteria for a qualifying special purpose entity (QSPE) under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” As a result, the SPE was consolidated and the transaction was accounted for as a secured financing (on-balance sheet securitization). During the third quarter, the NIM trust was terminated and the related residual interests were subsequently securitized in a NIM transaction with a QSPE.
Cash flows of $127,997 and $117,522 were received from the securitization trusts for the nine months ended January 31, 2004 and 2003, respectively. An additional $17,000 and $142,486 was received during the nine months ended January 31, 2004 and 2003, respectively, as a result of the sale of previously securitized residuals. Cash received on residual interests is included in investing activities in the condensed consolidated statements of cash flows.
Residual interests are classified as either available-for-sale (AFS) or trading securities and are therefore reported at fair market value (based on discounted cash flow models). Unrealized holding gains represent the write-up in value of AFS residual interests as a result of actual or projected performance factors that are better than the projected assumptions previously used in the Company’s valuation models, such as interest rates, loan losses or loan prepayments. Trading securities are marked-to-market through the income statement.
Aggregate net unrealized gains on residual interests, which had not yet been accreted into income, totaled $107,066 at January 31, 2004 and $98,089 at April 30, 2003. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and may be recognized in income in future periods either through accretion or upon further securitization or sale of the related residual interest.
In connection with securitization transactions, the Company, as servicer, generally has a 10% clean-up call option, whereby the Company, at its discretion, may repurchase the outstanding loans in the securitization once the current value of the loans is 10% or less of their original

~~Activity related to residual interests in securitizations for the six months ended October 31, 2003 and 2002 and the twelve months ended April 30, 2003 consists of the following:~~-7-

Six Months Ended Year Ended

October 31, 2003 October 31, 2002 April 30, 2003

Balance, beginning of period $ 264,337 $ 365,371 $ 365,371
Additions from NIM transactions 1,814 753 753
Additions from secured financing, held as collateral 40,196 — —
Cash received (68,850 ) (103,885 ) (140,795 )
Cash received on sales of residual interests — — (142,486 )
Accretion 70,906 92,853 145,165
Impairments of fair value (11,106 ) (24,132 ) (54,111 )
Exercise of call option (2,603 ) — —
Changes in unrealized holding gains arising during the period, net 22,910 55,796 90,440

Balance, end of period $ 317,604 $ 386,756 $ 264,337

The Company sold $11,631,790 and $7,813,332 of mortgage loans in whole loan sales to third-party trusts (Trusts) during the six months ended October 31, 2003 and 2002, respectively, with gains totaling $424,034 and $320,517, respectively, recorded on these sales.

Residual interests valued at $199,021 and $136,766 were securitized in net interest margin (NIM) transactions during the respective six-month periods. Net cash proceeds of $147,107 and $136,013 were received from the NIM transactions for the six months ended October 31, 2003 and 2002, respectively. Additional cash proceeds of $50,100 were received as a result of the secured financing, as described below. Total net additions to residual interests from NIM transactions for the six months ended October 31, 2003 and 2002 were $1,814 and $753, respectively.

In the second quarter of fiscal year 2004, the Company completed a NIM transaction with a special purpose entity (SPE) that did not qualify as a qualifying special purpose entity (QSPE), and therefore the SPE has been consolidated and the transaction is being accounted for as a secured financing (on-balance sheet securitization). As a result of the on-balance sheet securitization, the condensed consolidated balance sheet includes a residual interest of $40,196, which is held as collateral for the related financing, and an interest rate cap, which is a derivative instrument. The residual interest is accounted for as a trading security. The interest rate cap of $9,904 is included in other assets. Additionally, a liability for the principal balance of the bonds issued by the NIM trust of $50,100 has been included in other noncurrent liabilities on the condensed consolidated balance sheet.

The residual interest and interest rate cap underlying the bonds are owned by the NIM trust and are not available to the Company’s creditors. As such, the bondholders have no recourse to the Company for the failure of the underlying mortgage loan borrowers to pay when due. The

~~-7-~~

value. During the nine months ended January 31, 2004, the Company exercised call options on residual interests initially recorded in 1996 and 1999. The outstanding loans were repurchased from the securitization trust, and the proceeds were used to pay off the remaining bondholders. These repurchased loans may be included in future sale transactions. At the time the call options were exercised, the book value of the corresponding residual interests was $5,875.
Activity related to mortgage servicing rights (MSRs) consists of the following:


	Nine Months Ended						Year Ended
	January 31, 2004			January 31, 2003			April 30, 2003
Balance, beginning of period	$	99,265		$	81,893		$	81,893
Additions		64,265			55,960			65,345
Amortization		(57,334	)		(33,273	)		(47,107	)
Impairments of fair value		—			—			(866	)

Balance, end of period	$	106,196		$	104,580		$	99,265

~~interest rate cap is held for the benefit of the underlying bondholders of the NIM bonds to mitigate risk associated with the residual cash flows.~~

Cash flows of $68,850 and $103,885 were received from the securitization trusts for the six months ended October 31, 2003 and 2002, respectively. Cash received on residual interests is included in investing activities in the condensed consolidated statements of cash flows.

Residual interests are classified as either available-for-sale (AFS) or trading securities and are therefore reported at fair market value (based on discounted cash flow models). Unrealized holding gains represent the write-up of AFS residual interests as a result of actual or estimated lower interest rates, loan losses or loan prepayments than previously projected in the Company’s valuation models. Trading securities are marked-to-market through the income statement.

Aggregate net unrealized gains on residual interests, which had not yet been accreted into income, totaled $120,903 at October 31, 2003 and $98,089 at April 30, 2003. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and may be recognized in income in future periods either through accretion or upon further securitization or sale of the related residual interest.

In connection with securitization transactions, the Company, as servicer, has a 10% call option, whereby the Company, at its discretion, may repurchase the outstanding loans in the securitization once the current value of the loans is 10% or less of their original value. During the quarter ended July 31, 2003, the Company, as servicer, exercised its 10% call option on a residual interest originally recorded in 1996. The remaining outstanding loans were repurchased from the securitization trust, and the proceeds were used to pay off the remaining bondholders. These repurchased loans may be included in future sale transactions. At the time the call option was exercised, the book value of the residual interest was $2,603.

~~Activity related to mortgage servicing rights (MSRs) consists of the following:~~

Six Months Ended Year Ended

October 31, 2003 October 31, 2002 April 30, 2003

Balance, beginning of period $ 99,265 $ 81,893 $ 81,893
Additions 48,002 37,968 65,345
Amortization (35,307 ) (20,087 ) (47,107 )
Impairments of fair value — — (866 )

Balance, end of period $ 111,960 $ 99,774 $ 99,265

~~-8-~~

~~The key assumptions the Company utilized to originally estimate the cash flows and values of residual interests for securitizations during the three months ended October 31, 2003 are as follows:~~

The key assumptions the Company used to estimate the cash flows and values of residual interests in securitizations initially recorded during the three months ended January 31, 2004 are as follows:


Estimated annual prepayments		~~30%~~35% to 90%
Estimated credit losses		~~4.74%~~	4.72%
Discount rate —– residual interests		~~13.21%~~25% to ~~18.19%~~28%
Variable returns to third-party beneficial interest holders		LIBOR forward curve
	~~beneficial interest holders~~		at NIM closing date

~~The following table illustrates key assumptions the Company utilizes to estimate the cash flows and values of residual interests and MSRs at October 31, 2003:~~

The following table illustrates key assumptions the Company used to estimate the cash flows and values of residual interests and MSRs held at January 31, 2004:


Estimated annual prepayments	30% to 90%
Estimated credit losses	~~1.71%~~0.74% to ~~14.08%~~11.67%
Discount rate —– residual interests	~~12%~~18% to ~~45.30%~~25%
Discount rate —– MSRs		12.80%

~~At October 31, 2003, the sensitivities of the current fair value of the residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are as follows:~~-8-

Residential Mortgage Loans

Original NIM Servicing
Residuals Residuals Asset

Carrying amount/fair value of residuals $ 26,251 $ 291,353 $ 111,960
Weighted average life (in years) 2.1 1.8 1.2
Prepayments (including defaults):
Adverse 10% — $impact on fair value $ 1,236 $ 2,714 $ (19,707 )
Adverse 20% — $impact on fair value 2,484 8,020 (39,236 )
Credit losses:
Adverse 10% — $impact on fair value $ (1,477 ) $ (33,035 ) Not applicable
Adverse 20% — $impact on fair value (2,765 ) (62,588 ) Not applicable
Discount rate:
Adverse 10% — $impact on fair value $ (777 ) $ (5,142 ) $ (1,865 )
Adverse 20% — $impact on fair value (1,485 ) (9,342 ) (3,431 )
Variable interest rates:
Adverse 10% — $impact on fair value $ 104 $ (10,540 ) Not applicable
Adverse 20% — $impact on fair value 210 (19,943 ) Not applicable

These sensitivities are hypothetical and should be used with caution. As the table indicates, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be

~~-9-~~

linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions. It is likely that changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.

6. ~~Intangible Assets~~At January 31, 2004, the sensitivities of the current fair value of the residual interests and ~~Goodwill~~MSRs to 10% and 20% adverse changes in the above key assumptions are as follows:

~~Intangible assets consist of the following:~~

October 31, 2003 April 30, 2003

Gross Gross

Carrying Accumulated Carrying Accumulated

Amount Amortization Amount Amortization

U.S. Tax Operations:
Customer relationships $ 21,362 $ (855 ) $ — $ —
Noncompete agreements 10,031 (859 ) — —
Business Services:
Customer relationships 120,178 (50,421 ) 120,178 (44,192 )
Noncompete agreements 26,909 (7,447 ) 26,909 (6,157 )
Trade name — amortizing 1,450 (277 ) 1,450 (205 )
Trade name — non-amortizing 55,637 (4,868 ) 55,637 (4,868 )
Investment Services:
Customer relationships 293,000 (114,758 ) 293,000 (100,108 )
Corporate Operations:
Customer relationships 844 (24 ) 172 (10 )
Noncompete agreements 295 (9 ) 60 (1 )

Total intangible assets $ 529,706 $ (179,518 ) $ 497,406 $ (155,541 )


	Residential Mortgage Loans
	Original			NIM			Trading			Servicing
	Residuals			Residuals			Residuals			Asset
Carrying amount/fair value of residuals	$	14,674		$	219,177		$	52,564		$	106,196
Weighted average life (in years)		2.2			1.9			2.2			1.2
Prepayments (including defaults):
Adverse 10% - $ impact on fair value	$	657		$	5,135		$	(562	)	$	(19,644	)
Adverse 20% - $ impact on fair value		1,305			9,967			3,272			(38,463	)
Credit losses:
Adverse 10% - $ impact on fair value	$	(832	)	$	(28,099	)	$	(1,452	)	Not applicable
Adverse 20% - $ impact on fair value		(1,536	)		(52,187	)		(2,185	)	Not applicable
Discount rate:
Adverse 10% - $ impact on fair value	$	(436	)	$	(4,218	)	$	(846	)	$	(1,516	)
Adverse 20% - $ impact on fair value		(834	)		(8,068	)		(1,662	)		(3,032	)
Variable interest rates:
Adverse 10% - $ impact on fair value	$	54		$	(9,749	)	$	(2,388	)	Not applicable
Adverse 20% - $ impact on fair value		109			(18,550	)		(4,781	)	Not applicable

Amortization of intangible assets for the three and six months ended October 31, 2003 was $12,861 and $23,977, respectively. Amortization of intangible assets for the three and six months ended October 31, 2002 was $10,966 and $22,285, respectively. Estimated amortization of intangible assets for fiscal years 2004 through 2008 is $51,384, $50,556, $49,559, $42,988 and $41,218, respectively.

~~Changes in the carrying amount of goodwill for the six months ended October 31, 2003, consist of the following:~~

April 30, 2003 Additions Other October 31, 2003

U.S. Tax Operations $ 130,502 $ 88,892 $ — $ 219,394
Mortgage Operations 152,467 — — 152,467
Business Services 279,650 25,832 — 305,482
Investment Services 145,732 — — 145,732
International Tax Operations 5,666 512 591 6,769
Corporate Operations 198 11 — 209

Total goodwill $ 714,215 $ 115,247 $ 591 $ 830,053

~~-10-~~

Additions to goodwill for U.S. Tax Operations include $83,267 related to asset acquisitions involving former major franchise businesses and other acquisitions of $5,625. Additions to goodwill for Business Services primarily result from the last contingent payment related to the acquisition of the non-attest assets of McGladrey & Pullen, LLP of approximately $25,000.

The Company tests goodwill for impairment annually, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit’s net assets below its carrying value. During the six months ended October 31, 2002, a goodwill impairment charge of $24,000 was recorded for the Investment Services segment. No such impairment or events indicating potential impairment have been identified within any of the Company’s segments during the six months ended October 31, 2003.

7~~. Derivative Instruments~~These sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions. It is likely that changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.

The Company, in the normal course of business, enters into commitments with its customers to fund mortgage loans for specified periods of time at “locked-in” interest rates. These financial instruments represent commitments (rate-lock equivalent) to fund loans. The estimated fair value of these rate-lock equivalents is determined based on the difference in the value of the commitments to fund loans between the date of commitment and the date of valuation, taking into consideration the probability of the commitments being exercised and changes in other market conditions. At October 31, 2003 and April 30, 2003, the Company recorded assets totaling $13,144 and $12,531, respectively, in prepaid expenses and other current assets on the condensed consolidated balance sheets related to these commitments.-9-

The NIM Trust, in the normal course of business, enters into interest rate caps to mitigate interest rate risk to the underlying bondholders of the NIM bonds. The interest rate cap is owned by the NIM Trust, which is normally not consolidated by the Company. As a result of the secured financing completed in October 2003, an interest rate cap of $9,904 has been included in other assets on the condensed consolidated balance sheet at October 31, 2003. The interest rate cap will be marked-to-market monthly through the income statement. There are no adjustments to the interest rate cap included in the consolidated income statements for the three and six months ended October 31, 2003.

The Company entered into an agreement with Household Tax Masters, Inc. (Household) during fiscal year 2003, whereby the Company waived its right to purchase any participation interests in and receive license fees relating to RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights, the Company received a series of payments from Household, subject to certain adjustments based on delinquency rates on RALs made by Household through December 31, 2003. The adjustment to the payments will be paid in January 2004. This adjustment is a derivative and will be marked-to-market monthly through December 31, 2003. During the three and six months ended October 31, 2003, the Company recognized $1,446 and $5,560, respectively, of revenues related to this instrument. A receivable of $10,731 and $5,171 is included on the condensed consolidated balance sheet as of October 31, 2003 and April 30, 2003, respectively.

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8.6. ~~Comprehensive Income~~Intangible Assets and Goodwill
Intangible assets consist of the following:


	January 31, 2004					April 30, 2003
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization
U.S. Tax Operations:
Customer relationships	$	18,167	$	(2,295	)	$	—	$	—
Noncompete agreements		17,069		(3,573	)		—		—
Business Services:
Customer relationships		121,588		(53,590	)		120,178		(44,192	)
Noncompete agreements		27,504		(8,016	)		26,909		(6,157	)
Trade name – amortizing		1,450		(314	)		1,450		(205	)
Trade name – non-amortizing		55,637		(4,868	)		55,637		(4,868	)
Investment Services:
Customer relationships		293,000		(122,083	)		293,000		(100,108	)
Corporate Operations:
Customer relationships		844		(45	)		172		(10	)
Noncompete agreements		295		(22	)		60		(1	)

Total intangible assets	$	535,554	$	(194,806	)	$	497,406	$	(155,541	)

Amortization of intangible assets for the three and nine months ended January 31, 2004 was $15,286 and $39,265, respectively. Amortization of intangible assets for the three and nine months ended January 31, 2003 was $11,085 and $33,322, respectively. Estimated amortization of intangible assets for fiscal years 2004 through 2008 is $53,284, $52,342, $51,313, $42,506 and $40,897, respectively.

The Company’s comprehensive income is comprised of net income (loss), the change in net unrealized gain on marketable securities and foreign currency translation adjustments. The components of comprehensive income (loss) for the three and six months ended October 31, 2003 and 2002 were:

Changes in the carrying amount of goodwill for the nine months ended January 31, 2004, consist of the following:

Three months ended Six months ended

October 31, October 31,

2003 2002 2003 2002

Net income (loss) $ 10,376 $ (37,347 ) $ 15,536 $ (46,891 )
Change in net unrealized gain on marketable securities (6,172 ) 450 14,036 34,200
Change in foreign currency translation adjustments 6,087 1,289 11,730 771

Comprehensive income (loss) $ 10,291 $ (35,608 ) $ 41,302 $ (11,920 )


	April 30, 2003		Additions		Other		January 31, 2004
U.S. Tax Operations	$	130,502	$	201,254	$	—	$	331,756
Mortgage Operations		152,467		—		—		152,467
Business Services	��	279,650		31,467		—		311,117
Investment Services		145,732		—		—		145,732
International Tax Operations		5,666		849		734		7,249
Corporate Operations		198		11		—		209

Total goodwill	$	714,215	$	233,581	$	734	$	948,530

9. ~~Stock-Based Compensation~~Preliminary additions to goodwill for U.S. Tax Operations include $194,883 related to asset and stock acquisitions involving former major franchise territories and other acquisitions of $6,371. Additions to goodwill for Business Services primarily result from the final contingent payment related to the acquisition of the non-attest assets of McGladrey & Pullen, LLP of $26,685.

Prior to fiscal year 2004, the Company accounted for stock-based compensation plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Effective May 1, 2003, the Company adopted the fair value recognition provisions of SFAS 123, under the prospective transition method as described in Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). Had compensation cost for all stock-based compensation plan grants been determined in accordance with the fair value accounting method prescribed under SFAS 123, the Company’s net income (loss) and earnings (loss) per share for the three and six months ended October 31, 2003 and 2002 would have been as follows:
The Company tests goodwill for impairment annually at the beginning of its fourth quarter, or more frequently if events occur that indicate a potential reduction in the fair value of a reporting

~~-12-~~-10-

Three Months Ended Six Months Ended

October 31, October 31,

2003 2002 2003 2002

Net income (loss) as reported $ 10,376 $ (37,347 ) $ 15,536 $ (46,891 )
Add: Stock-based compensation expense included in reported net income, net of related tax effects 2,005 310 2,797 532
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects (5,565 ) (5,586 ) (10,631 ) (12,214 )

Pro forma net income (loss) $ 6,816 $ (42,623 ) $ 7,702 $ (58,573 )

Basic earnings (loss) per share:
As reported $ .06 $ (.21 ) $ .09 $ (.26 )
Pro forma .04 (.24 ) .04 (.33 )
Diluted earnings (loss) per share:
As reported $ .06 $ (.21 ) $ .09 $ (.26 )
Pro forma .04 (.24 ) .04 (.33 )

unit’s net assets below its carrying value. During the nine months ended January 31, 2003, a goodwill impairment charge of $24,000 was recorded for the Investment Services segment. No such impairment or events indicating potential impairment have been identified within any of the Company’s segments during the nine months ended January 31, 2004.

~~10.~~7. Derivative Instruments
The Company, in the normal course of business, enters into commitments with its customers to fund mortgage loans for specified periods of time at “locked-in” interest rates. These financial instruments represent commitments (rate-lock equivalent) to fund loans. The estimated fair value of these rate-lock equivalents is determined based on the difference in the value of the commitments to fund loans between the date of commitment and the date of valuation, taking into consideration the probability of the commitments being exercised and changes in other market conditions. At January 31, 2004 and April 30, 2003, the Company recorded assets totaling $8,620 and $12,531, respectively, in prepaid expenses and other current assets on the condensed consolidated balance sheets related to these commitments. See related discussion of Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105) in note 14.
The Company, in the normal course of business, enters into interest rate caps to mitigate interest rate risk and to enhance the marketability of NIM transactions. As of January 31, 2004 the Company held $52,564 in residual interests – trading securities. The Company elected not to securitize the residuals in a NIM transaction prior to quarter end. Therefore, an interest rate cap valued at $9,376 has been included in other assets on the condensed consolidated balance sheet related to these trading residual interests. The interest rate cap will be marked-to-market monthly through the income statement. The net adjustment to trading securities and the interest rate cap in the condensed consolidated income statements was zero for the three and nine months ended January 31, 2004.
The Company entered into an agreement with Household Tax Masters, Inc. (Household) during fiscal year 2003, whereby the Company waived its right to purchase any participation interests in and receive license fees relating to RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights, the Company received a series of payments from Household, subject to certain adjustments based on delinquency rates on RALs made by Household through December 31, 2003. This adjustment provision was accounted for as a derivative and was marked-to-market monthly through December 31, 2003. Accordingly, during the three and nine months ended January 31, 2004, the Company recognized $988 and $6,548, respectively, of revenues related to this instrument. The final settlement in accordance with this agreement was received in January 2004. A receivable of $5,171 was included on the condensed consolidated balance sheet as of April 30, 2003.

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8. Comprehensive Income
The Company’s comprehensive income is comprised of net income, the change in net unrealized gain on marketable securities and foreign currency translation adjustments. The components of comprehensive income for the three and nine months ended January 31, 2004 and 2003 are:


	Three months ended						Nine months ended
	January 31,						January 31,
	2004			2003			2004		2003
Net income	$	106,726		$	132,313		$	122,262	$	85,422
Change in net unrealized gain on marketable securities		(8,356	)		(65,585	)		5,680		(31,385	)
Change in foreign currency translation adjustments		2,319			9,204			14,049		9,975

Comprehensive income	$	100,689		$	75,932		$	141,991	$	64,012

9. Stock-Based Compensation

Prior to fiscal year 2004, the Company accounted for stock-based compensation plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Effective May 1, 2003, the Company adopted the fair value recognition provisions of SFAS 123, under the prospective transition method as described in Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148). Had compensation cost for all stock-based compensation plan grants been determined in accordance with the fair value accounting method prescribed under SFAS 123, the Company’s net income and earnings per share for the three and nine months ended January 31, 2004 and 2003 would have been as follows:

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	Three Months Ended						Nine Months Ended
	January 31,						January 31,
	2004			2003			2004			2003
Net income as reported	$	106,726		$	132,313		$	122,262		$	85,422
Add: Stock-based compensation expense included in reported net income, net of related tax effects		4,733			413			7,530			945
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects		(7,132	)		(4,455	)		(17,763	)		(16,669	)

Pro forma net income	$	104,327		$	128,271		$	112,029		$	69,698

Basic earnings per share:
As reported	$	.60		$	.74		$	.69		$	.48
Pro forma		.59			.72			.63			.39
Diluted earnings per share:
As reported	$	.59		$	.73		$	.67		$	.46
Pro forma		.58			.71			.62			.38

10. Supplemental Cash Flow Information
During the nine months ended January 31, 2004, the Company paid $245,355 and $57,458 for income taxes and interest, respectively. During the nine months ended January 31, 2003, the Company paid $176,168 and $55,193 for income taxes and interest, respectively.
During the nine months ended January 31, 2004 and 2003, the Company characterized the following as non-cash investing activities:


	Nine months ended January 31,
	2004		2003
Additions to residual interests	$	1,604	$	753
Residual interest mark-to-market		24,731		48,631

11. Commitments and Contingencies

During the six months ended October 31, 2003, the Company paid $170,826 and $42,724 for income taxes and interest, respectively. During the six months ended October 31, 2002, the Company paid $124,844 and $39,927 for income taxes and interest, respectively.

~~During the six months ended October 31, 2003 and 2002, the Company treated the following as non-cash investing activities:~~

Six months ended October 31,

2003 2002

Additions to residual interests $ 1,814 $ 753
Residual interest mark-to-market 22,910 55,796
Accrued payment on acquisition debt 25,000 —

~~11.~~ ~~Commitments, Contingencies, Litigation~~The Company offers guarantees under its Peace of Mind (POM) program to tax clients whereby the Company will assume the cost of additional tax assessments attributable to tax return preparation error for which the Company is responsible. The Company defers the revenue and ~~Risks~~direct costs associated with these guarantees, recognizing these amounts over the term of the guarantee based upon historic and actual payment of claims. The related current asset and liability are included in prepaid expenses and other current assets and accounts payable, accrued expenses and other, respectively, on the condensed consolidated balance sheets. The related noncurrent asset and liability are included in other assets and other noncurrent liabilities, respectively, on the condensed consolidated balance sheets. A loss on these POM guarantees

~~Commitments and Contingencies~~-13-

The Company offers separately priced guarantees under its Peace of Mind guarantee program to tax clients whereby the Company will assume the cost of additional tax assessments attributable to tax return preparation error. The Company defers the revenue and expenses associated with these guarantees, and recognizes these amounts over the term of the guarantee based upon historical claims data. The related current asset and liability are included in prepaid expenses and other current assets and accounts payable, accrued expenses and other, respectively, on the

~~-13-~~

would be recognized if the sum of expected costs for services exceeded unearned revenue. Changes in the deferred revenue liability for the nine months ended January 31, 2004 and 2003 and the twelve months ended April 30, 2003 are as follows:


	Nine Months Ended						Year Ended
	January 31,						April 30,
	2004			2003			2003
Balance, beginning of period	$	49,280		$	44,982		$	44,982
Amounts deferred for new guarantees issued		19,098			7,592			28,854
Revenue recognized on previous deferrals		(47,273	)		(17,809	)		(24,556	)
Adjustment resulting from change in accounting principle (note 14)		61,487			—			—

Balance, end of period	$	82,592		$	34,765		$	49,280

condensed consolidated balance sheets. The related noncurrent asset and liability are included in other assets and other noncurrent liabilities, respectively, on the condensed consolidated balance sheets. During the three months ended October 31, 2003, the Company adopted EITF 00-21 and recorded a cumulative effect of a change in accounting principle as of May 1, 2003. See further discussion in note 13. Changes in the deferred revenue liability for the six months ended October 31, 2003 and 2002 and the twelve months ended April 30, 2003 are as follows:

Six Months Ended Year Ended

October 31, April 30,

2003 2002 2003

Balance, beginning of period $ 49,280 $ 44,982 $ 44,982
Amounts deferred for new guarantees issued 975 193 28,854
Revenue recognized on previous deferrals (37,558 ) (14,131 ) (24,556 )
Adjustment resulting from change in accounting principle 61,487 — —

Balance, end of period $ 74,184 $ 31,044 $ 49,280

Option One Mortgage Corporation provides a guarantee up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts (qualifying special purpose entities) before ultimate disposition of the loans by the Trusts. This guarantee would be called upon in the event adequate proceeds were not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. No losses have been sustained on this commitment since its inception. The total principal amount of Trust obligations outstanding as of October 31, 2003 and April 30, 2003 was $3,811,085 and $2,176,286, respectively. The fair value of mortgage loans held by the Trusts as of October 31, 2003 and April 30, 2003 was approximately $3,960,000 and $2,273,000, respectively. At October 31, 2003 and April 30, 2003, a liability, which represents the estimated value of the 10% guarantee, of $10,256 and $6,175, respectively, was recorded in accounts payable, accrued expenses and other on the condensed consolidated balance sheets.

The Company manages its interest rate risk by entering into forward loan sale commitments to be settled at a future date. The Company had commitments to sell loans of $5,310,000 and $1,470,031 as of October 31, 2003 and April 30, 2003, respectively.

The Company has entered into whole loan sale agreements with investors in the normal course of business, which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require the Company to repurchase loans previously sold. A liability has been established related to the potential loss on repurchase of loans previously sold of $28,682 and $18,859 at October 31, 2003 and April 30, 2003, respectively. This liability is included in accounts payable, accrued expenses and other on the condensed consolidated balance sheets. Repurchased loans are normally sold in subsequent sale transactions.

Option One Mortgage Corporation provides a guarantee up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts (QSPEs) before ultimate disposition of the loans by the Trusts. This guarantee would be called upon in the event adequate proceeds were not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. No losses have been sustained on this commitment since its inception. The total principal amount of Trust obligations outstanding as of January 31, 2004 and April 30, 2003 was $2,785,603 and $2,176,286, respectively. The fair value of mortgage loans held by the Trusts as of January 31, 2004 and April 30, 2003 was approximately $2,895,000 and $2,273,000, respectively.
The Company may enter into forward loan sale commitments to be settled at a future date as a part of its interest rate risk management strategy. The Company had commitments to sell loans of approximately $4,500,000 and $1,470,000 as of January 31, 2004 and April 30, 2003, respectively.
The Company has entered into whole loan sale agreements with investors in the normal course of business, which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require the Company to repurchase loans previously sold. A liability has been established related to the potential loss on repurchase of loans previously sold of $21,907 and $18,859 at January 31, 2004 and April 30, 2003, respectively. This liability is included in accounts payable, accrued expenses and other on the condensed consolidated balance sheets. Repurchased loans are normally sold in subsequent sale transactions.
The Company and its subsidiaries have various contingent purchase price obligations in connection with prior acquisitions. In many cases, contingent payments to be made in connection with these acquisitions are not subject to a stated limit. The Company estimates the potential payments (undiscounted) total approximately $7,112 and $52,290 as of January 31, 2004 and April 30, 2003, respectively. The Company’s estimate is based on current financial conditions. Should actual results differ materially from the Company’s assumptions, the

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connection with these acquisitions are not subject to a stated limit. The Company estimates the potential payments (undiscounted) total approximately $8,750 and $52,290 as of October 31, 2003 and April 30, 2003, respectively. The Company’s estimate is based on current financial conditions. Should actual results differ materially from the Company’s assumptions, the potential payments will differ from the above estimate. Such payments, if and when paid, would be recorded as additional goodwill.

The Company has contractual commitments to fund certain franchises requesting draws on Franchise Equity Lines of Credit (FELCs). The commitment to fund FELCs as of October 31, 2003 and April 30, 2003 totaled $60,307 and $56,070, respectively, with a related receivable balance of $39,370 and $33,341, respectively, included on the condensed consolidated balance sheets. The receivable represents the amount drawn on the FELCs as of October 31, 2003 and April 30, 2003.

The Company and its subsidiaries also routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Other guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counter parties from losses arising from the following: a) tax, legal and other risks related to the purchase or disposition of businesses; b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; c) indemnification of the Company’s directors and officers; and d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against the Company or its subsidiaries and the ultimate liability related to any such claims, if any, is difficult to predict. While management cannot provide assurance the Company and its subsidiaries will ultimately prevail in the event any such claims are asserted, management believes the fair value of these guarantees and indemnifications is not material as of October 31, 2003.

~~Litigation~~

~~In November 2002, the Company and a major franchisee of a subsidiary of the Company, reached an agreement with the plaintiff class in the class action lawsuit entitled~~~~Ronnie and Nancy Haese, et al. v. H&R Block, Inc. et al.~~, Case No. CV96-423, in the District Court of Kleberg County, Texas, related to RALs. The settlement provides a five-year package of coupons class members can use to obtain a variety of tax preparation and tax planning services from the Company’s subsidiaries. The Company’s major franchisee, which operates more than half of all H&R Block offices in Texas, will share a portion of the total settlement cost. As a result, the Company recorded a liability and pretax expense of $41,672, during the second quarter of fiscal year 2003, which, at the time, represented the Company’s best estimate of its share of the settlement cost for plaintiff class legal fees and expenses, tax products and associated mailing expenses. The settlement was approved by the court as a part of a final judgment entered on June 24, 2003. No appeals of the judgment and award were filed. The Company paid the award of $49,900 of attorneys’ fees and expenses to class counsel on August 22, 2003. In addition to the liability that has already been recorded and/or paid, the Company will reduce revenues associated with tax
potential payments will differ from the above estimate. Such payments, if and when paid, would be recorded as additional goodwill.
The Company has contractual commitments to fund certain franchises requesting draws on Franchise Equity Lines of Credit (FELCs). The commitment to fund FELCs as of January 31, 2004 and April 30, 2003 totaled $61,152 and $56,070, respectively, with a related receivable balance of $46,729 and $33,341, respectively, included on the condensed consolidated balance sheets. The receivable represents the amount drawn on the FELCs as of January 31, 2004 and April 30, 2003.
The Company and its subsidiaries routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Other guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counter parties from losses arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) indemnification of the Company’s directors and officers; and (d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against the Company or its subsidiaries and the ultimate liability related to any such claims, if any, is difficult to predict. While management cannot provide assurance the Company and its subsidiaries will ultimately prevail in the event any such claims are asserted, management believes the fair value of these guarantees and indemnifications is not material as of January 31, 2004.
12. Litigation Commitments and Contingencies
In November 2002, the Company and a major franchisee of a subsidiary of the Company, reached an agreement with the plaintiff class in the class action lawsuit entitledRonnie and Nancy Haese, et al. v. H&R Block, Inc. et al., Case No. CV96-423, in the District Court of Kleberg County, Texas, related to RALs. The settlement provides a five-year package of coupons class members can use to obtain a variety of tax preparation and tax planning services from the Company’s subsidiaries. The Company’s major franchisee (a co-defendant), which operates more than half of all H&R Block offices in Texas, will share a portion of the total settlement cost. As a result, the Company recorded a liability and pretax expense of $41,672, during the second quarter of fiscal year 2003, which, at the time, represented the Company’s best estimate of its share of the settlement cost for plaintiff class legal fees and expenses, tax products and associated mailing expenses. The Company’s share of the settlement is less than the total amount awarded due to amounts recoverable from a co-defendant in the case. The settlement was approved by the court as a part of a final judgment entered on June 24, 2003. No appeals of the judgment and award were filed. The Company paid the award of $49,900 of attorneys’ fees and expenses to class counsel on August 22, 2003. In addition to the liability that has already been recorded and/or paid, the Company will reduce revenues associated with tax preparation services as the coupons are redeemed each year. The settlement coupons were distributed prior to the 2004 tax season.

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~~preparation services as the coupons are redeemed each year. Distribution of the settlement coupons was made following the end of the second quarter.~~

The Company has been involved in a number of other putative RAL class action cases since 1990 and has successfully defended many cases. In order to avoid the uncertainty of litigation and the diversion of resources and personnel resulting from the lawsuits, the Company, the lending bank, and the plaintiffs in the case~~Joel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., et al.(renamed~~~~Lynne A. Carnegie, et al. v. H&R Block, Inc., et al.~~), Case No. 98-C-2178 in the United States District Court for Northern Illinois, had agreed to a settlement class and a settlement of RAL-related claims on a nationwide basis. Under that settlement, the Company and the lending bank agreed to each pay $12,500 toward a $25,000 settlement fund for the benefit of the class members. The settlement was approved by the District Court in February 2001 and the defendants paid the $25,000 into an escrow fund. Certain class members who had objected to the settlement appealed the order approving the settlement to the Seventh Circuit Court of Appeals. In April 2002, the Court of Appeals reversed the District Court’s order approving the settlement and remanded the matter back to the District Court for further consideration of the fairness and adequacy of the proposed settlement by a new District Court judge. In April 2003, the District Court judge declined to approve the $25,000 settlement, 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 appointed new counsel for the plaintiffs in the first quarter of fiscal year 2004 and named their client, Lynne A. Carnegie, as lead plaintiff. The new counsel for the plaintiffs have since filed an amended complaint and a motion for partial summary judgment. The defendants have filed a motion to dismiss, a brief in response to allegations in the plaintiffs’ amended complaint relating to class certification, and responses to plaintiffs’ motion for partial summary judgment. The Company recorded a receivable in the amount of its $12,500 share of the settlement fund in the fourth quarter of fiscal year 2003 and recorded a reserve in such quarter of $12,500 consistent with the existing settlement authority of the Board of Directors. The defendants requested the release of the escrowed settlement fund and the $12,500 was received during the second quarter of fiscal year 2004. The Company intends to defend the case and the remaining RAL class action litigation vigorously and there are no assurances that any of the matters will result in settlements or as to the amount of any settlement.

