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

Nov.27.07 | About: Jackson Hewitt (JHTXQ)

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

Operator

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

David Kraut

Good morning andwelcome to the Jackson Hewitt Tax Service second quarter fiscal 2008 earningsconference call. I am David Kraut, Vice President of Treasury and InvestorRelations. Joining me today are Michael Yerington, President and ChiefExecutive Officer, and Mark Heimbouch, Chief Operating Officer and InterimChief Financial Officer.

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

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

Please note that this presentation contains statements thatare forward-looking statements within the meaning of the Private Securities LitigationReform Act of 1995. Such forward-looking statements involve risks anduncertainties that could cause actual events or results to differ materiallyfrom those expressed or implied.

In addition, this conference call contains time-sensitiveinformation that reflects management's analysis, expectations and assumptionsas of the date of this live call. For further information concerning issues andrisk factors that could materially affect the company's business and financialperformance, 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 ourother SEC filings.

Jackson Hewitt does not assume or undertake any obligationto update or alter any forward-looking statements made or information presentedduring this call. This call is open to the public, and is being webcastsimultaneously on our website at www.JacksonHewitt.com. Additionally, thewebcast will be available for replay on our website.

The information provided on this call is not disclosed inconnection with an offer to sell, or the solicitation of an offer to buy afranchise. Any such offer or solicitation is made only through our uniformfranchise offering circular and only in jurisdictions where such offers arelawful.

Now let me introduce Mike Yerington.

Mike Yerington

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

I would also like to thank our employees, franchise partnersand vendors for all the work they've undertaken to get us to this point. Thishas been a very busy and productive off season for Jackson Hewitt and I amconfident we are well prepared to serve a record number of clients this comingtax season.

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

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

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

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

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

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

I also look at the organization. This includes such thingsas bench strength, succession planning, and leadership development. We'vealready added to our leadership and have restructured several groups to betterserve our franchisees and customers.

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

Then I focus on the metrics of the business. Do we measurethose 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? Markhas already instituted a lot of these metrics in his role as CFO, and will nowbe 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 wehave and do we reward clearly defined objectives? I will discuss more of these initiativesshortly.

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

Overall, I agree with Jackson Hewitt's strategy of being thetax 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 drivingproductivity by achieving a better balance between same-store sales growth andtargeted office expansion. The key to our success, beyond focus, is to executewell 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 theindustry as a leader in high quality tax preparation. This effort will besupported by the previously announced enhancements to our processes and systemsand the formalization of roles such as the Office of Tax Compliance. Leading thisdepartment is Tom Smith, a former IRS executive with over 35 years experiencewith the Internal Revenue Service. More than ever before, high quality taxpreparation and improved customer experience will differentiate us in themarketplace.

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

We have met and will continue to meet to discuss our focuson quality with the senior management at HSBC, Santa Barbara Bank and Trust andRepublic Bank and Trust who are all valued partners and who recently signedagreements 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 ofcreating same-store sales growth and improving profitability for both thefranchisee and the franchisor. We offer tools, training and a national brandthat stands for quality, innovation and consistency.

We also have a clear understanding of the needs of our corecustomers, the workforce of Americaand the products and services that they demand. We are going to make the focuson quality tax preparation and the customer experience a competitive advantage.

To further build and develop the brand, we recently hiredthe company's first Chief Marketing Officer, Douglas Foster. Doug has more than20 years of leadership responsibility building and managing high performancemarketing and brand development teams. Doug was most recently with 7-11, wherehe served as Chief Marketing Officer. Additionally, Doug held senior leadershiproles at J Walter Thomson advertising agency for 15 years. He will manage anumber of responsibilities at Jackson Hewitt including marketing, businessdevelopment, financial product development, and corporate communications. Dougis well qualified to provide us with a marketing edge in all of these areas.

In the future, our marketing messages will more closelyconnect with high quality tax preparation with both early season and lateseason customers. We expect this and our new targeted distribution strategy todrive new customer acquisition, and customer retention, as well as improveoffice productivity and same-store sales. We are prioritizing our advertisingspend among the markets that have the highest growth potential with low JacksonHewitt market share.

