NewtekOne, Inc. (NEWT) Q2 2008 Earnings Report, Transcript and Summary

Good day and welcome to the Newtek Business Services second quarter 2008 earnings results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Chairman of the Board, Mr. Barry Sloane. Please go ahead, sir.

Thank you. Good afternoon, everybody. My name is Barry Sloane; I am CEO, Chairman of the Board. I also have with me today Seth Cohen, our Chief Financial Officer, who I will ask to read the Safe Harbor statement.

The statements in the slide presentation, including statements regarding anticipated future financial performance, Newtek's 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. Also, we need to point out that our Capcos operate under a different set of rules in each of the eight jurisdictions and that these place varying requirements on the structure of our investments. In some cases, particularly in Louisiana and New York, we don't control the equity or management of a qualified business, but that cannot always be presented orally or in written presentations.

Thank you, Seth. Regarding our conference call agenda today, we are going to go over a financial results snapshot. I might ask some of you to go to our newtekbusinessservices.com website, go to our Investor Relations section where this PowerPoint presentation is on display, and you will be able to also see future guidance and projections that we have for each of the business lines. Today we'll also be talking about the momentum, which is continuing in our electronic payments processing segment, various Web hosting initiatives, small business finance initiatives, cost reduction measures, industry comparison, financial review given by Seth Cohen and a 2008 further guidance outlook. In the second quarter 2008, we met our previously stated 2008 guidance but actually came in better than our pretax net loss guidance. Our electronic payment processing segment came in at $15.9 million in revenues, up 22% over the second quarter of '07. Our Web hosting segment came in at $4.5 million of revenues, up 14% over Q2 of 2007, and our small business lending segment came in at $2.1 million, which was a decline of 36% over Q2 2007. The quarter came in at a pretax loss of $2.5 million. We actually had beaten previously-given loss guidance for the second quarter. I would like to also add that we have depreciation and amortization, a noncash expense, of $1.8 million in the second quarter of 2008. We had significant drag on our earnings by our lending segment, which affected Q2 2008 earnings. We ended the quarter with approximately $28 million in cash and cash equivalents and restricted cash, which equates to about $0.78 a share. Our electronic payment processing segment continued with very positive momentum. Revenue up 22%, EBITDA margins at 10.8% for the second quarter, which is consistent with the first quarter…

Thank you, Barry. In the second quarter of 2008, we recorded a loss before benefit for income taxes and discontinued operations of $2.5 million. This compared with a loss before benefits or income taxes and discontinued operations of $2.8 million one year ago. It is important to note that the second quarter 2008 loss is not unexpected and was better than previously stated guidance. Net loss was $2 million or a $0.06 per share on the second quarter of 2008, compared to a net loss of $2.4 million or $0.07 per share in the second quarter of 2007. Revenue increased by $1.2 million, or 5.2% to $24.6 million in the second quarter compared to $23.4 million one year ago. This is primarily attributable to the growth in our electronic payment processing and Web hosting segments. I would now like to review the performance by segments. If you could turn your attention to slide 14 in the PowerPoint presentation, you will see the comparison of second quarter 2008 versus our results in the second quarter of 2007. Electronic payment processing segment revenue increased by $2.9 million or 22%, to $15.9 million in the second quarter of 2008. The revenue increase is predominantly due to organic revenue growth of 17% because the result of both an increase in the average number of active processing merchants and an increase in the average monthly processing volume per merchant. Income before taxes increased 23% to $1.2 million over the second quarter of 2007, and our margins remain constant over the same time period. Our Web hosting segment revenue increased by $550,000 or 14% in the second quarter of 2008, to $4.5 million, due to do the organic growth of hosted sites. In the second quarter of 2008, we increased our average number of monthly websites…

