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Executives

David Weselcouch – Vice President, Investor Relations

Harry W. Buckley – President and Chief Executive Officer

Daniel P. O'Brien – Chief Financial Officer

Analysts

David Burtzlaff - Stephens Inc.

Scott Schneeberger – Oppenheimer & Co.

Vance Edelson – Morgan Stanley

John Healey - Northcoast Research

Michael Millman – Millman Research Associates

Sloan Bohlen - Goldman Sachs

Jackson Hewitt Tax Service Inc. (JTX) F1Q10 Earnings Call Transcript September 3, 2009 8:30 AM ET

Operator

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Jackson Hewitt Tax Service Incorporated earnings conference call. (Operator instructions) As a reminder, this conference is recorded for replay purposes. I would now like to turn the call over to your host for today's call, Mr. David Weselcouch.

David Weselcouch

Good morning, everyone. I’m David Weselcouch, Vice President of Treasury and Investor Relations for Jackson Hewitt, and I’d like to welcome you to our fiscal 2010 first quarter results conference call. Joining me this morning are Harry Buckley, our President and CEO, and Dan O’Brien, our Executive Vice President and Chief Financial Officer.

Our earnings release went out on the national wire early this morning and hopefully you’ve had an opportunity to review it. The earnings release can be accessed at the Investor Relations section of our Web site located at www.jacksonhewitt.com.

The format for today’s call will be as follows. First, we'll hear from Harry Buckley, who will share his views on the state of Jackson Hewitt. Following Harry, Dan O’Brien will briefly discuss our 2010 first quarter financial results and capital structure. And finally, we’ll open the call up to your questions. This morning's call is scheduled to conclude at around 9:15.

Before I turn the call over to Harry, 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 earlier this morning, our Annual Report on Form 10-K for the fiscal year ended April 30, 2009 and 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 Web cast simultaneously on our website at www.jacksonhewitt.com. Additionally, the Web cast will be available for replay on our Web site.

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

Harry W. Buckley

Good morning everyone. Tomorrow will mark roughly 90 days since I returned to Jackson Hewitt, back on June 4. It has been a fast-paced three months and I am fully immersed in our planning to achieve the charge given me by our board on my arrival, which is to execute a strategy that will reverse our declining market share and put Jackson Hewitt on a course towards sustainable, profitable growth.

Back in June I told you that I was returning to a company with many strengths on which to build, including a sizeable base of nearly 3.0 million clients, outstanding employees, a well-established brand, committed franchisees, and a solid distribution network.

Now, despite the existence of these strengths, the reality was I was also joining a company coming off of two consecutive, challenging, and difficult years of declining profitability. Two years of significant market share losses.

This morning I want to speak frankly with you about three topics. First I want to share with you my observations about Jackson Hewitt over my first 90 days. Second, now that our management consulting engagement has concluded, I want to share with you what we learned from this effort. And third, I want to begin to answer a very important question that I know is on all of your minds. That question is, what are you going to do differently in 2010.

Let me start with my observations about Jackson Hewitt since my arrival. First, having been here three months, a period which included our annual franchisee convention, which I will speak to shortly, I can tell you that I've inherited an excellent group of employees and franchisees who have definitely felt the results of the past two tax seasons and are highly motivated, collectively, to turn this business around.

Now, notwithstanding the existence of quality employees and franchisees, Jackson Hewitt simply has not gotten the job done over the past two tax seasons. It's been my observation that over this period Jackson Hewitt was beginning to lose sight of the client. And knowing how important the client is in this business, I call losing sight of the client self destruction.

My question to our employees and franchisees has been, when was the last time you made a decision based on what effect the result would have on the client. The answers have not been satisfactory. There has been a lesser emphasis on the client versus profit optimization and this approach will not win in the long run.

This is what I refer to as the pendulum effect. By this I mean the balancing of net profit and growth. There has been an over-reaction and today the pendulum is all the way on the side of net profit.

Increased pricing has been the ploy in an attempt to drive the top line, while not doing the things that retain clients and gain new clients for long-term viability in an increasingly competitive marketplace.

The pendulum needs to swing back to the center and to doing the things that will grow returns prepared and in turn grow revenues and enhance profitability. We need this balanced approach to achieve sustainable net profit and we simply cannot get there by increasing our fees.

We are also losing the fight of the franchise business versus the company-owned business. The number of company-owned locations has been increasing as we have acquired certain franchisee locations due to difficulties encountered in the current credit environment and overall economic climate.