We have improved our database marketing capabilities overthe last year, to better refine a unique marketing message for each returningcustomer and each potential new customer. We're also piloting a customerloyalty program this coming season that will reward those customers who returnyear after year to Jackson Hewitt and we continue to reward those customers whorefer 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 thefirst person who can influence the customer experience and drive customerretention. We will recognize increasing levels of experience and achievementamong tax preparers as we seek to build a bond between them and the JacksonHewitt brand. Simply put, tax preparer retention is important in drivingcustomer retention.

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

In addition to the initiatives that I have described forthis year, we are actively pursuing a long-term strategy to drive same-storesales and franchisee productivity and profitability. We were in the earlystages of these efforts and anticipate engaging internal and external resourcesas 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 800franchisees is the primary distribution method for our services. They are ourpartners and we rely on each other for success. Renewing and elevating thelevel of partnership between franchisor and franchisees has been a keyobjective of mine during the past year. I believe we've been highly successfulin this effort and believe that the level of satisfaction among franchisees ishigher than it was a year ago, even with a tough season that many franchiseesexperienced in 2007. That renewed level of partnership within our communitywill be a key competitive advantage that will serve us well in aggressivelysupporting many of our initiatives to drive tax return growth.

For example, we have significantly increased the formalchannels of communication and support for our franchise system. We have alsoredeployed the field management team so that franchisees of different sizesthat have different needs will get different types of support. This is resultedin over a 300% increase in the number of in-person meetings with ourfranchisees. By sharing best practices among the franchisees, we believe we candrive the improvements in store productivity, improve the quality of customerexperience, and help franchisees to improve their profitability, all of whichof are key focus areas for Jackson Hewitt.

As we look to expand our footprint nationwide, we will relyon 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 theirexisting and adjacent territories by concentrating on higher officeproductivity, same-store sales growth and targeted expansion. We will providethe tools and the expertise to help franchisees in selecting those locationsfor expansion that will help to us further penetrate the late season.

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

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

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

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

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

The U.S. Department of Justice resolved lawsuits that it hadfiled during the prior tax season against one of our franchisees and othernamed defendants. I will remind you that the company was not named in thelawsuits and the company's internal review determined that there was nocorporate involvement in the allegations made against the franchisees.

That franchisee has exited the Jackson Hewitt system and weacquired his tax preparation business in Atlanta,Chicago and Detroitmarkets for $19.1 million. We will operate those stores as company ownedlocations, beginning in the 2008 tax season. We continue to expect that thesebusinesses which generated approximately $14 million in revenue for thefranchisee last year will be accretive to our earnings in the current fiscalyear.

In addition to my promotion Mark Heimbouch, formerly ChiefFinancial Officer, was promoted to Chief Operating Officer and will remaininterim CFO as we continue to search for a replacement. Our board of directorsseparated the Chairman and Chief Executive Officer roles with MargaretRichardson, former IRS Commissioner and a board member being named non-executivechair of the board.

Now let me update you on our outlook for distribution forthis coming tax season. As we discussed on our last quarter's call, we expectedto see an increase in the pace of new territory sales and new officedevelopment following the resolution of all the off-season activities. I amvery pleased to report that we did see that increased pace of activity. Itactually started in October, after all the events were brought to a formalconclusion, resulting in a number of territory sales being recorded subsequentto quarter end.

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

We alsocontinue to refine our expectations for new store openings as it gets closer totax season and as our franchisees review our targeted locations. We currentlyexpect to open about 400 to 500 net new offices in the current year, bringingthe total network to between 6,900 and 7,000 locations. We are spendingconsiderable efforts on balancing new store expansion with same-store salesgrowth initiatives and are concentrating our new stores in markets thatcurrently have low distribution in order to maximize immediate reach andminimize the risk of cannibalization.

