UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________TO __________.
COMMISSION FILE NUMBER 001-31924
NELNET, INC.
(Exact name of registrant as specified in its charter)
NEBRASKA 84-0748903
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
121 SOUTH 13TH STREET, SUITE 201 68508
LINCOLN, NEBRASKA (Zip Code)
(Address of principal executive offices)
(402) 458-2370
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of April 30, 2007, there were 38,101,338 and 11,495,337 shares of Class A
Common Stock and Class B Common Stock, par value $0.01 per share, outstanding,
respectively.
NELNET, INC.
FORM 10-Q
INDEX
MARCH 31, 2007
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 2
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 47
Item 4. Controls and Procedures 50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 51
Item 1A. Risk Factors 52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54
Item 6. Exhibits 56
SIGNATURES 57
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
AS OF AS OF
MARCH 31, 2007 DECEMBER 31, 2006
-------------- -----------------
(UNAUDITED)
ASSETS:
Student loans receivable (net of allowance for loan losses of
$26,224 and $26,003, respectively) $ 25,013,045 23,789,552
Cash and cash equivalents:
Cash and cash equivalents - not held at a related party 41,743 38,705
Cash and cash equivalents - held at a related party 78,825 67,381
-------------- -----------------
Total cash and cash equivalents 120,568 106,086
Restricted cash 1,029,525 1,388,719
Restricted investments 114,763 129,132
Restricted cash - due to customers 77,237 153,557
Accrued interest receivable 547,109 503,365
Accounts receivable, net 57,307 64,859
Goodwill 191,214 191,420
Intangible assets, net 154,176 162,994
Property and equipment, net 71,091 67,924
Other assets 89,926 93,166
Fair value of derivative instruments 140,831 146,099
-------------- -----------------
Total assets $ 27,606,792 26,796,873
============== =================
LIABILITIES:
Bonds and notes payable $ 26,537,482 25,562,119
Accrued interest payable 114,791 120,211
Other liabilities 257,230 261,163
Due to customers 77,237 153,557
Fair value of derivative instruments 8,934 27,973
-------------- -----------------
Total liabilities 26,995,674 26,125,023
-------------- -----------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value. Authorized 50,000,000 shares;
no shares issued or outstanding -- --
Common stock:
Class A, $0.01 par value. Authorized 600,000,000 shares;
issued and outstanding 38,097,623 shares as of March 31,
2007 and 39,035,169 shares as of December 31, 2006 381 390
Class B, $0.01 par value. Authorized 60,000,000 shares;
issued and outstanding 11,495,377 shares as of March 31,
2007 and 13,505,812 shares as of December 31, 2006 115 135
Additional paid-in capital 110,254 182,846
Retained earnings 507,596 496,341
Unearned compensation (4,909) (5,168)
Employee notes receivable (2,701) (2,825)
Accumulated other comprehensive income, net of taxes 382 131
-------------- -----------------
Total shareholders' equity 611,118 671,850
-------------- -----------------
COMMITMENTS AND CONTINGENCIES
Total liabilities and shareholders' equity $ 27,606,792 26,796,873
============== =================
See accompanying notes to consolidated financial statements.
2
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
---------------------------
2007 2006
------------- ------------
INTEREST INCOME:
Loan interest $ 397,054 325,660
Investment interest 21,496 19,541
------------- ------------
Total interest income 418,550 345,201
INTEREST EXPENSE:
Interest on bonds and notes payable 350,226 258,949
------------- ------------
Net interest income 68,324 86,252
Less provision for loan losses 2,753 9,618
------------- ------------
Net interest income after provision
for loan losses 65,571 76,634
------------- ------------
OTHER INCOME (EXPENSE):
Loan and guarantee servicing income 49,445 47,074
Other fee-based income 40,029 18,155
Software services income 5,748 3,409
Other income 6,931 1,987
Derivative market value, foreign currency,
and put option adjustments and derivative
settlements, net (7,890) 44,007
------------- ------------
Total other income 94,263 114,632
------------- ------------
OPERATING EXPENSES:
Salaries and benefits 70,009 57,684
Other operating expenses:
Depreciation and amortization 11,740 9,405
Advertising and marketing 14,286 4,812
Professional and other services 10,271 7,816
Occupancy and communications 6,336 5,826
Postage and distribution 5,351 5,850
Trustee and other debt related fees 2,843 3,105
Other 15,350 13,749
------------- ------------
Total other operating expenses 66,177 50,563
------------- ------------
Total operating expenses 136,186 108,247
------------- ------------
Income before income taxes
and minority interest 23,648 83,019
Income tax expense 8,868 30,711
------------- ------------
Income before minority interest 14,780 52,308
Minority interest in subsidiary income -- (242)
------------- ------------
Net income $ 14,780 52,066
============= ============
Earnings per share, basic and diluted $ 0.29 0.96
============= ============
Weighted average shares outstanding,
basic and diluted 50,982,187 54,241,341
============= ============
See accompanying notes to consolidated financial statements.
3
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(Dollars in thousands, except share data)
(unaudited)
Preferred Common Stock Shares Class A Class B Additional
Stock ------------------------- Preferred Common Common Paid-in Retained
Shares Class A Class B Stock Stock Stock Capital Earnings
--------- ------------ ------------ ---------- ---------- --------- ----------- -----------
(Dollars in thousands, except share data)
Balance as of
December 31, 2005 -- 40,040,841 13,962,954 $ -- 400 140 220,432 428,186
Comprehensive income:
Net income -- -- -- -- -- -- -- 52,066
Other comprehensive
income related
to foreign
currency translation -- -- -- -- -- -- -- --
Total comprehensive
income
Issuance of common stock,
net of forfeitures -- 368,147 -- -- 3 -- 21,290 --
Compensation expense for
stock based awards -- -- -- -- -- -- -- --
Conversion of common stock -- 20,000 (20,000) -- 1 (1) -- --
--------- ------------ ------------ ---------- ---------- --------- ----------- -----------
Balance as of March 31, 2006 -- 40,428,988 13,942,954 $ -- 404 139 241,722 480,252
========= ============ ============ ========== ========== ========= =========== ===========
Balance as of December 31, 2006 -- 39,035,169 13,505,812 $ -- 390 135 182,846 496,341
Comprehensive income:
Net income -- -- -- -- -- -- -- 14,780
Other comprehensive
income:
Foreign currency
translation -- -- -- -- -- -- -- --
Non-pension
postretirement benefit
plan - amortization
of actuarial
loss and prior
service costs -- -- -- -- -- -- -- --
Total comprehensive
income
Cash dividend on
Class A and Class B
common stock -
$0.07 per share -- -- -- -- -- -- -- (3,464)
Adjustment to adopt
provisions of
FASB Interpretation
No. 48 -- -- -- -- -- -- -- (61)
Issuance of common stock,
net of forfeitures -- 113,091 -- -- 1 -- 2,838 --
Compensation expense for
stock based awards -- -- -- -- -- -- -- --
Repurchase of common stock -- (3,061,072) -- -- (30) -- (75,430) --
Conversion of common stock -- 2,010,435 (2,010,435) -- 20 (20) -- --
Payments received on employee
stock notes receivable -- -- -- -- -- -- -- --
--------- ------------ ------------ ---------- ---------- --------- ----------- -----------
Balance as of March 31, 2007 -- 38,097,623 11,495,377 $ -- 381 115 110,254 507,596
========= ============ ============ ========== ========== ========= =========== ===========
Continued
Accumulated
Unearned Employee Other Total
Compen- Notes Comprehensive Shareholders'
Sation Receivable Income Equity
--------- ----------- ------------ ---------------
(Dollars in thousands, except share data)
Balance as of
December 31, 2005 (86) -- 420 649,492
Comprehensive income:
Net income -- -- -- 52,066
Other comprehensive
income related
to foreign
currency translation -- -- (31) (31)
---------------
Total comprehensive
income 52,035
Issuance of common stock,
net of forfeitures (5,979) -- -- 15,314
Compensation expense for
stock based awards 365 -- -- 365
Conversion of common stock -- -- -- --
--------- ----------- ------------ ---------------
Balance as of March 31, 2006 (5,700) -- 389 717,206
========= =========== ============ ===============
Balance as of December 31, 2006 (5,168) (2,825) 131 671,850
Comprehensive income:
Net income -- -- -- 14,780
Other comprehensive
income:
Foreign currency
translation -- -- 252 252
Non-pension
postretirement benefi
plan - amortization
of actuarial
loss and prior
service costs -- -- (1) (1)
---------------
Total comprehensive
income 15,031
Cash dividend on
Class A and Class B
common stock -
$0.07 per share -- -- -- (3,464)
Adjustment to adopt
provisions of
FASB Interpretation
No. 48 -- -- -- (61)
Issuance of common stock,
net of forfeitures (499) -- -- 2,340
Compensation expense for
stock based awards 758 -- -- 758
Repurchase of common stock -- -- -- (75,460)
Conversion of common stock -- -- -- --
Payments received on employee
stock notes receivable -- 124 -- 124
--------- ----------- ------------ ---------------
Balance as of March 31, 2007 (4,909) (2,701) 382 611,118
========= =========== ============ ===============
See accompanying notes to consolidated financial statements.
