**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| ** ** | **ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE********SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|------------|--------------------------------------------------------------------------------------------------------------|------------|

 

**For TheQuarterly Period Ended July 31, 2004**

 

**OR**

 
| ** ** | **o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|------------|----------------------------------------------------------------------------------------------------|------------|

 

**Commission File No. 1-32215**

 

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**Jackson Hewitt Tax Service Inc.**

 

| **A  DELAWARE  CORPORATION**                                                     | ** ** | **I.R.S.  EMPLOYER IDENTIFICATION  NO. 20-0779692** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|
| ** **                                                                       | ** ** | ** **                                          |
| **7 Sylvan  Way  Parsippany, New Jersey 07054  Telephone Number (973) 496-1040** |

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements, for thepast 90 days: Yes o  No ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined by Rule 12b-2 of theSecurities and Exchange Act of 1934): Yes o  No ý

 

The number of sharesoutstanding of the registrant’s common stock was 37,600,890 as of July 31,2004.

 

 

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###### **Jackson Hewitt Tax Service Inc.**

 

**TABLE OF CONTENTS**

 

**Description**

 
|    | ** **                                                                                  | **Page** |
|---------|---------------------------------------------------------------------------------------------|----------|
|    | **PART 1 - FINANCIAL INFORMATION**                                                          |     |
|    |                                                                                        |     |
| Item 1. | Financial  Statements                                                                       | 3        |
|    |                                                                                        |     |
| Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 18       |
|    |                                                                                        |     |
| Item 3. | Quantitative  and Qualitative Disclosures about Market Risk                                 | 28       |
|    |                                                                                        |     |
| Item 4. | Controls  and Procedures                                                                    | 28       |
|    |                                                                                        |     |
|    | **PART II - OTHER INFORMATION**                                                             |     |
|    |                                                                                        |     |
| Item 1. | Legal Proceedings                                                                           | 29       |
|    |                                                                                        |     |
| Item 2. | Unregistered Sales of Equity Securities and  Use of Proceeds                                | 29       |
|    |                                                                                        |     |
| Item 3. | Defaults Upon Senior Securities                                                             | 29       |
|    |                                                                                        |     |
| Item 4. | Submission of Matters to a Vote of Security  Holders                                        | 29       |
|    |                                                                                        |     |
| Item 5. | Other Information                                                                           | 29       |
|    |                                                                                        |     |
| Item 6. | Exhibits                                                                                    | 29       |
|    |                                                                                        |     |
|    | Signatures                                                                                  | 31       |

 

2

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**PART 1 – FINANCIAL INFORMATION**

 

**Item 1.***** ****Financial Statement**s***

 

**JACKSON HEWITT TAX SERVICE INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(Dollars in thousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                            | ** ** | **For the Three  Months Ended July 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                                     | ** ** | **2003** | ** ** |
| **Revenues**                                          |       |                                                         |       |   |   |
| Franchise operations revenues:                        |       |                                                         |       |   |   |
| Royalty                                               |       | $                                                            | 600        |   | $ | 244 |   |
| Marketing and advertising                             |       | 275                                                          |       | 116 |   |
| Financial product fees                                |       | 1,702                                                        |       | 607 |   |
| Other financial product revenue                       |       | 3,496                                                        |       | 2,256 |   |
| Other                                                 |       | 2,259                                                        |       | 1,925 |   |
| Service revenue from company-owned office  operations |       | 451                                                          |       | 624 |   |
| Net revenues                                          |       | 8,783                                                        |       | 5,772 |   |
|                                                  |       |                                                         |       |   |   |
| **Expenses**                                          |       |                                                         |       |   |   |
| Cost of franchise operations                          |       | 6,854                                                        |       | 6,129 |   |
| Marketing and advertising                             |       | 2,212                                                        |       | 1,786 |   |
| Cost of company-owned office operations               |       | 4,617                                                        |       | 4,278 |   |
| Selling, general and administrative                   |       | 10,480                                                       |       | 11,070 |   |
| Depreciation and amortization                         |       | 2,839                                                        |       | 3,104 |   |
| Total expenses                                        |       | 27,002                                                       |       | 26,367 |   |
|                                                  |       |                                                         |       |   |   |
| **Loss from operations**                              |       | (18,219                                                      | )          | (20,595 | ) |
| Other income/(expense):                               |       |                                                         |       |   |   |
| Interest income                                       |       | 152                                                          |       | 156 |   |
| Interest expense                                      |       | (757                                                         | )          | (68 | ) |
| Loss before income taxes                              |       | (18,824                                                      | )          | (20,507 | ) |
| Benefit for income taxes                              |       | (7,378                                                       | )          | (8,147 | ) |
| Net loss                                              |       | $                                                            | (11,446    | ) | $ | (12,360 | ) |
|                                                  |       |                                                         |       |   |   |
| **Loss per share**                                    |       |                                                         |       |   |   |
| Basic and Diluted                                     |       | $                                                            | (0.30      | ) | $ | (0.33 | ) |

 

SeeNotes to Consolidated Financial Statements.

 

3

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**JACKSON HEWITT TAX SERVICE INC.**

 

**CONSOLIDATED BALANCE SHEETS**

 

**(Dollars in thousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                             | ** ** | **As of**            | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                             | ** ** | **July 31,****2004** | ** ** | **April 30,****2004** | ** ** |
| **ASSETS**                                                                                                                             |       |                 |       |   |   |
| Current assets:                                                                                                                        |       |                 |       |   |   |
| Cash and cash equivalents                                                                                                              |       | $                    | 18,911     |   | $ | 5,266 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $1,316 and $1,121                                                      |       | 6,127                |       | 31,315 |   |
| Notes receivable, net                                                                                                                  |       | 2,779                |       | 1,944 |   |
| Prepaid expenses                                                                                                                       |       | 4,945                |       | 4,810 |   |
| Deferred income taxes                                                                                                                  |       | 5,092                |       | 5,074 |   |
| Total current assets                                                                                                                   |       | 37,854               |       | 48,409 |   |
|                                                                                                                                   |       |                 |       |   |   |
| Property and equipment, net                                                                                                            |       | 35,616               |       | 37,347 |   |
| Goodwill                                                                                                                               |       | 392,371              |       | 392,368 |   |
| Other intangibles, net                                                                                                                 |       | 89,230               |       | 89,902 |   |
| Due from Cendant Corporation                                                                                                           |       | —               |       | 143,985 |   |
| Notes receivable, net                                                                                                                  |       | 2,195                |       | 1,985 |   |
| Other non-current assets                                                                                                               |       | 15,255               |       | 11,946 |   |
| Total assets                                                                                                                           |       | $                    | 572,521    |   | $ | 725,942 |   |
|                                                                                                                                   | ** ** | ** **           | ** ** | ** ** | ** ** |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                         |       |                 |       |   |   |
| Current liabilities:                                                                                                                   |       |                 |       |   |   |
| Accounts payable and accrued liabilities                                                                                               |       | $                    | 26,222     |   | $ | 31,653 |   |
|                                                                                                                                   | ** ** | ** **           | ** ** | ** ** | ** ** |
| Total current liabilities                                                                                                              |       | 26,222               |       | 31,653 |   |
|                                                                                                                                   |       |                 |       |   |   |
| Deferred income taxes                                                                                                                  |       | 21,581               |       | 26,335 |   |
| Long-term debt                                                                                                                         |       | 175,000              |       | — |   |
| Other non-current liabilities                                                                                                          |       | 8,874                |       | 12,858 |   |
| Total liabilities                                                                                                                      |       | 231,677              |       | 70,846 |   |
|                                                                                                                                   | ** ** | ** **           | ** ** | ** ** | ** ** |
| COMMITMENTS AND CONTINGENCIES (Note 12)                                                                                                |       |                 |       |   |   |
|                                                                                                                                   |       |                 |       |   |   |
| STOCKHOLDERS’ EQUITY                                                                                                              |       |                 |       |   |   |
| Common stock, par value $0.01 per  share—authorized 200,000,000 shares; issued and outstanding, 37,600,890 and  37,500,000 shares |       | 376                  |       | 375 |   |
| Additional paid-in capital                                                                                                             |       | 348,276              |       | 475,844 |   |
| (Accumulated deficit) retained earnings                                                                                                |       | (7,808               | )          | 178,877 |   |
| Total stockholders’ equity                                                                                                        |       | 340,844              |       | 655,096 |   |
| Total liabilities and stockholders’ equity                                                                                        |       | $                    | 572,521    |   | $ | 725,942 |   |

 

SeeNotes to Consolidated Financial Statements.

 

4

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**JACKSON HEWITT TAX SERVICE INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **For the Three Months Ended  July 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| **Operating Activities:**                                                                  |       |                                     |       |   |   |
| Net loss                                                                                   |       | $                                        | (11,446    | ) | $ | (12,360 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                                     |       |   |   |
| Depreciation and amortization                                                              |       | 2,839                                    |       | 3,104 |   |
| Loss on disposal of assets                                                                 |       | —                                   |       | 2 |   |
| Amortization of extended warranty product  revenue                                         |       | (394                                     | )          | (194 | ) |
| Amortization of development advances                                                       |       | 241                                      |       | 212 |   |
| Amortization of deferred financing fees                                                    |       | 49                                       |       | — |   |
| Provision for uncollectible receivables                                                    |       | 325                                      |       | 129 |   |
| Decrease of bad debt reserve                                                               |       | —                                   |       | (2,001 | ) |
| Stock-based compensation                                                                   |       | 4,955                                    |       | — |   |
| Provision for litigation settlement                                                        |       | —                                   |       | 8,044 |   |
| Deferred income taxes                                                                      |       | (4,772                                   | )          | (9,221 | ) |
| Changes in assets and liabilities,  excluding the impact of acquisitions:                  |       |                                     |       |   |   |
| Accounts receivable                                                                        |       | 24,863                                   |       | 4,122 |   |
| Notes receivable                                                                           |       | (1,045                                   | )          | (1,010 | ) |
| Prepaid expenses                                                                           |       | (135                                     | )          | (65 | ) |
| Other non-current assets                                                                   |       | (143                                     | )          | 405 |   |
| Accounts payable and accrued liabilities                                                   |       | (6,325                                   | )          | (5,238 | ) |
| Other non-current liabilities                                                              |       | (2,621                                   | )          | 2,205 |   |
| Net cash provided by (used in) operating  activities                                       |       | 6,391                                    |       | (11,866 | ) |
|                                                                                       |       |                                     |       |   |   |
| **Investing Activities:**                                                                  |       |                                     |       |   |   |
| Capital expenditures                                                                       |       | (436                                     | )          | (336 | ) |
| Funding of development advances                                                            |       | (1,556                                   | )          | (1,308 | ) |
| Net assets acquired                                                                        |       | (3                                       | )          | (1,024 | ) |
| Net cash used in investing activities                                                      |       | (1,995                                   | )          | (2,668 | ) |
|                                                                                            |       |                                          |       |   |   |
| **Financing Activities:**                                                                  |       |                                     |       |   |   |
| Proceeds from issuance of notes                                                            |       | 175,000                                  |       | — |   |
| Cash portion of special dividend to Cendant  Corporation                                   |       | (175,000                                 | )          | — |   |
| Debt issuance costs                                                                        |       | (2,884                                   | )          | — |   |
| Decrease in Due from Cendant Corporation                                                   |       | 12,133                                   |       | 13,364 |   |
| Net cash provided by financing activities                                                  |       | 9,249                                    |       | 13,364 |   |
|                                                                                       |       |                                          |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |       | 13,645                                   |       | (1,170 | ) |
| Cash and cash equivalents, beginning of  period                                            |       | 5,266                                    |       | 1,543 |   |
| Cash and cash equivalents, end of period                                                   |       | $                                        | 18,911     |   | $ | 373 |   |
|                                                                                       |       |                                          |       |   |   |
| Supplemental Disclosure of Non-Cash  Transactions:                                         |       |                                     |       |   |   |
| Special Dividend – Distribution of Due from  Cendant Corporation                      |       | $                                        | 131,852    |   | $ | — |   |

 

SeeNotes to Consolidated Financial Statements.

