Jackson Hewitt Tax Service F2Q08 (Qtr End 10/31/07) Earnings Call Transcript

Jackson Hewitt Tax Service (JTX)

F2Q08 Earnings Call

November 27, 2007 8:30 am ET

Executives

David Kraut - VP of Treasury, IR

Mike Yerington - President, CEO

Mark Heimbouch - COO, Interim CFO

Analysts

Scott Schneeberger - CIBC World Markets

John Healy - FTN Midwest Securities

Paul Bartolai - Credit Suisse

Mark Sproule - Thomas Weisel Partners

James Fotheringham - Goldman Sachs

Michael Millman - Soleil Securities

Presentation

Operator

Welcome to the second quarter 2008 Jackson Hewitt Tax Service Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today, Mr. David Kraut, Vice President of Treasury and Investor Relations. Please proceed, sir.

David Kraut

Good morning and welcome to the Jackson Hewitt Tax Service second quarter fiscal 2008 earnings conference call. I am David Kraut, Vice President of Treasury and Investor Relations. Joining me today are Michael Yerington, President and Chief Executive Officer, and Mark Heimbouch, Chief Operating Officer and Interim Chief Financial Officer.

Earlier this morning we issued a press release announcing the company's second quarter fiscal 2008 financial results. You may access that press release in the investor relations section of our website located at www.JacksonHewitt.com.

Today's call will begin with Mike Yerington reviewing the initiatives to support the company's growth strategies beginning with the 2008 tax season. He will also provide an update on the recent developments that occurred during the quarter. After that, Mark Heimbouch will discuss financial highlights from the quarter, provide an update on our financial product agreements, and review the capital structure. Following our prepared remarks, we will leave sufficient time for questions.

Please note that this presentation 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 could 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, 2007 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 webcast simultaneously on our website at www.JacksonHewitt.com. Additionally, the webcast will be available for replay on our website.

The information provided on this call is not disclosed in connection with an offer to sell, or the solicitation of an offer to buy a franchise. Any such offer or solicitation is made only through our uniform franchise offering circular and only in jurisdictions where such offers are lawful.

Now let me introduce Mike Yerington.

Mike Yerington

Good morning. I am pleased to be speaking to you today for the first time as Jackson Hewitt's Chief Executive Officer. I would like to thank the board of directors for their confidence in me and I look forward to taking Jackson Hewitt to the next level of success.

I would also like to thank our employees, franchise partners and vendors for all the work they've undertaken to get us to this point. This has been a very busy and productive off season for Jackson Hewitt and I am confident we are well prepared to serve a record number of clients this coming tax season.

Jackson Hewitt's mission is to be the tax preparer of choice for the workforce of America. We plan to execute upon that strategy to drive strong returns for investors by growing the business, generating strong cash flows and aggressively returning excess capital to shareholders. We will also strive to accelerate tax return growth this coming tax season and in the future by driving office productivity and same-store sales growth and by balancing that growth with targeted, new office expansions.

But before I discuss specific growth initiatives, let me spend a few minutes discussing my background and observations of the company. I joined Jackson Hewitt in July of 2006 after spending over 30 years with The Western Union Company, which is a subsidiary of First Data Corporation. I served in a variety of senior roles, including President of Western Union North America and also as a member of the executive committee of First Data.

During my tenure there, I was responsible for developing a number of products and services for Western Union's clients, which demographically are very similar to Jackson Hewitt's clients. I also managed a network of 55,000 independent agents comprised of entrepreneurs with similar needs as Jackson Hewitt's franchisee base.

What attracted me originally to Jackson Hewitt was its market share opportunity. The company has only a 4% share of the paid preparer market and participates in an overall market that has been growing by about 1.5 million new taxpayers each year. Currently, the company's distribution channels are convenient to only about 40% of the addressable market, and about three-quarters of that addressable market is being served by tens of thousands of small independent practitioners who do not have the partner relationships, product line, brand or support of a company with nearly $1 billion market capitalization behind them, like our franchisees do.

Over the past year-and-a-half, I have been focusing my time in several areas which, in my experience, represent the building blocks for growth for any company.

First, what is the vision of the company? What are we trying to achieve? Simply put, Jackson Hewitt's vision is to become the tax preparer of choice for the workforce of America.

I also look at the organization. This includes such things as bench strength, succession planning, and leadership development. We've already added to our leadership and have restructured several groups to better serve our franchisees and customers.

The next area is infrastructure. Are we built to deliver high growth? Are our systems and architecture scalable? Are we built to operate at peak performance? By continuing to improve the tools that we provide to franchisees, they will be better able to operate at higher levels of productivity in the future.

Then I focus on the metrics of the business. Do we measure those things that are important? Do we measure all the key drivers of growth? Are we measuring what's important to our franchisees and our customers? Mark has already instituted a lot of these metrics in his role as CFO, and will now be implementing additional metrics.

After that, I look at our reward and recognition programs. Do we pay for performance? Does everyone understand what excellence is? Do we have and do we reward clearly defined objectives? I will discuss more of these initiatives shortly.

I believe all of these areas are important to focus on if Jackson Hewitt is to become the company that I want it to be. I also know that each one of these areas must be working properly if we are to create and maintain a sustainable, long-term growth plan.