4
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
2007 2006
------------- --------------
Net income $ 14,780 52,066
Adjustments to reconcile net income to net cash
provided by operating activities, net of business acquisitions:
Depreciation and amortization, including loan premiums and
deferred origination costs 70,698 33,845
Derivative market value adjustment (3,613) (50,278)
Foreign currency transaction adjustment 13,686 10,483
Change in value of put options issued in business acquisitions 2,057 532
Payments to terminate floor contracts (8,100) --
Gain on termination of floor contracts (2,058) --
Gain on sale of student loans (1,786) (481)
Non-cash compensation expense 844 484
Deferred income tax (benefit) expense (1,086) 16,370
Provision for loan losses 2,753 9,618
Other non-cash items (185) 381
Increase in accrued interest receivable (43,744) (45,510)
Decrease (increase) in accounts receivable 7,684 (2,809)
Decrease in other assets 2,506 6,356
(Decrease) increase in accrued interest payable (5,420) 7,542
(Decrease) increase in other liabilities (4,026) 1,212
----------- ------------
Net cash provided by operating activities 44,990 39,811
----------- ------------
Cash flows from investing activities,
net of business acquisitions:
Originations, purchases, and consolidations of
student loans, including loan premiums
and deferred origination costs (1,751,965) (1,637,804)
Purchases of student loans, including loan premiums,
from a related party (22,197) (126,648)
Net proceeds from student loan repayments,
claims, capitalized interest, and other 475,211 636,229
Proceeds from sale of student loans 53,432 37,657
Purchases of property and equipment, net (7,327) (5,514)
Decrease in restricted cash 359,194 72,960
Purchases of restricted investments (124,690) (210,552)
Proceeds from maturities of restricted investments 139,059 228,498
Distribution from equity method investment 100 --
Business acquisitions, net of cash acquired 1,883 (18,411)
----------- ------------
Net cash used in investing activities (877,300) (1,023,585)
----------- ------------
Cash flows from financing activities:
Payments on bonds and notes payable (690,492) (1,095,387)
Proceeds from issuance of bonds and notes payable 1,669,801 2,082,121
Payments on notes payable due to a related party, net (53,008) --
Payments of debt issuance costs (1,369) (5,544)
Dividends paid (3,464) --
Proceeds from issuance of common stock 525 467
Repurchases of common stock (75,460) --
Payments received on employee stock notes receivable 124 --
----------- ------------
Net cash provided by financing activities 846,657 981,657
----------- ------------
Effect of exchange rate fluctuations on cash 135 (26)
Net increase (decrease) in cash and cash equivalents 14,482 (2,143)
Cash and cash equivalents, beginning of period 106,086 103,650
----------- ------------
Cash and cash equivalents, end of period $ 120,568 101,507
=========== ============
Supplemental disclosures of cash flow information:
Interest paid $ 315,682 246,154
=========== ============
Income taxes paid, net of refunds $ 780 4,140
=========== ============
Supplemental disclosures of noncash operating, investing, and financing
activities regarding the Company's acquisitions are contained in note 4.
See accompanying notes to consolidated financial statements.
5
NELNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 2007 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2007 AND 2006 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE NOTED)
1. BASIS OF FINANCIAL REPORTING
The accompanying unaudited consolidated financial statements of Nelnet, Inc. and
subsidiaries (the "Company") as of March 31, 2007 and for the three months ended
March 31, 2007 and 2006 have been prepared on the same basis as the audited
consolidated financial statements for the year ended December 31, 2006 and, in
the opinion of the Company's management, the unaudited consolidated financial
statements reflect all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of results of operations for the interim
periods presented. The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates. Operating results for the three months ended March 31, 2007 are
not necessarily indicative of the results for the year ending December 31, 2007.
The unaudited consolidated financial statements should be read in conjunction
with the Company's Annual Report on Form 10-K for the year ended December 31,
2006. Certain amounts from 2006 have been reclassified to conform to the current
period presentation.
2. RECENT DEVELOPMENTS
DEPARTMENT OF EDUCATION SETTLEMENT
In June 2005, the Office of Inspector General of the U.S. Department of
Education (the "OIG") commenced an audit of the portion of the Company's student
loan portfolio receiving special allowance payments at a minimum 9.5% interest
rate based on provisions of the Higher Education Act and regulations and
guidance of the U.S. Department of Education (the "Department") and related
interpretations. On September 29, 2006, the Company received a final audit
report from the OIG where the OIG found that an increase in the amount of 9.5%
special allowance payments received by the Company was based on what the OIG
deemed to be ineligible loans.
On January 19, 2007, the Company entered into a Settlement Agreement with the
Department to resolve the OIG audit of the Company's portfolio of student loans
receiving 9.5% special allowance payments. Under the terms of the Settlement
Agreement, the Company is permitted to retain the 9.5% special allowance
payments that it received from the Department prior to July 1, 2006. In
addition, the Settlement Agreement eliminates all 9.5% special allowance
payments with respect to the Company's portfolios of student loans for periods
on and after July 1, 2006.
The Company disagrees with the OIG audit report, and continues to believe that
it billed for the 9.5% special allowance payments in accordance with applicable
laws, regulations, and the Department's previous guidance. As a part of the
Settlement Agreement, the Company and the Department acknowledge a dispute
exists related to guidance previously issued by the Department and the
application of the existing laws and regulations related to the Company
receiving certain 9.5% special allowance payments, and that the Settlement
Agreement is based in part on the parties' desire to avoid costly litigation
regarding that dispute. The new guidance provided to the Company in the
Settlement Agreement eliminates all 9.5% special allowance payments for the
Company. These loans will continue to receive special allowance payments using
other applicable special allowance formulas.
INDUSTRY INVESTIGATIONS AND REGULATORY DEVELOPMENTS
Since January 2007, a number of state attorneys general and the U.S. Senate
Committee on Health, Education, Labor, and Pensions have announced or are
reportedly conducting broad inquiries or investigations of the activities of
various participants in the student loan industry, including activities which
may involve perceived conflicts of interest. The general focus of the inquiries
or investigations to date has primarily been on any financial arrangements among
student loan lenders and other industry participants which may facilitate
increased volumes of student loans for particular lenders. Legislation
addressing certain issues raised by these inquiries or investigations has
recently been passed in New York, and similar federal legislation has been
introduced. Like many other student loan lenders, the Company has received
informal requests for information from certain state attorneys general and the
Chairman of the U.S. Senate Committee on Health, Education, Labor, and Pensions
in connection with their inquiries or investigations. In addition, the Company
has received subpoenas for information from the New York Attorney General and
the New Jersey Attorney General. In each case the Company is cooperating with
the requests and subpoenas for information that it has received.
6
On April 20, 2007, the Company announced that it had agreed with the Nebraska
Attorney General to voluntarily adopt a Nelnet Student Loan Code of Conduct,
post a review of the Company's business practices on its website, and commit $1
million to help educate students and families on how to plan and pay for their
education. While the Company cannot predict the ultimate outcome of any other
inquiry or investigation, it is possible these inquiries or investigations may
result in additional agreements. The Company currently believes that the
ultimate resolution of these inquiries or investigations and regulatory
developments will not have a material adverse effect on the Company's financial
condition or ongoing operations.
3. STUDENT LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Student loans receivable consist of the following:
AS OF AS OF
MARCH 31, 2007 DECEMBER 31, 2006
-------------- -----------------
Federally insured loans $ 24,392,160 23,217,321
Non-federally insured loans 224,870 197,147
------------- -------------
24,617,030 23,414,468
Unamortized loan premiums and deferred origination costs 422,239 401,087
Allowance for loan losses - federally insured loans (7,859) (7,601)
Allowance for loan losses - non-federally insured loans (18,365) (18,402)
------------- -------------
$ 25,013,045 23,789,552
============= =============
Non-federally insured allowance as a percentage of
ending balance of non-federally insured loans 8.17% 9.33%
Total allowance as a percentage of
ending balance of total loans 0.11% 0.11%
LOAN SALES
As part of the Company's asset management strategy, the Company periodically
sells student loan portfolios to third parties. During the three months ended
March 31, 2007 the Company sold $51.6 million (par value) of student loans
resulting in the recognition of a gain of $1.8 million. The gain on the sale of
the student loans is included in "other income" on the consolidated statement of
income.
4. BUSINESS ACQUISITIONS
The Company has positioned itself for growth by building a strong foundation
through business and certain asset acquisitions. Although the Company's assets,
loan portfolios, net interest income, and fee-based revenues increase through
such transactions, a key aspect of each transaction is its impact on the
Company's prospective organic growth and the development of its integrated
platform of services. The acquisitions described below expand the Company's
products and services offered to education and financial institutions and
students and families throughout the education and education finance process. In
addition, these acquisitions diversify the Company's asset generation streams
and/or diversify revenue by offering other products and services that are not
dependent on government programs, which management believes will reduce the
Company's exposure to legislation and political risk. The Company also expects
to reduce costs from theses acquisitions through economies of scale and by
integrating certain support services. In addition, the Company expects to
increase revenue from these acquisitions by offering multiple products and
services to its customers.
During 2006, the Company (i) purchased the remaining 20% of the stock of FACTS
Management Co. ("FACTS"), (ii) purchased the remaining 50% of the stock of
infiNET Integrated Solutions, Inc. ("infiNET"), (iii) purchased 100% of the
membership interests of CUnet, LLC ("CUnet"), and (iv) purchased certain assets
and assumed certain liabilities (hereafter referred to as "Peterson's") from
Thompson Learning Inc. These acquisitions were accounted for by the Company
under purchase accounting and are described in footnote 4 in the Company's
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2006. During the first quarter of
2007, the Company finalized the purchase price allocation of infiNET. The final
purchase price allocation of infiNET is presented below. The Company is in the
process valuing certain intangible assets of CUnet and Peterson's; thus, the
allocation of the purchase price is subject to refinement. The Company's
estimate of the value of certain intangible assets as of March 31, 2007 for
CUnet and Peterson's is presented below.
INFINET INTEGRATED SOLUTIONS, INC.
On April 20, 2004, the Company purchased 50% of the stock of infiNET for $4.9
million. On February 17, 2006, the Company purchased the remaining 50% of the
stock of infiNET. infiNET provides software for customer-focused electronic
transactions, information sharing, and electronic account and bill presentment
for colleges and universities. Consideration for the purchase of the remaining
50% of the stock of infiNET was $9.5 million in cash and 95,380 restricted
shares of the Company's Class A common stock. Under the terms of the purchase
agreement, the 95,380 shares of Class A common stock issued in the acquisition
are subject to stock price guaranty provisions whereby if on or about February
28, 2011 the average market trading price of the Class A common stock is less
than $104.8375 per share and has not exceeded that price for any 25 consecutive
trading days during the 5-year period from the closing of the acquisition to
February 28, 2011, then the Company must pay additional cash to the sellers of
infiNET for each share of Class A common stock issued in an amount representing
the difference between $104.8375 less the greater of $41.9335 or the gross sales
7
price such seller obtained from a prior sale of the shares. In connection with
the acquisition, the Company entered into employment agreements with two of the
infiNET sellers, in which the guaranteed value related to the shares of Class A
common stock issued is dependent on their continued employment with the Company.
Accordingly, the guaranteed value associated with the shares of Class A common
stock of $5.7 million issued to these employees was recorded as unearned
compensation in the accompanying consolidated balance sheet and will be
recognized by the Company as compensation expense over the three-year term of
the employment agreements. The total purchase price recorded by the Company to
acquire the remaining interest in infiNET was $13.8 million, which represents
the $9.5 million in cash and $4.3 million attributable to the guaranteed value
of the shares of Class A common stock issued to the infiNET shareholders other
than the two shareholders who entered into employment agreements with the
Company. Any cash paid by the Company in consideration of satisfying the
guaranteed value of stock issued for this acquisition would be recorded by the
Company as a reduction to additional paid-in capital.