 

5

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

**1.    BACKGROUNDAND BASIS OF PRESENTATION**

 

***InitialPublic Offering***

 

OnJune 25, 2004, Cendant Corporation (“Cendant”) divested 100% of its ownershipinterest in Jackson Hewitt Tax Service Inc. (“JHTS” or the “Company”) throughan initial public offering (“IPO”). JHTS did not receive any proceeds from thesale of the Company’s common stock by Cendant. In contemplation of the IPO, JHTS declared a stock dividend, whichincreased the number of common shares outstanding from 100 to 37.5 million.Stockholders’ equity has been adjusted retroactively for the effect of thestock dividend for all periods presented prior to the separation from Cendant.

 

JHTSwas incorporated in Delaware on February 20, 2004. Simultaneous with theincorporation of JHTS, Cendant contributed all outstanding shares of JacksonHewitt Inc., a Virginia corporation, to JHTS. Jackson Hewitt Inc. is a 100% owned subsidiary of JHTS.  JHTS accounted for the contribution ofoutstanding shares as a change in reporting entities under common control andhas recognized the outstanding shares at their carrying amounts at the date oftransfer. Accordingly, the accompanying consolidated financial statements havebeen prepared as though JHTS existed throughout the periods presented.

 

***Descriptionof Business***

 

Underthe brand name Jackson Hewitt, JHTS provides computerized preparation offederal and state personal income tax returns through a network of franchisedand company-owned offices. The consolidated financial statements include theaccounts and transactions of JHTS and its subsidiaries as well as entities inwhich JHTS directly or indirectly has a controlling financial interest.

 

***Basisof Presentation***

 

Theaccompanying consolidated financial statements as of April 30, 2004 and for thethree months ended July 31, 2004 and 2003, have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial statements and the rules and regulations of theSecurities and Exchange Commission (“SEC”) for interim financial statements,and should be read in conjunction with the Company’s consolidated financial statementsand other financial information for the fiscal year ended April 30, 2004, whichare included in the Company’s registration statement on Form S-1 filed with theSEC on June 21, 2004.

 

Inpresenting the consolidated financial statements, management makes estimatesand assumptions that affect the amounts reported and related disclosures.Estimates, by their nature, are based on judgment and available information.Accordingly, actual results could differ from those estimates. In management’sopinion, the consolidated financial statements contain all normal and recurringadjustments necessary for a fair presentation of interim results reported.  The results of operations reported forinterim periods are not necessarily indicative of the results of operations tobe experienced for the entire fiscal year or any subsequent interim period.

 

The Company’sresults of operations and cash flows for the period from May 1, 2004 throughthe IPO date and for the three months ended July 31, 2003, reflect thehistorical results of operations and cash flows of the business divested byCendant in the IPO.  As a result, theaccompanying consolidated financial statements may not necessarily reflect theCompany’s results of operations and cash flows in the future or what theCompany’s results of operations and cash flows would have been had it been astand-alone public company during these periods.  See Note 7, “Related Party Transactions,” fora more detailed description of transactions with Cendant.

 

***ComprehensiveIncome (Loss)***

 

TheCompany’s comprehensive income (loss) is solely comprised of net income (loss).

 

6

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

**2.    SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

***Stock-Based Compensation***

 

Effectivewith the IPO, the Company adopted an equity and incentive plan under which theCompany’s employees and selected others may be granted certain equity-basedawards.  As discussed more fully below,the Company accounts for such stock-based compensation in accordance with theprovisions of Statement of Financial Accounting Standards (“SFAS”)No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amendedby SFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure” (“SFAS 148”).

 

Priorto the IPO, Cendant common stock awards were granted to the Company’s employeesunder Cendant’s stock plans. Prior to January 1, 2003, the Company measured itsstock-based compensation using the intrinsic value approach under AccountingPrinciples Board Opinion No. 25, as permitted by SFAS 123. Accordingly,the Company did not recognize compensation expense upon the issuance of itsstock options to employees because the option terms were fixed and the exerciseprice equaled the market price of the underlying common stock on the date ofgrant. Therefore, the Company was not allocated compensation expense uponCendant’s issuance of stock options to the Company’s employees.

 

OnJanuary 1, 2003, the Company (in conjunction with Cendant’s adoption) adoptedthe fair value method of accounting for stock-based compensation provisions ofSFAS 123. The Company also adopted SFAS 148 in its entirety on January 1, 2003,which amended SFAS 123 to provide alternative methods of transition for avoluntary change to the fair value based method of accounting. As a result, theCompany now expenses all employee stock awards over their vesting period, whichis typically four years, based upon the fair value of the award on the date ofgrant.   The fair value of stock optionsis estimated at the grant date using the Black-Scholes option-pricingmodel.  As the Company elected to use theprospective transition method, Cendant allocated expense to the Company onlyfor employee stock awards that were granted or modified subsequent toDecember 31, 2002.

 

Thefollowing table illustrates the effect on net loss and loss per share for thethree months ended July 31, 2003 as if the fair value based method had beenapplied to all employee stock awards granted by Cendant to the Company’semployees.

 
| ** **                                                                                                                      | ** ** | **For the Three  Months Ended  July 31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
|                                                                                                                            |       |                                           |       |
| Reported net loss                                                                                                               |       | $                                              | (12,360    | ) |
| Add back: Stock-based employee compensation  expense included in reported net loss, net of tax                                  |       | 81                                             |       |
|                                                                                                                            |       |                                           |       |
| Less: Total stock-based employee  compensation expense determined under the fair value based method for all  awards, net of tax |       | (239                                           | )          |
| Pro forma net loss                                                                                                              |       | $                                              | (12,518    | ) |
|                                                                                                                            |       |                                           |       |
| Pro forma loss per share:                                                                                                       |       |                                           |       |
| Basic and diluted                                                                                                               |       | $                                              | (0.33      | ) |

 

SeeNote 9, “Stock-Based Compensation,” for a more detailed description of theawards granted under the Company’s equity and incentive plan.

 

***Revenue Recognition – Other Financial Product Revenue***

 

Otherfinancial product revenue is solely related to the facilitation of refundanticipation loans.  In addition to thefixed fees recorded in financial product fees revenue the Company earns fromthe facilitation of refund anticipation loans, the Company earned otherfinancial product revenue equal to a portion (ranging from 59% to 100%) of thedifference between finance fees paid by customers throughout the Company’snetwork to the financial institutions and loan amounts that the financialinstitutions were unable to collect.  Thefinance fees were calculated as a percentage (typically 3%) of the total loanamount (subject to a minimum and maximum fee). The financial institutionsmaintained the finance fees as a reserve against uncollected loans. Otherfinancial product revenue was recognized only to the extent that the reservesmaintained by the lending financial institutions exceeded the uncollected loansmade by these financial institutions at the end of each reporting period.  Other financial product revenue has varied inthe past based upon the financial institutions’ ability to manage credit riskand collect loan balances either through the remittance of refunds from the IRSor from the customers.

 

To reduce the variability of other financialproduct revenue, the Company executed a new agreement on May 5, 2004 with SantaBarbara Bank & Trust (“SBB&T”), the provider in fiscal 2004 ofapproximately 80% of the refund anticipation loans that the Companyfacilitates.  Under the new agreement, inlieu of earning revenue based upon the amount of finance fees and uncollected

 

7

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

loans,effective with the 2005 tax season, the Company will earn primarily a fixed feebased upon the number of refund anticipation loans facilitated during the taxseason. Under the Company’s current agreement with Household Tax Masters Inc.,its other provider of refund anticipation loans, the Company will continue toearn other financial product revenue based on the amount of finance feescollected and uncollected loans.

 

***Marketing and Advertising Expenses***

 

Marketingand advertising costs are expensed in the period the advertising occurs.  Advertising expense amounted to $785 and $621for the three months ended July 31, 2004 and 2003, respectively.

 

**3.    GOODWILLAND OTHER INTANGIBLES, NET**

 

Intangibleassets as of July 31, 2004 consist of:

 
| ** **                         | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                         |       |                        |       |                          |       |                      |       |
| **Amortized intangible assets:**   |       |                        |       |                          |       |                      |       |
| Franchise agreements (a)           |       | $                           | 16,052     |                          | $          | (9,980                    | )          | $ | 6,072 |   |
| Customer relationships (b)         |       | 6,664                       |       | (4,506                        | )          | 2,158                     |       |
|                               |       | $                           | 22,716     |                          | $          | (14,486                   | )          | $ | 8,230 |   |
|                               |       |                        |       |                          |       |                      |       |
| **Unamortized intangible assets:** |       |                        |       |                          |       |                      |       |
| Goodwill                           |       | $                           | 392,371    |                          |       |                      |       |   |
| Jackson Hewitt trademark           |       | $                           | 81,000     |                          |       |                      |       |   |

 

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(a) Amortized over a period of 10 years.

(b) Amortized over a period of 5 years.