~~The Company and certain of its current and former officers and directors are named defendants in litigation entitled~~~~Paul White, et al. v. H&R Block, et al.,~~consolidated Case Numbers 02CV8965, 02CV9661, 02CV9682 and 02CV9830 pending in the United States District Court for the Southern District of New York since the third quarter of fiscal year 2003. The respective named plaintiffs seek to represent a class of shareholders who purchased the Company’s stock between November 8, 1997 and November 6, 2002, and allege that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by failing to disclose to shareholders various cases in which the Company had been sued regarding the RAL program, by failing to set adequate reserves for those cases, and by failing to disclose the supposed implications of those cases for the future of the RAL program. The four securities law cases were all assigned to the same judge and consolidated for pre-trial matters. A consolidated complaint was filed in March 2003 and the defendants responded by filing a motion to dismiss in
The Company has been involved in a number of putative RAL class action cases since 1990. While the Company has successfully defended many such cases, several cases are still pending and the amounts claimed in some of those cases is very substantial. In order to avoid the uncertainty of litigation and the diversion of resources and personnel resulting from the lawsuits, the Company, the lending bank, and the plaintiffs in the caseJoel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., et al.(renamedLynne A. Carnegie, et al. v. H&R Block, Inc., et al.), Case No. 98-C-2178 in the United States District Court for Northern Illinois, had agreed to a settlement class and a settlement of RAL-related claims on a nationwide basis. Under that settlement, the Company and the lending bank agreed to each pay $12,500 toward a $25,000 settlement fund for the benefit of the class members. The settlement was approved by the District Court in February 2001 and the defendants paid the $25,000 into an escrow fund. Certain class members who had objected to the settlement appealed the order approving the settlement to the Seventh Circuit Court of Appeals. In April 2002, the Court of Appeals reversed the District Court’s order approving the settlement and remanded the matter back to the District Court for further consideration of the fairness and adequacy of the proposed settlement by a new District Court judge. In April 2003, the District Court judge declined to approve the $25,000 settlement, 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 appointed new counsel for the plaintiffs in the first quarter of fiscal year 2004 and named their client, Lynne A. Carnegie, as lead plaintiff. The new counsel for the plaintiffs have since filed an amended complaint and a motion for partial summary judgment. The defendants have filed a motion to dismiss, a brief in response to allegations in the plaintiffs’ amended complaint relating to class certification, and responses to plaintiffs’ motion for partial summary judgment. Rulings on these motions are pending, and extensive discovery is proceeding. The Company recorded a receivable in the amount of its $12,500 share of the settlement fund in the fourth quarter of fiscal year 2003 and recorded a reserve in such quarter of $12,500 consistent with the existing settlement authority of the Board of Directors. The defendants requested the release of the escrowed settlement fund and the $12,500 was received during the second quarter of fiscal year 2004. The Company intends to defend the case and the remaining RAL class action litigation vigorously, but there are no assurances as to their outcome.
The Company and certain of its current and former officers and directors are named defendants in litigation entitledPaul White, et al. v. H&R Block, et al.,consolidated Case Numbers 02CV8965, 02CV9661, 02CV9682 and 02CV9830 pending in the United States District Court for the Southern District of New York since the third quarter of fiscal year 2003. The respective named plaintiffs seek to represent a class of shareholders who purchased the Company’s stock between November 8, 1997 and November 6, 2002, and allege that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by failing to disclose to shareholders various cases in which the Company had been sued regarding the RAL program, by failing to set adequate reserves for those cases, and by failing to disclose the supposed implications of those cases for the future of the RAL program. The four securities law cases were all assigned to the same judge and consolidated for pre-trial matters. A consolidated complaint was filed in March 2003 and the defendants responded by filing a motion to dismiss in April 2003. In response to defendants’ motion to dismiss, the plaintiffs informed defendants that they wished further to amend their complaint. Defendants consented to the filing of an amended

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April 2003. In response to defendants’ motion to dismiss, the plaintiffs informed defendants that they wished further to amend their complaint. Defendants consented to the filing of an amended complaint as a pleading matter, the plaintiffs filed the amended complaint, and the defendants filed a motion to dismiss it in August 2003. The Company believes the claims in these actions are without merit, and intends to defend them vigorously.

~~The Company is a named defendant in litigation entitled~~~~William R. Smith, Inc., et al. v. H&R Block, Inc., et al.~~~~, Case No. 99-CV-206379, pending in the Circuit Court of Jackson County, Missouri (previously known as~~~~Armstrong Business Services, Inc., et al. v. H&R Block, Inc., et al.~~). The action was filed by “major” franchisees against the Company and certain of its subsidiaries relating to alleged breaches of contract and other matters. The Company’s subsidiary, HRB Royalty, Inc., the franchisor under the applicable franchise agreements, filed a counterclaim and subsequently a motion for summary judgment seeking a declaration that HRB Royalty, Inc. could elect not to renew the major franchise agreements when the then current five-year terms came to an end. Such motion for summary judgment was granted in March 2001 and upheld on appeal. HRB Royalty notified the plaintiff major franchisees in 2000 that it did not intend to renew their franchise agreements at the expiration of the then current renewal terms and that the agreements would terminate at those times. The renewal dates varied among the franchisees. Pursuant to the franchise agreements, HRB Royalty must pay a “fair and equitable price” to the franchisee for the franchisee’s franchise business, and such price must be no less than 80% of the franchisee’s revenues for the most recent 12 months ended April 30, plus the value of equipment and supplies, and certain off-season expenses. The Circuit Court ruled in May 2003 that major franchise agreements with renewal terms scheduled to expire prior to July 1, 2003, will expire on July 1, 2003, and other major franchise agreements will expire as the renewal terms expire commencing in September 2003 and ending in fiscal year 2005. The Court ordered defendants to pay for the franchise businesses as provided in the franchise agreements on the applicable dates of expiration. During the six months ended October 31, 2003, franchise agreements of twelve major franchisees expired and subsidiaries of the Company acquired and began operating tax preparation businesses as company-owned operations in the franchise territories of ten former major franchisees. With respect to the two other franchisees with expired franchise agreements, one franchisee entered into a new franchise agreement with a limited term and one franchisee continued litigation challenging the expiration of the franchise agreement. Cash payments of $118,828 were made or accrued related to these former major franchises during the six months ended October 31, 2003.

In~~Smith~~, plaintiffs’ claims against the Company and its subsidiaries remain in the trial court. In their second amended petition, the plaintiffs seek in excess of $20,000 in actual damages, punitive damages, unspecified statutory damages, declaratory, injunctive and other relief, including attorneys’ fees under allegations of breach of contract, breach of the covenant of good faith and fair dealing, unfair business practices, state anti-trust violations, breach of fiduciary duty, prima facie tort, violations of various state franchise statutes, fraud and misrepresentation, waiver and estoppel, ambiguity and reformation, relief with respect to a post-termination covenant not to compete in the franchise agreements, and a request for a fair and equitable payment upon nonrenewal of the franchise agreements. The major franchisees allege, among other things, that the sale of TaxCut® income tax return preparation software and online tax
complaint as a pleading matter, the plaintiffs filed the amended complaint, and the defendants filed a motion to dismiss it in August 2003. The Company believes the claims in these actions are without merit, and intends to defend them vigorously.
In January 2004, the Company and most of its former major franchisees entered into settlement of the litigation entitledWilliam R. Smith, Inc., et al. v. H&R Block, Inc., et al., Case No. 99-CV-206379, in the Circuit Court of Jackson County, Missouri (previously known asArmstrong Business Services, Inc., et al. v. H&R Block, Inc., et al.). In this litigation, the former major franchisees alleged breaches of contract and other matters against the Company and certain subsidiaries. The Company’s subsidiary, HRB Royalty, Inc., in turn sought and received a declaration that it could elect not to renew the major franchise agreements upon expiration of their current terms. HRB Royalty subsequently notified the plaintiff major franchisees that it did not intend to renew their major franchise agreements upon expiration. During the nine months ended January 31, 2004, the plaintiffs’ major franchise agreements accordingly expired and subsidiaries of the Company acquired and began operating the tax preparation business as company-owned operations in the former major franchise territories. The major franchise agreements required HRB Royalty to pay a “fair and equitable price” to the franchisee for the franchise business. The major franchise agreements provided further such price must be no less than 80% of the franchisee’s revenues for the most recent twelve months ended April 30 plus the value of equipment and supplies and certain off-season expenses. Cash payments of $243,257 were made related to these former major franchises during the nine months ended January 31, 2004.
TheSmithsettlement provides for payment to the franchisees of $130,096, which is included in the amount above, as additional payment for the value of their former franchise businesses and resolves all other disputes involved in the litigation. The settlement also resolved all issues regarding the first trial involving one of the plaintiffs in theSmithlitigation held in October 2003, with the settlement payment encompassing payment of the jury verdict in the first trial of $3,197 for the franchise business and $921 for plaintiff’s claims for damages against the Company. In December 2003, one other “major” franchisee whose franchise agreement did not expire until early 2005 entered into a new franchise agreement with a limited term.
In addition to the aforementioned cases, the Company and its subsidiaries have from time to time been parties to claims and lawsuits arising out of such subsidiaries’ business operations, including other claims and lawsuits relating to RALs, and claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of income tax returns, the fees charged customers for various services, the Peace of Mind guarantee program associated with income tax return preparation services, relationships with franchisees 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. The Company’s management considers these cases to be ordinary, routine litigation incidental to its business, believes the Company and its subsidiaries have meritorious defenses to each of them and is defending, or intends to defend, them vigorously. While management cannot provide assurance the Company and its subsidiaries will

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services and the purchase of accounting firms encroached on their exclusive franchise territories. The defendants believe that the allegations against them are without merit and continue to defend the case vigorously. Management believes that amounts, if any, required to be paid by the Company and its subsidiaries in the discharge of liabilities or settlements relating to these claims of the plaintiffs in this litigation will not have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial position.

In August 2003, a subsidiary of the Company entered into a transaction with one of the former major franchisees whose franchise agreements expired in the first quarter, pursuant to which such subsidiary acquired the stock of the franchisee and the franchisee released the Company and its affiliates from any further liability regarding additional payments under the major franchise agreements. With the exceptions of the former franchisee that executed a release and the franchisee that entered into a new franchise agreement, the court will determine if any additional payments are required for these franchise businesses.

~~The first trial involving one of the plaintiffs in the~~~~Smith~~litigation was held in October 2003. At the conclusion of this trial, the jury rendered a verdict and the court entered a judgment requiring the Company to make an additional payment of $3,197 for the franchise business. As of October 31, 2003, the Company recorded this liability in accounts payable, accrued expenses and other on the condensed consolidated balance sheet. The original payment for the franchise business made in the first quarter of fiscal year 2004 was $4,955. This trial also involved the issues relating to that plaintiff’s claims for damages against the Company. The jury rendered a verdict of $921 in favor of the plaintiff on the plaintiff’s claims against the Company. The outcome of the trial is subject to post-trial motions and possible appeals. The next trial to take place as a part of the~~Smithlitigation is scheduled for May 2004.~~

In addition to the aforementioned cases, the Company and its subsidiaries have from time to time been party to claims and lawsuits arising out of such subsidiaries’ business operations, including other claims and lawsuits relating to RALs, and claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of income tax returns, the fees charged customers for various services, the Peace of Mind guarantee program associated with income tax return preparation services, relationships with franchisees 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. The Company’s management considers these cases to be ordinary, routine litigation incidental to its business, believes the Company and its subsidiaries have meritorious defenses to each of them and is defending, or intends to defend, them vigorously. While management cannot provide assurance the Company and its subsidiaries will
ultimately prevail in each instance, management believes that amounts, if any, required to be paid by the Company and its subsidiaries in the discharge of liabilities or settlements will not have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial position. Regardless of outcome, claims and litigation can adversely affect the Company and its subsidiaries due to defense costs, diversion of management and publicity related to such matters.
It is the Company’s policy to accrue for amounts related to legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable. Many of the various legal proceedings are covered in whole, or in part, by insurance.
13. Segment Information
Information concerning the Company’s operations by reportable operating segment for the three and nine months ended January 31, 2004 and 2003 is as follows:


	Three months ended						Nine months ended
	January 31,						January 31,
	2004			2003			2004			2003
Revenues:
U.S. Tax Operations	$	463,646		$	403,571		$	551,357		$	460,286
Mortgage Operations		331,926			396,980			985,977			921,874
Business Services		112,293			100,741			319,816			293,938
Investment Services		57,753			48,047			167,443			156,737
International Tax Operations		10,849			8,779			35,403			28,388
Corporate Operations		690			295			2,706			(48	)

	$	977,157		$	958,413		$	2,062,702		$	1,861,175

Income (loss) from:
U.S. Tax Operations	$	68,236		$	34,137		$	(155,874	)	$	(212,192	)
Mortgage Operations		154,476			262,466			502,331			563,071
Business Services		1,955			(4,197	)		(7,456	)		(12,255	)
Investment Services		(12,811	)		(31,755	)		(41,904	)		(92,488	)
International Tax Operations		(6,409	)		(5,735	)		(12,262	)		(12,436	)
Corporate Operations		(29,327	)		(31,982	)		(72,752	)		(88,917	)

Income before taxes	$	176,120		$	222,934		$	212,083		$	144,783

14. New Accounting Pronouncements
SAB 105
On March 9, 2003, the SEC Staff issued SAB 105. SAB 105 states that, when valuing loan commitments, registrants may not include expected future cash flows related to the associated servicing of the loan and, similarly, may not recognize any other internally developed intangible assets as part of the loan commitment derivative. The guidance in SAB 105 is effective for new loan commitments entered into after March 31, 2004. At January 31, 2004, the Company had recorded assets totaling $8,620 related to its loan commitments. It is possible that the effect of SAB 105 will be to delay recognition of all, or a portion, of the loan commitment asset, and

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It is the Company’s policy to accrue for amounts related to legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable. Many of the various legal proceedings are covered in whole, or in part, by insurance.

~~12.~~ ~~Segment Information~~related gain, until the loans are sold. The Company is in the process of analyzing the effect of SAB 105 and has not yet determined the impact of adoption.
SFAS 149
In April 2003, Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149) was issued. SFAS 149 amends and clarifies the accounting for derivative instruments and incorporates many of the implementation issues cleared as a result of the Derivatives Implementation Group process. The provisions of this standard are effective for contracts entered into or modified after June 30, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
FIN 46
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). A revision of FIN 46 was issued in December 2003. FIN 46 provides guidance with respect to the consolidation of certain variable interest entities (VIEs) whereby a VIE must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among parties involved. The primary beneficiary is one who absorbs a majority of the expected losses, residual returns, or both as a result of holding variable interests. FIN 46 also requires disclosures for both the primary beneficiary of a VIE and other parties with significant variable interests in the entity.
The provisions of FIN 46 apply immediately to VIEs created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. As revised, application of FIN 46 is required for interests in VIEs commonly referred to as special-purpose entities in financial statements for periods ending after December 15, 2003. Application for interests in all other types of entities is required in financial statement for periods ending after March 15, 2004.
The Mortgage Operations segment has an interest in certain QSPEs it currently does not consolidate, which are exempt from the provisions of FIN 46. Adoption of FIN 46 where application was required during the quarter ended January 31, 2004 did not have a material impact on the Company’s consolidated financial statements.
The Company is continuing its evaluation of interests in other potential VIEs, and will continue to monitor additional guidance as provided by the FASB.
EITF 00-21
In August 2003, the Company adopted Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF 00-21 requires consideration received in connection with arrangements involving multiple revenue generating activities be measured and allocated to each separate unit of accounting in the arrangement. Revenue recognition is determined separately for each unit of accounting within the arrangement. EITF 00-21 impacts revenue and expense recognition related to tax preparation in the Company’s premium tax offices where POM guarantees are included in the price of a completed tax return. Prior to the adoption of EITF 00-21, revenues and expenses related to POM guarantees at

~~Information concerning the Company’s operations by reportable operating segment for the three and six months ended October 31, 2003 and 2002 is as follows:~~-19-

Three months ended Six months ended

July 31, October 31, October 31, October 31,

2003 2003 2002 2003 2002

Revenues:
U.S. Tax Operations $ 40,522 $ 47,189 $ 33,429 $ 87,711 $ 56,715
Mortgage Operations 302,895 351,156 274,588 654,051 524,894
Business Services 98,499 109,024 97,883 207,523 193,197
Investment Services 56,987 52,703 50,027 109,690 108,690
International Tax Operations 5,459 19,095 15,326 24,554 19,609
Corporate Operations 1,328 688 143 2,016 (343 )

$ 505,690 $ 579,855 $ 471,396 $ 1,085,545 $ 902,762

Income (loss) from:
U.S. Tax Operations $ (93,172 ) $ (130,938 ) $ (152,299 ) $ (224,110 ) $ (246,329 )
Mortgage Operations 163,829 184,026 153,520 347,855 300,605
Business Services (6,679 ) (2,732 ) (3,785 ) (9,411 ) (8,058 )
Investment Services (13,757 ) (15,336 ) (27,936 ) (29,093 ) (60,733 )
International Tax Operations (6,408 ) 555 (250 ) (5,853 ) (6,701 )
Corporate Operations (24,984 ) (18,441 ) (31,495 ) (43,425 ) (56,935 )

Income (loss) before taxes $ 18,829 $ 17,134 $ (62,245 ) $ 35,963 $ (78,151 )

~~Results for the quarter ended July 31, 2003 have been restated for the adoption of EITF 00-21.~~

~~13.~~ ~~New Accounting Pronouncements~~

~~SFAS 149~~
In April 2003, Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149) was issued. SFAS 149 amends and clarifies the accounting for derivative instruments and incorporates many of the implementation issues cleared as a result of the Derivatives Implementation Group process. The provisions of this standard are effective for contracts entered into or modified after June 30, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

~~-19-~~

~~FIN 46~~
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 provides guidance with respect to the consolidation of certain variable interest entities (VIEs) whereby a VIE must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among parties involved. The primary beneficiary is one who absorbs a majority of the expected losses, residual returns, or both as a result of holding variable interests. FIN 46 also requires disclosures for both the primary beneficiary of a VIE and other parties with significant variable interests in the entity.

~~The provisions of FIN 46 apply immediately to VIEs created after~~
premium offices were recorded in the same period as tax preparation revenues. Beginning May 1, 2003, revenues and direct expenses related to POM guarantees are now initially deferred and recognized over the guarantee period in proportion to POM claims paid. As a result of the adoption of EITF 00-21, the Company recorded a cumulative effect of a change in accounting principle of $6,359, net of taxes of $4,031, as of May 1, 2003.
Restated results for the three months ended July 31, 2003 and pro forma results, as if EITF 00-21 had been applied during the three and nine months ended January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. In October 2003, the FASB issued a staff position delaying the effective date of the consolidation requirements of FIN 46 under certain circumstances to periods ending on or after December 15, 2003 for entities created before February 1, 2003.
The Mortgage Operations segment has an interest in certain QSPEs it currently does not consolidate, which are exempt from the provisions of FIN 46. The Company is continuing its evaluation of interests in potential VIEs, and will continue to monitor additional guidance as provided by the FASB on this standard.
~~EITF 00-21~~
In August 2003, the Company adopted EITF 00-21. EITF 00-21 requires consideration received in connection with arrangements involving multiple revenue generating activities be measured and allocated to each separate unit of accounting in the arrangement. Revenue recognition is determined separately for each unit of accounting within the arrangement. EITF 00-21 impacts revenue and expense recognition related to tax preparation in the Company’s premium tax offices where Peace of Mind (POM) guarantees are included in the price of a completed tax return. Prior to the adoption of EITF 00-21, revenues and expenses related to POM guarantees at premium offices were recorded in the same period as tax preparation revenues. Beginning May 1, 2003, revenues and direct expenses related to POM guarantees are now initially deferred and recognized over the guarantee period in proportion to POM claims paid. As a result of the adoption of EITF 00-21, the Company recorded a cumulative effect of a change in accounting principle of $6,359, net of taxes of $4,031, as of May 1, 2003. The Company’s results of operations for the three months ended July 31, 2003 have been restated to reflect the cumulative effect of a change in accounting principle as of May 1, 2003 and to reflect the recognition of deferred revenues and expenses for the three months ended July 31, 2003.
Restated results for the three months ended July 31, 2003 and pro forma results, as if EITF 00-21 had been applied during each period, for the three months ended July 31, 2002 and October 31, 2002 and the six months ended October 31, 2002 are as follows:


	Three months ended July 31, 2003
	As reported		Restated
Revenues	$	494,843	$	505,690

Income before taxes		17,297		18,829
Net income before cumulative effect of change in accounting principle		10,582		11,519
Cumulative effect of change in accounting principle		—		(6,359	)

Net income	$	10,582	$	5,160

Basic and diluted earnings per share	$	.06	$	.03


	Three months ended				Nine months ended
	January 31, 2003				January 31, 2003
	As reported		Pro forma		As reported		Pro forma
Net income	$	132,313	$	132,680	$	85,422	$	88,124

Basic earnings per share	$	.74	$	.74	$	.48	$	.49
Diluted earnings per share		.73		.73		.46		.48

Revenues recognized during the three and nine months ended January 31, 2004, which were initially recognized in prior periods and recorded as part of the cumulative effect of a change in accounting principle, totaled $6,206 and $26,631, respectively.
Current Accounting Issues
Exposure Draft – Amendment of SFAS 140

The FASB intends to reissue the exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of FASB Statement No. 140,” during the first quarter of calendar year 2004. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a QSPE.
Provisions in the first exposure draft, if adopted, may have required the Company to consolidate its current QSPEs (the Trusts) established in its Mortgage Operations segment. As of January 31, 2004, the Trusts had assets and liabilities of $2,785,603. The provisions of the exposure draft are subject to FASB due process and are subject to change. The Company will continue to monitor

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Three months ended July 31,

2003 2002

As reported Restated As reported Pro forma

Revenues $ 494,843 $ 505,690 $ 431,366 $ 442,757

Income (loss) before taxes 17,297 18,829 (15,906 ) (13,514 )
Net income (loss) before cumulative effect of change in accounting principle 10,582 11,519 (9,544 ) (8,109 )
Cumulative effect of change in accounting principle — (6,359 ) — —

Net income (loss) $ 10,582 $ 5,160 $ (9,544 ) $ (8,109 )

Basic and diluted earnings (loss) per share $ .06 $ .03 $ (.05 ) $ (.04 )

Three months ended Six months ended

October 31, 2002 October 31, 2002

As reported Pro forma As reported Pro forma

Revenues $ 471,396 $ 481,003 $ 902,762 $ 923,760

Loss before taxes (62,245 ) (60,744 ) (78,151 ) (74,258 )
Net loss $ (37,347 ) $ (36,446 ) $ (46,891 ) $ (44,555 )

Basic and diluted loss per share $ (.21 ) $ (.20 ) $ (.26 ) $ (.25 )

Revenues recognized during the three months ended July 31, 2003 and October 31, 2003 and the six months ended October 31, 2003, which were initially recognized in prior periods and reversed as part of the cumulative effect of a change in accounting principle, totaled $10,847, $9,578 and $20,425, respectively.

~~Exposure Draft — Amendment of SFAS 140~~
The FASB has decided to reissue its exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of FASB Statement No. 140,” during the first quarter of calendar year 2004. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a QSPE.

Provisions in the first exposure draft, if adopted, may have required the Company to consolidate its current QSPEs (the Trusts) established in its Mortgage Operations segment. As of October 31, 2003, the Trusts had assets and liabilities of $3,811,085. The provisions of the exposure draft are subject to FASB due process and are subject to change. The Company will continue to

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~~monitor the status of the exposure draft, and consider changes to current structures to comply with the proposed rules.~~

~~14.~~ the status of the exposure draft, and consider changes, if any, to current structures as a result of the proposed rules.
15. Condensed Consolidating Financial Statements

Block Financial Corporation (BFC) is an indirect, wholly owned consolidated subsidiary of the Company. BFC is the Issuer and the Company is the Guarantor of the Senior Notes issued on October 21, 1997 and April 13, 2000. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholder’s equity and other intercompany balances and transactions.


	Three months ended January 31, 2004
	H&R Block, Inc.		BFC		Other					Consolidated
	(Guarantor)		(Issuer)		Subsidiaries		Elims			H&R Block
Total revenues	$	—	$	457,873	$	519,412	$	(128	)	$	977,157

Expenses:
Compensation & benefits		—		121,229		271,626		(20	)		392,835
Occupancy & equipment		—		16,789		77,975		—			94,764
Depreciation & amortization		—		18,785		27,702		—			46,487
Marketing & advertising		—		16,955		51,130		(110	)		67,975
Interest		—		10,515		10,846		—			21,361
Supplies, freight & postage		—		5,526		23,083		—			28,609
Other		—		117,725		33,005		(108	)		150,622

		—		307,524		495,367		(238	)		802,653

Operating income		—		150,349		24,045		110			174,504
Other income, net		176,120		—		1,616		(176,120	)		1,616

Income before taxes		176,120		150,349		25,661		(176,010	)		176,120
Income taxes		69,394		60,986		8,364		(69,350	)		69,394

Net income	$	106,726	$	89,363	$	17,297	$	(106,660	)	$	106,726

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	Three months ended January 31, 2003
	H&R Block, Inc.		BFC		Other						Consolidated
	(Guarantor)		(Issuer)		Subsidiaries			Elims			H&R Block
Total revenues	$	—	$	484,901	$	473,597		$	(85	)	$	958,413

Expenses:
Compensation & benefits		—		105,387		246,785			37			352,209
Occupancy & equipment		—		19,780		67,569			—			87,349
Depreciation & amortization		—		20,490		22,180			—			42,670
Marketing & advertising		—		9,999		45,486			(154	)		55,331
Interest		—		13,960		10,857			—			24,817
Supplies, freight & postage		—		8,167		24,987			—			33,154
Other		—		76,035		66,626			(70	)		142,591

		—		253,818		484,490			(187	)		738,121

Operating income (loss)		—		231,083		(10,893	)		102			220,292
Other income, net		222,934		—		2,642			(222,934	)		2,642

Income (loss) before taxes (benefit)		222,934		231,083		(8,251	)		(222,832	)		222,934
Income taxes (benefit)		90,621		93,931		(3,354	)		(90,577	)		90,621

Net income (loss)	$	132,313	$	137,152	$	(4,897	)	$	(132,255	)	$	132,313


	Nine months ended January 31, 2004
	H&R Block, Inc.			BFC		Other						Consolidated
	(Guarantor)			(Issuer)		Subsidiaries			Elims			H&R Block
Total revenues	$	—		$	1,230,483	$	832,451		$	(232	)	$	2,062,702

Expenses:
Compensation & benefits		—			339,308		534,450			46			873,804
Occupancy & equipment		—			55,586		197,643			—			253,229
Depreciation & amortization		—			54,877		67,620			—			122,497
Marketing & advertising		—			33,396		66,809			(439	)		99,766
Interest		—			34,978		29,479			—			64,457
Supplies, freight & postage		—			13,627		37,723			—			51,350
Other		—			279,610		110,659			(278	)		389,991

		—			811,382		1,044,383			(671	)		1,855,094

Operating income (loss)		—			419,101		(211,932	)		439			207,608
Other income, net		212,083			—		4,475			(212,083	)		4,475

Income (loss) before taxes (benefit)		212,083			419,101		(207,457	)		(211,644	)		212,083
Income taxes (benefit)		83,462			170,537		(87,248	)		(83,289	)		83,462

Net income (loss) before change in accounting		128,621			248,564		(120,209	)		(128,355	)		128,621
Cumulative effect of change in accounting		(6,359	)		—		(6,359	)		6,359			(6,359	)

Net income (loss)	$	122,262		$	248,564	$	(126,568	)	$	(121,996	)	$	122,262

-22-

	��
	Nine months ended January 31, 2003
	H&R Block, Inc.		BFC		Other						Consolidated
	(Guarantor)		(Issuer)		Subsidiaries			Elims			H&R Block
Total revenues	$	—	$	1,121,858	$	739,547		$	(230	)	$	1,861,175

Expenses:
Compensation & benefits		—		294,779		496,553			360			791,692
Occupancy & equipment		—		51,199		172,443			—			223,642
Depreciation & amortization		—		58,027		56,711			—			114,738
Marketing & advertising		—		22,561		63,237			(463	)		85,335
Interest		—		47,690		22,099			—			69,789
Supplies, freight & postage		—		16,724		38,748			—			55,472
Impairment of goodwill		—		24,000		—			—			24,000
Other		—		185,195		171,643			(538	)		356,300

		—		700,175		1,021,434			(641	)		1,720,968

Operating earnings (loss)		—		421,683		(281,887	)		411			140,207
Other income, net		144,783		—		4,576			(144,783	)		4,576

Earnings (loss) before income taxes (benefit)		144,783		421,683		(277,311	)		(144,372	)		144,783
Income taxes (benefit)		59,361		180,671		(121,478	)		(59,193	)		59,361

Net earnings (loss)	$	85,422	$	241,012	$	(155,833	)	$	(85,179	)	$	85,422

Three months ended October 31, 2003

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Total revenues $ — $ 407,279 $ 172,638 $ (62 ) $ 579,855

Expenses:
Compensation & benefits — 114,390 141,352 22 255,764
Occupancy & equipment — 19,810 62,504 — 82,314
Interest — 11,612 8,288 — 19,900
Depreciation & amortization — 18,391 21,689 — 40,080
Marketing & advertising — 9,831 12,016 (164 ) 21,683
Supplies, freight & postage — 3,684 10,503 — 14,187
Other — 90,981 39,060 (84 ) 129,957

— 268,699 295,412 (226 ) 563,885

Operating income (loss) — 138,580 (122,774 ) 164 15,970
Other income, net 17,134 — 1,164 (17,134 ) 1,164

Income (loss) before taxes (benefit) 17,134 138,580 (121,610 ) (16,970 ) 17,134
Income taxes (benefit) 6,758 56,410 (49,716 ) (6,694 ) 6,758

Net income (loss) $ 10,376 $ 82,170 $ (71,894 ) $ (10,276 ) $ 10,376

~~-22-~~

Three months ended October 31, 2002

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Total revenues $ — $ 326,054 $ 145,384 $ (42 ) $ 471,396

Expenses:
Compensation & benefits — 98,007 131,197 91 229,295
Occupancy & equipment — 17,256 54,175 — 71,431
Interest — 16,004 6,694 — 22,698
Depreciation & amortization- 19,066 17,429 — 36,495
Marketing & advertising — 8,039 12,934 (155 ) 20,818
Supplies, freight & postage — 4,660 9,192 — 13,852
Impairment of goodwill — 6,000 — — 6,000
Other — 55,437 78,190 (132 ) 133,495

— 224,469 309,811 (196 ) 534,084

Operating income (loss) — 101,585 (164,427 ) 154 (62,688 )
Other income, net (62,245 ) — 443 62,245 443

Income (loss) before taxes (benefit) (62,245 ) 101,585 (163,984 ) 62,399 (62,245 )
Income taxes (benefit) (24,898 ) 32,099 (57,060 ) 24,961 (24,898 )

Net income (loss) $ (37,347 ) $ 69,486 $ (106,924 ) $ 37,438 $ (37,347 )

Six months ended October 31, 2003

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Total revenues $ — $ 772,610 $ 313,039 $ (104 ) $ 1,085,545

Expenses:
Compensation & benefits — 218,079 262,824 66 480,969
Occupancy & equipment — 38,797 119,668 — 158,465
Interest — 24,463 18,633 — 43,096
Depreciation & amortization — 36,092 39,918 — 76,010
Marketing & advertising — 16,441 15,679 (329 ) 31,791
Supplies, freight & postage — 8,101 14,640 — 22,741
Other — 161,885 77,654 (170 ) 239,369

— 503,858 549,016 (433 ) 1,052,441

Operating income (loss) — 268,752 (235,977 ) 329 33,104
Other income, net 35,963 — 2,859 (35,963 ) 2,859

Income (loss) before taxes (benefit) 35,963 268,752 (233,118 ) (35,634 ) 35,963
Income taxes (benefit) 14,068 109,551 (95,612 ) (13,939 ) 14,068

Net income (loss) before change in accounting 21,895 159,201 (137,506 ) (21,695 ) 21,895
Cumulative effect of change in accounting (6,359 ) — (6,359 ) 6,359 (6,359 )

Net income (loss) $ 15,536 $ 159,201 $ (143,865 ) $ (15,336 ) $ 15,536

~~-23-~~

Six months ended October 31, 2002

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Total revenues $ — $ 636,957 $ 265,950 $ (145 ) $ 902,762

Expenses:
Compensation & benefits — 189,392 249,768 323 439,483
Occupancy & equipment — 31,419 104,874 — 136,293
Interest — 33,730 11,242 — 44,972
Depreciation & amortization — 37,537 34,531 — 72,068
Marketing & advertising — 12,562 17,751 (309 ) 30,004
Supplies, freight & postage — 8,557 13,761 — 22,318
Goodwill impairment — 24,000 — — 24,000
Other — 109,160 105,017 (468 ) 213,709

— 446,357 536,944 (454 ) 982,847

Operating income (loss) — 190,600 (270,994 ) 309 (80,085 )
Other income, net (78,151 ) — 1,934 78,151 1,934

Income (loss) before taxes (benefit) (78,151 ) 190,600 (269,060 ) 78,460 (78,151 )
Income taxes (benefit) (31,260 ) 76,364 (107,748 ) 31,384 (31,260 )

Net income (loss) $ (46,891 ) $ 114,236 $ (161,312 ) $ 47,076 $ (46,891 )

Condensed Consolidating Balance Sheets


	January 31, 2004
	H&R Block, Inc.			BFC			Other						Consolidated
	(Guarantor)			(Issuer)			Subsidiaries			Elims			H&R Block
Cash & cash equivalents	$	—		$	157,737		$	513,352		$	—		$	671,089
Cash & cash equivalents - - restricted		—			591,398			15,434			—			606,832
Receivables from customers, brokers and dealers, net		—			645,357			—			—			645,357
Receivables, net		543			801,636			290,872			—			1,093,051
Intangible assets and goodwill, net		—			469,116			820,162			—			1,289,278
Investments in subsidiaries		3,700,167			205			333			(3,700,167	)		538
Other assets		(193	)		1,085,228			396,182			825			1,482,042

Total assets	$	3,700,517		$	3,750,677		$	2,036,335		$	(3,699,342	)	$	5,788,187

Notes payable	$	—		$	1,411,177		$	—		$	—		$	1,411,177
Accts. payable to customers, brokers and dealers		—			1,126,103			—			—			1,126,103
Long-term debt		—			498,075			53,331			—			551,406
Other liabilities		2			575,153			647,780			—			1,222,935
Net intercompany advances		2,223,949			(981,478	)		(1,242,857	)		386			—
Stockholders’ equity		1,476,566			1,121,647			2,578,081			(3,699,728	)		1,476,566

Total liabilities and stockholders’ equity	$	3,700,517		$	3,750,677		$	2,036,335		$	(3,699,342	)	$	5,788,187

-23-

October 31, 2003

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Cash & cash equivalents $ — $ 158,659 $ 102,671 $ — $ 261,330
Cash & cash equivalents - - restricted — 559,715 11,448 — 571,163
Receivables from customers, brokers and dealers, net — 584,721 — — 584,721
Receivables, net 2,393 173,556 164,845 — 340,794
Intangible assets and goodwill, net — 476,441 703,800 — 1,180,241
Investments in subsidiaries 3,593,778 215 797 (3,593,778 ) 1,012
Other assets (240 ) 1,156,433 365,205 717 1,522,115

Total assets $ 3,595,931 $ 3,109,740 $ 1,348,766 $ (3,593,061 ) $ 4,461,376

Notes payable $ — $ 124,630 $ — $ — $ 124,630
Accts. payable to customers, brokers and dealers — 999,009 — — 999,009
Long-term debt — 747,875 59,863 — 807,738
Other liabilities 2 413,318 580,782 — 994,102
Net intercompany advances 2,060,032 (215,954 ) (1,844,465 ) 387 —
Stockholders’ equity 1,535,897 1,040,862 2,552,586 (3,593,448 ) 1,535,897

Total liabilities and stockholders’ equity $ 3,595,931 $ 3,109,740 $ 1,348,766 $ (3,593,061 ) $ 4,461,376

~~-24-~~

April 30, 2003

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Cash & cash equivalents $ — $ 180,181 $ 695,172 $ — $ 875,353
Cash & cash equivalents - - restricted — 420,787 17,455 — 438,242
Receivables from customers, brokers and dealers, net — 517,037 — — 517,037
Receivables, net 168 171,612 231,417 — 403,197
Intangible assets and goodwill, net — 491,091 564,989 — 1,056,080
Investments in subsidiaries 3,546,734 215 1,105 (3,546,734 ) 1,320
Other assets (1,321 ) 1,019,118 293,930 949 1,312,676

Total assets $ 3,545,581 $ 2,800,041 $ 1,804,068 $ (3,545,785 ) $ 4,603,905

Accts. payable to customers, brokers and dealers $ — $ 862,694 $ — $ — $ 862,694
Long-term debt — 747,550 74,752 — 822,302
Other liabilities 2,654 360,125 892,457 (36 ) 1,255,200
Net intercompany advances 1,879,218 (37,776 ) (1,841,943 ) 501 —
Stockholders’ equity 1,663,709 867,448 2,678,802 (3,546,250 ) 1,663,709

