Jackson Hewitt Tax Service Inc. F3Q09 (Qtr End 01/31/09) Earnings Call Transcript

Mar. 4.09 | About: Jackson Hewitt (JHTXQ)

Jackson Hewitt Tax Service Inc. (JTX) F3Q09 (Qtr End 01/31/09) Earnings Call Transcript March 4, 2009 4:45 PM ET

Executives

David Weselcouch – VP, Treasury and IR

Mike Yerington – President and CEO

Dan O'Brien – EVP, CFO and Treasurer

Analysts

Kartik Mehta – FTN Equity Markets

Scott Schneeberger – Oppenheimer

Todd Young – Morningstar

Vance Edelson – Morgan Stanley

Fred Thomason [ph] – Goldman Sachs

Michael Millman – Millman Research Associates

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Jackson Hewitt Tax Service Incorporated earnings conference call. My name is Louisa and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is recorded for replay purposes.

I would now like to turn the call over to Mr. David Weselcouch. Please proceed, sir.

David Weselcouch

Thank you, Louisa, and good afternoon, everyone. I’m David Weselcouch, Vice President, Treasury and Investor Relations for Jackson Hewitt, and I’d like to welcome you to our fiscal 2009 third quarter results conference call. Joining me this afternoon are Mike Yerington, our President and Chief Executive Officer, and Dan O’Brien, our Executive Vice President and CFO.

Our earnings release went out on the wire just after 4:00 PM, and hopefully you’ve had an opportunity to take a quick look at it. The earnings release can be accessed at the Investor Relations section of our website located at www.jacksonhewitt.com.

The format for today’s call will be as follows. First, Mike Yerington will provide commentary on our 2009 Tax Season. Following Mike, Dan O’Brien will review our third quarter financial results, provide select full year guidance, and cover our capital structure. And finally, we’ll open the call up to your questions. Today’s call is scheduled to conclude at around 5:45.

Before I turn the call over to Mike, let me briefly state our Safe Harbor disclaimer. Please note that this morning’s conference call contains statements that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied.

In addition, this conference call contains time-sensitive information that reflects management’s analysis, expectations, and assumptions as of the date of this live call. For further information concerning issues and risk factors that can materially affect the Company’s business and financial performance, please refer to the press release we issued today, our Annual Report on Form 10-K for the fiscal year ended April 30, 2008 or our other SEC filings.

Jackson Hewitt does not assume or undertake any obligation to update or alter any forward-looking statements made or information presented during this call. This call is open to the public and is being webcast simultaneously on our website at www.jacksonhewitt.com. Additionally, the webcast will be available for replay on our website.

At this time, I’d like to turn the call over to our President and CEO Mike Yerington.

Mike Yerington

Thank you, David, and good afternoon everyone. Today I am reporting mixed news to you regarding our Company. First, we are providing 2009 full year guidance today that reflects operating and financial results that fall below the expectations we had coming into this tax season. And our performance today will be the predominant focus of my comments on this call.

However, I will also be discussing our announcement today that Jackson Hewitt has been selected to be the exclusive provider of tax preparation services in Walmart stores. I thank you for your patience over the last few days, this past day and a half, as the timing of the Walmart announcement slightly delayed our earnings release and our conference call. I will have more to say about this important announcement with Walmart in a few minutes.

Let’s move right into our results. We experienced a disappointing 2009 Tax Season through the end of February. Further, the fiscal 2009 full year guidance we are providing today reflects our current expectations and underscores the challenging year we had experienced. Specifically, for the fiscal year 2009 full year, following a slower-than-anticipated start to the tax season for us, we are currently expecting our total tax return prepared year-over-year to be down in the range of 12% to 13%, and revenues to be in the range of 8% to 10% compared to last year.

We have moved quickly to address some of the factors that contributed to our slow start. We have instituted certain marketing and promotion, and incentive actions as well as taken certain cost control measures to improve our operating and financial performance over the remainder of the tax season. We understand that given our footprint’s orientation towards the first tax season, it will be difficult to make up lost ground during the second tax season, but we expect these changes to have some impact on our fourth quarter and position us more effectively, going forward.

I would like to spend a few minutes talking to you about our plans we had in place for the 2009 Tax Season and our observations about how the season has unfolded. We entered the 2009 Tax Season feeling positive and poised to execute our plans and with an expectation that all of our off-seasons preparations to put Jackson Hewitt back on track following last year’s results would deliver a successful season.

We approach the 2009 Tax Season as the first step in returning Jackson Hewitt to long term profitable growth by undertaking several initiatives to prepare us for improved performance in 2009 with a focus on new product development, with particular emphasis on being in the market with a compelling early season product, significantly enhancing our marketing and branding programs, improving same-store sales and profitability, selectively broadening our distribution and partnership arrangements, and creating a more efficient, flexible cost structure throughout our organization. As we approach the season, we believe we had made excellent progress and we are well positioned for the 2009 Season. And we told you so at our analyst day meeting in December.

We rolled out the first phase of our early season product back on November 21st, 2008, to a high level of interest and demand in the marketplace. Given the extraordinarily challenging credit market, we were very pleased to be in the market with the product albeit at a somewhat smaller overall program than we would have liked. From our November launch to the end of our early season product offering in mid-January, we were generally pleased with the program. The first phase of our early season program generated significant store traffic. Remember, the early season product is primarily a retention device for us.

One thing we did observe was a somewhat less-than-anticipated demand for the second phase of our early season product offering in early January. This may have been a harbinger of our slow start in the tax season. Conversions of early season product customers to tax preparation were such that we don not anticipate any material requirements for the back staff we provided to the lender [ph] for this program.

We hit our peak during the first week of February and had several solid days that week. However, the following week, we continued to trail the 2008 Tax Season results on a comparable day basis during the second week of February. And this sluggish pace continued throughout February.