 

The changes in the carrying amount of goodwill by segment are asfollows:

 
| ** **                | ** ** | **Franchise  Operations** | ** ** | **Company-  Owned  Office  Operations** | ** ** | **Total**  | ** ** |
|---------------------------|------------|---------------------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                | ** ** | ** **                | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Balance at April 30, 2004 |       | $                         | 336,767    |                                    | $          | 55,601     |       | $ | 392,368 |   |
| Additions                 |       | —                    |       | 3                                       |       | 3          |       |
| Balance at July 31, 2004  |       | $                         | 336,767    |                                    | $          | 55,604     |       | $ | 392,371 |   |

 

Amortization expense relating to the Company’s amortizable intangibleassets was as follows:

 
| ** **             | ** ** | **For the Three Months Ended  July 31,** | ** ** |
|------------------------|------------|------------------------------------------|------------|
| ** **             | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| ** **             | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Franchise agreements   |       | $                                        | 401        |   | $ | 375 |   |
| Customer relationships |       | 271                                      |       | 656 |   |
| Total                  |       | $                                        | 672        |   | $ | 1,031 |   |

 

8

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

Estimated amortization expense related to the Company’s amortizableintangible assets for each of the respective periods in the fiscal years endedApril 30 is as follows:

 
| ** **                           | ** ** | **Amount** | ** ** |
|--------------------------------------|------------|------------|------------|
| Remaining nine months in fiscal 2005 |       | $          | 1,983      |   |
| 2006                                 |       | 2,393      |       |
| 2007                                 |       | 2,151      |       |
| 2008                                 |       | 1,150      |       |
| 2009                                 |       | 105        |       |
| Thereafter                           |       | 448        |       |
| Total                                |       | $          | 8,230      |   |

 

**4.    NOTESRECEIVABLE, NET**

 

TheCompany finances a portion of the initial franchise fee associated with newterritory sales under promissory notes receivable from franchisees. These notesaccrue interest annually, ranging from 8% to 12%, and are typically due in fourannual installments, including accrued interest, at February 28th of each year.These notes are recorded on the Company’s Consolidated Balance Sheets at cost,and are reviewed periodically for collectibility based on the underlyingfranchisee’s payment history, financial status and revenue base. The resultingprovision is included within cost of franchise operations on the Company’sConsolidated Statements of Operations.

 
| ** **                               | ** ** | **As of**          | ** ** |
|------------------------------------------|------------|--------------------|------------|
| ** **                               | ** ** | **July 31,  2004** | ** ** | **April 30,  2004** | ** ** |
|                                     |       |               |       |   |   |
| Notes receivable                         |       | $                  | 8,745      |   | $ | 7,480 |   |
| Less allowance for uncollectible amounts |       | (3,771             | )          | (3,551 | ) |
| Notes receivable, net                    |       | 4,974              |       | 3,929 |   |
| Less current portion                     |       | 2,779              |       | 1,944 |   |
| Notes receivable, net—non-current   |       | $                  | 2,195      |   | $ | 1,985 |   |

 

**5.    DEVELOPMENTADVANCES**

 

TheCompany maintains a program to advance monies to independent tax practices toassist in the conversion of their operations to the Jackson Hewitt brand and tofurther expand their businesses. These development advances are capitalized andmade in the form of promissory notes that are forgivable over a 10-year periodsubject to the achievement of certain performance standards. Advances were$7,931 and $6,616 as of July 31, 2004 and April 30, 2004, respectively, and areincluded in other non-current assets on the Consolidated Balance Sheets.

 

9

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

**6.    ACCOUNTSPAYABLE AND ACCRUED LIABILITIES**

 

Accountspayable and accrued liabilities consist of the following:

 
| ** **                                      | ** ** | **As of**          | ** ** |
|-------------------------------------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **July 31,  2004** | ** ** | **April 30,  2004** | ** ** |
| ** **                                      | ** ** | ** **         | ** ** | ** ** | ** ** |
| Accounts payable                                |       | $                  | 1,365      |   | $ | 2,168 |   |
| State income taxes payable                      |       | 1,560              |       | 1,473 |   |
| Accrued payroll and related liabilities         |       | 4,788              |       | 6,653 |   |
| Legal settlement                                |       | 3,597              |       | 2,672 |   |
| Deferred warranty income                        |       | 5,525              |       | 5,508 |   |
| Accrued marketing and advertising               |       | 4,962              |       | 8,946 |   |
| Accrued purchase price                          |       | 1,301              |       | 1,814 |   |
| Other accrued liabilities                       |       | 3,124              |       | 2,419 |   |
| Total accounts payable and accrued  liabilities |       | $                  | 26,222     |   | $ | 31,653 |   |

 

**7.    RELATEDPARTY TRANSACTIONS**

 

***SpecialDividend Paid to Cendant***

 

Uponcompletion of the IPO in June 2004, the Company declared a special dividend toCendant in the amount of $306,852 (the “Special Dividend”).  The $175,000 cash portion of this SpecialDividend was funded entirely from the net proceeds of the Floating Rate SeniorNotes (see Note 8, “Long-Term Debt and Credit Facility”).  The remaining $131,852 represents thedistribution of a receivable from Cendant.

 

The Companyrecorded the Special Dividend as a reduction to retained earnings of $175,239and a reduction to additional paid-in capital of $131,613.  The amount by which retained earnings wasreduced represents the accumulation of all earnings by the Company up to theIPO date at which time the Company began operating as a separate publiccompany.

 

***Allocationand Funding of Expenses***

 

Throughthe IPO date, the Company was allocated general corporate overhead expensesfrom Cendant for corporate-related functions as well as other expenses directlyattributable to the Company. Cendant allocated corporate overhead to theCompany based on a percentage of the Company’s forecasted revenues andallocated other expenses that directly benefited the Company based on theCompany’s actual utilization of the services. Corporate expense allocationsincluded executive management, finance, human resources, informationtechnology, legal and real estate facility usage. These amounts are included inselling, general and administrative expenses in the Consolidated Statements ofOperations. The Company believes the assumptions and methodologies underlyingthe allocations of general corporate overhead and direct expenses from Cendantto the Company were reasonable and represented the amounts that would have beenincurred if the Company had performed these functions as a stand-alone company.

 

Allallocated overhead expenses as well as direct charges were included in Due fromCendant in the Consolidated Balance Sheets. No interest was charged by Cendantor received by the Company in any period presented with respect to intercompanybalances. Cendant used cash swept from the Company’s bank accounts to fundthese disbursements.

 

10

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

The major categories of intercompany activitybetween the Company and Cendant were as follows:

 
| ** **                                             | ** ** | **For the Period  From May 1,  2004 to the IPO  Date** | ** ** | **For the Three  Months Ended  July 31, 2003** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------|------------|
|                                                   |       |                                                   |       |                                           |       |
| Due from Cendant as of April 30, 2004 and  2003        |       | $                                                      | 143,985    |                                           | $          | 93,664 |   |
| Corporate allocations                                  |       | (750                                                   | )          | (1,232                                         | )          |
| Payroll and related                                    |       | (5,461                                                 | )          | (8,620                                         | )          |
| Accounts payable funding                               |       | (12,878                                                | )          | (7,856                                         | )          |
| Income taxes                                           |       | 2,509                                                  |       | 406                                            |       |
| Cash sweeps                                            |       | 4,447                                                  |       | 3,938                                          |       |
| Subtotal                                               |       | (12,133                                                | )          | (13,364                                        | )          |
| Special dividend - distribution of Due  from Cendant   |       | (131,852                                               | )          | —                                         |       |
| Due from Cendant as of the IPO date and  July 31, 2003 |       | $                                                      | —     |                                           | $          | 80,300 |   |

 

***TransitionalAgreement and Other Related Agreements***

 

Uponcompletion of the IPO, the Company entered into a transitional agreement withCendant to provide for an orderly transition to being an independent companyand to govern the continuing arrangements between the Company and Cendant. TheCompany also entered into a sublease agreement for its New Jersey corporateheadquarters and a sublease assignment and assumption agreement for itstechnology facility in Sarasota, Florida. Under the transitional agreement,Cendant agreed to provide the Company with various services, including servicesrelating to facilities, human resources and employee benefits, payroll,financial systems management, treasury and cash management, accounts payableservices, tax support, event marketing, franchise field audit services,telecommunications services, information technology services, call supportservices and public and regulatory affairs. The transitional agreement alsocontains agreements relating to indemnification, tax sharing and taxindemnification, access to information and non-solicitation of employees.

 

Under the transitional agreement, the cost ofeach transitional service generally reflects the same payment terms and iscalculated using the same cost allocation methodologies for the particularservice as those associated with the costs in the Company’s historicalfinancial statements. The transitional agreement was negotiated in the contextof a parent-subsidiary relationship.  Theprovisions of many services were transitioned at similar costs to those allocatedby Cendant historically. Additionally, all of the services provided under thetransitional agreement may be terminated by the Company, without penalty, uponnot less than 30 days prior written notice to Cendant, except for informationtechnology services which will require a termination payment to Cendant in anamount equal to the unamortized lease costs of computer hardware specific tothe Company’s mainframe environment, as well as for any unpaid actual costsincurred by Cendant with respect to these services.  There are no fixed or minimum contractualpurchase obligations under the transitional agreement.

 

Forthe period from the IPO date through July 31, 2004, the Company incurred $186of expenses related to such transitional and other related agreements withCendant.

 

**8.     LONG-TERM DEBT AND CREDIT FACILITY**

 

***FloatingRate Senior Notes***

 

On June 25,2004, the Company issued $175,000 of five-year floating rate senior unsecurednotes that mature on June 25, 2009 (the “Notes”).  The proceeds from the sale of the Notesissuance were used to fund the cash portion of the Special Dividend paid toCendant on that date.  The Notes bearinterest based on the three-month LIBOR plus 1.5%, which is 3.06% for thethree-month period beginning June 25, 2004. Interest is payable quarterly inMarch, June, September and December, with the first payment commencing inSeptember 2004.  The Company is requiredto pay the entire principal amount on June 25, 2009, but has the option toprepay all or a portion of the Notes at any time on or after June 25, 2005.

 

Interestexpense related to amounts outstanding under the Notes amounted to $550 for theperiod from June 25 through July 31, 2004.

 

11

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

In connectionwith the issuance of the Notes, the Company incurred $1,471 of financing feeswhich have been deferred and are being amortized to interest expense over thelife of the Notes.  Amortization of suchfees amounted to $25 for the period from June 25 through July 31, 2004.  Unamortized financing fees as of July 31,2004 amounted to $1,446, which is included in other non-current assets.

 

***CreditFacility***

 

On June 25,2004, the Company entered into a $100,000 five-year revolving credit facility(the “Credit Facility”), which expires on June 25, 2009.  Borrowings under the Credit Facility are tobe used to finance working capital needs, potential acquisitions and othergeneral corporate purposes of the Company. The Credit Facility provides for loans in the form of Eurodollar orAlternate Base Rate borrowings. Eurodollar borrowings bear interest at the adjusted LIBOR, as defined inthe Credit Facility, plus 1.25% per annum. Alternate Base Rate borrowings bear interest primarily at the primerate, as defined in the agreement, plus 0.25% per annum.  The Company may also use the Credit Facilityto issue letters of credit for general corporate purposes.  The Credit Facility carries a facility fee of0.25% of the total commitment amount of $100,000, which is payablequarterly.  Any borrowings made under theCredit Facility must be repaid by the maturity date of the Credit Facility ofJune 25, 2009.

 

In connectionwith entering into the Credit Facility, the Company incurred $1,413 offinancing fees, which have been deferred and are being amortized to interestexpense over the 5-year term of the Credit Facility.  Amortization of financing fees amounted to$24 for the period from June 25 through July 31, 2004.  Unamortized financing fees as of July 31,2004 amounted to $1,389, which is included in other non-current assets.

 

There were noborrowings outstanding under the Credit Facility as of July 31, 2004.