Total liabilities and stockholders’ equity $ 3,545,581 $ 2,800,041 $ 1,804,068 $ (3,545,785 ) $ 4,603,905

~~-25-~~

~~Condensed Consolidating Statements of Cash Flows~~

Six months ended October 31, 2003

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Net cash provided by (used in) operating activities: $ 6,269 $ (93,412 ) $ (376,207 ) $ — $ (463,350 )

Cash flows from investing:
Purchase of AFS securities — — (9,557 ) — (9,557 )
Cash received on residuals — 68,850 — — 68,850
Sales of AFS securities — 10,827 2,894 — 13,721
Purchase property & equipment — (10,212 ) (33,379 ) — (43,591 )
Payments for business acq — — (123,337 ) — (123,337 )
Net intercompany advances 180,814 — — (180,814 ) —
Other, net — 5,873 (3,346 ) — 2,527

Net cash provided by (used in) investing activities 180,814 75,338 (166,725 ) (180,814 ) (91,387 )

Cash flows from financing:
Repayments of notes payable — (499,771 ) — — (499,771 )
Proceeds from notes payable — 624,401 — — 624,401
Proceeds from securitization financing — 50,100 — — 50,100
Payments on acquisition debt — — (45,100 ) — (45,100 )
Dividends paid (68,087 ) — — — (68,087 )
Acquisition of treasury shares (178,847 ) — — — (178,847 )
Proceeds from issuance of common stock 59,851 — — — 59,851
Net intercompany advances — (178,178 ) (2,636 ) 180,814 —
Other, net — — (1,833 ) — (1,833 )

Net cash provided by (used in) financing activities (187,083 ) (3,448 ) (49,569 ) 180,814 (59,286 )

Net decrease in cash — (21,522 ) (592,501 ) — (614,023 )
Cash — beginning of period — 180,181 695,172 — 875,353

Cash — end of period $ — $ 158,659 $ 102,671 $ — $ 261,330

~~-26-~~

Six months ended October 31, 2002

H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block

Net cash provided by (used in) operating activities $ 19,163 $ (1,181 ) $ (367,810 ) $ — $ (349,828 )

Cash flows from investing:
Purchase of AFS securities — — (7,692 ) — (7,692 )
Cash received on residuals — 103,885 — — 103,885
Sales of AFS securities — — 7,946 — 7,946
Purchase property & equipment — (7,486 ) (49,517 ) — (57,003 )
Payments for business acq — — (21,397 ) — (21,397 )
Net intercompany advances 261,247 — — (261,247 ) —
Other, net — (556 ) (2,257 ) — (2,813 )

Net cash provided by (used in) investing activities 261,247 95,843 (72,917 ) (261,247 ) 22,926

Cash flows from financing:
Repayments of notes payable — (6,430,067 ) — — (6,430,067 )
Proceeds from notes payable — 6,911,680 — — 6,911,680
Payments on acquisition debt — — (47,995 ) — (47,995 )
Dividends paid (61,474 ) — — — (61,474 )
Acquisition of treasury shares (313,603 ) — — — (313,603 )
Proceeds from issuance of common stock 94,667 — — — 94,667
Net intercompany advances — (670,362 ) 409,115 261,247 —
Other, net — — (1,536 ) — (1,536 )

Net cash provided by (used in) financing activities (280,410 ) (188,749 ) 359,584 261,247 151,672

Net decrease in cash — (94,087 ) (81,143 ) — (175,230 )
Cash — beginning of period — 197,959 238,186 — 436,145

Cash — end of period $ — $ 103,872 $ 157,043 $ — $ 260,915

~~15.~~

April 30, 2003
H&R Block, Inc. BFC Other Consolidated
(Guarantor)
(Issuer)
Subsidiaries
Elims
H&R Block
Cash & cash equivalents $ — $ 180,181 $ 695,172 $ — $ 875,353
Cash & cash equivalents - - restricted — 420,787 17,455 — 438,242
Receivables from customers, brokers and dealers, net — 517,037 — — 517,037
Receivables, net 168 171,612 231,417 — 403,197
Intangible assets and goodwill, net — 491,091 564,989 — 1,056,080
Investments in subsidiaries 3,546,734 215 1,105 (3,546,734 ) 1,320
Other assets (1,321 ) 1,019,118 293,930 949 1,312,676

Total assets $ 3,545,581 $ 2,800,041 $ 1,804,068 $ (3,545,785 ) $ 4,603,905

Accts. payable to customers, brokers and dealers $ — $ 862,694 $ — $ — $ 862,694
Long-term debt — 747,550 74,752 — 822,302
Other liabilities 2,654 360,125 892,457 (36 ) 1,255,200
Net intercompany advances 1,879,218 (37,776 ) (1,841,943 ) 501 —
Stockholders’ equity 1,663,709 867,448 2,678,802 (3,546,250 ) 1,663,709

Total liabilities and stockholders’ equity $ 3,545,581 $ 2,800,041 $ 1,804,068 $ (3,545,785 ) $ 4,603,905

-24-
Condensed Consolidating Statements of Cash Flows

Nine months ended January 31, 2004
H&R Block, Inc. BFC Other Consolidated
(Guarantor)
(Issuer)
Subsidiaries
Elims
H&R Block
Net cash provided by (used in) operating activities: $ 30,336 $ (630,337 ) $ (401,639 ) $ — $ (1,001,640 )

Cash flows from investing:
Purchase of AFS securities — — (10,495 ) — (10,495 )
Cash received on residuals — 127,997 — — 127,997
Proceeds from sale of NIM residuals — 17,000 — — 17,000
Sales of AFS securities — 4,165 13,439 — 17,604
Purchase property & equipment — (28,037 ) (53,141 ) — (81,178 )
Payments for business acq. — — (280,280 ) — (280,280 )
Net intercompany advances 333,289 — — (333,289 ) —
Other, net — 19,309 (7,366 ) — 11,943

Net cash provided by (used in) investing activities 333,289 140,434 (337,843 ) (333,289 ) (197,409 )

Cash flows from financing:
Repayments of notes payable — (1,022,716 ) — — (1,022,716 )
Proceeds from notes payable — 2,433,893 — — 2,433,893
Repayments of securitization financing — (50,100 ) — — (50,100 )
Proceeds from securitization financing — 50,100 — — 50,100
Payments on acquisition debt — — (50,820 ) — (50,820 )
Dividends paid (103,538 ) — — — (103,538 )
Acquisition of treasury shares (371,242 ) — — — (371,242 )
Proceeds from issuance of common stock 111,155 — — — 111,155
Net intercompany advances — (943,718 ) 610,429 333,289 —
Other, net — — (1,947 ) — (1,947 )

Net cash provided by (used in) financing activities (363,625 ) 467,459 557,662 333,289 994,785

Net decrease in cash — (22,444 ) (181,820 ) — (204,264 )
Cash - beginning of period — 180,181 695,172 — 875,353

Cash - end of period $ — $ 157,737 $ 513,352 $ — $ 671,089

-25-

Nine months ended January 31, 2003
H&R Block, Inc. BFC Other Consolidated
(Guarantor)
(Issuer)
Subsidiaries
Elims
H&R Block
Net cash provided by (used in) operating activities: $ 27,060 $ (21,514 ) $ (372,295 ) $ — $ (366,749 )

Cash flows from investing:
Purchase of AFS securities — (10,577 ) — — (10,577 )
Cash received on residuals — 117,522 — — 117,522
Proceeds from sale of NIM residuals — 142,486 — — 142,486
Maturities of AFS securities — 7,730 2,000 — 9,730
Purchase property & equipment — (30,149 ) (65,480 ) — (95,629 )
Payments for business acq. — — (24,239 ) — (24,239 )
Net intercompany advances 271,380 — — (271,380 ) —
Other, net — (1,518 ) (4,486 ) — (6,004 )

Net cash provided by (used in) investing activities 271,380 225,494 (92,205 ) (271,380 ) 133,289

Cash flows from financing:
Repayments of notes payable — (9,301,285 ) — — (9,301,285 )
Proceeds from notes payable — 9,888,088 — — 9,888,088
Payments on acquisition debt — — (52,107 ) — (52,107 )
Dividends paid (93,645 ) — — — (93,645 )
Payments to acquire treasury shares (317,608 ) — — — (317,608 )
Proceeds from issuance of common stock 112,813 — — — 112,813
Net intercompany advances — (812,757 ) 541,377 271,380 —
Other, net — — (2,023 ) — (2,023 )

Net cash provided by (used in) financing activities (298,440 ) (225,954 ) 487,247 271,380 234,233

Net increase (decrease) in cash — (21,974 ) 22,747 — 773
Cash - beginning of period — 197,959 238,186 — 436,145

Cash - end of period $ — $ 175,985 $ 260,933 $ — $ 436,918

16. Subsequent Event
On ~~November 25, 2003,~~February 24, 2004, the Company declared a cash dividend of $.20 per share to shareholders of record as of ~~December 12, 2003,~~March 11, 2004, payable on ~~January 2,~~April 1, 2004.

-26-

MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

RESULTS OF OPERATIONS

H&R Block, Inc. (the Company) is a diversified company with subsidiaries primarily engaged in the business of providing financial services including tax services, investment and mortgage products and services, and accounting and consulting services. For nearly 50 years, the Company has been developing relationships with millions of tax clients and its strategy is to expand on these relationships.

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 the Company’s mission and vision is enhancing client experiences through consistent delivery of valuable services and advice. The Company believes offering advice facilitates a financial partnership and increases client satisfaction and retention. New products and services are continually introduced to bring additional value to the overall experience and allow clients to reach their financial objectives. Operating in multiple lines of business allows the Company to serve the changing financial needs of all its customers. The Company carries out its mission and vision through the following reportable operating segments:

U.S. Tax Operations:This segment primarily consists of the Company’s income tax preparation businesses. Retail tax offices served 16.5 million taxpayers in fiscal year 2003 - more than any other personal tax services company. Digital tax services also served 2.1 million clients through TaxCut tax preparation software (includes only federal e-filings) and online tax preparation in fiscal year 2003. By offering professional and do-it-yourself tax preparation options, the Company can serve its clients how they choose to be served.

Mortgage Operations:This segment is primarily engaged in the origination of non-prime mortgage loans, the sale and securitization of mortgage assets (which includes mortgage loans and residual interests), and the servicing of non-prime loans. A key focus of Mortgage Operations is to optimize cash flows from its operations. The Company believes offering mortgage products to other segments’ clients results in added value to the total client experience.

Business Services:This segment is engaged in providing accounting, tax, consulting, payroll, employee benefits and capital markets services to business clients and tax, financial and estate planning, wealth management and insurance services to individuals. The Company continues to focus on establishing core service relationships with middle-market clients by adding non-traditional business and personal services to enhance these client relationships. In doing so, the

-27-

Company intends to develop Business Services as a leading provider of middle-market professional services.

Investment Services:This segment is primarily engaged in offering investment services and securities products. Investment Services also offers these services and products to U.S. Tax and Mortgage Operations clients, bringing additional value to the overall client experience.

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.

The analysis that follows should be read in conjunction with the tables below and the condensed consolidated income statements found on page 2.

Consolidated H&R Block, Inc.

Consolidated H&R Block, Inc. – Three-Month Results


(in 000s, except per share amounts)	January 31, 2004		January 31, 2003		October 31, 2003
Revenues	$	977,157	$	958,413	$	579,855

Pretax income		176,120		222,934		17,134
Net income	$	106,726	$	132,313	$	10,376

Basic earnings per share	$	.60	$	.74	$	.06

Diluted earnings per share	$	.59	$	.73	$	.06

Overview

A summary of the Company’s results for the three months ended January 31, 2004 is as follows:

~~-27-~~

~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION~~

~~RESULTS OF OPERATIONS~~

~~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.~~

~~U.S. Tax Operations:~~This segment primarily consists of the Company’s income tax preparation businesses. Retail tax offices served 16.5 million taxpayers in fiscal year 2003 — more than any other personal tax services company. This segment also served 2.1 million clients through TaxCut tax preparation software (includes only federal e-filings) and online tax preparation in fiscal year 2003. By offering professional and do-it-yourself tax preparation options, the Company can serve its clients how they choose to be served.

~~Mortgage Operations:~~This segment is primarily engaged in the origination of non-prime mortgage loans, the sale and securitization of mortgage assets (which includes mortgage loans and residual interests), and the servicing of non-prime loans. A key focus of Mortgage Operations is to optimize cash flows from its operations. The Company believes offering mortgage products to other segments’ clients results in added value to the total client experience.

~~Business Services:~~This segment is engaged in providing accounting, tax, consulting, payroll, employee benefits and capital markets services to business clients and tax, financial and estate planning, wealth management and insurance services to individuals. The Company continues to focus on establishing core service relationships with middle-market clients by adding non-traditional business and personal services to enhance these client relationships. In doing so, the

~~-28-~~

~~Company intends to develop Business Services as a leading provider of middle-market professional services.~~

~~Investment Services:~~This segment is primarily engaged in offering investment services and securities products. Investment Services also offers these services and products to U.S. Tax and Mortgage Operations clients, bringing additional value to the overall client experience.

~~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.

~~The analysis that follows should be read in conjunction with the tables below and the condensed consolidated income statements found on page 2.~~

~~Consolidated H&R Block, Inc.~~

~~Consolidated H&R Block, Inc. — Three-Month Results~~

~~(in 000s, except per share amounts)~~

Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Revenues $ 579,855 $ 471,396 $ 505,690

Pretax income (loss) 17,134 (62,245 ) 18,829

Net income (loss) before change in accounting principle 10,376 (37,347 ) 11,519
Cumulative effect of change in accounting principle — — (6,359 )

Net income (loss) $ 10,376 $ (37,347 ) $ 5,160

Basic earnings (loss) per share:
Before change in accounting principle $ .06 $ (.21 ) $ .06

Net income (loss) $ .06 $ (.21 ) $ .03

Diluted earnings (loss) per share:
Before change in accounting principle $ .06 $ (.21 ) $ .06

Net income (loss) $ .06 $ (.21 ) $ .03

~~Results for the quarter ended July 31, 2003 have been restated for the adoption of Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21).~~

~~Overview~~

~~A summary of the Company’s results for the three months ended October 31, 2003 is as follows:~~

•		Net income was ~~$10.4~~$106.7 million, compared to ~~a net loss of $37.3~~$132.3 million in the prior year. ~~-29-~~

•		Revenues grew ~~$108.5~~$18.7 million, or ~~23.0%~~2.0%, over the prior year.

•		U.S. Tax Operations’ revenues increased ~~$13.8~~$60.1 million, or ~~41.2%~~14.9%, primarily due to ~~increased Peace of Mind~~company-owned operations in former major franchise territories, which contributed $24.3 million, $10.5 million in additional revenues from the digital tax solutions business, and revenues related to the ~~adoption of EITF 00-21, while expenses decreased 4.1%~~Company’s RAL business, which increased $6.2 million.

•		U.S. Tax Operations’ pretax income increased $34.1 million, or 99.9%, ~~primarily~~in conjunction with the increased revenues and as a result of a ~~litigation reserve recorded~~decline of $8.3 million in ~~the prior year.~~ legal expenses and effective management of off-season expenses.

•		Mortgage Operations’ revenues and pretax earnings ~~increased $76.6~~decreased $65.1 million and ~~$30.5~~$108.0 million, respectively, from the prior year and $19.2 million and $29.6 million, respectively, from the preceding quarter. The decline from the prior year is due to the gain on sale of NIM residual interests of $130.9 million recorded in November 2002, compared to a similar gain of only $17.0 million in the current year.

•		Mortgage originations totaled $5.4 billion, an increase of 18.1% over the prior year and ~~$48.3 million and $20.2 million, respectively, over the preceding quarter.~~ ~~Mortgage originations totaled $6.3 billion, an increase~~a decrease of ~~63.5% over the prior year and 19.4%~~15.6% over the preceding quarter. Execution pricing on sales of mortgage assets ~~declined to 3.87% from 4.78% in the prior year and 4.42% in the preceding quarter.~~ ~~Investment Services’ pretax results improved 45.1% due primarily to a $6.0 million goodwill impairment charge recorded in the prior year.~~

-28-

~~Consolidated H&R Block, Inc. — Six-Month Results~~

~~(in 000s, except per share amounts)~~

Six months ended

October 31, 2003 October 31, 2002

Revenues $ 1,085,545 $ 902,762

Pretax income (loss) 35,963 (78,151 )

Net income (loss) before change in accounting principle 21,895 (46,891 )
Cumulative effect of change in accounting principle (6,359 ) —

Net income (loss) $ 15,536 $ (46,891 )

Basic earnings (loss) per share:
Before change in accounting principle $ .12 $ (.26 )

Net income (loss) $ .09 $ (.26 )

Diluted earnings (loss) per share:
Before change in accounting principle $ .12 $ (.26 )

Net income (loss) $ .09 $ (.26 )

~~Overview~~

~~A summary of the Company’s results for the six months ended October 31, 2003 is as follows:~~

~~Net income~~

was ~~$15.5 million, compared to a net loss of $46.9 million in the prior year.~~

~~Revenues grew $182.8 million, or 20.2%, over the prior year.~~

~~U.S. Tax Operations’ revenues increased $31.0 million, or 54.7%, primarily due to increased Peace of Mind revenues related to the adoption of EITF 00-21.~~

~~Mortgage Operations’ revenues and pretax earnings increased $129.2 million and $47.3 million, respectively, over the prior year.~~

~~Mortgage originations totaled $11.7 billion, an increase of 60.7% over the prior year.~~

~~Investment Services’ pretax results improved 52.1% due primarily to a $24.0 million goodwill impairment charge recorded in the prior year.~~

~~-30-~~

~~U.S. Tax Operations~~

This segment is primarily engaged in providing tax return preparation, filing and related services in the United States. Segment revenues include fees earned for tax-related services performed at company-owned tax offices, royalties from franchise offices, sales of tax preparation and other software, fees from online tax preparation, and payments related to refund anticipation loan (RAL) participations.

TaxCut from H&R Block enables do-it-yourself users to prepare their federal and state tax returns easily and accurately. Several versions of the software are available to suit the needs of individual users, including TaxCut Standard, TaxCut Deluxe (includes free state and electronic filing), TaxCut Platinum for more complex returns and TaxCut Home & Business for small business owners. Other personal productivity software packages are also offered, including H&R Block Deduction Pro, WillPower and Home & Business Attorney.

Clients also have the option of online do-it-yourself tax preparation, online professional tax review, online tax advice and online tax preparation through a tax professional (whereby the client completes an online tax organizer and sends it to a tax professional for preparation) through the~~hrblock.com~~ website. The Company participates in the Free File Alliance, formed in fiscal year 2003. This alliance was created by the industry and the Internal Revenue Service (IRS), and allows qualified lower-income filers to prepare and file their federal return online at no charge.

During the six months ended October 31, 2003, subsidiaries of the Company began operating income tax return preparation businesses in the franchise territories previously operated by ten of its former major franchisees. As a result of these operations, the company expects to have 476 more company-owned and 238 more regular franchise offices for the upcoming tax season. The final purchase prices are pending litigation or settlement. Preliminary purchase price allocations have been made and will be adjusted upon determination of the final purchase price. The results for the three and six months ended October 31, 2003 include compensation, occupancy, legal, amortization and other expenses related to the commencement of company-owned operations in the former franchise territories totaling $12.8 million and $13.2 million, respectively.

Financial results for the three months ended July 31, 2003 have been restated as a result of the adoption of Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21), as it relates to the Peace of Mind (POM) guarantee program. See note 13 to the condensed consolidated financial statements for additional information.

~~-31-~~

~~U.S. Tax Operations — Three-Month Results~~

~~(in 000s)~~

Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Tax preparation and related fees $ 12,792 $ 13,370 $ 11,839
Royalties 1,651 1,402 1,036
RAL waiver fees 1,446 — 4,114
Software sales 933 560 260
Online tax services 430 242 556
Peace of Mind revenue 17,658 6,775 19,909
Other 12,279 11,080 2,808

Total revenues 47,189 33,429 40,522

Compensation and benefits 35,927 36,677 27,340
Occupancy and equipment 44,286 37,241 40,280
Depreciation and amortization 10,781 6,387 7,842
Cost of software sales 723 295 251
Supplies, freight and postage 3,947 4,204 1,183
Legal 11,101 45,947 3,782
Other 27,050 16,373 20,382
Allocated corporate and shared costs:
Information technology 22,908 18,524 19,655
Marketing 5,634 6,732 2,749
Finance 4,708 4,760 3,555
Supply 4,886 3,284 2,084
Other 6,176 5,304 4,591

Total expenses 178,127 185,728 133,694

Pretax loss $ (130,938 ) $ (152,299 ) $ (93,172 )

~~Three months ended October 31, 2003 compared to October 31, 2002~~

~~U.S. Tax Operations’ revenues increased $13.8 million, or 41.2%, for the three months ended October 31, 2003, compared to the three months ended October 31, 2002.~~

Tax preparation and related fees decreased $0.6 million, or 4.3%, for the three months ended October 31, 2003. This decrease is primarily due to a 2.6% decrease in the average charge, net of discounts, offset by a 7.3% increase in tax returns prepared. The net average charge decreased to $185.474.08% in the current quarter compared to $190.37 last year. Average charge is calculated as tax preparation and filing fees, less discounts if applicable, divided by the number of clients served. Tax returns prepared in company-owned offices during the current quarter were 75 thousand, compared to 70 thousand4.60% in the prior ~~year.~~year and 3.87% in the preceding quarter.

•

Investment Services’ pretax loss improved 59.7% due primarily to increases in production revenues coupled with lower operating expenses.

Consolidated H&R Block, Inc. – Nine-Month Results


(in 000s, except per share amounts)	January 31, 2004			January 31, 2003
Revenues	$	2,062,702		$	1,861,175

Pretax income		212,083			144,783
Net income before change in accounting principle		128,621			85,422
Cumulative effect of change in accounting principle		(6,359	)		—

Net income	$	122,262		$	85,422

Basic earnings per share:
Before change in accounting principle	$	.72		$	.48

Net income	$	.69		$	.48

Diluted earnings per share:
Before change in accounting principle	$	.71		$	.46

Net income	$	.67		$	.46

Overview

A summary of the Company’s results for the nine months ended January 31, 2004 is as follows:

~~During fiscal year 2003,~~
• Net income was $122.3 million, compared to $85.4 million in the ~~Company entered into an agreement with Household~~prior year.
• Revenues grew $201.5 million, or 10.8%, over the prior year.
• U.S. Tax ~~Masters, Inc. (Household)~~Operations’ revenues increased $91.1 million, or 19.8%, ~~whereby the Company waived its right~~primarily due to ~~purchase any participation interests~~company-owned operations in ~~and receive license fees for RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights the Company received a series~~former major franchise territories, which contributed $24.9 million, increased Peace of ~~payments from Household in fiscal year 2003, subject to certain adjustments in fiscal year 2004 based on delinquency rates. During the three months ended October 31, 2003 the Company recorded~~
~~-32-~~
~~additional~~Mind (POM) revenues of ~~$1.4~~$23.3 million based on projected delinquency rates through December 31, 2003. The waiver agreement with Household was a one-year agreement. The final payment is expected to be received in January 2004, based on actual delinquency rates as of December 31, 2003. The Company intends to participate in RALs during the upcoming tax season.
~~POM revenues for the three months ended October 31, 2003 increased $10.9 million, or 160.6%, due to the adoption of EITF 00-21. Prior~~related primarily to the adoption of EITF 00-21, revenues related to ~~POM guarantees in premium offices were recorded within~~RALs, which increased $11.7 million, and the digital tax ~~preparation revenues. With the adoption of EITF 00-21, the~~solutions business, which increased $10.8 million.
• Mortgage Operations’ revenues ~~are deferred~~increased $64.1 million 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.
Total expenses for the three months ended October 31, 2003 were $178.1 million, down $7.6 million, or 4.1%, from the prior year. The decrease from the prior year is a result of a litigation settlement recorded in the prior year and effective off-season cost controls. These decreases were partially offset by additional costs from the commencement of company-owned operations in former major franchise territories. Legal expenses declined $34.8 million, or 75.8%, primarily due to the Texas RAL litigation reserve of $41.7 million recorded in the previous year, partially offset by legal costs incurred related to other open litigation. Occupancy and equipment costs increased $7.0pretax earnings decreased $60.7 million over the prior ~~year, due to increases~~year.
• Mortgage originations totaled $17.0 billion, an increase of 215 in company-owned offices under lease and offices related to the former major franchise territories. Depreciation and amortization expenses increased in conjunction with additional equipment purchased for new office locations opened during the period. Amortization of intangible assets increased $1.7 million due to the acquisition of assets from former major franchisees. Other expenses in the current quarter increased $10.7 million over last year. The increase was primarily due to $5.6 million of additional POM expenses related to the adoption of EITF 00-21. Additionally, travel and consulting expenses increased by $1.6 million and $1.2 million, respectively. Information technology expenses increased $4.4 million, or 23.7%, for the quarter ended October 31, 2003, primarily due to additional technology projects.
~~The pretax loss of $130.9 million for the three months ended October 31, 2003, represents a 14.0% improvement~~44.3% over the prior ~~year loss of $152.3 million.~~
Due to the seasonal nature of this segment’s business, operating results for the three months ended October 31, 2003 are not comparable to the three months ended July 31, 2003 and are not indicative of the expected results for the entire fiscal year.
~~-33-~~
~~U.S. Tax Operations — Six-Month Results~~
~~(in 000s)~~

Six months ended

October 31, 2003 October 31, 2002

Tax preparation and related fees $ 24,631 $ 24,378
Royalties 2,687 2,318
RAL waiver fees 5,560 —
Software sales 1,193 1,431
Online tax services 986 519
Peace of Mind revenue 37,567 14,326
Other 15,087 13,743

Total revenues 87,711 56,715

Compensation and benefits 63,267 63,211
Occupancy and equipment 84,566 74,431
Depreciation and amortization 18,623 12,525
Cost of software sales 974 569
Supplies, freight and postage 5,130 5,752
Legal 14,883 48,305
Other 47,432 26,897
Allocated corporate and shared costs:
Information technology 42,563 34,226
Marketing 8,383 11,801
Finance 8,263 8,968
Supply 6,970 5,585
Other 10,767 10,774

Total expenses 311,821 303,044

Pretax loss $ (224,110 ) $ (246,329 )

~~Six months ended October 31, 2003 compared to October 31, 2002~~
~~U.S. Tax Operations’ revenues increased $31.0 million, or 54.7%, for the six months ended October 31, 2003, compared to the six months ended October 31, 2002.~~
Tax preparation and related fees increased slightly for the six months ended October 31, 2003, as a result of a 2.2% increase in the average charge, net of discounts, and a 1.7% increase in tax returns prepared. The net average charge increased to $171.36 in the current period compared to $167.68 last year. Tax returns prepared in company-owned offices during the current period were 162 thousand, compared to 159 thousand in the prior year.
During the six months ended October 31, 2003 the Company recorded revenues of $5.6 million in conjunction with the RAL waiver agreement with Household based on projected delinquency rates through December 31, 2003.
~~POM revenues for the six months ended October 31, 2003 increased $23.2 million, or 162.2%, principally due to the adoption of EITF 00-21.~~
~~-34-~~
Total expenses for the six months ended October 31, 2003 were $311.8 million, up $8.8 million, or 2.9%, from the prior year. The increase over the prior year is primarily a result of the costs of additional offices and the commencement of company-owned operations in former major franchise territories. These increased costs were offset by lower legal expenses as a result of a prior year litigation settlement, and effective off-season cost controls. Occupancy and equipment costs increased $10.1 million due to increases of 215 in company-owned offices under lease and offices related to the former major franchise territories. Depreciation and amortization expenses increased in conjunction with additional equipment purchased for new office locations opened during the period. Amortization of intangible assets increased $1.7 million due to the acquisition of assets from former major franchisees. Other expenses in the current period increased $20.5 million over last year. The increase was primarily due to $11.8 million of additional POM expenses related to the adoption of EITF 00-21, and $4.2 million of additional interest accretion related to a legal settlement. Additionally, consultant fees and travel expenses increased $3.0 million and $1.4 million, respectively. Information technology expenses increased $8.3 million, or 24.4%, for the six months ended October 31, 2003, primarily due to additional technology projects. Offsetting these increases, legal expenses declined $33.4 million, or 69.2%, primarily due to the Texas RAL litigation reserve of $41.7 million recorded in the previous year, partially offset by legal costs incurred related to other open litigation.
~~The~~
• Investment Services’ pretax loss ~~of $224.1 million for the six months ended October 31, 2003, represents a 9.0% improvement over the prior year loss of $246.3 million.~~
~~Mortgage Operations~~
~~This segment is~~improved 54.7% due primarily engaged in the origination of non-prime mortgage loans, sales and securitizations of mortgage assets and servicing of non-prime loans. Revenues consist of proceeds from sales and securitizations of loans and related assets, accretion on residual interests, loan servicing fees and interest received on loans.
Substantially all non-prime mortgage loans originated are sold daily to qualifying special purpose entities (Trusts). The Company removes the mortgage loans from its balance sheet and records the gain on the sale, cash and a receivable which represents the ultimate expected outcome from the disposition of the loans by the Trusts. The Trusts, as directed by the third-party beneficial interest holders, either sell the loans directly to third-party investors or back to the ~~Company’s securitization entity to pool the loans for securitization, depending on market conditions.~~
In a securitization transaction, the Trusts transfer the loans to a special purpose entity, which is a consolidated subsidiary of the Company, and the Company simultaneously transfers the loans and its receivable, and the right to receive all payments on the loans, to a securitization trust. The securitization trust meets the definition of a qualifying special purpose entity (QSPE) and is therefore not consolidated by the Company. The securitization trust issues bonds, which are supported by cash flows from the pooled loans, to third-party investors. The Company retains an interest in the loans in the form of a residual interest (including overcollateralization (OC) accounts and uncertificated interests) and usually assumes first risk of loss for credit losses in the loan pool. As the cash flows of the underlying loans and market conditions change, the value of
~~-35-~~
~~the Company’s residual interests may also change, resulting in either additional unrealized gains or impairment of the residual interests.~~
To accelerate cash flows from its residual interests, the Company securitizes the majority of its residual interests in net interest margin (NIM) transactions. In a NIM transaction, residual interests are normally transferred to another QSPE (NIM trust), which then issues bonds to third-party investors. In the second quarter of fiscal year 2004, the Company completed a NIM transaction with a special purpose entity (SPE) that did not qualify as a QSPE and, therefore the SPE has been consolidated and the transaction was accounted for as a secured financing (on-balance sheet securitization).
Proceeds from the bonds are returned to the Company as payment for the residual interests. The bonds are secured by pooled residual interests and are obligations of the NIM trust. The Company retains a subordinated interest in the NIM trust, and receives cash flows on its residual interest generally after the bonds issued to the third-party investors are paid in full. Residual interests retained from NIM securitizations may also be bundled and sold in a subsequent securitization.
Substantially all non-prime loans originated and subsequently sold or securitized are transferred with servicing rights retained. Servicing activities include processing of mortgage loan payments and the administration of mortgage loans, with loan servicing fees received monthly over the life of the mortgage loans. The Company has traditionally received a servicing fee of 50 basis points per annum on the outstanding principal balance of loans sold or securitized, as well as the right to receive certain ancillary income including, but not limited to, late fees. In recent transactions, step-servicing fee structures have been implemented. The purpose of step-servicing is to better match the stream of incoming servicing revenues against the related servicing expenses. Generally, the cost to service a pool of loans is lower immediately after origination and increases as the related loan pool ages. Recent step-servicing fee structures provide the company with a servicing fee of 30 basis points per annum for the first 10 months of servicing, 40 basis points per annum for the next 20 months of servicing and 65 basis points for the remainder of the servicing term.
~~Prime mortgage loans are sold in whole loan sales, servicing rights released, to third-party buyers.~~
Market interest rates have begun to increase after a sustained period of declining rates. In a rising interest rate environment the Company expects its profit margins will narrow from their historically high levels due to less favorable loan execution pricing. Actual execution pricing on sales of mortgage assets declined to 3.87% during the three months ended October 31, 2003 compared to 4.78% in the prior year. As such, growth in pretax income for the mortgage operations segment is expected to be more moderate or perhaps decline from results (excluding a $130.9 million gain on sale of NIM residual interests) for the fiscal year ended April 30, 2003.
~~-36-~~
~~Mortgage Operations — Three-Month Statistics~~
~~(dollars in 000s)~~

Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Number of loans originated:
Wholesale (non-prime) 36,233 21,536 28,494
Retail: Prime 1,944 3,089 4,005
Non-prime 4,110 2,754 3,004

Total 42,287 27,379 35,503

Volume of loans originated:
Wholesale (non-prime) $ 5,603,118 $ 3,083,895 $ 4,405,224
Retail: Prime 247,661 444,469 540,326
Non-prime 492,977 351,694 365,331

Total $ 6,343,756 $ 3,880,058 $ 5,310,881

Loan sales $ 6,330,449 $ 3,821,649 $ 5,301,341
Weighted average FICO score⁽²⁾
611 604 607
Execution price — Net gain on sale⁽¹⁾
3.87 % 4.78 % 4.42 %
Weighted average interest rate for borrowers⁽²⁾
7.51 % 8.24 % 7.54 %
Weighted average loan-to-value⁽²⁾
78.2 % 79.1 % 78.3 %
~~(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 — Three-Month Results~~
~~(in 000s)~~

Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Components of gains on sales:
Gains on sales of mortgage assets $ 220,652 $ 155,079 $ 203,382
Impairment of residual interests (363 ) (3,702 ) (10,743 )

Total gains on sales 220,289 151,377 192,639
Loan servicing revenue 51,659 41,325 48,317
Accretion income 36,843 54,092 34,063
Interest income 41,858 27,429 27,274
Other 507 365 602

Total revenues 351,156 274,588 302,895

Compensation and benefits 77,152 62,226 65,483
Servicing and processing 26,609 16,606 25,251
Occupancy and equipment 12,589 10,364 11,558
Bad debt expense 12,226 3,296 9,514
Other 38,554 28,576 27,260

Total expenses 167,130 121,068 139,066

Pretax income $ 184,026 $ 153,520 $ 163,829

~~-37-~~
~~Three months ended October 31, 2003 compared to October 31, 2002~~
Mortgage Operations’ revenues increased $76.6 million, or 27.9%, for the three months ended October 31, 2003 compared to the prior year. Revenue increased primarily as a result of higher production volumes.
~~The following table summarizes the key drivers of gains on sales of mortgage loans:~~
~~(dollars in 000s)~~

Three months ended October 31,

2003 2002

Number of sales associates⁽¹⁾
2,476 2,005
Total number of applications 72,858 55,026
Closing ratio⁽²⁾
58.0 % 49.8 %
Total number of originations 42,287 27,379
Average loan size $ 150 $ 142
Total originations $ 6,343,756 $ 3,880,058
Non-prime / prime ratio 24.6 : 1 7.7 : 1
Commitments to fund loans $ 3,244,958 $ 2,221,671
Loan sales $ 6,330,449 $ 3,821,649
Gains on sales of mortgage assets $ 220,652 $ 155,079
Execution price — net gain on sale⁽³⁾
3.87 % 4.78 %
~~(1)~~ ~~Includes all direct sales and back office sales support associates.~~
~~(2)~~ ~~Percentage of loans funded divided by total applications.~~
~~(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).
Gains on sales of mortgage loans and related assets increased $65.6 million for the three months ended October 31, 2003. The increase over last year is a result of a significant increase in loan origination volume, partially offset by a decrease in loan sale execution pricing and an increase in loan origination expenses. During the second quarter, the Company originated $6.3 billion in mortgage loans compared to $3.9 billion last year, an increase of 63.5%. The execution price on mortgage loans originated and sold decreased to 3.87% for the current quarter compared to 4.78% last year, primarily as a result of a decrease in the average interest rate during the period.
~~Impairments of residual interests in securitizations of $0.4 million were recognized in the current period, compared to $3.7 million for the three months ended October 31, 2002.~~
~~The following table summarizes the key drivers of loan servicing revenues:~~
~~(dollars in 000s)~~

