Business Context and Reporting Period
Company: Newtek Business Services Corp. (formerly Newtek Business Services, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2014
Key Corporate Event: On November 12, 2014, the company completed a merger and reincorporation in Maryland, converting from an operating company into a Business Development Company (BDC) regulated under the Investment Company Act of 1940. The company also intends to elect Regulated Investment Company (RIC) status for tax purposes beginning in 2015.
Business Model: Newtek is a leading national lender and FinTech company serving the Small and Medium-sized Business (SMB) market. Its primary revenue drivers include SBA 7(a) lending, electronic payment processing, managed technology solutions, insurance, and payroll services. The company utilizes a proprietary referral system (NewTracker) to acquire customers cost-effectively through alliances with financial institutions and other partners.
Key Financial Metrics
Note: Financial data for the full year 2014 is presented on a "Pro Forma" basis to allow for year-over-year comparison, as the BDC conversion occurred mid-year. Post-conversion results (Nov 12–Dec 31, 2014) are limited to a two-month period.
| Metric (in thousands) | Pro Forma 2014 | 2013 | Change |
|---|---|---|---|
| Total Operating Revenues | $148,764 | $143,593 | +3.6% |
| Net Income Attributable to Newtek | $3,293 | $7,528 | (56.3%) |
| Pretax Income (Pro Forma) | $7,497 | $11,069 | (32.3%) |
| Total Assets | $301,832 | $198,612 | +52.0% |
| Total Liabilities | $135,414 | $121,603 | +11.4% |
| Net Assets / Stockholders' Equity | $166,418 | $77,009 | +116.1% |
| Net Asset Value (NAV) per Share | $16.31 | $10.88 | +50.0% |
| Debt Obligations | $122,543 | $101,358 | +20.9% |
Debt Composition (Dec 31, 2014):
- Notes Payable: $43,023
- Securitization Notes Payable: $79,520
- Notes Payable in Credits in Lieu of Cash: $2,229
Material Changes vs. Prior Period
- Revenue Growth: Total pro forma revenues increased by $5.2 million (3.6%) driven by growth in the Small Business Finance and Electronic Payment Processing segments.
- Profitability Decline: Pro forma pretax income decreased by $3.6 million (32.3%) to $7.5 million. This decline was primarily due to:
- A goodwill impairment charge of $1.7 million in the Small Business Finance segment.
- A $1.735 million legal reserve related to an FTC matter in the Electronic Payment Processing segment.
- Increased operating expenses, including salaries and general administrative costs.
- Segment Performance:
- Small Business Finance: Pretax income increased 27% to $12.9 million, driven by a 55% increase in servicing fee income and higher interest income. SBA loan originations increased to $202.3 million.
- Electronic Payment Processing: Pretax income decreased 19% to $6.7 million despite a 2% revenue increase, due to the FTC legal reserve and higher chargeback provisions.
- Managed Technology Solutions: Pretax income decreased 13.6% to $3.1 million due to a 10% revenue decline caused by a reduction in active web hosting plans.
- Capital Structure: Net assets increased significantly (116%) due to a November 2014 equity offering of 2.53 million shares at $12.50 per share, generating gross proceeds of $31.6 million.
Guidance, Outlook, and Risks
Outlook and Strategy:
- BDC Operations: The company will now operate as an internally managed BDC, focusing on debt investments in SMBs, primarily through SBA 7(a) loans. It targets a coupon rate of Prime + 2.75%.
- Distributions: The company intends to pay quarterly distributions to stockholders beginning in Q1 2015, subject to asset coverage requirements and available income. A distribution of $0.39 per share was declared on March 19, 2015.
- Capital Deployment: Proceeds from the recent equity offering are being used to expand SBA lending activities and make direct investments in portfolio companies.
Key Risks and Contingencies:
- Legal Proceedings: The company is subject to an FTC order regarding telemarketing sales rule violations. A reserve of $1.735 million was recorded for equitable monetary relief. The company intends to appeal the ruling.
- Regulatory Compliance: As a BDC, the company must maintain an asset coverage ratio of at least 200%. Failure to meet this could restrict borrowing and dividend payments.
- Internal Controls: The company previously identified material weaknesses in internal controls (2012) related to merchant processing chargebacks. Management states these have been remediated, but future deficiencies could impact financial reporting.
- Market Risk: The company is exposed to interest rate fluctuations and the availability of the secondary market for SBA loans. A downturn in the secondary market could impair profitability.
Investor Verification Checklist
- Verify BDC Asset Coverage: Confirm the company maintains the required 200% asset coverage ratio to ensure continued ability to pay dividends and borrow.
- Monitor FTC Litigation: Track the status of the appeal regarding the FTC summary judgment and the potential impact of the $1.735 million reserve on future earnings.
- Assess SBA Loan Secondary Market: Evaluate the robustness of the secondary market for SBA guaranteed loans, as the company relies on selling these portions to generate premiums and liquidity.
- Review Internal Control Remediation: Verify that the remediation of 2012 internal control weaknesses remains effective and that no new material weaknesses have been identified.
- Check Dividend Sustainability: Analyze the source of distributions (earnings vs. return of capital) to ensure they are sustainable under RIC tax rules and BDC leverage constraints.