We are a franchisor and we want to increase franchise locations as a percentage of total locations, not the other way around. We are looking at new and different approaches to get company-owned locations back in the hands of motivated franchisee entrepreneurs such as selling individual offices rather than whole markets where it makes sense.

Growth, however, is the answer to achieving an expanded franchisee base. We have got to improve our performance in order to grow the overall franchise distribution system to the attraction of new entrepreneur operators.

Along this subject of franchise expansion, let me mention that we did not record any new territory sales in the 2010 first quarter versus four territories sold in last year's first quarter. On a positive note, our sales pipeline has been very active in both the first and second quarters in connection with our Walmart expansion. As you know, we don't record new territory sales until a franchise agreement has been executed.

In terms of our franchisee relations, I feel we are moving in the right direction. For example, the corporation and the franchise community are making great strides toward the completion of a new franchise agreement, which is an excellent example of what can be accomplished when both sides are working toward a common goal.

When completed, we expect that the new franchise will effectively align the interest of both the franchise community and the corporation in terms of getting back on a path towards sustainable, profitable growth. As you are aware, about a third of our franchise agreements are up for renewal between now and late next calendar year and we continue to expect that we will achieve a very high renewal rate under this new agreement.

With regard to our management consulting engagement, back in June we told you that we had engaged a management consulting firm to work jointly with us to better and more fully understand the sources of our weak performance. The management consulting engagement concluded, as planned, in early August and I would like to share with you a high-level summary of their key findings.

Recall that we told you in June that we were determined to understand what issues were causing us the biggest problems, so some of the findings were not entirely new to us, but the relative impact on our business, based on the consulting team's work, was clearly defined and dictates that we need to do certain things differently.

Against the backdrop where certain competitors grew their distribution networks and maintained or increased productivity, we achieved a significant decrease in the volume of returns prepared and same store sales. And this was also during a period where the paid tax preparation brick and mortar market remained relatively stable.

For marketing to identified as a weakness is not new news, as our overall marketing activities have not been effective over the past two tax seasons, particularly at the local level, as demonstrated by our inability to drive new clients into our offices.

By taking a deeper dive into this issue with our consultants, it was abundantly clear that we had marketing issues that must be resolved. Although we already possess many of the tools required for effective local marketing, the plain fact is that engagement in local marketing efforts has been highly inconsistent across our network.

The research conducted by our consulting firm also showed that we need to improve our tax preparer retention ratio and increase our percentage of satisfied clients.

Another issue of note is our inability to compete and file a high percentage of tax returns when we have control of the client in our office. For a variety of reasons that we must get our hands around, a large number of clients who enter our offices begin a transaction and then do not complete a return, or complete a return and then don't have us electronically file it. This is what we call holes and voids and it is a significant problem that needs to be rectified.

We also need to price more effectively. Our research has told us certain things about our pricing. First, there is a gap perceived by our clients between expected and actual prices, which has had a negative effect on our ability to retain clients and draw new clients into our offices. And second, we need to resolve what I will call the price value relationship. There appears to be a sense, among some of our clients, that appropriate value is not being received for the price paid.

As I said earlier, Jackson Hewitt has taken its eye off the ball when it comes to meeting and exceeding the expectations of the client and the declining market share of the past two years must be stemmed.

We also note that we were reasonably positioned competitively with our pre-season line of credit product last year, but the execution problems we experienced resulted in a degree of client dissatisfaction.

Now, believe me, it does not please me to have to outline for you this list of negative factors that have hurt our company. Further, we certainly don't want to be addressing you next March, explaining why our marketing program was ineffective again. We cannot, and will not, maintain the status quo and hope for the best, because that approach will not work.

To counter the negative effect of our past actions, we have already begun to put the plans in motion that legally will result in improved operational and financial performance in the 2010 tax year.

So at this time, I want to begin to address the answer to the question that I know you all want to pose to me, what are you going to do differently in 2010.

Well, here's what we're going to be doing different at Jackson Hewitt in 2010. In brief, we expect to put into practice a renewed focus on our core business: tax preparation and the client in all that we do. We expect to improve tax preparer training and retention, we expect to effectively execute a more impactful pre-season product, to significantly enhance our overall marketing program with local marketing effectiveness at the forefront. We are providing more market-by-market information and tools that we expect will lead to more effective pricing across our franchise system to improve the performance of our company-owned office segment. We also expect to effectively execute on our exclusive Walmart arrangement, to successfully launch our first-ever online tax preparation product, and to achieve a more collaborative partnership with our franchise community.

