NewtekOne, Inc. 8.50% Fixed Rate Senior Notes due 2029 (NEWTG) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Newtek Business Services Corporation Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, CEO of Newtek Business Corporation, Barry Sloane. Please go ahead.

Thank you, everyone, and truly appreciate everyone joining us for our second quarter 2015 financial results conference call. I am Barry Sloane, Founder, President, CEO of Newtek Business Services Corp. NASDAQ stock symbol NEWT. And here with me today to present our results for the second quarter is Jenny Eddelson, our Chief Accounting Officer. Jenny, would you like to read the Safe Harbor statement?

Sure. This presentation contains certain forward-looking statements. Words such as believes, expects, plans, anticipates, forecasts and future or similar expressions are intended to identify forward-looking statements. 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 other things 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 other 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 SEC and available through https://www.SEC.gov.com

Thank you, Jenny. And we are very pleased to present our second quarter financial highlights, our second full quarter reporting as a business development Corporation. Net asset value for the quarter ended June 30, 2015 equaled $169.6 million, compared with a NAV of $169.6 million at the end of the prior quarter and a NAV of $16.31 at the end of the prior year. I would like to remind everybody when we were doing our road show prior to becoming a business development corp, we were out with a $16.65 NAV based on a 7.8 million share count. When we actually raised our shares, we went from a 7.8 million share count to a 10.2 million share count, so the minute the money hit us as a BDC, our NAV was effectively $12.73. So we’ve had a fairly significant increase in NAV from the time we raised money on November 12 from $12.73 effective to $16.62, which is where we are today, almost a 30% increase over the course of eight months. Adjusted net income for the period was $5 million, or $0.49 a share. And for the six months ended June 30, 2015, adjusted net income was $10.3 million, or $1.01 a share. Newtek Business Service Corp. in the quarter restructured it’s $50 million revolving line of credit with Capital One Bank to remove the guarantees from all the other portfolio companies as well as the stock pledges, and we were able to extend our line of credit to finance SBA 7(a) loans with Capital One Bank an additional year. We also signed a lease for 34,000 square feet of office space in Lake Success, New York, which is on the Long Island-Queens border, that we should be into that space in 2016. We anticipate that moving a lot of our portfolio of companies into one location and will help facilitate cross-selling and operational efficiencies. We have recently revised our loan funding forecast for 7(a) loans only from previously forecasted of $240 million to $280 million, down $10 million to $230 million to $270 million. That’s a 24% increase over where we closed loans in 2014. That does not include 504 loans. Further highlights, Goldman Sachs in June of 2015 provided a $38 million, four-year, multi-draw term loan. That facility is primarily for business service entities, and we were able to draw against our merchant processing business, the Universal Processing Services of Wisconsin and our technology business known as Newtek Technology Solutions. The recent acquisition that we did of Premier Payments will also be part of the borrowing base, and we’ll be able to draw on that in the future. As of this date, we have not drawn on the value from Premier. The Premier acquisition was completed within the last two weeks. We’re very excited about the acquisition of Premier Payments LLC, one of the leading electronic payment processors, which currently is growing at double-digit revenue and EBITDA numbers. We’ll go into that a little bit further in the presentation. We paid approximately $16.5 million in cash as well as restricted newly issued shares, and the total purchase price of $16.5 million was cash and shares together. Our electronic payment processing division for the second quarter recovered from a slightly lower performance in the first quarter. Our revenue was up over 10% year over year to $25.5 million, and our adjusted EBITDA came in at $2.5 million, an increase of 10% over $2.2 million in the second quarter of 2014. We also have recently announced and want to further emphasize that Newtek Business Credit, a portfolio company that primarily does financing of lines of credit to businesses backed by inventory and receivables as well as being 504 loans, we anticipate finalizing and securing a $50 million warehouse line of credit. On page 4 of our presentation, which I will add is on the investor relations section of our website, which many of you can follow online, we talk about the acquisition of Premier Payments further. We talked about the total purchase price of $14 million of cash, $2.5 million in restricted shares of Newtek common stock. We love the acquisition of Premier for a few reasons. Number one, by the end of 2015 we anticipate total processing volume under Newtek Business Service Corp. will be approximately $5.5 billion. The Premier Payments acquisition adds approximately 2,500 new customers. Premier had processed with Newtek previously as a selling agent, and I think we had about 2,000 customers on the books already with them. When you look at the growth of Premier, clearly Premier is a fast-growing selling agency for us and actually has direct processor relationship with Elavon bank, which is – with Elavon, which is owned by US Bank, an extremely valuable asset to the Newtek Enterprises. But take a look at the growth. Q1 2014 versus Q1 2015, revenue growth of 29.3%. Over 20% growth in Q2 2014 versus Q2 2015. I will add these are unaudited numbers that we received in the diligence, but they were reviewed and compiled by a third-party due diligence entity and we tied the numbers out pretty tightly. The EBITDA growth in both of those quarters, also significant. Q1 2014 growth to Q2 2015 growth, 59% EBITDA growth; and Q2 2014 to Q2 2015, approximately 52% EBITDA growth. So we are really excited about the acquisition of Premier. As I said previously, the ability to buy a business at 6 times EBITDA is on a non-levered basis equivalent to approximately a 16.7% cash-on-cash equity return. Put a little bit of leverage on that, which we will anticipate when we draw on Golden, that will get in excess of 20%. Obviously, if we can continue to put money out at the current dividend and invest it north of 20%, our shareholders and our management team and the Board will be extremely happy. On slide number 5, we talk about dividend distributions. On July 15, we paid a second quarter cash dividend of $0.47 a share. So far, through the first two quarters we paid $0.86 in cash dividends. The $0.86 payment in cash dividends represents about 85% of the adjusted NII, or $1.01 for the six months ended June 30. Obviously, that’ll need to get bumped up to the 90% range, but it also shows there’s some build-up in cash dividend payments that we will be paying out if we keep on this pace through the second half of the year. We have formally announced in the release last night that our annual cash dividend of $1.82, which is being paid quarterly, will be maintained. I want to repeat this particular point because I get asked this quite a bit. The special dividend that we’re about to talk about will not affect the quarterly cash dividend. The special dividend is a one-time dividend that will be paid to shareholders of record date when it is formally declared and announced by the Board, and that is to distribute retained earnings that the Company achieved as a C Corp. That is a bonus payment effectively to shareholders because obviously you’re get the reoccurring cash flow that comes off of our business. You’re getting our NAV that comes off of our business. The premium to NAV is representative of the market’s expectation of the parts of our business having significant enterprise value above where they’re sitting on our books. The $3.29 expected one-time dividend declaration and announcement must be paid by the end of 2015. We also anticipate that the breakdown of the payment of the cash portion will be 24% to 