Overall, I agree with Jackson Hewitt's strategy of being the tax preparer of choice for the workforce of America, but there are some changes that I anticipate making to accelerate our growth. We need to focus more on marketing, more on distribution, more on driving productivity by achieving a better balance between same-store sales growth and targeted office expansion. The key to our success, beyond focus, is to execute well in all of these areas.

Let me now turn to brand and high quality tax preparation. As we accelerate expansion, first and foremost we will be known throughout the industry as a leader in high quality tax preparation. This effort will be supported by the previously announced enhancements to our processes and systems and the formalization of roles such as the Office of Tax Compliance. Leading this department is Tom Smith, a former IRS executive with over 35 years experience with the Internal Revenue Service. More than ever before, high quality tax preparation and improved customer experience will differentiate us in the marketplace.

I am very pleased that our product partners and our franchisees share our commitment to the highest level of quality. For example, Santa Barbara Bank and Trust, our financial product partner with the largest share of our business, recently announced initiatives to drive high quality tax preparation for this coming tax season. We fully support Santa Barbara's approach and high standards and look forward to a continued and long-term partnership with them.

We have met and will continue to meet to discuss our focus on quality with the senior management at HSBC, Santa Barbara Bank and Trust and Republic Bank and Trust who are all valued partners and who recently signed agreements with us in order to serve our customers.

Let me talk a minute about brand and customer experience. Focusing on the customer experience is a key driver of our ongoing goals of creating same-store sales growth and improving profitability for both the franchisee and the franchisor. We offer tools, training and a national brand that stands for quality, innovation and consistency.

We also have a clear understanding of the needs of our core customers, the workforce of America and the products and services that they demand. We are going to make the focus on quality tax preparation and the customer experience a competitive advantage.

To further build and develop the brand, we recently hired the company's first Chief Marketing Officer, Douglas Foster. Doug has more than 20 years of leadership responsibility building and managing high performance marketing and brand development teams. Doug was most recently with 7-11, where he served as Chief Marketing Officer. Additionally, Doug held senior leadership roles at J Walter Thomson advertising agency for 15 years. He will manage a number of responsibilities at Jackson Hewitt including marketing, business development, financial product development, and corporate communications. Doug is well qualified to provide us with a marketing edge in all of these areas.

In the future, our marketing messages will more closely connect with high quality tax preparation with both early season and late season customers. We expect this and our new targeted distribution strategy to drive new customer acquisition, and customer retention, as well as improve office productivity and same-store sales. We are prioritizing our advertising spend among the markets that have the highest growth potential with low Jackson Hewitt market share.

We have improved our database marketing capabilities over the last year, to better refine a unique marketing message for each returning customer and each potential new customer. We're also piloting a customer loyalty program this coming season that will reward those customers who return year after year to Jackson Hewitt and we continue to reward those customers who refer their friends or neighbors.

We're also introducing a tax preparer recognition program. The tax preparer is the primary point of contact for our customers and is the first person who can influence the customer experience and drive customer retention. We will recognize increasing levels of experience and achievement among tax preparers as we seek to build a bond between them and the Jackson Hewitt brand. Simply put, tax preparer retention is important in driving customer retention.

With respect to franchisees, we will recognize best in class performance as a key driver of improved franchisee growth throughout the system. Those franchisees who demonstrate strong performance may also qualify for financial rewards while those with strong performance in customer retention, preparer retention, office improvement and other key attributes will be separately recognized by the system.

In addition to the initiatives that I have described for this year, we are actively pursuing a long-term strategy to drive same-store sales and franchisee productivity and profitability. We were in the early stages of these efforts and anticipate engaging internal and external resources as we develop our strategies and tactics. I will keep you informed about this on future calls.

Moving to distribution. As you know, a network of about 800 franchisees is the primary distribution method for our services. They are our partners and we rely on each other for success. Renewing and elevating the level of partnership between franchisor and franchisees has been a key objective of mine during the past year. I believe we've been highly successful in this effort and believe that the level of satisfaction among franchisees is higher than it was a year ago, even with a tough season that many franchisees experienced in 2007. That renewed level of partnership within our community will be a key competitive advantage that will serve us well in aggressively supporting many of our initiatives to drive tax return growth.

For example, we have significantly increased the formal channels of communication and support for our franchise system. We have also redeployed the field management team so that franchisees of different sizes that have different needs will get different types of support. This is resulted in over a 300% increase in the number of in-person meetings with our franchisees. By sharing best practices among the franchisees, we believe we can drive the improvements in store productivity, improve the quality of customer experience, and help franchisees to improve their profitability, all of which of are key focus areas for Jackson Hewitt.

As we look to expand our footprint nationwide, we will rely on a three-part strategy.

1. First, we want to remain primarily a franchisor, and we'll seek to have a franchisee operate, or make acquisitions within a new territory.
2. Next, we will seek to convert independent practitioners.
3. Finally, we will consider establishing a company-owned presence if it is in a high growth opportunity with no viable franchisee alternative .

We continue to rely on existing franchisees to develop their existing and adjacent territories by concentrating on higher office productivity, same-store sales growth and targeted expansion. We will provide the tools and the expertise to help franchisees in selecting those locations for expansion that will help to us further penetrate the late season.

