Liberty Tax, Inc. (NASDAQ:TAX)
Q1 2015 Earnings Conference Call
August 28, 2014, 08:30 AM ET
Executives
Carrie Fischer - Investor Relations
John Hewitt - Founder, Chairman and Chief Executive Officer
Kathy Donovan - Vice President and Chief Financial Officer
Analysts
Alex Paris - Barrington Research
Lee Jagoda - CJS Securities
Michael Millman - Millman Research
Operator
Good morning. At this time, I would like to welcome everyone to the Liberty Tax First Quarter Fiscal 2015 Earnings Conference Call. All the lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)
I would now turn the conference over to Carrie Fischer, Investor Relations. Go ahead, Carrie.
Carrie Fischer - Investor Relations
Thank you. Good morning, everyone, and thank you for joining us. With me today are John Hewitt, our Founder, Chairman and Chief Executive Officer; and Kathy Donovan, our Vice President and Chief Financial Officer.
The press release announcing our first quarter earnings was distributed this morning. The earnings release may be accessed at the Investor Relations section of our website located at www.libertytax.com. A replay of this call will be available shortly after the conclusion of the call. The information to access the replay was in the earnings press release.
I'd like to remind everyone that today's remarks may include forward-looking statements as defined under the Securities Exchange Act of 1934. Such statements are based on current information and management's expectations as of this date and are not guarantees of future performance. Forward-looking statements involve certain risks, uncertainties and assumptions that are difficult to predict. As a result, our actual outcomes and results could differ materially. You can learn more about these risks in our Annual Report on Form 10-K for the fiscal year ended April 30, 2014, and our other SEC filings. Liberty Tax undertakes no obligation to publicly update these risk factors or forward-looking statements.
I would now like to turn the call over to our Founder, Chairman, and CEO, John Hewitt. John?
John Hewitt - Founder, Chairman and Chief Executive Officer
Thank you, Carrie, and good morning, everyone. Our first quarter is at the very beginning of our franchise selling season at a time when we focus on improving our operations and preparing for the next tax season. It would be reasonable to compare our first quarter to the first or second inning of a baseball game. You cannot determine the outcome of the entire game after just the first inning and you cannot determine our full year results after just our first quarter.
The seasonal nature of the tax business caused us to generate the majority of our revenue and all of our profit during the tax season, which of course runs from January to April of each year. We operate at net loss during the first and second quarters of each fiscal year when we are selling to new franchises, developing new programs and getting compared for the following season.
During the first quarter, we brought in approximately the same number of new franchises as the prior-year period. The first quarter last year was a relatively numb one for us. Our dark period started the second quarter last year in August. So we believe we will see significant year-over-year improvement in the second quarter compared to the short selling quarter last year. At this point, we see our new franchisee numbers trending towards where they were two years ago.
Wal-Mart has significantly increased the rent of a planted chart for being in their stores this year. As a result, our Wal-Mart presence will be negatively impacted. However, these locations have historically produced much lower volumes than our traditional store fronts. So we do not see this having any material impact on our overall performance.
We have made significant enhancements to our NextGen software to include new mobile and tablet applications. These enhancements will provide customers with fast and convenient access to our online offerings. They will be able to complete many actions such as filing the taxes and checking the refund status directly on their phone or tablet.
You may recall that last year we implemented NextGen only for online returns. We plan to test it in over 500 auctions during the upcoming tax season. Once the in-store launch of NextGen is in place, this will allow the customers to walk into an office with their partially-integrated tax filing in-hand to make the transition from DIY to paid preparer even smoother.
We are also testing an accounting package that our franchisees can use to provide booking service for small business customers and have partnered with Kashoo cloud accounting for this purpose. We will sell them our white-labeled version of Kashoo Liberty Accounting as a recommended small business online accounting solution in our over 4,400 offices. This offering will serve our small business customers by giving them a technological edge.