The pricing strength we saw in January continued during the remainder of the first tax season, although at somewhat reduced levels. While this provided improved revenue per customer in February, it worked against our return count. All-in-all, this has been a challenging and disappointing first tax season for us. As I stated in our analyst day meeting in December we needed to own the first season and to win in the first season, particularly given the first season orientation of our current footprint. And we did not accomplish this.

We are assessing the aspects of our plan that did not produce the results we desired. We have already learned certain things that I want to share with you that appear to have hurt us in the first tax season. First, the relationship of our pricing to demand throughout our system hurt our tax return count, particularly in this tough economic environment where our customers sought less-expensive options. For the 2009 Tax Season, we provided our franchise system with guidance reflecting low-single digit price increases that we believed were available even in view of the economy and the competitive environment.

During the first tax season, franchisee pricing increased above our suggested guideline. This is an area in which we need to have greater influence and in partnership with our franchisees we need to jointly review and reform our pricing strategy in this increasingly price-sensitive market.

Pricing in our own Company-owned operations did not increase as much as in the franchise system, but was at a level during the early season that reduced return volume.

There has clearly been a heightened awareness of price and value among first season customers. And this has hurt us given our pricing levels versus competitive discounting during this period. In addition to pricing, there are a number of factors, which we believe that affected our results and will need to be addressed, going forward.

Our second observation is that we saw an increasing competitive intensity from independents. In general, we believe the independents continued to engage in pay stub tax filing, exhibiting – exhibited a lower compliance orientation versus Jackson Hewitt and deployed a more aggressive street-level marketing.

On the subject of pay stub filing, we have and will continue to diligently pursue stricter enforcement against this practice. We recently provided a position paper on this subject to the IRS and we believe the IRS and our bank partners have greater awareness of this issue now than in the past. It will take time, but we will continue to push for greater enforcement in this area or a leveling of the competitive playing field by the IRS.

As for compliance, we have no intention of backtracking. In fact, we expect to set the standard in the industry for compliance effectiveness. We have lost some customers due to our compliance standards, but in fact these are customers we may not want. What we will continue to improve is the overall customer experience that we attract and – so that we attract and retain customers who choose us for our products, our services, and ease of doing business with us, and because we fully comply with IRS standards.

As you know, we revamped [ph] our marketing and brand image efforts in the off season with a new look, new messages, and the addition of Magic Johnson as our spokesperson. And we and our franchisees feel we have improved greatly in this area. The addition of Magic Johnson as our spokesperson has been a positive and our national brand advertising to increase brand awareness was well received. But, the overall program was not effective to the degree we had envisioned in terms of enhanced retention and attracting new customers into our location. We need to dramatically improve our local marketing and promotion activities because more than ever street-level marketing is prevalent in the first tax season and this is the market we (inaudible).

In addition to pricing and increased competition from independents, the third issue we have seen is a significantly higher level of encroachment from online filing, a further indication that lower-priced channels were being sort out by the market. We expect to have our own online presence in place for the 2010 Tax Season.

Fourth, we were impacted by having an overall reduced footprint versus the prior year. In fact, notwithstanding our excellent relationship with Walmart, we were in about 140 fewer Walmart locations this year versus 2008. Walmart corporate changes involving floor space resulted in less desk space for us in some locations and made certain locations unfeasible. Year-to-date through February the returns generated through our Walmart distribution channel have declined by roughly 70,000 or 21% versus a year ago. In connection with today’s Walmart announcement, we are working jointly to mitigate these issues in advance of next tax season.

Fifth, we also less effective store rollouts – new store rollouts, particularly in our Company-owned segment where we had closed approximately 200 underperforming locations after last season and then reopened roughly 160 new locations that have not performed up to our expectations.

Finally, we did not deliver as good a customer experience as we had envisioned with our expanded debit card platform, primarily due to the issues involving back office execution of card loads and call center responsiveness and our customers’ reaction to receiving refunds on the debit card versus the paper check. These areas of concern apply to our performance across both our franchise operations and our Company-owned stores.

We are committed to taking the actions that were necessary to change the direction of our business and we are approaching this situation with an absolute sense of urgency. We are currently assessing our pricing strategy, our marketing effectiveness with emphasis on our street-level marketing tactics and strategy, the execution and roll out of new products, our overall cost structure, and the structure and foot print of our Company-owned operations. We are not sitting back waiting for this tax season to end before taking action.

We have put in place marketing and incentive programs to drive incremental tax returns and revenues during the second tax season. We are currently utilizing select franchisees and Company-owned operations to aggressively test pricing alternatives, not only to help drive performance over the remainder of this tax season, but also to begin to formulate our pricing strategy in preparation for the next tax season. You can be assured that we will carefully and thoughtfully develop a pricing strategy that enhances our competitive position in the first season, while optimizing our revenue opportunities.

We have also already taken actions to take cost out of our business to maximize our cash flow and profitability over the remainder of current tax season. Our objective right now is to finish this year as strong as possible and then make the required changes to get us on track in advance of the next tax season.

Now, before I turn the call over to Dan, let me comment about the new Walmart announcement – what the new Walmart announcement means to Jackson Hewitt. First of all, to be selected by Walmart as their exclusive tax preparation provider following a competitive evaluation process means a lot to Jackson Hewitt, and says a lot about the commitment we share with Walmart for quality and service. I thank all of the Jackson Hewitt team members and franchisees who played a role in showcasing our capabilities during the process and I also want to thank Walmart for their commitment.

Let me be clear, that this is a very significant announcement for Jackson Hewitt. Jackson Hewitt has been associated with Walmart since 1995 and the relationship has provided a productive, efficient, and profitable retail distribution channel for Jackson Hewitt’s tax preparation service. Historically, Walmart has provided tax preparation on a non-exclusive basis by splitting their locations across competing tax providers. To give you some perspective on how meaningful this is to Jackson Hewitt, consider that Walmart is providing tax preparation services through its vendor relationships this tax season in about 2250 store locations of which Jackson Hewitt is operating in roughly 1200 stores. So, as you can see, to be names Walmart’s exclusive provider is truly a huge opportunity for us.