Additionally, we will seek to attract new franchisees more than in the past, to accelerate expansion in high growth regions in which our current franchisees do not have a significant presence.

We have also redeployed the dollars spent on franchisee financing initiatives to focus on those under-penetrated territories and have begun offering financing for those franchisees who open offices in these high growth areas. We've structured our sales compensation plans to reward sales people who sell in these targeted territories. These efforts are being made in an effort to prioritize our expansion among those territories that demonstrate high growth, low existing share, and low Jackson Hewitt distribution.

Next, let me update you on some recent developments. While the initiatives I just mentioned were being developed in the off-season, our corporate team was working diligently to conclude a number of previously disclosed events well in advance of the tax season. Mark will speak to the financial impact of several of these events, but in summary:

Financial product agreements were executed with three financial partners. That secures access to the full network of Jackson Hewitt offices for the next three tax seasons.

The Internal Revenue Service audit of the company's systems and processes was closed.

The U.S. Department of Justice resolved lawsuits that it had filed during the prior tax season against one of our franchisees and other named defendants. I will remind you that the company was not named in the lawsuits and the company's internal review determined that there was no corporate involvement in the allegations made against the franchisees.

That franchisee has exited the Jackson Hewitt system and we acquired his tax preparation business in Atlanta, Chicago and Detroit markets for $19.1 million. We will operate those stores as company owned locations, beginning in the 2008 tax season. We continue to expect that these businesses which generated approximately $14 million in revenue for the franchisee last year will be accretive to our earnings in the current fiscal year.

In addition to my promotion Mark Heimbouch, formerly Chief Financial Officer, was promoted to Chief Operating Officer and will remain interim CFO as we continue to search for a replacement. Our board of directors separated the Chairman and Chief Executive Officer roles with Margaret Richardson, former IRS Commissioner and a board member being named non-executive chair of the board.

Now let me update you on our outlook for distribution for this coming tax season. As we discussed on our last quarter's call, we expected to see an increase in the pace of new territory sales and new office development following the resolution of all the off-season activities. I am very pleased to report that we did see that increased pace of activity. It actually started in October, after all the events were brought to a formal conclusion, resulting in a number of territory sales being recorded subsequent to quarter end.

We expect that as of November 30, we will have sold 120 territories year-to-date. Recently the pace of territory sales has been above the comparable year ago period. Additionally, we believe that the quality of these territory sales is high since we spent considerable effort to encourage investment, primarily in targeted markets. I am pleased that well over half of our territory sales this year have been in targeted markets.

We also continue to refine our expectations for new store openings as it gets closer to tax season and as our franchisees review our targeted locations. We currently expect to open about 400 to 500 net new offices in the current year, bringing the total network to between 6,900 and 7,000 locations. We are spending considerable efforts on balancing new store expansion with same-store sales growth initiatives and are concentrating our new stores in markets that currently have low distribution in order to maximize immediate reach and minimize the risk of cannibalization.

From an industry and competitive viewpoint, there are several interesting dynamics in play this coming tax season. First as has been widely reported, the U.S. Congress continues to deliberate on the tax policies related to the alternative minimum tax. There are estimated to be 21 million more Americans who will be impacted by the AMT this year as compared to a year ago, unless the issue is addressed by Congress.

Additionally, there are another 25 million Americans who rely on a variety of tax credits such as dependent care. Although not directly impacted by AMT, the priority of applying these tax credits when calculating the refund is typically determined in the AMT legislation. The IRS has indicated that it will take up to ten weeks following Congressional resolution before they're ready to fully accept and process all tax returns impacted by the proposed legislation.

Jackson Hewitt is an industry leader that owns and develops its proprietary software, is working closely with the IRS and other members of the industry to be able to minimize any impact on individual taxpayers. As a tax preparation firm, this is all we do, all year. We do not rely on others to build our software and so from a competitive standpoint, we will be ready to transmit tax returns as soon as the IRS is ready to accept them.

Looking to the future, I would also like to take this opportunity to reaffirm our long-term financial targets. I am excited about the growth opportunities for the cash flow generating capabilities of the business model. Over the next five years, we continue to target annualized revenue growth of 10% to 15% and annualized diluted earnings per share growth of 15% to 20%.

We do not provide guidance for a single year, and obviously there are incremental costs recurring and nonrecurring in this year. However over time we continue to expect free cash flow to exceed net income and to be able to return at least 100% of prior year net income in the form of dividends and share repurchases to shareholders. In the first six months of this year, we have already surpassed that full year expectation for 2008.

With that, let me turn the call to Mark Heimbouch.

Mark Heimbouch

Thanks, Mike. Good morning, everyone. Before I review the financial results for the quarter, I would like to spend a couple of minutes discussing my transition from the role of Chief Financial Officer and some initial priorities as Chief Operating Officer of Jackson Hewitt.

Over the past four-and-a-half years as Chief Financial Officer, I have learned a lot about the industry, beginning with leading our initial public offering. I have also been responsible for overall financial management, including having developed our capital allocation strategy and returning capital to shareholders through share repurchases and above market dividend rates.