It begins with what I call getting back to basics. Our core business providing quality, accurate tax returns, and doing so with a keen focus on our clients, meeting and exceeding their needs and expectations, particularly in terms of pricing, value, and their overall experience with Jackson Hewitt.

In fact, our strategic theme for the 2010 tax season can be summarized as follows: back to basics with a keen focus on the client.

In the recent past, Jackson Hewitt was beginning to head down a road of being more of a financial service company, being more than just a tax preparation provider to its core client base, is where last year's tag line, a Partner and a Path, was born. We are definitively returning to our core product, tax preparation.

Let me comment on some of our planned changes for the 2010 tax season, beginning with our focus and efforts to improve tax preparer training and retention. From my experience, there is a direct correlation between tax preparer training and retention and client satisfaction and retention. I go back to something I said in June. There are two things you need to grow the tax preparation business: people, well trained and client-oriented, to prepare quality, accurate tax returns; and places. You need to be in the right locations, convenient and available.

We have identified a need to improve on the people side of this equation and that's what we're proceeding to do.

Continuing to define what will be different in 2010, let's talk about our pre-season product. As you know, we were in the market last year with a pre-season line of credit product. Overall, the product was not as impactful as we would have liked due to its limited size and unanticipated execution issues that hurt its effectiveness, such as system bugs, client service issues, and client expectations.

Again this year, we expect to be in the market with a pre-season product and we expect to collaborate with MetaBank on the delivery of this product. However, the difference between last year and the 2010 tax season will be two-fold.

First, we will optimize the design of our product in conjunction with MetaBank and second, whereas we experienced significant execution issues with our pre-season product last year, this year we intend to achieve effective execution of our product.

I can state this with confidence because we've already completed extensive work to resolve last year's execution issues, working closely with our bank partner, and we're ahead of schedule in terms of readiness for the upcoming tax season.

The size of the overall program is yet to be determined, as it will be dictated in part by market conditions as we get closer to the tax season.

Let's move to marketing and what will be different in 2010. First, we have new, experienced marketing leadership in place for the 2010 tax season. Under this leadership, we expect to make meaningful alterations to our marketing strategy for the upcoming tax season that we believe will increase its effectiveness, particularly on the local level.

For one, in 2010 we will have less emphasis on national advertising and a renewed focus on our regional and local marketing activities. In line with this approach, our engagement with Magic Johnson as our national spokesperson has concluded. Rather, we will focus on regional and local advertising, including television, and plan to work closely with our franchisees to not only provide advertising spending incentives, but also to put more choice in the hands of the franchisee in terms of determining the most effective use of local marketing dollars in their respective markets.

Towards this end, our marketing function in already well progressed with holding marketing planning meetings with franchisees in each of our top 60 markets, with the end result being a detailed marketing plan that is specifically tailored to each franchisee's respective market.

To assist the franchisees with the achievement of more impact to local marketing, we have developed local promotional tool kits that we believe will be more effective in helping our franchisees generate increased traffic in their offices and these kits will be available well in advance of the tax season.

We are also doing much more this year to analyze and segment our market, with the expectation that this effort will result in separate tailored marketing campaigns that will be more effective in both the first tax season, roughly January 15 through February 28, and the second tax season from March 1 through April 15.

Our research has shown us that our geographic locations may enforce a better second-season opportunity than previously may have been thought and we are developing our marketing plans to take advantage of this potential opportunity.

By segmenting the market more effectively, we expect to achieve more touch points with perspective clients and to attract new clients to our offices, an area in which last year's marketing program proved particularly weak, as well as to increase second-season penetration.

The bottom line is that we're coming off of two years where our marketing efforts have not been effective and in 2010 we are changing our approach based on our past experience and our research.

We expect to be able to point back to a successful and effective local marketing program in 2010 and as a result we expect to achieve improved client retention and we expect to bring more new clients into our locations.

With regard to pricing, we are spending a significant amount of time educating our franchise community regarding pricing more effectively in the upcoming tax season. In fact, the price value discussion was an important component of our recent franchisee convention. For the 2010 tax season we are providing our franchisees with five year's worth of historical data on pricing and client retention so they can establish effective pricing for each market they operate in. In addition, we're providing market-by-market pricing information and enhanced tools to monitor pricing activity by market during the season.