What is also exciting for us as we look to the future is that about a third of the incremental new Walmart locations are in territories where we do not have a presence today and are located in more suburban demographic versus our current footprint. The key message here is that this exclusive arrangement provides us with a unique opportunity to rapidly expand our footprint into markets where we are not today as well as immediately enhance our overall footprint relative to the second season.

Further, this incremental opportunity does not carry the associated cost and risk of opening up new store front locations. These Walmart locations have been occupied by a competing tax service with proven volume. If they prove similar to our volume of roughly 350 returns per Walmart store, this will be a great opportunity for us. The bottom line is that the expansion of our relationship with Walmart is a win-win proposition, and we look forward to maximizing the potential of this opportunity as we head into the next tax season.

At this time, let me turn the call over to Dan to cover our operating and financial results for the quarter as well as our guidance and capital structure. Dan?

Dan O'Brien

Thank you, Mike. This afternoon, I will cover three areas in my remarks. First, I will briefly review our operating and financial results for the third quarter. Second, I will discuss our fiscal 2009 full year guidance, and lastly I will review our capital structure.

Before I touch on our third quarter financial results, let me cover certain operating statistics that will help you understand the relationship of our third quarter financial results to our full year guidance. I will start with our location count. We have approximately 6600 locations across the combined footprint of our franchise and Company-owned operations, a decrease of around 3% versus the same period last tax season.

During the first nine months of the 2009 fiscal year ending on January 31st, 2009, our total system, including franchisees and Company-owned operations prepared 1.16 million tax returns, a decline of 3% versus the 1.21 million tax returns prepared during the same period a year ago.

But this 3% decline in returns does not tell the full story of how we stood coming out of the quarter. On a comparable day-over-day basis, for example, Friday versus Friday the same week the year before, consistent with how the IRS and industry observers track interim performance, tax returns were running just under 20% below the same period a year ago as we headed into February. Under this comparable day-over-day basis, due to the manner in which the calendar days fell at month-end, two filing days that were reflected in this year’s third quarter tax return results were reflected in the fourth quarter a year ago. Since these were relatively high volume days, this had the effect of having our third quarter return count reflect a much smaller decline on a reported basis compared to how overall return volume was performing.

Subsequent to the end of the 2009 third quarter year-to-date through the end of February Jackson Hewitt and its franchisees had prepared 2.22 million tax returns, reflecting a decrease of 12% versus the 2.50 million tax returns prepared during the same month-end period last year, excluding the 2008 economic stimulus rebate tax returns.

The effect of the comparable day-over-day basis on return count is also reflected in our third quarter financial results versus the year ago quarter. I mention this because on a GAAP reporting basis, our third quarter results would appear to be somewhat disconnected from our full year guidance.

However, for the same reasons I mentioned regarding return count, we came out of the third quarter in a less favorable financial condition compared to last year than it appears when you just look at our reported third quarter results.

Now, with that as backdrop, let me briefly cover the reported numbers in the quarter. This afternoon, we reported net income of $20.9 million or $0.73 per diluted share versus net income of $18.2 million in the third quarter of fiscal 2008 or $0.61 per diluted share. Since normalizing adjustments in the quarter were negligible, on an adjusted basis our net income in the 2009 third quarter was $21 million or $0.74 per diluted share versus an adjusted net income of $18.4 million or $0.61 per diluted share in the year-ago quarter.

A schedule entitled, ‘Condensed Adjusted Results of Operations,’ which reconciles the reported and adjusted results, accompanies this afternoon’s earnings release.

Jackson Hewitt’s reported consolidated total revenues in the 2009 third quarter were $97.8 million versus $97.6 million in the same period last year. The slight increase in revenues versus last year’s third quarter resulted from higher average revenues per return, offset by a lower number of tax returns prepared and lower financial product revenues. Our overall year-to-date revenues per return increase of 10.6% from $202 to $224 per return was in part impacted by additional fees this year that were not in place in the prior year. Of the increase, approximately 2% to 3% was related to tax planning and other fees connected with the early season loan program and 1% to 2% was associated with the new check fee introduced this year. Core tax prep fees increased in the area of 6%.

In our franchise operations, reported total revenues in the 2009 third quarter was $65.9 million versus $66.9 million in the 2008 third quarter. Royalty and marketing and advertising revenues were $42.7 million in the 2009 third quarter versus $39.3 million in last year’s third quarter, reflecting an increase of 9%. This change was due to higher franchisee revenues, resulting from an increase in average revenues per return, partially offset by lower reported franchisee tax return volume in the quarter versus last year. The average royalty rate across the system in the quarter increased modestly from 13.39% last year to 13.58% this year, given the increased level of returns generated from franchisees with a 15% royalty rate versus 12%.

Financial product fees were $21.2 million in the third quarter, reflecting a decline of 13% versus the $24.5 million of financial product fees in the 2008 third quarter. This 2009 decline versus last year’s third quarter reflects somewhat lower fixed fees in this year’s program as compared to last year, a timing change related to the recognition of certain financial product revenues versus last year as well as lower overall product counts. The fixed fee component of the financial product agreements are accounted for on a percentage of completion method over the tax season.

In the 2009 third quarter Jackson Hewitt recorded sales of five new territories versus 30 new territory sales in the same period a year ago. Year-to-date, 70 new territories have been sold versus 123 in the comparable period last year. The decline in territory sales year-to-date continues to be due in part to the ongoing difficult economic environment for sales. Territory sales are reported in the Other revenue line item.

Reported total expenses in the franchise segment were $29.7 million in the 2009 third quarter versus $31.9 million in the 2008 third quarter. Income before income taxes was $36.6 million for the 2009 third quarter versus $35.4 million in the prior year quarter.

Turning now to our Company-owned offices segment. In the 2009 third quarter service revenues from Company-owned operations increased 4% to $31.9 million versus $30.6 million in the year ago quarter. The increased service revenues, as with the franchise segment, resulted from higher revenues per return, impacted by the new fees outlined earlier, offset in part by a decline in tax returns prepared.