27%, is expected to be paid in cash when and if declared, and the remaining will be paid in shares of Newtek common stock. We also anticipate that the Board and the Company will declare a special dividend to be reported to shareholders as a qualified dividend. That determination can only be made by the shareholders and their own tax representatives. Focusing on slide number 6, one of our core businesses obviously is the 7(a) business, Newtek Small Business Finance. We are the largest non-bank 7(a) lender in the United States. There’s only 14 non-bank licenses that exist out there. We’ve been very successful. Been in this business for over 12 years. We have demonstrated in past calls and will today the ROI on 7(a) lending is in excess of 30% on equity. We have a 12-year history of loan default frequency and severity statistics. I will report that our current portfolio is 99% current. I don’t think it’s going to get any better than that, so in the future reports when I say 97% or 98% don’t take me to task. But we are 99% current as of today, and we are very happy about that statistic. The Company has issued five S&P rated securitizations since 2010, when nobody was doing securitizations. We were able to get them done. All were Standard & Poor’s rated. The uninsured portions of our SBA 7(a) loans fit in our balance sheet. That is for all of you to look at and assess the risk as well as the reward. Our average loan size is $173,000 of uninsured, senior secured participation certificates. I think it’s important to note that we are not dealing with mez investments, subordinated loans, loans with equity kickers. As a matter of fact, none of our SBA loans have equity kickers associated with them. So you get a nice pool of diversified loans that are all floating-rate quarterly adjusted over prime. In our deal with borrowers, they get a great deal, too. They get a seven- to 25-year amortization schedule. They’re paying prime plus 2 3/4, or 6%. So we are not looking at really high-yielding, loan-of-last-resort type financing to borrowers. There is a secondary market that’s established for the SBA 7(a) government guarantee participation certificates. Been around for over 61 years. And when you take a look at some of the math that we’ll be presenting in future slides, when we make a 7(a) loan, sell the government-guaranteed piece and ultimately finance the uninsured piece through securitizations, we’re in excess of 100% of the principles returned. However, the securitization does not present any accounting gains. That’s treated as a financing, and the uninsured loan participations sit in our books. Looking at some market comparables, on the last couple of weeks an important market comparable is Live Oak Bancshares. NASDAQ symbol LOB. I believe this bank priced itself approximately seven to 10 days ago. Live Oak Bank is primarily an SBA 7(a) bank. They focus obviously on small business lending using the same 7(a) product that we do. They raised $81 million in IPO. According to their perspectives, the transaction is priced about approximately 4.8 times tangible book. When I took a look at it trading in the market, priced at about 3.7 times book and approximately 16 to 17 times earnings. 16 to 17 times earnings on our SBA business, we’ll probably do about $25 million of pretax at 40% tax rate. That will be about $15 million annualized. A 16-, 17-times number, you’re looking at about $240 million valuation for our 7(a) business. Our 7(a) business is on our books effectively as part of the BDC, and it’s strictly the value of the loans as well as the value of the servicing asset. So we think there is interesting asset value built up in that particular business. Our current 7(a) pipeline, fairly robust; total of $491 million. We expect to fund between $230 million, $270 million of 7(a) loans in 2015. That’s down $10 million. This does not include 504 loans, which we anticipate closing some, and we’ll go over the math of 504 lending this calendar year. When you go to slide number 9 and I’ve done this in previous shareholder conference calls, so I won’t get too details on it. We used our standard $1 million example, which is approximately on average what we originate in 7(a) loans. We advertise $50,000 to $5 million. It creates a $750,000 government guarantee participation certificate; $250,000 uninsured, but not subordinated loan participation certificate. That’s what sits on our books. We sell the government-guaranteed piece off at 12% premium. When we do securitizations, we net approximately $1.021 million, so we are creating cash of securitization. That’s the cash aspect of 7(a) lending, which is one of the reasons why our return on equities are driven to very high levels because we get all the cash back. When it goes into a securitization, it’s nonrecourse. On the accounting side, we book the 12.5% cash gain because that’s what it is. We capitalize the servicing asset at now we are on slide number 10 at $18,000 on the million-dollar loan example, with a $93,000 premium on the government-guaranteed piece. On the negative side of revenue, we write the uninsured piece down by approximately 5 points. The 5 point non-cash write-down is based upon the fact that we believe this portfolio risk-adjusted yields 5.35%. Our uninsured pieces are valued at fair value, market value. We assume that over the life one and four loans will go bad and will have a 30% severity. We run it through our discounted cash flow. We use a 19% pre-pay rate, which includes voluntary and involuntary prepays. And that portfolio yields 5.35%, which historically is a 1.8% premium over where we fund our single-A rated securitizations. And it’s risk-adjusted. So we believe that that would be an attractive asset for most portfolio managers, particularly banks of today. The net risk-adjusted profit recognized on $1 million is $94,000. When we look at guaranteed loan pricing we provide regular transparency, but transparency is also offered in the capital markets through 11 pool assemblers. The pricing has been fairly stable. Approximately 112.49% was their guaranteed pricing through the average of 2014 through 2015. 112.44% in Q1, 112.46% in year two; that’s based upon not only the market but the blend between us doing 10-year advertising loans and 25-year advertising loans. 25-year advertising loans traded at higher prices in the market. When we look at the gain on sale premium trends, there are participants who look at a gain on sale and saying it’s not reoccurring income. We say it’s a reoccurring event. This is the history. As we are originating loans with the exception of 2010 and 2009 we had the market meltdown, we didn’t do a lot of business then. However, as we grew through the years you would see a gain on sale doing real well. And I will point out that the issue with respect to premiums had come off of the government-guaranteed pieces. People say, what happens if rates rise. I have to point out these are floaters. So it’s not the floating-rate aspect that will change the pricing. What prospectively might change the pricing is the expectation of the voluntary and involuntary prepaid going from 19% to 23% or 19% to 25% or 19% to 30%, which means that investors would be less interested in buying those government-guaranteed pieces. It would take a dramatic change to the economy and a dramatic change in interest rates to dramatically change those prepaid speeds. I want to point that out. So if market participants think rates are going to move 1% over the course of the next year, or 2%, I can’t see default rates spiking to change that on our loans. Nor can we see, all of a sudden, the banking environment changing where everybody based upon a small movement in interest rates tries to refi out on the floating-rate loans. That is just our opinion. We think there is a risk in that. However, we don’t see that risk as being significant. When you look at the quality of the portfolio on slide 13, you can see that concentrations are down over the course of five years both in state, both in industry. We have very high FICO and guarantee scores. We have very fair weighted-average current LTVs. We are very comfortable with our loan portfolio; the size of it, as I mentioned to you, about $175,000, a lot of diversification. The SBA 504 loan business is another SBA program that we are pushing forward with the addition of Gary Taylor, the new President of Newtek