 

The CreditFacility agreement contains covenants, including the requirement that theCompany maintain certain financial covenants, including a maximum consolidatedleverage ratio of 3.25 to 1.00 and a minimum consolidated fixed charge coverageratio of 3.00 to 1.00 each through April 30, 2005. The consolidated leverageratio is the ratio of consolidated debt to consolidated EBITDA (or earningsbefore interest, taxes, depreciation and amortization), each as defined in theCredit Facility. The consolidated fixed charge coverage ratio is the ratio ofconsolidated EBITDA to consolidated fixed charges.  Consolidated fixed charges includeconsolidated interest expense and regular quarterly dividends paid on theCompany’s common stock, each as defined in the Credit Facility.

 

The CreditFacility contains various customary restrictive covenants that limit theCompany’s ability to, among other things, (i) incur additional indebtedness orguarantees, (ii) create liens or other encumbrances on the Company’s property,(iii) enter into a merger or similar transaction, (iv) sell or transfer any ofthe Company’s property except in the ordinary course of business, and (v) makedividend and other restricted payments. In addition, the Credit Facility limits the maximum amount of restrictedpayments to 30% of the Company’s cumulative consolidated net income for theperiod commencing on May 1, 2003 and ending on April 30 of the fiscal yearpreceding the year in which such restricted payments are made.

 

The agreementgoverning the Notes contains substantially similar provisions and covenants tothose contained in the Credit Facility, as well as customary eventof default provisions and other terms and conditions that are consistent withthose contained in similar debt obligations of issuers with a credit qualitysimilar to the Company’s.

 

As of July 31,2004, the Company was in compliance with these covenants.

 

**9.    STOCK-BASEDCOMPENSATION**

 

***Stock Compensation Plan***s

 

Following the IPO, the Company adopted the 2004 Equity and IncentivePlan, which provides for the grant of incentive stock options, nonqualifiedstock options, stock appreciation rights, restricted stock, restricted stockunits (“RSUs”) and/or other stock- or cash-based awards representing JHTScommon stock to non-employee directors, officers, employees, advisors andconsultants who are selected by the Company’s compensation committee forparticipation in the plan.  In addition,the Company has authorized a stock purchase plan under which eligible employeeshave the ability to purchase shares of JHTS common stock at 95% of marketvalue.** **No stock has been offered for purchase under this plan as ofJuly 31, 2004.

 

12

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

***Exchange Transaction***

 

Prior to the IPO, certain employees of the Company were granted stockoptions and RSUs under Cendant’s stock-based compensation plans.  In connection with the IPO and pursuant tothe consent of each holder, the Company issued 903,935 vested stock options and100,890 shares of common stock to employees in exchange for their Cendant stockoptions and RSUs.  The exchange transactionwas structured to provide the same relative value to employees as the Cendantawards held by such employees prior to the IPO. As a result of the exchange transaction, the Company recordedcompensation expense of $4,508, of which $1,865 is related to the issuance ofvested stock options and $2,643 is related to the issuance of common stock,which is included in selling, general and administrative expenses on theConsolidated Statement of Operations for the three months ended July 31, 2004.

 

***Stock Options***

 

Under the Company’s stock compensation plan, stock options, exceptstock options granted pursuant to the exchange transaction described above, aregenerally granted with an exercise price equal to the market price of a shareof common stock on the date of grant, have a term of ten years or less and vestwithin four years from the date of grant. As of July 31, 2004, there were approximately 4 million stock optionsauthorized for grant to purchase JHTS common stock under the Company’s stockcompensation plan, including the stock options issued by the Company inexchange for Cendant stock options at the IPO date.

 

Following the IPO, the Company recorded a $1,865 charge to compensationexpense in the three months ended July 31, 2004 representing the issuance of903,935 vested stock options granted to employees in exchange for their Cendantoptions.  In addition, the Companygranted new stock options to employees to purchase approximately 1.1 millionshares of common stock and recognized compensation expense of $164 in the threemonths ended July 31, 2004.

 

The tablesbelow summarize the status of the Company’s stock options as of July 31, 2004:

 
| ** **                                                                                           | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|
|                                                                                                 |       |                   |       |                                   |       |
| Cendant stock options related to the  Company’s employees prior to the IPO as of April 30, 2004 |       | 1,396,595              |       | $                                      | 16.06      |   |
|                                                                                                 |       |                   |       |                                   |       |
| Converted JHTS stock options from Cendant  stock options at the IPO date                             |       | 903,935                |       | $                                      | 13.97      |   |
| Granted                                                                                              |       | 1,129,987              |       | $                                      | 17.00      |   |
| JHTS stock options outstanding  as of July 31, 2004.                                                 |       | 2,033,922              |       | $                                      | 15.66      |   |

 

The tablebelow summarizes information regarding outstanding and exercisable JHTS stockoptions issued to employees as of July 31, 2004:

 
| ** **       | ** ** | **Options Outstanding** | ** ** | **Exercisable Options**                             | ** ** |
|------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|
| ** **       | ** ** | **Number of  Options**  | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.01 to $10.00  |       | 65,641                  |       | 7.3                                                 |       | $ | 9.07 |   | 65,641 |   | $ | 9.07 |   |
| $10.01 to $16.00 |       | 804,785                 |       | 6.5                                                 |       | $ | 14.24 |   | 804,784 |   | $ | 14.24 |   |
| $16.01 to $20.00 |       | 1,163,496               |       | 9.7                                                 |       | $ | 17.01 |   | 33,510 |   | $ | 17.19 |   |
|             |       | 2,033,922               |       |                                                |       | $ | 15.66 |   | 903,935 |   | $ | 13.97 |   |

 

13

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

The weighted average grant date fair value of the JHTS stock optionsgranted during the three months ended July 31, 2004 was $6.01.  The fair value of these stock options isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted average assumptions for the stock options grantedin the three months ended July 31, 2004:

 
| Dividend  yield                 |   | 1.7  | %      |
|---------------------------------|--------|------|--------|
| Expected volatility             |   | 31.3 | %      |
| Risk-free interest rate         |   | 4.4  | %      |
| Expected holding period (years) |   | 7.5  |   |

 

***Restricted Stock Units***

 

Following the IPO, Cendant RSUs held by the Company’s employees werecancelled and converted into JHTS awards. As a result, the Company issued 100,890 shares of JHTS common stock inexchange for the unvested Cendant RSUs held by such employees and recorded acharge of $2,643 as compensation expense in the three months ended July 31,2004.

 

The following table presents the total number of shares of common stockrepresented by RSUs granted to the Company’s employees and non-employeedirectors, including those granted in connection with the exchange transactionas of July 31, 2004.

 
| ** **                                                                 | ** ** | **RSUs** | ** ** | **Weighted  Average  Grant Price** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|------------------------------------|------------|
| Cendant RSUs related to the Company’s  employees as of April 30, 2004 |       | 106,497  |       |                               | $          | 13.76 |   |
| Transferred (1)                                                            |       | 8,844    |       |                               | $          | 13.64 |   |
| Forfeited (2)                                                              |       | (5,718   | )          |                               | $          | 13.64 |   |
| Cendant RSUs to be exchanged for JHTS  common stock at the IPO date        |       | 109,623  |       |                               | $          | 13.76 |   |
|                                                                       |       |     |       |                               |       |   |
| JHTS awards issued in exchange for unvested  Cendant RSUs at the IPO date  |       | 100,890  |       |                               | $          | 17.29 |   |
| Vested                                                                     |       | (100,890 | )          |                               | $          | 17.29 |   |
| Granted at fair value                                                      |       | 16,247   |       |                               | $          | 17.11 |   |
| Ending balance                                                             |       | 16,247   |       |                               | $          | 17.11 |   |

 

----

(1)          RepresentsRSUs attributable to the movement of employees between the Company and Cendant.

(2)          RepresentsRSUs attributable to employees who departed from the Company prior to the IPOdate.

 

14

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

**10.    LOSS PER SHARE**

 

Thecomputation of basic loss per share is calculated by dividing the Company’s netloss available to common stockholders by the weighted average number of commonshares outstanding during the period. Diluted loss per share gives effect tothe dilution, if any, arising from stock options outstanding.

 

The following table presents the computation ofbasic and diluted loss per share:

 
| ** **                                         | ** ** | **For the Three Months  Ended July 31,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
|                                               |       |                                     |       |   |   |
| Net loss, basic and diluted                        |       | $                                        | (11,446    | ) | $ | (12,360 | ) |
| Weighted average shares outstanding  (000’s): |       |                                     |       |   |   |
| Basic and Diluted                                  |       | 37,547                                   |       | 37,500 |   |
| Loss per share:                                    |       |                                     |       |   |   |
| Basic and Diluted                                  |       | $                                        | (0.30      | ) | $ | (0.33 | ) |

 
| ** **                                                                                   | ** ** | **For the Three Months  Ended July 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
|                                                                                         |       |                                     |       |   |   |
| **Securities excluded from  the computation of diluted loss per common share (000’s):** |       |                                     |       |   |   |
| Stock options (1)                                                                            |       | 2,034                                    |       | — |   |

 

----

(1)   These securities have beenexcluded from the diluted loss per common share calculation because theirinclusion would have been antidilutive.

 

**11.    SEGMENTINFORMATION**

 

TheCompany manages and evaluates the operating results of its business in twosegments:

 

•                  FranchiseOperations – This segment consists of the operations of the Company’s franchisebusiness, including royalty and marketing and advertising revenue, financialproduct fees, other financial product revenue and other revenue;

 

•                  Company-OwnedOffice Operations – This segment consists of the operations of the Company’sowned offices for which the Company earns service revenue for the preparationof tax returns and related services.

 

Management evaluates the operating results of eachof its reportable segments based upon revenues and loss before income taxes.

 

15

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 
| ** **                              | ** ** | **Franchise  Operations** | ** ** | **Company-  Owned  Office  Operations** | ** ** | **Corporate****(a)** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------------|------------|-----------------------------------------|------------|----------------------|------------|-----------|------------|
| *** ***                            |       |                      |       |                                    |       |                 |       |      |       |
| ***Three  months ended July 31, 2004*** |       |                      |       |                                    |       |                 |       |      |       |
| Net revenues                            |       | $                         | 8,332      |                                    | $          | 451                  |       | $         | —     |   | $ | 8,783 |   |
|                                    |       |                      |       |                                    |       |                 |       |      |       |
| Loss before income taxes                |       | $                         | (3,253     | )                                       | $          | (6,268               | )          | $         | (9,303     | ) | $ | (18,824 | ) |
|                                    |       |                      |       |                                    |       |                 |       |      |       |
| ***Three  months ended July 31, 2003*** |       |                      |       |                                    |       |                 |       |      |       |
| Net revenues                            |       | $                         | 5,148      |                                    | $          | 624                  |       | $         | —     |   | $ | 5,772 |   |
|                                    |       |                      |       |                                    |       |                 |       |      |       |
| Loss before income taxes                |       | $                         | (5,336     | )                                       | $          | (5,810               | )          | $         | (9,361     | ) | $ | (20,507 | ) |

 

----

(a)          Represents unallocated corporate overheadsupporting both segments including legal, finance, human resources, real estatefacilities and strategic development, as well as interest expense.  Beginning in the first quarter of fiscal2005, corporate also includes incremental costs related to becoming a stand-alonepublic company, including additional insurance, stock-based compensation andBoard of Director fees.