Total expenses for Company-owned operations were $24.5 million in the 2009 third quarter, reflecting a decrease of $0.4 million versus the year ago quarter with improved productivity in the operations of the stores being partially offset by a higher marketing spend during the third quarter. Income before income taxes was $7.4 million versus $5.7 million in the prior year period.

Lastly, in our Corporate and Other segment, our loss before income taxes in the 2009 third quarter was $9.3 million versus a loss before income taxes of $11.1 million in the 2008 third quarter, primarily due to a decline in general, and administrative expenses year-over-year.

Let me now turn our attention to our expectations for the fiscal year 2009 full year. As you know, prior to today we have not provided any fiscal 2009 full year guidance, but at this time, we believe it’s prudent to provide you with our current view regarding certain metrics. Accordingly, for the 2009 fiscal year, as Mike indicated earlier, we are now projecting that total system tax returns prepared will decline by 12% to 13% versus the prior fiscal year excluding the impact of incremental, but lower-priced economic stimulus program tax returns from the 2008 fiscal year. We are also projecting that our average revenues per tax return will increase in the range of 7% to 9% for the full year versus the 2008 fiscal year, also excluding the impact of the economic stimulus returns in the prior year.

Based on these expectations, we expect the total revenues for the 2009 fiscal year will be in the range of $250 million to $255 million, consistent with the percent decline Mike highlighted earlier. And adjusted diluted earnings per share will be in the range $1.00 to $1.10. This adjusted diluted earnings per share range excludes various non-operating items as depicted and reconciled in the schedule I mentioned earlier entitled, ‘Condensed Adjusted Results of Operations,’ which accompanies our earnings release.

Moving now to our capital structure. We ended our 2009 third quarter with a debt balance of $356 million, which left the unused portion of our $450 million credit facility at $94 million at quarter-end. We hit our peak borrowing day towards the end of the quarter and have subsequently been reducing debt as revenues from the tax season have come in. Our leverage ration at the end of the third quarter was 3.1 times versus our maximize allowable ratio under our credit agreement covenant of 3.5 times.

We continue to use our excess cash to reduce our debt during the fourth quarter. However, we expect our leverage ratio will likely come in higher than previously projected at the end of the 2009 fourth quarter, given the guidance that we have provided today. You may recall that we amended our credit facility at the conclusion of the 2008 Tax Season in order to create additional near-term flexibility in our leverage ratio covenant. In connection with last year’s amendment, our leverage ratio will step down fro 3.5 times to 3.15 times for the period ending April 30th, 2009, and it is this 3.15 times leverage ratio from which we believe we will need additional relief.

Accordingly, given the challenging 2009 Tax Season we are experiencing coupled with this step down in our maximize leverage ratio at the end of the fourth quarter, we have begun discussions with the agent bank and our credit facility. In fact, we have reached out to all of the member banks in our credit facility syndicate to advise them that we intend to seek relief in connection with our leverage ratio covenants under our amended and restated credit agreement in advance of the 2009 fourth quarter measurement date.

We believe we will be able to successfully work with our bank group to amend this covenants in advance of the conclusion of our fiscal fourth quarter, which ends on April 30th.

With that, let me now turn the call back to Mike.

Mike Yerington

Thanks, Dan. Before I go any further, I want to publicly thank our employees, our franchise partners, and our vendors for all their efforts as we prepare for the 2009 Tax Season and their ongoing work as the season moves forwards.

To briefly summarize, we are disappointed with the results we have achieved to-date and our expectations for the full 2009 Tax Season. We have made select in-season adjustments to improve our performance over the remainder of the tax season. We are currently assessing the aspects of our business that require change and we expect to be in a position on our June call to outline specific actions we intend to take in advance of the 2010 Tax Season.

Lastly, I want to reiterate the importance of the Walmart announcement. To be the top choice for tax preparation services in the store – in stores for the world’s largest retailer is a very – is very gratifying and is a very meaningful first step in developing our plans for the 2010 Tax Season.

At this time, we will open the call for your questions, and I ask that you please provide your name and company affiliation at the outset of your question. I’d like to ask our conference call moderator to review the procedures for the questions-and-answer session.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Kartik Mehta with FTN Equity Markets. Please proceed.

Kartik Mehta – FTN Equity Markets

Good afternoon.

Mike Yerington

(inaudible) correct.

Kartik Mehta – FTN Equity Markets

Hi, how are you?

Mike Yerington

Good.

Kartik Mehta – FTN Equity Markets

A big picture question to start off with, I guess as you look at next tax season and you want to grow your store base, with the couple of last – couple of tax seasons you’ve had it has been a little bit disappointing. What do you think the impact of that – is there going to be on getting new franchisees on board to sell locations, or do you think you have to now open more Company-owned stores?

Mike Yerington

You know, I think it’s a good question. With the Walmart announcement today, there are over 300 locations, which are available for sale to either new or existing franchisees. I think that there will be a lot of franchisees. It will be very excited about being able to get into that opportunity because those operations are, as you know, or may know, are available for the season only. And so the cost to rent that space for the season is good for them versus renting a store for the whole year. And I think that we are just now starting to see some effort on the sales side of the house that would give us some other stores besides Walmart. So, even though we have not focused on that this year, and with the addition of the Walmart distribution we probably won't spend a lot of time focusing except to get Walmart to get rolled out, I think that we’ll have a great footprint next year as we end the season.

Kartik Mehta – FTN Equity Markets

And you talked a little bit about market share loss and I am trying to figure out how much would you say your market share loss is to independents versus branded companies?

Mike Yerington

You know, I don’t know the answer to that question. I think that we’ve lost some market share across the board. I think if you had to put it in perspective, I think independents are probably – in most of territories we compete with 35 independents to one of our stores. We compete, for example, with Block, with about three to four stores to one of our stores. So, I think there is probably some impact from both those as well as other players.