During this time, I have also been a member of the senior management team, setting direction for Jackson Hewitt and in doing so, have led several operational initiatives including driving improvement in the company-owned office operations both in terms of growth and profitability. This is demonstrated by margin improvement in the company-owned office operations of nearly 1,500 basis points since the IPO. I have also played a significant role in negotiating with our financial product providers through many of the changes we've seen over the past few years.

Most recently, I have been involved in bringing to conclusion the internal review, the completion of the IRS examination and the acquisition of the businesses in Atlanta, Chicago and Detroit.

In my new role, initially I have three key areas of focus. First is to continue to focus on partnership to increase the value of the franchise. Mike Yerington has made great strides in strengthening the partnership with franchisees so I look to continue to work with franchisees to strengthen the brand. Partnership doesn't end there. It also entails working with our financial product and other providers to deliver value to our consumer, the workforce of America.

Second is distribution, which remains a key component to Jackson Hewitt's growth. We will continue to seek to increase our share of the addressable market through expansion, but with a renewed focus on driving improved productivity, same-store sales and profitability for the franchisee.

The third area of responsibility is technology. We made changes in the technology organization to improve our software over the past several months as we look to continue to be an industry leader in tax preparation. Soon we expect to announce the new Chief Technology Officer as we strengthen our organization to be best in class. Technology is the backbone for both our industry-leading profiler tax preparation software and also the tool to deliver new products and services in the future.

Next I will review the second quarter financial highlights. Our press release from this morning provides detailed financial results for the quarter, so I will concentrate on highlights, including reviewing the financial impact from the recent developments.

As you know, operating results from the first and second quarter are not indicative of the company's full year performance. In fact, we have historically generated about 2% of our annual total revenues in each of the first and second quarters. Additionally, the net loss in these off-season quarters typically increases each year as a result of the prior year office expansion in the company-owned segment, anticipated growth in the business and the cumulative effect of the share repurchase programs on interest expense.

Revenues were $5.6 million for the quarter, as compared to $6.2 million in the prior year period. These revenues consisted primarily of financial product fees earned from the sales of the Gold Guarantee product in prior seasons and fees earned from the sale of new territories.

Net loss was $23.7 million for the period, and included $8.3 million or $0.18 per share of non-recurring charges. On a per share basis, net loss for the quarter excluding the non-recurring charges was $0.60 compared to $0.46 per share in the prior-year period.

First, we incurred a non-recurring charge of $5.7 million or $0.11 per share for the severance of our former Chief Executive Officer. Of this charge, $2.8 million was a cash payment with the remainder a non-cash expense related to the accelerated vesting of his stock options. We would expect that most analysts would exclude the $5.7 million expense figure from their model.

We also incurred $2.2 million or $0.06 per share of internal review-related costs during the quarter. These costs are included within the $6 million full year estimate provided on the last earnings call and consist primarily of professional fees and the $1.5 million voluntary compliance payment made during the quarter as part of the closing agreement with the Internal Revenue Service. We would also expect most analysts would exclude the $6 million expense from their model.

As we said in the past, we do expect to incur approximately $1million to $2 million of recurring operating costs beginning this year that are incremental to the $6 million internal review related costs as we make enhancements to our compliance processes and systems. We would expect that margin improvement would be somewhat constrained for only this year by this incremental and ongoing expense. This increased investment is also consistent with our commit to quality tax preparation.

On the franchise side of the business, marketing and advertising expenses increased by $1.2 million in the quarter, mostly as a result of the changing contractual arrangements highlighted last quarter in which the expenses are amortized over the full year, as opposed to only during tax season. For the full year, we would continue to expect marketing expenses this year would grow at a slightly faster rate than total revenues.

On the company-owned side of the business, operating expenses increased during the quarter by about $1 million, largely due to the incremental stores open last tax season and the acquisition of approximately 150 offices in Atlanta, Chicago and Detroit late in the quarter.

As mentioned, interest expense increased by $1 million in the quarter. The increase is primarily a function of the ongoing share repurchase programs and the corresponding increase in average debt balances.

During the quarter, we repurchased 800,000 shares for $25 million. Through the first two quarters of the year, we have returned $66 million to shareholders in the form of dividends and share repurchases, returning more than 100% of prior year’s net income to shareholders.

As of quarter end, there was approximately $78 million remaining for share repurchases under previously authorized programs. Since our buyback programs began in June 2005, we repurchased 8.8 million shares for $259 million. This represents nearly 25% of our original share count at the IPO in 2004.

The weighted average share count for the first quarter was 30.2 million shares outstanding as compared to 33.6 million shares outstanding in the prior-year period. Recall that in periods of losses, basic, not diluted, share count is used in the calculation and that the lower share count resulting from share repurchase programs adversely affects the loss per share.

Despite the off season impact on reported financial results, we believe that share repurchases are an important part of our capital structure and demonstrate our commitment to shareholder value. The conclusion of recent developments over the past several months has removed our inability to repurchase shares.

During the quarter, we increased our ability to support ongoing and aggressive share repurchases by amending the definition of a covenant in our credit facility to measure leverage on an average basis as opposed to a point in time basis. The result is that although the leverage covenant level remains at three times, we now have the ability to reach a seasonal peak of over 3.5 times. We appreciate the confidence that our lenders demonstrated in the success and sustainability of Jackson Hewitt's business model by approving this covenant change at a time of uncertainty in the overall credit markets.