Prior to purchasing the remaining 50% of the common stock of infiNET, the
Company accounted for this investment under the equity method. The purchase of
the remaining 50% of the stock of infiNET was accounted for under purchase
accounting and the results of operations have been included in the consolidated
financial statements from January 31, 2006, the effective date of the
acquisition.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition for the remaining 50% of the
stock of infiNET.
Cash and cash equivalents $ 3,266
Restricted cash - due to customers 16,343
Accounts receivable 558
Intangible assets 4,172
Property and equipment 134
Other assets 576
Excess cost over fair value of net assets
acquired (goodwill) 12,474
Due to customers (16,343)
Other liabilities (2,334)
Previously recorded investment in equity interest (5,047)
----------
$ 13,799
==========
As of the date of acquisition, the $4.2 million of acquired intangible assets
had a weighted average useful life of approximately seven years. The intangible
assets that made up this amount included non-competition agreements of $2.0
million (5-year useful life), customer relationships of $1.6 million (10-year
useful life), computer software of $0.4 million (5-year useful life), and trade
names of $0.2 million (3-year useful life). All intangible assets are amortized
using a straight-line amortization method with the exception of customer
relationships. The customer relationships intangible asset is amortized over the
period of projected revenues and expenses (cash flows) attributable to this
asset as of the date of acquisition. Because of customer attrition, the
estimated annual cash flows related to customer relationships diminish as time
extends from the date of acquisition. As such, the Company uses an accelerated
amortization method that reflects the pattern in which the estimated economic
benefits of this acquired asset is used by the Company.
The $12.5 million of goodwill was assigned to the Tuition Payment Processing and
Campus Commerce operating segment and is not expected to be deductible for tax
purposes.
CUNET, LLC
On June 30, 2006, the Company purchased 100% of the membership interests of
CUnet. The initial consideration paid by the Company was $40.1 million in cash,
including $0.1 million of direct acquisition costs. CUnet provides campus
locations and online schools with performance-based educational marketing,
web-based marketing, lead generation, and vendor management services to enhance
their brands and improve student recruitment and retention.
In addition to the initial purchase price, additional payments are to be paid by
the Company based on the operating results of CUnet. The contingent
consideration is based on the aggregate cumulative net income before taxes
(excluding any amortization of intangibles from the purchase price allocation)
of CUnet earned for the period from July 1, 2006 through June 30, 2009
("Cumulative Net Income"), provided, however, that the contingent consideration
may not exceed $80.0 million. The Company will calculate the Cumulative Net
Income as of each June 30, 2007, June 30, 2008, and June 30, 2009 (individually,
the "Calculation Period"). In partial satisfaction of the contingent
consideration, the Company will issue shares of Class A common stock subsequent
to each Calculation Period, provided, however, that the market value of the
shares issued shall not exceed $5.0 million in any one year, unless the Company
elects at its option to make a distribution in a higher amount. No later than
June 30, 2010, 10% of the remaining contingent consideration will be paid in
cash, and the balance of 90% of the contingent consideration will be paid in
cash no later than December 31, 2010. The cash portion of the contingent
consideration to be paid in December 2010 will be reduced by the market value as
of December 15, 2010 of any shares previously issued as contingent
consideration. The Company will record the contingency payments when the
applicable contingency is resolved and the additional consideration is issued or
issuable or the outcome of the contingency is determinable beyond a reasonable
doubt. In connection with the acquisition, the Company entered into employment
agreements with certain sellers, in which the contingency payments are related
to their continued employment with the Company. Accordingly, when these
contingency payments are paid, they will be recognized by the Company as
compensation expense over the remaining term of the employment agreements.
8
This acquisition was accounted for under purchase accounting and the results of
operations have been included in the consolidated financial statements from the
date of the acquisition.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition. The Company is in the
process of valuing certain intangible assets; thus, the allocation of the
purchase price is subject to refinement.
Accounts Receivable $ 5,154
Intangible assets 14,962
Property and equipment 360
Other assets 520
Excess cost over fair value of net
assets acquired (goodwill) 23,868
Other liabilities (4,776)
----------
$ 40,088
==========
As of the date of acquisition, the $15.0 million of acquired intangible assets
had a weighted-average useful life of approximately seven years. The intangible
assets that made up this amount included customer relationships of $10.4 million
(8-year useful life), non-competition agreements of $2.6 million (5-year useful
life), trade names of $1.7 million (4-year useful life), and computer software
of $0.3 million (3-year useful life). All intangible assets are amortized using
a straight-line amortization method with the exception of customer
relationships. The customer relationships intangible asset is amortized over the
period of projected revenues and expenses (cash flows) attributable to this
asset as of the date of acquisition. Because of customer attrition, the
estimated annual cash flows related to customer relationships diminish as time
extends from the date of acquisition. As such, the Company uses an accelerated
amortization method that reflects the pattern in which the estimated economic
benefits of this acquired asset is used by the Company.
The $23.9 million of goodwill was assigned to the Enrollment Services and List
Management operating segment and is expected to be deductible for tax purposes.
PETERSON'S
On July 27, 2006, the Company purchased certain assets and assumed certain
liabilities from Thomson Learning Inc. The initial consideration paid by the
Company was $38.6 million in cash. The final purchase price of Peterson's was
subject to certain purchase price adjustments as defined in the purchase price
agreement. During the first quarter of 2007, the purchase price for Peterson's
was finalized per the terms of the purchase agreement and the Company received a
$2.2 million working capital settlement. As such, the total consideration paid
by the Company for Peterson's was $36.4 million. Peterson's provides a
comprehensive suite of education and career-related solutions in the areas of
education search, test preparation, admissions, financial aid information, and
career assistance. Peterson's reaches an estimated 105 million consumers
annually with its publications and online information about colleges and
universities, career schools, graduate programs, distance learning, executive
training, private secondary schools, summer opportunities, study abroad,
financial aid, test preparation, and career exploration resources. This
acquisition was accounted for as a business combination under purchase
accounting and the results of operations have been included in the consolidated
financial statements from the date of the acquisition.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition. The Company is in the
process of valuing certain intangible assets; thus, the allocation of the
purchase price is subject to refinement.
Accounts receivable $ 7,055
Intangible assets 3,714
Property and equipment 2,341
Other assets 2,375
Excess cost over fair value of net
assets acquired (goodwill) 35,114
Other liabilities (14,173)
---------
$ 36,426
=========
As of the date of acquisition, the intangible assets consist of database content
and computer software of $1.9 million and $1.8 million, respectively, and are
being amortized using a straight-line amortization method over their estimated
useful life of three years.
The $35.1 million of goodwill was assigned to the Enrollment Services and List
Management operating segment and is expected to be deductible for tax purposes.
9
PRO FORMA INFORMATION
The following pro forma information presents the combined results of the Company
as though the 2006 acquisitions of FACTS (20%), infiNET, CUnet, and Peterson's
occurred as of the beginning of each reporting period. The pro forma information
does not necessarily reflect the results of operations if the acquisitions had
been in effect at the beginning of the period or that may be attained in the
future. In addition, the pro forma information reflects the results of
operations based on the Company's preliminary allocation of purchase price
(where applicable).
THREE MONTHS ENDED MARCH 31,
----------------------------
2007 2006
------------- --------------
Net interest income $ 68,324 86,283
Other income (expense) (a) 94,263 131,113
Net income 14,780 51,068
Weighted average shares outstanding,
basic and diluted 50,982,187 54,356,254
Earnings per share, basic and diluted $ 0.29 0.94
(a) Other income (expense) includes derivative market value, foreign
currency, and put option adjustments and net derivative
settlements.
5. INTANGIBLE ASSETS AND GOODWILL
Intangible assets consist of the following:
WEIGHTED
AVERAGE
REMAINING
USEFUL LIFE AS AS OF AS OF
OF MARCH 31, MARCH 31, DECEMBER 31,
2007 2007 2006
-------------- ---------- ------------
Amortizable intangible assets:
Customer relationships (net of accumulated
amortization of $14,143 and $11,515, respectively) 124 months $ 66,893 68,736
Covenants not to compete (net of accumulated
amortization of $11,542 and $9,559, respectively) 54 months 33,440 37,573
Loan origination rights (net of accumulated
amortization of $8,323 and $7,238, respectively) 65 months 26,485 27,571
Student lists (net of accumulated amortization of
$4,269 and $3,757, respectively) 23 months 3,928 4,440
Trade names (net of accumulated amortization of
$506 and $363, respectively) 36 months 1,604 1,746
Computer software (net of accumulated
amortization of $2,147 and $1,759, respectively) 15 months 3,036 3,578
Other (net of accumulated amortization of $470 and
$348, respectively) 9 months 1,691 2,251
-------------- ---------- -----------
Total - amortizable intangible assets 89 months 137,077 145,895
==============
Unamortizable intangible assets - trade names 17,099 17,099
---------- -----------
$154,176 162,994
========== ===========
10
The Company recorded amortization expense on its intangible assets of $6.9
million and $5.6 million for the three months ended March 31, 2007 and 2006,
respectively. The Company will continue to amortize intangible assets over their
remaining useful lives. As disclosed in note 4, the Company is in the process of
obtaining third party valuations of certain intangible assets; however, as of
March 31, 2007 the Company estimates it will record amortization expense as
follows:
2007 $ 20,552
2008 25,851
2009 22,130
2010 18,170
2011 12,841
2012 and thereafter 37,533
---------
$ 137,077
=========
The change in the carrying amount of goodwill by operating segment was as
follows:
Tuition
Asset Payment Enrollment Software
Generation Student Loan Processing Services and
and and Guaranty and Campus and List Technical
Management Servicing Commerce Management Services Total
---------- ----------- ----------- ---------- ---------- -----------
Balance as of December 31, 2006 $ 42,550 -- 57,858 82,416 8,596 191,420
Goodwill from prior period
acquisition allocated
during the period -- -- 228 (434) -- (206)
---------- ----------- ----------- ---------- ---------- -----------
Balance as of March 31, 2007 $ 42,550 -- 58,086 81,982 8,596 191,214
========== =========== =========== ========== ========== ===========
11
6. BONDS AND NOTES PAYABLE
The following tables summarize outstanding bonds and notes payable by type of
instrument:
AS OF MARCH 31, 2007
---------------------------------------------
CARRYING INTEREST RATE
AMOUNT RANGE FINAL MATURITY
------------- ------------- ----------------
Variable-rate bonds and notes (a):
Bonds and notes based on indices $ 16,126,370 3.70% - 6.06% 04/01/07 - 05/01/42
Bonds and notes based on auction 2,435,820 3.58% - 5.40% 11/01/09 - 07/01/43
-------------
Total variable-rate bonds and notes 18,562,190
Commercial paper and other 6,922,096 5.32% - 5.59% 05/11/07 - 11/28/07
Fixed-rate bonds and notes (a) 376,394 5.20% - 6.68% 11/01/09 - 05/01/29
Unsecured fixed rate debt 475,000 5.13% - 7.40% 06/01/10 - 09/29/36
Unsecured line of credit 141,619 5.36% - 5.40% 4/27/07
Other borrowings 60,183 5.10% - 5.78% 06/29/07 - 11/01/15
-------------
$ 26,537,482
=============
(a) Issued in securitization transactions
AS OF DECEMBER 31, 2006
---------------------------------------------
CARRYING INTEREST RATE
AMOUNT RANGE FINAL MATURITY
------------ ------------- ----------------
Variable-rate bonds and notes (a):
Bonds and notes based on indices $ 16,622,385 3.63% - 6.08% 02/26/07 - 05/01/42
Bonds and notes based on auction 2,671,370 3.63% - 5.45% 11/01/09 - 07/01/43
------------
Total variable-rate bonds and notes 19,293,755
Commercial paper and other 5,173,723 5.26% - 5.62% 05/11/07 - 10/17/08
Fixed-rate bonds and notes (a) 403,431 5.20% - 6.68% 11/01/09 - 05/01/29
Unsecured fixed rate debt 475,000 5.13% - 7.40% 06/01/10 - 09/29/36
Unsecured line of credit 103,000 5.69% - 8.25% 08/19/10
Other borrowings 113,210 5.10% - 5.78% 06/29/07 - 11/01/15
------------
$ 25,562,119
============
(a) Issued in securitization transactions
As of March 31, 2007, the Company had a loan warehousing capacity of $4.3
billion, of which $3.6 billion was outstanding, through bank supported
commercial paper conduit programs. The Company had $0.7 billion in warehouse
capacity available under its warehouse facilities as of March 31, 2007.
