NewtekOne, Inc. (NEWT) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Newtek Business Services First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today’s call is being recorded. I would now like to turn the conference over to your host, Barry Sloane. Sir, you may begin.

Thank you very much, and welcome to our First Quarter 2012 Earnings Conference Call. I’m Barry Sloane, President and CEO of Newtek Business Services, a small business authority, stock symbol NEWT on the NASDAQ. And here with me today to help present the conference call information, is Jennifer Eddelson, our Chief Accounting Officer. Jenny, would you care to read the Safe Harbor Statement?

Sure. The statements in this slide presentation, including statements regarding anticipated future financial performance, Newtek beliefs, expectations, intentions or strategies for the future may be forward-looking statements under the Private Securities Litigation Reform Act of 1995. All forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from the plans, intentions and expectations reflected in or suggested by the forward-looking statements. Such risks and uncertainties include, among others, intensified competition, operating problems and their impact on revenues and profit margins, anticipated future business strategies and financial performance, anticipated future number of customers, business prospects, legislative developments, and similar matters. Risk factors, cautionary statements and other conditions which could cause Newtek’s actual results to differ from management's current expectations are contained in Newtek’s filings with the Securities and Exchange Commission and available through www.sec.gov. Our Capcos operate under a different set of rules in each of the 7 jurisdictions and these place varying requirements on the structure of our investment. In some cases, particularly in Louisiana or in certain situations in New York, we do not control the equity or management of a qualified business, but that cannot always be presented orally or in written presentation.

Jenny, thank you very much. And to begin the call, we’d like to call all your attention to our PowerPoint presentation, which is available on our website at thesba.com, go to the Investor Relations section, and you could follow the presentation along. We’ll begin on Page 3 with first quarter key performance statistics. The company had consolidated pre-tax income of $2.1 million, which was an increase of $1.3 million over the first quarter of 2011. We’re happy to report that our earnings per share for the first quarter were coming in at approximately $0.04 per diluted share as compared to $0.01 per diluted share in the first quarter of 2011. Consolidated EBITDA, modified EBITDA, came in at $3.6 million as compared to $2.6 million from the first quarter in 2011. Our electronic payment processing segment pre-tax increased 72% to $2.1 million for the first quarter as compared to $1.2 million. Our small business finance pre-tax income increased by 15% to $1.5 million from the first quarter as compared to $1.3 million. Our SBA lender funded $25 million of loans in the first quarter as compared to $19 million. Our forecast for our lending segment includes $125 million fund origination year or SBA 7A loans. We have previously announced that we had signed an agreement with Summit Capital Partners for $10 million to $15 million mezzanine debt, $10 million has been pulled down, there's another $5 million that will be, as anticipated, to be pulled down within the next several months subject to certain conditions. That mezzanine capital is primarily there to support new tax continued growth and provide the necessary working capital to expand its product offerings, particularly its small business lending function. The company anticipates full year earnings per share of approximately $0.12 and we revised our pre-tax guidance…

Thank you, Barry. For the quarter ended March 31, 2012, the company had consolidated pre-tax income of $2.1 million, an improvement of $1.3 million over the $834,000 recorded in the first quarter last year. We had consolidated net income of $1.3 million or $0.04 per diluted share for the quarter compared to net income of $509,000 or $0.01 per diluted share in the first quarter of 2011. With the exception of Managed Technology Solutions, each of the segments reported improvements in current quarter earnings compared with the year-ago prior. Revenue increased by $206,000 to $30.7 million primarily from growth in our electronic payment processing segment. In addition, the total fair value loss decreased by $1 million period over period, which I’ll review in further detail on the small business finance segment discussion. Please turn to Slide 38 for a discussion of the first quarter 2012 segment performance. Electronic payment processing segment revenue increased by $529,000 or 3% period over period to $20.6 million, predominantly due to a combination of increased processing volumes, selected fee increases in addition to services provided to our merchants. Pre-tax income increased by $862,000 or 72% to $2.1 million for the first quarter of 2012, compared to $1.2 million recorded in the same period last year. The improvement was due primarily to the $742,000 increase in the dollar margin of operating revenues less electronic payment processing costs, resulting from the introduction of new higher margin products and services during 2011, as well as the impact on revenues and EPP costs resulting from debit card pricing and inter-change cost adjustments. In addition, depreciation and amortization decreased by $140,000 period over period due to intangible assets becoming fully amortized. Managed Technology Solutions segment revenue totaled $4.7 million for the quarter of 2012, a decrease of $136,000 compared with…

Thank you, Jenny. Operator, we’d like to begin to take questions.

[Operator Instructions] Our first question comes from Keith Zdrowak with National Securities.

Barry, I just wanted to -- I had a couple of questions. One is, for the cloud computing, how significant can that be to your business as far as revenues and earnings going forward? And then the second question I had would be, I know you guys paid a dividend a couple of years ago. Any talks or chance that we may have another small dividend coming anytime soon?

