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JTH Holding Inc. (NASDAQ:TAX)

F3Q 2014 Earnings Conference Call

March 13, 2014 8:30 AM ET

Executives

Darby Schoenfeld – Director, IR

John Hewitt – Chairman, President and CEO

Kathy Donovan – VP and CFO

Analysts

Joe Janssen – Barrington Research

Arnie Ursaner – CJS Securities

Michael Millman – Millman Research

Scott Schneeberger – Oppenheimer

Thomas Allen – Morgan Stanley

Operator

Good morning. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the JTH Holding’s Third Quarter Fiscal Year 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)Thank you.

I will now turn the conference over to Ms. Schoenfeld, Director of Investor Relations. Please go ahead.

Darby Schoenfeld

Thank you, Jennifer. Good morning everyone and thank you for joining us. With me today are John Hewitt, our Founder, Chairman and Chief Executive Officer; and Kathy Donovan, our new Chief Financial Officer. Also available for Q&A is Mark Baumgartner, the CEO of JTH Financials.

The press release announcing our third quarter earnings was distributed this morning. The earnings release may be accessed at the Investor Relations section of our website located at www.libertytax.com under the About tab. A replay of this call will be available shortly after the conclusion of this call. The information needed to access the replay was in the earnings press release.

I’d like to remind everyone that today’s remarks may include forward-looking statements as defined under the Securities Exchange Act of 1934. Such statements are based on current information and management’s expectations as of this date and are not guarantees of future performance. Forward-looking statements involve certain risks, uncertainties and assumptions that are difficult to predict. As a result, our actual outcomes and results could differ materially. You can learn more about these risks in our Annual Report on Form 10-K for the fiscal year ended April 30, 2013 and our other SEC filings. JTH Holding Inc. undertakes no obligation to publicly update these risk factors or forward-looking statements.

I would now like to turn the call over to our Founder, Chairman and CEO, John Hewitt.

John Hewitt

Thank you, Darby. The tax season is off to a good start for Liberty. We increased the number of U.S. customers during the calendar year to February 28 by 7.7% while the IRS is showing total tax receipts, up 1.4% to the same day. We continue to take market share and are happy to be able to provide exceptional customer service to an increasing number of customers. The results of the industry thus far continued to outpace last year, while the timing of this year’s tax season was similar to the last, the two years have turned out to be very different. For starters, the late this year was announced well in advance of the season. Last year, the announcement came in early January and this year was announced in October.

Since we filed our summits earlier, we were able to plan sooner and better strip some of our advertising dollars into the fourth quarter, where they coincided with the peak of the early season. Second, this year there was no conversion for states over to the modernized e-filing, so the early season has had very little in the way of technological work. Third, all forms were ready when the IRS hoping to do is for e-filing this year. So we didn’t have to hold the insurance back from the IRS, because certain forms weren’t available. There is a possibility that some of the people who were unable to file early in the season last year due to the missing forms that filed already this year increasing the filing accounts earlier and this year.

Finally, last year one of the items we believe decreased the number of filings with the change in earning credit rules, where customers were required to provide documentation that depends with that. This year, our customers were aware of those changes and we are better prepared. Because of all the worries between the two seasons, it is difficult to tell where the season will end up, but based on what we have seen so far and our experience in the industry, we still believe that $1.5 million to $2 million to 1% to 1.5%, more people will file this year versus last year. That includes gets us back to being more in line with where the industry has grown historically and we think it will be going forward. On the company’s front again we are pleased with where things stand at the moment. Half way through the season we are meeting our expectations, our franchises continued to work hard and grow above and beyond to make sure that our customers receive the best possible customer service in the industry.

With the late start to the season again this year we had expanding hours with some franchisees being opened 24/7 so that people could file their returns quickly, efficiently and on their own schedule. We are proud of what they had accounted so far this year. In regards to the decrease in our office count, we call them as 15% of our office a much higher rate than the typically 10% we normally experienced. However, the net decline of 2% in our office count in the U.S. has now significantly impacted our results thus far. And while due to the restatement we are unable to bring in as many new franchises as we normally do, our operational results are still about where we are expecting them to be. We are pleased that we are able to focus this year on our higher performing franchises and hope that we can continue to help them achieve their goals with the Liberty in the future.

