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2001 BW 50



Q&A with H&R Block's Mark Ernst
The CEO is out to diversify the tax-preparation giant, but only if it complements the core business

For being only the third CEO hired from outside the Bloch family, Mark A. Ernst of H&R Block (HRB ) is pretty bold. Just four days after taking over the top job in January, 2001, Ernst decided to squash a pilot offering of home and auto insurance to H&R Block customers. Considering it was a pet project of the previous CEO, the decision sent shock waves through the staid organization. "Insurance was just the wrong place to start when offering financial services," says Ernst, who paid his way through school by preparing tax returns at his father's business in Bellevue, Iowa.

This isn't the first time the nation's largest tax preparer, which is No. 19 on this year's BusinessWeek 50 list of top-performing companies, has attempted to branch out. Founder Henry Bloch, who started the business in 1955 with his brother Richard, had tried to diversify into legal services in the '70s and was even an early Internet service provider, through its purchase of CompuServe in 1980 (it sold that business in 1998). But past experience is obviously not causing Ernst any distress. He's pretty certain H&R Block should diversify, but only into financial services that complement its core tax business.

Ernst wants Block advisers to offer customers a chance to save for retirement with IRAs, offer more competitive interest rates for their home mortgages, and even help them invest in mutual funds. So far, Wall Street loves the idea, sending the stock up 117% in 2001. Block's most recent quarterly net profits were up six-fold, at $29.6 million. Best of all for Ernst, the tax business is looking even more promising, as the many changes in the tax code should continue to send taxpayers into Block's 9,000 offices nationwide.

Ernst talked recently with BusinessWeek Chicago Correspondent Pallavi Gogoi about his various plans. Edited excerpts from their conversation follow:

Q: What's driving the current expansion of H&R Block into financial services?
A: H&R Block is one of the great brands in America, and we have had a long history of serving millions of people preparing their taxes. And our clients -- made up mostly of middle America, with an income of less than $85,000 [per year] -- don't have any place to turn to for good financial advice, as brokers tend to serve the top 10% of the population.... We are targeting the 90% that's left over.

Q: Well, almost everybody seems to be offering financial services today. What's your competitive edge?
A: Very few of our competitors have 17 million office-based clients. We have about 10,000 full-time employees, and we ramp up to 100,000 during tax season. Our clients have a pretty strong relationship with their tax preparers. Besides, we also have access to a lot of data that our competitors don't. And as we look at [customer] information, we might be able to offer a better rate on their home mortgage or offer them a way of saving money through IRAs or mutual funds or other forms of investing.

Q: But isn't that an improper use of financial data?
A: That's a topic we care deeply about and watch very carefully. We know that it's a bigger risk in our business if people believe that we're using their personal financial data in a way that's inappropriate. But our approach and strategy is to ask their permission to use their data for their gain. In fact, so far in this tax season, 7 out of 10 clients are saying yes to our free financial advice.

Q: How have you prepared for this?
A: At this point, we only have 2,000 people who are registered financial advisers, and we have a long way to go before we can serve all our clients.

Q: How is your tax business doing?
A: The bulk of our revenue and profitability comes from our tax business. But it's a boringly consistent business, where the number of tax filers has grown an average 1.5% a year. It doesn't grow much faster than that, nor does it go down, it just marches along.

The good thing is, 20 years ago, 45% of the population paid someone to do their taxes. Today, its 55%. Besides, there have been a lot of tax-law changes that will have a positive effect on our business as [they phase in] over the next 10 years. Our latest TV ads are designed to take advantage of the tax-law changes.

Q: You have only a 30% share of the online-taxpaying business. How is that doing?
A: So far this year, we have had 100% growth in online filers. But that's only 5% of our tax business. That market has shaken out very quickly -- there's only Intuit and us among the better-known players that offer online tax filing.

Q: Your mortgage business seems to be growing nicely. But interest rates won't remain low forever. How are you positioning yourself for that?
A: It has been the fastest-growing part of our company over the last two years. This year, new loans have grown at an 80% pace, which is incredible. Earnings grew 57% last year and will double this year. While we clearly believe that the low-interest-rate environment won't last, we don't expect our business to slow down dramatically.

Our focus has been in purchasing the term-refinancing business where people refinance in an attempt to get money out of their home equity. And research shows that people who do are driven by events like finally deciding to pay down credit-card debt or their children's college and are not driven by low rates.

Q: There's worry that much of your mortgage business is in the subprime area. And other lenders have had problems because of rising delinquency rates.
A: The concern in the industry comes from a history of poor or marginal players doing bad things. For instance, there are companies who use gain on sale accounting too aggressively and, as a result, end up reporting income they don't realize in cash until later on. But we've been very cautious in our accounting. We certainly know and believe that we are conservative. In fact, last fall we had to write up some of our assets. Then there's always the reputation problem of whether we offer high-cost loans, but we've never done that.

Q: Haven't you recently settled a class action claiming that you lend at high rates? Considering that those lawsuits could reappear, why do you continue doing that?
A: Last year, we had $133 million in revenues from refund-anticipation loans [given in advance of an expected tax refund], and of that we made $67 million. People who take issue with refund loans point to the fact that if you calculate the annualized percentage rate [on what is essentially a two-week loan], it is high. But the cost to us for those loans is not the interest's the bad debt [from customers who don't get their government refunds].

A lot of people may not qualify for a tax refund because of various factors, and we might not get that loan back. From our perspective, these loans fill a demand or need that we can't get rid of or do much about, since consumers demand fast refunds. Only if the IRS can return refunds in 48 hours will it wipe out the need for the refund-anticipation loans. That will be a good thing for our customer when that happens.

Q: You are changing a lot of things at a company that had previously been pretty insular. How's that working?
A: I was brought in as a change agent with the board's desire to move business beyond the traditional tax preparation. So I have had support from the board from the start. The organization was skeptical about it at first, especially since it's relatively easy to change a place when it's in trouble. But here business has been fine, so there's not as much galvanizing need to do anything different.

How do you get an organization to recognize opportunity or a need to change where it's not because business is at risk? That's part of the reason why it has taken three years to gain momentum.

MARCH 3, 2002

Edited by Beth Belton

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