Dan O'Brien

I would expect – just to add into that, that Block and other players have – had online presence, which we don’t have. So, I think losses from a market share or return basis would probably be higher on the online side to a Block than kind of brick-and-mortar from an independent standpoint.

Kartik Mehta – FTN Equity Markets

And maybe – that’s a good segue to my last question, which would be the online presence. You talked a little bit about that, Mike, maybe having one next year. Is this something you anticipate partnering with somebody or is this something you’ll do on you own and create a product and will it be – Internet-based or gotten by software or both?

Mike Yerington

Yes, I think it will be Internet-based and I think we are looking at all options at this point. I can't really tell you which way we will go. I think likely since we are coming to the game late we will probably partner with somebody that has an offering that we can modify to our satisfaction.

Kartik Mehta – FTN Equity Markets

Thank you very much.

Mike Yerington

Yes.

Operator

Your next question comes from the line of Scott Schneeberger with Oppenheimer. Please proceed.

Scott Schneeberger – Oppenheimer

Thanks, good afternoon. Following up on the theme of where the lost market share may have gone, you guys mentioned that you think it might online as opposed to other store front peers. Is that – what do you think the retail business as an industry will grown this year overall with what you’ve seen through the season?

Mike Yerington

You know, if I had (inaudible) I would say it will be flat to down some based on what we’ve seen so far

Scott Schneeberger – Oppenheimer

And why do you think that is? Anything to do with unemployment perhaps this year or just adding theories along why (inaudible)?

Dan O'Brien

I think the economy is going is going to be a piece of it, but I think online is the other piece of it. I think from a retail standpoint, would expect, as Mike said, probably for it to be more or less flat with growth in the industry occurring on the online, certainly that seems consistent with what we are seeing at this point.

Mike Yerington

One other bit of data reflects the online – folks moving to online, we do exit surveys, Scott, every year with our customers to find out if customers have left us why they left. Last year, when we asked the question, “Did you move online?” we had a single digit response to that. This year we’ve had five times that where people have said, “No, we moved on line.” So, I think that that’s becoming more of an issue for us as we go forward.

Scott Schneeberger – Oppenheimer

Okay. That’s interesting. The – okay, I guess just going back to the store front then, is – could you talk a little bit to what you were seeing by – at the – you said one of the things that you had trouble with was the street-level promotion. Could you just talk about what was occurring that you were doing wrong or that others were doing that was hindering you?

Mike Yerington

Yes, let me – I don’t want to leave with the impression that we did not focus on street-level marketing. That would be a misnomer. We have spent a great deal of time on that. We’ve done folks in the field passing out coupons, flyers, we’ve done President’s weekend Day promotions, St. Patrick’s Day promotions, you name it, we’ve got promotions going in at all levels. We’ve also been out working in our workshops. We’ve just finished 42 markets where we’ve gone out and talked to people about local market, what I call in-your-face marketing, local guerrilla marketing. So I don’t want to leave with the impression that we had not done local marketing because we have. I think that the aggressiveness that we’ve seen in the marketplace this year by independents has been particularly hurtful to our business. And I am talking about – you know I was in a location down in Baton Rouge where people were coming into a waiting room offering discount coupons, in our waiting room. So I think that we’ve been aggressive. We’ve been, I think for our franchise base, I think we’ve been fairly aggressive, some better than others, but I think that the local marketing I am talking about is in-your-face, here is a coupon, I am in your lobby, I am going to give your guy a coupon to come to my stores. So, things like that, which I think are what I call bare knuckle fights and I think we took glove off this year, maybe we need to take both of them off.

Scott Schneeberger – Oppenheimer

Okay, thanks, and then it sounds like that’s predominantly mom and pops. Anything from Block or even Liberty that you might have seen that was surprising, any changes in pricing or behavior that was different from what was – what made them stay in previous seasons.

Dan O'Brien

Yes, I think that, again, I can't talk to Liberty. I visited some Liberty offices earlier in the season. I kind of get a sense of how they do business. It’s probably different than the way we do business. But with Block I know they route early in the marketplace with a $50-off coupon, a direct mail coupon and so that’s one instance – one instance of where I see them being very aggressive on price. I think that that’s probably the only hard, concreted thing that I’ve seen. I haven’t seen in comparison, when we have people do mystery shopping within our competitive environment. Their pricing seems to be similar to ours. It’s not a – in the Block case, anyway, it’s not significantly different. And in the independent area, I think it’s significantly different because that’s the only way they have to compete. I mean they will go out and take a return, do it for $100, we may have to charge $150 for it, but they’ve been very, very aggressive in the independent base.

Scott Schneeberger – Oppenheimer

Okay, thanks. One more and then (inaudible) could you speak a bit about the situation with the covenant being broken in the April quarter or at least certainly do you think that will happen? What type of scenario to envision from here with regard to the – getting credit just (inaudible).

Dan O'Brien

Scott, I don’t think there’s much more that I can say than I’ve already said, which is we’re engaged in discussions with our agent bank and the other banks. We will go through a process with them over the next 60 days whereby we will share with them our plans. We will share with them our expectations. We will work to then recast and provide modification to our fourth quarter covenant level and adjust our going forward views in accordance with that plan. It is a very similar process to one that the Company went through last year. And where we would expect given our good relationship with the banks that we will come to a reasonable conclusion around that before the end of the fourth quarter so as to remain in compliance with our agreement.

Scott Schneeberger – Oppenheimer

Okay, thanks. Now the – you already passed the point where you need to borrow and now you are turning cash flow positive, so I imagine you won't have an adverse impact in the fiscal year ’09 – it is a tough credit environment, so say rates increase what have you, could have an adverse impact on how 2010 occurs, but I guess the root of my question is should it have any type of impact on ’09 financial impact?

Dan O'Brien

There will be no impact on 2009 and to your point it is typical in these kinds of arrangements where you reach some sort of economic agreement with the banks with respect to going forward terms. I would expect that in this case as well. But there will be no impact on our 2009 business.