 

**12.    COMMITMENTSAND CONTINGENCIES**

 

***LegalProceedings***

 

OnAugust 27, 2002, a plaintiff group comprising 154 franchisees filed an actionagainst the Company and SBB&T in the Superior Court of New Jersey, MorrisCounty. The suit alleged, among other things, that the Company breached anagreement with the plaintiffs by not paying them a portion of surpluses inrefund anticipation loan loss reserves. The plaintiffs sought a declaratory judgment,an accounting, payment of an incentive rebate, unspecified compensatory andpunitive damages, treble damages and attorneys’ fees. By an order datedDecember 6, 2002, the court dismissed the conversion and fraud counts of thecomplaint with prejudice. The plaintiffs filed an amended complaint on March17, 2003. The parties submitted the matter to mediation in July 2003, whichresulted in a settlement in which the Company agreed, among other things, tomake a $2,000 cash payment, spend an additional $2,000 on regional advertisingfrom 2004 through 2006, pay additional rebates to franchisees of up to $3.00per refund anticipation loan processed during the 2004 through 2006 taxseasons, subject to performance criteria, and implement a temporary royalty feereduction program for certain new franchise offices. On December 19, 2003, thecourt issued a ruling enforcing the settlement and dismissed the action withprejudice. As of July 31, 2004, 151 plaintiffs in the action have executed thesettlement agreement, and one has appealed the enforcement order of December19, 2003. Accordingly, a $10,410 charge was recognized in fiscal 2004 of which$8,044 was recorded in the first quarter of fiscal 2004 and is included withinselling, general and administrative expense on the accompanying ConsolidatedStatement of Operations.

 

On April 4, 2003, CanievaHood and Congress of California Seniors brought a purported class action suitagainst SBB&T and the Company in the Superior Court of California (SantaBarbara) in connection with the provision of refund anticipation loans, seekingdeclaratory relief as to the lawfulness of the practice of cross-lender debtcollection, the validity of Santa Barbara’s cross-lender debt collectionprovision and whether the method of disclosure to customers with respect to theprovision is unlawful or fraudulent. The Company was joined in the action forallegedly collaborating, and aiding and abetting, in the actions ofSBB&T.  The Company filed a demurrerto the complaint.  The Court denied thedemurrer and granted leave to plaintiffs to amend their complaint. Ms. Hood hasalso filed a separate suit against the Company and Cendant on December 18, 2003in the Ohio Court of Common Pleas (Montgomery County) and is seeking to certifya class in the action. The allegations relate to the same set of facts as theCalifornia action. In January 2004, the Company filed a motion to remove thiscase to federal court in Ohio and also moved the federal court to stay, ordismiss, the Ohio action while permitting the California action to proceed. Thecase was remanded to state court where the Company has filed its motion to stayor dismiss, which is pending. While this matter is at a preliminary stage, theCompany believes that it has meritorious defenses to the claims and intends todefend them vigorously.

 

On June 18, 2004, MyronBenton brought a purported class action against SBB&T and the Company inthe Supreme Court of the State of New York (County of New York) in connectionwith disclosures made in connection with the provision of refund anticipationloans, alleging that the disclosures and related practices are fraudulent andotherwise unlawful, and seeking equitable and monetary relief.  While this matter is at a preliminary stage,the Company believes it has meritorious defenses to the claims and intends todefend them vigorously.

 

16

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**JACKSON HEWITT TAX SERVICE INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unless otherwise noted, all dollar amounts are in thousandsexcept per share amounts)**

 

The Company isfrom time to time subject to other legal proceedings and claims in the ordinarycourse of business, none of which the Company believes are likely to have amaterial adverse effect on its financial position, results of operations orcash flows.  However, there can be noassurance that such litigation, or any future litigation, will not have amaterial adverse effect on the Company’s financial position, results ofoperations or cash flows.

 

**13.    SUBSEQUENTEVENT**

 

***Declaration of Dividend***

 

On August 19,2004, the Company’s Board of Directors declared a quarterly cash dividend of$0.07 per share of common stock, payable on October 15, 2004, to stockholdersof record on September 27, 2004.

 

17

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**Item2.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion should be read in conjunction withour consolidated financial statements and the related notes included elsewherein this Quarterly Report on Form 10-Q and our Management’s Discussion andAnalysis of Financial Condition and Consolidated Financial Statements includedin our initial registration on Form S-1 filed with the SEC on June 21, 2004.*

 

**FORWARD-LOOKING STATEMENTS**

 

**(Cautionary Statements Under the PrivateSecurities Litigation Reform Act of 1995)**

 

Forward-looking statements in our publicfilings or other public statements are subject to known and unknown risks,uncertainties and other factors which may cause our actual results, performanceor achievements to be materially different from any future results, performanceor achievements expressed or implied by such forward-looking statements. Theseforward-looking statements were based on various factors and were derivedutilizing numerous important assumptions and other important factors that couldcause actual results to differ materially from those in the forward-lookingstatements. Forward-looking statements include the information concerning ourfuture financial performance, business strategy, projected plans andobjectives. Statements preceded by, followed by or that otherwise include thewords “believes”, “expects”, “anticipates”, “intends”, “projects”, “estimates”,“plans”, “may increase”, “may fluctuate” and similar expressions or future orconditional verbs such as “will”, “should”, “would”, “may” and “could” aregenerally forward-looking in nature and not historical facts. You shouldunderstand that the following important factors and assumptions could affectour future results and could cause actual results to differ materially fromthose expressed in such forward-looking statements:

 

•                  our ability to achieve the same level ofgrowth in revenues and profits that we have in the past;

 

•                  government initiatives that simplify taxreturn preparation, improve the timing and efficiency of processing tax returnsor decrease the number of tax returns filed or the size of the refunds;

 

•                  government regulation and oversight,including regulation of refund anticipation loans;

 

•                  our exposure to litigation;

 

•                  our ability to protect our customers’personal information;

 

•                  the success of our franchised offices and ourability to exert control over them;

 

•                  our responsibility to third parties for theacts of our franchisees;

 

•                  disruptions in our relationships with ourfranchisees;

 

•                  changes in our relationships with financialproduct providers that could affect our ability to facilitate the sale offinancial products;

 

•                  changes in our relationships with retailersthat could affect our growth and profitability;

 

•                  seasonality of our business and its effect onour stock price;

 

•                  our ability to sustain or negotiate servicescurrently provided by Cendant at reasonable costs;

 

•                  competition from tax return preparationservice providers;

 

•                  our ability to offer innovative new productsand services;

 

•                  our reliance on electronic communications;

 

•                  our reliance on cash flow from subsidiaries;

 

•                  our compliance with debt and credit facilitycovenants;

 

•                  our exposure to increases in prevailingmarket interest rates;

 

•                  the effect of market conditions, generalconditions in the tax return preparation industry or general economicconditions; and

 

•                  changes in accounting policies or practices.

 

Other factorsand assumptions not identified above were also involved in the derivation ofthese forward-looking statements, and the failure of such other assumptions tobe realized as well as other factors may also cause actual results to differmaterially from those projected. Most of these factors are difficult to predictaccurately and are generally beyond our control.

 

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**You should consider the areas of riskdescribed above in connection with any forward-looking statements that may bemade by us and our businesses generally. Except for our ongoing obligations todisclose material information under the federal securities laws, we undertakeno obligation to release publicly any revisions to any forward-looking statements,to report events or to report the occurrence of unanticipated events unlessrequired by law.  For any forward-lookingstatements contained in any document, we claim the protection of the safeharbor for forward-looking statements contained in the Private SecuritiesLitigation Reform Act of 1995.**

 

**Overview**

 

JacksonHewitt Tax Service Inc. is the second largest paid tax return preparer in theUnited States, based on the number of tax returns filed by paid preparers, witha nationwide network comprised of 4,330 franchised offices and 605company-owned offices during the 2004 tax season.  We have grown rapidly, more than doubling thenumber of offices in our network since 1998 and our annual volume of taxreturns prepared since 1999. In 2004, our network filed 3.1 million taxreturns, an increase of 11% as compared to 2003. Our revenues and operatingincome are primarily dependent on the successful operations of our franchisesystem and our company-owned offices.

 

We manage and evaluate the operating results of ourbusiness in two segments:

 

•                  Franchiseoperations: This segment consists of the operations of our franchise business,including royalty and marketing and advertising revenue, financial productfees, other financial product revenue and other revenue.

 

•                  Company-ownedoffice operations: This segment consists of the operations of our company-ownedoffices for which we earn service revenue for the preparation of tax returnsand related services.

 

**Separationfrom Cendant and Related Party Transactions**

 

***ContinuingBusiness Arrangements with Cendant Upon Separation***

 

OnJune 25, 2004, Cendant Corporation completed an initial public offering, or anIPO, for the sale of 100% of its ownership interest in us.  Upon the completion of this offering, weentered into a transitional agreement with Cendant to provide for an orderlytransition to being an independent company and to govern the continuingarrangements between us and Cendant. We also entered into a sublease agreementfor our New Jersey corporate headquarters and a sublease assignment andassumption agreement for our technology facility in Sarasota, Florida.  Under the transitional agreement, Cendantagreed to provide us with various services, including services relating tofacilities, human resources and employee benefits, payroll, financial systemsmanagement, treasury and cash management, accounts payable services, taxsupport, event marketing, franchise field audit services, telecommunicationsservices, information technology services, call support services and public andregulatory affairs. The transitional agreement also contains agreementsrelating to indemnification, tax sharing and tax indemnification, access toinformation and non-solicitation of employees.

 

***PeriodsCovered Under Transitional Agreement***

 

Themajority of the services covered in the transitional agreement will expire byDecember 31, 2005, with the exception of information technology services andtelecommunications services, which will expire in June 2006 and June 2007,respectively. We do not expect any of the services provided under theseagreements to expire before December 31, 2004. Additionally, all of theservices provided under the transitional agreement may be terminated by us,without penalty, upon not less than 30 days prior written notice to Cendant,except for information technology services which will require a terminationpayment to Cendant in an amount equal to the unamortized lease costs ofcomputer hardware specific to our mainframe environment, as well as for anyunpaid actual costs incurred by Cendant with respect to these services. Foralmost all services provided, Cendant does not have the ability to terminatethe provision of the services prior to the expiration date, with the exceptionof telecommunications services, franchise field audit services and call supportservices, which Cendant may terminate upon prior written notice to us of 180days, 120 days, and 120 days, respectively. Cendant may terminate the subleasefor our New Jersey corporate headquarters prior to the expiration date upon 120days prior written notice, but Cendant is required to relocate us, at Cendant’scost, to mutually acceptable office space. As of August 31, 2004, we have not received any such notice fromCendant.