In August 2006, the Company established a $5.0 billion loan warehouse program
under which it can issue one or more short-term extendable secured liquidity
notes (the "Secured Liquidity Notes"). The Secured Liquidity Notes are secured
by Federal Family Education Loan Program ("FFELP" or "FFEL Program") loans
purchased in connection with the program. As of March 31, 2007, the Company had
$3.4 billion of Secured Liquidity Notes outstanding and an additional $1.6
billion authorized for future issuance under this warehouse program.
On August 19, 2005, the Company entered into a credit agreement for a $500.0
million unsecured line of credit. As of March 31, 2007, there were no borrowings
outstanding on this line and $500.0 million available for future use. On May 8,
2007, the Company amended this agreement to increase the line of credit to $750
million. The amended agreement terminates in May 2012.
12
On January 24, 2007, the Company established a $475 million unsecured commercial
paper program. Under the program, the Company may issue commercial paper for
general corporate purposes. The maturities of the notes issued under this
program will vary, but may not exceed 397 days from the date of issue. Notes
issued under this program will bear interest at rates that will vary based on
market conditions at the time of issuance. As of March 31, 2007, there was
$141.6 million outstanding under this program and $333.4 million available for
future use.
As of March 31, 2007 and December 31, 2006, bonds and notes payable includes
$55.1 million and $108.1 million of notes due, respectively, to Union Bank and
Trust, an entity under common control with the Company. The Company has used the
proceeds from these notes to invest in student loan assets via a participation
agreement.
Notes issued in February 2006 and May 2006 included (euro)420.5 million and
(euro)352.7 million (500.0 million and 450.0 million in U.S. dollars,
respectively) with variable interest rates initially based on a spread to
EURIBOR (the "Euro Notes"). As of March 31, 2007 and 2006, the Euro Notes were
recorded on the Company's balance sheet at $1.0 billion and $510.5 million,
respectively. The increase in the principal amount of Euro Notes as a result of
the fluctuation of the foreign currency exchange rate of $13.7 million and $10.5
million for the three months ended March 31, 2007 and 2006, respectively, is
included in the "derivative market value, foreign currency, and put option
adjustments and derivative settlements, net" in the consolidated statements of
operations. Concurrently with the issuance of the Euro Notes, the Company
entered into cross-currency interest rate swaps which are further discussed in
note 7.
7. DERIVATIVE FINANCIAL INSTRUMENTS
The Company maintains an overall risk management strategy that incorporates the
use of derivative instruments to reduce the economic effect of interest rate
volatility and fluctuations in foreign currency exchange rates. Derivative
instruments used as part of the Company's risk management strategy include
interest rate swaps, basis swaps, interest rate floor contracts, and
cross-currency interest rate swaps.
INTEREST RATE SWAPS
The Company uses interest rate swaps to hedge fixed-rate student loan assets.
The following table summarizes the outstanding interest rate swaps as of March
31, 2007 used by the Company to hedge its fixed-rate loan portfolio:
Weighted average
Notional fixed rate paid by
Maturity values the Company
----------- ----------- ------------------
2008 $462,500 3.76 %
2009 312,500 4.01
----------- ----------------
Total $775,000 3.86 %
=========== ================
As previously disclosed, the Company reached a Settlement Agreement with the
Department to resolve the audit by the OIG of the Company's portfolio of student
loans receiving 9.5% special allowance payments. Under the terms of the
Agreement, the Company will no longer receive 9.5% special allowance payments.
In consideration of not receiving the 9.5% special allowance payments on a
prospective basis, the Company entered into a series of off-setting interest
rate swaps that mirror the $2.45 billion in pre-existing interest rate swaps
that the Company had utilized to hedge its loan portfolio receiving 9.5% special
allowance payments against increases in interest rates. The net effect of the
new offsetting derivatives is to lock in a series of future income streams on
underlying trades through their respective maturity dates. The following table
summarizes these derivatives is as of March 31, 2007:
Weighted Weighted
average fixed average fixed
Notional rate paid by Notional rate received by
Maturity Amount the Company Amount the Company
------------ ------------ -------------- ----------- ----------------
2007 $ 512,500 3.42 % $ 512,500 5.25 %
2010 1,137,500 4.25 1,137,500 4.75
2012 275,000 4.31 275,000 4.76
2013 525,000 4.36 525,000 4.80
------------ -------------- ----------- ----------------
$ 2,450,000 4.11 % $ 2,450,000 4.87 %
============ ============== =========== ================
13
BASIS SWAPS
On May 1, 2006, the Company entered into three, 10-year basis swaps with
notional amounts of $500.0 million each in which the Company receives
three-month LIBOR and pays one-month LIBOR less a spread as defined in the
agreements. The effective dates of these agreements were November 25, 2006,
December 25, 2006, and January 25, 2007.
On April 4, 2007, the Company entered into three, 2-year swaps with notional
amounts of $1.0 billion each. For each swap, the Company receives three-month
LIBOR set discretely in advance and pays a daily weighted average three-month
LIBOR less a spread as defined in the agreements. The effective dates of these
agreements are May 27, 2008, June 25, 2008, and July 25, 2008. The Company
entered into these derivative instruments to better match the interest rate
characteristics on its student loan assets and the debt funding such assets.
INTEREST RATE FLOOR CONTRACTS
In June 2006, the Company entered into interest rate floor contracts in which
the Company received an upfront fee of $8.6 million. These contracts were
structured to monetize on an upfront basis the potential floor income associated
with certain consolidation loans. On January 30, 2007, the Company paid $8.1
million to terminate these interest rate floor contracts which resulted in the
recognition of a $2.1 million gain that is included in other income on the
consolidated statement of income.
CROSS-CURRENCY INTEREST RATE SWAPS
The Company entered into derivative instruments in 2006 as a result of the
issuance of the Euro Notes as discussed in note 6. Under the terms of these
derivative instrument agreements, the Company receives from a counterparty a
spread to the EURIBOR index based on a notional amount of (euro)420.5 million
and (euro)352.7 million, respectively, and pays a spread to the LIBOR index
based on a notional amount of $500.0 million and $450.0 million, respectively.
In addition, under the terms of these agreements, all principal payments on the
Euro Notes will effectively be paid at the exchange rate in effect as of the
issuance of these notes.
ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS
The Company accounts for derivative instruments under Statement of Financial
Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES ("SFAS No. 133"), which requires that every derivative
instrument be recorded on the balance sheet as either an asset or liability
measured at its fair value. Management has structured all of the Company's
derivative transactions with the intent that each is economically effective;
however, the Company's derivative instruments do not qualify for hedge
accounting under SFAS No. 133. As a result, the change in fair value of
derivative instruments is recorded in the consolidated statements of income at
each reporting date.
As of March 31, 2007, the net fair value of the Company's derivative portfolio
was $131.9 million and the net decrease in the fair value of the Company's
derivative portfolio included in "derivative market value, foreign currency, and
put option adjustments and derivative settlements, net" on the Company's
consolidated statements of income resulted in a gain of $3.6 million and $50.3
million for the three months ended March 31, 2007 and 2006, respectively.
The following table summarizes the net derivative settlements for the three
months ended March 31, 2007 and 2006, which are included in the "derivative
market value, foreign currency, and put option adjustments and derivative
settlements, net" on the consolidated statements of income:
Three months ended
--------------------------
March 31, March 31,
2007 2006
------------ ------------
Interest rate swaps $ 7,499 6,210
Basis swaps 60 (314)
Cross-currency interest rate swaps (3,319) (1,152)
------------ ------------
Derivative settlements, net $ 4,240 4,744
============ ============
By using derivative instruments, the Company is exposed to credit and market
risk. When the fair value of a derivative contract is positive, this generally
indicates that the counterparty owes the Company. If the counterparty fails to
perform, credit risk is equal to the extent of the fair value gain in a
derivative. When the fair value of a derivative contract is negative, the
Company owes the counterparty and, therefore, it has no credit risk. The Company
minimizes the credit (or repayment) risk in derivative instruments by entering
into transactions with high-quality counterparties that are reviewed
periodically by the Company's risk committee. The Company also maintains a
policy of requiring that all derivative contracts be governed by an
International Swaps and Derivatives Association, Inc. Master Agreement.