Thank you, Seth. I think, just going forward to point out our 2008 segment guidance, which you can find on our Investor Relations sections of our website, you know, as we're looking at our business model, going forward, we've got the electronic payment processing business guiding towards $6.9 million to $7.2 million of EBITDA, all without any debt. We've got the Web hosting segment guiding toward $6.1 million to $6.3 million of EBITDA with no debt. The small business finance business should be looked at, because it actually does pay interest on its warehouse borrowing lines, but on an EBITDA basis, it's looking to be negative $300,000 to $200,000 and basically, going forward, we anticipate revenues on a consolidated basis of $100 million on the high end full year to about $102 million. It should be 100 on the low end to $102 million on the high end. So we're looking forward to completing a very successful year, it's a challenging year. We are having issues with the lending business. That's clearly not uncommon for those that are in the lending space today. We think we are faring much better than others, but we are looking forward to greater originations and to be able to put on enough business to cover our operating overhead and leverage in that particular space. With that, I would now like to turn the call back to the operator to see if we have any questions.

Thank you. We will take our first question from Evan Greenberg with Meadowbrook Capital Management. Evan Greenberg – Meadowbrook Capital Management: I'm worried, I'm worried. A couple of questions, how much of the cash is restricted right now? Has that restriction been coming off?

The total amount of restricted cash – hold on – we have total cash and cash equivalents and restricted cash of – the number we gave was about $28 million; $11 million is restricted cash; $16.946 million is cash and cash equivalents. Evan Greenberg – Meadowbrook Capital Management: How much of the restricted do you think is in the Capco?

About $10.5 million is in the Capco. Evan Greenberg – Meadowbrook Capital Management: And so cash that's in the Capco does come up through management fees?

Right.

Cash and (inaudible) investments that – Evan Greenberg – Meadowbrook Capital Management: Right, okay. And could you talk about – I want to talk about the hosting business a little bit – can you explain what wholesale outreach just a little bit?

Basically, Evan, we – if you look at the hosting space, which is pretty fragmented, entities like Go Daddy will market themselves by advertising on the Super Bowl, buying keywords or maybe advertising in a variety of different trade publications or cable TV. Our primary strategy has been to really work the Web developers and IT professionals in the market today – primarily Web developers that have an expertise using Microsoft-type products or Microsoft-type software. Historically, we have not done any form of an outreach to them through telecommunications. We have offered them various types of specials, but we're going to aggressively go after that marketplace by offering them various types of promotions, affinity relationships, giving them our other services to resell to their customers. It's a valuable customer base, and we believe that a good way to grow and expand ourselves cost effectively is to work with those resellers and developers, and we have recently gone from a dedicated sales force of two to four people – we've increased that to about 10 people. And that's going to be aggressively rolled out beginning in the fourth quarter, late in the third quarter of this year. Evan Greenberg – Meadowbrook Capital Management: Is that the largest reason why EBITDA growth, while revenue growth has been strong, EBITDA growth really hasn't been that great in that area because there has been a lot of reinvestment into the company, and it's not being recognized?

The answer is yes, but it wouldn't be from that type of activity. If you look at some of these comparisons, particularly over the first six months, we moved from a real estate location, so we had an increase in real estate, we had an increase in electricity. There were certain licensing fees from Microsoft that increased. So we're hopeful that, going forward, we do have the ability to get a better margin expansion from an EBITDA perspective. But we talked about our NOC center being at 50% of real estate capacity, so that kind of gives you an idea that hopefully, as we put more revenues on, while we've got great margins now, we've had better margins in the past, and we want to get back up there. Evan Greenberg – Meadowbrook Capital Management: I look at this Hostopia acquisition – this is the way – most Web hosting businesses have EBITDA margins that aren’t even as good as Hostopia's – CrystalTech, Newtek's Web hosting business, the EBITDA margins are twice of what Hostopia's are, probably, somewhere in that range. The pretax earnings margin is twice what Hostopia's is. The valuation of the two entities, the Web hosting – and you know where I'm going with this question, I'm leading the witness here – and the two main businesses and the payment processing businesses are reflecting almost a negative stock valuation, where if you broke those two pieces off, they would be worth significant less. I am sure you were probably surprised by the price that Hostopia received, but the valuations are really dwarfed. If they were two independently run companies, you'd probably see the pieces of Newtek trading at around – at least double what the stock is right now. Is there any way to possibly – other than you explaining it here, you don't want to sit there and say, "Okay, this is what our breakup value is, you want to talk about the whole company.” But what can we expect from Newtek to explain this any further than we already have?