Business Credit. Gary’s former background Chief Operation Credit Officer at CIT Small Business; similar title at Lehman Brothers Bank USA; similar title at AT&T Credit. A very experienced executive taking over the reins of the Newtek Business Credit. We are excited about the opportunity to do SBA 504 loans, which importantly have a similar profile in terms of how we interact in the lending business. We just make the loan, and the entire loan comes off of our books. So when you go to slide number 15–16, you’ll see the basic characteristics of a 504 loan. You can look at approximately a piece of property that an owner-occupied business owner would like to acquire. In order to do that through the 504 program, he’s got to put 10% equity down, and effectively we put up 90% of the financing. That creates a 50% conventional first mortgage and a 40% second mortgage in the form of a second mortgage which is taken out by the government and the SBA. So when they take it out after 90 days in the bridge, we then sell the 50% first mortgage originated and created by Newtek, and we sell that typically for a 3 to 5 point gain. The details of that are on slide number 15. So one of the things that we earn when we do that loan we earn fees from the borrower, we earn servicing income, we get a gain on sale of the conventional piece and the second piece gets taken out. We get all of our capital back. The return on investment in this business, also very high, 40%. So when you look at how we lend in the market to maintain our status and relish our status as a BEC and the good assets and good income that come off our lending business are generated by making a loan and getting our cash back and reaping income through gain on sale, which we view as reoccurring event. Servicing income in the 504 area fees. We like our strategy, we like our market, we think it provides great risk adjusted returns and a great value proposition as the enterprise value of our business grows and grows over the course of time in the lending space. For those of you that are familiar with Newtek Business Corp. [Inaudible]saying that a significant portion of the other assets of the BEC are businesses that we have owned and operated, in most cases, for over 10 years. That includes merchant processing business, managed tech solutions business, and the insurance agency. The fourth business is a payroll business we’ve been in at about 4.5 years. Our payment processing business is our second flagship type business. We estimate that in 2015 we will do approximately $100 million of revenues, and adjusted EBITDA is $9.5 billion. This does not include the Premier acquisition. In future presentations we will include Premier to sort of categorize the entire space. We have this business valued on our books at 5.3 times EBITDA, where we’re proud of the second quarter revenue growth which got back into double digits as well as the EBITDA growth. We believe this business, obviously, is fairly valued. When you look at larger publicly traded entities like Heartland or Vanif, they trade at 9 and 10 times. As we do more acquisitions in this space, bulk up revenues, bulk up EBITDA, develop economies of scale, we think we’ll move more and more towards what I would call the offer size public valuations. There also is an opportunity down the road as we grow these different portfolio companies to spin them off into their own separate public companies and reap further valuation down the road. Newtek Technology Solutions is a Company that we have a 10-year history in. Formerly known as Crystal Tech. We acquired it in 2004 when it was doing $6 million of revenues, $2 million of EBITDA. And its height, accrued to an excess of $20 million of revenues and $7.69 of EBITDA and really was a jewel for the Company. We still believe it is a jewel. The key here is markets are changing quickly, technology is changing and the bulk of the company’s historic portfolio was in Microsoft Windows-only type managed tech and hosting solutions. John Raven, our new Chief Operating Officer, has had the reins for 60 days. We have a real nice pipeline of other types of products, which I’ll describe shortly, which we believe will stabilize the Company and regenerate revenue growth. I’ve been asked many times why are you in this market, why are you in this space. The biggest growth sector that we are in is the migration of businesses to have their hardware and software in a data center in the cloud. [Inaudible] argue that 24 hours a day, seven days a week. We have execution risk, but we are in the right market with the right strategy, and we’ve got a great facility and staff that will be able to take large and small businesses so we’re going to upscale in the customer account. Large and small businesses take their dedicated server boxes, condense them. We will actually physically migrate them to our cloud and our data center in a restructured relationship with I/O. The restructured relationship gives us physical presence or virtual presence in London, New Jersey, Scottsdale, Phoenix as well as Denver. So we are able to actually give customers real-time, 24-hour, managed tech solutions where they could reduce their cost of labor, reduce their server purchases, be in the cloud, and also have redundancy on a real-time, hot back-up basis in multiple locations. So for those of you that were affected by Katrina or Sandy or Andrew or some other problematic event where power grids shut down. And you have an e-commerce site and you don’t want to be shut down. Or you’ve got a business where, historically, if you didn’t – weren’t able to get to your account, you weren’t able to get to your lawyer, you were afraid, today if you can’t turn on your Blackberry or iPhone, I know from my standpoint I start to get the shakes. Businesses are going to migrate their hardware and software to data centers. We are in the right space. This is an execution issue. This business is on our books at 1.4 times revenue, valued at $21 million. The public comps, endurance, rack space, Go Daddy, those businesses are on their books at 3 to 4 times revenue. We are an internally managed BDC. Our interests are very much aligned with shareholders. We do not pay ourselves external fees. We traded a discount in NAV to where other externally, internally managed BDCs trade at. The comps on slide number 19: Hercules, KCAP, Main Street Triangle. In summation today, before I turn the presentation over to Jenny, we’ve had tremendous NAV growth since we hit our capital raise and converted to a BDC in November. We have or reforecasted or reclaimed that we will do $1.82 in cash dividends in 2015. We have changed our forecasts for the special dividend to $3.29, of which we looking to pay out between $0.24 and $0.27. I will repeat: this has not been declared by the Board. This is not set in stone. We are still working through numbers with our accounting team. But this needs to be paid out and will be paid out between now and the end of December. I think management would rather pay us sooner than later. That will be determined by a variety of number of factors. When you look at an investment in Newtek, you’ve got to look at the risk versus the reward. We’ve got 70% leverage at the end of the quarter on our leverage test. We’ve got a history of owning and operating these businesses for in excess of 10 years. One through four years, we know them well. Effectively, you’re investing in a portfolio of companies and the SBA 7(a) and 504 business, which generates high-velocity returns by turning it to capital. We are an internally managed BDC; our interests very much aligned with yours. My interest as a major shareholder is to grow the dividend and the stock price and the NAV. Not necessarily growth for growth’s sake, so you won’t be seeing us doing capital raises because it pays a higher base and a higher bonus to staff. We do capital raises because when we took in money at $12.50, we converted it to a BDC. We are able to deploy it in these businesses that are generating higher rates of return on equity and high cash flows, which is representative in an approximate $18.5 to $19 stock price today. So we do good things with money. We take it; we invest it at high rates of return. We’re not putting it to second lien, mez financing or derivative securities. I appreciate your time today. I’d like to turn the final finance review over to Jenny Eddelson.