Looking towards the next tax season, the IRS is expecting a growth of 1.5% in the number of individuals' returns filed for 2015. We believe this growth may actually be 2% to 3%. We see two drivers of this strong growth. First, the number of people employed has grown over 3% since December of 2013. And second, the ACA requirements will bring in new filers who may not have chosen to file the taxes in the past. In order to determine their eligibility for and the amount of subsidy related to the ACA, they will now be forced to file.
The ACA forms were released last month. And as expected, there is a level of complexity that we believe will drive prior DIY customers to a paid preparer. These forms include Form 8962, which will be used if a customer received a premium tax credit; and Form 8965, which will be used to determine if the customer is eligible for an exemption. It is likely that the appearance of these forms, especially 8962, will be intimidating to the taxpayer and many of them will seek assistance.
There will also be a worksheet, which we haven't seen yet, to determine the amount of penalty, if any, that taxpayers will be required to pay if they deny either obtaining insurance or qualify for an exemption.
Earlier this month, the Congressional Budget Office and the Joint Committee on Taxation issued a report, which lowers the projected number of people expected to pay the penalty for not obtaining insurance due to the multiple number of exemptions that have been recently made available. Because of this, the number of people required to complete the penalty worksheet will be less than we previously expected, delaying a portion of our projected average net fee increase related to the Affordable Care Act from fiscal 2015 to fiscal 2016. We now expect the projected fee increase relating to the ACA in 2015 to be 2.5% to 3% versus our earlier projection of 5%, with the remainder being pushed to the following year.
We continue to believe that the ACA is a game-changer and we'll have a two or three year impact on our growth. As we continue to grow, our success partly relies on both our franchisees' compliance with IRS and state tax authorities. We are proactively working with the states to helping strengthen their fraud prevention programs. There is a positive movement at the state level to require tax preparer certification.
Earlier this year, New York passed the required competency exam for taxpayers and there is an effort in Ohio to pass a similar requirement. We applaud and support the states in this effort, because we believe this is important for the integrity of our industry. We run at the forefront of this progressive initiative. For the past five years, we have required all the paid preparers to pass a certification test before they could prepare tax returns. We also continue to work within our industry to support the IRS in efforts to improve their ability to identify tax fraud.
As announced last week, Mark Baumgartner, our Chief Investment Officer and CEO of the JTH Financial, will be leaving the company effective August 30th. Mark will be greatly missed and we wish him the best in his future endeavors.
Lastly, we have new initiatives in the works for this upcoming tax season that we believe will be of great benefit to our customers and our franchisees. We plan to announce these in November and more details will be provided at that time.
Now I'd like to turn the call over to our CFO, Kathy Donovan.
Kathy Donovan - Vice President and Chief Financial Officer
Thanks, John. Good morning, everyone. As John has already mentioned, the majority of our revenue is generated during the tax season from January to April of each year and revenue in our first quarter is seasonally low.
That said, for the first quarter of fiscal year 2015, we generated revenue of $7.8 million compared to $8.1 million in fiscal 2014. Franchise fee revenue declined $0.3 million versus prior year. Franchise fee revenue is recognized as cashes received. So the revenue we recognize in a quarter represents payments for sales that were made over several prior periods. While the number of franchise sales this quarter were in line with last year, cash payments on prior-year franchise notes were lower.
Turning to expenses, we continue to invest to prepare for and effectively manage the growth of the business. As we have discussed on prior calls, we are investing in the management and technology infrastructure as well as new programs to help us drive toward our long-term growth objectives. Reported operating expenses grew by $4.4 million to $21.9 million in the first quarter. There were non-recurring items in the first quarter of 2014 and the first quarter of 2015.
In the first quarter of last year, we recorded an $872,000 one-time benefit from the reclassification of stock options back to equity instruments. And in the first quarter of this year, we incurred $483,000 of severance cost. Those two items drove $1.4 million of the expense growth. Increases in non-cash depreciation and stock compensation accounted for another $1 million of the increase and the remainder of the year-over-year variance reflects the investments described above as well as salary increases for existing staff and higher advertising expenses for new franchisees. For the full year, we expect revenue growth to outpace adjusted expense growth.