During the quarter, we also signed three financial product agreements. We sought three key objectives in these arrangements:

1. To secure long-term access to financial products for our entire network.
2. To obtain contracts that were structured primarily as fixed payments, yet providing for growth over time as we grow our business.
3. To strengthen our relationship with key financial partners while maintaining multiple product sources.

We believe that we achieved these goals with economic terms materially similar to those in effect last tax season. The structure of our three agreements is similar to prior agreements, resulting in a highly predictable cash flow stream that is approximately 90% fixed. We will continue to receive an annual fee for providing access and technology support to the financial partners who offer their products to our customers.

It is important to once again point out that our compensation is not calculated on a per product basis.

Additionally, it should be noted that after 2008 the contacts with Santa Barbara and Republic provide for increasing volumes and fees to account for the expiring HSBC contract. As a result, we believe that we have secured access to products for our entire network through the 2010 tax season on a primarily fixed annual fee basis.

Before I turn the call back to Mike, let me reiterate management's confidence in the business’ ongoing ability to generate strong earnings and cash flow. It is the intent of the management and the Board of Directors to return excess cash to shareholders in the form of share repurchases and dividends while driving strong earnings per share growth and maintaining a flexible capital structure.

Looking back over the many changes of the past several months, 2008 would appear to be a year of transition for Jackson Hewitt. However, we believe the events of the past several months make the company stronger and we remain optimistic for the long-term prospects for the business. The long-term targets that we reaffirm today significantly exceed the current Wall Street consensus growth projections for Jackson Hewitt.

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

Mike Yerington

Thanks, Mark. To summarize, we are focused on our strategy to be the tax preparer of choice for the workforce of America. We have specific initiatives in place to accelerate growth in same-store sales, new customer acquisition and targeted office expansion, beginning in the current tax season. We have elevated the level of partnership between franchisor and franchisee, and have seen a rebound in reinvestment by franchisees well in advance of the tax season.

We are committed to driving shareholder value, and assure you that the interest of employees, franchisees, management and the board of directors are aligned with shareholders to do so.

With that, we'll open the call to questions.

Question-and-Answer Session

Operator

Your first question comes from Scott Schneeberger - CIBC World Markets.

Scott Schneeberger - CIBC World Markets

On the territory sales, Mike, you mentioned half are in targeted markets. Could you just elaborate a little bit more on that? The other half, how did that come about? The mix of territory sales -- who are existing franchisees and what percent is new? Thanks.

Mike Yerington

Let me talk for a minute about the concept of targeted territories, Scott. We've been focused on making sure that we expand our foot print where we need to. That sounds kind of simple on the concept, but basically it is taking a territory that has demonstrated that it has high growth and low share and probably low Jackson Hewitt distribution, so when I say targeted, I mean that about 70% of our territories that we targeted that way have been sold as part of the new territory mix. If you look at that, that would represent about 23% new franchisees into the system, versus about 15% from last year.

Scott Schneeberger - CIBC World Markets

Also, this legislation surrounding AMT is obviously a very big deal on the tax season. Could you talk about scenarios of how you think it may affect tax filers in the season? Speak around how it impacts you specifically, and perhaps relative to some of your peers? Thanks.

Mike Yerington

Let me first talk a little bit about the situation itself. Many of you on this call may know that Congress is looking at various scenarios affecting the alternative minimum tax. There are three scenarios we see that could possibly play out here. One is if the Congress does nothing, then this new law will take effect and you'll impact about another 21 million additional taxpayers. That's one scenario.

The other scenario is that Congress could change or delay the whole season, which we think is highly unlikely because that would impact 137 million taxpayers.

We think the most likely scenario would be that Congress would come up with a patch that would probably allow processing and be able to get some of the tax preparation done in a timely fashion; some may be delayed.

I think as far as the impact on us in that situation is we think any time there is a dynamic change in the marketplace it creates an opportunity for Jackson Hewitt. I think part of what we'll be doing is making sure that we educate and tell our customers what's going on. I think overall that should be viewed as a positive by our investors for the future, for us.

Scott Schneeberger - CIBC World Markets

Going into the tax season -- I know you get this every year, probably every quarter -- but pricing; what is your feel as you head into this year? Is the viewpoint the standard 5% to 7% as we've seen historically or maybe a little more, a little less this year and why? Thanks.

Mike Yerington

Scott, we don't give guidance specifically on pricing. What we've been telling our franchisees is to look at the value they provide to their customer to make sure that the value proposition is in line with the service they're providing. We try to give our franchisees as much information as we can about the local pricing going on in their marketplace, so they can make an informed decision.

Scott Schneeberger - CIBC World Markets

Finally, when might we hear an update on the CFO search?

Mike Yerington

We are actively in the process of searching for a candidate as we speak. We've seen a few candidates but we're not trying to rush it. We want to make sure we have time to get the right candidate on board and Mark seems to be okay doing both roles right now but we want to make sure he is able to focus on his new role.

Operator

Your next question comes from John Healy - FTN Midwest Securities.

John Healy - FTN Midwest Securities

From a big picture standpoint as you approach the tax season this year, are there any anomalies or calendar issues you guys are expecting to impact the way results are presented for the second half of the tax season?