The early season success of our franchisees can be seen in our operational results. While they are in line with our expectations, the results are promising. Our return to profits (indiscernible) increased 6.1% and our online returns are up 29.1%, average net fee has increased as well and our system-wide revenue increased 13.3%. Finally I would like to mention our efforts to run the Affordable Care Act. We have partnered with a third party vendor to create a Liberty brand ACA website and Liberty health exchange and our office has been referring to customers through it. There they can not only learn about the ACA but also determine eligibility to a subsidy in China for health insurance.

We and our franchisees have spent much of the off season educating our customers through presentations that explained the impact of the ACA not only on individuals but also on small business. This website helps us tie together that education we have given each customers with the ability to sign up in this season affordable healthcare through the exchanges. Some of our franchisees and area developers had identified other ways to divide their customers to get access to health insurance options. And we look forward to analyzing the results of different approaches as we plan for 2014 when we believe ACA will have a greater impact on the tax business.

With that I would like to turn the call over to Kathy Donovan, our new Chief Financial Officer, who will go through the financial results of the quarter.

Kathy Donovan

Thank you, John. Good morning everyone. I am happy to be here today after my first six weeks with Liberty. I arrived here at the beginning of February just in time to see the whirlwind of tax season begin. I am excited to start building relationships with everyone on the call and look forward to getting to know you all better. As John indicated our team was off to a good start. We had a strong third quarter and that continued into February.

Focusing on the quarter our system-wide revenue grew driven by both higher return counts and an increase in average net fee. This drove our royalties and advertising fees higher and the increase in return count also increased our downstream financial products revenue. Our total revenue for the quarter was up 8% and we are up 3.5% for the year. You probably noticed in our press release that financial products revenue grew faster than royalty revenue. Financial products require a return to be expected by the IRS before we can originate the refund transfer products and record the associated revenue.

This year the IRS accepted a much larger portion of our returns by January 31 than they did last year, so financial products revenue was higher. We believe this was primarily due to the fact that all of the IRS forms were available this year when they opened for e-filing on January 31. That compares to last year when some forms were not available until mid-February or even March. We believe this is just timing and that the growth in financial products revenue will be much more in line with the growth in royalty revenues by the time this season is over.

Our online business also grew in the quarter. This is reflected in the tax preparation fee line item where we saw increases in both the number of DIY returns processed through one of our online offerings as well as in the net – average net fee online. We are continuing to work on this area and expect this growth to accelerate in the future as we continue to rollout our next gen products and look to grow both organically and through acquisition opportunity. Offsetting these revenue increases were declined in franchise and the area developer fees.

As John said, we were not able to sell franchises during a portion of the second quarter while we were working to complete our restatement. That is traditionally the time during which we sign up the most new franchisees. Area developer fees are also down, because we repurchased several areas from existing AD during fiscal 2014. This caused a reduction in the area developer fee revenue now, but in the long run will result in lower cost as we no longer need to catch along 50% of the associated royalties to those AD.

The overall increase in revenue was partially offset by higher operating expenses. For the quarter, we incurred higher bad debt expense reflecting the increased level of office closures that John described. We also incurred higher area developer expense, which is directly related to the higher royalty revenues. As I mentioned earlier, our area developers will see 50% of the royalties that are paid to us by franchisees in their area. So as royalty revenue increases so does area developer expense.

Finally, depreciation and amortization and impairment charges were also higher than prior year. As planned, we placed our NextGen software into use on the DIY side this year and began depreciating it during the third quarter. We also incurred some higher amortization expense in the quarter from the area developer rights we repurchased earlier this year. There is one last thing that I should point out on the income statement. During the third quarter, we recorded a gain of approximately $2 million from the sale of a very successful investment we made last year in one of our strategic partners.