Keith, I appreciate that. Cloud computing, I think, is one of the biggest trends that businesses are going to embrace. When you think of cloud computing, I think a lot of people today think of the larger businesses, where using maybe Google or Amazon structure. And there clearly are savings and benefits from large MPs using Google and Amazon’s facilities. Google and Amazon, this is just a matter of opinion, they’re pretty large organization and they’re not really set up to handle smaller businesses and do the hand-holding that is required to take the smaller businesses. As the percentage of cost savings, however, when you think about a business owner that can be a law firm or a medical professional, they may have an internal IT person and then an outside local provider. The cost savings that they have, particularly with respect to labor in a pay-for-what-you-use format versus an internal professional who makes $6,000 or $7,000 a month, my out-house person makes $4,000 or $5,000, and then the cost savings of buying the box and the software versus renting it, which is really what cloud offers, is significant. So we think that as a general trend, cloud computing is going to be huge and it’s here to stay. The other important trend with respect to the cloud is the use of tablets and iPhones, smartphones that business owners tend to be gravitating towards. And we have done surveys on this in our market settlement survey, which has been used so far on market intelligence. So we plan on embracing the cloud, offering cloud services to intermediaries, designers, developers and resellers. That business is an important growing business for us. And then, in addition to that, we plan on having all of our business services hosted in the cloud environment…

Our next question comes from Marc Silk with Silk Investments.

So on the capital raise, you’ve lined up kind of what you’re going to do with the money, which is fine, you can always add anything if you like. But I guess my question is, why was it worth the expense of taking the capital on? Because I know you’re a shareholder, as well, and there is some dilution there, but I just figured -- what your opinion on this is.

Well, the guidance that you see for 2012 includes the cost of that capital. So, clearly, without much of the capital being deployed, in my opinion, to give us the benefit of it, we're still on good numerical basis in terms of 2012. And I think when we give our guidance out for 2013, and I think that it’ll become more readily apparent that this capital is enabling the company to lever ourselves and to grow. I think most importantly for us to get on the radar screens of more larger, meaningful investor’s growth is important, growth in revenues, growth in bottom line, as well as maybe growth in customer count and total asset size. So when we talk today about being able to add loan growth increments of $100 million, we believe that in 2013 our lending business, potentially, could add $100 million of incremental growth. So let me just take a peek here. Our guidance for 2012 in this lending segment, pre-tax is 5567, midpoint, call it 061 mid-point for small business finance, let’s just say we go up to $200 million, so it’s 3 quarters, put $3 million onto that, so we could be up to $9.1 million. And when you actually filter it down from an EPS perspective, it’s accretive. At the end of the day, despite the fact that all capital is expensive today, we believe this capital will be worthwhile. And it’ll be able to generate increasing revenues, increasing gross profits, enable us to grow our prominence in the lending business and our stature in lending business, which would lift the boats of all the different business segments. So on a fully diluted basis, and we analyzed this fairly heavily, we believe, and do believe, that this capital will wind up being accretive to earnings.

The irony here is that, it seems that for you to go -- let’s say off the board to borrow more money, instead of a bank, that might show me that it’s still hard to borrow money from a bank. Having said that, on your lending side, you can obviously expose that because of your small business loans, and that’s why -- is that why you just feel that the demand is just increasing?

Well, I think this capital, what this capital does is it gives us the ability to borrow more from the bank and to lever our capital. Because this capital is subordinated to senior bank loans. So I think what this capital enables us to do, is to larger securitizations, ramp up our level of originations, increase and improve our liquidity, which generates larger income plus more servicing income and more servicing revenues with larger, more meaningful customers. So I think that it’s important not to mistake the mezz capital from increase in just senior lines because it’s not. What it does is it really supports senior lending which, obviously, is at much lower rates, enables us to put more money out, hold larger amounts of uninsured pieces and do larger potential securitizations of the uninsured pieces.

What’s the amount of the uninsured piece that you can resell? I know it used to be 90%, and then 75%, I think.

Yes, so on a $100 million of loans, you’re creating $25 million of bank value of uninsureds.

Okay. And then, do you have a particular collateral versus an SBA loan, I know I’ve gone through the process with you and you definitely like to take a lot of collateral, but I don’t know if there are different scenarios, whether it’s property or account receivables, et cetera?

Well, I think that approximately 80% to 85% of our loans are secured by real estate. And particularly at today’s valuation, we like that. There is no real magic formula or underwriting box. And every loan that we do under the 7A program is personally guaranteed by every 20% business owner or greater. We take all personal assets. We take all business assets. And historically, we’ve done pretty well with our underwriting guidelines and have survived the ’08, '09 credit crunch to be positioned today to grow the lending business. So we’re real happy with where we are. We don’t see a lot of competition currently coming in from banks. And given the capital constraints in the market, I’m not sure that's going to change anytime in the near future.

I know you've definitely done a good job getting through ’08 and ’09, so actually on that venue, I’m concerned about major headwinds ahead in the economy for business in general. Obviously, what’s going on in Europe, I think it’s going to carry on to China and affect us. So having said that, if this is the case, do you take additional measures of caution above and beyond what you have presently been doing in regards to the SBA program, as far as lending?