Market risk is the adverse effect that a change in interest rates, or implied
volatility rates, has on the value of a financial instrument. The Company
manages market risk associated with interest rates by establishing and
monitoring limits as to the types and degree of risk that may be undertaken.
14
8. SHAREHOLDERS' EQUITY
CONVERSION OF CLASS B COMMON STOCK
In February 2007, a principal shareholder gifted 10,435 shares of Class B common
stock to a charitable organization. Per the articles of incorporation, these
shares were voluntarily converted to Class A shares upon transfer. Also in
February 2007, in anticipation of selling shares to the Company under the
Company's stock repurchase program in a private transaction, a principal
shareholder voluntarily converted 2,000,000 shares of Class B common stock to
shares of Class A common stock.
STOCK REPURCHASE PROGRAM
In February 2007, the Company's Board of Directors increased the number of
shares the Company is authorized to repurchase under a stock repurchase program
from five million to 10 million shares of the Company's Class A common stock.
The program has an expiration date of May 24, 2008. During the three months
ended March 31, 2007, the Company repurchased 3,061,072 shares of Class A common
stock, including 2,725,000 shares repurchased from certain members of management
of the Company, for $75.5 million (average price of $24.65 per share) under this
authority.
CASH DIVIDEND
On February 7, 2007, the Company's Board of Directors approved a cash dividend
of $0.07 per share on the Company's Class A and Class B common stock which was
paid on March 15, 2007 to shareholders of record as of March 1, 2007.
9. INCOME TAXES
On January 1, 2007, the Company adopted the provisions of Financial Accounting
Standards Board Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME
TAXES--AN INTERPRETATION OF FASB STATEMENT NO. 109 ("FIN 48"), which clarifies
the accounting for uncertainty in income tax positions. This interpretation
requires the Company to recognize in the consolidated financial statements only
those tax positions determined to be more likely than not of being sustained
upon examination, based on the technical merits of the positions. Upon adoption,
the Company recognized approximately $61,000 of tax liabilities for positions
that were previously recognized, of which the Company accounted for as a
reduction to retained earnings. Additionally, the adoption of FIN 48 resulted in
the recognition of additional tax reserves for positions where there is
uncertainty about the timing or character of such deductibility. These
additional reserves were largely offset by increased deferred tax assets.
After considering the impact of adopting FIN 48, the Company had a $10.8 million
reserve for uncertain income tax positions as of January 1, 2007. Movement in
the reserve balance during the three months ended March 31, 2007 was not
material. The Company currently anticipates such uncertain income tax positions
will decrease by $3.7 million prior to March 31, 2008; however, actual
developments in this area could differ from those currently expected. The
majority of such unrecognized tax positions, if ever recognized in the financial
statements, would be recorded in the statement of operations as part of the
income tax provision.
The Company's policy is to recognize interest and penalties accrued on uncertain
tax positions as part of interest expense and other expense, respectively. As of
January 1, 2007, approximately $1.5 million in accrued interest and penalties
was included in other liabilities. The impact of timing differences and tax
attributes are considered when calculating interest and penalty accruals
associated with the unrecognized tax benefits. The change in the accrual for
interest and penalties for the three months ended March 31, 2007 was
approximately $269,000.
The Company and its subsidiaries file a consolidated federal income tax return
in the U.S. and the Company or one of its subsidiaries files income tax returns
in various state, local, and foreign jurisdictions. With few exceptions, the
Company is not subject to federal or foreign income tax examinations for taxable
years prior to 2003, or state and local examinations prior to 2002.
As a U.S. corporation, Nelnet, Inc. and its subsidiaries are subject to U.S.
taxation, currently, on all foreign pretax earnings earned by a foreign branch.
Pretax earnings of a foreign subsidiary or affiliate are subject to U.S.
taxation when effectively repatriated. The Company provides income taxes on
undistributed earnings on non-U.S. subsidiaries except to the extent that such
earnings are indefinitely invested outside of the United States. At March 31,
2007, $6.7 million of accumulated undistributed earnings of EDULINX Canada
Corporation ("EDULINX"), the Company's only non-U.S. subsidiary, was
indefinitely invested. At the existing U.S. federal income tax rate, additional
taxes (net of U.S. foreign tax credits) of approximately $552,000 would have to
be provided if those earnings were remitted currently.
15
10. SEGMENT REPORTING
The Company has five operating segments as defined in SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF ENTERPRISE AND RELATED INFORMATION ("SFAS No. 131") as
follows: Asset Generation and Management, Student Loan and Guaranty Servicing,
Tuition Payment Processing and Campus Commerce, Enrollment Services and List
Management, and Software and Technical Services. The Company's operating
segments are defined by the products and services they offer or the types of
customers they serve, and they reflect the manner in which financial information
is currently evaluated by management. During 2006, the Company changed the
structure of its internal organization in a manner that caused the composition
of its operating segments to change. As a result, the presentation of segment
financial information for the three months ended March 31, 2006, has been
restated to conform to the current operating segment presentation. The
accounting policies of the Company's operating segments are the same as those
described in the summary of significant accounting policies included in the
Company's consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2006. Intersegment revenues
are charged by a segment to another segment that provides the product or
service. The amount of intersegment revenue is based on comparable fees charged
in the market. Intersegment revenues and expenses are included within each
segment consistent with the income statement presentation provided to
management. Changes in management structure or allocation methodologies and
procedures may result in changes in reported segment financial information.
The management reporting process measures the performance of the Company's
operating segments based on the management structure of the Company as well as
the methodology used by management to evaluate performance and allocate
resources. Management, including the Company's chief operating decision maker,
evaluates the performance of the Company's operating segments based on their
profitability. As discussed further below, management measures the profitability
of the Company's operating segments based on "base net income." Accordingly,
information regarding the Company's operating segments is provided based on
"base net income." The Company's "base net income" is not a defined term within
GAAP and may not be comparable to similarly titled measures reported by other
companies. Unlike financial accounting, there is no comprehensive, authoritative
guidance for management reporting.
Substantially all of the Company's revenues are earned from customers in the
United States except for revenue generated from servicing Canadian student loans
at EDULINX. For the three months ended March 31, 2007 and 2006, the Company
recognized $19.0 million and $16.8 million, respectively, from Canadian student
loan servicing customers. The business of servicing Canadian student loans by
EDULINX is limited to a small group of servicing customers and the agreement
with the largest of such customers is currently scheduled to expire on March 31,
2008. For the three months ended March 31, 2007 and 2006, the Company recognized
$14.9 million, or 9.2%, and $12.6 million, or 8.1%, respectively, of its total
consolidated revenue from this customer.
ASSET GENERATION AND MANAGEMENT
In the Company's Asset Generation and Management segment, the Company generates
primarily federally guaranteed student loans, which are administered by the
Department in the FFELP, through direct origination or through acquisitions. The
student loan assets are held in a series of education lending subsidiaries
designed specifically for this purpose. Revenues are primarily generated from
net interest income on the student loan assets. Earnings and earnings growth are
directly affected by the size of the Company's portfolio of student loans, the
interest rate characteristics of its portfolio, the costs associated with
financing, servicing, and managing its portfolio, and the costs associated with
origination and acquisition of the student loans in the portfolio, which
includes, among other things, borrower benefits and rebate fees paid to the
federal government. The Company generates the majority of its earnings from the
spread, referred to as its student loan spread, between the yield it receives on
its student loan portfolio and the costs previously described. While the spread
may vary due to fluctuations in interest rates, the special allowance payments
the Company receives from the federal government ensure the Company receives a
minimum yield on its student loans, so long as certain requirements are met.
STUDENT LOAN AND GUARANTY SERVICING
The Student Loan and Guaranty Servicing segment provides for the servicing of
the Company's student loan portfolios and the portfolios of third parties and
servicing provided to guaranty agencies. The servicing activities include
application processing, underwriting, disbursement of funds, customer service,
account maintenance, federal reporting and billing collections, payment
processing, default aversion, claim filing, and recovery/collection services.
These activities are performed internally for the Company's portfolio in
addition to generating fee revenue when performed for third-party clients. The
following are the primary product and service offerings the Company offers as
part of its Student Loan and Guaranty Servicing segment:
o Origination and servicing of FFELP loans;
o Origination and servicing of non-federally insured student loans;
o Servicing and support outsourcing for guaranty agencies; and
o Origination and servicing of loans under the Canadian
government-sponsored student loan program.
16
TUITION PAYMENT PROCESSING AND CAMPUS COMMERCE
The Tuition Payment Processing and Campus Commerce segment provides actively
managed tuition payment solutions, online payment processing, detailed
information reporting, and data integration services to K-12 and post-secondary
educational institutions, families, and students. In addition, this segment
provides financial needs analysis for students applying for aid in private and
parochial K-12 schools. This segment also provides customer-focused electronic
transactions, information sharing, and account and bill presentment to
educational institutions.
ENROLLMENT SERVICES AND LIST MANAGEMENT
The Enrollment Services and List Management segment provides a wide range of
direct marketing products and services to help schools and businesses reach the
middle school, high school, college bound high school, college, and young adult
market places. In addition, this segment offers enrollment products and services
that are focused on helping i) education seeking families plan for and prepare
for college and ii) colleges recruit and retain students.
SOFTWARE AND TECHNICAL SERVICES
The Software and Technical Services segment uses internally developed student
loan servicing software and also provides this software to third-party student
loan holders and servicers. In addition, this segment provides information
technology products and services, with core areas of business in student loan
software solutions for schools, lenders, and guarantors; technical consulting
services; and enterprise content management.
SEGMENT OPERATING RESULTS - "BASE NET INCOME"
The tables below include the operating results of each of the Company's
operating segments. Management, including the chief operating decision maker,
evaluates the Company on certain non-GAAP performance measures that the Company
refers to as "base net income" for each operating segment. While "base net
income" is not a substitute for reported results under GAAP, the Company relies
on "base net income" to manage each operating segment because it believes this
measure provides additional information regarding the operational and
performance indicators that are most closely assessed by management.
"Base net income" is the primary financial performance measure used by
management to develop the Company's financial plans, track results, and
establish corporate performance targets and incentive compensation. Management
believes this information provides additional insight into the financial
performance of the core business activities of the Company's operating segments.