Now, let’s take a look at the balance sheet. We ended the quarter with $3.7 million of cash compared to $849,000 at January 31, 2013. In addition, the amount drawn on our revolver was $104.6 million at the end of the quarter compared to $108.1 million last year. And now, we have completely repaid the revolver almost three weeks earlier than we did last year.

In conclusion, we had a great start to the tax season. We believe the increased productivity per office both in terms of total returns and average net fee bodes very well for our plans for next year. As you saw, our operational results have been better than the industry and we have continued taking market share.

With that, I’d now like to turn the call back to John.

John Hewitt

Thank you, Kathy. And with that operator, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Alex Paris with Barrington Research.

John Hewitt

Welcome, Alex.

Joe Janssen – Barrington Research

Hey, John. This is actually Joe filling in for Alex. Maybe Kathy real quick, you mentioned the $2 million gain on sale during the quarter, maybe what was the tax rate had been excluding that and maybe the after-tax effect on EPS?

Kathy Donovan

That didn’t really have an impact on our full year tax rate. You may have noticed that the tax rate we booked this year is different than earlier. That was just a year so they true up. And I think we are looking at our tax rate this year to be about 1% less than last year.

Joe Janssen – Barrington Research

Well, for the quarter, what were the EPS have looked like if you adjusted? My sense was like $0.18, $0.19 if I kind of normalize the tax rate? Am I thinking about it the right way?

Kathy Donovan

You could look at it that way, but I’d have to do the math. I don’t have it in front of me.

Joe Janssen – Barrington Research

Okay. And then from a modeling perspective you talked about which is the late start you mentioned you hold back on advertising, how should I be thinking about that in Q4 from a modeling point of you, expect that kind of to be shy at maybe guidance on that would be appreciated?

John Hewitt

I think, Joe, the way to think of it is that it’s already reflected in our results that we announced in February 28. So we have spent on plan through February 28 that was just (indiscernible) with the spend in January versus February. So that’s already – it’s already taken place.

Joe Janssen – Barrington Research

Okay. And then I noticed in the press release, you made a smaller acquisition of online tax company here in January, maybe just some color on that? And then maybe if you look at your online filings maybe just kind of split it out between what came into NextGen and what came into the acquisition?

John Hewitt

Yes. We are not going to break out what comes from the acquisition and what our results are internally. It’s Joe, just too small. We continue that the second online purchase we have made over the last 24 months. We continue to look for acquisitions in both the store front and online as they become available, but it’s only minor event.

Joe Janssen – Barrington Research

Okay, okay. Well I will jump back in queue, but impressive quarter and very impressive volume growth. Congratulations.

John Hewitt

Thank you.

Operator

Your next question is from Arnie Ursaner with CJS Securities.

John Hewitt

Welcome, Arnie.

Arnie Ursaner – CJS Securities

One of the factors that may have led to your gain this year versus the industry is that this year your competitors decided to charge for the 1040EZ, last year, it was free and you had charged for it. How do you expect your market share gains to trend as we enter the back end of the tax season, where you get the more sophisticated customers who may have a more complex return? How do you see that evolving?

John Hewitt

Obviously, there is a modest positive impact with charges in the 1040EZ for the first time in after three years we are not charging for it. So we will have a modest impact, but we didn’t see a huge part of our gain as a result of customers changing. We believe most of those customers that were having the 1040EZ done for free or the high percentage of when did their own.

Arnie Ursaner – CJS Securities

Okay. My second question maybe a little more difficult with the answer on a conference call, but you have lower franchise locations, yet your profitability is dramatically improving and you have been perhaps reevaluating some of your franchisees with a goal towards upgrading? Is that a fair statement and where do you think we are in the process?

John Hewitt

Yes, I think it is. We ever year received 90% of our franchisees and I have made for a long time, I wish it is just 85%. We have some people that hang on too long. And in the franchisees we make the best performance are those that follow our licensing follow the few weeks at a plan. And you are just going to get some that are I am not going to do that. And so we feel good about this going forward and we have the right franchises. And there was after five years of difficult tax seasons for one reason or another different reasons for different years, it’s finally normalizing and we look forward with the changes we have going forward.