Thank you, Barry. Good morning, everyone, and thank you for joining today’s call. I’d like to start with some financial highlights from our second quarter 2015 consolidated statement of operations. As Barry mentioned earlier, this is our second [Inaudible] reporting as a BDC, so there are no consolidated BDC financial statements to refer to for the comparable prior period. Please turn to slide 22. We had investment income of $5.6 million, which included approximately $2.2 million of interest income. Substantially, all interest income for the three months ended June 30, 2015 and June 30, 2014 was derived from our SBA loan portfolio, which generated $2.2 million and $1.6 million of interest income, respectively. The increase in interest income can be attributed to the increase in the average outstanding performing loan portfolio, which went from $102 million at June 30, 2014 to $132.6 million as of June 30, 2015. The increase was the result of new loan originations over the 12-month period. Servicing income, which is recurring revenues that we earn from servicing the guaranteed portions of loans originated and sold by Newtek Small Business Finance, increased $153,000 for the three months ended June 30, 2015 compared to the same period in 2014. The increase was attributable to the growth in the size of the total SBA loan portfolio for which we earn servicing income of approximately $144.2 million period over period. Dividend income was approximately $1.8 million for the three months ended June 30, 2015 and represents dividend declared from our controlled portfolio companies. Our expenses for the quarter totaled approximately $7.9 million and include salaries, interest expense and other G&A such as rent, marketing and referral fees. As an internally managed BDC, we do not pay any incentive or base management fees to an external manager. We believe the internally managed structure presents multiple benefits to shareholders including better aligning the interest of our employees with our shareholders. Our net realized and unrealized gains for the period totaled a positive $7.2 million. For the three months ended June 30, 2015, we originated 85 loans totaling $53.9 million and sold 80 loans for $52.2 million, generating $7.3 million in realized gains. The average sale price for the period as a percentage of the principal balance was 112.46%. During the same period last year, the Company originated 49 loans totaling $42.6 million and sold 43 loans for $33.4 million, generating $5 million in premium income. The average sale price in the second quarter of 2014 was 112.57%. As a reminder, we originate 7(a) loans and are able to sell the guaranteed portions, which are typically 75% of the loan balance for a premium which averaged a net 112.46% of par in the June quarter. This premium income is recognized as a realized gain on sale for loans sold in the quarter and an unrealized gain for loans held at quarter end. Other fair value adjustments included a $1.5 million net unrealized loss from the net valuation change in our loans held for sale, which I’ll discuss in more detail when I review slide 23. We also had $470,000 of unrealized depreciation on our unguaranteed SBA 7(a) loan portfolio, which represents the valuation adjustment we immediately record on loans originated during the quarter. The $2 million appreciation of controlled investment was the result of an increase in [Inaudible] of our electronic payment processing and small business lending portfolios. Finally, we had a $256,000 depreciation on the servicing asset, which effectively represents amortization on this asset. Overall, a net increase in net assets from operations was $4.9 million, and our net increase in net assets per share was $0.48 for the quarter. Please turn now to slide 23, which is an analysis that changes the NAV and NAV per share for the first half of the year. Overall, our NAV per share increased by $0.31 or 1.9% for the six-month period. We began the year with NAV of $16.31 per share. The positive contributors to growth in NAV per share in the first six months of the year were $1.47 per share of net realized gains from selling the unguaranteed – the guaranteed portion of 7(a) loans and $0.93 per share of net unrealized appreciation of our controlled investment. This growth was offset by a net investment income loss of $0.40 per share and unrealized net depreciation, or $0.42 per share or $4.2 million. The $0.42 of net unrealized depreciation consisted of $470,000 in fair-value adjustments of unguaranteed 7(a) loans held on balance sheet and the remainder of guaranteed loans held for sale at quarter end that were marked up to reflect the premium expected from a future sale, which was subsequently reversed when those loans were sold in the following quarter and the premium income was recognized as a net realized gain. Amortization of our servicing asset also generated a loss of $0.06 per share. Overall, the preceding accounted for a 9% or $1.46 increase in NAV per share before taking into account the dividends and deferred tax adjustments which reduced NAV per share by $0.86 and $0.28, respectively. The deferred tax asset was adjusted for the opening equity balance as a result of the Company’s election of RIC status for 2015. And with that, like to turn the call back to Barry.