Accordingly, the tables presented below reflect "base net income," which is the
operating measure reviewed and utilized by management to manage the business.
Reconciliation of the segment totals to the Company's operating results in
accordance with GAAP are also included in the tables below.
17
SEGMENT RESULTS AND RECONCILIATIONS TO GAAP
Three Months Ended March 31, 2007
--------------------------------------------------------------------------------------------------------
Student Tuition Enrollment "Base Net
Asset Loan Payment Services Software Corporate Eliminations income"
Generation and Processing and and Activity and adjustments GAAP
and Guaranty and Campus List Technical Total and Reclassifi- to GAAP Results of
Management Servicing Commerce Management Services Segments Overhead cations results Operations
-------------------------------------------------------------------------------------------------------
Total interest income $ 414,490 2,315 1,010 87 18 417,920 3,801 (3,171) -- 418,550
Interest expense 341,658 -- 5 2 -- 341,665 11,732 (3,171) -- 350,226
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Net interest income 72,832 2,315 1,005 85 18 76,255 (7,931) -- -- 68,324
Less provision for
loan losses 2,753 -- -- -- -- 2,753 -- -- -- 2,753
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Net interest income
after provision
for loan losses 70,079 2,315 1,005 85 18 73,502 (7,931) -- -- 65,571
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Other income (expense):
Loan and guarantee
servicing income -- 49,445 -- -- -- 49,445 -- -- -- 49,445
Other fee-based income 3,311 -- 11,771 24,947 -- 40,029 -- -- -- 40,029
Software services
income -- -- -- 130 5,618 5,748 -- -- -- 5,748
Other income 4,829 58 3 -- -- 4,890 2,041 -- -- 6,931
Intersegment revenue -- 16,464 152 750 3,832 21,198 2,016 (23,214) -- --
Derivative market
value,
foreign currency,
and put option
adjustments -- -- -- -- -- -- -- -- (12,130) (12,130)
Derivative
settlements, net (424) -- -- -- -- (424) 4,664 -- -- 4,240
--------- -------- -------- -------- -------- ---------- -------- ---------- ---------- -----------
Total other
income (expense) 7,716 65,967 11,926 25,827 9,450 120,886 8,721 (23,214) (12,130) 94,263
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Operating expenses:
Salaries and benefits 7,279 31,309 4,918 9,369 6,475 59,350 12,706 (2,524) 477 70,009
Other expenses 8,265 15,353 2,160 14,559 784 41,121 18,138 -- 6,918 66,177
Intersegment expenses 16,636 3,318 374 156 -- 20,484 206 (20,690) -- --
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Total operating
expenses 32,180 49,980 7,452 24,084 7,259 120,955 31,050 (23,214) 7,395 136,186
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Income (loss) before
income taxes 45,615 18,302 5,479 1,828 2,209 73,433 (30,260) -- (19,525) 23,648
Income tax expense
(benefit) (a) 17,105 6,863 2,055 686 828 27,537 (12,031) -- (6,638) 8,868
--------- -------- -------- -------- -------- ---------- -------- --------- ---------- -----------
Net income (loss) 28,510 11,439 3,424 1,142 1,381 45,896 (18,229) -- (12,887) 14,780
========= ======== ======== ======== ======== ========== ======== ========= ========== ===========
(a) Income taxes are based on a percentage of net income before tax for
the individual operating segment.
18
Three Months Ended March 31, 2006
--------------------------------------------------------------------------------------------------------
Student Tuition Enrollment "Base Net
Asset Loan Payment Services Software Corporate Eliminations income"
Generation and Processing and and Activity and Adjustments GAAP
and Guaranty and Campus List Technical Total and Reclassifi- to GAAP Results of
Management Servicing Commerce Management Services Segments Overhead cations results Operations
--------------------------------------------------------------------------------------------------------
Total interest income $ 341,976 1,873 882 83 18 344,832 535 (166) -- 345,201
Interest expense 253,833 -- 1 -- -- 253,834 5,281 (166) -- 258,949
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Net interest income 88,143 1,873 881 83 18 90,998 (4,746) -- -- 86,252
Less provision for
loan losses 9,618 -- -- -- -- 9,618 -- -- -- 9,618
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Net interest income
after provision
for loan losses 78,525 1,873 881 83 18 81,380 (4,746) -- -- 76,634
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Other income (expense):
Loan and guarantee
servicing income -- 47,074 -- -- -- 47,074 -- -- -- 47,074
Other fee-based income 2,899 -- 9,654 5,602 -- 18,155 -- -- -- 18,155
Software services
income 50 -- -- 6 3,353 3,409 -- -- -- 3,409
Other income 1,642 21 -- -- -- 1,663 324 -- -- 1,987
Intersegment revenue -- 14,513 -- 752 3,920 19,185 41 (19,226) -- --
Derivative
market value,
foreign currency,
and put option
adjustments -- -- -- -- -- -- -- -- 39,263 39,263
Derivative
settlements, net 4,744 -- -- -- -- 4,744 -- -- -- 4,744
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Total other income
(expense) 9,335 61,608 9,654 6,360 7,273 94,230 365 (19,226) 39,263 114,632
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Operating expenses:
Salaries and benefits 11,771 28,054 3,955 1,178 4,716 49,674 10,183 (2,491) 318 57,684
Other expenses 12,045 15,053 2,048 1,393 735 31,274 13,656 -- 5,633 50,563
Intersegment expenses 12,876 3,157 -- -- -- 16,033 702 (16,735) -- --
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Total operating
expenses 36,692 46,264 6,003 2,571 5,451 96,981 24,541 (19,226) 5,951 108,247
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Income (loss) before
income taxes 51,168 17,217 4,532 3,872 1,840 78,629 (28,922) -- 33,312 83,019
Income tax expense
(benefit) (a) 18,933 6,370 1,677 1,432 680 29,092 (11,242) -- 12,861 30,711
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Net income (loss)
before minority
interest 32,235 10,847 2,855 2,440 1,160 49,537 (17,680) -- 20,451 52,308
Minority interest in
subsidiary income -- -- (242) -- -- (242) -- -- -- (242)
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- ----------
Net income (loss) $ 32,235 10,847 2,613 2,440 1,160 49,295 (17,680) -- 20,451 52,066
========== ======== ======== ======== ======== ========== ======== ======== ========== ==========
(a) Income taxes are based on a percentage of net income before tax for
the individual operating segment.
Corporate Activity and Overhead in the previous tables primarily includes the
following items:
o Income earned on certain investment activities;
o Interest expense incurred on unsecured debt transactions;
o Other products and service offerings that are not considered
operating segments; and
o Corporate activities and overhead functions such as executive
management, human resources, accounting and finance, legal,
marketing, and corporate technology support.
The assets held at the corporate level are not identified with any of the
operating segments. Accordingly, these assets are included in the reconciliation
of segment assets to total consolidated assets. These assets consist primarily
of cash, investments, property and equipment, and other assets.
The adjustments required to reconcile from the Company's "base net income"
measure to its GAAP results of operations relate to differing treatments for
derivatives, foreign currency transaction adjustments, and certain other items
that management does not consider in evaluating the Company's operating results.
The following table reflects adjustments associated with these areas by
operating segment and Corporate Activities and Overhead for the three months
ended March 31, 2007 and 2006:
19
Three Months Ended March 31, 2007
----------------------------------------------------------------------------------
Student Tuition Enrollment
Asset Loan Payment Services Software Corporate
Generation and Processing and and Activity
and Guaranty and Campus List Technical and
Management Servicing Commerce Management Services Overhead Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Derivative market value, foreign currency, and
put option adjustments (1) $ 6,214 -- -- -- -- 5,916 12,130
Amortization of intangible assets (2) 1,985 1,324 1,469 1,810 330 -- 6,918
Non-cash stock based compensation related
to business combinations (3) -- -- -- -- -- 477 477
Variable-rate floor income (4) -- -- -- -- -- --
Net tax effect (5) (3,116) (503) (558) (688) (125) (1,648) (6,638)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total adjustments to GAAP $ 5,083 821 911 1,122 205 4,745 12,887
========== ========== ========== ========== ========== ========== ==========
Three Months Ended March 31, 2006
----------------------------------------------------------------------------------
Student Tuition Enrollment
Asset Loan Payment Services Software Corporate
Generation and Processing and and Activity
and Guaranty and Campus List Technical and
Management Servicing Commerce Management Services Overhead Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Derivative market value, foreign currency, and
put option adjustments (1) $ (39,795) -- -- -- -- 532 (39,263)
Amortization of intangible assets (2) 2,227 1,501 1,175 610 120 -- 5,633
Non-cash stock based compensation related
to business combinations (3) -- -- -- -- -- 318 318
Variable-rate floor income (4) -- -- -- -- -- -- --
Net tax effect (5) 14,276 (570) (446) (232) (46) (121) 12,861
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total adjustments to GAAP $ (23,292) 931 729 378 74 729 (20,451)
========== ========== ========== ========== ========== ========== ==========
(1) Derivative market value, foreign currency, and put option
adjustments: "Base net income" excludes the periodic unrealized
gains and losses that are caused by the change in fair value on
derivatives in which the Company does not qualify for "hedge
treatment" under GAAP. Included in "base net income" are the
economic effects of the Company's derivative instruments, which
includes any cash paid or received being recognized as an
expense or revenue upon actual derivative settlements. "Base net
income" also excludes the foreign currency transaction gains or
losses caused by the re-measurement of the Company's
Euro-denominated bonds to U.S. dollars and the change in fair
value of put options issued by the Company for certain business
acquisitions.
(2) Amortization of intangible assets: "Base net income" excludes the
amortization of acquired intangibles.
(3) Non-cash stock based compensation related to business
combinations: As discussed in note 4, the Company has structured
certain business combinations in which the stock consideration
paid has been dependent on the sellers' continued employment with
the Company. As such, the value of the consideration paid is
recognized as compensation expense by the Company over the term
of the applicable employment agreement. "Base net income"
excludes this expense.
(4) Variable-rate floor income: Loans that reset annually on July 1
can generate excess spread income compared with the rate based on
the special allowance payment formula in declining interest rate
environments. The Company refers to this additional income as
variable-rate floor income. The Company excludes variable rate
floor income from its "base net income" since its timing and
amount (if any) is uncertain and it is in excess of expected
spreads.