Our plan is also to significantly improve our clients' experience with us, to close the gap between both the expected and actual price perception, as well as the value price perception through better timing of the client visit to our offices, improved tax preparer training, and an improved office environment, which we believe will result in a superior overall client experience.

We have no intention of dropping the bottom out of our prices, but we do intend to price more effectively and we do intend to ratchet up the value we deliver so that our client satisfaction improves and our clients perceive and obtain matching value received for value paid to us.

Let's turn to our company-owned office segment. This business segment is coming off of two consecutive weak tax seasons with significant declines in tax returns prepared and margin performance. The first step toward improving this segment, as I told you back in June, was to increase management accountability by having the leadership of this segment report directly to me. We have gone on to make a series of changes that we believe will result in a significant improvement to the profitability profile of this business.

To start, we reduced the headcount in this segment and moved quickly to close about 200 unprofitable locations. We took charges for each of these activities in the fourth quarter of 2009. The reduction in headcount resulted in a restructured and flattened organization by eliminating a layer of management and improving the span and control of our field management by lowering the number of locations per manager, while increasing accountability for results, and we will directly link the compensation of the field management to the results within their control.

Over time, we'll look to move more company-owned offices into the hands of motivated franchisees and as I mentioned earlier, we are exploring various means to improve our ability to do that, such as selling single offices rather than whole markets.

One thing that will be different in 2010 is our new, exclusive arrangement with Walmart. With regard to the Walmart arrangement, we believe this will be an important piece of incremental business for Jackson Hewitt in 2010. Let me update you on our Walmart activities.

We are currently very busy solidifying all our Walmart locations for the upcoming tax season and expect this effort to be completed by late September. At present, we expect that we will be in approximately 1,500 to 1,750 Walmart stores in the 2010 tax season. This range is somewhat below the store count level we had hoped to achieve, but still affords us a solid incremental growth opportunity that we intend to fully capitalize on.

The lower-than-anticipated Walmart store count results from Walmart's initiation of a remodeling effort in its smaller stores, which has resulted in our inability to fit into certain Walmart locations. We are continuing to work with Walmart to optimize our opportunity to operate in these smaller stores in 2010.

To counteract the lower store count, we are exploring the possibility of opening new store locations in areas where we may not achieve Walmart store access this year but still want to take advantage of an attractive new market opportunity.

We remain very excited about the incremental Walmart under our exclusive arrangement and are geared up to take full advantage of it, with a great reception and support from our franchise community.

Under our new exclusive Walmart arrangement we look forward to a well-coordinated effort between Jackson Hewitt and Walmart, to jointly drive customers shopping in their stores and Walmart associates to our tax preparation services located in the Walmart stores.

For the first time we will go beyond just leasing space within the Walmart U.S. stores for providing tax preparation services by working with Walmart's financial services business to strengthen communications about our respective service offerings so that both companies can benefit.

We will also launch our first-ever online tax preparation product in advance of the 2010 tax season. We are very much on track with this plan. Our efforts here have the potential for further enhancement through a planned tie-in between Jackson Hewitt and Walmart.com.

Joint marketing efforts planned between Walmart and Jackson Hewitt have the potential to drive tax preparation clients and Walmart associates to Jackson Hewitt's new online product.

Our mission in 2010 is to get this product into the market and make sure it works. We do not expect this product to be a significant contributor to our bottom-line results in 2010, given its late entry into a market with experienced incumbents and the time it will take to promote it and gain market share.

Let me comment briefly on our efforts to improve franchise relations. As I mentioned earlier, we recently held our annual franchisee convention and it went very well. One thing I can tell you is that our franchisees are highly motivated to achieve growth in 2010. They appreciated the business atmosphere of this year's convention as we eliminated the glitz and glitter that made it very cost-effective.

Numerous workshops were conducted on a variety of topics, including marketing, Walmart, taxable changes and pricing, and these sessions were very well received by the franchisees.

One thing our franchisees told me was that Jackson Hewitt Corporation needs to improve its communications with its franchise community. In response, we've developed plans and programs to improve franchisee communications and we will continue to take the necessary steps to achieve effective communications with our franchisees so that we meet their expectations in this regard. We know, and the franchise community knows, that together, we must make this a win-win partnership and we intend to do what it takes to achieve that end.

Before I turn the call over to Dan, I want to comment on some recent activity at the internal revenue service. As you may be aware, the topic of tax preparer professional standards has been part of ongoing dialogue at the IRS. We fully support and are participating in the commissioner's initiative to hold open conversations with all stakeholders in order to develop a thorough understanding of the issues involved in strengthening tax preparer ethics and professional standards.

