Jackson Hewitt: Unemployment, Electronic Alternatives Muddle Outlook

Jan.14.09 | About: Jackson Hewitt (JHTXQ)

Jackson Hewitt (JTX) plays in a stagnant market and has suffered from bad execution. If the company can return to its historical pattern of gaining share versus CPAs, it should be able to grow modestly for some time. Improved execution during the FY09 tax season, including a more aggressive early-season strategy, could restore profit growth. However, Jackson Hewitt faces the longer-term challenge of consumers increasingly opting for electronic tax preparation and tax filing alternatives.

BUSINESS OVERVIEW

Jackson Hewitt is the second-largest paid tax return preparer in the U.S., behind H&R Block (NYSE:HRB). The company has a branded network of 5,763 franchised and 1,000 company-owned offices. The network provides income tax return preparation, electronic filing services, and refund anticipation loans. Filers earning less than $30,000 accounted for 67% of unit volume in FY08 (compared to 50% nationwide). Jackson Hewitt was spun off from Cendant in an IPO in 2004.

SELECTED OPERATING DATA1

FYE April 30

2006
2007
2008

% of revenue by segment:

Franchise operations

74%
73%
69%

Company-owned offices

26%
27%
31%

Revenue growth by segment:

Franchise operations

20%
4%
-10%

Company-owned offices

14%
12%
8%
Total revenue growth
18%
6%
-5%

EBIT margin by segment:

Franchise operations

62%
61%
53%

Company-owned offices

17%
19%
6%

Corporate and other

-12%
-10%
-15%
Total EBIT margin
38%
39%
24%

% of franchise revenue by type:

Royalty
37%
39%
40%
Marketing
17%
17%
18%
RALs2
37%
38%
37%
Other
9%
6%
5%

Frachised offices (period end)

5,379
5,778
5,763

Company offices (period end)

643
723
1,000

Total tax returns prepared (mn)

3.66
3.65
3.39

Avg revenue per tax return ($)

$178
$192
$192
Click to enlarge

1Q1 FY09 data not shown, as it is not meaningful due to seasonality.

2Includes revenue from refund anticipation loans and other financial products.

INVESTMENT HIGHLIGHTS
  • Prepared 3.4 million tax returns in FY08, or 4% of returns prepared by a paid preparer. The paid preparer market is fragmented and stagnates due to competition from software alternatives. Jackson Hewitt may grow by taking share from CPAs.
  • Franchisees pay marketing fees of 6% of revenue and royalties of 15% of revenue (12% for territories sold before mid-year 2000). Franchisees also pay a $2 fee to Jackson Hewitt for each tax return filed electronically. 20% of franchisees earned revenue of more than $1 million in FY08.
  • 35% of 5,100 total territories remain available for sale (~60,000 people per territory). 78% of new territories were sold to existing franchisees in FY08.
  • Existing territories under-penetrated. In FY08, 31% of territories reached a target of 3+ offices per territory. The company had 2.1 offices per territory.
  • 28% of offices have been in existence for three years or less. As offices mature to 7+ years, their number of tax returns prepared more than doubles.
  • Bought 3.5 million shares for $99 million in FY08 and 4.4 million shares for $142 million in FY07.
INVESTMENT RISKS & CONCERNS
  • Weak FY08 tax season, with returns prepared by Jackson Hewitt down 7%, driven by the lack of an early-season product, brand damage from DOJ lawsuits, and greater compliance requirements.
  • Brand damage from settled DOJ lawsuits against a franchisee for fraudulent tax return preparation.
  • Terminated CEO Lister on heels of IRS and DOJ settlements in 2007, promoting Michael Yerington from COO to CEO and Mark Heimbouch from CFO to COO. Daniel O’Brien joined as CFO in January 2008, while Heimbouch resigned in October.
  • Refund anticipation loans (RALs) are short-term loans with a high implied interest rate. In January 2008, the IRS issued an advance notice of proposed rulemaking (ANPRM) regarding the use of tax return information for the marketing of RALs.
  • Franchise renewals coming up in 2009-10. 93% of franchisees opted to renew their ten-year deals in the last renewal cycle in 1999-2000. One-third of franchise deals will be up for renewal in the next two years (no renewals prior to April 15, 2009).
  • Competition from H&R Block, Liberty Tax and alternatives, including Intuit’s TurboTax software (NASDAQ:INTU) and the Free File Alliance, an IRS consortium.
  • Highly seasonal business presents hiring and space utilization challenges. There were 7,700 seasonal hires in company-owned offices in FY08, compared to a year-round base of 430 employees.
MAJOR HOLDERS

CEO Yerington <1% │ Other insiders 2% │ Invesco 16% │ Shamrock 10% │ Fidelity 9% │ Cap World 6% │ Burgundy 5%

RATINGS
VALUE

Intrinsic value materially higher than market value?

***
MANAGEMENT

Capable and properly incentivized?

***
FINANCIAL STRENGTH

Solid balance sheet?

**
MOAT

Able to sustain high returns on invested capital?

***
EARNINGS MOMENTUM

Fundamentals improving?

**
MACRO

Poised to benefit from economic and secular trends?

**
EXPLOSIVENESS

5%+ probability of 5x upside in one year?

**
Click to enlarge

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