Arnie Ursaner – CJS Securities

Final question if I could the preliminary data as you have it regarding financial product mix of in-house versus outsourced and the percent of return for reducing financial products so far this tax season. Do you have any of those numbers available?

John Hewitt

I can say that it’s consistent with prior years we have been for the last decade in the low 50s. People have used financial products. So that trend continues to make this all clear.

Arnie Ursaner – CJS Securities

Thank you very much.

John Hewitt

Thanks Arnie.

Operator

Your next question is from Michael Millman with Millman Research.

John Hewitt

Welcome Michael.

Michael Millman – Millman Research

So just talk about where you think you are picking up clients and maybe the dual competitor on existing store bases?

John Hewitt

Yes. Our same-store, obviously our same-store sales have increased and if we talk about tenuring with first year, second year, third year, fourth year locations and so forth that our tenuring is improving and our performance is improving from what we have heard from our competitors that Block and Jackson Hewitt, they continue to struggle. So we and the Mom and Pops continued market share.

Michael Millman – Millman Research

So you think Mom and Pops are also picking up share?

John Hewitt

Based on the numbers we have heard from Block and Jackson Hewitt, yes believe that’s uncertain.

Michael Millman – Millman Research

Could you talk about the level or maybe (indiscernible) on the IRS data, which suggests that all the increases comes from DIY?

John Hewitt

Yes. It’s hard to tell that partway to the season we think that will normalize by the end of the season. And as you know, the number of people that seek assistance in offices has been consistently 61% or 60% for the last six or seven years. We think that trend will continue as we end the tax season. That will be over 60% will have come into brick-and-mortar.

Michael Millman – Millman Research

So, with the reason, I believe that has been abnormal in the first half has to do with weather or are there some other things that are occurring?

John Hewitt

I think it could be a number of things. Certainly, weather is a factor, because if you are sitting at home and not going to work or not going to school or can’t get anywhere, you are more likely to do taxing earlier in the year than later. Also the – as I said earlier some of the customers in the last year – over the last few years have had the return done for free at Block. They went online. So that may be a partial reason for that. It’s hard to tell. We will know far better when the season is over.

Michael Millman – Millman Research

To what extent do you think the 88-67 has helped online and assisted?

John Hewitt

Well, it’s difficult to judge, but the fact that you have to produce extra documentation to filing the income credit, what we believe is somewhat of a factor in moving people.

Michael Millman – Millman Research

So, you still see the 60-40 despite that I guess in the quality or?

John Hewitt

Yes, I would bet that it’s going to be over 60% at the end of the season. And the number with ACA, we expect that to increase significantly over the next couple of years as the ACA kicks in. So we expect that 61% or 60% to increase over the next couple of years.

Michael Millman – Millman Research

Okay, thanks John.

John Hewitt

Thank you, Michael.

Operator

Your next question is from Scott Schneeberger with Oppenheimer.

John Hewitt

Welcome, Scott.

Scott Schneeberger – Oppenheimer

Hey, thanks John. Good morning. Following up on Michael’s question, just with regard to pricing you had mentioned you thought you saw perhaps slight benefit from H&R Block going to a paid 1040EZ and a lot of shift to do it yourself from that dynamic, which is a little change and actually Michael was thinking on. But you did say obviously you think of a rebound with ACA in coming years, do you think there will be a pronounced move in the 60-40 shift this year. I didn’t know, I suppose I didn’t hear the response to that, but I am just curious because that’s a bit of a change from your prior perspective levels?

John Hewitt

We still believe that it will be somewhere in that 60% to 62% will seek to have a lot of assistance this year.

Scott Schneeberger – Oppenheimer

Okay, thanks. And I am curious did you do much pricing change with your own forms, I believe that you hadn’t obviously bought exchange, but you had much more success thus far in the season than they have. So maybe speak a little bit to your – did you do a lot of pricing activity, increased pricing activity?