Our tax rate for the first quarter was 39.7%. We expect the full rate to come down closer to last year's rate when Congress renews the R&D tax credits for this year. As a result of the increase in expenses, our quarter one reported net loss increased to $8.6 million or $0.67 per share and our adjusted non-GAAP net loss excluding the non-recurring items and stock-based compensation expense increased to $8.1 million or $0.63 per share.
Now let's take a look at the balance sheet and cash flow. As expected, we began to draw on our revolver in July. We generally plan to draw on our revolver from June or July through January each year and then pay it back completely by the end of March as we begin to receive funding from the IRS. We drew $2.7 million less on the revolver this quarter even after the repurchase of 800,000 shares from an affiliate for $20 million in June.
Our average basic share count for the quarter dropped approximately 300,000 shares from the fourth quarter. This reflects the benefit of the 800,000 shares we repurchased in early June as well as the impact of stock option exercises through the quarter.
Finally, I would also like to thank Mark Baumgartner for his assistance over the last seven months. I have appreciated his insights and I wish him and his family all the best.
Now I'd like to turn the call back to John.
John Hewitt - Founder, Chairman and Chief Executive Officer
Thanks. Operator, we are now ready for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Alex Paris, Barrington Research.
Alex Paris - Barrington Research
With regard to the price increases associated with ACA, so you've seen the forms now, can you take us through the mechanics of how you get to 2.5% to 3%? I know, John, you had done in the past. You kind of looked at a quarter of your tax filers would be impacted. There'd be an additional form, blah, blah, blah. How do you look at that now? What's the rough back-of-the-napkin math on that?
John Hewitt - Founder, Chairman and Chief Executive Officer
We were anticipating that we will get about $40 for each of the digital forms, the credit form and the penalty form and that about 25% of our customers would be required to file them. And thus, it would be $10. And on our average fee, that'd be about a 5% impact. We're saying now that because of the numerous exemptions that were put in place that only about half of the number of customers are going to have to fill out the entire penalty calculation. Many of them will fill out a simpler form, which is the exemption form. So it's more of a check-the-box form and the calculation. So the fees will be considerably less for those forms.
Alex Paris - Barrington Research
Yet, you do expect that to roll over into next year. How does that work, the next tax season?
John Hewitt - Founder, Chairman and Chief Executive Officer
Typically when the IRS implements new penalties and credits, they will make exceptions. And in the past, there've always been a one-year exception. So we think they will just not have the same exemptions next year that they have this year.
Alex Paris - Barrington Research
With regard to franchise selling season, remind me, the prime selling season starts July, ends October, what is that again?
John Hewitt - Founder, Chairman and Chief Executive Officer
The sweet spot for us is really August to October. I mean people that are ready to open a new business in January aren't ready to invest the previous January. They are no more interested as they get closer and closer to tax season. So historically, most of our sales have come in the August, September and October time period, because once you get to November and December, people think it's too late. So they're scared to open. So that's our prime selling season. And we lost most of it last year when we were dark in August and September.
Alex Paris - Barrington Research
Last year, you actually had a net decrease in the numbers because of that blackout. This year, because you're kind of on the pace that you were two years ago and that your average number of stores opened over the last few years is 350, do you think you'll do more than 350, 350 or less than 350 this year? What's the target?
John Hewitt - Founder, Chairman and Chief Executive Officer
We're not going to forecast that number, except to say that last year was an anomaly. I've been competing with lots of 32 years and 15 years with Liberty since my non-compete. And we've grown every year. So last year was an anomaly. We had a decrease because of the dark period. And we expect to get back to normal this year. And with the tailwinds of ACA and the other initiatives that we're going to announce later in the year, we're more excited about this tax season than I've been in over 20 years.