Thank you, Jenny. Operator, we would love to take questions from the audience.

Thank you. Ladies and Gentlemen. [Operator Instructions] Our first question comes from the line of Chris York with JMP Securities. Your line is open, please go ahead.

Good morning, Barry and Jenny.

Hi, Chris. How’re doing?

Good, thanks. A couple of question to begin this morning, on the acquisition of Premier. So it’s my understanding that Premier will be treated as a wholly owned portfolio company. So is it correct to assume that the income will be in the form to the BDC in dividend income? And then do you guys intend to distribute all earnings at Premier to the BDC?

We do, Chris. The portfolio companies don’t need much of any CapEx to run their business, and we see that being distributed straight up.

Got it. Okay. And then could you elaborate a little bit more on the 25% year-to-date revenue growth at Premier? What was driving that? Was that a – did the company invest in more sales people? Was it new product driven? Maybe just a little bit more color.

One of the attractive aspects of Premier, which was created and established by former founder Jeff, is their operations and methodologies to how they handle clients. They do a great job in the growth aspects of the payment processing space, which is mobile payments and tablet based integration as well as integration into point of sales terminals that are non-tablet based. I’d non-tablet base say the fourth area of growth relates to payment processing for educational institutes and municipalities where visibility to do convenience fees and surcharging. In the payment space today, the old how you got them business of walking in with a statement and a rep, saying I could beat your pricing doesn’t work anymore. Premier has developed what I would call a front-end technology to be able to consultatively talk to the customer, book and bind the customer, and put them on multiple platforms. So from our perspective, in addition to acquiring a great team of people, great cash flows in the right space, good distribution channel we also picked up a relationship with Elavon, which is owned by US Bank. That’s a top five processor. So we’ve got more processing platforms to be on. Those things all reduce our costs. And although we’re going to keep Premier as a separate segregate portfolio company based in Long Island, which should fit well into our Queens-Long Island strategy of growing under one roof, we believe that premier has a business methodology and technologies that will be able to migrate to UPS Wisconsin as just better business practices. So when we look at the two books of business with customers coming into us looking for solutions, not only do we think we’ve got a great opportunity with premier in terms of its cash flows and its methodology, but we believe that the things that they’ve perfected we’re going to be able to migrate over to UPS list to get that hyper growth out of that entity as well. So when you combine these entities, you’re looking at probably $13 million of EBITDA. So as we continue to grow and do acquisitions, we would love to get that $13 million to $23 million to $33 million to $53 million. Now you’re looking at a business opportunity where you could maybe spin it off and get that big public multiple that the Heartlands and the Vaniffs enjoy. And we also think about our overall strategy and customer count, cross selling, driving into the customer. By the way, none of this is going to happen in the next quarter. So - my investor base always wants to know, but it just takes time. And we’re excited about what we’re doing. We’re excited about that acquisition. These are the kinds of acquisitions that we need to do.

[Inaudible] for all that color. Elaborating on the vision is very helpful. You know, you had 40% EBITDA margins in that business, or Premier did. Would you predict or assume that that could be potentially sustainable? How should I think about that from a modeling perspective?

From your mouth to God’s ears, I just don’t see that being sustainable, particularly as the business grows and we look to reinvest and to get it onto a bigger platform. So typically these businesses are – they’re barely double digit margins. So I think that as we grow, the nice thing is we had a pretty big gap between 40% and 10% or 12%, which is considered good in the business. So all of our shareholders, God willing, should be able to enjoy that over the course of time. I think as you model it, you kind of – maybe you want to gradually straight-line that. Over the course of three years or five years, it shrinks to a more normalized approach. But at that point, hopefully Premier is $20 million of EBITDA and not $2.5 million of EBITDA.

Sure. Thanks for that. Switching gears a little bit, so jumping to 7(a) loans. I missed in Jenny’s comments how many you guys originated in the second quarter and sold. So you could you just refresh me on that real quickly?

Yes, we funded $53 million; we funded $50 million in the first quarter. Jenny is thumbing through her documents for the actual amount of loans that were sold. We typically look at the first half of the year as 40% of our originations and the second half as 60%. And if you look at those numbers, we are probably 255, 260. We did change our 7(a) guidance from 230 to 270. 504 will be outside of that. We haven’t forecasted that yet. Maybe do that on the next call. Right. Originations and sold, $53 million for the second quarter originated [multiple speakers] – originated $54 million and sold $52 million.

That’s helpful. And then maybe a little context in regards to I mean you only trimmed your guidance by $10 million on both the lower end and upper end. But maybe just kind of qualitatively, what’s going on there?