Three months ended October 31,

2003 2002

Number of loans serviced 295,636 220,842
Average servicing portfolio $ 36,825,033 $ 26,141,181
Average delinquency rate 6.28 % 7.21 %
Value of MSRs $ 111,960 $ 99,774
~~-38-~~
Loan servicing revenues increased $10.3 million, or 25.0%, compared to the prior year. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the three-month period ended October 31, 2003 increased $10.7 billion, or 40.9%, to $36.8 billion.
Total accretion of residual interests of $36.8 million for the three months ended October 31, 2003 represents a decrease of $17.2 million from prior year accretion of $54.1 million. This decline is due to a lower average balance of related residuals, resulting primarily from the sale of previously securitized residual interests (NIM residuals) during the third quarter of fiscal year 2003.
During the second quarter of fiscal year 2004, the Company’s residual interests continued to perform better than expected compared to internal valuation models, primarily due to sustained low interest rates and more favorable prepayment and loss rates. As a result of these items, the Company recorded pretax mark-to-market write-ups, which increased the fair value of its residual interests $20.9 million during the quarter. These write-ups were recorded, net of write-downs of $10.4 million and deferred taxes of $4.0 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests. Future changes in interest rates or other assumptions, based on market conditions or actual loan pool performance, could cause additional 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 NIM residual interests would result in decreases to accretion income in future periods.
Interest income increased $14.4 million, or 52.6%, for the quarter ended October 31, 2003, primarily due to an increase in the average balance on loans held by the Trusts. This increase was offset by lower interest margin earned. Interest margin is the difference between the rate on the underlying loans and the financing costs of the Trusts. The interest margin decreased to 5.39% for the three months ended October 31, 2003, from 5.64% a year ago.
Total expenses for the three months ended October 31, 2003, increased $46.1 million, or 38.0%, over the year-ago quarter. This increase is primarily due to $14.9 million in increased compensation and benefits as a result of a 23.5% increase in sales associates needed to support higher loan production volumes. Servicing and processing expenses increased by $10.0 million as a result of a higher average servicing portfolio during the three months ended October 31, 2003. Occupancy and equipment charges increased $2.2 million due to nine additional branch offices opened since the prior year quarter ended, continued expansion of the second servicing center that opened in August 2002 and additional administrative office space. Bad debt expense increased $8.9 million primarily due to more whole loan sales than securitizations in the current year, for which higher reserves are set up at the time of sale for estimated repurchases. Whole loan sales accounted for 79% of total loan sales, compared to 72% in the prior year. Other expenses increased by $10.0 million to $38.6 million for the current quarter, primarily due to $2.0 million in increased marketing expenses and $4.5 million in increased allocated corporate and shared costs. Allocated costs increased as a result of additional insurance costs and the expensing of stock-based compensation.
~~-39-~~
~~Pretax income increased $30.5 million to $184.0 million for the three months ended October 31, 2003.~~
~~Three months ended October 31, 2003 compared to July 31, 2003~~
~~Mortgage Operations’ revenues increased $48.3 million, or 15.9%, for the three months ended October 31, 2003, compared to the preceding quarter.~~
~~The following table summarizes the key drivers of gains on sales of mortgage loans:~~

(dollars in 000s) Three months ended

October 31, 2003 July 31, 2003

Number of sales associates⁽¹⁾
2,476 2,330
Total number of applications 72,858 62,544
Closing ratio⁽²⁾
58.0 % 56.8 %
Total number of originations 42,287 35,503
Average loan size $ 150 $ 150
Total originations $ 6,343,756 $ 5,310,881
Non-prime / prime ratio 24.6 : 1 8.8 : 1
Commitments to fund loans $ 3,244,958 $ 2,900,917
Loan sales $ 6,330,449 $ 5,301,341
Gains on sales of mortgage assets $ 220,652 $ 203,382
Execution price — net gain on sale⁽³⁾
3.87 % 4.42 %
~~(1)~~ ~~Includes all direct sales and back office sales support associates.~~
~~(2)~~ ~~Percentage of loans funded divided by total applications.~~
~~(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).
Gains on sales of mortgage loans and related assets for both wholesale and retail increased $17.3 million to $220.7 million for the current quarter. This increase from the preceding quarter is primarily a result of a 19.4% increase in loans originated, which was partially offset by a decrease in execution price on loan sales as a result of the rising interest rate environment. The execution price on loan sales for the quarter decreased to 3.87% from 4.42% for the three months ended July 31, 2003.
Impairments of residual interests in securitizations of $0.4 million were recognized during the second quarter, compared to $10.7 million for the three months ended July 31, 2003. The first quarter impairments resulted from a decline in value of older residuals based on loan performance.
~~The following table summarizes the key drivers of loan servicing revenues:~~

(dollars in 000s) Three months ended

October 31, 2003 July 31, 2003

Number of loans serviced 295,636 261,344
Average servicing portfolio $ 36,825,033 $ 32,757,225
Average delinquency rate 6.28 % 6.60 %
Value of MSRs $ 111,960 $ 106,056
~~-40-~~
Loan servicing revenues increased $3.3 million, or 6.9%, compared to the first quarter of fiscal year 2004. The increase reflects a higher loan-servicing portfolio. The average servicing portfolio for the three months ended October 31, 2003 increased $4.1 billion, or 12.4%, to $36.8 billion.
Accretion of residual interests of $36.8 million represents an increase of 8.2% from the preceding quarter accretion of $34.1 million, primarily due to write-ups taken during the first quarter of fiscal year 2004.
Interest income increased $14.6 million, or 53.5%, for the quarter ended October 31, 2003, due to an increase in the average balance on loans held by the Trusts. This increase was offset by lower interest margin earned. The interest margin decreased to 5.39% during the three months ended October 31, 2003, from 5.51% in the first quarter.
Total expenses increased $28.1 million, or 20.2%, primarily due to increased compensation and benefit costs associated with the increase in sales associates. Bad debt expense increased $2.7 million primarily due to more whole loan sales than securitizations in the current quarter, which requires higher reserves to be set up at the time of sale for estimated repurchases. Whole loan sales accounted for 79% of total loan sales, compared to 57% in the first quarter. Other expenses also increased $11.3 million due to $2.7 million of additional marketing expenses, $2.3 million in additional consulting expenses and $1.2 million of additional depreciation and amortization. Allocated corporate and shared costs also increased $2.5 million, primarily due to increased insurance costs and the expensing of stock-based compensation.
~~Pretax income increased $20.2 million, or 12.3%, for the three months ended October 31, 2003 compared to the preceding quarter.~~
~~-41-~~
~~Mortgage Operations — Six-Month Statistics~~

(dollars in 000s) Six months ended

October 31, 2003 October 31, 2002

Number of loans originated:
Wholesale (non-prime) 64,727 42,310
Retail: Prime 5,949 4,988
Non-prime 7,114 5,133

Total 77,790 52,431

Volume of loans originated:
Wholesale (non-prime) $ 10,008,341 $ 5,920,954
Retail: Prime 787,987 698,509
Non-prime 858,308 633,984

Total $ 11,654,636 $ 7,253,447

Loan sales:
Loans originated and sold $ 11,631,790 $ 7,179,379
Loans acquired and sold — 633,953

Total $ 11,631,790 $ 7,813,332

Weighted average FICO score⁽²⁾
609 601

Execution price — Net gain on sale⁽¹⁾
4.18 % 4.83 %
Loans originated and sold 4.18 % 4.83 %
Loans acquired and sold — % 0.18 %

Total 4.18 % 4.44 %

Weighted average interest rate for borrowers⁽²⁾
7.53 % 8.52 %
Weighted average loan-to-value⁽²⁾
78.2 % 79.1 %
~~(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.~~
~~-42-~~
~~Mortgage Operations — Six-Month Results~~

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Components of gains on sales:
Gains on sales of mortgage assets $ 424,034 $ 320,517
Impairment of residual interests (11,106 ) (24,132 )

Total gains on sales 412,928 296,385

Loan servicing revenue 99,976 80,275
Accretion income 70,906 92,853
Interest income 69,132 54,266
Other 1,109 1,115

Total revenues 654,051 524,894

Compensation and benefits 142,635 115,195
Servicing and processing 51,860 31,627
Occupancy and equipment 24,147 17,938
Bad debt expense 21,740 9,117
Other 65,814 50,412

Total expenses 306,196 224,289

Pretax income $ 347,855 $ 300,605

~~Six months ended October 31, 2003 compared to October 31, 2002~~
Mortgage Operations’ revenues increased $129.2 million, or 24.6%, for the six months ended October 31, 2003 compared to the prior year. Revenue increased primarily as a result of higher production volumes.
~~The following table summarizes the key drivers of gains on sales of mortgage loans:~~

(dollars in 000s) Six months ended October 31,

2003 2002

Number of sales associates⁽¹⁾
2,476 2,005
Total number of applications 135,402 102,661
Closing ratio⁽²⁾
57.5 % 51.1 %
Total number of originations 77,790 52,431
Average loan size $ 150 $ 138
Total originations $ 11,654,636 $ 7,253,447
Non-prime / prime ratio 13.8 : 1 9.4 : 1
Commitments to fund loans $ 3,244,958 $ 2,221,671
Loan sales $ 11,631,790 $ 7,813,332
Gains on sales of mortgage assets $ 424,034 $ 320,517
Execution price — net gain on sale⁽³⁾
4.18 % 4.44 %
~~(1)~~ ~~Includes all direct sales and back office sales support associates.~~
~~(2)~~ ~~Percentage of loans funded divided by total applications.~~
~~(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).
~~-43-~~
Gains on sales of mortgage loans and related assets increased $103.5 million for the six months ended October 31, 2003. The increase over last year is a result of a significant increase in loan origination volume, partially offset by a decrease in loan sale execution pricing and increased loan origination expenses. During the current year, the Company originated $11.7 billion in mortgage loans compared to $7.3 billion last year, an increase of 60.7%. The execution price on mortgage loans originated and sold decreased to 4.18% for the current period compared to 4.83% last year, primarily as a result of a decrease in the average interest rate during the period.
Impairments of residual interests in securitizations of $11.1 million were recognized in the six months ended October 31, 2003, due to a decline in value of older residuals based on loan performance. Impairments of residuals for the six months ended October 31, 2002 totaled $24.1 million.
~~The following table summarizes the key drivers of loan servicing revenues:~~

(dollars in 000s) Six months ended October 31,

2003 2002

Number of loans serviced 295,636 220,842
Average servicing portfolio $ 34,896,920 $ 25,707,639
Average delinquency rate 6.43 % 6.92 %
Value of MSRs $ 111,960 $ 99,774
Loan servicing revenues increased $19.7 million, or 24.5%, this year. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the six months ended October 31, 2003 increased $9.2 billion, or 35.7%, to $34.9 billion.
Total accretion of residual interests of $70.9 million for the six months ended October 31, 2003 represents a decrease of $21.9 million from prior year accretion of $92.9 million. This decline is due to a lower average balance of related residuals, resulting primarily from the sale of NIM residuals during the third quarter of fiscal year 2003.
The Company recorded pretax mark-to-market write-ups on its residual interests, which increased the fair value $78.4 million during the period. These write-ups were recorded, net of write-downs of $14.3 million and deferred taxes of $24.4 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests. Future changes in interest rates or other assumptions, based on market conditions or actual loan pool performance, could cause additional 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 NIM residual interests would result in decreases to accretion income in future periods.
Interest income increased $14.9 million, or 27.4%, for the six months ended October 31, 2003, due to an increase in the average balance on loans held by the Trusts. This increase was offset by lower interest margin earned. The interest margin decreased to 5.45% during the six months ended October 31, 2003, from 5.85% a year ago.
~~-44-~~
Total expenses for the six months ended October 31, 2003, increased $81.9 million, or 36.5% over the year-ago period. This increase is primarily due to a $27.4 million increase in compensation and benefits as a result of a 23.5% increase in sales associates needed to support higher loan production volumes. Servicing and processing expenses increased by $20.2 million as a result of a higher average servicing portfolio during the six months ended October 31, 2003. Occupancy and equipment charges increased $6.2 million due to nine additional branch offices opened since October 2002, continued expansion of the second servicing center that opened in August 2002 and additional administrative office space. Bad debt expense increased $12.6 million primarily as a result of the increase in whole loan sales compared to securitizations, for which higher reserves are set up at the time of sale for estimated repurchases. Other expenses increased by $15.4 million to $65.8 million for the current period, primarily due to $4.4 million in increased marketing expenses and $5.9 million in increased allocated corporate and shared costs. Allocated costs increased due to higher insurance costs and the expensing of stock-based compensation.
~~Pretax income increased $47.3 million to $347.9 million for the six months ended October 31, 2003.~~
~~Business Services~~
This segment is engaged in providing accounting, tax, consulting, payroll, employee benefits and capital markets services to business clients and tax, financial and estate planning, wealth management and insurance services to individuals. Business Services provides accounting, payroll and human resources services to McGladrey & Pullen LLP (M&P) in exchange for a management fee. The Company also has commitments to fund M&P’s operations.
A substantial portion of Business Services’ business is generated by one-time projects or extended services. Improvements in the current business environment have caused clients to begin cautiously spending money on discretionary projects. Results in the Company’s consulting services remain weak while other service revenues are seeing improvement.
~~-45-~~
~~Business Services — Three-Month Results~~

(in 000s) Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Traditional accounting $ 54,441 $ 51,195 $ 45,096
Business consulting 21,174 21,755 21,575
Capital markets 17,870 10,563 16,630
Other 15,539 14,370 15,198

Total revenues 109,024 97,883 98,499

Compensation and benefits 75,397 65,654 70,285
Occupancy and equipment 6,785 6,789 6,066
Depreciation and amortization 5,647 5,457 5,496
Marketing and advertising 1,660 1,775 2,195
Bad debt expense 1,116 2,439 1,361
Other 21,151 19,554 19,775

Total expenses 111,756 101,668 105,178

Pretax loss $ (2,732 ) $ (3,785 ) $ (6,679 )

~~Three months ended October 31, 2003 compared to October 31, 2002~~
Business Services’ revenues for the three months ended October 31, 2003 increased $11.1 million, or 11.4%, from the prior year. This increase was primarily due to a $7.3 million increase in capital markets revenues, resulting from a higher number of business valuation projects. Traditional accounting revenues also increased $3.2 million due to more billable hours during the quarter for tax services.
Total expenses increased $10.1 million, or 9.9%, for the three months ended October 31, 2003 compared to the prior year. Compensation and benefits costs increased $9.7 million, primarily as a result of the increased activity in the capital markets business. Additionally, other expenses increased $1.6 million, primarily due to increased employee recruiting costs.
~~The pretax loss for the three months ended October 31, 2003 was $2.7 million compared to a loss of $3.8 million in the prior year.~~
Due to the seasonal nature of this segment’s business, operating results for the three months ended October 31, 2003 are not comparable to the three months ended July 31, 2003 and are not indicative of the expected results for the entire fiscal year.
~~-46-~~
~~Business Services — Six-Month Results~~

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Traditional accounting $ 99,537 $ 101,117
Business consulting 42,749 43,493
Capital markets 34,500 20,481
Other 30,737 28,106

Total revenues 207,523 193,197

Compensation and benefits 145,682 134,728
Occupancy and equipment 12,851 11,291
Depreciation and amortization 11,143 11,192
Marketing and advertising 3,855 3,265
Bad debt expense 2,477 3,328
Other 40,926 37,451

Total expenses 216,934 201,255

Pretax loss $ (9,411 ) $ (8,058 )

~~Six months ended October 31, 2003 compared to October 31, 2002~~
Business Services’ revenues for the six months ended October 31, 2003 increased $14.3 million, or 7.4%, from the prior year. This increase was primarily due to a $14.0 million increase in capital markets revenues, resulting from a higher number of business valuation projects. Other revenues also increased $2.6 million due to improved performance in the outsourced services area. These increases were partially offset by a slight decline in traditional accounting revenues.
Total expenses increased $15.7 million, or 7.8%, for the six months ended October 31, 2003 compared to the prior year. Compensation and benefits costs increased $11.0 million, primarily as a result of the increased activity in the capital markets business. Additionally, other expenses increased $3.5 million, primarily due to increased recruiting and insurance costs.
~~The pretax loss for the six months ended October 31, 2003 was $9.4 million compared to a loss of $8.1 million in the prior year.~~
~~Investment Services~~
This segment is primarily engaged in offering investment services and securities products through H&R Block Financial Advisors, Inc. (HRBFA), a full-service securities broker-dealer and a registered investment advisor. Products and services offered to Investment Services’ customers include: equities, annuities, fixed income products, mutual funds, margin accounts, money market funds with sweep provisions for settlement of customer transactions, checking privileges, account access/review via the internet, online trading, fee-based accounts, individual retirement accounts, dividend reinvestment and option accounts, equity research and focus lists, model portfolios, asset allocation strategies, economic commentaries and other investment tools and information. In addition, clients of the Company’s U.S. Tax Operations segment are given the opportunity to open an Express IRA through HRBFA as a part of the income tax return preparation process.
~~-47-~~
Key to the future success of the Investment Services segment is retention of its financial advisors and recruitment of new advisors. One of the Company’s key initiatives is to build revenues through the addition of experienced financial advisors. More than 100 new advisors have been recruited through the second quarter, which was offset by attrition of primarily less experienced advisors. The retention and recruitment of experienced advisors continues to be a key initiative for fiscal year 2004.
~~Investment Services — Three-Month Statistics~~

Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Customer trades (1) 347,828 292,880 363,053
Customer daily average trades 5,351 4,576 5,339
Average revenue per trade (2) $ 116.22 $ 119.21 $ 126.46
Number of active accounts 748,403 710,495 755,643
Average trades per active account per quarter 0.46 0.41 0. 48
Average trades per active account per year (annualized) 1.86 1.65 1.92
Ending balance of assets under administration (billions) $ 25.7 $ 21.4 $ 24.3
Average assets per active account $ 34,340 $ 30,102 $ 32,114
Ending margin balances (millions) $ 538 $ 503 $ 517
Ending customer payables balances (millions) $ 981 $ 821 $ 923
Number of advisors 1,010 1,055 1,001

Included in the numbers above are the following relating to fee-based accounts:
Customer accounts 5,174 4,351 4,894
Average revenue per account $ 1,897 $ 1,505 $ 1,701
Ending balance of assets under administration (millions) $ 1,088 $ 658 $ 916
Average assets per active account $ 210,290 $ 151,170 $ 187,064
~~(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.~~
~~-48-~~
~~Investment Services — Three-Month Results~~

(in 000s) Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Transactional revenue $ 23,162 $ 22,906 $ 25,985
Annuitized revenue 13,689 8,029 12,476

Production revenue 36,851 30,935 38,461

Other revenue 7,795 9,334 9,996

Non-interest revenue 44,646 40,269 48,457

Margin interest revenue 8,057 9,758 8,530
Less: interest expense 207 1,586 610

Net interest revenue 7,850 8,172 7,920

Total revenues (1) 52,496 48,441 56,377

Commissions 10,875 9,740 12,441
Other variable expenses 1,403 831 1,201

Total variable expenses 12,278 10,571 13,642

Gross profit 40,218 37,870 42,735

Compensation and benefits 22,751 23,360 22,430
Occupancy and equipment 6,823 6,640 7,221
Depreciation and amortization 11,046 12,946 11,591
Impairment of goodwill — 6,000 —
Other 10,223 13,929 11,469
Allocated corporate and shared costs 4,711 2,931 3,781

Total fixed expenses 55,554 65,806 56,492

Pretax loss $ (15,336 ) $ (27,936 ) $ (13,757 )

~~(1)~~ ~~Total revenues, less interest expense.~~
~~Three months ended October 31, 2003 compared to October 31, 2002~~
Investment Services’ revenues, net of interest expense, for the three months ended October 31, 2003 increased $4.1 million, or 8.4%, to $52.5 million compared to prior year revenues of $48.4 million. The increase is primarily due to higher annuitized revenues, which are based on customer assets rather than transactions.
Transactional revenue, which is based on transaction or trade quantities, rose $0.3 million, or 1.1%, from the prior year due to an increase in trading activity, partially offset by a decline in the average revenue per trade. Annuitized revenues increased $5.7 million, or 70.5%, due to increased sales of annuities and mutual funds.
Margin interest revenue declined 17.4% from the prior year to $8.1 million, which is primarily a result of a 13.4% decline in interest rates and an 8.1% decrease in average margin balances. Margin balances have declined from an average of $560.0 million for the three months ended October 31, 2002 to $514.4 million in the current period, due to weak investor confidence.
~~-49-~~
~~Interest expense for the second quarter of fiscal year 2004 declined 87.0% to $0.2 million compared to $1.6 million in the second quarter of fiscal year 2003.~~
~~Total expenses decreased $8.5 million, or 11.2%, to $67.8 million primarily as a result of the $6.0 million~~ goodwill impairment charge recorded in the prior ~~year. Other expenses decreased~~year and increases in annuitized revenues.

U.S. Tax Operations

This segment is primarily engaged in providing tax return preparation, filing, advice and related services in the United States. Segment revenues include fees earned for tax-related services performed at company-owned tax offices, royalties from franchise offices, sales of tax preparation and other software, fees from online tax preparation, and payments related to refund anticipation loan (RAL) participations.

-29-

Clients also have the option of online do-it-yourself tax preparation, online professional tax review, online tax advice and online tax preparation through a tax professional (whereby the client completes an online tax organizer and sends it to a tax professional for preparation) through thehrblock.com website. The Company also participates in the Free File Alliance, formed in fiscal year 2003. This alliance was created by the tax preparation industry and the Internal Revenue Service (IRS), and allows qualified lower-income filers to prepare and file their federal return online at no charge.

During the nine months ended January 31, 2004, the Company began operating income tax return preparation businesses in the franchise territories previously operated by ten of its former major franchisees. As a result of these operations, the company has 459 company-owned and 277 company-owned franchise offices for the current tax season in these territories. The current year includes the results for company-owned operations in these former franchise territories. These retail offices contributed pretax losses of $2.3 million and $8.2 million for the three and nine months ended January 31, 2004, respectively.

The Company has been named as a defendant in a number of lawsuits around the country alleging that the Company’s subsidiaries 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 the Company suppressed the fact that it would receive part of the finance charges paid by the customer for such loans; and that the Company owes, and breached, a fiduciary duty to its 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 Legal Proceedings section for additional information.

On November 19, 2002, the Company announced a settlement had been reached in the casesRonnie 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, the Company recorded a liability and pretax expense of $43.5 million during the 2003 fiscal year.

The Company believes it has strong defenses to the various RAL cases and will vigorously defend its 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 the Company’s financial statements.

-30-

U.S. Tax Operations – Operating Statistics


	Period January 1 through January 31,
(in 000s except average fee and offices)	2004		2003
Clients served:
Company-owned offices⁽¹⁾		2,191		2,218
Former major franchise territories⁽²⁾		168		**

Total company-owned offices		2,359		2,218
Franchise offices⁽³⁾		1,347		1,340
Former major franchise territories⁽²⁾		**		157

Total franchise offices		1,347		1,497
Digital tax solutions⁽⁴⁾		1,268		1,042

		4,974		4,757

Average fee per client served:⁽⁵⁾
Company-owned offices⁽¹⁾	$	141.05	$	129.40
Former major franchise territories⁽²⁾		130.29		**

Total company-owned offices		140.28		129.40
Franchise offices⁽³⁾	$	125.71	$	115.59
Former major franchise territories⁽²⁾		**		119.20

Total franchise offices		125.71		115.97

	$	134.99	$	123.99

Refund anticipation loans (RALs):
Company-owned offices⁽¹⁾		1,112		1,146
Former major franchise territories⁽²⁾		81		**

Total company-owned offices		1,193		1,146
Franchise offices⁽³⁾		713		703
Former major franchise territories⁽²⁾		**		81

Total franchise offices		713		784
Digital tax solutions⁽⁴⁾		20		19

		1,926		1,949

Offices:
Company-owned offices⁽¹⁾		4,746		4,672
Former major franchise territories⁽²⁾		459		**
Company-owned shared office locations⁽⁶⁾		947		607

Total company-owned offices		6,152		5,279

Franchise offices⁽³⁾		3,374		3,398
Former major franchise territories⁽²⁾		**		529
Franchise shared office locations⁽⁶⁾		325		95

Total franchise offices		3,699		4,022

		9,851		9,301

⁽¹⁾ Excludes company-owned offices in former major franchise territories which commenced operations during fiscal year 2004.
⁽²⁾ Impact of company-owned offices in former major franchise territories which commenced operations during fiscal year 2004.
⁽³⁾ Represents remaining major franchise territories and other franchises.
⁽⁴⁾ Includes online completed and paid returns and federal software units sold.
⁽⁵⁾ Calculated as tax preparation and related fees divided by clients served.
⁽⁶⁾ Shared locations include offices located within Wal-Mart, Sears and other third-party businesses.

-31-

U.S. Tax Operations – Three-Month Results


(in 000s)	January 31, 2004		January 31, 2003		October 31, 2003
Tax preparation and related fees	$	332,138	$	289,540	$	12,792
Royalties		43,357		38,211		1,651
RAL participation fees		37,185		37		7
RAL waiver fees		988		31,676		1,446
Software sales		20,995		15,703		933
Online tax services		8,414		3,174		430
Peace of Mind revenue		9,712		9,634		17,658
Other		10,857		15,596		12,272

Total revenues		463,646		403,571		47,189

Compensation and benefits		160,162		151,251		35,927
Occupancy and equipment		61,342		50,180		44,286
Depreciation and amortization		16,324		10,188		10,781
Cost of software sales		9,650		8,511		723
Supplies, freight and postage		11,991		13,454		3,947
Legal		2,096		10,430		11,101
Other		45,398		40,366		27,050
Allocated corporate and shared costs:
Information technology		24,183		21,896		22,908
Marketing		44,653		39,601		5,634
Finance		4,981		5,532		4,708
Supply		8,235		12,049		4,886
Other		6,395		5,976		6,176

Total expenses		395,410		369,434		178,127

Pretax income (loss)	$	68,236	$	34,137	$	(130,938	)

Three months ended January 31, 2004 compared to January 31, 2003

U.S. Tax Operations’ revenues increased $60.1 million, or 14.9%, for the three months ended January 31, 2004, compared to the three months ended January 31, 2003.

Tax preparation and related fees increased $42.6 million, or 14.7%, for the three months ended January 31, 2004. This increase is primarily due to the former major franchise territories now being operated as company-owned, which contributed $21.9 million in additional tax preparation and related fees. The Company also saw an 8.4% increase in the average fee per client served, which increased to $140.28 in the current year compared to $129.40 last year. Average fee per client served is calculated as tax preparation and related fees divided by the number of clients served. Clients served in company-owned offices during the current tax season totaled 2.4 million, up 6.4% from the prior year, due entirely to the former major franchise territories now being operated as company-owned.

The average fee per client served at franchise offices increased by 8.4%, while clients served declined 10.0%. The decline is due to the former major franchise territories being operated as company-owned in fiscal year 2004. These changes, coupled with the re-franchising of certain

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former major franchise territories at higher royalty rates, resulted in an increase in royalty revenue of 13.5%.

During fiscal year 2003, the Company entered into an agreement with Household Tax Masters, Inc. (Household), whereby the Company waived its 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 the Company received a series of payments from Household in fiscal year 2003, subject to certain adjustments in fiscal year 2004 based on delinquency rates.

Revenues earned during the current quarter in connection with RAL participations totaled $37.2 million. These revenues are approximately $5.5 million higher than waiver fees earned during the three months ended January 31, 2003. The Company’s RAL participation revenues are also benefiting from the new company-owned operations in former major franchise territories. The Company participates in RALs at a rate of nearly 50% for company-owned offices compared to 25% in major franchise offices.

Revenues from software sales increased $5.3 million, or 33.7%. A total of 1.6 million software units were sold during the quarter ended January 31, 2004, an increase of 26.0% from the 1.3 million units sold in the prior year. Software units include all software products. Unit growth is due, in part, to marketing strategies, which may be accelerating sales from the fourth quarter into the third quarter. Therefore, unit growth experienced during the third quarter may not be representative of growth expected for the full year.

Online revenues increased $5.2 million, or 165.1%, due to a 102.4% increase in total clients served and a 24.0% increase in the average price per unit over the prior year.

Total expenses for the three months ended January 31, 2004 were up $26.0 million, or 7.0%, from the prior year. The increase from the prior year is primarily a result of additional occupancy and equipment and compensation and benefits expenses. Occupancy and equipment costs increased $11.2 million over the prior year due to an increase of 1.6% in the number of company-owned offices under lease, a 6.9% increase in the average rent and new offices related to the former major franchise territories. Compensation and benefits increased $8.9 million as a result of additional personnel in the former major franchises and $3.2 million in costs associated with seasonal stock options, which were not expensed in the prior year. Depreciation and amortization expenses increased as a result of $4.2 million of intangible amortization recorded for the acquisition of assets from former major franchisees, and for additional equipment purchased for new office locations opened during the period. Other expenses increased $5.0 million, primarily as a result of $8.3 million in additional bad debt expenses recorded in conjunction with the Company’s participation in RALs in the current year. Allocated marketing and information technology costs increased $5.1 million and $2.3 million, respectively, as a result of targeted marketing projects and additional technology projects, respectively. These increases were partially offset by a decline in legal expenses of $8.3 million.

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Pretax income of $68.2 million for the three months ended January 31, 2004, represents a 99.9% improvement over the prior year pretax income of $34.1 million.

Due to the seasonal nature of this segment’s business, operating results for the three months ended January 31, 2004 are not comparable to the three months ended October 31, 2003 and are not indicative of the expected results for the entire fiscal year.

U.S. Tax Operations – Nine-Month Results


(in 000s)	January 31, 2004			January 31, 2003
Tax preparation and related fees	$	356,769		$	313,918
Royalties		46,044			40,529
RAL waiver fees		6,548			31,727
RAL participation fees		37,192			268
Software sales		22,188			17,134
Online tax services		9,400			3,693
Peace of Mind revenue		47,279			23,960
Other		25,937			29,057

Total revenues		551,357			460,286

Compensation and benefits		223,429			214,462
Occupancy and equipment		145,908			124,611
Depreciation and amortization		34,947			22,713
Cost of software sales		10,624			9,080
Supplies, freight and postage		17,121			19,206
Legal		16,979			58,735
Other		92,830			67,263
Allocated corporate and shared costs:
Information technology		66,746			56,122
Marketing		53,036			51,402
Finance		13,244			14,500
Supply		15,205			17,634
Other		17,162			16,750

Total expenses		707,231			672,478

Pretax loss	$	(155,874	)	$	(212,192	)

Nine months ended January 31, 2004 compared to January 31, 2003

U.S. Tax Operations’ revenues increased $91.1 million, or 19.8%, for the nine months ended January 31, 2004, compared to the nine months ended January 31, 2003.

Tax preparation and related fees increased $42.9 million for the nine months ended January 31, 2004. This increase is primarily due to the former major franchise territories now being operated as company-owned, which contributed $22.3 million in additional tax preparation and related fees. The Company also saw an 8.4% increase in the average fee per client served, which increased to $140.28 in the first month of the tax season, compared to $129.40 last year. Clients served in company-owned offices during the current tax season were 2.4 million, compared to 2.2 million in the prior year.

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Revenues earned during the current year in connection with RAL participations totaled $37.2 million. These revenues are approximately $5.5 million higher than waiver fees earned during the nine months ended January 31, 2003, primarily as a result of the Company’s higher participation rate in company-owned offices, as discussed previously.

During the nine months ended January 31, 2004 the Company recorded revenues of $6.5 million in conjunction with the RAL waiver agreement with Household based on actual delinquency rates through December 31, 2003.

Software and online revenues increased $5.1 million and $5.7 million, respectively, due to significant increases in units sold and the average price per unit, as discussed previously.

POM revenues for the nine months ended January 31, 2004 increased $23.3 million, or 97.3%, principally due to the adoption of EITF 00-21. 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 change in accounting principle, which increased revenues by $26.6 million.

Total expenses for the nine months ended January 31, 2004 were $707.2 million, up $34.8 million, or 5.2%, from the prior year. The increase from the prior year is primarily a result of additional occupancy and equipment and other expenses. Occupancy and equipment costs increased $21.3 million over the prior year due to a 4.2% increase in the number of company-owned offices under lease, a 6.0% increase in the average rent and offices related to the former major franchise territories. Other expenses increased $10.9 million related to the POM program and $8.3 million for additional bad debt expenses recorded in conjunction with the Company’s participation in RALs in the current year. Interest expense increased $4.2 million as a result of interest accretion related to a legal settlement and commercial paper borrowings used to fund RAL participations. Increases were also seen in depreciation and amortization, which increased as a result of $5.9 million in intangible amortization from the acquisition of assets from former major franchisees and additional equipment purchased for new office locations opened during the period. Allocated information technology costs increased $10.6 million as a result of additional technology projects. These increases were partially offset by a decline in legal expenses of $41.8 million, resulting from the Texas RAL litigation recorded in the prior year.

The pretax loss of $155.9 million for the nine months ended January 31, 2004, represents a 26.5% improvement over the prior year loss of $212.2 million.

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Mortgage Operations

This segment is primarily engaged in the origination of non-prime mortgage loans, sales and securitizations of mortgage assets and servicing of non-prime loans. Revenues consist of proceeds from sales and securitizations of loans and related assets, accretion on residual interests, loan servicing fees and interest received on loans.

Substantially all non-prime mortgage loans originated are sold daily to qualifying special purpose entities (Trusts). The Company removes the mortgage loans from its balance sheet and records the gain on the sale, cash and a receivable which represents the ultimate expected outcome from the disposition of the loans. The Trusts, as directed by the third-party beneficial interest holders, either sell the loans directly to third-party investors or back to the Company’s securitization entity to pool the loans for securitization, depending on market conditions.

In a securitization transaction, the Trusts transfer the loans to a special purpose entity, which is a consolidated subsidiary of the Company, and the Company simultaneously transfers the loans and its receivable, and the right to receive all payments on the loans, to a securitization trust. The securitization trust meets the definition of a qualifying special purpose entity (QSPE) and is therefore not consolidated by the Company. The securitization trust issues bonds, which are supported by cash flows from the pooled loans, to third-party investors. The Company retains an interest in the loans in the form of a residual interest (including overcollateralization (OC) accounts and uncertificated interests) and usually assumes first risk of loss for credit losses in the loan pool. As the cash flows of the underlying loans and market conditions change, the value of the Company’s residual interests may also change, resulting in either additional unrealized gains or impairment of the residual interests.

To accelerate cash flows from its residual interests, the Company securitizes the majority of its residual interests in net interest margin (NIM) transactions. In a NIM transaction, residual interests are normally transferred to another QSPE (NIM trust), which then issues bonds to third-party investors.

Proceeds from the bonds are returned to the Company as payment for the residual interests. The bonds are secured by pooled residual interests and are obligations of the NIM trust. The Company retains a subordinated interest in the NIM trust, and receives cash flows on its residual interest generally after the bonds issued to the third-party investors are paid in full. Residual interests retained from NIM securitizations may also be bundled and sold in a subsequent securitization.

Substantially all non-prime loans originated and subsequently sold or securitized are transferred with servicing rights retained. Servicing activities include processing of mortgage loan payments and the administration of mortgage loans, with loan servicing fees received monthly over the life of the mortgage loans. The Company has traditionally received a servicing fee of 50 basis points per annum on the outstanding principal balance of loans sold or securitized, as well as the right to receive certain ancillary income including, but not limited to, late fees. In recent transactions, step-servicing fee structures have been implemented. The purpose of step-servicing is to better match the stream of incoming servicing revenues against the related servicing expenses.

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Generally, the cost to service a pool of loans is lower immediately after origination and increases as the related loan pool ages. Recent step-servicing fee structures have typically provided the company with a servicing fee of 30 basis points per annum for the first 10 months of servicing, 40 basis points per annum for the next 20 months of servicing and 65 basis points per annum for the remainder of the servicing term.

Prime mortgage loans are sold in whole loan sales, servicing rights released, to third-party buyers.

Market interest rates have begun to increase after a sustained period of declining rates. In a rising interest rate environment the Company expects its profit margins will narrow from their historically high levels due to less favorable loan execution pricing. Execution pricing on sales of mortgage assets was 4.08% during the three months ended January 31, 2004 compared to 4.60% in the prior year and 3.87% in the preceding quarter. As such, growth in pretax income for the mortgage operations segment is expected to be more moderate or perhaps decline as compared to recent results.

Mortgage Operations – Three-Month Statistics


(dollars in 000s)	January 31, 2004			January 31, 2003			October 31, 2003
Number of loans originated:
Wholesale (non-prime)		30,678			25,061			36,233
Retail: Prime		1,291			3,560			1,944
Non-prime		3,826			2,284			4,110

Total		35,795			30,905			42,287

Volume of loans originated:
Wholesale (non-prime)	$	4,732,182		$	3,756,809		$	5,603,118
Retail: Prime		157,438			496,176			247,661
Non-prime		464,926			280,738			492,977

Total	$	5,354,546		$	4,533,723		$	6,343,756

Loan sales	$	5,308,800		$	4,599,255		$	6,330,449
Weighted average FICO score⁽²⁾		607			606			611
Execution price – Net gain on sale⁽¹⁾		4.08	%		4.60	%		3.87	%
Weighted average interest rate for borrowers⁽²⁾		7.47	%		7.94	%		7.51	%
Weighted average loan-to-value⁽²⁾		78.1	%		78.6	%		78.2	%

⁽¹⁾ Defined as ~~a result~~total premium received divided by total balance of ~~consulting fees incurred~~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.