Alex Paris - Barrington Research
And then with the Wal-Mart issue, it's going to impact the number of kiosks or small stores within Wal-Mart. Does that count in the number of stores, even though it's not going to have a material impact on revenue or filings? Is one Wal-Mart store listed as one store in your financials?
John Hewitt - Founder, Chairman and Chief Executive Officer
Yes, that's how we list it. And we do less than 2% of our revenue in Wal-Mart. It's a very de minimis impact.
Operator
Your next question comes from Lee Jagoda with CJS Securities.
Lee Jagoda - CJS Securities
John, can you just repeat the commentary regarding your expectation for industry volumes as it relates to the ACA?
John Hewitt - Founder, Chairman and Chief Executive Officer
The IRS is projecting a solid increase of 1.5%. And we're thinking that it's going to be 2% possibly as high as 3% because of two major impacts, all of the people that have joined the labor force in the last couple of years and also the impact of some people who weren't previously required to file are going to need to file to either take their credit under tax or pay a penalty or file for an exemption to the penalty. And they're going to have to do that through the tax return. So for two reasons, we expect the number of filers to increase more substantially than the IRS does.
Lee Jagoda - CJS Securities
I know you said you expect the franchise fee growth similar to what you saw two years ago? What feedback early on are you hearing from existing franchisees given that they probably know as well as anybody the impact or the opportunity that ACA should represent?
John Hewitt - Founder, Chairman and Chief Executive Officer
Our franchisees, that's the biggest source of our office openings each year, more impact than our new sales. And our franchisees are prepared for a robust tax season and more excited than they've ever been. They've been around our organization the strongest I've seen.
Lee Jagoda - CJS Securities
Can you just talk about a little more about the services you provide to small businesses? As a percentage of your total revenue, what does that represent? How you expect this new cloud software rollout to change that dynamic from both the volume and the price perspective?
John Hewitt - Founder, Chairman and Chief Executive Officer
The partnership with Kashoo is not designed to get us more small business accounting. We are not in the accounting business. We are in the tax business. What it allows us to do is have our customers who are small businesses or even if they are not small businesses to input their information into an accounting system that would be transitioned right into our tax software, so preparing the tax return will be even easier for them and doing their ad-hoc accounting would be easier for them. So the customers win in two ways and our franchisees win because the information that our customers are inputting into Liberty Accounting will be transitioned into their tax return seamlessly.
Lee Jagoda - CJS Securities
So is there any revenue share in the fee that they pay to use this service? Does any of that flow through to you or does that all go to your partner?
John Hewitt - Founder, Chairman and Chief Executive Officer
There is no economic impact other than increased customer satisfaction.
Operator
Your next question comes from Michael Millman with Millman Research.
Michael Millman - Millman Research
You said that the 8865 and the 8862 each would have a $40 charge or together would have a $40 charge?
John Hewitt - Founder, Chairman and Chief Executive Officer
The easiest way to think of it is it's about $40 per customer whether they get a credit or pay a penalty. It's per customer, not per form.
Michael Millman - Millman Research
And the delayed instructions, do you expect the instructions to have some impact on this $40 or is it pretty much $40, whatever the instructions are going to be?
John Hewitt - Founder, Chairman and Chief Executive Officer
Yes, it's $40 whatever the instructions are going to be.
Michael Millman - Millman Research
I think it's 8868 type of form for the online do-it-yourself.
John Hewitt - Founder, Chairman and Chief Executive Officer
I don't know what you mean by movement.
Michael Millman - Millman Research
You fill a 8868 and do-it-yourself don't seems to be a big advantage for some filers.
John Hewitt - Founder, Chairman and Chief Executive Officer
Obviously in our own online software and our competitors, they'll have all the impacted forms. We believe that over the next two or three years as everyone who is required to purchase insurance, whether they do or not, is confused or confounded by the new laws and the new instructions and the new penalties and credits that there is going to be a switch from do-it-yourself to assisted tax preparation.