Well, you know, Evan, this has sort of been our age-old problem. Something a little bit like Rodney Dangerfield in this particular area. The valuations that these companies go at are driven somewhat by the financial aspects of what they do, but based upon the fact that they are able to acquire small and medium-size business customers, because Intuit bought them for the combination to grow their presence with respect to QuickBooks software and payments, because you put these things together, right? And Hostopia was acquired by Deluxe, and I can't tell you exactly what Deluxe does, but I believe they distribute supplies to small to medium-size businesses. So they are looking at the ability to communicate with customers in the small to medium-size business space and really to become a distribution channel. Evan Greenberg – Meadowbrook Capital Management: Did you see Hostopia in the market in terms of competition? Were they somebody you regularly would come up against in terms of (inaudible) customers?

No. And the Web hosting space is extremely fragmented. There is no one that's got a monstrous amount of market share. Evan Greenberg – Meadowbrook Capital Management: Right.

So – no, we don't really run across them too often. Evan Greenberg – Meadowbrook Capital Management: All right, I'll let other people ask questions, I have dominated enough.

Evan, thank you. Appreciate it.

We will take our next question from Stephen Silk with C. Silk & Sons. Stephen Silk – C. Silk & Sons: Good afternoon. Actually, I had some questions along the same lines, that the value of those independent units, when you show the value that was put on the other two, I think each of those units, as a whole, would probably dwarf your market capitalization right now. And what you just explained, Barry, is that you have other people who are buying them for the services that they provide and then the ability to integrate, like, Intuit's offering or Deluxe's offering, which is something that we've always talked about in the past to have you – you have 90,000 customers to be able to offer them more. So is there a line in the sand when you say, you know what? We're not getting the value that somebody else might put on these units that are doing well, and the way that Newtek shareholders will enhance their value is maybe the sale of those units?

Well, you know, Steve, I think that – to be frank with you, I just want to clarify one thing. I think that was the question or the comment about valuation, not myself. But I'll leave that up to you guys in the audience. Stephen Silk – C. Silk & Sons: You had brought up in the slide presentation what somebody else had paid for a multiple of another company that you could correlate the similarities to what one of your divisions are. That's how I came up with that.

And I appreciate that, and that's clearly what the slide does show – that there are companies in this space that do similar things to what we do that trade at pretty good prices because they value what they do on a core basis but also in conjunction with being able to reach the customer in combined service offerings. I think, Steve, we are starting to see some effects of cross-selling and cross-marketing. We have a variety of different initiatives. I think you might see that in the near future in terms of press releases regarding various different types of product launches. We've had pretty good success this year in a loan/merchant services business called Merchant Cash Advance, and we've been actually doing a lot of that type of product this year. I think that what I'd focus on, for the most part, is increasing enterprise value of the company, making sure that every day we come in and grow the business. Evan made it a point to say, "Gee," you know, "is there anything that you can do to get stock investors to come and follow along?" You know, I was hopeful that this particular year, we’d get more appreciation of what we do, but unfortunately you've got tremendous amount of headwinds in the micro cap stock market, and it's difficult to get investors' attention, so we currently are fighting that. I also think that we're somewhat fighting the drag of being in the lending business, and people might look at us as a financial services company when, in fact, we view ourselves as a business services company, primarily over the financial services component. We are sensitive to the stock price not performing as well as people like yourself and Evan think it should, and we're constantly evaluating that and having discussions with the Board on that basis. Stephen Silk – C. Silk & Sons: The numbers that you put out, Barry, are they GAAP or non-GAAP?