I don’t know. I think that we always want to make sure we over-deliver. And we just thought it was prudent to make a $10 million midpoint adjustment. We didn’t adjust the dividend number because, based on where pricing is and our mechanics and the room we have in the model, we’re good on the cash flow. So I do think that I always try to be fair and forthright. The reality of the lending market is it is getting more competitive. There are more people trying to get into just small business lending in general, let alone 7(a). So I just think it’s prudent for us to adjust to market conditions, and we see there being more competition, so we made a slight adjustment.

Got it. Then one last one here and then I’ll jump back in the queue. So we know investors tend to appreciate the internal management structure, which many of the reasons were highlighted in slide 19. With some investment in the business in the first half of the year, what opportunities do you guys think exists for operational leverage potentially over the next 18 months?

Well, I think that clearly if you think about operational leverage, if we could do acquisitions and insurance agency and payroll and cloud, we’re going to experience really great operational leverage in those particular segments. From a lending perspective, if you look at what we’re doing in the financing side of things, our cost of capital is coming down. Our equity cost of capital has come down significantly. Look at what we’ve done on the debt side. We’ve got a 7(a) loan only. We have been able to borrow far more significantly on portfolio companies. We had $8 million of debt prior to the Goldman facility, and now we could – I guess at current EBITDA numbers, we’re up to $33 million without having to issue shares. So we see ourselves operating at a much higher level. It’s a lot easier to make money with $0.5 billion BDC than a $100 million BDC. And we plan on getting there through organic growth. There’s also prospectively portfolio acquisitions that we could do in the small business lending space. We’ve had lenders come to us looking to participate in that and give us some leverage. Mind you, it’s really hard to get a 30% equity risk-adjusted return that we currently get in our originations businesses. So in a perfect world, I just snap my fingers, ramp it up by 100% and call it a day. It’s just not realistic. I think that when you look at our Company, we are a 40s net Company. We are an asset allocator. And we want to be very thoughtful as we look at things going forward to make sure that we’ve got multiple businesses that generate really high cash flows. And a lot of people in the space do invest with the dividend, which is important. We want to make sure we return that dividend it’s a high dividend, it’s a stable dividend and also attempt to get higher NAV and share price appreciation. Now, when you look at our share price appreciation, we were up 17% from November 12, 2014 through the end of the year. And I think by July 24 and the beginning of this year, we’re up 38% given the dividend. So we’ve clearly been able to return to shareholders so far as a BDC. It’s tough because those are tough numbers to maintain. But if people really like this business model and actually believe that we can continue to execute at this high level, then I don’t see any reason why we shouldn’t. Maybe we have a lower market-clearing yield for our dividend versus other stocks. Anyway, that’s our thought process on that.

Yes, it makes sense. Thanks again for all of that color. That is it for me. Congrats on another good quarter as a BDC.

Thanks, Chris. We appreciate your early call from San Francisco.

Thanks.

Thank you. Our next question comes from the line of Robert Brock with West Family Investments. Your line is open. Please go ahead. Okay. It looks like he removed himself from the queue. Our next question comes from the line of Mickey Schleien with Ladenburg. Your line is open. Please go ahead.

Yes, good morning, Barry and Jenny. I wanted to start with a question about the process for Congress approving funding for SBA 7(a). I noticed that the Senate recently increased that. Given that many of us are unfamiliar with that process, could you just walk us through how that works and whether there’s any risk to your funding process given that Congress is so unpredictable?

Appreciate that, Mickey. You know, we’re in an unusual position that we participate in a government program that, with respect to the 7(a), actually returns money to the U.S. Treasury and historically has. It is looked at as a zero-budget item. However, there still needs to be an appropriation of guarantee. And what the SBA does with members of the Senate banking committee and House small business committee, they work on creating appropriation every year as part of the budget. We recently saw that the amount of allocation for 2014 was running out; I think it was $18.5 billion. And what that means, Mickey, was as of, say, some point July I don’t know the exact date you couldn’t go to the SBA and get any additional guarantee numbers from pipeline. We typically get guarantee numbers as somebody who has been doing this for 12 years. As early as the SOP, which is the SBA’s term for their policies and procedures, allows us to do so. So the pipeline was covered, and the House and Senate on a bipartisan basis which I’ve got to tell you, in this world to get Republicans and Democrats to actually agree on something quickly is a miracle and to put it through. So I think that the fact that in a very short order both the House and the Senate, Democrats and Republicans, came by and increased the funding amount this year which arguably wasn’t necessary because most people had their pipeline covered or at least people that have been in the business to $23.5 billion. So there’s plenty of availability. If you look at it as a percentage basis, which I haven’t done, that’s probably like a 20% to 25% increase. So, I think that it is a government program. We have got a lot of risk factors in our documents with the fact that we are involved in a government program and requires funding. The government can change rules at any time which is frankly true of private enterprise as well. But I think the most important fact is bipartisan program, real quick change. Obama actually signed the bill with an auto-sign technique overseas, which I’m told he’s only done six times in his presidency. It was important. We paid attention to it. We are plugged in. And it was important for us to follow, and we appreciate your bringing that up on the call.

Thanks for that explanation, Barry. I know that Newtek follows a variety of indicators from the small and medium-size businesses you lend to. And from our perspective, there’s just a lot of mixed messages out there given prices for commodities, the volatility in stock markets around the world, currency volatility. Can you just give us your 30,000-foot view level of where you think we are in the economic cycle and what risks that might pose to lending in general and Newtek specifically?