Scott Schneeberger – Oppenheimer

Okay, thanks.

Operator

And your next question comes from the line of Todd Young with Morningstar. Please proceed.

Todd Young – Morningstar

Hey, how is everyone doing?

Mike Yerington

Good.

Dan O'Brien

Hello, Todd.

Todd Young – Morningstar

I just want to – I am trying to back in a little bit from you guidance numbers and trying to figure out a like what you guys are seeing with op margins? Are you seeing relatively stable op margins, is that – am I looking at that correctly as I try to back into that?

Dan O'Brien

Yes, I don’t think you are far off from that. We have our – revenue is clearly down, but as are our expenses

Todd Young – Morningstar

Okay. And then regarding the – you mentioned something about 350 returns per store at Walmart. I didn’t catch. Was that what you guys have been doing at the Walmart stores or is that what competitors in those locations that you are going to be taking over have done?

Mike Yerington

No, what we did is, we looked at what we were doing in those Walmart stores and since CRO [ph] data is publicly available we looked at where we could what others may have been doing in those stores. So, an average of 350 if probably a good way to look at that.

Todd Young – Morningstar

Okay. So, going forward, if we look at an extra 350 returns for the extra stores you are taking over, that could potentially be what you guys could grow with the Walmart decision?

Mike Yerington

We’ll probably suffer some breakage there, but I think that – the thing about this deal as compared to – if we took – let’s just take 1000 as example – if we went out and try to sell those on our own, that’s like a four or five year or longer process. And every one of those stores would be starting from zero. These are stores that are existing, already have customers coming into them, and on average, if their average is similar to ours, they are doing about 350 returns each. So, it gives us a significant leg up from selling them as compared to selling them from scratch.

Todd Young – Morningstar

Okay.

Dan O'Brien

Hey, Todd, let me also clarify with respect to your first question, again, what I’d said was correct in terms of revenue being down and expenses being down. Our margin is compressed a little bit on that basis, so –

Todd Young – Morningstar

Okay. But nothing –

Dan O'Brien

Nothing huge.

Todd Young – Morningstar

Okay. And last thing, and I will turn it over. Can you give a little more color on what you guys are seeing on the financial side? Obviously, that looked like it took a hit worse than everything else at least going up in the quarter. I was wondering if there is – with trouble with approval ratings for customers looking for financial products, or percentage of people interested or things like that?

Dan O'Brien

No, that wasn’t the case. In our arrangements with Santa Barbara Bank and Republic, both banks are effectively obligated to pay fixed charges to us annually for access to our customers and to our technology. That was the case this year as well. The issues that we are seeing in that is we entered into this season with those fixed charges being somewhat less than they have been historically as a percent of our overall contracts. Again, nothing significant and I think we had said externally before that had we hit the return levels at year-end consistent with where we were last year, the overall economics of our financial product arrangements will be about the same. What we are seeing though is because we are recording principally fixed charges in the third quarter, and with those fixed charge levels being somewhat less, and the fact that we are not into earning variable compensation above those levels until the fourth quarter, we’ve seen some compression then in the fixed – the financial product levels of revenue and associated profitability in the third quarter.

Todd Young – Morningstar

Okay. But there was not issue as far as the lending facility with the two banks, because I know you had lost one that they were able to provide the volume, if the volume was there, is that correct?

Dan O'Brien

Yes, again we are not going to get into describing the approval rates for our banks. Obviously, that’s something you may want to talk with SBBT and Republic on their calls, but I think the lending facilities were there and I – so we don’t think that was a significant factor.

Todd Young – Morningstar

Okay. Well, I will turn it over. Thanks so much.

Dan O'Brien

You bet.

Operator

And your next question comes from the line of Vance Edelson with Morgan Stanley. Please proceed.

Vance Edelson – Morgan Stanley

Hi, thanks a lot. Just starting with the logistics of the Walmart agreement, is it physically possible to get the refund or the debit card in the hand of the customer and get it activated in time for that customer to literally hit the isles immediately or is that logistically too much to hope for?

Mike Yerington

Well, I mean there is an opportunity to load a customer’s card at the time they get their refund. So, yes, that’s possible to have that money available immediately.

Dan O'Brien

I’ll just add, I mean I think that’s the attractiveness to Walmart of our arrangement is that there is cash available to be spent in the store and with our arrangement we’ll be certainly seeking to get both checks and cards in the hands when refunds are received for that spending to occur.

Vance Edelson – Morgan Stanley

Okay. And when you mentioned the certain execution issues, this past season, was that (inaudible) always work out as planned?

Mike Yerington

What I was talking about there is that we had launched ipower Line of Credit 1, and ipower Line of Credit 2 with a bank partner and the execution problems really arose with the loading – for the most part loading the refund on the card, in which case we didn’t anticipate sufficiently the volumes that would be in – coming into the call center there. And then also there the behavior of the consumer who normally in prior environments with us would get their refund on a check and then because of the requirement of this particular bank we were required to load the refund on the card. And in think customers were not used to that extra step. In our prior pre-season products, we had loaded what was then called Help loan and then called the pre-file loan on the card, but the actual refund itself was in the form of a check. And I think the extra step that we added to the process this year at the request of the bank was probably the thing that caused us the most problem.

Vance Edelson – Morgan Stanley

Okay. And following on that, as you look to improve the execution on the debit cards in terms of call center responsiveness and so forth, is that something that could increase expenses or add to margin pressures next year.

Mike Yerington

No.

Dan O'Brien

No, we wouldn’t think so.

Mike Yerington

Yes.

Vance Edelson – Morgan Stanley

Okay. And following up on an earlier question, could you just remind us a year ago when you did negotiate for covenants relief, what was the penalty so to speak, what was the concession on your part, what was the economic impact?

Dan O'Brien

Yes, it actually was – it was principally in the spread that we had to pay. I’d have to come back to with the specific spreads. It varies depending on where we were in terms of our leverage ratio. It was not one (inaudible) spread difference.