(5) Tax effect computed at 38%. The change in the value of the put
option (included in Corporate Activity and Overhead) is not tax
effected as this is not deductible for income tax purposes.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS IS FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006. ALL DOLLARS
ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE NOTED).
The following discussion and analysis provides information that the Company's
management believes is relevant to an assessment and understanding of the
consolidated results of operations and financial condition of the Company. The
discussion should be read in conjunction with the Company's consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2006.
20
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
This report contains forward-looking statements and information based on
management's current expectations as of the date of this document. When used in
this report, the words "anticipate," "believe," "estimate," "intend," and
"expect" and similar expressions are intended to identify forward-looking
statements. These forward-looking statements are subject to risks,
uncertainties, assumptions, and other factors that may cause the actual results
to be materially different from those reflected in such forward-looking
statements. These factors include, among others, the risks and uncertainties set
forth in "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q and
the Company's Annual Report on Form 10-K for the year ended December 31, 2006
and changes in the terms of student loans and the educational credit marketplace
arising from the implementation of, or changes in, applicable laws and
regulations, which may reduce the volume, average term, special allowance
payments, and costs of yields on student loans under the Federal Family
Education Loan Program ("FFELP" or "FFEL Program") or result in loans being
originated or refinanced under non-FFEL programs or may affect the terms upon
which banks and others agree to sell FFELP loans to the Company. In addition, a
larger than expected increase in third party consolidations of the Company's
FFELP loans could materially adversely affect the Company's results of
operations. The Company could also be affected by changes in the demand for
educational financing or in financing preferences of lenders, educational
institutions, students, and their families; changes in the general interest rate
environment and in the securitization markets for education loans, which may
increase the costs or limit the availability of financings necessary to
initiate, purchase, or carry education loans; losses from loan defaults; changes
in prepayment rates, guaranty rates, loan floor rates, and credit spreads; and
the uncertain nature of the expected benefits from acquisitions and the ability
to successfully integrate operations. The reader should not place undue reliance
on forward-looking statements, which speak only as of the date of this Quarterly
Report on Form 10-Q. Additionally, financial projections may not prove to be
accurate and may vary materially. The Company is not obligated to publicly
release any revisions to forward-looking statements to reflect events after the
date of this Quarterly Report on Form 10-Q or unforeseen events. Although the
Company may from time to time voluntarily update its prior forward-looking
statements, it disclaims any commitment to do so except as required by
securities laws.
OVERVIEW
The Company is an education planning and financing company focused on providing
quality products and services to students, families, and schools nationwide. The
Company is a vertically-integrated organization that offers a broad range of
pre-college, in-college, and post-college products and services to its
customers.
Built through a focus on long-term organic growth and further enhanced by
strategic acquisitions, the Company earns its revenues from net interest income
on its portfolio of student loans and from fee-based revenues related to its
education finance and service operations.
During the three months ended March 31, 2007, the Company had solid asset
growth, diversified its revenue streams, increased fee-based revenue, and
deployed capital by repurchasing shares of the Company's stock and paying its
first quarterly dividend.
o Student loan assets increased by $3.7 billion, or 17%, as of
March 31, 2007 compared to March 31, 2006.
o Fee-based revenue for the three months ended March 31, 2007 was
$95.2 million, or 58% of total revenues, compared to $68.6
million, or 44% of total revenues, for the same period in 2006.
o The Company repurchased 3.1 million shares of its Class A common
stock, including 2.7 million from certain members of management,
for an average price of $24.65 per share. The Company has the
authority to repurchase an additional 5.0 million shares under
its existing stock repurchase program.
o On February 7, 2007, the Company's Board of Directors approved a
cash dividend of $0.07 per share on the Company's Class A and
Class B common stock which was paid by the Company on March 15,
2007 to shareholders of record as of March 1, 2007.
Net income reported based on generally accepted accounting principles for the
three months ended March 31, 2007 was $14.8 million compared to $52.1 million
for the same period in 2006. The change in net income was driven primarily by
the change in the derivative market value, foreign currency, and put option
adjustments, and not receiving 9.5% special allowance payments in accordance
with the Company's Settlement Agreement with the Department in January 2007.
RESULTS OF OPERATIONS
The Company's operating results are primarily driven by the performance of its
existing portfolio, the cost necessary to generate new assets, the revenues
generated by its fee based business, and the cost to provide those services. The
performance of the Company's portfolio is driven by net interest income and
losses related to credit quality of the assets along with the cost to administer
and service the assets and related debt.
21
ACQUISITIONS
Management believes the Company's business and asset acquisitions in recent
years have enhanced the Company's position as a vertically-integrated industry
leader and established a strong foundation for growth. Although the Company's
assets, loan portfolios, and fee-based revenues increased through such
transactions, a key aspect of each transaction is its impact on the Company's
prospective organic growth and the development of its integrated platform of
services. Management believes these acquisitions allow the Company to expand the
products and services offered to educational and financial institutions and
students and families throughout the education and education finance process. In
addition, these acquisitions diversify the Company's asset generation streams
and/or diversify revenue by offering other products and services that are not
dependent on government programs, which management believes will reduce the
Company's exposure to legislation and political risk. The Company also expects
to reduce costs from these acquisitions through economies of scale and by
integrating certain support services. In addition, the Company expects to
increase revenue from these acquisitions by offering multiple products and
services to its customers. As a result of these recent acquisitions and the
Company's rapid organic growth, the period-to-period comparability of the
Company's results of operations may be difficult.
NET INTEREST INCOME
The Company generates a significant portion of its earnings from the spread,
referred to as its student loan spread, between the yield the Company receives
on its student loan portfolio and the cost of funding these loans. This spread
income is reported on the Company's consolidated statements of income as net
interest income. The amortization of loan premiums, including capitalized costs
of origination, the consolidation loan rebate fee, and yield adjustments from
borrower benefit programs, are netted against loan interest income on the
Company's statements of income. The amortization of debt issuance costs is
included in interest expense on the Company's statements of income.
The Company's portfolio of FFELP loans originated prior to April 1, 2006 earns
interest at the higher of a variable rate based on the special allowance payment
(SAP) formula set by the U.S. Department of Education (the "Department") and the
borrower rate. The SAP formula is based on an applicable index plus a fixed
spread that is dependent upon when the loan was originated, the loan's repayment
status, and funding sources for the loan. As a result of one of the provisions
of the Higher Education Reconciliation Act of 2005 ("HERA"), the Company's
portfolio of FFELP loans originated on or after April 1, 2006 earns interest at
a variable rate based on the SAP formula. For the portfolio of loans originated
on or after April 1, 2006, when the borrower rate exceeds the variable rate
based on the SAP formula, the Company must return the excess to the Department.
On most consolidation loans, the Company must pay a 1.05% per year rebate fee to
the Department. Those consolidation loans that have variable interest rates
based on the SAP formula earn an annual yield less than that of a Stafford loan.
Those consolidation loans that have fixed interest rates less than the sum of
1.05% and the variable rate based on the SAP formula also earn an annual yield
less than that of a Stafford loan. As a result, as consolidation loans matching
these criteria become a larger portion of the Company's loan portfolio, there
will be a lower yield on the Company's loan portfolio in the short term.
However, due to the extended terms of consolidation loans, the Company expects
to earn the yield on these loans for a longer duration, making them beneficial
to the Company in the long term.
Because the Company generates a significant portion of its earnings from its
student loan spread, the interest rate sensitivity of the Company's balance
sheet is very important to its operations. The current and future interest rate
environment can and will affect the Company's interest earnings, net interest
income, and net income. The effects of changing interest rate environments are
further outlined in Item 3, "Quantitative and Qualitative Disclosures about
Market Risk -- Interest Rate Risk."
Investment interest income, which is a component of net interest income,
includes income from unrestricted interest-earning deposits and funds in the
Company's special purpose entities which are utilized for its asset-backed
securitizations.
PROVISION FOR LOAN LOSSES
Management estimates and establishes an allowance for loan losses through a
provision charged to expense. Losses are charged against the allowance when
management believes the collectibility of the loan principal is unlikely.
Recovery of amounts previously charged off is credited to the allowance for loan
losses. Management maintains the allowance for federally insured and
non-federally insured loans at a level believed to be adequate to provide for
estimated probable credit losses inherent in the loan portfolio. This evaluation
is inherently subjective because it requires estimates that may be susceptible
to significant changes. The Company analyzes the allowance separately for its
federally insured loans and its non-federally insured loans.
Management bases the allowance for the federally insured loan portfolio on
periodic evaluations of the Company's loan portfolios, considering past
experience, trends in student loan claims rejected for payment by guarantors,
changes to federal student loan programs, current economic conditions, and other
relevant factors. One of the changes to the Higher Education Act as a result of
HERA's enactment in February 2006, was to lower the guarantee rates on FFELP
loans, including a decrease in insurance and reinsurance on portfolios receiving
the benefit of the Exceptional Performance designation by 1%, from 100% to 99%
of principal and accrued interest (effective July 1, 2006), and a decrease in
insurance and reinsurance on portfolios not subject to the Exceptional
Performance designation by 1%, from 98% to 97% of principal and accrued interest
(effective for all loans first disbursed on and after July 1, 2006). In February
2006, as a result of the change in these legislative provisions, the Company
recorded an expense of $6.9 million ($4.3 million after tax) to increase the
Company's allowance for loan losses.
22
In September 2005, the Company was re-designated as an Exceptional Performer by
the Department in recognition of its exceptional level of performance in
servicing FFELP loans. As a result of this designation, the Company receives 99%
reimbursement (100% reimbursement prior to July 1, 2006) on all eligible FFELP
default claims submitted for reimbursement. Only FFELP loans that are serviced
by the Company, as well as loans owned by the Company and serviced by other
service providers designated as Exceptional Performers by the Department, are
eligible for the 99% reimbursement. As of March 31, 2007, 99.9% of the Company's
federally insured loans were serviced by providers designated as Exceptional
Performers. If the Company or a third party servicer were to lose its
Exceptional Performer designation, either by a legislative discontinuance of the
program or the Company or third party servicer not meeting the required
servicing standards or failing to get re-designated during the annual
application process, loans serviced by the Company or such third party would
become subject to the 3% risk sharing for all claims submitted after loss of the
designation (2% risk sharing effective for all loans disbursed prior to July 1,
2006).