 

***Costof Transitional Agreement***

 

Underthe transitional agreement, the cost of each transitional service generallyreflects the same payment terms and will be calculated using the same costallocation methodologies for the particular service as those associated withthe costs in our historical financial statements. The transitional agreementwas negotiated in the context of a parent-subsidiary relationship. Theprovision of many of the services was transitioned at similar costs to thoseallocated by Cendant historically. After the expiration of the transitional

 

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agreement,we may not be able to replace these services in a timely manner or on terms andconditions, including cost, as favorable as those we have received fromCendant.

 

Wehave developed a plan to increase our own internal capabilities with respect tothese transitional services. We expect to incur a substantial increase in costsfor the following services: insurance coverage (specifically directors andofficers and errors and omissions coverage); financial systems management; andemployee benefits. As part of this plan, we have, or will have, expanded ouraccounting and finance team and implemented the necessary systems to manage thetransition of these services and handle the additional responsibilities ofoperating as an independent public company. In addition, we have, or will have,expanded our capabilities in other functional areas such as human resources,legal and purchasing to enable us to adequately support and provide theservices, which we have received historically from Cendant.

 

Wehave identified completion dates in our transition plan that coincide with theexpiration dates for the services outlined in the transitional agreement. Forexample, for services we intend to perform internally, such as treasury andcash management, tax support, internal audit and purchasing support, we arecurrently recruiting individuals to fill these positions.  For services we intend to outsource tothird-party service providers at the end of calendar year 2004, such aspayroll, employee benefit plan administration and financial systemimplementation, we have begun the process of transitioning these services withcompletion planned during our third quarter of fiscal 2005. We expect to begina similar selection process later this year for other services we intend tooutsource during fiscal 2005, such as franchise field audit services and taxadvisory services.

 

***Prior Year Financial Statements***

 

Our unauditedconsolidated financial statements for the three months ended July 31, 2003reflect the historical results of operations and cash flows of our businessdivested by Cendant in the IPO.  Theseconsolidated financial statements may not necessarily reflect our results ofoperations and cash flows in the future or what our results of operations andcash flows would have been had we been a stand-alone public company duringthese periods.

 

***KeyTrends and Uncertainties Affecting Our Results***

 

The followingis a summary of the key trends and uncertainties that affected our financialresults up through the period ended July 31, 2004.  Please also see “Forward-Looking Statements”for a discussion of uncertainties facing our business.

 

Our revenuehas grown significantly over the past three years achieved, in part, throughrapidly establishing offices in urban areas with large markets for ourproducts.  The following are the keyfactors currently affecting our results:

 

•                  *Seasonalityof Revenue and Results of Operations*- Given the seasonal nature of the taxpreparation business, we have generated and expect to continue to generatesubstantially all of our revenues during the tax season period from Januarythrough April of each year, which overlaps our third and fourth quarters.During fiscal 2004, we generated approximately 91% of our revenues during thisperiod. We generally operate at a loss through the first eight months of eachfiscal year, during which we incur costs associated with preparing for theupcoming tax season.

 

•                  *Franchise Business Model*– A majority ofour revenue is derived from our franchise system which has increasedsignificantly over the past three years. Our franchise model enables us to grow more quickly with less capitalinvestment and lower operating expenses than if we directly operated all of theoffices in our network.  The franchisemodel has an inherently higher profit margin than our company-owned offices, asour existing infrastructure permits additional franchise growth without significantadditional fixed cost investment.

 

•                  *Variability of Other Financial Product Revenue*–In order to reduce the variability of our other financial product revenue, weexecuted a new agreement on May 5, 2004 with Santa Barbara Bank & Trust, orSBB&T, the provider in fiscal 2004 of approximately 80% of the refundanticipation loans that we facilitate. Accordingly, we expect our revenues related to a large portion of ourrefund anticipation loans to become less variable beginning with our 2005 taxseason.  Under the new agreement, we willearn primarily a fixed fee based upon the number of refund anticipation loansfacilitated during the tax season through SBB&T in lieu of earning revenuebased upon the amount of finance fees and uncollected loans.  We expect to earn most of our revenue duringthe filing season in conjunction with the filing of income tax returns and thefacilitation of refund anticipation loans. Given the reduced volatility under the new agreement, we expect thiscomponent of revenue to grow consistently with the number of refundanticipation loans facilitated through SBB&T.  Based on our historical experience, we do notcurrently expect that any remaining variable fees associated with the newagreement will have a material impact on our consolidated results ofoperations.

 

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***Expected Costs Associated with Being an Independent PublicCompany***

 

Inconjunction with being an independent public company effective June 2004, weexpect to incur significant costs in fiscal 2005, which are incremental to ourhistorical costs.  These costs areestimated to be $5.3 million and include: (i) $3.3 million related to directorsand officers and errors and omissions insurance coverage, and Board of Directorsfees, and (ii) $2.0 million associated with equity awards and increasedcompensation for our officers and employees. In addition to the estimated $5.3 million of annual incremental publiccompany costs, we incurred a charge during the first quarter of fiscal 2005 of$4.5 million in conjunction with the IPO related to the issuance of employeestock options and common stock in exchange for Cendant stock options andrestricted stock units that were held by our employees prior to the IPO.

 

**RESULTS OF OPERATIONS**

 

***Fiscal QuarterEnded July 31, 2004 as Compared to the Fiscal Quarter Ended July 31, 2003***

 

**Consolidated**

 

Ourconsolidated results of operations are set forth below and are followed by amore detailed discussion of each of our business segments, as well as adetailed discussion of certain corporate and other expenses.

 
| **Consolidated  Results of Operations**               | ** ** | **For the Three  Months Ended July 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **(in  thousands):**                                  | ** ** | **2004**                                                     | ** ** | **2003** | ** ** |
|                                                  |       |                                                         |       |   |   |
| **Revenues**                                          |       |                                                         |       |   |   |
| Franchise operations revenues:                        |       |                                                         |       |   |   |
| Royalty                                               |       | $                                                            | 600        |   | $ | 244 |   |
| Marketing and advertising                             |       | 275                                                          |       | 116 |   |
| Financial product fees                                |       | 1,702                                                        |       | 607 |   |
| Other financial product revenue                       |       | 3,496                                                        |       | 2,256 |   |
| Other                                                 |       | 2,259                                                        |       | 1,925 |   |
| Service revenue from company-owned office  operations |       | 451                                                          |       | 624 |   |
| Net revenues                                          |       | 8,783                                                        |       | 5,772 |   |
|                                                  |       |                                                         |       |   |   |
| **Expenses**                                          |       |                                                         |       |   |   |
| Cost of franchise operations                          |       | 6,854                                                        |       | 6,129 |   |
| Marketing and advertising                             |       | 2,212                                                        |       | 1,786 |   |
| Cost of company-owned office operations               |       | 4,617                                                        |       | 4,278 |   |
| Selling, general and administrative                   |       | 10,480                                                       |       | 11,070 |   |
| Depreciation and amortization                         |       | 2,839                                                        |       | 3,104 |   |
| Total expenses                                        |       | 27,002                                                       |       | 26,367 |   |
|                                                  |       |                                                         |       |   |   |
| **Loss from operations**                              |       | (18,219                                                      | )          | (20,595 | ) |
| Other income/(expense):                               |       |                                                         |       |   |   |
| Interest income                                       |       | 152                                                          |       | 156 |   |
| Interest expense                                      |       | (757                                                         | )          | (68 | ) |
| Loss before income taxes                              |       | (18,824                                                      | )          | (20,507 | ) |
| Benefit for income taxes                              |       | (7,378                                                       | )          | (8,147 | ) |
| Net loss                                              |       | $                                                            | (11,446    | ) | $ | (12,360 | ) |

 

Giventhe seasonality of our business, approximately 2% of the total tax returnsprepared by our network in fiscal 2004 were prepared in the first and secondfiscal quarters.  Consequently, thenumber of tax returns prepared during the first and second fiscal quarters andthe corresponding revenue is not indicative of the overall trends of ourbusiness for the fiscal year.  Most taxreturns prepared in the first and second fiscal quarters are related to taxreturns for which filing extensions have been applied for by the customer oramended tax returns were filed.

 

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Netrevenues increased $3.0 million, or 52%, in the first quarter of fiscal 2005 ascompared with the first quarter of fiscal 2004. Financial product fees contributed $1.1 million to the total increase,driven primarily by growth in the Gold Guarantee extended warrantyproduct.  Other financial productrevenues also contributed to the growth, increasing by $1.2 million due tohigher collections of refund anticipation loans.  Other financial product revenue has variedover the years, as it has been dependent upon a number of factors involvingrisk related to the receipt of income tax refunds. To reduce variability, werenegotiated our refund anticipation loan agreement with SBB&T.  Under the new agreement, other financialproduct revenue is expected to decline on a full year basis as compared tofiscal 2004 as we will earn primarily a fixed fee for refund anticipation loansfacilitated through SBB&T beginning with the 2005 tax-filing season.  As we transition to the new agreement, otherfinancial product revenue earned in the first and second fiscal quarters willdecline.  If the new agreement withSBB&T had always been in effect, other financial product revenue would havebeen limited to $0.6 million in the first quarter of fiscal 2005 solelyattributable to revenue from refund anticipation loans facilitated throughHousehold Tax Masters Inc.  Results forthe first quarter of fiscal 2005 also included $1.7 million in other revenuerelated primarily to the sale of 65 territories, which is consistent with thesame quarter last year.

 

Totalexpenses increased by $0.6 million, or 2%, in the first quarter of fiscal 2005as compared with the same quarter last year. Included in total expenses was a stock-based compensation charge of $4.5million related to the issuance of 903,935 vested stock options and 100,890shares of common stock to employees in exchange for Cendant stock options andrestricted stock units that were held by such employees prior to the IPO.  Included in the first quarter of fiscal 2004were additional costs of $6.0 million composed primarily of an $8.0 million litigationcharge, net of a $2.0 million reduction in bad debt reserves as a result ofimproved collection performance.  Theseadditional costs alone resulted in a net decrease in total expenses of $1.5million in the first quarter of fiscal 2005 as compared with the same quarterlast year.

 

Offsettingthis $1.5 million decrease were increased expenses of $1.1 million in ourfranchise operations segment and $0.3 million in expenses from ourcompany-owned office operations segment, as well as $0.7 million of incrementalcosts incurred in corporate and other primarily related to becoming a publiccompany, such as additional insurance costs, stock-based compensation and Boardof Director fees.  The higher franchiseoperations expenses included an increase in costs of $0.7 million, or 12%, inthe first quarter of fiscal 2005 due to growth in revenue from the GoldGuarantee product and higher costs to support the expansion needs of new andexisting territories.  Franchisemarketing and advertising expenses increased $0.3 million, or 20%, inconjunction with our overall growth.  Theincrease in cost of company-owned operations was due to higher off-season fixedcosts associated with the increased number of offices in the 2004 tax-filingseason.