Mark Heimbouch

In the past we've talked a lot about the fact that our third quarter ends at the end of January and that has historically been a peak in volume for our business. I think this year it has the potential of being more interesting. If you look back at the last few years, there has been a gradual shift from that January timeframe to later in the tax season, so some of has carried over into February as well as March and April.

We've given prior guidance. I think our view on this year is if you set aside the fact that there is the potential AMT changes, we would still expect that gradual shift to continue. So that could actually be further impacted by whatever changes Congress and the IRS makes. We don't really have it nailed down in terms of specific numbers, but we would expect that Q3 overall could be down, but that the demand doesn't go away so would be made up; and then continued growth in February and following months.

John Healy - FTN Midwest Securities

The one interesting thing I thought you guys said was looking at some company-owned stores. Is that a strategy that you would pursue for the long term or is that a strategy to maybe open up some company-owned stores, prove that those are viable markets, and then be able to sell those to franchisees longer term? I was hoping to get a better understanding of that strategy.

Mike Yerington

What we said, John, is that we would obviously try to work through franchisees first. We would try to get acquisitions. We would either try to have them open up territories where we see high growth or we would try to make acquisitions there, but I think one of the things we did say is that as a final third part of that strategy we would also look at opening company stores.

The intent long term is to still maintain our status as a franchisor, so we don't see a wholesale opening of company stores but there are certain new territories that I really want to be in because I know I can get volume just by showing up with a territory and making it convenient for my customers. We would do that as part of a three-prong strategy and over time those stores would probably be sold back to franchisees.

John Healy - FTN Midwest Securities

Obviously you have been successful at securing your financial products over the next three years. Are you hearing any rumors in the marketplace, some of the independents are having issues securing financial products? If that is the case does that provide more opportunity for you guys this year and maybe in the years to come?

Mike Yerington

First on the opportunity, yes, I think it does provide more opportunity for us in the coming years, but I would refer to a comment that was made by one of our bank partners that they were uninviting independents out of their system because they wanted to focus on quality tax preparation.

We, as you know, from what we just said are focused on quality tax preparation so I think that the independents, some of which who are not focused in that direction, will have a hard time getting bank partners to partner with them to provide financial products and I think that plays well for us in the market.

Operator

Your next question comes from Paul Bartolai - Credit Suisse.

Paul Bartolai - Credit Suisse

You guys talked a lot about some of the initiatives underway in terms of the loyalty rewards in the marketing. How do you think that impacts the profitability of the business longer term, or is it more of a near term issue? Do you think the benefits outweigh that longer term? Can you comment on the profitability outlook?

Mike Yerington

First of all, I think it has little impact on profitability, Paul. I think that one of the things we're trying to do is to reward those customers that come into the franchise more frequently. I look at it as what's the long term or lifetime value of a customer, not just a one-time event, but what's that customer worth to me over a period of years?

I think you can do some things that don't cost a lot of money that reinforce customers to come back into the franchise. I won't get into all those, but those are not high cost items and I don't see that impacting profit long term; with the exception I see it improving profit if those customers come in on a more regular basis.

Paul Bartolai - Credit Suisse

Great. Sorry if you mentioned this, but the 400-500 target in terms of store openings, does that include the stores you acquired from the one franchisee?

Mike Yerington

No, it does not. Those are 400 to 500 net new stores that we'll have in our system.

Paul Bartolai - Credit Suisse

Finally, you talked about same-store growth and balancing the growth with the cannibalization. Any comments on your outlook for same-store growth going forward? I know it has been a little bit challenged recently. Do you think we should see that back in the low to mid single-digits where it had been previously or what are your thoughts there?

Mike Yerington

We don't provide specific guidance on the same-store sales growth number, but with all the programs and processes we have in place to focus on that, I would see that improving over time. It could be slightly positive this year.

Paul Bartolai - Credit Suisse

You expect it to be positive this year?

Mike Yerington

Yes.

Paul Bartolai - Credit Suisse

Something we haven't talked a lot about is the royalty advertising rate charge to the franchisees. Is there any discussion or thought on altering that one way or the other, or is that something that is pretty much set for now?

Mike Yerington

The rates are contractually obligated from both sides so we don't see that changing. In fact, all of our contracts are ten-year, so unless we change a contract or change the wording of the contract, we don't see that changing in the short term.

Operator

Your next question comes from Mark Sproule - Thomas Weisel Partners.

Mark Sproule - Thomas Weisel Partners

You talked in the past about the timing of the season extending a little bit and then you're coupling on top of that the potential of some volatility with the IRS AMT. How does this benefit you considering the bulk of your season has historically been through that three-week window around January/February?

Mike Yerington

I think the demand is still there for the products and services that we sell. I think that we don't suffer any competitive disadvantage for sure but I think the opportunity to satisfy that pent-up demand is still there even though the system or the IRS may delay being able to accept returns for awhile. So I don't think anything changes from that perspective, Mark. I think that we still will have a very positive impact in the early season as well as the latter season customer. I don't see any major impact of the delay in filings.