John Hewitt

Yes. I have to say at this point since you talk about Block assessments as far as every season we have a lot more success what Block does, but that’s not at all surprising and we do increased our fees that you can do the math between the increase in returns and the increase in just my revenue that we have increased our fees 5% or 6%. We believe that, that’s where about what our competitors have in place hopefully lot more Block and Jackson Hewitt. So, and I think obviously the rush that Block seeing comes from fully monetizing their 1040EZ. So, we are up about 5% or 6%, which we think is we are looking at that for the next few years with the exception of the bump we are going to get next year from the ACA forms.

Scott Schneeberger – Oppenheimer

Alright, thanks. And John, any color on your financial products, your consumer finance product, just any updates you can pass on, on what you have seen with those this year and anticipate going on with next year?

John Hewitt

We continue to have more pricing power with the suppliers of the financial policy, because we are bringing them to market. And since we can do – we have shown that we can do that in in-house, the other banks are giving us better pricing on the products we are placing today. So, we are very happy with that change from a couple of years ago.

Scott Schneeberger – Oppenheimer

Thanks. And then lastly John, do you still anticipate the incremental form, federal form for ACA next year? And what type of pricing these people surrounds that? Thanks.

John Hewitt

Well, Scott, what we think is that about a quarter of our customers next year will have the ACA, required to have the ACA form with their term. And our best guest right now without in filling the forms or assuming instructions that it’s probably a four-year $50 fee. And so it would have an increase of about $10 per tax room, which for us would be about 5%.

Scott Schneeberger – Oppenheimer

Thanks. That’s helpful, John. I appreciate it.

John Hewitt

Thank you.

Operator

Your next question is from Thomas Allen with Morgan Stanley.

Thomas Allen – Morgan Stanley

Hi, John. Good morning.

John Hewitt

Good morning.

Thomas Allen – Morgan Stanley

Just following up in our last question, do you think there is an opportunity to charge an incremental fee for everyone given that that will be a requirement to show insurance? Thanks.

John Hewitt

I’d be thinking contractually, Tom as we haven’t seen the forms of (indiscernible) require. It’s certainly possible. But right now, we are taking a conservative $10 approach and 5% approach.

Thomas Allen – Morgan Stanley

And then in terms of all the pricing this year, it seems strange for me given that you see a potential ACA opportunity next year that company they are willing to try and push price maybe at the risk of losing share, how do you think about that?

John Hewitt

Yes. It’s always a balance between pricing and market share and obviously for example, I’d say we lowered our fees 50%. We wouldn’t double our customer base. So you have to walk aside mind of understanding the customers. The way we analyze with some is this we do something that’s it’s rare in any industry and that’s we call all of our customers. And we start to have early in the season, two days after the customers been in. So we are taking the policy of our customers from January 4 until throughout the whole season. If we see any situation where we are driving an inordinate number of customers away from us, then we modify our pricing. So we are in constant touch with that throughout the season. So we feel very comfortable that were after life price points in our offices.

Thomas Allen – Morgan Stanley

Very fine. So you guys obviously know your businesses better than we do. And then just finally in terms of the IRS testing requirements, obviously the court has cited against them. What do you think the chances are maybe we go a legislative route or even if they are happening at all? Thank you.

John Hewitt

Well, we certainly think it’s necessary for this industry in using that route. To give someone a haircut you need a license of legitimate tax when we don’t. So I think that it’s important to the industry. We hope that that the IRS find their way to certify for payers. We have for four years now we had our own internal certification. All of our 35,000 payers are certified. We know that our major competitors are (indiscernible). So it’s important to the industry and we hope that the IRS figure another way to do is that the Congress will pass legislation that will enable them to do. It’s important.

Thomas Allen – Morgan Stanley

Okay, thank you.

Operator

Thank you, ladies and gentlemen. I will now turn the conference back to John Hewitt for closing remarks.

John Hewitt

Well, thank you everyone. We had a great year and I look forward to meeting you and talking again next quarter. Have a great day everyone.

Operator

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may now disconnect your lines.

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