We believe this effort is good for the entire tax preparation industry, as it establishes a foundation for frank discussion on how industry oversight and standards can be strengthened, implemented, and maintained in a timely and cost-effective manner.

As a leader in the tax preparation industry, we have submitted our views in writing to the IRS and are participating in forums that the IRS is conducting on this subject.

Jackson Hewitt has significant tax law and ethics training material for its tax preparers that we update annually and we have developed exceptional oversight tools to monitor our tax preparation systems.

At this time, I will turn the call over to Dan for comments on our fiscal year financial results.

Daniel P. O'Brien

This morning's earnings release provides the detailed financial statements and summarizes results for the 2010 first quarter, so I would like to highlight just a few items.

First of all, as those of you who follow us are aware, operating results in the first and second quarter of our fiscal year are not indicative of our full year performance. Historically, we have generated roughly 2% of our total annual revenues in each of the first two fiscal quarters due to the seasonal nature of the tax return preparation business. As such, we incur a net loss during the first two quarters.

For the 2010 first quarter, we reported revenues of $5.0 million versus $4.3 million in the 2009 first quarter. In this period, revenues have historically consisted of financial product fees earned in large part from sales of our goal-guarantee product in prior tax seasons, which are amortized into revenue over the client contract period.

That being said, the revenue increase in the first quarter this year versus the year-ago quarter was primarily due to higher fees earned from our ipower card platform. On the bottom line, net loss as adjusted decreased to $19.2 million versus $19.7 million in the 2009 first quarter. On a per share basis, net loss as adjusted was $0.67 versus $0.69 in the year-ago quarter. Keep in mind that in periods of losses, basic, not diluted, share count is used in the loss per share calculation.

A schedule is included in our earnings release that you received today entitled Condensed, Adjusted Results of Operations, which reconciles the reported and adjusted results for the quarter. I would like to take a minute to discuss these adjusting items.

Let's start with last year's results. The 2009 first quarter included a $1.6 million pre-tax charge related to lease termination and related expense in connection with restructuring activity in our company-owned offices last year.

Also reflected in the 2009 first quarter was a charge associated with a workforce reduction resulting from initiatives to improve our overall cost structure at the start of last tax season. In connection with this action, and certain employee terminations, a $1.4 million pre-tax severance charge was recorded in last year's first quarter.

Lastly, we recorded a favorable insurance settlement of $1.5 million in the 2009 first quarter in connection with certain prior-period litigation.

Taken together, on an after-tax basis, these items increased last year's first quarter reported net loss by about $900,000.

As for the 2010 first quarter, first we recorded a $4.3 million pre-tax charge associated with our former CEO's departure in June. We also booked $126,000 of expense in connection with certain corporate advisory services. In total, on an after-tax basis, the net effect of these items increased our 2010 first quarter reported net loss by $2.6 million.

After giving effect to these items, our adjusted net loss was just over $400,000 less in the 2010 first quarter versus the year-ago quarter.

Let me briefly comment on the status of our bank partner arrangements for the 2010 tax season. With regard to the pre-season product, we are in discussions with MetaBank, as Harry had mentioned, our partner in last year's pre-season product program, and long-time provider of our ipower card platform, around the offering of a program this coming tax season.

Further, we are working to enhance the design of this program to improve its effectiveness in retaining our clients. Also, as mentioned earlier, working closely with MetaBank in the off season, we do expect smoother execution of this year's plan from an operational standpoint.

With regard to our RAL and assisted refund programs, we very recently learned of potential changes under consideration with respect to the offer of these RAL and assisted refund products by certain of our bank partners, including lowering the APR in the RAL program. These changes, which could go into effect as early as the 2010 tax season, have not been finalized. If these changes were to be implemented, they would likely reduce the shared economics of these programs. We, in turn, would likely give consideration to changes in our client pricing structure, with a goal to effectively offset the potential reduction in economics that may occur.

Since we operate under confidentiality with our bank partners, and discussions are in process, we are not at present able to say more on this topic, nor or we able to know what, if any net economic impact any such changes may have on Jackson Hewitt in the 2010 tax season. We will look to update you after our bank partner agreements for the 2010 tax season are finalized.

Moving on and talking about capital structure in closing. We ended our 2010 first quarter with a gross debt balance of $274.0 million, which left the unused portion of our overall $400.0 million credit facility at $126.0 million at quarter end.