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Mortgage Operations – Three-Month Results


(in 000s)	January 31, 2004			January 31, 2003			October 31, 2003
Components of gains on sales:
Gains on mortgage loans and related assets	$	166,907		$	176,940		$	220,652
Gains on residual interests previously securitized		17,000			130,881			—
Impairment of residual interests		(14,942	)		(1,457	)		(363	)

Total gains on sales		168,965			306,364			220,289
Loan servicing revenue		55,072			43,372			51,659
Accretion income		47,483			20,293			36,843
Interest income		59,838			26,357			41,858
Other		568			594			507

Total revenues		331,926			396,980			351,156

Compensation and benefits		78,841			68,442			77,152
Servicing and processing		32,692			20,331			26,609
Occupancy and equipment		12,030			10,986			12,589
Bad debt		12,633			5,898			12,226
Other		41,254			28,857			38,554

Total expenses		177,450			134,514			167,130

Pretax income	$	154,476		$	262,466		$	184,026

Three months ended January 31, 2004 compared to January 31, 2003

Mortgage Operations’ revenues decreased $65.1 million, or 16.4%, for the three months ended January 31, 2004 compared to the prior year. Revenue decreased primarily as a result of the significantly larger sale of previously securitized residual interests recorded in the prior year.

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


	Three months ended January 31,
(dollars in 000s)	2004			2003
Number of sales associates⁽¹⁾		2,649			2,163
Total number of applications		59,328			53,927
Closing ratio⁽²⁾		60.3	%		57.3	%
Total number of originations		35,795			30,905
Average loan size	$	150		$	147
Total originations	$	5,354,546		$	4,533,723
Non-prime / prime origination ratio		33.0 : 1			8.1 : 1
Commitments to fund loans	$	2,493,015		$	2,288,002
Loan sales	$	5,308,800		$	4,599,255
Gains on sales of mortgage assets	$	183,907		$	307,821
Execution price – net gain on sale⁽³⁾		4.08	%		4.60	%

⁽¹⁾ Includes all direct sales and back office sales support associates.
⁽²⁾ Percentage of loans funded divided by total applications in the ~~prior year related~~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 ~~conversion to a new back-office system.~~
~~The pretax loss for Investment Services for the second quarter~~effect of ~~fiscal year 2004 was $15.3 million compared to the prior year loss of $27.9 million.~~loan origination expenses).

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~~Three months ended October 31, 2003 compared to July 31, 2003~~

~~Investment Services’ revenues, net of interest expense, for the three months ended October 31, 2003 declined $3.9 million, or 6.9%, to $52.5 million compared to the preceding quarter.~~

~~Production revenue decreased $1.6 million, or 4.2%, primarily due to the continued shift to fee-based products.~~

~~Margin interest revenue fell $0.5 million, or 5.5%, to $8.1 million for the quarter ended October 31, 2003, which is primarily a result of lower interest rates.~~

~~Total expenses decreased $2.3 million from the preceding quarter. The $1.6 million decrease in commission expense~~

Gains on sales of mortgage assets decreased $123.9 million for the three months ended January 31, 2004. The decrease over last year is a result of the $130.9 million gain on sale of previously securitized residuals recorded in the prior year, partially offset by an increase in loan origination volume and a smaller sale of previously securitized residuals of $17.0 million in the current quarter. During the third quarter, the Company originated $5.4 billion in mortgage loans compared to $4.5 billion last year, an increase of 18.1%. The execution price on mortgage loans originated and sold decreased to 4.08% for the current quarter compared to 4.60% last year, primarily as a result of a decrease in the average interest rates on loans sold during the period.

Impairments of residual interests in securitizations of $14.9 million were recognized in the current period, compared to $1.5 million for the three months ended January 31, 2003. The increase is primarily due ~~to the decline in production revenues. In addition, other expenses declined $1.2 million primarily as a result of first quarter postage costs related to customer mailings.~~

~~The pretax loss for the Investment Services segment was $15.3 million, compared~~ to a decline in the value of certain older residual based on loan performance.

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


	Three months ended January 31,
(dollars in 000s)	2004			2003
Number of loans serviced		308,305			232,979
Average servicing portfolio	$	41,224,508		$	26,871,925
Average delinquency rate		6.00	%		7.48	%
Value of MSRs	$	106,196		$	104,580

Loan servicing revenues increased $11.7 million, or 27.0%, compared to the prior year. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the three-month period ended January 31, 2004 increased $14.4 billion, or 53.4%, to $41.2 billion.

Total accretion of residual interests of $47.5 million for the three months ended January 31, 2004 represents an increase of $27.2 million from prior year accretion of $20.3 million. This increase is due to write-ups taken during fiscal years 2003 and 2004.

During the third quarter of fiscal year 2004, the Company’s residual interests continued to perform better than expected compared to internal valuation models, primarily due to lower than originally modeled loss and interest rates. The Company recorded pretax mark-to-market write-ups, which increased the fair value of its residual interests $46.7 million during the quarter. These write-ups were recorded, net of write-downs of $10.7 million and deferred taxes of $13.8 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests. Future changes in interest rates or other assumptions, based on market conditions or actual loan pool performance, could cause additional 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 would result in decreases to accretion income in future periods.

Interest income increased $33.5 million, or 127.0%, for the quarter ended January 31, 2004, primarily due to an increase in the average balance on loans held by the Trusts. The average balance increased to $3.9 billion from $1.9 billion in the prior year, which was partially offset by

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lower interest margin earned. Interest margin is the difference between the rate on the underlying loans and the financing costs of the Trusts. The interest margin decreased to 5.48% for the three months ended January 31, 2004, from 5.72% a year ago.

Total expenses for the three months ended January 31, 2004, increased $42.9 million, or 31.9%, over the year-ago quarter. This increase is primarily due to $10.4 million in increased compensation and benefits as a result of a 22.5% increase in sales associates needed to support higher loan production volumes. Servicing and processing expenses increased by $12.4 million as a result of a higher average servicing portfolio during the three months ended January 31, 2004. Bad debt expense increased $6.7 million primarily due to more whole loan sales than securitizations in the current year, for which higher reserves are required at the time of sale for estimated repurchases. Whole loan sales accounted for 87% of total loan sales, compared to 25% in the prior year. Other expenses increased by $12.4 million for the current quarter, primarily due to $6.2 million in increased retail mortgage direct mail advertising, and $3.4 million in increased allocated corporate and shared costs. Allocated costs increased as a result of additional insurance costs and the expensing of stock-based compensation.

Pretax income decreased $108.0 million to $154.5 million for the three months ended January 31, 2004.

Three months ended January 31, 2004 compared to October 31, 2003

Mortgage Operations’ revenues decreased $19.2 million, or 5.5%, for the three months ended January 31, 2004, compared to the preceding quarter.

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


	Three months ended
(dollars in 000s)	January 31, 2004			October 31, 2003
Number of sales associates⁽¹⁾		2,649			2,476
Total number of applications		59,328			72,858
Closing ratio⁽²⁾		60.3	%		58.0	%
Total number of originations		35,795			42,287
Average loan size	$	150		$	150
Total originations	$	5,354,546		$	6,343,756
Non-prime / prime origination ratio		33.0 : 1			24.6 : 1
Commitments to fund loans	$	2,493,015		$	3,244,958
Loan sales	$	5,308,800		$	6,330,449
Gains on sales of mortgage assets	$	183,907		$	220,652
Execution price – net gain on sale⁽³⁾		4.08	%		3.87	%

⁽¹⁾ Includes all direct sales and back office sales support associates.
⁽²⁾ Percentage of loans funded divided by total applications in the ~~first quarter~~period.
⁽³⁾ Defined as total premium received divided by total balance of ~~fiscal year 2004.~~
~~-50-~~
~~Investment Services — Six-Month Statistics~~loans delivered to third party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses).

Six months ended

October 31, 2003 October 31, 2002

Customer trades⁽¹⁾
710,881 667,130
Customer daily average trades 5,345 5,253
Average revenue per trade⁽²⁾
$ 121.44 $ 119.04
Number of active accounts 748,403 710,495
Ending balance of assets under administration (billions) $ 25.7 $ 21.4
Average assets per active account $ 34,340 $ 30,102
Ending margin balances (millions) $ 538 $ 503
Ending customer payables balances (millions) $ 981 $ 821
Number of advisors 1,010 1,055

Gains on sales of mortgage assets decreased $36.7 million to $183.9 million for the current quarter. This decrease from the preceding quarter is primarily a result of a 15.6% decrease in

-40-

loans originated, partially offset by an increase in execution price on loan sales. The execution price on loan sales for the quarter increased to 4.08% from 3.87% for the three months ended October 31, 2003. The decline in originations is due to fewer funding days in the current quarter and a decrease in loan application volume.

Impairments of residual interests in securitizations of $14.9 million were recognized during the third quarter, compared to $0.4 million for the three months ended October 31, 2003. The increase is primarily due to a decline in the value of certain older residuals based on loan performance.

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


	Three months ended
(dollars in 000s)	January 31, 2004			October 31, 2003
Number of loans serviced		308,305			295,636
Average servicing portfolio	$	41,224,508		$	36,825,033
Average delinquency rate		6.00	%		6.28	%
Value of MSRs	$	106,196		$	111,960

Loan servicing revenues increased $3.4 million, or 6.6%, compared to the second quarter of fiscal year 2004. The increase reflects a higher loan-servicing portfolio. The average servicing portfolio for the three months ended January 31, 2004 increased $4.4 billion, or 11.9%, to $41.2 billion.

Accretion of residual interests of $47.5 million represents an increase of 28.9% from the preceding quarter’s accretion of $36.8 million, primarily due to write-ups taken during the first half of fiscal year 2004.

Interest income increased $18.0 million, or 43.0%, for the quarter ended January 31, 2004, due to a 21.9% increase in the average balance on loans held by the Trusts and an increase in the interest margin to 5.48% during the three months ended January 31, 2004, from 5.39% in the second quarter.

Total expenses increased $10.3 million, or 6.2%, primarily due to an increase of $6.1 million, or 22.9%, in servicing expenses, resulting from the increased servicing portfolio. Other expenses also increased $2.7 million primarily due to $3.6 million in additional retail mortgage direct mail advertising.

Pretax income decreased $29.6 million, or 16.1%, for the three months ended January 31, 2004 compared to the preceding quarter.

-41-

Mortgage Operations – Nine-Month Statistics


(dollars in 000s)	January 31, 2004			January 31, 2003
Number of loans originated:
Wholesale (non-prime)		95,405			67,371
Retail: Prime		7,240			8,548
Non-prime		10,940			7,417

Total		113,585			83,336

Volume of loans originated:
Wholesale (non-prime)	$	14,740,523		$	9,677,763
Retail: Prime		945,424			1,194,685
Non-prime		1,323,236			914,722

Total	$	17,009,183		$	11,787,170

Loan sales:
Loans originated and sold	$	16,940,590		$	11,778,634
Loans acquired and sold		—			633,953

Total	$	16,940,590		$	12,412,587

Weighted average FICO score⁽²⁾		608			603
Execution price – Net gain on sale⁽¹⁾
Loans originated and sold		4.14	%		4.75	%
Loans acquired and sold		—	%		0.18	%

Total		4.14	%		4.49	%
Weighted average interest rate for borrowers⁽²⁾		7.51	%		8.30	%
Weighted average loan-to-value⁽²⁾		78.2	%		78.9	%

Included in the numbers above are the following relating to fee-based accounts:
Customer accounts 5,174 4,351
Average revenue per account $ 1,753 $ 1,484
Ending balance of assets under administration (millions) $ 1,088 $ 658
Average assets per active account $ 210,290 $ 151,170

~~(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.~~

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

-42-

Mortgage Operations – Nine-Month Results

				��
(in 000s)	January 31, 2004			January 31, 2003
Components of gains on sales:
Gains on mortgage loans and related assets	$	590,941		$	497,457
Gains on residual interests previously securitized		17,000			130,881
Impairment of residual interests		(26,048	)		(25,589	)

Total gains on sales		581,893			602,749
Loan servicing revenue		155,048			123,647
Accretion income		118,389			113,146
Interest income		128,970			80,623
Other		1,677			1,709

Total revenues		985,977			921,874

Compensation and benefits		221,476			183,637
Servicing and processing		84,552			51,958
Occupancy and equipment		36,177			28,924
Bad debt		34,373			15,015
Other		107,068			79,269

Total expenses		483,646			358,803

Pretax income	$	502,331		$	563,071

Nine months ended January 31, 2004 compared to January 31, 2003

Mortgage Operations’ revenues increased $64.1 million, or 7.0%, for the nine months ended January 31, 2004 compared to the prior year. Revenue increased primarily as a result of higher interest income, loan servicing revenues and production volumes, partially offset by the significantly larger sale of previously securitized residual interests recorded in the prior year.

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


	Nine months ended January 31,
(dollars in 000s)	2004			2003
Number of sales associates⁽¹⁾		2,649			2,163
Total number of applications		194,730			156,588
Closing ratio⁽²⁾		58.3	%		53.2	%
Total number of originations		113,585			83,336
Average loan size	$	150		$	141
Total originations	$	17,009,183		$	11,787,170
Non-prime / prime origination ratio		17.0 : 1			8.9 : 1
Commitments to fund loans	$	2,493,015		$	2,288,002
Loan sales	$	16,940,590		$	12,412,587
Gains on sales of mortgage assets	$	607,941		$	628,338
Execution price – net gain on sale⁽³⁾		4.14	%		4.49	%

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

~~-51-~~

~~Investment Services — Six-Month Results~~⁽²⁾

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Transactional revenue $ 49,147 $ 51,865
Annuitized revenue 26,165 17,368

Production revenue 75,312 69,233

Other revenue 17,791 18,503

Non-interest revenue 93,103 87,736

Margin interest revenue 16,587 20,954
Less: interest expense 817 3,277

Net interest revenue 15,770 17,677

Total revenues⁽¹⁾
108,873 105,413

Commissions 23,316 21,120
Other variable expenses 2,604 1,379

Total variable expenses 25,920 22,499

Gross profit 82,953 82,914

Compensation and benefits 45,181 47,211
Occupancy and equipment 14,044 13,262
Depreciation and amortization 22,637 25,647
Impairment of goodwill — 24,000
Other 21,692 27,628
Allocated corporate and shared costs 8,492 5,899

Total fixed expenses 112,046 143,647

Pretax loss $ (29,093 ) $ (60,733 )

~~(1)~~

~~Total revenues, less interest expense.~~

~~Six months ended October 31, 2003 compared to October 31, 2002~~

~~Investment Services’ revenues, net~~

Percentage of interest expense, for the six months ended October 31, 2003 improved $3.5 million, or 3.3%, to $108.9 million compared to prior year revenues of $105.4 million. The increase is primarily due to higher annuitized revenue.
Transactional revenue declined $2.7 million, or 5.2%, from the prior year due to the continued shift to fee-based products. Annuitized revenues increased $8.8 million, or 50.7%, due to increased sales of annuities and mutual funds.

Margin interest revenue declined 20.8% from the prior year to $16.6 million, which is primarily a result of lower margin balances. Margin balances have declined from an average of $640.0 million for the six months ended October 31, 2002 to $507.7 millionloans funded divided by total applications in the ~~current~~ period. ~~Interest expense for the first half~~

⁽³⁾

Defined as total premium received divided by total balance of ~~fiscal year 2004 declined 75.1%~~loans delivered to ~~$0.8 million compared to $3.3 million in the first half of fiscal year 2003.~~
~~-52-~~

~~Total expenses decreased $28.2 million,~~third party investors or 17.0%, to $138.0 million primarily as a result of the $24.0 million goodwill impairment charge recorded in the prior year. Other expenses decreased $5.9 million primarily as a result of consulting fees incurred in the prior year related to the conversion to a new back-office system. Depreciation and amortization declined by $3.0 million as a result of the consolidation of field officessecuritization vehicles (excluding mortgage servicing rights and the ~~related asset sales. Commissions~~effect of loan origination expenses).

-43-

Gains on sales of mortgage assets decreased $20.4 million for the nine months ended January 31, 2004. The decrease over last year is a result of the $130.9 million gain on sale of previously securitized residuals recorded in the prior year, compared to $17.0 million in the current year, and a decrease in execution price, partially offset by an increase in loan origination volume. During the current year, the Company originated $17.0 billion in mortgage loans compared to $11.8 billion last year, an increase of 44.3%. The execution price on mortgage loans originated and sold decreased to 4.14% for the current period compared to 4.75% last year, primarily as a result of a decrease in the average interest rate during the period.

Impairments of residual interests in securitizations of $26.0 million were recognized in the nine months ended January 31, 2004, due to a decline in value of older residuals. Impairments of residuals for the nine months ended January 31, 2003 totaled $25.6 million.

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


	Nine months ended January 31,
(dollars in 000s)	2004			2003
Number of loans serviced		308,305			232,979
Average servicing portfolio	$	36,907,358		$	26,310,362
Average delinquency rate		6.27	%		7.12	%
Value of MSRs	$	106,196		$	104,580

Loan servicing revenues increased $31.4 million, or 25.4%, this year. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the nine months ended January 31, 2004 increased $10.6 billion, or 40.3%, to $36.9 billion.

Total accretion of residual interests of $118.4 million for the nine months ended January 31, 2004 represents an increase of $5.2 million over prior year accretion of $113.1 million.

The Company recorded pretax mark-to-market write-ups on its residual interests, which increased the fair value $125.1 million during the period primarily due to lower than originally modeled loss and interest rates. These write-ups were recorded, net of write-downs of $25.1 million and deferred taxes of $38.2 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests. Future changes in interest rates or other assumptions, based on market conditions or actual loan pool performance, could cause additional 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 would result in decreases to accretion income in future periods.

Interest income increased $48.3 million, or 60.0%, for the nine months ended January 31, 2004, due to an increase in the average balance on loans held by the Trusts. The average balance increased to $3.1 billion from $1.6 billion in the prior year, which was partially offset by lower interest margin earned. The interest margin decreased to 5.46% during the nine months ended January 31, 2004, from 5.99% a year ago.

-44-

Total expenses for the nine months ended January 31, 2004, increased $124.8 million, or 34.8% over the year-ago period. This increase is primarily due to a $37.8 million increase in compensation and benefits as a result of a 22.5% increase in sales associates needed to support higher loan production volumes. Servicing and processing expenses increased by $32.6 million as a result of a higher average servicing portfolio during the nine months ended January 31, 2004. Occupancy and equipment charges increased $7.3 million due to nine additional branch offices opened since October 2002, continued expansion of the second servicing center that opened in August 2002 and additional administrative office space. Bad debt expense increased $19.4 million primarily as a result a 36.5% increase in loan sales coupled with the increase in whole loan sales compared to securitizations, for which higher reserves are required at the time of sale for estimated repurchases. Whole loan sales accounted for 75% of total loan sales, compared to 35% in the prior year. Other expenses increased by $27.8 million to $107.1 million for the current period, primarily due to $10.6 million in increased marketing expenses and $9.3 million in increased allocated corporate and shared costs. Allocated costs increased due to higher insurance costs and the expensing of stock-based compensation.

Pretax income decreased $60.7 million to $502.3 million for the nine months ended January 31, 2004.

Business Services

This segment is engaged in providing accounting, tax, consulting, payroll, employee benefits and capital markets services to business clients and tax, financial and estate planning, wealth management and insurance services to individuals. Business Services provides accounting, payroll and human resources services to McGladrey & Pullen LLP (M&P) in exchange for a management fee. The Company also has a fully secured commitment to fund M&P’s operations on a revolving basis.

A substantial portion of Business Services’ revenues are generated by one-time projects or extended services. Improvements in the current business environment have caused clients to begin engaging Business Services in such discretionary projects. While revenues in the Company’s consulting services remain weak, profitability is improving through realization of better rates and productivity.

-45-

Business Services – Three-Month Results


(in 000s)	January 31, 2004		January 31, 2003			October 31, 2003
Traditional accounting	$	55,024	$	52,707		$	54,441
Business consulting		21,813		22,910			21,174
Capital markets		19,287		8,910			17,870
Other		16,169		16,214			15,539

Total revenues		112,293		100,741			109,024

Compensation and benefits		76,221		65,060			75,397
Occupancy and equipment		5,998		7,110			6,785
Depreciation and amortization		5,607		5,774			5,647
Marketing and advertising		2,127		3,599			1,660
Bad debt expense		744		3,009			1,116
Other		19,641		20,386			21,151

Total expenses		110,338		104,938			111,756

Pretax income (loss)	$	1,955	$	(4,197	)	$	(2,732	)

Three months ended January 31, 2004 compared to January 31, 2003

Business Services’ revenues for the three months ended January 31, 2004 increased $11.6 million, or 11.5%, from the prior year. This increase was primarily due to a $10.4 million increase in capital markets revenues, resulting from a 172.1% increase in the number of business valuation projects and capital market transactions. Traditional accounting revenues also increased $2.3 million due primarily to rate increases.

Total expenses increased $5.4 million, or 5.2%, for the three months ended January 31, 2004 compared to the prior year. Compensation and benefits costs increased $11.2 million, primarily as a result of the increased activity in the capital markets business. This increase was partially offset by a decrease of $2.3 million in bad debt expense and a reduction of $1.5 million in marketing and advertising.

Pretax income for the three months ended January 31, 2004 was $2.0 million compared to a loss of $4.2 million in the prior year.

-46-

Business Services – Nine-Month Results


(in 000s)	January 31, 2004			January 31, 2003
Traditional accounting	$	154,561		$	153,824
Business consulting		64,562			66,403
Capital markets		53,787			29,391
Other		46,906			44,320

Total revenues		319,816			293,938

Compensation and benefits		221,903			199,788
Occupancy and equipment		18,849			18,401
Depreciation and amortization		16,750			16,966
Marketing and advertising		5,982			6,864
Bad debt expense		3,221			6,337
Other		60,567			57,837

Total expenses		327,272			306,193

Pretax loss	$	(7,456	)	$	(12,255	)

Nine months ended January 31, 2004 compared to January 31, 2003

Business Services’ revenues for the nine months ended January 31, 2004 increased $25.9 million, or 8.8%, from the prior year. This increase was primarily due to a $24.4 million increase in capital markets revenues, resulting from a 104.5% increase in the number of business valuation projects and capital market transactions. Other revenues also increased $2.6 million due to improved performance in the outsourcing services line of business. These increases were partially offset by a slight decline in business consulting revenues.

Total expenses increased $21.1 million, or 6.9%, for the nine months ended January 31, 2004 compared to the prior year. Compensation and benefits costs increased $22.1 million, primarily as a result of the increased activity in the capital markets business and increased costs in traditional accounting. Additionally, other expenses increased $2.7 million, primarily due to increased recruiting and insurance costs. These increases were partially offset by a decline of $3.1 million in bad debt expense resulting from improved billing procedures, which have increased accounts receivable turnover and collections.

The pretax loss for the nine months ended January 31, 2004 was $7.5 million compared to a loss of $12.3 million in the prior year.

Investment Services

This segment is primarily engaged in offering investment services and securities products through H&R Block Financial Advisors, Inc. (HRBFA), a full-service securities broker-dealer and a registered investment advisor. U.S. Tax Operations clients are also given the opportunity to open an Express IRA through HRBFA as a part of the income tax return preparation process.

Key to the future success of the Investment Services segment is retention of its financial advisors and recruitment of new advisors. One of the Company’s major initiatives is to build revenues through the addition of experienced financial advisors. More than 200 new advisors have been

-47-

recruited through the third quarter, which was offset by attrition of primarily less experienced advisors. The retention and recruitment of experienced advisors continues to be a focus for fiscal year 2004.

Investment Services – Three-Month Statistics


	January 31, 2004		January 31, 2003		October 31, 2003
Customer trades⁽¹⁾		413,338		306,119		347,828
Customer daily average trades		6,776		4,638		5,351
Average revenue per trade⁽²⁾	$	113.61	$	115.57	$	116.22
Number of active accounts		741,824		672,247		748,403
Average trades per active account per quarter		0.56		0.46		0. 46
Average trades per active account per year (annualized)		2.23		1.83		1.86
Ending balance of assets under administration (billions)	$	27.5	$	21.0	$	25.7
Average assets per active account	$	37,122	$	31,397	$	34,340
Ending margin balances (millions)	$	594	$	535	$	538
Ending customer payables balances (millions)	$	1,076	$	802	$	981
Number of advisors		1,052		1,080		1,010
Included in the numbers above are the following relating to fee-based accounts:
Customer accounts		5,705		4,338		5,174
Average revenue per account	$	2,021	$	1,544	$	1,897
Ending balance of assets under administration (millions)	$	1,342	$	706	$	1,088
Average assets per active account	$	235,232	$	162,856	$	210,290

⁽¹⁾ Includes both trades on which commissions are earned (“commissionable trades”) and ~~other variable expenses increased~~trades for which no commission is earned (“fee-based trades”). Excludes open-ended mutual fund redemptions.
⁽²⁾ Calculated as ~~a result of higher production revenues.~~
~~The pretax loss for Investment Services for the first half of fiscal year 2004 was $29.1 million compared to the prior year loss of $60.7 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 in eight countries that prepare U.S. tax returns for U.S. citizens living abroad. This segment served 2.3 million taxpayers in fiscal year 2003.
Tax-related service revenues include fees from company-owned tax offices and royalties from franchise offices. The Canadian tax season is from January to April, the Australian tax season is from July to October and the United Kingdom’s tax season is from August to March.
~~Operations in this segment of the Company are transacted in the local currencies of the countries in which it operates, therefore the results can be affected~~total commissions divided by ~~the translation into U.S. dollars. The weakening of the U.S. dollar during the quarter had the impact of increasing reported revenues, income and losses.~~commissionable trades.

-48-

~~International Tax Operations — Three-Month Results~~

(in 000s) Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Revenues:
Canada $ 3,025 $ 2,529 $ 3,766
Australia 15,657 12,345 1,123
United Kingdom 305 329 319
Overseas 108 123 251

Total revenues 19,095 15,326 5,459

Pretax income (loss):
Canada (4,858 ) (4,260 ) (3,695 )
Australia 6,297 5,030 (2,010 )
United Kingdom (196 ) (193 ) (189 )
Overseas (127 ) (359 ) (78 )
Allocated corporate and shared costs (561 ) (468 ) (436 )

Pretax income (loss) $ 555 $ (250 ) $ (6,408 )

Investment Services – Three-Month Results


(in 000s)	January 31, 2004			January 31, 2003			October 31, 2003
Transactional revenue	$	26,960		$	23,111		$	23,162
Annuitized revenue		15,040			9,126			13,689

Production revenue		42,000			32,237			36,851
Other revenue		7,391			6,923			7,795

Non-interest revenue		49,391			39,160			44,646
Margin interest revenue		8,362			8,887			8,057
Less: interest expense		248			945			207

Net interest revenue		8,114			7,942			7,850

Total revenues⁽¹⁾		57,505			47,102			52,496

Commissions		14,160			10,521			10,875
Other variable expenses		814			1,332			1,403

Total variable expenses		14,974			11,853			12,278
Gross profit		42,531			35,249			40,218
Compensation and benefits		23,893			22,110			22,751
Occupancy and equipment		4,480			8,384			6,823
Depreciation and amortization		11,843			14,005			11,046
Other		10,067			17,906			10,223
Allocated corporate and shared costs		5,059			4,599			4,711

Total fixed expenses		55,342			67,004			55,554

Pretax loss	$	(12,811	)	$	(31,755	)	$	(15,336	)

~~-53-~~

~~Three months ended October 31, 2003 compared to October 31, 2002~~

~~International Tax Operations’~~
⁽¹⁾ Total revenues, for the three months ended October 31, 2003 increased $3.8 million, or 24.6%, compared to the three months ended October 31, 2002. This improvement is primarily due to results in Australia, where tax returns prepared in the current quarter increased 3.2% compared to the prior year. Additionally, the average charge per return increased 1.3%.
Pretax income of $0.6 million for the quarter ended October 31, 2003, was an improvement of $0.8 million compared to the loss recorded in the second quarter last year. This improvement is due primarily to strong performance in the Australian tax season. This improvement was partially offset by unfavorable exchange rates in Canada.
Due to the seasonal nature of this segment’s business, operating results for the three months ended October 31, 2003 are not comparable to the three months ended July 31, 2003 and are not indicative of the expected results for the entire fiscal year.
~~International Tax Operations — Six-Month Results~~less interest expense.

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Revenues:
Canada $ 6,791 $ 5,334
Australia 16,780 13,237
United Kingdom 624 642
Overseas 359 396

Total revenues 24,554 19,609

Pretax income (loss):
Canada (8,553 ) (8,490 )
Australia 4,287 3,451
United Kingdom (385 ) (331 )
Overseas (205 ) (456 )
Allocated corporate and shared costs (997 ) (875 )

Pretax income (loss) $ (5,853 ) $ (6,701 )

Three months ended January 31, 2004 compared to January 31, 2003

Investment Services’ revenues, net of interest expense, for the three months ended January 31, 2004 increased $10.4 million, or 22.1%. The increase is primarily due to higher annuitized revenues, which are based on customer assets rather than transactions.

Transactional revenue, which is based on transaction or trade quantities, increased $3.8 million, or 16.7%, from the prior year due to a 35.0% increase in trading activity, partially offset by a decline in average revenue per trade. Annuitized revenues increased $5.9 million, or 64.8%, due to increased sales of annuities and mutual funds.

Margin interest revenue decreased 5.9% from the prior year, which is primarily a result of a decline in interest rates, partially offset by a 10.3% increase in average margin balances. Margin balances have increased from an average of $515.0 million for the three months ended January 31, 2003 to $568.3 million in the current period, as the market has begun to recover. Interest expense for the third quarter of fiscal year 2004 declined 73.8% to $0.2 million compared to $0.9 million in the third quarter of fiscal year 2003.

Total expenses decreased $8.5 million, or 10.8%, to $70.3 million primarily as a result of a decline in consulting fees incurred in the prior year related to the conversion to a new back-office

-49-

system. Occupancy and equipment and depreciation and amortization costs declined $3.9 million and $2.2 million, respectively, as a result of the consolidation of field offices and the related asset sales. These decreases were partially offset by an increase of $3.6 million in commissions, related to increased production revenues, and a $1.8 million increase in compensation and benefits, related to higher bonus accruals due to improved overall performance.

The pretax loss for Investment Services for the third quarter of fiscal year 2004 was $12.8 million compared to the prior year loss of $31.8 million.

Three months ended January 31, 2004 compared to October 31, 2003

Investment Services’ revenues, net of interest expense, for the three months ended January 31, 2004 increased $5.0 million, or 9.5%, compared to the preceding quarter.

Production revenue increased $5.1 million, or 14.0%, primarily due to the increase in customer trades.

Margin interest revenue increased $0.3 million, or 3.8%, for the quarter ended January 31, 2004, which is primarily a result of higher average margin balances. Margin balances have increased from an average of $514.4 million for the three months ended October 31, 2003 to $568.3 million in the current period.

Total expenses increased $2.5 million from the preceding quarter, primarily due to a $3.3 million increase in commission expense resulting from the improvement in production revenues. Compensation and benefits also increased $1.1 million as a result of higher bonus accruals due to improved overall performance. These increases were partially offset by a decrease of $2.3 million in occupancy and equipment due to the consolidation of field offices and the related asset sales.

The pretax loss for the Investment Services segment was $12.8 million, compared to a loss of $15.3 million in the second quarter of fiscal year 2004.

-50-

Investment Services – Nine-Month Statistics


	January 31, 2004		January 31, 2003
Customer trades⁽¹⁾		1,124,219		973,249
Customer daily average trades		5,825		5,043
Average revenue per trade⁽²⁾	$	118.58	$	117.95
Number of active accounts		741,824		672,247
Ending balance of assets under administration (billions)	$	27.5	$	21.0
Average assets per active account	$	37,122	$	31,397
Ending margin balances (millions)	$	594	$	535
Ending customer payables balances (millions)	$	1,076	$	802
Number of advisors		1,052		1,080
Included in the numbers above are the following relating to fee-based accounts:
Customer accounts		5,705		4,338
Average revenue per account	$	1,734	$	1,507
Ending balance of assets under administration (millions)	$	1,342	$	706
Average assets per active account	$	235,232	$	162,856

~~Six months ended October 31, 2003 compared to October 31, 2002~~

~~International Tax Operations’ revenues~~
⁽¹⁾ Includes both trades on which commissions are earned (“commissionable trades”) and trades for ~~the six months ended October 31, 2003 increased $4.9 million, or 25.2%, compared to the six months ended October 31, 2002. This improvement~~which no commission is ~~primarily due to results in Australia, where tax returns prepared in the current period increased 3.5% compared to the prior year and the average charge per return increased 1.4%~~earned (“fee-based trades”). ~~Canadian revenues also improved, due to increases of 6.1% in both the number of off-season returns and average charge per return.~~
~~The pretax loss of $5.9 million for the six months ended October 31, 2003, was an improvement of $0.8 million compared to the loss recorded in the prior year. Results in Australia improved~~Excludes open-ended mutual fund redemptions.
⁽²⁾ Calculated as ~~a result of better performance in the Australian tax season.~~total commissions divided by commissionable trades.

-51-

~~-54-~~

~~Corporate Operations~~

This segment consists primarily of corporate support departments, which provide services to the Company’s operating segments. These support departments consist of marketing, information technology, facilities, human resources, executive, legal, finance, government relations and corporate communications. These support department costs are largely allocated to the Company’s operating segments. The Company’s captive insurance and franchise financing subsidiaries are also included within this segment.

~~Corporate Operations — Three-Month Results~~

(in 000s) Three months ended

October 31, 2003 October 31, 2002 July 31, 2003

Operating revenues $ 2,253 $ 1,553 $ 2,728
Eliminations (1,565 ) (1,410 ) (1,400 )

Total revenues 688 143 1,328

Corporate expenses:
Compensation and benefits 930 4,476 3,069
Interest expense:
Interest on acquisition debt 17,074 18,203 17,672
Other interest 89 1,299 175
Marketing and advertising (2 ) 83 (76 )
Other 2,869 5,353 6,845

20,960 29,414 27,685
Support departments:
Information technology 26,738 22,348 23,213
Marketing 5,430 6,069 2,664
Finance 8,835 7,293 6,899
Stock-based compensation 3,084 — 1,040
Other 14,108 13,483 9,783

58,195 49,193 43,599

Allocation of corporate and shared costs (58,021 ) (46,436 ) (43,777 )
Investment income, net 2,005 533 1,195

Pretax loss $ (18,441 ) $ (31,495 ) $ (24,984 )

Investment Services – Nine-Month Results


(in 000s)	January 31, 2004			January 31, 2003
Transactional revenue	$	76,107		$	74,976
Annuitized revenue		41,205			26,494

Production revenue		117,312			101,470
Other revenue		25,182			25,426

Non-interest revenue		142,494			126,896
Margin interest revenue		24,949			29,841
Less: interest expense		1,065			4,222

Net interest revenue		23,884			25,619

Total revenues⁽¹⁾		166,378			152,515

Commissions		37,476			31,641
Other variable expenses		3,418			2,711

Total variable expenses		40,894			34,352
Gross profit		125,484			118,163
Compensation and benefits		69,074			69,321
Occupancy and equipment		18,524			21,646
Depreciation and amortization		34,480			39,652
Impairment of goodwill		—			24,000
Other		31,759			45,534
Allocated corporate and shared costs		13,551			10,498

Total fixed expenses		167,388			210,651

Pretax loss	$	(41,904	)	$	(92,488	)

~~Three months ended October 31, 2003 compared to October 31, 2002~~
⁽¹⁾ Total revenues, less interest expense.

Nine months ended January 31, 2004 compared to January 31, 2003

Investment Services’ revenues, net of interest expense, for the nine months ended January 31, 2004 improved $13.9 million, or 9.1%, compared to prior year. The increase is primarily due to higher annuitized revenue.

Transactional revenue increased $1.1 million, or 1.5%, from the prior year due to an increase in customer trades. Annuitized revenues increased $14.7 million, or 55.5%, due to increased sales of annuities and mutual funds. The increases were also due, in part, to the improvement in consumer sentiment surrounding market conditions.