Sure. Mickey, one of the things that we do in our servicing department in addition to talking to all of our borrowers, one of our senior members of our loan committee Dave Lyons who heads up capital markets, directly speaks to our 25 largest borrowers in our portfolio. And those conversations, frankly, are consultative. Dave is a CPA and CFA and quite knowledgeable. And the conversations he has relate to how are things, what do you see in the economy, what do you see in revenue trends, expense trends, how are your cash flows? When he was speaking to Peter Downs, Chief Lending Officer, this morning, the reports that we’re getting back from our top 25 are business is doing very well, there’s no strings and it’s probably the first time in many years that people are optimistic. Now, I would say that this is a tough market for marginal businesses, but there are expenses creeping up. So you want to be careful as a lender. If the businesses are on the bubble, you want to be a little cautious now. Net asset values have increased; that is very important for businesses because they can tap it to equity in their homes. There’s more availability of credit. That’s very, very constructive. We have a very modest constructive outlook on business going forward. We think that most of the strains are behind us. Banks are significantly healthier. They are lending again. And I guess the biggest problem really is cost control, and that’s where businesses have got to keep making investments in technology. Which, by the way, was making it difficult in the area of jobs because software and technology is replacing headcount. And those are some of the trends that we see.

Very good. My last question, Barry if I’m not mistaken, Jeff Rubin will now be your Newtek’s single largest shareholder. Can you just walk us through potential for him to divest some of his holdings given how significant they’re going to be?

I think it’s a fair question. Jeff has been the second largest shareholder for, let’s see, September 2000, or 15 years. So if you look at the history, it’s pretty good. If you look at my [Inaudible] four filings, I’ve always been a buyer despite not having a tremendous amount of liquidity. I don’t see any changing in Jeff’s dynamic. He gets very healthy dividend. He likes what we’re doing. He’s close to us. He’s going to serve as an advisor to me to help continue to grow the trajectory not only in Premier but also in UPS Wisconsin. So I’m not totally concerned about Jeff divesting of his shares. And in the past, clearly someone like myself or Jeff divesting of shares would’ve been really problematic. But you look at our share volume, it’s doing well. But I’ve just got to be honest with you: anything can happen. I’m not Jeff’s financial advisor. I just don’t see him doing any divesting in the near future. I have no knowledge of it, and I’d be very surprised with it. If he said I’ve got to take all cash in the deal, we would’ve done it. But it’s [Inaudible]. Yes, he took $2.5 million of stock, which is restricted.

Right, right. I appreciate that. Those are all my questions for today. Thanks for taking my questions.

.:

Thank you. We do have a follow-up question from the line of Robert Brock with West Family Investments. Your line is now open.

Hi, Barry. Thanks for taking my call. Two questions. Could you talk a little bit about the 504 business? Since you don’t hold the loans for very long could you talk about the risk of the 504 program and how big you think it could be? And related to that, are there other SBA programs other than the 7(a) and the 504 that you’re looking at getting into? Thanks.

Appreciate that, Rob. In 504, let’s sort of use the business owner, the leasing is manufacturing company is leasing the real estate for his manufacturing company for years. He looks at it with his accountant and says, you know what, I’m much better off buying the building, not paying rent and depreciating real estate. So the building appraises at $1 million, he takes $100,000 out of the CD and he starts [Inaudible] making the 504 loan, which is strictly against the value of the real estate. And we charge him a couple points, we have a servicing fee, we price it fixed versus floating, and we create a $900,000 loan of which $500,000 is a conventional first; $400,000 is a second, which we have to hold for 90 days in what’s known in the file core business as the bridge. And then after that the government takes it out of the bridge. So you have a modest amount of risk. And I say modest, it’s fairly small, that for some reason the loan doesn’t perform or gets hung somehow and you can’t get it taken out. With our experienced staff, I look at that risk as extremely de minimis. As a matter fact, the advanced rate on that business from our prospective lender is 90%. So it’s 90% of the full value of the loan. So you can see even our lender that you’re familiar with realizes this is not tremendous on risk. So the government takes it out and then you have got the ability to sell the conventional first into the secondary market, and there’s an insatiable appetite from investors to own a 50% value on a piece of commercial real estate. We also can take that and hold it if we choose to and put it into our 7/8 securitizations. Once that’s sold, we’ve made a $900,000 loan, and we have gotten $900,000 back plus a premium plus fees from the borrower plus the servicing income and we’re back out on the street making those loans. I think in a full-year in 2016, I’d like to believe that we can do $50 million of loans conservatively. It’s not out of the question that that could be $100 million or $200 million. I don’t have good visibility on that at the moment, and I don’t want to pump up the number. But 504 loans are typically larger, and the number I threw out was the whole loan, right? So it’s not inconceivable we could do $200 million worth of loans, of which $100 million are conventional firsts that we get a premium on. Particularly with our distribution channels. So I would hope that we would get there in short order. Too early for me to determine what short order is, but I guess I’m going to get some pipeline guidance from Gary Taylor and I’m going to make sure he thanks you for having me ask him that question.

Thanks, Barry. One other question. You had talked about on previous conference calls and when we talked about having to have an equity raise possibly the fourth quarter this year. Has that changed given the fact that you now have such a line of credit or term loan with Goldman Sachs?

You know, Rob, I think that it’s a good question. What we do here, Jenny, myself, the Board, we’re looking at opportunities regularly. So our job function is to look at a great opportunity like premier, seize it, fund it and put it in the portfolio. So – and I’d like to attempt to try to change the mindset of investors on this call and investors that typically look at BDCs and think that equity raising is bad. In our case we raised equity at $12.5 in November, and now look at the stock price. And the only reason why the stock price is up is because the market believes we can take it, put it to work in these businesses and get higher returns, which are attractive to the instability of the dividend as well as NAV. So the timing of a capital raise can be based upon what acquisitions we have in the pipeline or constantly looking at things, what our loan business looks like and the timing of special dividends as well as securitizing uninsured pieces of our SBA portfolio. So if I had to make a guess, it could be fourth, it could be third, it could be first quarter of 2016. We have filed a shelf. The shelf enables us to do debt and equity. And we are pretty excited about where we are because our cost of equity capital with our stock price going higher has gone down. Our cost of debt capital has gone down because our lenders have given us more generous rates; we’re getting more leverage out of our other properties like our portfolio companies. There was a securitization done in the market by one of our competitors, ReadyCap, that did a [Inaudible] $100 million [ph] seasoned uninsured 7(a) securitization. It cleared the market at 1.8%. We our last transaction cleared at 3.5% single-A. It was smaller. So as we move toward the $100 hundred million dollars-plus, we might be able to add seasoned loans, our execution on securitizations will get better. So I know I just sort of filibustered a little bit on the question. I think it could be anywhere from - it could be anywhere, from – it really depends on the opportunities and I think that’s the best way to answer that question.