From an industry and competitive viewpoint, there areseveral interesting dynamics in play this coming tax season. First as has beenwidely reported, the U.S. Congress continues to deliberate on the tax policiesrelated to the alternative minimum tax. There are estimated to be 21 millionmore Americans who will be impacted by the AMT this year as compared to a yearago, unless the issue is addressed by Congress.

Additionally, there are another 25 million Americans whorely on a variety of tax credits such as dependent care. Although not directlyimpacted by AMT, the priority of applying these tax credits when calculatingthe refund is typically determined in the AMT legislation. The IRS has indicatedthat it will take up to ten weeks following Congressional resolution beforethey're ready to fully accept and process all tax returns impacted by theproposed legislation.

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

Looking to the future, I would also like to take thisopportunity to reaffirm our long-term financial targets. I am excited about thegrowth opportunities for the cash flow generating capabilities of the businessmodel. Over the next five years, we continue to target annualized revenuegrowth of 10% to 15% and annualized diluted earnings per share growth of 15% to20%.

We do not provide guidance for a single year, and obviouslythere are incremental costs recurring and nonrecurring in this year. Howeverover time we continue to expect free cash flow to exceed net income and to beable to return at least 100% of prior year net income in the form of dividendsand share repurchases to shareholders. In the first six months of this year, wehave 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 thefinancial results for the quarter, I would like to spend a couple of minutesdiscussing my transition from the role of Chief Financial Officer and someinitial priorities as Chief Operating Officer of Jackson Hewitt.

Over the past four-and-a-half years as Chief FinancialOfficer, I have learned a lot about the industry, beginning with leading ourinitial public offering. I have also been responsible for overall financialmanagement, including having developed our capital allocation strategy andreturning capital to shareholders through share repurchases and above marketdividend rates.

During this time, I have also been a member of the seniormanagement team, setting direction for Jackson Hewitt and in doing so, have ledseveral operational initiatives including driving improvement in the company-ownedoffice operations both in terms of growth and profitability. This isdemonstrated by margin improvement in the company-owned office operations ofnearly 1,500 basis points since the IPO. I have also played a significant rolein negotiating with our financial product providers through many of the changeswe've seen over the past few years.

Most recently, I have been involved in bringing toconclusion the internal review, the completion of the IRS examination and theacquisition 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 thefranchise. Mike Yerington has made great strides in strengthening thepartnership with franchisees so I look to continue to work with franchisees tostrengthen the brand. Partnership doesn't end there. It also entails workingwith our financial product and other providers to deliver value to ourconsumer, the workforce of America.

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

The third area of responsibility is technology. We madechanges in the technology organization to improve our software over the pastseveral months as we look to continue to be an industry leader in taxpreparation. Soon we expect to announce the new Chief Technology Officer as westrengthen our organization to be best in class. Technology is the backbone forboth our industry-leading profiler tax preparation software and also the toolto 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 thequarter, so I will concentrate on highlights, including reviewing the financialimpact from the recent developments.

As you know, operating results from the first and secondquarter are not indicative of the company's full year performance. In fact, wehave historically generated about 2% of our annual total revenues in each ofthe first and second quarters. Additionally, the net loss in these off-seasonquarters typically increases each year as a result of the prior year officeexpansion in the company-owned segment, anticipated growth in the business and thecumulative 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 offinancial product fees earned from the sales of the Gold Guarantee product inprior seasons and fees earned from the sale of new territories.

Net loss was $23.7 million for the period, and included $8.3million or $0.18 per share of non-recurring charges. On a per share basis, netloss 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. Ofthis charge, $2.8 million was a cash payment with the remainder a non-cashexpense related to the accelerated vesting of his stock options. We wouldexpect that most analysts would exclude the $5.7 million expense figure fromtheir model.