Vance Edelson – Morgan Stanley

Okay. And just one more question. I may have missed it, but I didn’t hear you mention the timing of the electronic filing window opening as a factor contributing to the challenging tax season. Did that play much of a role?

Dan O'Brien

I don’t think we felt it was a big reason. Obviously, it’s probably – if I go back to what I had said in terms of our day-over-day numbers being down roughly just under 20% by the end of January there is probably a little bit of the late start to the season that caught up in that day-over-day comparison in January. And we were a little stronger accordingly in the next week or so in February such that by the end of February, we were off approximately 12% to prior year. So, there is a little bit – it’s a little bit of a factor in our third quarter, but I wouldn’t want to over emphasize it either.

Vance Edelson – Morgan Stanley

Okay. That’s helpful. Thanks.

Operator

And your next question comes from the line of Fred Thomason with Goldman Sachs. Please proceed.

Fred Thomason – Goldman Sachs

Hi, this is Fred Thomason [ph] from Goldman Sachs. A couple of questions, if I may. I guess, firstly, you released highlights that your financial product count was lower year-on-year in your franchises. And I was wondering if you could provide a little more color on this. It seems somewhat, I guess, counterintuitive given your product offering was in fact expanded year-on-year and included a – the addition of an early season product.

Dan O'Brien

Yes, again we are not earning much– we are not earning much on the early season product, it’s principally a retention tool for us, Fred. The principal reason for financial product revenue being down is what I had mentioned, which is in the third quarter typically we will not have achieved the level or threshold at which we are earning variable fees under the financial product program. As such, what we do record is a percent – is we record on a percent of completion basis, we record a percent of the fixed fees earned from both banks. In this particular year, as we’ve transitioned last year from three banks to two banks, the structure was somewhat lower fixed payment or fixed charge for financial products, again a portion of which we realized in the third quarter, and that’s the principal driver. So, again, it is not – it’s not reflective of the fact we had a new product offered, we were not expecting to earn much through that.

Fred Thomason – Goldman Sachs

Okay, understood. But I guess you said specifically that your product count was low. I interpreted that as being I guess a lower volume of financial products.

Dan O'Brien

Yes, it certainly is a fact – it’s a really a smaller factor though. We had somewhat fewer Gold Guarantee products, somewhat fewer other product. It’s not the big driver. The big driver was related to the fixed charge – charges being lower, as well as with Republic Bank we basically have some level of contingency that we hold back paying until a little bit later in this season. So, we recorded somewhat less fixed charges due to that in the third quarter as well.

Fred Thomason – Goldman Sachs

Okay, that’s helpful. And then secondly, could you just confirm that basically you are seeing no change in behavior from clients in terms of, I guess the proportion of clients that will come back for tax preparation after taking out a credit product?

Dan O'Brien

Okay, well there is two factors there in that answer to that. One is that we know that if you take out an early season credit product that you have a very strong likelihood that you’ll come back. I mean, obviously, we want you to come back so you can pay back the loan, have your refund. We also found that even if you were denied in the early season, and we found this to be true again this year at even higher rates than was experienced in the past, that if you took out an early season product there was a very strong percentage of folks, above 50%, that came in even if they were denied the early season product. And so, both of those were factors that we were trying to get from the early season product and they played out as they have been in the – as they played out in the past.

Fred Thomason – Goldman Sachs

Okay, that’s helpful. And then just finally, I guess a back-of-the-envelope calculation suggests that your Walmart arrangement, you could generate if you take a 1,000 incremental locations, each generating something like 350 returns, maybe a little less. If you assume average revenues per tax return, that would be annul revenues of something like $60 million or $70 million. So, perhaps you could comment on that.

Dan O'Brien

Yes, I think we’ll get in more and – when we get further on into our fourth quarter, talk a little bit more about this relationship. I think your rough math of 1,000 stores and 350 returns per store is the opportunity that we have, and certainly what we would expect to be the kind of benefit we will realize. I think the prior occupier of those stores will be fighting hard to maintain some level of those customers, I’m sure. So, I don’t want it to seem like it’s a lay-up in this distribution area, but it should be a significant positive to us, but I’d rather not get into the specific numbers until we are a bit further down the road on that.

Fred Thomason – Goldman Sachs

Okay, but there is no reason to think I guess that the average revenues from your point of view per client should be different coming through this channel rather than different channels?

Dan O'Brien

Maybe not, I think it’s similar. And I think what we find – if you just look – and you just look at the Walmart customers, it’s a little bit lower in average revenue per customer, but again I think not meaningfully different.

Fred Thomason – Goldman Sachs

Okay, that’s very helpful. Thanks very much.

Operator

Your next question is a follow-up question coming from the line of Scott Schneeberger with Oppenheimer. Please proceed.

Scott Schneeberger – Oppenheimer

Yes, thanks for taking the follow-up. Could you guys comment on just through the end of February, what you were seeing with regard to refund anticipation loan decision versus not taking them versus choosing another financial product?

Mike Yerington

Yes, I mean I can give you a general top line on that, Scott. We were seeing that for the most part RALs were down a little bit and ARs were up a little bit. It seems that people were choosing the lower-priced alternative and waiting a little bit longer for their money.

Scott Schneeberger – Oppenheimer

Okay, thanks. And then, you said in the prepared remarks something about – I just want to make sure I caught it right – with MetaBank and their early season, you had outlined if there is losses there we could pay a certain multiple, but I believe the commentary was not any material impact. Is that correct?

Mike Yerington

Yes, that’s true. Yes, I mean we had a backstop, as we announced earlier, there was backstop in place if certain conditions existed. We feel very comfortable those conditions will not cause us to have any material impact on the backstop payment.

Scott Schneeberger – Oppenheimer

Okay, thanks. And then, just with – I’m kind of jumping around here, but with this Walmart negotiation, could you tell us – in the past – forget this Walmart negotiation, in the past what are kind of the economics that you work or share or negotiate with Walmart in getting these locations within their stores?