We are generally consuming cash in a manner consistent with our planning as we prepare for the new tax season. Our leverage ratio at quarter end was approximately 3.59x versus our current leverage ratio covenant of 4.25x.

With that, let me turn the call back to Harry.

Harry W. Buckley

At this time we will open the call up to your questions, and I ask that you please provide your name and company affiliation at the outset of your question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Burtzlaff - Stephens Inc.

David Burtzlaff - Stephens Inc.

In terms of the Walmart, you may be planning on opening another 300 to 500 stores, it looks like, compared to where you were last year. How many of those do you expect to be franchisees and company-owned?

Harry W. Buckley

I think right now, although we haven't finalized our total numbers, it's probably going to be 75% franchised and in the area of 25% company-owned.

David Burtzlaff - Stephens Inc.

And then on the pre-season loan product, what kind of enhancements can you do, or can you give any more details on what some of these new initiatives could be to improve that product?

Daniel P. O'Brien

One of the issues that we faced last year is there is a desire on the part of our clients, who come in after receiving the loan and come in for tax preparations services, to received proceeds on a check versus proceeds on a card. And some of the operational issues we had last year were associated with those folks who had received a loan trying to take the proceeds off of the card after their tax refund was loaded on it.

This year we plan to have a check option for our customers. We think that will certainly meet their desires more, and also help with some of the operational issues that we had.

Operator

Your next question comes from Scott Schneeberger – Oppenheimer & Co.

Scott Schneeberger – Oppenheimer & Co.

You have talked in the past about a pursuit of strategic alternatives. Could you give us an update if there are any developments there?

Harry W. Buckley

Are you referencing Goldman Sachs coming on in June?

Scott Schneeberger – Oppenheimer & Co.

Yes.

Harry W. Buckley

No, we have nothing to add at this time.

Scott Schneeberger – Oppenheimer & Co.

On the Walmart development, basically the talk before was that you had to be in 95% of what the two of you agreed on for in a list of the appropriate stores. Is that list finalized now and so you and Walmart have mutually come to the determination that that's the right amount to open this year? The underlying question is how is your relationship with Walmart? You mentioned in the press release and on the call that you're optimistic that you can continue to build in 2010 although there are some new restrictions for 2009. Can you give us a taste of how you think the relationship is going.

Harry W. Buckley

We haven't finalized our total store count. As I indicated, we expect to be in 1,500 to 1,700 stores. Mainly the stores that we're not getting into this year are what they refer to as their Division 1 stores, where they have widened the aisles, taken merchandise out of the aisles, the pallets are gone. You can really tell the difference when you see one that's been retrofitted compared to the existing Division 1 stores that are out there today.

Scott Schneeberger – Oppenheimer & Co.

And with regard to the developments with your bank partners, could you take us a little bit deeper, if possible, I understand there are confidentiality issues, but what are the possible scenarios or outcomes, the most probable I guess, that your bank partners are facing right now and you, in turn, are facing with regard to your economics?

Daniel P. O'Brien

I don't think there is a lot that we can say beyond that which we did say. The bank partners are looking at potentially a lower cost model. They have to come to the finalization of that as their approach. Again, that would change the economics of the overall program and cause us to have to consider how we adjust our model to ensure that our economics are unchanged.

Until that plays out, until we finish our discussions, there's really not a lot more that we can say on that.

Scott Schneeberger – Oppenheimer & Co.

I have a couple of follow-ups on that. One, I know you are contractually with two bank partners and if you could remind us in the answer on generally what the mix is of the two, going into this year. So that's part of question one, which is also are you exploring potential alternatives, perhaps adding other bank partners at this time.

And then the second question is overall with pricing, you mentioned at the convention a lot of discussion about pricing with the franchisees. Obviously some pricing changes with the bank partners. What is your view for pricing going into 2010 at this juncture?

Daniel P. O'Brien

Let me take the first part and I will hand the question off on pricing to Harry.

We have two providers today, SBBT, Santa Barbara Bank and Trust, and Republic Bank, both very good partners of ours, in the offering of these programs. The majority of product comes through Santa Barbara. But again, a meaningful amount coming through Republic. And so those are the relationships. We always want to entertain all of our options in this regard, but they have been our providers. We would expect them to be our providers going forward. And that's probably where I would leave it at present.

Harry W. Buckley

Getting to your second question on pricing, I think we found that certainly in 2009 people were more price sensitive than they had been in the past years, and particularly in the early season. We have reviewed our pricing strategy carefully and thoughtfully and will look to price in the future level that maximizes our revenue opportunities and hopefully retaining and building market share.