We also incurred $2.2 million or $0.06 per share of internalreview-related costs during the quarter. These costs are included within the $6million full year estimate provided on the last earnings call and consistprimarily of professional fees and the $1.5 million voluntary compliancepayment made during the quarter as part of the closing agreement with theInternal 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 thatare incremental to the $6 million internal review related costs as we makeenhancements to our compliance processes and systems. We would expect thatmargin improvement would be somewhat constrained for only this year by thisincremental and ongoing expense. This increased investment is also consistentwith our commit to quality tax preparation.

On the franchise side of the business, marketing andadvertising expenses increased by $1.2 million in the quarter, mostly as aresult of the changing contractual arrangements highlighted last quarter inwhich the expenses are amortized over the full year, as opposed to only duringtax season. For the full year, we would continue to expect marketing expensesthis year would grow at a slightly faster rate than total revenues.

On the company-owned side of the business, operatingexpenses increased during the quarter by about $1 million, largely due to theincremental stores open last tax season and the acquisition of approximately150 offices in Atlanta, Chicagoand Detroit late in the quarter.

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

During the quarter, we repurchased 800,000 shares for $25million. Through the first two quarters of the year, we have returned $66million 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 millionremaining for share repurchases under previously authorized programs. Since ourbuyback programs began in June 2005, we repurchased 8.8 million shares for $259million. This represents nearly 25% of our original share count at the IPO in2004.

The weighted average share count for the first quarter was30.2 million shares outstanding as compared to 33.6 million shares outstandingin 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 resultingfrom 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 capitalstructure and demonstrate our commitment to shareholder value. The conclusionof recent developments over the past several months has removed our inabilityto repurchase shares.

During the quarter, we increased our ability to supportongoing and aggressive share repurchases by amending the definition of acovenant in our credit facility to measure leverage on an average basis asopposed to a point in time basis. The result is that although the leveragecovenant level remains at three times, we now have the ability to reach aseasonal peak of over 3.5 times. We appreciate the confidence that our lendersdemonstrated in the success and sustainability of Jackson Hewitt's businessmodel by approving this covenant change at a time of uncertainty in the overallcredit markets.

During the quarter, we also signed three financial productagreements. 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 termsmaterially similar to those in effect last tax season. The structure of ourthree agreements is similar to prior agreements, resulting in a highly predictablecash flow stream that is approximately 90% fixed. We will continue to receivean annual fee for providing access and technology support to the financialpartners who offer their products to our customers.

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

Additionally, it should be noted that after 2008 thecontacts with Santa Barbara andRepublic provide for increasing volumes and fees to account for the expiringHSBC contract. As a result, we believe that we have secured access to productsfor our entire network through the 2010 tax season on a primarily fixed annualfee basis.

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

Looking back over the many changes of the past severalmonths, 2008 would appear to be a year of transition for Jackson Hewitt.However, we believe the events of the past several months make the companystronger and we remain optimistic for the long-term prospects for the business.The long-term targets that we reaffirm today significantly exceed the currentWall 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 strategyto 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 thecurrent tax season. We have elevated the level of partnership betweenfranchisor and franchisee, and have seen a rebound in reinvestment byfranchisees well in advance of the tax season.

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

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

Question-and-AnswerSession

Operator

Your first question comes from Scott Schneeberger - CIBCWorld Markets.

ScottSchneeberger - CIBC World Markets

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

Mike Yerington

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

ScottSchneeberger - CIBC World Markets

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

Mike Yerington

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

The other scenario is that Congress could change or delaythe whole season, which we think is highly unlikely because that would impact137 million taxpayers.

We think the most likely scenario would be that Congresswould come up with a patch that would probably allow processing and be able toget 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 wethink any time there is a dynamic change in the marketplace it creates anopportunity for Jackson Hewitt. I think part of what we'll be doing is makingsure that we educate and tell our customers what's going on. I think overallthat should be viewed as a positive by our investors for the future, for us.

ScottSchneeberger - 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 thisyear? Is the viewpoint the standard 5% to 7% as we've seen historically ormaybe a little more, a little less this year and why? Thanks.

