Skip to main content

Jackson Hewitt Faces Tax Crunch Time

Jackson Hewitt has faced pressure amid concern it will breach debt covenants, although CEO Harry Buckley is confident the tax preparer has turned a corner. The Dollar Store explores this under-$5 stock.

(Jackson Hewitt story updated to correct note about offering RALs.)



) --

Jackson Hewitt Tax Service


customers depend on the company to prepare their taxes before the April 15 deadline, but investors should be more concerned about the company's race to avoid defaulting on a debt payment before a critical April 30 deadline.

Jackson Hewitt

shares are down 53% in 2010 and more than 80% since the beginning of 2009 as the tax preparer has struggled with the same high unemployment that has plagued its customers. Those now jobless have turned to using low-cost, do-it-yourself tax software as a cheaper alternative to Jackson Hewitt, which still has strong competition from rival

H&R Block

(HRB) - Get H&R Block, Inc. Report


In a more troublesome development, Jackson Hewitt is also seeking relief from a $25 million term loan payment due on April 30 it may not be able to make due to the breach of its financial covenants.

To say 2010 hasn't been a banner year for

Jackson Hewitt

Scroll to Continue

TheStreet Recommends

would be an understatement. The company lost its refund application loan, or RAL, product in 50% of its shops after learning it had commitments for only half the funds it had last year to offer refund anticipation loans for 2010's tax season.

RALs are offered to customers who anticipate a refund from the Internal Revenue Service and are facilitated by companies like Jackson Hewitt. The loan is provided by banks, which can collect a number of fees and charge interest on what is essentially a very short term, safe loan.

"This year has been a challenging tax season for Jackson Hewitt," Harry Buckley, president and CEO of Jackson Hewitt Tax Service, tells


by email. "The sluggish economy, high unemployment, industry competition and the loss of a refund anticipation loan product in 50% of our system have all negatively affected our operational and financial results this year."

Earlier this month, Jackson Hewitt posted a fiscal third-quarter loss of $279 million, or $9.75 a share, although the company said it earned 46 cents a share when goodwill impairment and non-cash tax-related charges were stripped out. In the release, Jackson Hewitt said it expects prepared tax returns to fall between 17% and 19% from last year's tax season.

Jackson Hewitt spooked investors further when it warned that it will likely exceed its maximum stipulated covenant ratio by April 30. The company has already commenced discussions with


(C) - Get Citigroup Inc. Report


PNC Financial

(PNC) - Get PNC Financial Services Group, Inc. Report


JPMorgan Chase

(JPM) - Get JPMorgan Chase & Co. Report


Wells Fargo

(WFC) - Get Wells Fargo & Company Report

, which hold a total of $360 million of the company's debt.

"As we near April, we will soon initiate discussions with our lead agent regarding covenant relief in advance of a default," Buckley says. "How our fourth-quarter financial covenant situation will be resolved is unknown right now. An amended credit agreement is certainly a possibility."

Buckley also asserts that it would be in everyone's interest for Jackson Hewitt to complete a restructuring plan to continue to operate "and work to maximize the value of our business." He sees many parts of the Jackson Hewitt business that still remain strong: the company's brand, committed franchise owners and talented employees who all want to close the book on a tough chapter in the company's history.

However, investors and analysts are as easily sold on the idea that all of Jackson Hewitt's troubles are in the rearview mirror. In a big picture view, Morgan Stanley analyst Vance Edelson argues that the risk profile for Jackson Hewitt "remains high given the pending covenant breach and substantial uncertainty regarding its creditors' appetite for extending additional financing."

In a separate research note, Michael Millman of Millman Research Associates takes a harsher stance on Jackson Hewitt's prospects, arguing that a capital restructuring may be in the offering in the next several months. "We believe in a capital restructuring very little will remain for shareholders," he writes. Millman has a stock-price target of $1 on Jackson Hewitt shares.

Morgan Stanley's Edelson says it is now up to the four major lenders holding Jackson Hewitt's debt to decide whether an additional capital infusion -- as much as $40 million by Edelson's estimates -- will be in the banks' best interest. "One question they will have is whether RAL demand can be met next year, and indeed whether RALs will be allowed," Edelson writes.

The debt covenants may be the biggest issue the company faces in the short term, but future RAL activity is a major question mark for Jackson Hewitt over the long term. After losing 50% of commitments on funds for RAL loans, investors are worried the company will find itself in the same position (or worse) for the 2011 tax season.

"Our goal is to successfully put a program in place for 100% RAL coverage throughout our system for the 2011 tax season," Jackson Hewitt's Buckley tells


. "To obtain that goal, we are already in conversations with several potential alternative RAL funding sources."

Even if Jackson Hewitt were able to secure funding for 100% of its RALs, opponents of the loan practice have been calling for stronger regulation for what they say amounts to predatory lending, as studies have shown that a majority of RAL recipients are low-income taxpayers. Earlier this year, the Internal Revenue Service said it will examine RALs as it takes over regulation of tax preparers.

Oppenheimer analyst Scott Schneeberger says that scrutiny over RALs is particularly damaging to Jackson Hewitt because its business model is based primarily on serving early-season tax filers who typically seek financial products. However, Schneeberger notes that there are still positives that exist for investors who can stomach the risk in investing in an under $5 stock like Jackson Hewitt.

"An exclusive agreement to expand into additional Wal-Marts over the next couple years represents a thin silver lining to this otherwise cloudy story," Scheeberger writes in a recent research report.

Jackson Hewitt's Buckley says that the exclusive agreement with Wal-Mart "offers an excellent distribution channel with solid growth potential. This agreement is an important part of our mix, so we have had, and will continue to have, conversations with Wal-Mart on strategy for growth in the coming tax season."

Another positive for bullish investors is the company's role as a franchiser. Millman Research Associates' Millman notes that as a franchiser, Jackson Hewitt gets its royalty regardless of how its franchisees fare, at least in the short term. "It should continue to generate positive free cash flow (but possibly barely)," he adds.

Jackson Hewitt is still working on a new franchise agreement with approximately 25% of territories that are up for renewal throughout the end of the year. "Finalization of the new agreement has been on hold as we focused on the 2010 tax season and its challenges," Buckley writes. " We expect to re-engage in franchise agreement conversations during the fourth quarter so we can work together to strike a balance that will lead to longer-term sustainable growth for Jackson Hewitt and our franchise system."

Morgan Stanley's Edelson offers another upside scenario for Jackson Hewitt, noting that the company remains the second largest paid tax preparer in the U.S., and Buckley, who joined the company in June 2009 from H&R Block, has extensive tax experience. "While online efforts remain nascent, management seems pleased with its new offering which may contribute more in 2011," he writes.

Even with these long-term positives for the company, investors looking to play this tax-preparer stock may be wise to wait until the April 30 deadline to see how Jackson Hewitt navigates through this critical time. For now, Buckley pledges that the company is focused on working hard to obtain its share of the tens of millions of remaining tax returns yet to be filed.

"We are also managing our controllable expenses and our overall cost structure," Buckley writes. "Planning for the post-season and next tax season has already begun as we are meeting to discuss necessary short- and long-term plans to get our business and our brand back on track."

-- Written by Robert Holmes in Boston


Follow Robert Holmes on


and become a fan of on