Dan O'Brien

Again I think more to come on that. This is obviously a material contract; it’s one that will be in the public domain. So, there will be more to come on that, Scott.

Scott Schneeberger – Oppenheimer

Okay, thanks. And then just one or two more if I can sneak it in. Would you envision – first of all, what was your retention number last year and what do you envision for it this year, if you care to put that out at this point?

Dan O'Brien

Total season was about 58% last year. I think we are running that or maybe a touch lower than that.

Scott Schneeberger – Oppenheimer

Okay. And then one final cleanup for me. Dan, could you give me the breakout of the pricing, again? I just missed that and I want to make sure that I have that appropriately.

Dan O'Brien

Yes, I think what I had said was overall we had 10 to – 10.6% increase in fees. I think what we had said was 2% to 3% of that was related to products connected with the early season loans, and 1% to 2% was related to a new check fee put in place and that the core tax prep services grew at around 6.

Scott Schneeberger – Oppenheimer

Thank you.

Operator

And your next question comes from the line of Michael Millman with Millman Research Associates. Please proceed.

Michael Millman – Millman Research Associates

Thank you. It was actually Millman. I guess following up on several things; one, can you talk on the Walmart, who you are going to have operate these additional stores and typically what’s the average profitability on these stores compared with the profitability for return in storefronts? Regarding the switch that we are seeing between RALs and RACs, I guess a couple of things. One, Jackson Hewitt – and this is a long term, Jackson Hewitt has a RAL image to an extent has this changed the way you have to market going forward? Two, –

Dan O'Brien

Just – but why don’t we take this one at a time? This is becoming a memory exercise, Michael. I’m going to fail that personally.

Mike Yerington

Let me take the first one first on profitability. More to follow on that as we roll out in the Walmart stores. Let me just give you some general impression. Generally, the profitability, when you are renting space for a specific period of time in whatever retailer you are in is going to give you a more profitable operation than if you are renting a storefront. So it’ll start there, but as I said more to follow. As far as RACs to RALs, we have a footprint that is very much first season. I think that the Walmart distribution will help us move into a second season. I’ve talked a long time about wanting to move out into more suburban areas and I think this gives us an excellent opportunity to move into stores that are in more suburban areas outside of our traditional metropolitan footprint. So, I’m feeling very good about that, and don’t know yet what the total impact of that will be, but traditionally those suburban locations are less user or use less RALs than they do ARs or RACs in your case.

Michael Millman – Millman Research Associates

So, on that – one of the question was who is going to operate those additional 1,000 or 1,200–?

Mike Yerington

Well, I mean – again more to follow. Many of those stores are within our current footprint of franchise operations. The ones that are new, we still have to work on that. We will let you know at a future date.

Michael Millman – Millman Research Associates

And will the franchise be asked to pay something to be able to operate in those?

Mike Yerington

The way our territories work, Mike, if you have one Walmart store, five Walmart stores and they are in your geographic territory that is your exclusive territory, you have the right to operate in those stores.

Michael Millman – Millman Research Associates

Okay. And back on to the – there has been, as you indicated, a change and so it raises I guess long-term – at least to me raises a question to the effect on the company’s image as a RAL shop. And secondly, since RALs are far more profitable for PCBC than RACs like RTs, to what extent they likely to have to change the fee that they can pay for access?

Dan O'Brien

I think that’s a question, Michael, best placed with the bank providers of these products rather than us.

Michael Millman – Millman Research Associates

Okay. Can you talk about the first part?

Dan O'Brien

Could you repeat the first part, Michael?

Michael Millman – Millman Research Associates

The first part is that we are seeing generally a sea change in the business at least this year to the one where elasticity in fact does count. That’s the negatives that seems for RALs, positive for RACs, positive for online. And Jackson Hewitt has an image of a RAL shop in the marketplace and I was wondering to what extent long-term that changes how you have to operate the business and view the business.

Dan O'Brien

Well, I mean I think if you look at our footprint, we’ve said that we traditionally have more of a first season footprint than a second season footprint, I don’t know that I would concede that we have a reputation as for a RAL provider, but I would say as things move forward that if the economy continues at the rate it’s going in the next year there will be a certain amount of price sensitivity, which we’ll be very focused on coming into the new year. A lot of those folks that are price sensitive will go to different channels. They’ve done that this year based on our observation and research and we will be ready for that next year as well. I don’t know that beyond those two comments I would care to guess how the future may unfold.

Michael Millman – Millman Research Associates

Okay. And finally, on the capital structure, can you talk about to what extent that you may have to write off your goodwill and if you have to do that does this change any of the bank covenants because you’d be in a negative equity and to what extent are you reviewing the payment of dividends considering–?

Dan O'Brien

I thought you want to go with one question, Michael. You snuck in a couple extra. On the covenant question, no, this would – if indeed in the course of our looking at preparation for next year we look at what structural steps we may want to take if that we are ever to arise to some form of a – an adjustment to goodwill. That would be a non-cash charge and would not be something, which impacted our bank covenants.

In respect of the dividend, the dividend is ultimately a Board decision based on a recommendation by the Company. So, we are not in any position to talk at all about the dividend on this call. Typically we do announce something related to the dividend in the month of March, so stay tuned. But there is nothing that we are going to talk about at – on this call.

Michael Millman – Millman Research Associates

Okay.

Dan O'Brien

Was there another piece to that, Michael, or did I get it all?

Michael Millman – Millman Research Associates

Those were the two pieces to the capital question.

Dan O'Brien

Okay, thank you.

Michael Millman – Millman Research Associates

Thank you.

David Weselcouch

Okay, with that I will close out the Q&A period and we’ll say that thank you all for participating in the call today and for your continuing interest in Jackson Hewitt. We will report our full season tax – our full season results to you later in May on our – and our fourth quarter results in late June. Thanks for your time and have a great day. Bye now.

Operator

Thank you for your participation in today’s conference. This now concludes the presentation. You may now disconnect and have a great day.

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