Margin interest revenue declined 16.4% from the prior year, which is primarily a result of lower average margin balances. Margin balances have declined from an average of $598.7 million for the nine months ended January 31, 2003 to $528.1 million in the current period. Margin balances, which steadily declined during most of 2003, have steadily increased in the past four months and are now approaching last year’s average. Interest expense for the first nine months of fiscal year 2004 declined $3.2 million, or 74.8%, compared to the prior year.

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Total expenses decreased $36.7 million, or 15.0%, primarily as a result of the $24.0 million goodwill impairment charge recorded in the prior year. Other expenses decreased $13.8 million primarily as a result of consulting fees incurred in the prior year related to the conversion to a new back-office system. Depreciation and amortization and occupancy and equipment costs declined by $5.2 million and $3.1 million, respectively, as a result of the consolidation of field offices and the related asset sales. Commissions and other variable expenses increased $6.5 million as a result of higher production revenues.

The pretax loss for Investment Services for the current fiscal year was $41.9 million compared to the prior year loss of $92.5 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 in eight countries that prepare U.S. tax returns for U.S. citizens living abroad. This segment served 2.3 million taxpayers in fiscal year 2003.

Tax-related service revenues include fees from company-owned tax offices and royalties from franchise offices. The Canadian tax season is from January to April, the Australian tax season is from July to October and the United Kingdom’s tax season is from August to March.

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

International Tax Operations – Three-Month Results


(in 000s)	January 31, 2004			January 31, 2003			October 31, 2003
Revenues:
Canada	$	2,690		$	2,376		$	3,025
Australia		7,446			5,720			15,657
United Kingdom		329			435			305
Overseas		384			248			108

Total revenues		10,849			8,779			19,095

Pretax income (loss):
Canada		(6,879	)		(6,139	)		(4,858	)
Australia		1,699			1,243			6,297
United Kingdom		(196	)		(98	)		(196	)
Overseas		(102	)		(229	)		(127	)
Allocated corporate and shared costs		(931	)		(512	)		(561	)

Pretax income (loss)	$	(6,409	)	$	(5,735	)	$	555

-53-

Three months ended January 31, 2004 compared to January 31, 2003

International Tax Operations’ revenues for the three months ended January 31, 2004 increased $2.1 million, or 23.6%, compared to the three months ended January 31, 2003. This improvement is primarily due to results in Australia, where tax returns prepared in the current quarter increased 1.1% compared to the prior year and the average charge per return increased 2.7%. Revenues in Canada also improved due to a slight increase in the number of early returns completed.

The pretax loss of $6.4 million for the quarter ended January 31, 2004, was a decline of $0.7 million compared to the loss recorded in the third quarter last year. This is due primarily to unfavorable exchange rates in Canada, partially offset by improved performance in the Australian tax season.

International Tax Operations – Nine-Month Results


(in 000s)	January 31, 2004			January 31, 2003
Revenues:
Canada	$	9,481		$	7,710
Australia		24,226			18,957
United Kingdom		953			1,077
Overseas		743			644

Total revenues		35,403			28,388

Pretax income (loss):
Canada		(15,432	)		(14,629	)
Australia		5,986			4,694
United Kingdom		(581	)		(429	)
Overseas		(307	)		(685	)
Allocated corporate and shared costs		(1,928	)		(1,387	)

Pretax loss	$	(12,262	)	$	(12,436	)

Nine months ended January 31, 2004 compared to January 31, 2003

International Tax Operations’ revenues for the nine months ended January 31, 2004 increased $7.0 million, or 24.7%, compared to the nine months ended January 31, 2003. This improvement is primarily due to results in Australia, where tax returns prepared this year increased 3.5% compared to the prior year and the average charge per return increased 1.9%. Canadian revenues also improved, due to a 12.0% increase in tax returns prepared.

The pretax loss of $12.3 million for the nine months ended January 31, 2004, was basically flat compared to the loss recorded in the prior year. Results in Australia improved due to better performance in the Australian tax season, while Canadian results declined as a result of foreign currency translation.

-54-

Corporate Operations

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

Corporate Operations – Three-Month Results


(in 000s)	January 31, 2004			January 31, 2003			October 31, 2003
Operating revenues	$	2,332		$	1,846		$	2,253
Eliminations		(1,642	)		(1,551	)		(1,565	)

Total revenues		690			295			688

Corporate expenses:
Compensation and benefits		2,828			2,631			930
Interest expense:
Interest on acquisition debt		17,055			18,014			17,074
Other interest		350			4,283			89
Marketing and advertising		1,615			1,865			(2	)
Other		9,314			6,710			2,869

		31,162			33,503			20,960
Support departments:
Information technology		30,745			24,987			26,738
Marketing		44,513			39,488			5,430
Finance		8,406			7,530			8,835
Stock-based compensation		3,375			—			3,084
Other		19,468			24,741			14,108

		106,507			96,746			58,195
Allocation of corporate and shared costs		(106,593	)		(98,163	)		(58,021	)
Investment income, net		1,059			(191	)		2,005

Pretax loss	$	(29,327	)	$	(31,982	)	$	(18,441	)

Three months ended January 31, 2004 compared to January 31, 2003

Interest expense on acquisition debt decreased as a result of a $45.1 million payment on acquisition debt in August 2003 and lower financing costs. Other interest expense declined as a result of more of the cost of borrowing being absorbed by the U.S. Tax Operations segment in conjunction with RAL participations.

Information technology department expenses increased $5.8 million, or 23.0%, primarily due to an increase in headcount and related facilities. Stock-based compensation expenses increased as a result of the expensing of all stock-based compensation, which began on May 1, 2003. The related expenses reported in this segment do not include seasonal stock options for tax associates, which are charged directly to the segment in which they are employed. During the third quarter,

-55-

expenses totaling $3.2 million and $0.2 million were recorded directly in the U.S. Tax Operations and International Tax Operations segments, respectively, related to the seasonal stock options.

The pretax loss was $29.3 million, compared with last year’s third quarter loss of $32.0 million.

Corporate Operations – Nine-Month Results


(in 000s)	January 31, 2004			January 31, 2003
Operating revenues	$	7,313		$	4,137
Eliminations		(4,607	)		(4,185	)

Total revenues		2,706			(48	)

Corporate expenses:
Compensation and benefits		6,827			11,269
Interest expense:
Interest on acquisition debt		51,801			54,990
Other interest		614			2,728
Marketing and advertising		1,537			2,095
Other		19,028			19,074

		79,807			90,156
Support departments:
Information technology		80,696			66,266
Marketing		52,607			50,196
Finance		24,140			20,935
Stock-based compensation		7,499			—
Other		43,359			49,054

		208,301			186,451
Allocation of corporate and shared costs		(208,391	)		(186,312	)
Investment income, net		4,259			1,426

Pretax loss	$	(72,752	)	$	(88,917	)

Nine months ended January 31, 2004 compared to January 31, 2003

Operating revenues increased $2.8 million as a result of a write-down of investments in the prior year.

Compensation and benefits decreased primarily as a result of $3.5 million of additional expenses related to deferred compensation plans recorded in the prior year. The decrease in interest expense on acquisition debt is attributable to lower financing costs and a $45.1 million payment on acquisition debt in August 2003. Other interest expense declined as a result of more of the cost of borrowing being absorbed by the U.S. Tax Operations segment in conjunction with RAL participations.

Information technology department expenses increased $14.4 million, or 21.8%, primarily due to an increase in headcount and related facilities. Stock-based compensation expenses increased as a result of the expensing of all stock-based compensation, which began on May 1, 2003.

The pretax loss was $72.8 million, compared with last year’s loss of $88.9 million.

-56-

FINANCIAL CONDITION

These comments should be read in conjunction with the condensed consolidated balance sheets and condensed consolidated statements of cash flows found on pages 1 and 3, respectively.

The Company’s liquidity needs are met primarily through a combination of operating cash flows, commercial paper (CP) issuance and off-balance sheet financing arrangements.

OPERATING CASH FLOWS & LIQUIDITY BY SEGMENT

Operating cash requirements totaled $1.0 billion and $366.7 million for the nine months ended January 31, 2004 and 2003, respectively. A condensed consolidating statement of cash flows by segment for the nine months ended January 31, 2004 follows. Generally, interest is not charged on intercompany activities between segments.


	U.S. Tax			Mortgage			Business			Investment			International			Corporate			Consolidated
(in 000s)	Operations			Operations			Services			Services			Tax Operations			Operations			H&R Block
Cash provided by (used in):
Operations	$	(808,624	)	$	39,507		$	25,016		$	(52,167	)	$	2,273		$	(207,645	)	$	(1,001,640	)
Investing		(261,486	)		130,992			(35,964	)		1,705			(3,665	)		(28,991	)		(197,409	)
Financing		—			—			(51,306	)		—			(127	)		1,046,218			994,785
Net intercompany		1,114,204			(180,411	)		70,097			36,650			4,626			(1,045,166	)		—

Net intercompany activities are excluded from the investing and financing activities within the segment cash flows. The Company believes that by excluding the intercompany activities, the cash flows by segment more clearly depicts the cash generated and used by each segment. Had the intercompany activities been included, those segments in a net lending situation would have been included in investing activities, and those in a net borrowing situation would have been included in financing activities.

U.S. Tax Operations:U.S. Tax Operations has historically been the largest provider of annual operating cash flows to the Company. This segment generally operates at a loss during the first two quarters of the fiscal year due to off-season costs and preparation activities for the upcoming tax season. The seasonal nature of U.S. Tax Operations generally results in a large positive operating cash flow in the fourth quarter. U.S. Tax Operations had total cash requirements of $1.1 billion for the nine months ended January 31, 2004, which includes $243.3 million paid to former major franchisees.

Compensation and benefits decreased primarily as a result of $2.1 million of additional expenses related to deferred compensation plans in the prior year. The decrease in interest expense on acquisition debt is attributable to lower financing costs and a $45.1 million payment on acquisition debt in August 2003. Other expenses declined as a result of lower allocations of support department costs to Corporate Operations.

Information technology department expenses increased $4.4 million, or 19.6%, primarily due to an increase in headcount and related facilities. Stock-based compensation expenses increased as a result of the expensing of all stock-based compensation, which began on May 1, 2003.

~~-55-~~

~~The pretax loss was $18.4 million, compared with last year’s second quarter loss of $31.5 million.~~

Due to the nature of this segment, the three months ended October 31, 2003 are not comparable to the three months ended July 31, 2003 and are not indicative of the expected results for the entire fiscal year.

~~Corporate Operations — Six-Month Results~~

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Operating revenues $ 4,981 $ 2,291
Eliminations (2,965 ) (2,634 )

Total revenues 2,016 (343 )

Corporate expenses:
Compensation and benefits 3,999 8,638
Interest expense:
Interest on acquisition debt 34,746 36,976
Other interest 264 (1,555 )
Marketing and advertising (78 ) 230
Other 9,714 12,364

48,645 56,653
Support departments:
Information technology 49,951 41,279
Marketing 8,094 10,708
Finance 15,734 13,405
Stock-based compensation 4,124 —
Other 23,891 24,313

101,794 89,705

Allocation of corporate and shared costs (101,798 ) (88,149 )
Investment income, net 3,200 1,617

Pretax loss $ (43,425 ) $ (56,935 )

~~Six months ended October 31, 2003 compared to October 31, 2002~~

~~Operating revenues increased $2.7 million as a result of a write-down of investments in the prior year.~~

Compensation and benefits decreased as a result of $5.5 million of additional expenses related to deferred compensation plans in the prior year. The decrease in interest expense on acquisition debt is attributable to lower financing costs and a $45.1 million payment on acquisition debt in August 2003. Other expenses decreased as a result of lower allocations to Corporate Operations.

~~-56-~~

Information technology department expenses increased $8.7 million, or 21.0%, primarily due to an increase in headcount and related facilities. Stock-based compensation expenses increased as a result of the expensing of all stock-based compensation, which began on May 1, 2003.

~~The pretax loss was $43.4 million, compared with last year’s first quarter loss of $56.9 million.~~

~~-57-~~

~~FINANCIAL CONDITION~~

~~These comments should be read in conjunction with the condensed consolidated balance sheets and condensed consolidated statements of cash flows found on pages 1 and 3, respectively.~~

~~The Company’s liquidity needs are met primarily through a combination of operating cash flows, commercial paper (CP) issuance and off-balance sheet financing arrangements.~~

~~OPERATING CASH FLOWS & LIQUIDITY BY SEGMENT~~

Operating cash requirements totaled $463.4 million and $349.8 million for the six months ended October 31, 2003 and 2002, respectively. A condensed consolidating statement of cash flows by segment for the six months ended October 31, 2003 follows. Generally, interest is not charged on intercompany activities between segments.

(in 000s) U.S. Tax Mortgage Business Investment International Corporate Consolidated
Operations Operations Services Services Tax Operations Operations H&R Block

Cash provided by (used in):
Operations $ (268,343 ) $ 28,035 $ 13,285 $ (56,206 ) $ 16,341 $ (196,462 ) $ (463,350 )
Investing (120,939 ) 61,237 (4,785 ) 351 (2,214 ) (25,037 ) (91,387 )
Financing — 50,100 (45,425 ) — (107 ) (63,854 ) (59,286 )
Net intercompany 397,255 (144,844 ) 44,575 40,453 (10,352 ) (327,087 ) —

Net intercompany activities are excluded from the investing and financing activities within the segment cash flows. The Company believes that by excluding the intercompany activities, the cash flows by segment more clearly depict the cash generated and used by each segment. Had the intercompany activities been included, those segments in a net lending situation would have been included in investing activities, and those in a net borrowing situation would have been included in financing activities.

~~U.S. Tax Operations:~~U.S. Tax Operations has historically been the largest provider of annual operating cash flows to the Company. This segment generally operates at a loss during the first two quarters of the fiscal year due to off-season costs and preparation activities for the upcoming tax season. The seasonal nature of U.S. Tax Operations generally results in a large positive operating cash flow in the fourth quarter. U.S. Tax Operations had total cash requirements of $389.3 million for the six months ended October 31, 2003.

Mortgage Operations:This segment primarily generates cash as a result of loan sales and securitizations, NIM transactions, sales of NIM residual interests and as its residual interests mature. Mortgage Operations generated $39.5 million in cash from operating activities primarily from the sale and securitization of mortgage loans. This segment also generated $131.0 million in cash from investing activities primarily from cash received on residual interests.

Gains on sales
Gains on sales of mortgage loans and related assets totaled $581.9 million, of which 81% was received as cash. The cash was primarily recorded as operating activities. The percent of gains on sales of mortgage assets received as cash is calculated as follows:

-57-


	Nine months ended
(in 000s)	January 31, 2004			January 31, 2003
Cash:
Gains on whole loans sold by the Trusts	$	529,521		$	267,499
Gains on loans securitized		81,041			235,690
Gains on sale of previously securitized residuals		17,000			130,881
Loan origination expenses, net		(156,085	)		(120,218	)

		471,477			513,852
Non-cash:
Gains on retained mortgage servicing rights		64,265			50,691
Additions (reductions) to balance sheet⁽¹⁾		63,545			(11,605	)
Net change in receivable from the Trusts		12,565			73,494
Impairments to fair value of residual interests		(26,048	)		(25,589	)
Net change in fair value of rate-lock commitments		(3,911	)		1,906

		110,416			88,897

Reported gains on sales of mortgage assets	$	581,893		$	602,749

Percent of gains received as cash		81	%		85	%

⁽¹⁾ Includes residual interests and as its residual interests mature. Mortgage Operations generated $28.0 million in cash from operating activities primarily from the sale and securitization of mortgage loans. This segment also generated $61.2 million in cash from investing activities primarily from cash receivedinterest rate caps.

Another important measure of cash generation is the percentage of cash proceeds the Company receives from its capital market transactions. These amounts are also included within the gain on sale of mortgage assets as reconciled below. The percent calculation is as follows:


	Nine months ended
(in 000s)	January 31, 2004			January 31, 2003
Cash proceeds:
Gains on whole loans sold by the Trusts	$	529,521		$	267,499
Gains on loans securitized		81,041			235,690
Gains on sale of previously securitized residuals		17,000			130,881

		627,562			634,070
Non-cash:
Gains on retained mortgage servicing rights		64,265			50,691
Additions (reductions) to balance sheet⁽¹⁾		63,545			(11,605	)

		127,810			39,086

Portion of gain on sale related to capital market transactions	$	755,372		$	673,156
Other items included in gain on sale:
Net change in receivable from the Trusts		12,565			73,494
Impairments to fair value of residual interests		(26,048	)		(25,589	)
Net change in fair value of rate-lock commitments		(3,911	)		1,906
Loan origination expenses, net		(156,085	)		(120,218	)

		(173,479	)		(70,407	)

Reported gains on sales of mortgage assets	$	581,893		$	602,749

Percent of cash proceeds from capital market transactions		83	%		94	%

⁽¹⁾ Includes residual interests and ~~$50.1 million in cash from financing activities as a result of the on-balance sheet securitization completed during the quarter.~~
~~Gains on sales of mortgage loans and related assets totaled $412.9 million, of which 77% was received as cash. The cash was recorded as operating activities.~~
~~-58-~~
~~Gains on sales of mortgage assets consist of the following:~~

(in 000s) Six months ended

October 31, 2003 October 31, 2002

Gains on whole loans sold by the Trusts $ 298,460 $ 216,908
Gains on loans securitized 129,617 119,515
Net change in receivable from the Trusts 54,483 19,828
Gains on retained mortgage servicing rights 48,002 32,699
Net change in fair value of rate-lock commitments 613 4,615
Additions to residual interests 1,814 753
Impairments to fair value of residual interests (11,106 ) (24,132 )
Origination expenses, net (108,955 ) (73,801 )

$ 412,928 $ 296,385

Percent of gains received as cash 77 % 89 %
~~Cash received on residual interests in securitizations totaled $68.9 and $103.9 for the six months ended October 31, 2003 and 2002, respectively.~~
The mortgage segment regularly sells loans as a source of liquidity for its prime and non-prime mortgages. Whole loan sales to the Trusts through October 31, 2003 were $11.6 billion compared with $7.8 billion for the same period in fiscal year 2003. Additionally, Block Financial Corporation (BFC) provides the mortgage segment a $150 million line of credit for working capital needs.
In order to finance its prime originations, the Company utilizes a warehouse facility with capacity up to $50 million, which expires in June 2004. The facility bears interest at one-month LIBOR plus 64 to 175 basis points. As of October 31, 2003, the balance outstanding under this facility was $1.6 million and is included in accounts payable, accrued expenses and other on the condensed consolidated balance sheets.
Management believes the sources of liquidity available to the Mortgage Operations segment are predictable and sufficient for its needs. Risks to the stability of these sources include external events impacting the asset-backed securities market. The liquidity available from the NIM transactions is also subject to external events impacting this market. These external events include, but are not limited to, adverse changes in the perception of the non-prime industry or in the regulation of non-prime lending and, to a lesser degree, reduction in the availability of third parties that provide credit enhancement. Performance of the securitizations will also impact the segment’s future participation in these markets. The four warehouse facilities used by the Trusts are subject to annual renewal, each at a different time during the year, in April, August, December and February and any of the above events could lead to difficulty in renewing the lines. These risks are mitigated by the availability of whole loan sales and financing provided by the Company, and to a lesser extent, by staggered renewal dates related to these lines.
~~Business Services:~~~~Business Services funding requirements are largely related to working capital needs. Funding is available from the Company sufficient to cover these needs. This~~
~~-59-~~
segment generated $13.3 million in cash from operating activities primarily related to the collections of receivables in the first half of fiscal year 2004. Business Services used $45.4 million in financing activities, primarily as a result of payments on acquisition debt.
~~Investment Services:~~~~Investment Services used $56.2 million in cash from operating activities during the quarter, primarily due to the timing of cash deposits that are restricted for the benefit of customers.~~
Investment Services, through HRBFA, is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. HRBFA is required to maintain minimum net capital as defined under Rule 15c3-1 of the Securities Exchange Act of 1934 and complies with the alternative capital requirement, which requires a broker-dealer to maintain net capital equal to the greater of $250 thousand or 2% of the combined aggregate debit balances arising from customer transactions. The net capital rule also provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than the greater of 5% of combined aggregate debit items or 120% of the minimum required net capital. As of October 31, 2003, HRBFA’s net capital of $120.3 million, which was 18.9% of aggregate debit items, exceeded its minimum required net capital of $12.7 million by $107.6 million. Although HRBFA has always exceeded its minimum net capital requirements, during the six months ended October 31, 2003 the Company contributed $32.0 million of additional capital to HRBFA.
To manage short-term liquidity, HRBFA maintains a $300 million unsecured credit facility with BFC, its indirect corporate parent. As of October 31, 2003 there were no outstanding balances on this facility.
Liquidity needs relating to client trading and margin-borrowing activities are met primarily through cash balances in client brokerage accounts and working capital. Management believes these sources of funds will continue to be the primary sources of liquidity for Investment Services. Stock loans have historically been used as a secondary source of funding and could be used in the future, if warranted.
Securities borrowed and securities loaned transactions are generally reported as collateralized financings. These transactions require the Company to deposit cash and/or collateral with the lender. Securities loaned consist of securities owned by customers, which were purchased on margin. When loaning securities, the Company receives cash collateral approximately equal to the value of the securities loaned. The amount of cash collateral is adjusted, as required, for market fluctuations in the value of the securities loaned. Interest rates paid on the cash collateral fluctuate as short-term interest rates change.
To satisfy the margin deposit requirement of client option transactions with the Options Clearing Corporation (OCC), Investment Services pledges customers’ margined securities. Pledged securities as of October 31, 2003 totaled $73.8 million, an excess of $18.6 million over the margin requirement.
~~-60-~~
Management believes the funding sources for Investment Services are stable. Liquidity risk within this segment is primarily limited to maintaining sufficient capital levels to obtain securities lending liquidity to support margin borrowing by customers.
~~International Tax Operations:~~International Tax Operations provided $16.3 million in cash from operating activities during the quarter primarily due to higher earnings during the Australian tax season and collections of receivables from Revenue Canada related to its discounted return program.
International Tax Operations are generally self-funded. Cash balances are held in Canada, Australia and the United Kingdom independently in local currencies. H&R Block Canada has a commercial paper program up to $125 million (Canadian). At October 31, 2003, there was no commercial paper outstanding.
~~CAPITAL RESOURCES~~
~~Cash used in operating activities totaled $463.4 million for the six months ended October 31, 2003, compared with $349.8 million for the six months ended October 31, 2002.~~
Cash expenditures during the six months ended October 31, 2003 relating to investing and financing activities include the purchase of property and equipment ($43.6 million), payments on acquisition debt ($45.1 million), payment of dividends ($68.1 million), payments related to business acquisitions ($123.3 million) and the acquisition of treasury shares ($178.8 million).
Cash and cash equivalents — restricted totaled $571.2 million at October 31, 2003. HRBFA held $527.1 million of this total segregated in a special reserve account for the exclusive benefit of customers pursuant to Rule 15c3-3 of the Securities Exchange Act of 1934. Restricted cash held by Mortgage Operations totaled $32.6 million at October 31, 2003 as a result of cash held for outstanding commitments to fund mortgage loans. Restricted cash of $11.5 million at October 31, 2003 held by Business Services is related to funds held to pay payroll taxes on behalf of its clients.
On September 12, 2001, the Company’s Board of Directors authorized the repurchase of 15 million shares of common stock. On June 11, 2003 the Company’s Board of Directors approved an authorization to repurchase up to 20 million additional shares of its common stock. During the first half of fiscal year 2004, the Company purchased 4.1 million shares pursuant to these authorizations at an aggregate price of $177.6 million, or an average price of $42.99 per share. There are approximately 17.8 million shares remaining under the June 2003 authorization at October 31, 2003. The Company plans to continue to purchase its shares on the open market in accordance with this authorization, subject to various factors including the price of the stock, the ability to maintain progress toward a capital structure that will support a single A rating, the availability of excess cash, the ability to maintain liquidity and financial flexibility, compliance with securities laws and other investment opportunities available.
~~-61-~~
~~OFF-BALANCE SHEET FINANCING ARRANGEMENTS~~
The Company has commitments to fund mortgage loans in its pipeline of $3.2 billion at October 31, 2003, subject to contract verification. External market forces impact the probability of loan commitments being closed, and therefore, total commitments outstanding do not necessarily represent future cash requirements. If the loan commitments are exercised, they will be funded through the Company’s off-balance sheet arrangements.
For the six months ended October 31, 2003, the final disposition of loans was 33% securitizations and 67% third-party whole loan sales. For the six months ended October 31, 2002, the final disposition of loans was 43% securitizations and 57% third-party whole loan sales.
In the second quarter of fiscal year 2004, the warehouse facilities utilized by the Trusts were increased to $5.0 billion. An additional $1.0 billion facility was added that expires in August 2004 and bears interest at one-month LIBOR plus 50 to 60 basis points. This facility is subject to similar performance triggers, limits and financial covenants as the other facilities. In November 2003, two of the existing $1.5 billion facilities were increased to $2.0 billion each, which increased the total warehouse facilities to $6.0 billion.
The Financial Accounting Standards Board (FASB) has decided to reissue its exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of FASB Statement No. 140,” during the first quarter of calendar year 2004. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a QSPE.
Provisions in the first exposure draft, if adopted, may have required the Company to consolidate its current QSPEs (the Trusts) established in its Mortgage Operations segment. As of October 31, 2003, the Trusts had assets and liabilities of $3.8 billion. The provisions of the exposure draft are subject to FASB due process and are subject to change. The Company will continue to monitor the status of the exposure draft, and consider changes to current structures to comply with the proposed rules.
~~There have been no other material changes in the Company’s off-balance sheet financing arrangements from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.~~
~~COMMERCIAL PAPER ISSUANCE~~
The Company participates in the United States and Canadian commercial paper markets to meet daily cash needs. Commercial paper is issued by BFC and H&R Block Canada, Inc., wholly owned subsidiaries of the Company.
The Company incurs short-term borrowings throughout the year primarily to fund seasonal working capital needs, dividend payments and purchases of treasury stock. Because of the seasonality of its businesses, the Company has historically had short-term borrowings throughout
~~-62-~~
~~the year. Borrowings of $124.6 million were outstanding at October 31, 2003, compared with $481.6 million at October 31, 2002.~~
U.S. commercial paper issuances are supported by an unsecured committed line of credit (CLOC) from a consortium of twenty-four banks. The $2.0 billion CLOC is subject to annual renewal in August 2004 and has a one-year term-out provision with a maturity date in August 2005. This line is subject to various affirmative and negative covenants. This CLOC includes $1.5 billion for CP back-up and general corporate purposes and $500 million for working capital use, general corporate purposes and CP back-up. The CLOC was undrawn at October 31, 2003.
The Canadian issuances are supported by a credit facility provided by one bank in an amount not to exceed $125 million (Canadian). This line is subject to a minimum net worth covenant. The Canadian CLOC is subject to annual renewal in December 2003. The CLOC was undrawn at October 31, 2003.
Management believes the commercial paper market is stable. Risks to the stability of the Company’s commercial paper market participation would be a short-term rating downgrade, adverse changes in the Company’s financial performance, non-renewal or termination of the CLOCs, adverse publicity and operational risk within the commercial paper market. Management believes if any of these events were to occur, the CLOCs, to the extent available, could be used for an orderly exit from the commercial paper market, though at a higher cost to the Company. Additionally, the Company could turn to other sources of liquidity, including cash, debt issuance under the existing shelf registration and asset sales or securitizations.
~~CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS~~
In fiscal year 2000, HRB Royalty, Inc. (HRB Royalty), a wholly owned subsidiary of the Company, placed most of its major franchises on notice that it would not be renewing their respective franchise agreements as of the next renewal date. The agreements have expired or will expire on varying dates in fiscal years 2004 and 2005. Pursuant to the terms of the applicable franchise agreements, HRB Royalty must pay the major franchisee a “fair and equitable price” for the franchise business and such price shall not be less than eighty percent of the franchisee’s revenues for the most recent twelve months ended April 30, plus the value of equipment and supplies, and certain off-season expenses.
During the six months ended October 31, 2003, franchise agreements of twelve major franchisees expired and subsidiaries of the Company began operating tax preparation businesses as company-owned operations in the franchise territories of ten former major franchisees. With respect to the two other franchisees with expired franchise agreements, one franchisee entered into a new franchise agreement with a limited term and one franchisee continued litigation challenging the expiration of the franchise agreement. Cash payments of $118.8 million were made or accrued related to these former major franchises during the six months ended October 31, 2003.
In August 2003, a subsidiary of the Company entered into a transaction with one of the former major franchisees whose franchise agreements expired in the first quarter, pursuant to which such subsidiary acquired the stock of the franchisee and the franchisee released the Company and its
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affiliates from any further liability regarding additional payments under the major franchise agreements. With the exceptions of the former franchisee that executed a release and the franchisee that entered into a new franchise agreement, the court will determine if any additional payments are required for these franchise businesses. The first trial relating to one major franchisee was held in October 2003. At the conclusion of this trial, the jury rendered a verdict and the court entered a judgment requiring the Company to make an additional payment of $3.2 million for the franchise business. As of October 31, 2003, the Company recorded this liability in accounts payable, accrued expenses and other on the condensed consolidated balance sheet. The original payment for the franchise business made in the first quarter of fiscal year 2004 was $5.0 million. The outcome of the trial is subject to post-trial motions and possible appeals.
In light of the continuing litigation and possible negotiation with the former major franchisees, there is no certainty regarding the ultimate amount of payments or that subsidiaries of the Company will commence operations in all of the remaining former major franchise territories. Moreover, it is possible that HRB Royalty and certain former franchisees could agree to other arrangements, some of which may not require payments for the franchise businesses or any related assets.
~~There have been no other material changes in the Company’s contractual obligations and commercial commitments from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.~~
~~REGULATORY ENVIRONMENT~~
Certain state laws restrict or prohibit prepayment penalties on mortgage loans, and the Company 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, the Company 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 the Company from charging any prepayment penalty in six states and restrict the amount or duration of prepayment penalties that the Company may impose in an additional eleven states. This places the Company 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 caps.

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Warehouse Funding
The mortgage segment regularly sells loans as a source of liquidity for its prime and non-prime mortgages. Whole loan sales to the Trusts or other buyers through January 31, 2004 were $16.9 billion compared with $12.4 billion for the same period in fiscal year 2003. Additionally, Block Financial Corporation (BFC) provides the mortgage segment a $150 million line of credit for working capital needs.

In order to finance its prime originations, the Company utilizes a warehouse facility with capacity up to $50 million, which expires in June 2004. The facility bears interest at one-month LIBOR plus 64 to 175 basis points. As of January 31, 2004, the balance outstanding under this facility was $0.2 million and is included in accounts payable, accrued expenses and other on the condensed consolidated balance sheets.

Management believes the sources of liquidity available to the Mortgage Operations segment are sufficient for its needs. Risks to the stability of these sources include external events impacting the asset-backed securities market. The liquidity available from the NIM transactions is also subject to external events impacting this market. These external events include, but are not limited to, adverse changes in the perception of the non-prime industry or in the regulation of non-prime lending and, to a lesser degree, reduction in the availability of third parties that provide credit enhancement. Performance of the securitizations will also impact the segment’s future participation in these markets. The five off-balance sheet warehouse facilities used by the Trusts, which have a total current capacity of $7.0 billion, are subject to annual renewal, each at a different time during the year, and any of the above events could lead to difficulty in renewing the lines. These risks are mitigated by the availability of whole loan sales and financing provided by the Company, and to a lesser extent, by staggered renewal dates related to these lines.

Business Services:Business Services’ funding requirements are largely related to working capital needs. Funding is available from the Company sufficient to cover these needs. This segment generated $25.0 million in cash from operating activities primarily related to the collections of receivables. Business Services used $36.0 million in investing activities, primarily as a result of contingent payments on prior acquisitions, and $51.3 million in financing activities, primarily as a result of payments on acquisition debt.

Investment Services:Investment Services used $52.2 million in cash from operating activities during the quarter, primarily due to the timing of cash deposits that are restricted for the benefit of customers.

Investment Services, through HRBFA, is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. HRBFA is required to maintain minimum net capital as defined under Rule 15c3-1 of the Securities Exchange Act of 1934 and complies with the alternative capital requirement, which requires a broker-dealer to maintain net capital equal to the greater of $250 thousand or 2% of the combined aggregate debit balances arising from customer transactions. The net capital rule also provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than the greater of 5% of combined aggregate debit items or 120% of the minimum required net capital. As of

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January 31, 2004, HRBFA’s net capital of $126.3 million, which was 18.4% of aggregate debit items, exceeded its minimum required net capital of $13.7 million by $112.6 million. Although HRBFA has always exceeded its minimum net capital requirements, during the nine months ended January 31, 2004 the Company contributed $32.0 million of additional capital to HRBFA.

To manage short-term liquidity, HRBFA maintains a $300 million unsecured credit facility with BFC, its indirect corporate parent. As of January 31, 2004 there were no outstanding balances on this facility.

Liquidity needs relating to client trading and margin-borrowing activities are met primarily through cash balances in client brokerage accounts and working capital. Management believes these sources of funds will continue to be the primary sources of liquidity for Investment Services. Stock loans have historically been used as a secondary source of funding and could be used in the future, if warranted.

Securities borrowed and securities loaned transactions are generally reported as collateralized financings. These transactions require the Company to deposit cash and/or collateral with the lender. Securities loaned consist of securities owned by customers, which were purchased on margin. When loaning securities, the Company receives cash collateral approximately equal to the value of the securities loaned. The amount of cash collateral is adjusted, as required, for market fluctuations in the value of the securities loaned. Interest rates paid on the cash collateral fluctuate as short-term interest rates change.

To satisfy the margin deposit requirement of client option transactions with the Options Clearing Corporation (OCC), Investment Services pledges customers’ margined securities. Pledged securities as of January 31, 2004 totaled $68.0 million, an excess of $25.2 million over the margin requirement.

Management believes the funding sources for Investment Services are stable. Liquidity risk within this segment is primarily limited to maintaining sufficient capital levels to obtain securities lending liquidity to support margin borrowing by customers.

International Tax Operations:International Tax Operations provided $2.3 million in cash from operating activities during the nine months primarily due to higher earnings during the Australian tax season and collections of receivables from Revenue Canada related to its discounted return program.

International Tax Operations are generally self-funded. Cash balances are held in Canada, Australia and the United Kingdom independently in local currencies. H&R Block Canada has a commercial paper program up to $125 million (Canadian). At January 31, 2004, there was no commercial paper outstanding.

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CAPITAL RESOURCES

Cash and cash equivalents – restricted totaled $606.8 million at January 31, 2004. HRBFA held $576.4 million of this total segregated in a special reserve account for the exclusive benefit of customers pursuant to Rule 15c3-3 of the Securities Exchange Act of 1934. Restricted cash held by Mortgage Operations totaled $15.0 million at January 31, 2004 as a result of cash held for outstanding commitments to fund mortgage loans. Restricted cash of $15.4 million at January 31, 2004 held by Business Services is related to funds held to pay payroll taxes on behalf of its clients.

On September 12, 2001, the Company’s Board of Directors authorized the repurchase of 15 million shares of common stock. On June 11, 2003 the Company’s Board of Directors approved an authorization to repurchase up to 20 million additional shares of its common stock. During the nine months ended January 31, 2004, the Company purchased 7.8 million shares pursuant to these authorizations at an aggregate price of $370.0 million, or an average price of $47.51 per share. There are approximately 14.1 million shares remaining under the June 2003 authorization at January 31, 2004. The Company plans to continue to purchase its shares on the open market in accordance with this authorization, subject to various factors including the price of the stock, the ability to maintain progress toward a capital structure that will support a single A rating, the availability of excess cash, the ability to maintain liquidity and financial flexibility, compliance with securities laws and other investment opportunities available.

OFF-BALANCE SHEET FINANCING ARRANGEMENTS

The Company has commitments to fund mortgage loans in its pipeline of $2.5 billion at January 31, 2004, subject to contract verification. External market forces impact the probability of loan commitments being closed, and therefore, total commitments outstanding do not necessarily represent future cash requirements. If the loan commitments are exercised, they will be funded through the Company’s off-balance sheet arrangements.

For the nine months ended January 31, 2004, the final disposition of loans was 25% securitizations and 75% third-party whole loan sales. For the nine months ended January 31, 2003, the final disposition of loans was 65% securitizations and 35% third-party whole loan sales. The current year shift to whole loan sales is due to the more favorable pricing in the whole loan market. Increased whole loan sale transactions results in gains on loan sales being recorded earlier and cash being received earlier. Whole loan sales also do not add residual interests to the Company’s balance sheet, and therefore do not add additional balance sheet risk.