I think it’s a good question. And there is no question that we look at lending in all of our businesses, not in a vacuum but in conjunction with, what I would call the business environment. We think that barring a real sharp downturn, which we currently don’t see, we are somewhat optimistic that, irrespective of political persuasion, we think that the headwinds and the markets dictate to us that we will not, as American citizens, go the way of Europe. Where Europe recently, both in France and in Greece, voted for no austerity, we think that it is likely that there will be breaks on spending. That goes against conventional wisdom and cynicism, but if you actually look at what has transpired between both Democrats and Republicans, with Republicans leaning more towards being more austere than Democrats. But I think that whichever party gets in, I think you will have a serious effort to reduce government growth and government spending. I think that’s good for business in the near-term. As lenders, we do not need a robust economy. We need an economy that is flat to slightly up-swinging so that our businesses can maintain the current cash flows that we’ve underwritten to. So with that said, although we prefer an upswing, because it’s much better, as long as things remain slightly stable to the upside, which is the current trend, that’s a good lending environment for us to be in. I certainly prefer 5% growth or 10% growth and makes it totally brainless activity, but even flattish activity is okay from where we stand. And we don’t see that changing much, no matter who gets in, or it’s not really interacting on the forecast at this point in time.

And lastly, I think I’ve been in stocks since '06, but as I got my proxy in the mail today I just want to make a comment that you can’t control the stock price, you can control what you do in the company. And I do think that I continue to support you and that’s how my proxy will go as well. So keep up the good work.

Our next question comes from Harold Elish with UBS.

Barry, it’s actually Michael, Harry had to run to a meeting. He did have a question about the issues in Newtek’s Managed Technology Solutions Group. Do you see these as the function of decreased demand in a competitive field, or is it a problem with execution at Newtek?

It’s a good question and a tough one. And I think it’s a function of the fact that the market's changed. And I think it’s a function of the fact that we missed it, and we weren’t on top of things as much as we needed to be. And we are now in the process of making those changes. We’ve announced several changes in terms of our product offerings, what we're focusing on and concentrating on. But I also think that relative to being able to be positioned in this market, we talked about the types of cloud computing offerings that we will be rolling out this year and some of the management changes. We anticipate that the current flattish movements that we had last year and the downward movements that we had in the first quarter, we will be able to make up. So we take full accountability and responsibility for what I consider lackluster to poor results in the first quarter for that division and anticipate a turnaround. I can’t tell you how quickly that’s going to be. I do feel, in fact quite confidently because we’ve obviously given guidance, that our other businesses and divisions will make up in multiples for the downward swing in this particular segment, and that we have our hands around the issues. We have quantified the issues. And we have solutions to the issues that I believe will reverse that performance in that segment.

[Operator Instructions] Our next question comes from Ron Venin [ph] with High Investors Capital [ph].

I wanted to find out the size of the lending market, who the competition is if General Electric's finances come in and started to do the same type of work as you were doing. It seems like, from what I gathered, that you are the lead on this. I want to know the size of this market.

Well, the SBA 7A market in 2011 was about a $16 billion market. And that’s the market that was done under the program. The market can be significantly larger, and historically, prior to the Obama Recovery Act, the guidelines that were set out in the program by congress, which got altered in the Obama Recovery Act were pretty restrictive. It was a $2 million max loan cap and there were certain underwriting guidelines that really restricted the types of business that can go under the 7A program. With some of the changes in the Recovery Act in 2009, mainly increasing the loan size from $2 million to $5 million on a max basis and being able to accommodate the borrowers, we think that there is a growth for this business. And historically, the business has been one in which the premiums that come off of the program have returned money to the U.S. Treasury. So unlike Fannie and Freddie, which have been a drain on the Treasury, and HUD which has been problematic, the 7A program's loan fees have been a positive one. We are seeing loans that typically would go to banks in a conventional format being -- coming to us, because banks aren’t lending. We’re also seeing banks that need balance sheets that are basically telling good borrowers to go find another home without much notice. We are getting those opportunities as well. So when we took down the mezzanine capital, we did so with the thought process that we will go from $100 million to a $200 million run rate, and then from $200 million run rate to $300 million run rate at some point in time in the future. I will point out that the only forecast that we’ve given so far is $125 million for 2012. Obviously, you can't turn a lending business on without pulling a switch, but we’ve also indicated in the release today that we think that in calendar year 2012, we can do a $100 million to $200 million worth of 7A loans in origination. So I think that our goal is to have a bigger presence, put money out as long as we have good feelings about the economy, our loan loss discount that's in fair value accounting at our market position. So we feel very good about this particular segment and think it’s still the single best opportunity that we have right now in terms of return on capital and cash flow and shareholder value.

I show no further questions at this time. I would now like to turn the conference back over to Mr. Sloane for closing remarks.

Great. Thank you, operator. And we want to thank everybody for attending the call and participating in the call and the Q&A. And we look forward to reporting our second quarter results hopefully with the same positive outcome and optimism that we have here today. So, thank you once again. See you soon.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. And have a wonderful day.