 

  Interest expense increased by $0.7 millionprimarily as a result of the issuance in June 2004 of $175.0 million offloating rate senior notes in connection with the IPO.

 

Netloss decreased to $11.4 million in the first quarter of fiscal 2005 from $12.4million in the first quarter of fiscal 2004. Excluding the impact of the stock based compensation charge of $4.5million (pre-tax) in the first quarter of fiscal 2005 and the impact of the$6.0 million (pre-tax) in additional expenses incurred in the first quarter offiscal 2004, net loss was equal to approximately $8.7 million in each period.

 

**Segment Results andCorporate**

 

**FranchiseOperations**

 

Atthe core of our business strategy is the growth and development of ourfranchise system. We derive a significant portion of revenue during our thirdand fourth fiscal quarters from royalty and marketing and advertising fees,which are also our fastest growing source of revenue. We earn royalty feesbased on our franchisees’ revenue. We provide our franchisees with servicesdesigned to increase their revenues, including training, administrativesupport, access to our proprietary ProFiler tax return preparation software andtax refund-related financial products, product development and qualityassurance. Marketing and advertising fees are based on our franchisees’ revenueand are used to support national advertising programs, brand development,website development and our franchisees’ regional and local advertising.

 

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| **Franchise  Results of Operations** | ** ** | **For the Three  Months Ended July 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------|------------|
| **(in thousands):**                  | ** ** | **2004**                                                     | ** ** | **2003** | ** ** |
|                                 |       |                                                         |       |   |   |
| **Revenues**                         |       |                                                         |       |   |   |
| Royalty                              |       | $                                                            | 600        |   | $ | 244 |   |
| Marketing and advertising            |       | 275                                                          |       | 116 |   |
| Financial product fees               |       | 1,702                                                        |       | 607 |   |
| Other financial product revenue      |       | 3,496                                                        |       | 2,256 |   |
| Other                                |       | 2,259                                                        |       | 1,925 |   |
| Net revenues                         |       | 8,332                                                        |       | 5,148 |   |
|                                 |       |                                                         |       |   |   |
| **Expenses**                         |       |                                                         |       |   |   |
| Cost of franchise operations         |       | 6,854                                                        |       | 6,129 |   |
| Marketing and advertising            |       | 1,971                                                        |       | 1,638 |   |
| Selling, general and administrative  |       | 1,014                                                        |       | 1,008 |   |
| Depreciation and amortization        |       | 1,892                                                        |       | 1,865 |   |
| Total expenses                       |       | 11,731                                                       |       | 10,640 |   |
|                                 |       |                                                         |       |   |   |
| **Loss from operations**             |       | (3,399                                                       | )          | (5,492 | ) |
| Other income:                        |       |                                                         |       |   |   |
| Interest income                      |       | 146                                                          |       | 156 |   |
| Loss before income taxes             |       | $                                                            | (3,253     | ) | $ | (5,336 | ) |

 

Financialproduct fees increased by $1.1 million, or 180%, in the first quarter of fiscal2005 driven primarily by growth in the Gold Guarantee product for which revenueis deferred and amortized over the three year period of the extendedwarranty.  Other revenue increased $0.3million, or 17%, driven by increases in electronic filing fees, andmiscellaneous other revenue.  Otherrevenue included $1.7 million primarily from the sales of 65 territories, whichis consistent with the same quarter last year.

 

Otherfinancial product revenue increased $1.2 million, or 55%, in the first quarter offiscal 2005 related primarily to increased collections of refund anticipationloans by our financial institutions.  Ofthe total increase, $0.6 million was related to loans facilitated throughHousehold Tax Masters Inc. and $0.6 million was related to loans facilitatedunder our prior agreement with SBB&T, which has been renegotiated beginningwith the facilitation of loans in the 2005 tax-filing season.  As we transition to the new agreement withSBB&T, other financial product revenue earned in the first and secondfiscal quarters will decline.  If the newagreement with SBB&T had always been in effect, other financial productrevenue would have been limited to $0.6 million in the first quarter of fiscal2005 solely attributable to revenue from refund anticipation loans facilitatedthrough Household Tax Masters Inc.

 

Inthe first quarter of fiscal 2005, total expenses increased by $1.1 million, or10%, as compared to the first quarter of fiscal 2004, primarily due to anincrease in cost of franchise operations of $0.7 million, or 12%, due toincreased costs related to the growth in the Gold Guarantee product and highercosts to support the expansion needs of new and existing territories.  Franchise marketing and advertising expensesincreased $0.3 million, or 20%, in conjunction with the franchise segment’sgrowth.  Selling, general andadministrative expenses, as well as depreciation and amortization, increased atmodest rates in the first quarter of fiscal 2005 versus the same period lastyear.

 

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**Company-OwnedOffice Operations**

 

Complementingour franchise system are our company-owned offices.

 
| **Company-Owned  Office Results of Operations**       | ** ** | **For the Three  Months Ended July 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **(in thousands):**                                   | ** ** | **2004**                                                     | ** ** | **2003** | ** ** |
| ** **                                            |       |                                                         |       |   |   |
| **Revenue**                                           |       |                                                         |       |   |   |
| Service revenue from company-owned office  operations |       | $                                                            | 451        |   | $ | 624 |   |
|                                                  |       |                                                         |       |   |   |
| **Expenses**                                          |       |                                                         |       |   |   |
| Cost of operations                                    |       | 4,617                                                        |       | 4,278 |   |
| Marketing and advertising                             |       | 241                                                          |       | 148 |   |
| Selling, general and administrative                   |       | 920                                                          |       | 769 |   |
| Depreciation and amortization                         |       | 947                                                          |       | 1,239 |   |
| Total expenses                                        |       | 6,725                                                        |       | 6,434 |   |
|                                                  |       |                                                         |       |   |   |
| **Loss from operations**                              |       | (6,274                                                       | )          | (5,810 | ) |
| Other income:                                         |       |                                                         |       |   |   |
| Interest income                                       |       | 6                                                            |       | — |   |
| Loss before income taxes                              |       | $                                                            | (6,268     | ) | $ | (5,810 | ) |

 

Loss before income taxes increased $0.5million, or 8%, primarily due to higher off-season fixed costs associated withthe increased number of offices in the 2004 tax-filing season.

** **

**Corporateand Other**

 

Corporateand other expenses consist of corporate functions, including legal, finance,human resources, real estate facilities, strategic development activities andother costs that are not allocated to our franchise operations or company-ownedoffice operations, including expenses such as litigation settlement costs.  In addition, beginning with the first quarterof fiscal 2005, corporate and other expenses include incremental costs relatedto becoming a stand-alone public company, including additional insurance costs,stock based compensation, Board of Director fees and interest expense on ournew indebtedness.

 

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| **Corporate  and Other Results of Operations** | ** ** | **For the Three  Months Ended July 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **(in thousands):**                                 | ** ** | **2004**                                                     | ** ** | **2003** | ** ** |
|                                                |       |                                                         |       |   |   |
| **Expenses**                                        |       |                                                         |       |   |   |
| Stock based compensation charge related to  the IPO |       | $                                                            | 4,508      |   | $ | — |   |
| Litigation settlement charge                        |       | —                                                       |       | 8,044 |   |
| Bad debt reserve adjustment                         |       | —                                                       |       | (2,001 | ) |
| General and administrative expense                  |       | 4,038                                                        |       | 3,250 |   |
| Total expenses                                      |       | 8,546                                                        |       | 9,293 |   |
|                                                |       |                                                         |       |   |   |
| Other expense:                                      |       |                                                         |       |   |   |
| Interest expense                                    |       | (757                                                         | )          | (68 | ) |
| Loss before income taxes                            |       | $                                                            | (9,303     | ) | $ | (9,361 | ) |

 

Corporateand other expenses, excluding interest expense, declined by $0.7 million in thefirst quarter of fiscal 2005 as compared with the same period last year.  This decline was primarily the result of theadditional $6.0 million ($8.0 million litigation charge, net of $2.0 millionadjustment in bad debt reserves) of expenses incurred in the first quarter offiscal 2004, offset by a $4.5 million charge related to the issuance ofemployee stock options and common stock in connection with the IPO in the firstquarter of fiscal 2005.  Other generaland administrative expenses increased by $0.8 million due entirely to new costsin the first quarter of fiscal 2005 attributed to becoming a public company,including additional insurance costs, stock-based compensation, and Board ofDirector fees.  Interest expense alsoincreased by $0.7 million in the first quarter of fiscal 2005 as a result ofincremental indebtedness of $175.0 million.

 

**Liquidityand Capital Resources**

 

***HistoricalSources and Uses of Cash from Operations***

 

***Background***

 

Prior to theIPO, funds that we generated from our operations were regularly transferred toCendant.  In addition, Cendant would fundexpenses on our behalf.  As anindependent public company, we now maintain our cash and cash equivalents, fundour operations and enter into investing and financing activities independently.

 

Withrespect to financing activities, Cendant historically received the benefit ofour operating cash flow and funded our operations following the end of the taxseason. Consequently, until the completion of the IPO in June 2004, ourfinancing activities had consisted solely of the settlement of intercompanytransactions with Cendant.

 

***Seasonality of our Cash Flows***

 

Ourrevenues have been and are expected to continue to be highly seasonal. As aresult, we generate most of our operating funds during the tax season thatconsists of the period from January through April.  Certain of our expenses are also highlyseasonal in nature including our marketing and advertising expenses as well asthe costs to operate our company-owned offices, both of which increase shortlybefore and continue through the tax filing season.  Following the tax-filing season, we requirefunds to cover our operating expenses as well as to reinvest in the businessfor future growth. We expect to fund our operations through our operating cashflow and through our new credit facility, as required.

 

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***Increase in Debt and the Establishment of aCredit Facility***

 

In June 2004, in conjunction with the IPO, weissued $175.0 million of five-year floating rate notes, or the Notes, through aprivate placement.  The purpose of theNotes issuance was to fund the cash portion of the Special Dividend paid toCendant upon Cendant’s divestiture of its entire ownership interest in us.  We are required to repay the Notes on June25, 2009, but have the option to repay the Notes earlier beginning on June 25,2005.  In June 2004, we also establisheda $100.0 million five-year revolving credit facility.  Borrowings under the credit facility are tobe used to finance working capital needs, potential acquisitions and othergeneral corporate purposes.  To theextent we complete any acquisitions, we may require additional debt or equityfinancing to meet our capital needs.

 

Fora more detailed discussion of our Notes and our credit facility, including adescription of financial covenants which we are required to maintain, pleaserefer to Note 8, “Long-Term Debt and Credit Facility” to our consolidatedfinancial statements included elsewhere in this Quarterly Report on Form 10-Q.