Scott Schneeberger – Oppenheimer & Co.

If I can ask it in the context of historically we've seen in the industry, generally mixing of digit pricing increases. Let's just factor everything that you're looking at right now, it sounds like you would anticipate less of an increase this year and potentially even something that has a negative in front of it. Could you comment any further on that?

Harry W. Buckley

Well, as you know, we can't set prices for our franchisees. So therefore, we've been working closely with them in an attempt to get them to realize just what is going on in their market. That's why we're giving them five years of previous history and also showing them the retention of their clients over that period as well.

Operator

Your next question comes from Vance Edelson – Morgan Stanley.

Vance Edelson – Morgan Stanley

Just following up on that, how much do you view 2010 as a potential year of sacrifice and maybe even pricing reductions in the interest of promoting the long-term growth and profitability? And I certainly think the long-term approach is the way to go, but how much are you willing to sacrifice in terms of near-term margins and profitability.

Harry W. Buckley

Well, until we get the bank partners' issues resolved, I can't say at this point in time. I would say, though, that we are not going to be looking at large increases in average charge as they have in the past.

Vance Edelson – Morgan Stanley

And on the potential changes in APR, granted you can't give many more details at this point, but any thoughts on how such a change could actually assist in your efforts to lower prices or increase value, and therefore actually increase volumes? Because it sounds like overall it's going to boil down to price versus volume on that product, and hopefully the volume wins out. So any chance that a lower APR could actually help in that regard?

Harry W. Buckley

I think that's a good train of thought. I would rather not speculate on how this all turns out until we are working off of a firmer platform for discussion. So I think there is certainly a lot more to be said in our next quarterly conference call. But I think your thinking is right, to the extent that there, particularly the RAL prices are moved down, and they are, as such, lower cost, that may have some potential benefit.

More to come on that as we get a little more clarity on not only what occurs but how we react to what occurs.

Vance Edelson – Morgan Stanley

And Dan, any thoughts on the level of SG&A this quarter? Is that a decent run rate going forward? Any time of one-time hits?

Daniel P. O'Brien

I think the SG&A, we did have the larger severance item that had been talked about of $4.3 million that we, when you look at our non-GAAP statements at the back, have been adjusted out. So certainly that one would not be expected.

I would also tell you that our fee run rate on legal costs were somewhat higher this past quarter. A lot of activity, a lot of good activity in getting prepared for some of the cases that we're dealing with. But nonetheless, that's probably running a bit hot at this point.

Vance Edelson – Morgan Stanley

As you've continued to work closely with Walmart, any updated thoughts on the potential profitability of individual locations, what break-even levels are and how many returns need to be filed and so forth.

Harry W. Buckley

Not at this time. We know that, for instance, we are supplementing some of the franchisees for going into some of these stores, in order to improve their profitability, or certainly keep them on a break-even point of view. So other than that, that's all I can say at this time in regards to that.

Operator

Your next question comes from John Healey - Northcoast Research .

John Healey - Northcoast Research

Kind of an industry-type question, not specifically to Jackson Hewitt but to the industry, when you look at the paid tax preparation market this year, and you go through your planning stages for the business this year, what are you expecting the paid tax prep market to do this year, if you look at the changes we've seen in terms of your target demographic, in terms of employment and maybe the shifts that we've seen over the last year or two to other verticals of tax preparation?

Harry W. Buckley

In looking at the entire industry, if we look at the number of returns that were filed last year, and certainly we were down over 500,000 and Block was down over 600,000, and yet the total returns filed electronically were only down 27,000. I think it's indicative from that that there is a growing market out there for independents.

And I think that's why we have to, if we're going to grow, then we've got to not only have the people and places, in the right order, but we also need to make sure that the preparers are well trained and that we're pricing correctly.

John Healey - Northcoast Research

When you talk with your bank partners about the product this year, at what point do you think we'll have some updated color on where we understand where APR and the fee structure that you share are going to be? Should we expect that update on the Q2 call or will that be something that we might not know until we get up until the tax season?

Harry W. Buckley

I think if I were to give an expectation, I think we should know by that Q2 call. These are preparations we need to finalize in advance of the tax season and when you talk about early December we should be relatively square at that point. I can't promise it but that certainly would be our expectation.

Operator

Your next question comes from Michael Millman – Millman Research Associates.