All of our numbers are GAAP with the exception of – when we talk about EBITDA, obviously, that's a non-GAAP discussion, but we fully explained that both in these PowerPoint presentations. There's a whole table explaining our EBITDA calculations and, in our Ks and Qs, but everything we do is Generally Accepted Accounting Principles. Stephen Silk – C. Silk & Sons: The reason I was asking, you made a point to say that $1.8 million of your expenses was depreciation and amortization, but these are GAAP numbers. What would the number be for a stock-based compensation or other noncash expenses?

Well, we point out that of the loss in this quarter, $1.8 million was for depreciation and amortization. So for those people that are tracking cash relative to – are we generating cash? Are we burning cash? Obviously, you could look at an estimated loss of about $10 million for the year and say, "Gee, these guys are losing $10 million of cash." That's not the case, and that's because of a significant depreciation and amortization number that we're experiencing. Stephen Silk – C. Silk & Sons: Were there some stock-based compensation expenses in the quarter?

Was there stock-based compensation this quarter?

I'll have to take a look.

I think there was. I think the answer is yes. Hang on. Stephen Silk – C. Silk & Sons: Well, while you're looking, let me ask this next question – so the cash – both the cash and the restricted cash is down about $10 million from the beginning of the year. Now, you would purchase some stock back – how much cash did you use to repurchase stock, and where do we start seeing, perhaps, cash leveling out and you being able to add cash?

On your other question, for the quarter we had about a $450,000 expense for stock-based compensation. Stephen Silk – C. Silk & Sons: Okay.

That's treasury repurchases.

Oh, treasury repurchases, okay.

And I'm looking at the stock-based compensation right now.

So the buyback, Steve, was $450,000. Stephen Silk – C. Silk & Sons: So how can we look at the cash and say that perhaps leveling off and getting to the point where you're generating some cash even though you'll have reported losses?

If you go back through that analysis, and I might punt that one to Seth as well – a lot of that – some of that is what I'll call ‘true operating burn’ – maybe $2 million to $3 million. Some of that is repayment of debt, which is gone forever at this point in time. We had some premium financed debt based on the legacy capital business. I think there's about a $5.7 million broker receivable –

Right.

Which is basically SBA loans that were held on the books that didn't settle by the end of the quarter. Stephen Silk – C. Silk & Sons: So recycled back into cash, so the situation is a little bit better than it appears?

Correct. Stephen Silk – C. Silk & Sons: Okay. On the assets of the SBA loans held for investment, are those kind of like offset by the notes payable, which would have been drawn from your lines of credit for lending purposes?

Yes. Stephen Silk – C. Silk & Sons: So those are offsets, pretty much.

They are offsets, and you can see there's a pretty significant differential between the two, which is our equity in the business. Stephen Silk – C. Silk & Sons: Okay. And then the SBA loans held for investment – are those the full loans or – with the 75% guaranteed, or is that – some of the guarantees have been sold, and so there's more risk for the shareholders – or on the balance sheet than what appear?

SBA loans held for sale – it was SBA loans held for investments?

Held for investment – those are the uninsureds.

Those are the uninsureds, and the ones held for sale, the guaranteed portions of the loan, held for investment are the uninsureds. The six-month stock-comp expense is $165,000. Stephen Silk – C. Silk & Sons: Okay, so about $80,000 a quarter. I think that's all I have right now. Good luck going forward there.

(Operator instructions) And with no other questions in the queue, I'd like to turn the conference back over to Mr. Sloane for any closing or additional remarks.

Thank you, operator. I really appreciate the attendance today and the questions and look forward to speaking to you all and addressing you on the third quarter call. Have a nice day.

That does conclude today's teleconference. Thank you for your participation. You may now disconnect your lines.