Mark Heimbouch

Mark, the only thing I would add to that is this seems to be one of those periods of increased awareness for the consumer and looking back over time, events like this tend to drive people to a paid preparer. That would appear to be more of an advantage versus a disadvantage.

Mark Sproule - Thomas Weisel Partners

When you think about the last couple years with the season maybe extending a little bit, there has obviously been some different products in play in the early season from a loan perspective that aren't in play broadly this year. Does that throw a monkey wrench into expectations into how that early season will play out? How do you guys look at that?

Mike Yerington

I really don't think it does. I think that the early season customer, obviously with no early season products, they'll be coming in during the season. I think it gives us the advantage in that we have a little more money to spend to attract new customers during the season itself; money that we would have spent on marketing and overhead that our franchisees and/or we would experience go away in that early season because we'll be spending that money and time on the season itself.

I think there is really no disadvantage. I think probably it is an advantage in that we'll have more money to spend during the regular season.

Mark Sproule - Thomas Weisel Partners

When you look at the type of customer, the 21 million AMT or potential AMT individuals or households that get hit with that, I imagine much of that is the latter season customer. How do you target that customer versus your traditional early season refund customer?

Mike Yerington

We do have a different marketing message for early season versus later season customers, but let me just comment a minute on the AMT impact. When people look at AMT, they think this really doesn't impact customers in our case, which are traditionally in the $50,000 or below household income.

But if you look at the AMT legislation, and the impact of AMT in total, there are about 11 credits that are associated with AMT and these are things such as child tax credit or child dependent care, and those obviously have very much of an impact on our customers.

I think that the AMT legislation, even though people tend to think of it as higher income earners and maybe people in different socioeconomic classes, I think in fact there is a significant amount of our customers that would be impacted by that.

But as I said before, we do have targeted messages in our marketing efforts for early season; early season customers tend to want speed and that's one of our key focuses there. They also want dependability and they also want to be treated with dignity and respect, so those are things we'll focus on in the first part of the season.

In the latter season we see customers focusing more on quality tax returns, quality tax preparation, they're usually folks that are not getting a return and these are folks that are really interested in a different kind of tax preparation experience. We have a targeted message for both. I would say that quality tax preparation across both target markets is important to us.

Mark Sproule - Thomas Weisel Partners

One last question, in regard to the same-store growth, you guys have noted a few times in the last couple quarters really the expectation that you would see same-store filing growth.

What are the initiatives that the franchisees are doing to get that kind of filing growth, or is it as much a function of last year being a hiccup as anything else? Thanks.

Mike Yerington

There is a variety of different programs that are focused on same-store sales growth, both from a corporate standpoint as well as the local franchisee. We have special programs in place, marketing incentives in place for the franchisees to be able to go after their local market. We think they're probably in the best position to know what's going on in their local market.

We overlay those programs with corporate programs such as direct mail, targeted media, radio, television, billboards, a variety of different media programs that we have that are targeted to help build volume in those stores.

We mentioned before we're also focusing on Hispanic customers, making sure that part of our franchisee is well cared for and recognized. We are testing some customer loyalty programs which really focus on bringing customers back to the franchise. We have a variety of different ways that we are focused on bringing those customers back into the system and those are just a few of the ones we're working on.

Operator

Your next question comes from James Fotheringham - Goldman Sachs.

James Fotheringham - Goldman Sachs

Mark, just some quick questions about leverage. What is your current leverage ratio and how precisely do you calculate it? I think it's now 3.5 times covenant limit, and given your debt needs next quarter, could you comment on the near-term sustainability of your current rate of share repurchases? Thanks.

Mark Heimbouch

Just to be clear, on the call we mentioned 3.5 times; that's really an interim period peak. The calculation itself would still have a maximum of 3 so its an average calculation including the prior four quarters.

Through the current quarter the leverage calculation, to be precise, is about 2 so that's really not meaningfully different if you look over time, we have always said that we'd expect to be between a low and a high of 1 to 2 times and I think we have also said we will continue share repurchase programs and borrowing in the off-season from the operations that we could approach something towards 3. So that is overall; overall it would creep up on a year-over-year basis, but then coming back down again as we collect on the cash during tax season. It is a moderate year-over-year increase, really.

In terms of guidance towards expectations around share repurchase programs, what we have said is we have a strategy of being consistent and that's really all I would say. We don't really give guidance in terms of how much we would expect to repurchase over the next period.

James Fotheringham - Goldman Sachs

That's understood and appreciated. In terms of the modest increase in leverage, basically being driven by your impressive rate of buybacks, if you take a longer-term view, how long can that go on? How high would you be willing to push the leverage ratio, ultimately?

Mark Heimbouch

I guess that's not guidance we would give at this point in time, other than what we've said before is that over time it gradually creeps up. You have to keep in mind we generate a ton of cash during tax season, over $150 million, perhaps close to $200 million of cash, so it gives us an ability to make a significant pay down really beginning in January through tax season.

James Fotheringham - Goldman Sachs

My second question is more about strategy, Mike. You lost your early season products and Block did not. Apart from the special programs, what specifically are you proposing to replace what was your key marketing differentiator to drive positive same-store sales this year?

Mike Yerington

I guess I am not sure I understand your question about losing our early season products and Block did not.