In the third quarter of fiscal year 2004, the warehouse facilities utilized by the Trusts were increased to $7.0 billion. An additional $1.0 billion facility was added that expires in November and bears interest at one-month LIBOR plus 50 to 60 basis points. This facility is subject to similar performance triggers, limits and financial covenants as the other facilities. In November 2003, two of the existing $1.5 billion facilities were increased to $2.0 billion each.

The Financial Accounting Standards Board (FASB) has decided to reissue its exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of

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FASB Statement No. 140,” during the first quarter of calendar year 2004. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a QSPE.

Provisions in the first exposure draft, if adopted, may have required the Company to consolidate its current QSPEs (the Trusts) established in its Mortgage Operations segment. As of January 31, 2004, the Trusts had assets and liabilities of $2.8 billion. The provisions of the exposure draft are subject to FASB due process and are subject to change. The Company will continue to monitor the status of the exposure draft, and consider changes, if any, to current structures as a result of the proposed rules.

There have been no other material changes in the Company’s off-balance sheet financing arrangements from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.

COMMERCIAL PAPER ISSUANCE

Borrowings of $1.4 billion were outstanding at January 31, 2004, with zero outstanding at April 30, 2003.

U.S. commercial paper issuances are supported by an unsecured committed line of credit (CLOC) from a consortium of twenty-four banks. The $2.0 billion CLOC is subject to annual renewal in August 2004 and has a one-year term-out provision with a maturity date in August 2005. This line is subject to various affirmative and negative covenants. This CLOC includes $1.5 billion for CP back-up and general corporate purposes and $500 million for working capital use, general corporate purposes and CP back-up. An additional line of credit of $500 million was put into place for the period of January 26 to February 25, 2004 to back-up peak commercial paper issuance. This line is subject to various covenants, substantially similar to the primary CLOC. These CLOCs were undrawn at January 31, 2004.

The Canadian issuances are supported by a credit facility provided by one bank in an amount not to exceed $125 million (Canadian). This line is subject to a minimum net worth covenant. The Canadian CLOC is subject to annual renewal in December 2004. The CLOC was undrawn at January 31, 2004.

There have been no other material changes in the Company’s commercial paper arrangements from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

In fiscal year 2000, HRB Royalty, Inc. (HRB Royalty), a wholly owned subsidiary of the Company, placed most of its major franchises on notice that it would not be renewing their respective franchise agreements as of the next renewal date. The agreements have expired or were going to expire on varying dates in fiscal years 2004 and 2005. Pursuant to the terms of the applicable franchise agreements, HRB Royalty must pay the major franchisee a “fair and equitable price” for the franchise business and such price shall not be less than eighty percent of

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the franchisee’s revenues for the most recent twelve months ended April 30, plus the value of equipment and supplies, and certain off-season expenses.

During the nine months ended January 31, 2004, franchise agreements of twelve major franchisees expired and subsidiaries of the Company began operating tax preparation businesses as company-owned operations in the franchise territories of ten former major franchisees. Cash payments of $243.3 million were made related to the ten former major franchises during the nine months ended January 31, 2004. Of the two other franchisees with expired franchise agreements one franchisee entered into a new franchise agreement with a limited term and the other franchisee continued litigation challenging the post-expiration restrictive covenants and disputing the payment due under the franchise agreement terms.

In August 2003, a subsidiary of the Company entered into a transaction with one of the former major franchisees whose franchise agreements expired in the first quarter, pursuant to which such subsidiary acquired the stock of the franchisee and the franchisee released the Company and its affiliates from any further liability regarding additional payments under the major franchise agreements. A trial relating to one major franchisee was held in October 2003, at the conclusion of which, the jury rendered a verdict and the court entered a judgment requiring the Company to make an additional payment of $3.2 million for the franchise business. The original payment for the franchise business made in the first quarter of fiscal year 2004 was $5.0 million.

In December 2003, one additional major franchise whose franchise agreement was scheduled to expire in 2005 entered into a new franchise agreement with a limited term.

On January 8, 2004, the Company reached an agreement to settle pending litigation with nine of its former major franchisees whose franchise agreements expired during the nine months ended January 31, 2004. The Company agreed to pay a total of $227.0 million as the “fair and equitable price” for the franchise businesses. During the third quarter of fiscal year 2004, the remaining $130.1 million was paid, which included the trial verdict payments of $3.2 million and $0.9 million.

In October 1997, the company issued $250.0 million of 63/4% Senior Notes under its shelf registration. These Senior Notes are due November 1, 2004 and are included in the current portion of long-term debt in the Company’s condensed consolidated balance sheet. The Company plans to refinance these Senior Notes during fiscal year 2005.

There have been no other material changes in the Company’s contractual obligations and commercial commitments from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.

REGULATORY ENVIRONMENT

Certain state laws restrict or prohibit prepayment penalties on mortgage loans, and the Company 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

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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, the Company 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 the Company from charging any prepayment penalty in nine states and restrict the amount or duration of prepayment penalties that the Company may impose in an additional eleven states. This places the Company 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 the Company is able to offer. It is estimated that the net impact to Mortgage Operations will be a reduction in revenues of approximately $35.0 million in fiscal year 2004 as a result of the elimination of prepayment penalties.

The United States, various state, local, provincial and foreign governments and some self-regulatory organizations have enacted statutes and ordinances, and/or adopted rules and regulations, regulating aspects of the businesses in which the Company’s subsidiaries are involved, including, but not limited to, commercial income tax return preparers, income tax courses, the electronic filing of income tax returns, the facilitation of refund anticipation loans, loan originations and assistance in loan originations, mortgage lending, privacy, consumer protection, franchising, sales methods, brokers, broker-dealers and various aspects of securities transactions, financial planners, investment advisors, accountants and the accounting practice. The Company’s subsidiaries seek to determine the applicability of such statutes, ordinances, rules and regulations (collectively, Laws) and comply with those Laws that apply to their activities. From time to time in the ordinary course of business, the Company and its subsidiaries receive inquiries from governmental and self-regulatory agencies regarding the applicability of Laws to the products and services offered by the Company’s subsidiaries. In response to past inquiries, the Company’s subsidiaries have agreed to comply with such Laws, convinced the authorities that such Laws were not applicable or that compliance already exists, and/or modified such subsidiaries’ activities in the applicable jurisdiction to avoid the application of all or certain parts of such Laws. The Company’s management believes that the past resolution of such inquiries and its ongoing compliance with Laws have not had a material adverse effect on the consolidated financial statements of the Company and its subsidiaries. The Company cannot predict what effect future Laws, changes in interpretations of existing Laws, or the results of future regulator inquiries with respect to the applicability of Laws may have on the Company’s subsidiaries, the consolidated financial statements of the Company and its subsidiaries.

FORWARD-LOOKING INFORMATION

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thereto. Words such as “will,” “plan,” “expect,” “remain,” “intend,” “estimate,” “approximate,” and variations thereof and similar expressions are intended to identify such forward-looking statements. 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 that are difficult to predict. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in such forward-looking statements. Such differences could be caused by a number of factors including, but not limited to, the uncertainty of laws, legislation, regulations, supervision and licensing by Federal, state and local authorities and self-regulatory organizations and their impact on any lines of business in which the Company’s subsidiaries are involved; unforeseen compliance costs; the uncertainty that the Company will achieve or exceed its revenue, income and earnings per share growth goals and expectations for fiscal year 2004; the uncertainty that actual fiscal year 2004 financial results will fall within the guidance provided by the Company; the uncertainty that the growth rate for mortgage originations in the Mortgage Operations segment will equal or exceed the growth rate experienced in fiscal year 2003 or the first three quarters of fiscal year 2004; the uncertainty as to the effect on the consolidated financial statements of the adoption of accounting pronouncements; risks associated with sources of liquidity for each of the lines of business of the Company; changes in interest rates; changes in economic, political or regulatory environments; changes in competition and the effects of such changes; the inability to implement the Company’s strategies; changes in management and management strategies; the Company’s inability to successfully design, create, modify and operate its computer systems and networks; the uncertainty of assumptions utilized to estimate cash flows from residual interests in securitizations and mortgage servicing rights; the uncertainty of assumptions and criteria used in the testing of goodwill and long-lived assets for impairment; litigation involving the Company and its subsidiaries; the uncertainty as to the outcome of any litigation; the uncertainty as to the timing or cost of commencement of operations in former major franchise territories or the fair and equitable price to be paid for any major franchise business; and risks described from time to time in reports and registration statements filed by the Company and its subsidiaries with the Securities and Exchange Commission. Readers should take these factors into account in evaluating any such forward-looking statements. The Company undertakes no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risk from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.

CONTROLS AND PROCEDURES

Disclosure controls and procedures are controls and other procedures that are designed to ensure information required to be disclosed in reports filed or submitted under the Securities Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure such information is accumulated and communicated to management, including the Chief Executive Officer and Chief

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Financial Officer or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosures.

In conjunction with management, including the Chief Executive Officer and Principal Accounting Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, the Chief Executive Officer and Principal Accounting Officer have concluded these controls and procedures are effective. There have been no significant changes in internal controls, or in other factors, which would significantly affect these controls subsequent to the date of evaluation.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information below should be read in conjunction with the information included in note 12 to the Company’s condensed consolidated financial statements contained in Part I. The information included in note 12 to the Company’s condensed consolidated financial statements contained in Part I is hereby incorporated in this Part II by reference.

~~The United States, various state, local, provincial and foreign governments and some self-regulatory organizations have enacted statutes and ordinances, and/or adopted rules and~~

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regulations, regulating aspects of the businesses in which the Company’s subsidiaries are involved, including, but not limited to, commercial income tax return preparers, income tax courses, the electronic filing of income tax returns, the facilitation of refund anticipation loans, loan originations and assistance in loan originations, mortgage lending, privacy, consumer protection, franchising, sales methods, brokers, broker-dealers and various aspects of securities transactions, financial planners, investment advisors, accountants and the accounting practice. The Company’s subsidiaries seek to determine the applicability of such statutes, ordinances, rules and regulations (collectively, Laws) and comply with those Laws that apply to their activities. From time to time in the ordinary course of business, the Company and its subsidiaries receive inquiries from governmental and self-regulatory agencies regarding the applicability of Laws to the products and services offered by the Company’s subsidiaries. In response to past inquiries, the Company’s subsidiaries have agreed to comply with such Laws, convinced the authorities that such Laws were not applicable or that compliance already exists, and/or modified such subsidiaries’ activities in the applicable jurisdiction to avoid the application of all or certain parts of such Laws. The Company’s management believes that the past resolution of such inquiries and its ongoing compliance with Laws have not had a material adverse effect on the consolidated financial statements of the Company and its subsidiaries. The Company cannot predict what effect future Laws, changes in interpretations of existing Laws, or the results of future regulator inquiries with respect to the applicability of Laws may have on the Company’s subsidiaries, the consolidated financial statements of the Company and its subsidiaries.

~~FORWARD-LOOKING INFORMATION~~

The information contained in this Form 10-Q and the exhibits hereto may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based upon current information, expectations, estimates and projections regarding the Company, the industries and markets in which the Company operates, and management’s assumptions and beliefs relating thereto. Words such as “will,” “plan,” “expect,” “remain,” “intend,” “estimate,” “approximate,” and variations thereof and similar expressions are intended to identify such forward-looking statements. 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 that are difficult to predict. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in such forward-looking statements. Such differences could be caused by a number of factors including, but not limited to, the uncertainty of laws, legislation, regulations, supervision and licensing by Federal, state and local authorities and self-regulatory organizations and their impact on any lines of business in which the Company’s subsidiaries are involved; unforeseen compliance costs; the uncertainty that the Company will achieve or exceed its revenue, income and earnings per share growth goals and expectations for fiscal year 2004; the uncertainty that actual fiscal year 2004 financial results will fall within the guidance provided by the Company; the uncertainty that the growth rate for mortgage originations in the Mortgage Operations segment will equal or exceed the growth rate experienced in fiscal year 2003 or the first and second quarters of fiscal year 2004; the uncertainty as to the effect on the consolidated financial statements of the adoption of accounting pronouncements; risks associated with sources of liquidity for each of the lines of business of the Company; changes in interest rates; changes in economic, political or regulatory environments; changes in competition and the effects of such

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changes; the inability to implement the Company’s strategies; changes in management and management strategies; the Company’s inability to successfully design, create, modify and operate its computer systems and networks; the uncertainty of assumptions utilized to estimate cash flows from residual interests in securitizations and mortgage servicing rights; the uncertainty of assumptions and criteria used in the testing of goodwill and long-lived assets for impairment; litigation involving the Company and its subsidiaries; the uncertainty as to the outcome of any litigation; the uncertainty as to the timing or cost of commencement of operations in former major franchise territories or the fair and equitable price to be paid for any major franchise business; and risks described from time to time in reports and registration statements filed by the Company and its subsidiaries with the Securities and Exchange Commission. Readers should take these factors into account in evaluating any such forward-looking statements. The Company undertakes no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

~~QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK~~

~~There have been no material changes in market risk from those reported at April 30, 2003 in the Company’s Annual Report on Form 10-K.~~

~~CONTROLS AND PROCEDURES~~

~~PART II — OTHER INFORMATION~~

~~ITEM 1. LEGAL PROCEEDINGS~~

RAL Litigation

The Company reported in current reports on Forms 8-K, previous quarterly reports on Form 10-Q and in its annual report on Form 10-K for the year ended April 30, 2003, certain events and information relating to class action litigation and putative class action litigation involving its

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subsidiaries’ refund anticipation loan programs (collectively, “RAL Cases”). The Company has successfully defended numerous class action and putative class action lawsuits filed against it involving the RAL program and a variety of legal theories asserted by ~~plaintiffs.~~plaintiffs, although several such cases are still pending. The amounts claimed in these lawsuits have been substantial in some instances. Of the cases that are no longer pending, some were dismissed on the Company’s motions for dismissal or summary judgment, some were dismissed voluntarily by the plaintiffs after a denial of class certification, and some were settled. Two RAL Cases involving statewide classes (discussed ~~below)~~in note 12 to the condensed consolidated financial statements contained in Part I) had final trial court approvals of settlements during the first ~~six~~nine months of fiscal year 2004 and two other RAL Cases were dismissed in August 2003 in connection with one of those settlements. One new putative class action RAL Case was filed in August 2003. The Company continues to believe it has meritorious defenses to the RAL Cases and intends to defend the remaining RAL Cases vigorously. 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 ~~on and~~regarding the impact of the RAL Cases on the Company’s financial position. The following is updated information regarding the pending RAL Cases in which developments occurred during or after the three months ended ~~October~~January 31, ~~2003:~~2004:

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”) andRonnie 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. On November 19, 2002, the Company announced that a settlement

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had been reached pursuant to which the Company and its major franchisee will issue coupons to class members that may be redeemed over a five-consecutive-year period following final approval of the settlement and once all appeals have been exhausted. Each class member will receive a packet containing 15 coupons under the settlement. Three coupons will be redeemable each year —– one for a $20 rebate onoff tax ~~preparation or electronic filing~~ services at Block offices, one that may be redeemed for TaxCut Platinum tax preparation software, ~~(or a product of equivalent value),~~ and one that may be redeemed forTax Planning Advisor,, a tax planning ~~book (or a product of equivalent value).~~book. The settlement also provides that defendants will be responsible for the payment of court-approved legal fees up to $49 million and expenses of class counsel up to $900,000. As a result of the settlement announcement, the Company recorded a liability and pretax expense of $41.7 million during the second quarter of fiscal year 2003, which represented, at that time, the Company’s best estimate of its share of the settlement cost for plaintiff class attorneys’ fees and expenses, tax products and associated mailing expenses. The Company ~~paid~~recorded an additional liability and pretax expense of $1.0 million during the ~~award~~three months ended October 31, 2003, for a total liability and pretax charge of ~~$49.9~~$47.6 million ~~of attorneys’ fees and expenses to class counsel on August 22,~~through July 31, 2003. During the fourth quarter of fiscal year 2003 and prior to the filing of the final settlement agreement with the court and any motions for preliminary approval of the settlement and legal fees and expenses of class counsel, the plaintiffs ~~had~~ filed a motion asking the Texas court to direct that $26 million of awarded class counsel fees be paid to the plaintiff class members. AThe final settlement agreement was filed with the District Court in March 2003 and preliminary approval of the settlement agreement was granted by the court on March 31, 2003. Notice of the settlement was sent to the class, a hearing on the final approval of the settlement agreement was held on June 24, 2003, and the judge entered a final judgment on June 24, 2003 fully and finally approving the settlement agreement, finding it fair, adequate and reasonable and that it protects the rights of the class, is in the best interests of the settlement class and meets all criteria required by Texas law. As a part of the final judgment, the court also (1) dismissed with prejudice the claims of class members who obtained RALs in Texas during the period from 1992 through 1996; (2) granted defendants’ Supplemental Motion for Summary Judgment as to class members who only

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obtained RALs from 1988 through 1991, and ordered that such defendants take nothing on their claims against the defendants; (3) granted defendants’ Motion to Compel Arbitration as to those members of the class who obtained a RAL for the first time from 1997 to 2002, and dismissed the claims of those class members without prejudice as to those members’ rights to pursue those claims through binding arbitration; (4) vacated its January 30, 1998 Order pertaining to arbitration clauses and contacts with the class; and (5) withdrew its rulings as to fiduciary duty, breach or the nature of the breach thereof, and for forfeiture as reflected in the Court’s November 6, 2002 letter. In a separate Order dated June 24, 2003, the Court found that the awarding of attorneys’ and expenses was appropriate and ordered that class counsel and objectors’ class counsel be awarded attorneys’ fees in the amount of $49.0 million on condition that, upon payment of the fees to class counsels’ trust account, class counsel shall pay $26.0 million of the attorneys’ fees to the class members pursuant to an approved distribution plan. The Order also provided that $100,000 from the award of attorneys’ fees be used to create a cy pres fund pursuant to an approved cy pres plan and specified the manner in which the remaining award of attorneys’ fees was to be distributed among the class counsel and objectors’ class counsel. There were no appeals of such final judgment and Order relating to attorneys’ fees and expenses. The Company paid the award of attorneys’ fees and expenses to class counsel on August 22, 2003. In addition to the $49.9 million liability that has already been recorded and/or

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paid, the Company will reduce revenues associated with tax preparation services as the coupons are redeemed each year. ~~Distribution of~~Coupons were distributed prior to the ~~settlement coupons was made following the end of the second quarter.~~2004 tax season.

~~Haese II~~~~arose from plaintiffs’ splitting off some claims from~~~~Haese I~~~~and, in connection with the settlement of~~~~Haese I~~~~, the case was dismissed on August 20, 2003.~~

~~Veronica I. Martinez,~~Belinda Peterson, et al. v. H&R Block ~~Inc., et al.~~Tax Services, Inc., Case No. ~~02-3629-E~~95CH2389, in the ~~District~~Circuit Court of ~~Nueces~~Cook County, ~~Texas,~~Illinois. A settlement was ~~dismissed on August 20,~~reached in April 2003 ~~in accordance with~~involving an estimated maximum total amount of $295,000. As a part of the settlement, ~~agreement involved~~class members who submit a claim will receive $25 in cash, with a guaranteed minimum total payout of $40,000 and a maximum total payout of $55,000. Class counsel will receive $220,000, the named class representative will receive $5,000, and it is expected that it will cost up to $15,000 to administer the settlement. Preliminary approval of the settlement was granted on June 12, 2003 and notices of~~Haese I~~. the settlement and claim forms have been sent to the class. The settlement was approved and a judgment entered after a final fairness hearing held in October 2003. The settlement was funded and attorneys’ fees were paid in December 2003, and payments were mailed to class members in February 2004.

Lynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et al., (formerlyJoel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., Block Financial Corporation, et al.)Case No. 98 C 2178, United States District Court for the Northern District of Illinois, Eastern Division. On April 15, 2003, the District Court judge declined to approve a $25 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 appointed new counsel for the plaintiffs in May 2003 and named their client, Lynne Carnegie, as lead plaintiff. The new counsel for the plaintiffs filed an amended complaint and a motion for partial summary judgment during the quarter ended July 31, 2003. The defendants filed a motion to dismiss, a brief in response to allegations in the plaintiffs’ amended complaint relating to class certification, and responses to plaintiffs’ motion for partial summary judgment. ~~Extensive~~Rulings on these motions are pending, and extensive discovery is proceeding. In the fourth quarter of fiscal year 2003, the Company recorded a receivable in the amount of its $12.5 million share of the settlement fund and recorded a reserve of $12.5 million consistent with the existing settlement authority of the Board of Directors. The defendants requested the release of the escrowed settlement fund and the Company’s $12.5 million share of such fund was received during the second quarter of fiscal year 2004. The Company intends to defend the case vigorously, ~~and~~but there are no assurances ~~that the matter will result in a settlement or~~ as to ~~the amount of any settlement.~~its outcome.

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~~Belinda Peterson, et al. v. H&R Block Tax Services, Inc.~~, Case No. 95CH2389, in the Circuit Court of Cook County, Illinois. A settlement was reached in April 2003 involving an estimated maximum total amount of $295,000. As a part of the settlement, class members who submit a claim will receive $25 in cash, with a guaranteed minimum total payout of $40,000 and a maximum total payout of $55,000. Class counsel will receive $220,000, the named class representative will receive $5,000, and it is expected that it will cost up to $15,000 to administer the settlement. Preliminary approval of the settlement was granted on June 12, 2003 and notices of the settlement and claim forms have been sent to the class. The settlement was approved and a judgment entered after a final fairness hearing held in October 2003.

~~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. The court granted plaintiffs’ motion for class certification during the quarter ended July 31, 2003, and the defendants filed their notice of appeal regarding such certification on August 14, 2003.

~~Roy Carbajal, et al. v. H&R Block Tax Services, Inc., et al~~., Case No. 00C-0626 in the United States District Court for the Northern District of Illinois. The defendants’ motion to compel arbitration was granted on September 16, 2003, and the case was dismissed. Plaintiffs have appealed.

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, was originally filed in the Circuit Court for Phillips County, Arkansas on August 12, 2003, and was subsequently removed to federal court. It is a putative class action alleging fraudulent misrepresentation, fraudulent concealment, dual agency, breach of fiduciary duty, violation of Arkansas Deceptive and Unconscionable Trade Practices Law, violation of Arkansas’ Secret Payments or Allowance of Rebates and Refunds Law, unjust enrichment, breach of contract and deceit in connection with the RAL program. The complaint requests that the court certify a nationwide class of all persons who obtained a RAL from September 1987 through December 1997, who do not have an arbitration provision in their contract. It also seeks a subclass of class members who are 60 years of age or older, or who are Disabled Persons under

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Arkansas Statutes section 4-88-201. Plaintiffs seek an unspecified amount of damages, restitution, equitable relief, attorneys’ fees, and costs of court. Defendants have moved to dismiss and compel arbitration. 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.

~~Dennis J. Smith v.~~Deandra D. Cummins, et al. V. H&R Block, Inc., et al.,, Case No. ~~3:03CV7181~~03-C-134 in the ~~United States District~~Circuit Court ~~for~~of Kanawha County, West Virginia. Defendants’ motions to dismiss and to compel arbitration were heard in part in December 2003 during which the ~~Northern District of Ohio, Western Division. The Company was not served with~~judge discontinued the ~~original complaint filed~~hearing and ordered the parties to mediation. Mediation occurred in February 2004 during which the matter. The Company was served with an amended complaint in November 2003, alleging RICO violations, fraud, breach of fiduciary duties, negligence, conversion, and violation of Ohio consumer fraud statutes as a result of the wrongful deprivation of all or part of plaintiff’s tax refunds under the “Rapid Refund” program. The complaint generally alleges violations of the Fair Debt Collection Practices Act and appearsparties were unable to ~~relate to the~~reach agreement.

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~~cross-collection of prior RAL debt by banks involved in the RAL program or the refund anticipation check program. The amended complaint does not include any class allegations.~~

~~Shareholder Matter~~

~~Paul White,~~Sandra J. Basile, et al. v. H&R Block, Inc., et ~~al.~~al,~~, consolidated Case Numbers 02CV8965, 02CV9661, 02CV9682 and 02CV9830, respectively,~~April Term 1992 Civil Action No. 3246 in the ~~United States District~~ Court ~~for the Southern~~of Common Pleas, First Judicial District of ~~New York, involves four cases~~Pennsylvania, Philadelphia County. Court ordered mediation occurred in which the respective named plaintiffs seek to represent a class of shareholders who purchased the Company’s stock between November 8, 1997 and November 6, 2002, and allege that the Company and certain of its current and former officers and directors violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by failing to disclose to shareholders various cases in which the Company had been sued regarding the RAL program, by failing to set adequate reserves for those cases, and by failing to disclose the supposed implications of those cases for the future of the RAL program.December 2003. The ~~four securities law cases were all assigned to the same judge and consolidated for pre-trial matters. A consolidated complaint~~mediation was ~~filed in March 2003~~unsuccessful, and the ~~defendants responded by filing a motion to dismiss in April~~court decertified the class on December 31, 2003. ~~In response to defendants’ motion to dismiss, plaintiffs informed defendants that they desired further to amend their complaint. Defendants consented to~~Plaintiffs have appealed the filing of an amended complaint as a pleading matter, the plaintiffs filed the amended complaint, and the defendants filed a motion to dismiss it in August 2003. The Company believes the claims in these actions are without merit and intends to defend them vigorously.decertification.

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. A hearing on the motion to certify both a nationwide plaintiff class and a nationwide defendant class was held on August 14, 2003, and, on August 27, 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

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“H “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. Defendants ~~have~~ filed a motion asking the trial court to certify the class certification issues for interlocutory ~~appeal.~~appeal, which the trial court denied. Discovery is proceeding.

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There are two other putative class actions pending against the Company in Texas and Alabama that involve the Peace of Mind guarantee. The Texas case is being tried before the same judge that presided over theHaesecase and involves the same attorneys for the plaintiffs as are involved in theMarshalllitigation in Illinois and substantially similar allegations. The Alabama case involves allegations of selling insurance without ofa license in connection with the Peace of Mind program, the erroneous preparation of income tax returns that subjected plaintiffs to audits, failure to provide assistance in responding to auditors’ requests, failure to pay the penalties, interest, and additional taxes under Block’s standard guarantee and Peace of Mind programs, unjust enrichment, and breach of contract. No classes have been certified in either of these two cases. The Company believes the claims in these Peace of Mind actions are without merit and intends 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 the Company’s financial condition.

Franchise Litigation

The Company iswas a named defendant in litigation entitledWilliam R. Smith, Inc., et al. v. H&R Block, Inc., et al., Case No. 99-CV-206379, pending in the Circuit Court of Jackson County, Missouri (previously known asArmstrong Business Services, Inc., et al. v. H&R Block, Inc., et al.). The action was filed by certain “major” franchisees against the Company and certain of its subsidiaries relating to alleged breaches of contract and other matters. The Company’s subsidiary, HRB Royalty, Inc., the franchisor under the applicable franchise agreements, filed a counterclaim and subsequently a motion for summary judgment seeking a declaration that HRB Royalty, Inc. could elect not to renew the major franchise agreements when their present five-year terms came to an end. Such motion for summary judgment was grantedSee discussion in March 2001 and upheld on appeal. HRB Royalty notified the plaintiff major franchisees in 2000 that it did not intend to renew their franchise agreements at the expiration of the current renewal terms and that the agreements would terminate at that time. The renewal dates vary among the franchisees. Pursuantnote 12 to the ~~franchise agreements, HRB Royalty must pay~~condensed consolidated financial statements.

Other Claims and Litigation

As with other broker-dealers that distribute mutual fund shares, H&R Block Financial Advisors, Inc. (HRBFA), a “fair and equitable price” to the franchisee for franchisee’s franchise business, and such price must be no less than 80% of the franchisee’s revenues for the most recent 12 months ended April 30, plus the value of equipment and supplies, and certain off-season expenses. The Circuit Court ruled in May 2003 that major franchise agreements with renewal terms scheduled to expire prior to July 1, 2003, will expire on July 1, 2003, and other major franchise agreements will expire as their renewal terms expire commencing in September 2003 and ending in fiscal year 2005. The Court ordered defendants to pay for the franchise businesses as provided in the franchise agreements on the applicable dates of expiration. During the six months ended October 31, 2003, franchise agreements of twelve major franchisees expired and subsidiaries of the Company began operating tax preparation businesses as company-owned operations in the franchise territories previously operated by ten former major franchisees. Cash payments of $118.8 million were made or accrued related to these former major franchise businesses during the six months ended October 31, 2003. In August 2003, awholly owned indirect subsidiary of the Company, ~~entered~~is the subject of an investigation by the National Association of Securities Dealers, Inc. (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 ~~transaction~~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. The NASD has requested a written statement concerning HRBFA’s position on the ~~major franchisees whose franchise agreements had expired in~~staff’s preliminary determination. HRBFA is cooperating with the ~~first quarter, pursuant to which such~~

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~~subsidiary acquired the stock of the franchisee~~NASD and ~~the franchisee released the Company and~~is conducting its affiliates from any further liability regarding additional payments under the major franchise agreements. In addition, during the first quarter of fiscal year 2004, a Company subsidiary and one major franchise entered into a new franchise agreement with a limited term and a release of the Company and its affiliates from any liability in the litigation, including any liability regarding payments for the franchise business under the prior major franchise agreement. With the exception of the franchisees that have executed releases and the franchisee that entered into a new franchise agreement, the court will determine if any additional payments are required for these franchise businesses.own internal investigation. There iscan be no ~~certainty~~assurances as to the ~~timing~~outcome and ~~final cost~~resolution of ~~commencement of operations~~this matter at this time.

As reported in current report on Form 8-K dated December 12, 2003, the ~~former major franchise territories or the payments of fair~~United States Securities and ~~equitable prices for the franchise businesses.~~

In~~Smith, plaintiffs’ claims against~~Exchange Commission informed outside counsel to the Company and its subsidiaries remain in the trial court. In their second amended petition, the plaintiffs seek in excess of $20 million in actual damages, punitive damages, unspecified statutory damages, declaratory, injunctive and other relief, including attorneys’ fees under allegations of breach of contract, breach of the covenant of good faith and fair dealing, unfair business practices, state anti-trust violations, breach of fiduciary duty, prima facie tort, violations of various state franchise statutes, fraud and misrepresentation, waiver and estoppel, ambiguity and reformation, relief with respect to a post-termination covenant not to compete in the franchise agreements, and a request for a fair and equitable payment upon nonrenewal of the franchise agreements. The major franchisees allege, among other things,on December 11, 2003 that the ~~sale~~Commission had issued a Formal Order of ~~TaxCut income tax return preparation software~~Investigation concerning the Company’s disclosures, in and ~~online tax services and the purchase of accounting firms encroached on their exclusive franchise territories. The defendants believe that the allegations against them are without merit and continue~~before November 2002, regarding RAL litigation to ~~defend the case vigorously. Management believes that amounts, if any, required to be paid by~~which the Company was and ~~its subsidiaries in~~is a party. There can be no assurances as to the ~~discharge~~outcome and resolution of ~~liabilities or settlements relating to these claims of the plaintiffs in~~ this ~~litigation will not have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial position.~~

~~The trial involving one of the plaintiffs in the~~~~Smith~~litigation took place in October 2003 and involved the issues relating to that plaintiff’s claims against the Company and to determine if any additional payments are required to provide the former franchisee with a fair and equitable price for the franchise business. The jury rendered a verdict of $0.9 million in favor of the plaintiff on the plaintiff’s claims against the Company and a verdict of $3.2 million with respect to additional payments for the franchise business. A subsidiary of the Company had made a payment of $5.0 million to such plaintiff as payment for the franchise business in the first quarter of fiscal year 2004. The outcome of the trial is subject to post-trial motions and possible appeals. The next trial to take place as part of the~~Smithlitigation is scheduled for May 2004.~~

~~Other Claims and Litigation~~matter.

The Company and its subsidiaries have from time to time been party to claims and lawsuits not discussed herein arising out of its business operations, including additional claims and lawsuits concerning RALs and the Peace of Mind guarantee program, and claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of customers’ tax returns, the fees charged customers for various products and services, losses incurred by customers with

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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. The Company’s management considers these cases to be ordinary, routine litigation incidental to its business, believes and Company and its subsidiaries have meritorious defenses to each of them, and is defending, or intends to defend, them vigorously. While management cannot provide assurance that the Company and its subsidiaries will ultimately prevail in each instance, management believes that amounts, if any, required to be paid by the Company and its subsidiaries in the discharge of liabilities or settlements in these other matters will not have a material adverse effect on the Company’s consolidated results of operations or financial position.

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

The annual meeting of shareholders of the registrant was held on September 10, 2003. At such meeting, three Class II directors were elected to serve three-year terms. In addition, the proposals set forth below were submitted to a vote of shareholders. With respect to the election of directors and the adoption of each proposal, the number of votes cast for, against or withheld, the number of abstentions, and the number of no votes (if applicable) were as follows:

Election of Class II Directors
Nominee Votes FOR Votes WITHHELD

G. Kenneth Baum 154,492,796 1,939,685
Henry F. Frigon 150,062,319 6,370,162
Roger W. Hale 152,902,523 3,529,958


~~Approvals of an Amendment to the 2003 Long-Term Executive Compensation Plan~~

~~Votes For:~~			~~142,940,871~~
~~Votes Against:~~			~~12,792,495~~
~~Abstain:~~			~~699,113~~


~~Ratification of the Appointment of KPMG LLP as the Registrant's Independent Accountants for the year ended April 30, 2004~~

~~Votes For:~~			~~151,578,294~~
~~Votes Against:~~			~~4,509,546~~
~~Abstain:~~			~~344,641~~

At the close of business on July 8, 2003, the record date for the annual meeting of shareholders, there were 180,313,591 shares of Common Stock of the registrant outstanding and entitled to vote at the meeting. There were 156,432,481 shares represented at the annual meeting of shareholders held on September 10, 2003.

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~~ITEM~~ 6. EXHIBITS AND REPORTS ON FORM 8-K.

~~a) Exhibits~~
a) Exhibits


10.1		~~Separation~~Employment Agreement dated September 4,2, 2003 and fully executed on December 20, 2003 between HRB Management, Inc. and ~~Frank J. Cotroneo.~~Brad C. Iversen.

10.2		~~2003 Long-Term Executive Compensation Plan (as amended September 10, 2003)~~Settlement Agreement dated January 8, 2004 between (a) Herbert Dicker; HBD, Inc.; Robert Hildorf; RKL, Inc.; Ray Jiruska; HRB, LLC; RLJ Enterprises, Inc.; DFJ Enterprises, Inc.; RRJ Enterprises, Inc.; DEJ Enterprises, Inc.; Moore Business Service, Inc.; T.J. Enterprises, Inc.; Block Mountain West, Inc.; Orr Enterprises Limited Partnership; S.E. Iowa Business Services, Inc.; Taxsavers, Inc.; and JBW Limited Partnership and (b) H&R Block, Inc.; Block Financial Corporation; HRB Royalty, Inc.; H&R Block Tax Services, Inc.; and H&R Block Eastern Tax Services, Inc.

10.3		Third Amended and Restated Refund Anticipation Loan Participation Agreement dated as of January 1, 2004, between Block Financial Corporation and Household Tax Masters, Inc.

31.1		Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification by Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification by Principal Accounting Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.

b)
b) Reports on Form 8-K

The registrant filed a current report on Form 8-K dated ~~August 27,~~November 26, 2003, reporting under Item 12 thereof its issuance of a press release announcing the results of operations for its ~~first~~second quarter ending ~~July~~October 31, 2003.

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The registrant filed a current report on Form 8-K dated December 12, 2003, reporting under Item 5 thereof its issuance of a press release announcing the United States Securities & Exchange Commission enforcement staff had issued a Formal Order of Investigation concerning the Company’s disclosures, in and before November 2002, about refund anticipation loan litigation to which the Company was and is a party.

The registrant filed a current report on Form 8-K dated January 12, 2004, reporting under Item 5 thereof its issuance of a press release announcing the settlement of the major franchise litigation.

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SIGNATURES

~~SIGNATURES~~

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			H&R BLOCK, INC.