Michael Millman - Millman Research
I was thinking more of the fraud form? I thought it was an 8868, the thought that you fill out an assisted that you've asked all these fraud questions, but it's nothing like that in the do-it-yourself yet.
John Hewitt - Founder, Chairman and Chief Executive Officer
You're right. There has been a shift over the last four or five years in earned income credit customers who now are going to do-it-yourself, because we as preparers are required to provide more substantiation, ask more questions, do more due diligence than they are required to do online. So there has been a modest shift of the few million customers over the last several years to do-it-yourself and it's primarily in the earned income credit arena.
Michael Millman - Millman Research
Is there something similar on the horizon for the do-it-yourself?
John Hewitt - Founder, Chairman and Chief Executive Officer
We haven't seen that yet. So we'll have to wait until we see that from the IRS.
Michael Millman - Millman Research
With Mark leaving, does this suggest that you see less opportunity in the financial products? And so related to that, what do you see for RT pricing this year and going forward?
John Hewitt - Founder, Chairman and Chief Executive Officer
No. I really appreciate that Mark told me 12 years ago when he started that he was going to only work till he was 50. And fortunately, I got to keep him a couple of years past 50. So Mark leaving has a lot to do with the quality of his life and not like a workaholic like me that's going to work until I die. And we appreciate all the things he has done for us in the last 12 years. And he has been obviously the second most important clearly in our organization. But the RT pricing we see across the industry pretty much identical pricing to the last year. We do see increased profitability from the RT in bringing more volume in-house as we've done in the past.
Michael Millman - Millman Research
The tax receivables are up, assets for sale. Maybe you can talk what that's about? And then it looks like note receivable are down.
Kathy Donovan - Vice President and Chief Financial Officer
Assets held for sale we talked about last quarter. It's part of our company stores. We moved then into category of assets held for sale. Since we believe that franchisees can operate stores better than employees and we had removed them in the fourth quarter. And our goal is to every year sell all of the company stores that we come into the year with. So that's what happened there. You actually in the fourth quarter saw a reduction in goodwill and an increase in assets held for sale. So that's something that happened in the fourth quarter.
Notes receivable are down and the offset is really just up in trade accounts receivables, because we used to have a practice where we would take notes the customers had in pay or accounts receivable and put it into a note and we no longer do that. So you really have to look at those two in combination.
Operator
Your next question comes from Alex Paris with Barrington Research.
Alex Paris - Barrington Research
With regard to Mark, I think like Millman drew it out of you, this wasn't sudden, this was long planned. The day he joined you, he said I was going to retire at 50 and he stuck around a couple of extra years because he was needed and he really believes that while it's definitely your shop John that he had a big role there and he wanted to leave it in good hands. Kathy Donovan getting brought on board was a big part of it and I think he made a great choice there and even Mike Piper running financial services. So I personally don't view his departure as anything with regard to the company. I just wanted to echo your thoughts. And that doesn't require your response.
The other question was for Kathy. Back to the price increases, a little clarification. So I'm still modeling roughly a 5% price increase across the board not related to ACA, just ordinary course of business. And I was modeling additional 5% bump because of ACA. So now instead I'm at 7.5% or 8% instead of 10%. I've already actually run it through my model and it doesn't make a material difference anyway. But is that the right way to think about it?
Kathy Donovan - Vice President and Chief Financial Officer
Exactly. That's exactly what we're doing also, yeah.
Operator
I would now turn the call back over to John Hewitt.
John Hewitt - Founder, Chairman and Chief Executive Officer
Thank you, everyone, for your attention. And again, we understand that our future is based on having the successful franchisees and having successful employees and I thank you all. Have a great day.
Kathy Donovan - Vice President and Chief Financial Officer
Thank you, all.
Operator
Ladies and gentlemen, thank you for joining today's conference. Thank you for your participation. That does conclude the conference. You may now disconnect.