 

***Sources and Uses of Cash for the Three MonthsEnded July 31, 2004***

 

***Operating Activities***

 

Inthe first quarter of fiscal 2005, we generated net cash flows from operatingactivities of $6.4 million as compared with net cash used in operations of$11.9 million in the first quarter of fiscal 2004. Described below are some ofthe more significant items that contributed to, or partially offset, our cashprovided by operating activities for the three months ended July 31, 2004:

 

•                  *Thecollection of receivables related to other financial product revenue* -**Included in the increase in accountsreceivable are revenues earned from the facilitation of refund anticipationloans related to the finance fees paid by customers to the financialinstitutions less the loan amounts that financial institutions are unable tocollect.  This receivable was relatedprimarily to higher revenues earned from refund anticipation loans facilitatedin the 2004 tax-filing season, which was collected in the first quarter offiscal 2005 as compared to amounts being collected during the second quarter offiscal 2004.

 

•                  *Paymentsrelated to litigation settlements*– Included in the decrease in accountspayable during the first quarter of fiscal 2005, were payments of $1.9 millionrelated to the litigation settlement reserve that was established in fiscal2004.  These payments partially offsetthe improvement in cash flows from operations.

 

***Investing Activities***

 

Netcash used in investing activities amounted to $2.0 million in the first quarterof fiscal 2005 as compared with $2.7 million in the same quarter of fiscal2004.  The largest component in each ofthese periods was the funding of development advances by which we provide fundsto independent tax practices to assist in the conversion of their operations tothe Jackson Hewitt brand and to further expand their businesses.  We have historically invested in this type ofprogram and expect to continue to make such investments going forward.

 

***Financing Activities***

 

Inthe first quarter of fiscal 2005, we generated net cash from financingactivities of $9.2 million as compared with $13.4 million in the same quarterof fiscal 2004.  In connection with theIPO, we issued $175.0 million of Notes and used the entire proceeds of thisissuance to fund the cash portion of the Special Dividend to Cendant.  We also paid fees totaling $2.9 million toissue the Notes as well as to establish the $100.0 million creditfacility.  The changes in due fromCendant in the first quarter of both fiscal 2005 and 2004 represented the cashsettlement of intercompany transactions with Cendant.

 

Inaddition to the cash portion of the Special Dividend paid to Cendant in thefirst quarter of fiscal 2005, we settled our remaining intercompany balancewith Cendant through a non-cash distribution of amounts due from Cendant on thedate of disposition of $131.9 million. This amount is disclosed as a non-cash transaction in the SupplementalDisclosure section of the Consolidated Statements of Cash Flows.

 

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**Future CashRequirements and Sources of Cash**

 

***Future Cash Requirements***

 

Our primaryfuture cash requirements will be to fund operating activities, debt service,development advances, capital expenditures, acquisitions, and quarterlydividends.  Specifically, our primarycash requirements for the remainder of fiscal 2005 are as follows:

 

•                  *Credit facility repayments*– Although wecurrently do not have any borrowings outstanding under our revolving creditfacility, we anticipate that we will draw amounts in the second and thirdquarters of fiscal 2005, and repay such amounts by the fourth quarter of fiscal2005 using cash flows from our operations which we expect to peak during thefourth quarter.

 

•                  *Quarterly dividends* – In October 2004, wewill make our first quarterly cash dividend payment of $0.07 per share to ourcommon stockholders of record on September 27, 2004.  Based on our estimates, we anticipate thisdividend to be approximately $2.6 million.

 

•                  *Debt service* – In the second quarter offiscal 2005, we expect to make an interest payment of approximately $1.4million related to our $175.0 million Notes and anticipate making additionalquarterly interest payments on these notes during the remainder of fiscal 2005.

 

•                  *Marketing and advertising expenses*– Cashoutlays for marketing and advertising expenses are seasonal in nature and beginto increase in our third fiscal quarter and peak during our fourth fiscalquarter consistent with the tax-filing season. Marketing and advertising expenses include national, regional and localcampaigns designed to increase brand awareness and attract both early-seasonand late-season tax filers.  Franchiseecontributions and cash from our operations fund our budget for these types ofexpenses.

 

•                  *Costs to operate Company-owned offices* –Our Company-owned offices complement our franchise system and are focusedprimarily on organic growth through the opening of new Company-owned officeswithin existing territories as well as increasing office productivity.  Costs to operate our Company-owned officesbegin to increase during our third fiscal quarter and peak during our fourthfiscal quarter.  The increase in suchcosts is primarily due to an increase in labor costs related to the hiring oftemporary employees who provide tax-filing services to our customers.

 

We may fromtime to time prior to June 25, 2009 seek to retire all or a part of ouroutstanding debt through cash payments. Such prepayments, if any, will depend on prevailing market conditions,our liquidity requirements, contractual requirements and other factors.  The amounts involved may be material.

 

***Future Sources of Cash***

 

We expect ourprimary source of cash beginning in the third quarter of fiscal 2005 to bepositive net cash provided by operating activities.  Prior to the third quarter, we anticipate theneed to borrow against our credit facility during off-peak season to fundoperations.  However, we expect that cashprovided by operations during the tax-filing season will enable us to repay anysuch borrowings by the end of fiscal 2005. During the three months ended July 31, 2004, we had not borrowed anyamounts under our credit facility.

 

**Changesin Accounting Policies and Recently Issued Accounting Pronouncements**

 

Ourchanges in accounting policies and recently issued accounting pronouncementsare reflected in Note 2, “Summary of Significant Accounting Policies,” to ourconsolidated financial statements.

 

**CriticalAccounting Policies**

 

Inpresenting our financial statements in conformity with generally acceptedaccounting principles, we are required to make estimates and assumptions that affectthe amounts reported therein. Events that are outside of our control cannot bepredicted and, as such, they cannot be contemplated in evaluating suchestimates and assumptions. If there is a significant unfavorable change tocurrent conditions, it could result in a material adverse impact to ourconsolidated results of operations, financial position and liquidity. Webelieve that the estimates and assumptions we used when preparing our financialstatements were the most appropriate at that time. The following accountingpolicy may affect reported results which could cause variations in ourfinancial results both on an interim and fiscal year end basis.

 

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**Goodwill**

 

Weconducted the required annual goodwill impairment review during the fourthquarter of fiscal 2004.  In accordancewith the provisions of Statement of Financial Accounting Standard No. 142,“Goodwill and Other Intangible Assets,” we compared the carrying value of ourreporting units, which are our franchise operations segment and Company-ownedoffice operations segment, to their fair value and determined that the carryingamount of our reporting units did not exceed their respective fair values. Whendetermining fair value, we utilized various assumptions, including projectionsof future cash flows. A change in these underlying assumptions will cause achange in the results of the tests and, as such, could cause fair value to beless than the respective carrying amount. In such event, we would then berequired to record a charge, which would impact earnings. We will continue toreview the carrying value of goodwill for impairment annually, or morefrequently if circumstances indicate impairment may have occurred. An adversechange to our business will impact our consolidated results and may result inan impairment of our goodwill. The aggregate carrying value of our goodwill was$392.4 million at July 31, 2004. See Note 3 to our consolidated financial statements for more informationon goodwill.

 

**Item 3.****  *Quantitative and Qualitative Disclosures About MarketRisk***

 

Financialinstruments that potentially subject us to concentrations of credit riskconsist of accounts and notes receivable. We manage such risk by evaluating the financial position andcreditworthiness of such counterparties. As of July 31, 2004, there were no significant concentrations of creditrisk with any individual counterparty or groups of counterparties.  Concentrations of credit risk associated withreceivables are considered minimal due to our diverse customer base.  We do not normally require collateral orother security to support credit sales.

 

**Item 4.****  *Controls and Procedures***

 

(a)          *Disclosure Controls andProcedures.*Our management,with the participation of our Chief Executive Officer and Chief FinancialOfficer, has evaluated the effectiveness of our disclosure controls andprocedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’)) as of theend of the period covered by this quarterly report. Based on such evaluation,our Chief Executive Officer and Chief Financial Officer have concluded that, asof the end of such period, our disclosure controls and procedures areeffective.

 

(b)         *Internal Controls OverFinancial Reporting.* Therehave not been any changes in our internal controls over financial reporting (assuch term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)during the fiscal quarter to which this report relates that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PARTII – OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

See Note 12, “Commitments and Contingencies”,to the unaudited interim consolidated financial statements.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

None.

 

**Item 3. Defaults Upon Senior Securities.**

 

None.

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

 

None.

 

**Item 5. Other Information.**

 

We make available free of charge, through ourinvestor relations’ website, ir.jacksonhewitt.com, our Form 10-K, Form 10-Q andForm 8-K reports and all amendments to those reports as soon as reasonablypracticable after such material is electronically filed with or furnished tothe Securities and Exchange Commission.

 

**Item 6. Exhibits.**

 

**(a)****          Exhibits:**

 

3.1                       Amended and Restated Certificate ofIncorporation of Jackson Hewitt Tax Service Inc., dated June 21, 2004

 

3.2                       By-laws of Jackson Hewitt Tax Service Inc.,dated June 21, 2004

 

4.2                       Rights Agreement between Jackson Hewitt TaxService Inc. and The Bank of New York Rights Agent, dated June 24, 2004

 

10.1                 Employment Agreement between Jackson Hewitt TaxService Inc. and Michael D. Lister, dated June 2004

 

10.2                 Employment Agreement between Jackson HewittTax Service Inc. and Mark L. Heimbouch, dated June 2004

 

10.3                 Transitional Agreement among CendantCorporation, Cendant Operations, Inc. and Jackson Hewitt Tax Service Inc.,dated June 25, 2004

 

10.6                 Credit Agreement among Jackson Hewitt TaxService Inc., as Parent, Jackson Hewitt Inc., as Borrower, the Lenders namedtherein and JPMorgan Chase Bank, as Administrative Agent, dated June 25, 2004

 

10.13           Note Purchase Agreement relating to the Floating Rate Senior Notesamong Jackson Hewitt Tax Service Inc., Jackson Hewitt Inc. and the Purchasersnamed therein, dated June 21, 2004

 

31.1                 Certification of Chief Executive OfficerPursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the SecuritiesExchange Act of 1934, as amended.

 

31.2                 Certification of Chief Financial OfficerPursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the SecuritiesExchange Act of 1934, as amended.

 

32.1                 Certification of Chief Executive OfficerPursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2                 Certification of Chief Financial OfficerPursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

 

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**(b)****          Reports on Form 8-K:**

 

There were no current reports on Form 8-K filed by us during the fiscalquarter ended July 31, 2004.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                           | **JACKSON HEWITT TAX SERVICE INC.**              |
|--------------------------------|--------------------------------------------------|
|                           |                                             |
|                           |                                             |
| Date:  September 13, 2004 | /s/ Michael D. Lister                            |   |
|                           | Michael D.  Lister                               |
|                           | Chairman, President and  Chief Executive Officer |
|                           | (Principal executive  officer)                   |
|                           |                                             |
|                           |                                             |
| Date:  September 13, 2004 | /s/ Mark L. Heimbouch                            |   |
|                           | Mark L.  Heimbouch                               |
|                           | Chief Financial Officer  and Director            |
|                           | (Principal financial  officer and principal      |
|                           | accounting officer)                              |
|                                |                                                  |  |  |

 

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