			(Registrant)

DATE	~~12/10/03~~ 3/16/04	BY	/s/ Mark A. Ernst

			Mark A. Ernst
		Chairman of the Board, President
		and Chief Executive Officer

DATE	~~12/10/03~~ 3/16/04	BY	/s/ Melanie K. Coleman

			Melanie K. Coleman ~~Vice President and~~ ~~Corporate Controller~~

~~-75-~~

~~Exhibit Index~~

		Vice President and
~~Exhibit No.~~		~~Description~~

	~~10.1~~	~~Separation Agreement dated September 4, 2003 between HRB Management, Inc. and Frank J. Cotroneo.~~

	~~10.2~~	~~2003 Long-Term Executive Compensation Plan (as amended September 10, 2003)~~

	~~31.1~~	~~Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.~~

	~~31.2~~	~~Certification by Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.~~

	~~32.1~~	~~Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.~~

	~~32.2~~	~~Certification by Principal Accounting Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.~~Corporate Controller

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~~(Mark One)~~
x [X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended ~~October~~January 31, ~~2003~~2004


		~~Page~~
			Page
PART I	Financial Information
	Condensed Consolidated Balance Sheets ~~October~~ January 31, ~~2003~~2004 and April 30, 2003		1
	Condensed Consolidated Income Statements Three and ~~Six~~Nine Months Ended ~~October~~January 31, ~~2003~~2004 and ~~2002~~2003		2
	Condensed Consolidated Statements of Cash Flows ~~Six~~ Nine Months Ended ~~October~~January 31, ~~2003~~2004 and ~~2002~~2003		3
	Notes to Condensed Consolidated Financial Statements		4
	Management’s Discussion and Analysis of Results of Operations and Financial Condition		2827
	Quantitative and Qualitative Disclosures about Market Risk		6665
	Controls and Procedures		6665
PART II	Other Information		66
SIGNATURES			7573


					October 31,			April 30,			January 31,			April 30,
					2003			2003			2004			2003
											(Unaudited)
ASSETS
Cash and cash equivalents											$	671,089		$	875,353
Cash and cash equivalents - restricted												606,832			438,242
Marketable securities - trading												70,280			23,859
Receivables from customers, brokers, dealers and clearing organizations, net												645,357			517,037
Receivables, net (note 4)												1,093,051			403,197
Prepaid expenses and other current assets												611,561			489,673
					(Unaudited)
Total current assets												3,698,170			2,747,361
Residual interests in securitizations (note 5)												233,851			264,337
Mortgage servicing rights (note 5)												106,196			99,265
Property and equipment, at cost less accumulated depreciation and amortization of $550,662 and $485,608												284,148			288,594
Intangible assets, net (note 6)												340,748			341,865
Goodwill, net (note 6)												948,530			714,215
Other assets												176,544			148,268
				ASSETS
Total assets											$	5,788,187		$	4,603,905
	Cash and cash equivalents				$	261,330		$	875,353
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Commercial paper											$	1,411,177		$	—
Current portion of long-term debt												277,599			55,678
Accounts payable to customers, brokers and dealers												1,126,103			862,694
Accounts payable, accrued expenses and other												398,250			468,933
Accrued salaries, wages and payroll taxes												170,043			210,629
Accrued income taxes												73,419			299,262
	Cash and cash equivalents — restricted					571,163			438,242
Total current liabilities												3,456,591			1,897,196
Long-term debt												551,406			822,302
Other noncurrent liabilities												303,624			220,698
	Receivables from customers, brokers, dealers and clearing organizations, net					584,721			517,037
	Receivables, net (note 4)					340,794			403,197
	Prepaid expenses and other current assets					638,496			513,532

		Total current assets				2,396,504			2,747,361

	Residual interests in securitizations (note 5)					317,604			264,337
	Mortgage servicing rights (note 5)					111,960			99,265
	Property and equipment, at cost less accumulated depreciation and amortization of $523,897 and $485,608					283,556			288,594
	Intangible assets, net (note 6)					350,188			341,865
	Goodwill, net (note 6)					830,053			714,215
	Other assets					171,511			148,268

				Total assets	$	4,461,376		$	4,603,905

				LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
	Current portion of long-term debt				$	25,385		$	55,678
	Notes payable — commercial paper					124,630			—
	Accounts payable to customers, brokers and dealers					999,009			862,694
	Accounts payable, accrued expenses and other					455,362			468,933
	Accrued salaries, wages and payroll taxes					83,202			210,629
	Accrued income taxes					130,614			299,262

		Total current liabilities				1,818,202			1,897,196

	Long-term debt					807,738			822,302
	Other noncurrent liabilities					299,539			220,698

			Total liabilities			2,925,479			2,940,196
Total liabilities												4,311,621			2,940,196

Stockholders’ equity:	Stockholders’ equity:
Common stock, no par, stated value $.01 per share, 500,000,000 shares authorized; 217,945,398 shares issued at January 31, 2004 and April 30, 2003												2,179			2,179
Additional paid-in capital												530,282			496,393
Accumulated other comprehensive income (note 8)												56,591			36,862
Retained earnings												2,240,592			2,221,868
Less cost of 42,409,777 and 38,343,944 shares of common stock in treasury												(1,353,078	)		(1,093,593	)
	Common stock, no par, stated value $.01 per share					2,179			2,179
Total stockholders’ equity												1,476,566			1,663,709
	Additional paid-in capital					510,951			496,393
Total liabilities and stockholders’ equity											$	5,788,187		$	4,603,905
	Accumulated other comprehensive income (note 8)					62,628			36,862
	Retained earnings					2,169,317			2,221,868
	Less cost of 40,343,784 and 38,343,944 shares of common stock in treasury					(1,209,178	)		(1,093,593	)

			Total stockholders’ equity			1,535,897			1,663,709

				Total liabilities and stockholders’ equity	$	4,461,376		$	4,603,905


o[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from ______ to ______


MISSOURI (State or other jurisdiction of incorporation or organization)		44-0607856 (I.R.S. Employer Identification No.)


		Three Months Ended					Six Months Ended

		October 31,					October 31,

		2003		2002			2003			2002

Revenues:
	Service revenues	$	236,800	$	206,404		$	446,262		$	396,973
	Gains on sales of mortgage assets		220,289		151,377			412,928			296,385
	Interest income		87,868		92,726			158,819			170,946
	Product sales		28,164		15,510			56,515			30,922
	Royalties		3,416		2,855			4,983			4,056
	Other		3,318		2,524			6,038			3,480

			579,855		471,396			1,085,545			902,762

Operating expenses:
	Employee compensation and benefits		255,764		229,295			480,969			439,483
	Occupancy and equipment		82,314		71,431			158,465			136,293
	Interest		19,900		22,698			43,096			44,972
	Depreciation and amortization		40,080		36,495			76,010			72,068
	Marketing and advertising		21,683		20,818			31,791			30,004
	Supplies, freight and postage		14,187		13,852			22,741			22,318
	Impairment of goodwill		—		6,000			—			24,000
	Other		129,957		133,495			239,369			213,709

			563,885		534,084			1,052,441			982,847

Operating income (loss)			15,970		(62,688	)		33,104			(80,085	)
Other income, net			1,164		443			2,859			1,934

Income (loss) before taxes			17,134		(62,245	)		35,963			(78,151	)
Income taxes (benefit)			6,758		(24,898	)		14,068			(31,260	)

Net income (loss) before cumulative effect of change in accounting principle			10,376		(37,347	)		21,895			(46,891	)
Cumulative effect of change in accounting principle for multiple deliverable revenue arrangements, less taxes of $4,031			—		—			(6,359	)		—

Net income (loss)		$	10,376	$	(37,347	)	$	15,536		$	(46,891	)

Basic earnings (loss) per share:
	Before change in acctg. principle	$	.06	$	(.21	)	$	.12		$	(.26	)
	Cumulative effect of change in accounting principle		—		—			(.03	)		—

	Net income (loss)	$	.06	$	(.21	)	$	.09		$	(.26	)

Diluted earnings (loss) per share:
	Before change in acctg. principle	$	.06	$	(.21	)	$	.12		$	(.26	)
	Cumulative effect of change in accounting principle		—		—			(.03	)		—

	Net income (loss)	$	.06	$	(.21	)	$	.09		$	(.26	)

		litigation involving major franchisees in note 12 to the condensed consolidated financial statements.

3.		Earnings Per Share

		Basic earnings per share is computed using the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share. The computations of basic and diluted earnings per share are as follows:

3.		~~Earnings (Loss) Per Share~~Diluted earnings per share excludes the impact of shares of common stock issuable upon the exercise of options to purchase 283 shares and 3.7 million shares of stock for the three and nine months ended January 31, 2004, respectively, as the options’ exercise prices were greater than the average market price of the common shares during those periods and therefore, the effect would be antidilutive. Diluted earnings per share for the three and nine months ended January 31, 2003 excludes the impact of 4.7 million shares and 2.1 million shares, respectively, issuable upon the exercise of stock options as they are antidilutive.

		The weighted average shares outstanding for the three and nine months ended January 31, 2004 decreased to 176.7 million and 178.0 million, respectively, from 178.8 million and 179.6 million last year, respectively, primarily due to the purchase of treasury shares by the Company. The effect of these purchases was partially offset by the issuance of treasury shares related to the Company’s stock-based compensation plans.

		During the nine months ended January 31, 2004, the Company issued 3.8 million shares of common stock pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares, in accordance with the Company’s stock-based compensation plans. During the nine months ended January 31, 2003, the Company issued 4.4 million shares of common stock


(in 000s, except per share amounts)		Three months ended					Six months ended

		October 31,					October 31,

		2003		2002			2003		2002

Net income (loss) before change in accounting principle		$	10,376	$	(37,347	)	$	21,895	$	(46,891	)

Basic weighted average common shares			177,828		178,880			178,616		180,045
Dilutive potential shares from stock options and restricted stock			3,282		—			3,348		—
Convertible preferred stock			1		—			1		—

Dilutive weighted average common shares			181,111		178,880			181,965		180,045

Earnings (loss) per share before change in accounting principle:
	Basic and diluted	$	.06	$	(.21	)	$	.12	$	(.26	)

		pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares.

		During the nine months ended January 31, 2004, the Company acquired 7.8 million shares of its common stock at an aggregate cost of $371,242. During the nine months ended January 31, 2003, the Company acquired 6.6 million shares of its common stock at an aggregate cost of $317,608.

4.		Receivables

		Receivables consist of the following:


	October 31, 2003			April 30, 2003

Business Services accounts receivable	$	154,143		$	185,023
Mortgage loans held for sale		100,174			68,518
Loans to franchisees		39,370			33,341
Refund anticipation loans (RALs) and related receivables		17,200			12,871
Software receivables		1,522			36,810
Other		50,886			89,054

		363,295			425,617
Allowance for doubtful accounts		(12,678	)		(17,038	)
Lower of cost or market adjustment		(9,823	)		(5,382	)

	$	340,794		$	403,197

5.		~~Mortgage Banking Activities~~The Company sold $16,940,590 and $12,412,587 of mortgage loans in whole loan sales to third-party trusts (Trusts) or other buyers during the nine months ended January 31, 2004 and 2003, respectively, with gains totaling $590,941 and $497,457, respectively, recorded on these sales.

		Residual interests valued at $199,021 and $326,395 were securitized in net interest margin (NIM) transactions during the respective nine-month periods. Net cash proceeds of $197,417 and $325,642 were received from the NIM transactions for the nine months ended January 31, 2004 and 2003, respectively. Total net additions to residual interests from NIM transactions for the nine months ended January 31, 2004 and 2003 were $1,604 and $753, respectively.

		At January 31, 2004, the Company had $52,564 of residual interests classified as trading securities. These residual interests are included in marketable securities – trading on the condensed consolidated balance sheet. There were no such trading securities recorded as of April 30, 2003.

		In the second quarter of fiscal year 2004, the Company completed a NIM transaction with a special purpose entity (SPE) that did not meet the criteria for a qualifying special purpose entity (QSPE) under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” As a result, the SPE was consolidated and the transaction was accounted for as a secured financing (on-balance sheet securitization). During the third quarter, the NIM trust was terminated and the related residual interests were subsequently securitized in a NIM transaction with a QSPE.

		Cash flows of $127,997 and $117,522 were received from the securitization trusts for the nine months ended January 31, 2004 and 2003, respectively. An additional $17,000 and $142,486 was received during the nine months ended January 31, 2004 and 2003, respectively, as a result of the sale of previously securitized residuals. Cash received on residual interests is included in investing activities in the condensed consolidated statements of cash flows.

		Residual interests are classified as either available-for-sale (AFS) or trading securities and are therefore reported at fair market value (based on discounted cash flow models). Unrealized holding gains represent the write-up in value of AFS residual interests as a result of actual or projected performance factors that are better than the projected assumptions previously used in the Company’s valuation models, such as interest rates, loan losses or loan prepayments. Trading securities are marked-to-market through the income statement.

		Aggregate net unrealized gains on residual interests, which had not yet been accreted into income, totaled $107,066 at January 31, 2004 and $98,089 at April 30, 2003. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and may be recognized in income in future periods either through accretion or upon further securitization or sale of the related residual interest.

		In connection with securitization transactions, the Company, as servicer, generally has a 10% clean-up call option, whereby the Company, at its discretion, may repurchase the outstanding loans in the securitization once the current value of the loans is 10% or less of their original

		value. During the nine months ended January 31, 2004, the Company exercised call options on residual interests initially recorded in 1996 and 1999. The outstanding loans were repurchased from the securitization trust, and the proceeds were used to pay off the remaining bondholders. These repurchased loans may be included in future sale transactions. At the time the call options were exercised, the book value of the corresponding residual interests was $5,875.

		Activity related to mortgage servicing rights (MSRs) consists of the following:


		Residential Mortgage Loans

		Original			NIM			Servicing
		Residuals			Residuals			Asset

Carrying amount/fair value of residuals		$	26,251		$	291,353		$	111,960
Weighted average life (in years)			2.1			1.8			1.2
Prepayments (including defaults):
	Adverse 10% — $impact on fair value	$	1,236		$	2,714		$	(19,707	)
	Adverse 20% — $impact on fair value		2,484			8,020			(39,236	)
Credit losses:
	Adverse 10% — $impact on fair value	$	(1,477	)	$	(33,035	)	Not applicable
	Adverse 20% — $impact on fair value		(2,765	)		(62,588	)	Not applicable
Discount rate:
	Adverse 10% — $impact on fair value	$	(777	)	$	(5,142	)	$	(1,865	)
	Adverse 20% — $impact on fair value		(1,485	)		(9,342	)		(3,431	)
Variable interest rates:
	Adverse 10% — $impact on fair value	$	104		$	(10,540	)	Not applicable
	Adverse 20% — $impact on fair value		210			(19,943	)	Not applicable

8.6.		~~Comprehensive Income~~Intangible Assets and Goodwill

		Intangible assets consist of the following:

~~10.~~7.		Derivative Instruments

		The Company, in the normal course of business, enters into commitments with its customers to fund mortgage loans for specified periods of time at “locked-in” interest rates. These financial instruments represent commitments (rate-lock equivalent) to fund loans. The estimated fair value of these rate-lock equivalents is determined based on the difference in the value of the commitments to fund loans between the date of commitment and the date of valuation, taking into consideration the probability of the commitments being exercised and changes in other market conditions. At January 31, 2004 and April 30, 2003, the Company recorded assets totaling $8,620 and $12,531, respectively, in prepaid expenses and other current assets on the condensed consolidated balance sheets related to these commitments. See related discussion of Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105) in note 14.

		The Company, in the normal course of business, enters into interest rate caps to mitigate interest rate risk and to enhance the marketability of NIM transactions. As of January 31, 2004 the Company held $52,564 in residual interests – trading securities. The Company elected not to securitize the residuals in a NIM transaction prior to quarter end. Therefore, an interest rate cap valued at $9,376 has been included in other assets on the condensed consolidated balance sheet related to these trading residual interests. The interest rate cap will be marked-to-market monthly through the income statement. The net adjustment to trading securities and the interest rate cap in the condensed consolidated income statements was zero for the three and nine months ended January 31, 2004.

		The Company entered into an agreement with Household Tax Masters, Inc. (Household) during fiscal year 2003, whereby the Company waived its right to purchase any participation interests in and receive license fees relating to RALs during the period January 1 through April 30, 2003. In consideration for waiving these rights, the Company received a series of payments from Household, subject to certain adjustments based on delinquency rates on RALs made by Household through December 31, 2003. This adjustment provision was accounted for as a derivative and was marked-to-market monthly through December 31, 2003. Accordingly, during the three and nine months ended January 31, 2004, the Company recognized $988 and $6,548, respectively, of revenues related to this instrument. The final settlement in accordance with this agreement was received in January 2004. A receivable of $5,171 was included on the condensed consolidated balance sheet as of April 30, 2003.

10.		Supplemental Cash Flow Information

		During the nine months ended January 31, 2004, the Company paid $245,355 and $57,458 for income taxes and interest, respectively. During the nine months ended January 31, 2003, the Company paid $176,168 and $55,193 for income taxes and interest, respectively.

		During the nine months ended January 31, 2004 and 2003, the Company characterized the following as non-cash investing activities:


	Six months ended October 31,

	2003		2002

Additions to residual interests	$	1,814	$	753
Residual interest mark-to-market		22,910		55,796
Accrued payment on acquisition debt		25,000		—

		Option One Mortgage Corporation provides a guarantee up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts (QSPEs) before ultimate disposition of the loans by the Trusts. This guarantee would be called upon in the event adequate proceeds were not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. No losses have been sustained on this commitment since its inception. The total principal amount of Trust obligations outstanding as of January 31, 2004 and April 30, 2003 was $2,785,603 and $2,176,286, respectively. The fair value of mortgage loans held by the Trusts as of January 31, 2004 and April 30, 2003 was approximately $2,895,000 and $2,273,000, respectively.

		The Company may enter into forward loan sale commitments to be settled at a future date as a part of its interest rate risk management strategy. The Company had commitments to sell loans of approximately $4,500,000 and $1,470,000 as of January 31, 2004 and April 30, 2003, respectively.

		The Company has entered into whole loan sale agreements with investors in the normal course of business, which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require the Company to repurchase loans previously sold. A liability has been established related to the potential loss on repurchase of loans previously sold of $21,907 and $18,859 at January 31, 2004 and April 30, 2003, respectively. This liability is included in accounts payable, accrued expenses and other on the condensed consolidated balance sheets. Repurchased loans are normally sold in subsequent sale transactions.

		The Company and its subsidiaries have various contingent purchase price obligations in connection with prior acquisitions. In many cases, contingent payments to be made in connection with these acquisitions are not subject to a stated limit. The Company estimates the potential payments (undiscounted) total approximately $7,112 and $52,290 as of January 31, 2004 and April 30, 2003, respectively. The Company’s estimate is based on current financial conditions. Should actual results differ materially from the Company’s assumptions, the

		potential payments will differ from the above estimate. Such payments, if and when paid, would be recorded as additional goodwill.

		The Company has contractual commitments to fund certain franchises requesting draws on Franchise Equity Lines of Credit (FELCs). The commitment to fund FELCs as of January 31, 2004 and April 30, 2003 totaled $61,152 and $56,070, respectively, with a related receivable balance of $46,729 and $33,341, respectively, included on the condensed consolidated balance sheets. The receivable represents the amount drawn on the FELCs as of January 31, 2004 and April 30, 2003.

		The Company and its subsidiaries routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Other guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counter parties from losses arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) indemnification of the Company’s directors and officers; and (d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against the Company or its subsidiaries and the ultimate liability related to any such claims, if any, is difficult to predict. While management cannot provide assurance the Company and its subsidiaries will ultimately prevail in the event any such claims are asserted, management believes the fair value of these guarantees and indemnifications is not material as of January 31, 2004.

12.		Litigation Commitments and Contingencies

		In November 2002, the Company and a major franchisee of a subsidiary of the Company, reached an agreement with the plaintiff class in the class action lawsuit entitledRonnie and Nancy Haese, et al. v. H&R Block, Inc. et al., Case No. CV96-423, in the District Court of Kleberg County, Texas, related to RALs. The settlement provides a five-year package of coupons class members can use to obtain a variety of tax preparation and tax planning services from the Company’s subsidiaries. The Company’s major franchisee (a co-defendant), which operates more than half of all H&R Block offices in Texas, will share a portion of the total settlement cost. As a result, the Company recorded a liability and pretax expense of $41,672, during the second quarter of fiscal year 2003, which, at the time, represented the Company’s best estimate of its share of the settlement cost for plaintiff class legal fees and expenses, tax products and associated mailing expenses. The Company’s share of the settlement is less than the total amount awarded due to amounts recoverable from a co-defendant in the case. The settlement was approved by the court as a part of a final judgment entered on June 24, 2003. No appeals of the judgment and award were filed. The Company paid the award of $49,900 of attorneys’ fees and expenses to class counsel on August 22, 2003. In addition to the liability that has already been recorded and/or paid, the Company will reduce revenues associated with tax preparation services as the coupons are redeemed each year. The settlement coupons were distributed prior to the 2004 tax season.

		The Company has been involved in a number of putative RAL class action cases since 1990. While the Company has successfully defended many such cases, several cases are still pending and the amounts claimed in some of those cases is very substantial. In order to avoid the uncertainty of litigation and the diversion of resources and personnel resulting from the lawsuits, the Company, the lending bank, and the plaintiffs in the caseJoel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., et al.(renamedLynne A. Carnegie, et al. v. H&R Block, Inc., et al.), Case No. 98-C-2178 in the United States District Court for Northern Illinois, had agreed to a settlement class and a settlement of RAL-related claims on a nationwide basis. Under that settlement, the Company and the lending bank agreed to each pay $12,500 toward a $25,000 settlement fund for the benefit of the class members. The settlement was approved by the District Court in February 2001 and the defendants paid the $25,000 into an escrow fund. Certain class members who had objected to the settlement appealed the order approving the settlement to the Seventh Circuit Court of Appeals. In April 2002, the Court of Appeals reversed the District Court’s order approving the settlement and remanded the matter back to the District Court for further consideration of the fairness and adequacy of the proposed settlement by a new District Court judge. In April 2003, the District Court judge declined to approve the $25,000 settlement, 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 appointed new counsel for the plaintiffs in the first quarter of fiscal year 2004 and named their client, Lynne A. Carnegie, as lead plaintiff. The new counsel for the plaintiffs have since filed an amended complaint and a motion for partial summary judgment. The defendants have filed a motion to dismiss, a brief in response to allegations in the plaintiffs’ amended complaint relating to class certification, and responses to plaintiffs’ motion for partial summary judgment. Rulings on these motions are pending, and extensive discovery is proceeding. The Company recorded a receivable in the amount of its $12,500 share of the settlement fund in the fourth quarter of fiscal year 2003 and recorded a reserve in such quarter of $12,500 consistent with the existing settlement authority of the Board of Directors. The defendants requested the release of the escrowed settlement fund and the $12,500 was received during the second quarter of fiscal year 2004. The Company intends to defend the case and the remaining RAL class action litigation vigorously, but there are no assurances as to their outcome.

		The Company and certain of its current and former officers and directors are named defendants in litigation entitledPaul White, et al. v. H&R Block, et al.,consolidated Case Numbers 02CV8965, 02CV9661, 02CV9682 and 02CV9830 pending in the United States District Court for the Southern District of New York since the third quarter of fiscal year 2003. The respective named plaintiffs seek to represent a class of shareholders who purchased the Company’s stock between November 8, 1997 and November 6, 2002, and allege that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by failing to disclose to shareholders various cases in which the Company had been sued regarding the RAL program, by failing to set adequate reserves for those cases, and by failing to disclose the supposed implications of those cases for the future of the RAL program. The four securities law cases were all assigned to the same judge and consolidated for pre-trial matters. A consolidated complaint was filed in March 2003 and the defendants responded by filing a motion to dismiss in April 2003. In response to defendants’ motion to dismiss, the plaintiffs informed defendants that they wished further to amend their complaint. Defendants consented to the filing of an amended

		complaint as a pleading matter, the plaintiffs filed the amended complaint, and the defendants filed a motion to dismiss it in August 2003. The Company believes the claims in these actions are without merit, and intends to defend them vigorously.

		In January 2004, the Company and most of its former major franchisees entered into settlement of the litigation entitledWilliam R. Smith, Inc., et al. v. H&R Block, Inc., et al., Case No. 99-CV-206379, in the Circuit Court of Jackson County, Missouri (previously known asArmstrong Business Services, Inc., et al. v. H&R Block, Inc., et al.). In this litigation, the former major franchisees alleged breaches of contract and other matters against the Company and certain subsidiaries. The Company’s subsidiary, HRB Royalty, Inc., in turn sought and received a declaration that it could elect not to renew the major franchise agreements upon expiration of their current terms. HRB Royalty subsequently notified the plaintiff major franchisees that it did not intend to renew their major franchise agreements upon expiration. During the nine months ended January 31, 2004, the plaintiffs’ major franchise agreements accordingly expired and subsidiaries of the Company acquired and began operating the tax preparation business as company-owned operations in the former major franchise territories. The major franchise agreements required HRB Royalty to pay a “fair and equitable price” to the franchisee for the franchise business. The major franchise agreements provided further such price must be no less than 80% of the franchisee’s revenues for the most recent twelve months ended April 30 plus the value of equipment and supplies and certain off-season expenses. Cash payments of $243,257 were made related to these former major franchises during the nine months ended January 31, 2004.

		TheSmithsettlement provides for payment to the franchisees of $130,096, which is included in the amount above, as additional payment for the value of their former franchise businesses and resolves all other disputes involved in the litigation. The settlement also resolved all issues regarding the first trial involving one of the plaintiffs in theSmithlitigation held in October 2003, with the settlement payment encompassing payment of the jury verdict in the first trial of $3,197 for the franchise business and $921 for plaintiff’s claims for damages against the Company. In December 2003, one other “major” franchisee whose franchise agreement did not expire until early 2005 entered into a new franchise agreement with a limited term.

		In addition to the aforementioned cases, the Company and its subsidiaries have from time to time been parties to claims and lawsuits arising out of such subsidiaries’ business operations, including other claims and lawsuits relating to RALs, and claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of income tax returns, the fees charged customers for various services, the Peace of Mind guarantee program associated with income tax return preparation services, relationships with franchisees 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. The Company’s management considers these cases to be ordinary, routine litigation incidental to its business, believes the Company and its subsidiaries have meritorious defenses to each of them and is defending, or intends to defend, them vigorously. While management cannot provide assurance the Company and its subsidiaries will

		ultimately prevail in each instance, management believes that amounts, if any, required to be paid by the Company and its subsidiaries in the discharge of liabilities or settlements will not have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial position. Regardless of outcome, claims and litigation can adversely affect the Company and its subsidiaries due to defense costs, diversion of management and publicity related to such matters.

		It is the Company’s policy to accrue for amounts related to legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable. Many of the various legal proceedings are covered in whole, or in part, by insurance.

13.		Segment Information

		Information concerning the Company’s operations by reportable operating segment for the three and nine months ended January 31, 2004 and 2003 is as follows:

14.		New Accounting Pronouncements

		SAB 105

		On March 9, 2003, the SEC Staff issued SAB 105. SAB 105 states that, when valuing loan commitments, registrants may not include expected future cash flows related to the associated servicing of the loan and, similarly, may not recognize any other internally developed intangible assets as part of the loan commitment derivative. The guidance in SAB 105 is effective for new loan commitments entered into after March 31, 2004. At January 31, 2004, the Company had recorded assets totaling $8,620 related to its loan commitments. It is possible that the effect of SAB 105 will be to delay recognition of all, or a portion, of the loan commitment asset, and

~~12.~~		~~Segment Information~~related gain, until the loans are sold. The Company is in the process of analyzing the effect of SAB 105 and has not yet determined the impact of adoption.

		SFAS 149

		In April 2003, Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149) was issued. SFAS 149 amends and clarifies the accounting for derivative instruments and incorporates many of the implementation issues cleared as a result of the Derivatives Implementation Group process. The provisions of this standard are effective for contracts entered into or modified after June 30, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

		FIN 46

		In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). A revision of FIN 46 was issued in December 2003. FIN 46 provides guidance with respect to the consolidation of certain variable interest entities (VIEs) whereby a VIE must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among parties involved. The primary beneficiary is one who absorbs a majority of the expected losses, residual returns, or both as a result of holding variable interests. FIN 46 also requires disclosures for both the primary beneficiary of a VIE and other parties with significant variable interests in the entity.

		The provisions of FIN 46 apply immediately to VIEs created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. As revised, application of FIN 46 is required for interests in VIEs commonly referred to as special-purpose entities in financial statements for periods ending after December 15, 2003. Application for interests in all other types of entities is required in financial statement for periods ending after March 15, 2004.

		The Mortgage Operations segment has an interest in certain QSPEs it currently does not consolidate, which are exempt from the provisions of FIN 46. Adoption of FIN 46 where application was required during the quarter ended January 31, 2004 did not have a material impact on the Company’s consolidated financial statements.

		The Company is continuing its evaluation of interests in other potential VIEs, and will continue to monitor additional guidance as provided by the FASB.

		EITF 00-21

		In August 2003, the Company adopted Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF 00-21 requires consideration received in connection with arrangements involving multiple revenue generating activities be measured and allocated to each separate unit of accounting in the arrangement. Revenue recognition is determined separately for each unit of accounting within the arrangement. EITF 00-21 impacts revenue and expense recognition related to tax preparation in the Company’s premium tax offices where POM guarantees are included in the price of a completed tax return. Prior to the adoption of EITF 00-21, revenues and expenses related to POM guarantees at


		Three months ended									Six months ended

		July 31,			October 31,			October 31,			October 31,

		2003			2003			2002			2003			2002

Revenues:
	U.S. Tax Operations	$	40,522		$	47,189		$	33,429		$	87,711		$	56,715
	Mortgage Operations		302,895			351,156			274,588			654,051			524,894
	Business Services		98,499			109,024			97,883			207,523			193,197
	Investment Services		56,987			52,703			50,027			109,690			108,690
	International Tax Operations		5,459			19,095			15,326			24,554			19,609
	Corporate Operations		1,328			688			143			2,016			(343	)

		$	505,690		$	579,855		$	471,396		$	1,085,545		$	902,762

Income (loss) from:
	U.S. Tax Operations	$	(93,172	)	$	(130,938	)	$	(152,299	)	$	(224,110	)	$	(246,329	)
	Mortgage Operations		163,829			184,026			153,520			347,855			300,605
	Business Services		(6,679	)		(2,732	)		(3,785	)		(9,411	)		(8,058	)
	Investment Services		(13,757	)		(15,336	)		(27,936	)		(29,093	)		(60,733	)
	International Tax Operations		(6,408	)		555			(250	)		(5,853	)		(6,701	)
	Corporate Operations		(24,984	)		(18,441	)		(31,495	)		(43,425	)		(56,935	)

	Income (loss) before taxes	$	18,829		$	17,134		$	(62,245	)	$	35,963		$	(78,151	)

		Revenues recognized during the three and nine months ended January 31, 2004, which were initially recognized in prior periods and recorded as part of the cumulative effect of a change in accounting principle, totaled $6,206 and $26,631, respectively.

		*Current Accounting Issues*

		Exposure Draft – Amendment of SFAS 140 The FASB intends to reissue the exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of FASB Statement No. 140,” during the first quarter of calendar year 2004. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a QSPE.

		Provisions in the first exposure draft, if adopted, may have required the Company to consolidate its current QSPEs (the Trusts) established in its Mortgage Operations segment. As of January 31, 2004, the Trusts had assets and liabilities of $2,785,603. The provisions of the exposure draft are subject to FASB due process and are subject to change. The Company will continue to monitor


	Three months ended July 31,

	2003					2002

	As reported		Restated			As reported			Pro forma

Revenues	$	494,843	$	505,690		$	431,366		$	442,757

Income (loss) before taxes		17,297		18,829			(15,906	)		(13,514	)
Net income (loss) before cumulative effect of change in accounting principle		10,582		11,519			(9,544	)		(8,109	)
Cumulative effect of change in accounting principle		—		(6,359	)		—			—

Net income (loss)	$	10,582	$	5,160		$	(9,544	)	$	(8,109	)

Basic and diluted earnings (loss) per share	$	.06	$	.03		$	(.05	)	$	(.04	)


	Three months ended						Six months ended

	October 31, 2002						October 31, 2002

	As reported			Pro forma			As reported			Pro forma

Revenues	$	471,396		$	481,003		$	902,762		$	923,760

Loss before taxes		(62,245	)		(60,744	)		(78,151	)		(74,258	)
Net loss	$	(37,347	)	$	(36,446	)	$	(46,891	)	$	(44,555	)

Basic and diluted loss per share	$	(.21	)	$	(.20	)	$	(.26	)	$	(.25	)

~~14.~~		the status of the exposure draft, and consider changes, if any, to current structures as a result of the proposed rules.

15.		Condensed Consolidating Financial Statements


		Three months ended October 31, 2003

		H&R Block, Inc.		BFC		Other						Consolidated
		(Guarantor)		(Issuer)		Subsidiaries			Elims			H&R Block

Total revenues		$	—	$	407,279	$	172,638		$	(62	)	$	579,855

Expenses:
	Compensation & benefits		—		114,390		141,352			22			255,764
	Occupancy & equipment		—		19,810		62,504			—			82,314
	Interest		—		11,612		8,288			—			19,900
	Depreciation & amortization		—		18,391		21,689			—			40,080
	Marketing & advertising		—		9,831		12,016			(164	)		21,683
	Supplies, freight & postage		—		3,684		10,503			—			14,187
	Other		—		90,981		39,060			(84	)		129,957

			—		268,699		295,412			(226	)		563,885

Operating income (loss)			—		138,580		(122,774	)		164			15,970
Other income, net			17,134		—		1,164			(17,134	)		1,164

Income (loss) before taxes (benefit)			17,134		138,580		(121,610	)		(16,970	)		17,134
Income taxes (benefit)			6,758		56,410		(49,716	)		(6,694	)		6,758

Net income (loss)		$	10,376	$	82,170	$	(71,894	)	$	(10,276	)	$	10,376


		Three months ended October 31, 2002

		H&R Block, Inc.			BFC		Other						Consolidated
		(Guarantor)			(Issuer)		Subsidiaries			Elims			H&R Block

Total revenues		$	—		$	326,054	$	145,384		$	(42	)	$	471,396

Expenses:
	Compensation & benefits		—			98,007		131,197			91			229,295
	Occupancy & equipment		—			17,256		54,175			—			71,431
	Interest		—			16,004		6,694			—			22,698
	Depreciation & amortization-					19,066		17,429			—			36,495
	Marketing & advertising		—			8,039		12,934			(155	)		20,818
	Supplies, freight & postage		—			4,660		9,192			—			13,852
	Impairment of goodwill		—			6,000		—			—			6,000
	Other		—			55,437		78,190			(132	)		133,495

			—			224,469		309,811			(196	)		534,084

Operating income (loss)			—			101,585		(164,427	)		154			(62,688	)
Other income, net			(62,245	)		—		443			62,245			443

Income (loss) before taxes (benefit)			(62,245	)		101,585		(163,984	)		62,399			(62,245	)
Income taxes (benefit)			(24,898	)		32,099		(57,060	)		24,961			(24,898	)

Net income (loss)		$	(37,347	)	$	69,486	$	(106,924	)	$	37,438		$	(37,347	)


		Six months ended October 31, 2003

		H&R Block, Inc.			BFC		Other						Consolidated
		(Guarantor)			(Issuer)		Subsidiaries			Elims			H&R Block

Total revenues		$	—		$	772,610	$	313,039		$	(104	)	$	1,085,545

Expenses:
	Compensation & benefits		—			218,079		262,824			66			480,969
	Occupancy & equipment		—			38,797		119,668			—			158,465
	Interest		—			24,463		18,633			—			43,096
	Depreciation & amortization		—			36,092		39,918			—			76,010
	Marketing & advertising		—			16,441		15,679			(329	)		31,791
	Supplies, freight & postage		—			8,101		14,640			—			22,741
	Other		—			161,885		77,654			(170	)		239,369

			—			503,858		549,016			(433	)		1,052,441

Operating income (loss)			—			268,752		(235,977	)		329			33,104
Other income, net			35,963			—		2,859			(35,963	)		2,859

Income (loss) before taxes (benefit)			35,963			268,752		(233,118	)		(35,634	)		35,963
Income taxes (benefit)			14,068			109,551		(95,612	)		(13,939	)		14,068

Net income (loss) before change in accounting			21,895			159,201		(137,506	)		(21,695	)		21,895
Cumulative effect of change in accounting			(6,359	)		—		(6,359	)		6,359			(6,359	)

Net income (loss)		$	15,536		$	159,201	$	(143,865	)	$	(15,336	)	$	15,536