Michael Millman – Millman Research Associates

Regarding the bank partner front, can you tell us what those rebates represented last year and how adjusting, I assume, increasing pricing will square with what you talked about pricing generally and get back to the corporation to offset the potential loss of rebates?

Daniel P. O'Brien

In terms of the amount of revenue associated with these products, they show up in our financial product fee line, a number which for last year was in the area of $60.0 million. The greatest portion of that was related to the RAL and AR product, probably in the area of $50.0 million in aggregate.

I don't think we're going to have a lot more to say with respect to how much of that may be at risk with the changes which are going on, and as a result of those changes, what steps we may need to take to maintain to the economics of the business.

So I think that gives you a framework for that the revenue that we're talking about, but again, I don't think we're going to have a lot more to say until we get on firmer footing with what the adjustments may be, their impact, and what steps we then need to take.

Michael Millman – Millman Research Associates

How would, I assume, raising pricing at the franchisee level square with what your outlook is for pricing generally and to offset any potential rebate loss?

Daniel P. O'Brien

I think, first of all, until this gets finalized, again, we're sort of avoiding your questions and I really don't have an answer to that at this point.

Michael Millman – Millman Research Associates

At this point, what do you see as your net stores in operation for the coming year compared with 2009?

Daniel P. O'Brien

As far as what we know today, we know that we have closed 200 under-performing company-owned locations since the end of last tax season. And until we get closer to the actual tax season we will be in a better position to outline the configuration of the locations for 2010.

Michael Millman – Millman Research Associates

Do you expect an increase in locations in 2010?

Daniel P. O'Brien

I'll have a lot more to say at the end of the second quarter. I think Harry has outlined that we've had some reductions that we know in the company-owned side. That's of course leaving aside what's going on with Walmart. There are increases which are occurring there. And we are assessing, as well, those steps our franchisees may have taken to reduce certain stores. At the same time as with store additions they may have put on to take advantage of certain opportunities. So it's too early at this point. We'll have more to say in the next quarter.

Michael Millman – Millman Research Associates

And traditionally the industry has not found much elasticity in pricing. Can you talk about why you think you'll see that elasticity?

Harry W. Buckley

Again, I go back to what I said earlier, in reference to pricing, the research indicated that some of our clients don't feel that they are getting what they're actually expecting. So with the prices higher than they anticipated and as a result of that we're unable to retain those customers, and that's the area that we're looking into for this coming tax season.

Operator

Your final question comes from Sloan Bohlen - Goldman Sachs.

Sloan Bohlen - Goldman Sachs

Back to your comments about opening new company-owned stores, for those that weren't going to open because of remodeling, did you have a sense of how many stores that could be in the 2010 tax season?

And secondly to that, what potential capital outlay there might be to open those stores.

Harry W. Buckley

I think most of those stores that we're going into, we had the cost of the kiosk, we obviously had the cost of the labor, we obviously have rent, but how many we're going into, we don't know at this time.

Daniel P. O'Brien

Outside of the kiosks, those are principally variable costs associated with our opening up those operations, but you're right, there is an investment. A kiosk, for instance, is in the area of $4,000 for a stand size and it could be somewhat smaller if we have a smaller footprint within the store.

Sloan Bohlen - Goldman Sachs

With regard to the agreement, where the remodeling plans known at the time that you entered into that agreement, and at this point are those all the stores that Walmart intends to remodel, or in the future could they decide to remodel more?

Harry W. Buckley

We are still within the limits of the contract. The contract indicated that we would be in over I think it was 900 stores in 2010, and we will certainly exceed that number. They continue to remodel, on a probably an every five-year basis, so that there's going to be remodeling going on each and every year in the future.

Sloan Bohlen - Goldman Sachs

On the tighter IRS standards, could you wager a guess as to what impact that might have on what kind of pay-stub filing we saw last year and how that could be incrementally beneficial this year?

Harry W. Buckley

I don't think they will address that. It has been brought to their attention. Last year during tax season it was brought to the IRS's attention. They did close down a few. But the numbers are just so high out there for them to take an active stance and go after them, tax season would be over.

Operator

There are no further questions in the queue.

Harry W. Buckley

I thank all of you for participating on our call this morning and for your continuing interest in Jackson Hewitt. I look forward to reporting to you on our progress in early December, following the conclusion of our fiscal second quarter.

Operator

This concludes today’s conference call.

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Source: Jackson Hewitt Tax Service Inc. F1Q10 (Qtr End 07/31/09) Earnings Call Transcript
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