James Fotheringham - Goldman Sachs

They still have their [inaudible] product, whereas you've backed away from early season lending. That's all I meant by that. Without the comparative even, if you have lost your early season refund lending capability, that was a key marketing differentiator for you. In terms of the special programs that you were talking about, I am wondering what you would propose to replace that key marketing differentiator for you?

Mike Yerington

Let me first comment on maybe a competitor's product that you were describing as a preseason product. I think you might be referring to the line of credit from Block, and I look at that product as probably a product that's not easily understood by our consumers. It is fairly complex in that it has to be tied to a savings account with a deposit. It has a resetting interest rate and is only available to prior year customers of 2005 and 2006. I don't know that I would view that as a direct competitor to preseason product, first. That's the first point I would make.

Secondly, we do not have preseason products. We have decided, for a lot of reasons, that this is not something we're going to provide in the early season. We decided to focus on quality tax preparation and driving customers into the normal season. A lot of the programs I talked about before -- improved direct mail, telesales, customer loyalty programs, a variety of things -- that we think will be important to our customers will be focused on this year, instead of preseason products.

As I mentioned before, the money we would have spent on preseason we will heavy up and have targeted certain DMAs where we know there is a chance for demonstrated high growth, and we have low share.

I am not going to get into all the techniques we're going to use; that would be telling my competitor what I might be working on, but I will tell you that we're well prepared to handle many new customers in our stores this year.

Operator

Your final question comes from Michael Millman - Soleil Securities.

Michael Millman - Soleil Securities

Last year you attributed at least part of your volume decline to delays. Also, that Block also had an early season retention product. This year it looks like the AMT again is going to be a delayer and Block again has an early season retention product, even though it may be limited. Can you talk about why this year is different regarding those volume declines than last year?

Mike Yerington

Well, let me talk in a couple of areas, Michael. First I think that if you look at products that Block offered and I will take the 36% [inaudible] as one example. From my estimations the Block volume actually went down by about 150,000 last year so I don't know that it was a major competitive advantage in that respect.

As far as the delay in AMT, the demand is still there. People still want cash, and we still have good relationships with banks and we'll be able to provide that cash, so I don't see that as an issue for us going forward.

Michael Millman - Soleil Securities

The issue was more that you said delays cost you last year, and we see another delay this year.

Mike Yerington

I think that as I said, I don't think the demand for cash, the need for cash goes down. I think the supply we have with our bank partners is there and I think if anything, it will probably create more awareness for the paid preparers, ourselves included, hopefully we'll be out there with a more clear and definitive message on how we can help folks that have the AMT issue as it relates to the credits to be able to file their returns.

Mark Heimbouch

Mike, actually I don't think we said last year was a result of delays. What we said is that we had seen a continued shift over the past years in which customers were filing later. I think the other thing is what you are seeing is a flattening in terms of a percentage rate of the number of paid preparers, with all the growth literally occurring in the last days. We obviously all know we were impacted meaningfully after April 3.

That's really how we looked at last year and I think if you set that compared to this year, there would appear to be a meaningful opportunity in terms of customer awareness, and driving those people to a paid preparer with in fact potentially increased demand.

If you look at people not being able to potentially get their refund until later, that could have a significant impact on driving demand versus hurting demand.

Michael Millman - Soleil Securities

Regarding the impact of later [ROW], the banks are going to I guess earn less, since they will have their money out longer. Do you think that this will cause them to come back in future years and want to renegotiate?

Mark Heimbouch

No. I don't understand your question, Michael. What are you suggesting here? I don't think the banks are going to earn less and I think that the banks that we negotiated with for these deals, the three-year deals that we just talked about, are very excited about working with us for those three years.

I think we've secured access to our customer base to those bank partners for those three years, so I don't think the negotiation issue is even on the table for us.

Michael Millman - Soleil Securities

Could you update us on the K project?

Mike Yerington

Which?

Michael Millman - Soleil Securities

The K project, the IRS project.

Mark Heimbouch

We really don't have an update at this point in time. The IRS has continued over the years to pursue means of receiving and processing returns more quickly and processing refunds. That's still on their agenda, and so in terms of budget my understanding is there is a budget for it. Again, it is something we'll work closely with the IRS in terms of moving forward and preparing for that.

Michael Millman - Soleil Securities

Could you tell us what your financing this year has been to buyers of territories to opening new stores and new territories compared with last year?

Mike Yerington

I can tell you generally how we handle that. We offer financing to people that want to expand, or open up new territories. Generally those loans are in the $25,000 range and we have done that again this year. We continue to do that. We provided about 100 of those kinds of financing in the last two years. We would expect that to be more in the current year.

Michael Millman - Soleil Securities

100 in each of the last two years?

Mike Yerington

100 in each of the last two years, yes.

Michael Millman - Soleil Securities

Finally, could you give us an idea of what your financial targets might be over the next two to three years?

Mike Yerington

No, we don't break it out that way.

Operator

There are no further questions in the queue. I would now like to turn the presentation back over to Mr. Michael Yerington, President and CEO, for final comments.

Mike Yerington

Thank you for joining us on today's call and your interest in Jackson Hewitt. We're excited about the 2008 season in just a few weeks and look forward to speaking with you on an update of the early half of the season in late February.

This concludes our call. Thank you very much.

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