Mike Yerington

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

ScottSchneeberger - 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 candidateas we speak. We've seen a few candidates but we're not trying to rush it. Wewant to make sure we have time to get the right candidate on board and Markseems to be okay doing both roles right now but we want to make sure he is ableto focus on his new role.

Operator

Your next question comes from John Healy - FTN MidwestSecurities.

John Healy - FTN Midwest Securities

From a big picture standpoint as you approach the tax seasonthis year, are there any anomalies or calendar issues you guys are expecting toimpact 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 thirdquarter ends at the end of January and that has historically been a peak involume for our business. I think this year it has the potential of being moreinteresting. If you look back at the last few years, there has been a gradualshift from that January timeframe to later in the tax season, so some of has carriedover into February as well as March and April.

We've given prior guidance. I think our view on this year isif you set aside the fact that there is the potential AMT changes, we wouldstill expect that gradual shift to continue. So that could actually be furtherimpacted by whatever changes Congress and the IRS makes. We don't really haveit nailed down in terms of specific numbers, but we would expect that Q3overall 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 waslooking at some company-owned stores. Is that a strategy that you would pursuefor the long term or is that a strategy to maybe open up some company-ownedstores, prove that those are viable markets, and then be able to sell those tofranchisees longer term? I was hoping to get a better understanding of thatstrategy.

Mike Yerington

What we said, John, is that we would obviously try to workthrough franchisees first. We would try to get acquisitions. We would eithertry to have them open up territories where we see high growth or we would tryto make acquisitions there, but I think one of the things we did say is that asa final third part of that strategy we would also look at opening companystores.

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

John Healy - FTN Midwest Securities

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

Mike Yerington

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

We, as you know, from what we just said are focused onquality tax preparation so I think that the independents, some of which who arenot focused in that direction, will have a hard time getting bank partners topartner with them to provide financial products and I think that plays well forus 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 underwayin terms of the loyalty rewards in the marketing. How do you think that impactsthe profitability of the business longer term, or is it more of a near termissue? Do you think the benefits outweigh that longer term? Can you comment onthe 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 thosecustomers that come into the franchise more frequently. I look at it as what's the long term orlifetime value of a customer, not just a one-time event, but what's thatcustomer worth to me over a period of years?

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

Paul Bartolai - Credit Suisse

Great. Sorry if you mentioned this, but the 400-500 targetin terms of store openings, does that include the stores you acquired from theone 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 balancingthe growth with the cannibalization. Any comments on your outlook for same-storegrowth going forward? I know it has been a little bit challenged recently. Doyou think we should see that back in the low to mid single-digits where it hadbeen previously or what are your thoughts there?

Mike Yerington

We don't provide specific guidance on the same-store salesgrowth number, but with all the programs and processes we have in place tofocus on that, I would see that improving over time. It could be slightly positivethis 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 royaltyadvertising rate charge to the franchisees. Is there any discussion or thoughton altering that one way or the other, or is that something that is pretty muchset for now?

Mike Yerington

The rates arecontractually 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 thewording of the contract, we don't see that changing in the short term.

Operator

Your next question comes from Mark Sproule - Thomas WeiselPartners.

Mark Sproule - Thomas Weisel Partners

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

Mike Yerington

I think the demand isstill there for the products and services that we sell. I think that we don'tsuffer any competitive disadvantage for sure but I think the opportunity tosatisfy that pent-up demand is still there even though the system or the IRSmay delay being able to accept returns for awhile. So I don't think anythingchanges from that perspective, Mark. I think that we still will have a verypositive 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 thingI would add to that is this seems to be one of those periods of increasedawareness for the consumer and looking back over time, events like this tend todrive people to a paid preparer. That would appear to be more of an advantageversus a disadvantage.

Mark Sproule - Thomas Weisel Partners

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

Mike Yerington

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

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

Mark Sproule - Thomas Weisel Partners

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

Mike Yerington

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

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

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

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

In the latter season we see customers focusing more onquality tax returns, quality tax preparation, they're usually folks that arenot getting a return and these are folks that are really interested in adifferent kind of tax preparation experience. We have a targeted message forboth. I would say that quality tax preparation across both target markets isimportant to us.

