Action Jackson Hewitt

Carl Weathers, best known for playing boxer Apollo Creed in the Rocky Balboa films, starred in a 1988 cop-thriller film called Action Jackson. The movie flopped; so did tax-preparation firm Jackson Hewitt's (NYSE: JTX  ) third-quarter results. Let's take a closer look at the action, or lack thereof.

The tax-related Jackson missed analyst earnings expectations by about $0.06, after a slow January and a sluggish start to the tax season. That's a worrying sign, since last year, about 75% of the company's clients filed their tax returns by the end of February. That leaves Jackson even more dependent on its fourth quarter, which coincides with the period running up to when taxes are due in mid-April.

The weak third quarter knocked the shares down more than 5%, but don't expect Hewitt to stay down for the count. Sales and earnings still grew 20% for the quarter, and the company expects strong bottom-line results for fiscal 2007. Then there's the free cash flow generation.

Jackson-Hewitt generates substantial cash flow, since it operates in a service business and also franchises its brand for high-margin and recurring royalty revenue. As a result, operating cash flow tends to exceed reported net income by a wide margin, and capex needs are low, meaning free cash flow is also greater than the earnings reported on the income statement.

Additionally, Jackson is staying active and has compelling growth prospects. There is plenty of room to expand, since the tax preparation business is highly fragmented and the company estimates it only has a 4% share of the "paid tax return preparer market." Management also recently detailed that it estimates a third of the U.S. remains to be parceled off and sold to franchisees.

Investing in Jackson-Hewitt is not without risks. Close to 80% of its business comes from tax returns with adjusted gross income, or AGI, of less than $35,000. This is the most competitive part of the market, heavily pursued by the company's arch-rivals, H&R Block (NYSE: HRB  ) and Intuit (Nasdaq: INTU  ) . Plus, close to 30% of the company's business stems from related financial services, including refund anticipation loans (RALs) -- loans backed by a client's anticipated tax refund. The business has been politically charged at times; less reputable entities can charge sky-high interest rates, and take advantage of customers by not fully informing them of the costs and related fees involved with accelerating the receipt of their refunds.

Overall, I believe Jackson-Hewitt's investment merits outweigh the risks, and trends support tax-preparation firms as filings become increasingly complex. Because of the recent stock pummeling, I'm seriously considering stepping into the ring with Jackson -- the tax-related one, that is.

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.


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