Thanks a lot, Barry. Appreciate it.

Thank you, Rob.

[Operator Instruction] Our next question comes from the line of Marc Silk with Silk Investment Advisors. Your line is now open.

Hi, Barry. How are you?

Good, Marc. How’re you doing today?

Good. A lot of information to digest. Maybe I’m naive, but I’m surprised that I’m the only one who’s bringing up well, besides you that one time $3.29 dividend. I really had no idea what to expect. And I just want to say for my client base, thank you. So let’s see, I saw that article about Congress, and I agree with you, it shows you how important this is the SBA program to have bipartisanship support. But I was really impressed that I guess three quarters of the fiscal year not even have already surpassed the amount that’s being loaned out, which just shows you that there is just incredible growth in this area, which should be definitely exciting for you I would think.

Clearly, utilization guarantee shows that there is greater borrower demand. People are getting more optimistic off of very low levels. So there’s no question; the economy is better, the capital is better. From our standpoint, we still want to make sure we pick really good credits. So, we’ll let others be involved and get the weaker credits. We want to make sure we are selective and get the good credits. You know, extending credit is an important aspect the important aspect to extending credit is not to try to make loans from making loans safe, but you really want to make good loans. So we want to be really prudent and have prudent growth versus explosive growth. Beware of lenders that are growing 50%, 100%, 200% a year because it’s I don’t care how much capital you have; you’re not being too choosy.

Well, you know I’ve been a shareholder since 2006, and that’s the one thing that I really respect about the Company is that you’re not going to do a loan just to do loan. You have had a fantastic success rate, and I know that’s the key to your business. I thought it was interesting where you said now a lot of people try to get in this business. And as a long-term shareholder, I’m in this for the long haul. But it wouldn’t surprise me if someone wants to be the number one SBA lender and look at Newtek and see there’s some interesting things going on there. So I actually prepared this question before your recent purchase of Premier. But where have you I guess I can still ask it and where were you kind of seeing, besides the lending or where were you anticipating to see more organic growth going forward over the next few years?

Subject to our ability to execute the cloud businesses – and I know people are looking at me like, are you wacky? The cloud business is the single biggest growth opportunity. It’s currently one of our underperformers. But when you think of the amount of businesses out there that have their data not in the data center, in a closet, we are the local IT provider without hot backup, which is not that expensive anymore. Having an internal IT person, which is a waste of money, you should be leveraging having managed technology 24/7, pay for it when you use it versus paying $4,000, $5,000, $6,000, $7,000 a month to somebody that’s not utilized all the time. So that’s the growth. We’ve got to figure out how to exploit it. And even though it doesn’t look very pretty today, it’s an investment and we think that’s the most prudent investment that we have. I will tell you one thing is for sure: credit markets are going to cycle in and out. And you know, I question whether the lending business can return 60%, 70%, 80% on equity. Do you follow what I’m saying?

Yes.

I do not question whether the cloud business can grow explosively without any credit exposure just by being it. So when I look at things, I’m looking at risk reward, I’m looking at capital allocation, I’m looking at positioning the business not for the next quarter but for the next three, four or five years. We’ve always been a business builder, which is hard to do in a public setting. I think the BDC model works very well for us because investors can get a very generous dividend while they wait for the things that we are working on, which has historically turned out to be good things, to be successful.

Well, I’m glad you brought up the cloud because I had a few interesting thoughts. Number one is you are very unique where you have clients, customers that do other stuff small business loans, payment processing, et cetera. And I know a cloud customer is a very sticky customer. So one thing you can offer and I know my brother Steven has always asked you about cross-selling, and I know you have always been trying to do that. And your move to near Long Island shows that. But what you can also do is say, listen, okay, you’re a customer of the small business model. We can offer you a one-time maybe discount to getting you set up on the cloud, and then you have that customer forever. Number one. And then the other thing is and we can talk off-line – with your newest hire is that – so I think Microsoft 365 they’re going to start offering through a company called I-PASS exposure to 20 of their hot Wi-Fi hotspots which is probably going to go 40 or 50 million Wi-Fi hotspots. Which if you can access Wi-Fi instead of 3G and then you’re bringing your cell phone bill down, or even if you travel and you’re going to Wi-Fi, you can package that whole thing together. So you’re not just offering cloud but you want to be able to offer something else, right? Because I know cloud is very competitive, but those are just my thoughts on cloud and I’ll let you go there. But I needed to make a comment but I just want to thank you for all of you - what you’ve been doing and continued success.

Thank you, Marc. I appreciate it.

Thank you. I’m showing no further questions. I would now like to turn the call back to Barry Sloane for further remarks.

Thank you very much and truly appreciate the analyst and investor participation in the call. I also want to thank obviously our accounting and legal staff. When you look at this quarter, we cranked out significant acquisitions. Goldman Sachs line of credit, producing the Q, and the adjustment on the Capital and Bank line. We have another line of credit in the pipeline. We have a few things going on. Tremendous team effort between legal and accounting. I also want to thank our new Treasurer and Senior Vice President of Finance, Dean Choksi, he was immeasurably helpful in making the presentation and a very successful quarter. Worked well for us. So thank you, everybody. Look forward to reporting our third-quarter results.

Ladies and gentlemen thank you for participating in today’s conference. This does conclude this conference call. You may disconnect at this time. Have a wonderful day.