Mark Sproule - Thomas Weisel Partners

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

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

Mike Yerington

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

We overlay those programs with corporate programs such asdirect mail, targeted media, radio, television, billboards, a variety ofdifferent media programs that we have that are targeted to help build volume inthose stores.

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

Operator

Your next question comes from James Fotheringham - GoldmanSachs.

JamesFotheringham - Goldman Sachs

Mark, just some quick questions about leverage. What is yourcurrent leverage ratio and how precisely do you calculate it? I think it's now3.5 times covenant limit, and given your debt needs next quarter, could youcomment on the near-term sustainability of your current rate of sharerepurchases? Thanks.

Mark Heimbouch

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

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

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

JamesFotheringham - Goldman Sachs

That's understood andappreciated. In terms of the modest increase in leverage, basically beingdriven by your impressive rate of buybacks, if you take a longer-term view, howlong 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 intime, other than what we've said before is that over time it gradually creepsup. 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 abilityto make a significant pay down really beginning in January through tax season.

JamesFotheringham - Goldman Sachs

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

Mike Yerington

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

JamesFotheringham - Goldman Sachs

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

Mike Yerington

Let me first comment on maybe a competitor's product thatyou were describing as a preseason product. I think you might be referring to theline of credit from Block, and I look at that product as probably a productthat's not easily understood by our consumers. It is fairly complex in that ithas to be tied to a savings account with a deposit. It has a resetting interestrate and is only available to prior year customers of 2005 and 2006. I don'tknow 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 theearly season. We decided to focus on quality tax preparation and drivingcustomers into the normal season. A lot of the programs I talked about before-- improved direct mail, telesales, customer loyalty programs, a variety ofthings -- that we think will be important to our customers will be focused onthis year, instead of preseason products.

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

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

Operator

Yourfinal question comes from Michael Millman - Soleil Securities.

Michael Millman - Soleil Securities

Lastyear 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 likethe AMT again is going to be a delayer and Block again has an early seasonretention product, even though it may be limited. Can you talk about why thisyear is different regarding those volume declines than last year?

Mike Yerington

Well, let me talk in a couple of areas, Michael. First Ithink 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 byabout 150,000 last year so I don't know that it was a major competitiveadvantage 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 andwe'll be able to provide that cash, so I don't see that as an issue for usgoing forward.

Michael Millman - Soleil Securities

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

Mike Yerington

I think that as Isaid, I don't think the demand for cash, the need for cash goes down. I thinkthe supply we have with our bank partners is there and I think if anything, itwill 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 wecan help folks that have the AMT issue as it relates to the credits to be ableto file their returns.

Mark Heimbouch

Mike, actually Idon't think we said last year was a result of delays. What we said is that wehad seen a continued shift over the past years in which customers were filinglater. I think the other thing is what you are seeing is a flattening in termsof a percentage rate of the number of paid preparers, with all the growthliterally occurring in the last days. We obviously all know we were impactedmeaningfully after April 3.

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

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

Michael Millman - Soleil Securities

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

Mark Heimbouch

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

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

Michael Millman - Soleil Securities

Could you update uson the K project?

Mike Yerington

Which?

Michael Millman - Soleil Securities

The K project, theIRS project.

Mark Heimbouch

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

Michael Millman - Soleil Securities

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

Mike Yerington

I can tell you generally how we handle that. We offerfinancing to people that want to expand, or open up new territories. Generallythose loans are in the $25,000 range and we have done that again this year. Wecontinue to do that. We provided about 100 of those kinds of financing in thelast 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 financialtargets 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 nowlike to turn the presentation back over to Mr. Michael Yerington, President andCEO, for final comments.

Mike Yerington

Thank you for joiningus on today's call and your interest in Jackson Hewitt. We're excited about the2008 season in just a few weeks and look forward to speaking with you on anupdate of the early half of the season in late February.

This concludes our call. Thank you very much.

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