In June 2006, the Company submitted its application for Exceptional Performer
redesignation to the Department to continue receiving reimbursements at the 99%
level for the 12-month period from June 1, 2006 through May 31, 2007. As of the
date of this Report, the Department has not notified the Company of its
redesignation. Until the Department confirms or denies the Company's application
for renewal, the Company continues to receive the benefit of the Exceptional
Performer designation. It is the opinion of the Company's management, based on
information currently known, that there is no reason to believe the Company's
application will be rejected. If the Department rejected the Company's
application for Exceptional Performer status, the Company would have to
establish a provision for loan losses related to the risk sharing on those loans
that the Company services internally. Based on the balance of federally insured
loans outstanding as of March 31, 2007, this provision would be approximately
$15.1 million.
In determining the adequacy of the allowance for loan losses on the
non-federally insured loans, the Company considers several factors including:
loans in repayment versus those in a nonpaying status, months in repayment,
delinquency status, type of program, and trends in defaults in the portfolio
based on Company and industry data. The Company places a non-federally insured
loan on nonaccrual status and charges off the loan when the collection of
principal and interest is 120 days past due.
OTHER INCOME
The Company also earns fees and generates income from other sources, including
principally loan and guaranty servicing income; fee-based income on borrower
late fees, payment management activities, and certain marketing and enrollment
services; and fees from providing software services.
LOAN AND GUARANTY SERVICING INCOME - Loan servicing fees are determined
according to individual agreements with customers and are calculated based on
the dollar value or number of loans serviced for each customer. Guaranty
servicing fees are calculated based on the number of loans serviced or amounts
collected. Revenue is recognized when earned pursuant to applicable agreements,
and when ultimate collection is assured.
OTHER FEE-BASED INCOME - Other fee-based income includes borrower late fee
income, payment management fees, the sale of lists and print products, and
subscription-based products and services. Borrower late fee income earned by the
Company's education lending subsidiaries is recognized when payments are
collected from the borrower. Fees for payment management services are recognized
over the period in which services are provided to customers. Revenue from the
sale of lists and printed products is generally earned and recognized, net of
estimated returns, upon shipment or delivery. Revenues from the sales of
subscription-based products and services are recognized ratably over the term of
the subscription. Subscription revenue received or receivable in advance of the
delivery of services is included in deferred revenue.
SOFTWARE SERVICES - Software services income is determined from individual
agreements with customers and includes license and maintenance fees associated
with student loan software products. Computer and software consulting services
are recognized over the period in which services are provided to customers.
Other income also includes the derivative market value and foreign currency
adjustments and derivative net settlements from the Company's derivative
instruments and Euro Notes as further discussed in Item 3, "Quantitative and
Qualitative Disclosures about Market Risk." The change in the fair value of put
options (issued as part of the consideration for certain business combinations)
is also included in other income.
OPERATING EXPENSES
Operating expenses includes indirect costs incurred to generate and acquire
student loans, costs incurred to manage and administer the Company's student
loan portfolio and its financing transactions, costs incurred to service the
Company's student loan portfolio and the portfolios of third parties, costs
incurred to provide tuition payment processing, campus commerce, enrollment,
list management, software, and technical services to third parties, and other
general and administrative expenses. Operating expenses also includes the
depreciation and amortization of capital assets and intangible assets.
23
RECENT DEVELOPMENTS
In June 2005, the Office of Inspector General of the U.S. Department of
Education (the "OIG") commenced an audit of the portion of the Company's student
loan portfolio receiving special allowance payments at a minimum 9.5% interest
rate based on provisions of the Higher Education Act and regulations and
guidance of the Department and related interpretations. On September 29, 2006,
the Company received a final audit report from the OIG where the OIG found that
an increase in the amount of 9.5% special allowance payments received by the
Company was based on what the OIG deemed to be ineligible loans.
On January 19, 2007, the Company entered into a Settlement Agreement with the
Department to resolve the OIG audit of the Company's portfolio of student loans
receiving 9.5% special allowance payments. Under the terms of the Settlement
Agreement, the Company is permitted to retain the 9.5% special allowance
payments that it received from the Department prior to July 1, 2006. In
addition, the Settlement Agreement eliminates all 9.5% special allowance
payments with respect to the Company's portfolios of student loans for periods
on and after July 1, 2006.
The Company disagrees with the OIG audit report, and continues to believe that
it billed for the 9.5% special allowance payments in accordance with applicable
laws, regulations, and the Department's previous guidance. As a part of the
Settlement Agreement, the Company and the Department acknowledge a dispute
exists related to guidance previously issued by the Department and the
application of the existing laws and regulations related to the Company
receiving certain 9.5% special allowance payments, and that the Settlement
Agreement is based in part on the parties' desire to avoid costly litigation
regarding that dispute. The new guidance provided to the Company in the
Settlement Agreement eliminates all future 9.5% special allowance payments for
the Company. These loans will continue to receive special allowance payments
using other applicable special allowance formulas.
The Company believes the prospective loss of the 9.5% special allowance payments
will not have a material adverse affect on the Company's operations. In
addition, the Company does not expect the Settlement Agreement to have any
material adverse effect on the outstanding debt obligations issued by the
Company's education lending subsidiaries in the securitization of student loan
assets. The Settlement Agreement resolves all issues between the Company and the
Department that arise out of or relate to the contents of the OIG audit report
and the Department's review of the issues raised therein. The Settlement
Agreement does not preclude any other government agency from reviewing the
issues raised in the OIG audit report.
INDUSTRY INVESTIGATIONS AND REGULATORY DEVELOPMENTS
Since January 2007, a number of state attorneys general and the U.S. Senate
Committee on Health, Education, Labor, and Pensions have announced or are
reportedly conducting broad inquiries or investigations of the activities of
various participants in the student loan industry, including activities which
may involve perceived conflicts of interest. The general focus of the inquiries
or investigations to date has primarily been on any financial arrangements among
student loan lenders and other industry participants which may facilitate
increased volumes of student loans for particular lenders. Legislation
addressing certain issues raised by these inquiries or investigations has
recently been passed in New York, and similar federal legislation has been
introduced. Like many other student loan lenders, the Company has received
informal requests for information from certain state attorneys general and the
Chairman of the U.S. Senate Committee on Health, Education, Labor, and Pensions
in connection with their inquiries or investigations. In addition, the Company
has received subpoenas for information from the New York Attorney General and
the New Jersey Attorney General. In each case the Company is cooperating with
the requests and subpoenas for information that it has received.
On April 20, 2007, the Company announced that it had agreed with the Nebraska
Attorney General to voluntarily adopt a Nelnet Student Loan Code of Conduct,
post a review of the Company's business practices on its website, and commit $1
million to help educate students and families on how to plan and pay for their
education. While the Company cannot predict the ultimate outcome of any other
inquiry or investigation, it is possible these inquiries or investigations may
result in additional agreements. The Company currently believes that the
ultimate resolution of these inquiries or investigations and regulatory
developments will not have a material adverse effect on the Company's financial
condition or ongoing operations.
EDULINX - LOSS OF SERVICING CONTRACT
Under its existing contract with the Government of Canada, EDULINX, a subsidiary
of the Company, provides services in support of the Canada and Integrated
Student Loan Programs ("CSLP") for student borrowers attending public
institutions. The Government of Canada is EDULINX's largest customer. On
December 22, 2006, EDULINX was notified that the Government of Canada had
decided to award the CSLP contract to another service provider upon the
expiration of the contract with EDULINX on March 31, 2008. As a result of this
decision, EDULINX will be required to transition the existing direct-financed
CSLP portfolio it services to the selected service provider. EDULINX's servicing
revenue for the three months ended March 31, 2007 and 2006 was $19.0 million and
$16.8, respectively, of which $14.9 million and $12.6 million was earned under
the CSLP contract, respectively.
24
PROPOSED LEGISLATION RELATED TO THE HIGHER EDUCATION ACT
The Department's authority to provide interest subsidy payments, special
allowance payments, and federal insurance for FFELP loans terminates on a date
specified in the Higher Education Act. The provisions of the Higher Education
Act governing the FFEL Program are periodically amended and the Higher Education
Act must be reauthorized by Congress from time to time in order to prevent
sunset of the Higher Education Act. Although HERA extended the authorization of
the FFEL Program through September 30, 2012, the remainder of the Higher
Education Act was not reauthorized under HERA. On September 30, 2006, President
Bush signed the Third Higher Education Extension Act of 2006 which provided a
temporary extension of the Higher Education Act through June 30, 2007. As of the
date of this Report, Congress has not passed any legislation which would
reauthorize or further extend the Higher Education Act.
Recently Congress introduced legislation and the President proposed a new budget
both of which contain provisions with significant implications for participants
in the FFEL Program. Among other things, these proposals include various
reductions in federal government payments to lenders and guaranty agencies and
increases in fees paid by lenders. The proposals include:
o reducing special allowance payments to lenders;
o reducing default insurance rates (including reducing default insurance
rates for lenders/servicers with an Exceptional Performer designation)
and the possible elimination of the Exceptional Performer program;
o increasing lender origination fees on consolidation loans;
o reduction of guaranty agency collection retention;
o changing the way guaranty agency account fees are charged;
o requiring disclosures relating to placement on "preferred
lender lists" and various arrangements between lenders and schools;
o banning lenders from offering certain gifts to school employees;
o encouraging borrowers to maximize their borrowing through government
loan programs prior to private loan programs with higher interest rates;
o increasing annual and aggregate loan limits for certain Stafford loans;
o reducing interest rates for subsidized Stafford loans;
o encouraging schools to participate in the Federal Direct Lending
Program through increased federal scholarship funds; and
o increasing the consolidation rebate fees for certain lenders.
As of the date of this Report, none of these proposals have been enacted into
law. While the Company supports the federal government's efforts to make higher
education more accessible and affordable, the Company does not support paying
for these efforts by cutting the FFEL Program, which originated approximately
71% of all Stafford, PLUS, and consolidation loans during 2006.
The impact of the proposed legislation is difficult to predict. If the proposed
federal government spending cuts and increased fees for FFEL Program
participants are enacted, the Company's revenues would be negatively impacted.
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
NET INTEREST INCOME
Three months ended March 31,
---------------------------
2007 2006 $ Change
------------ ------------ ----------
Interest income:
Loan interest $ 397,054 325,660 71,394
Investment interest 21,496 19,541 1,955
------------ ------------ ----------
Total interest income 418,550 345,201 73,349
Interest expense:
Interest on bonds and notes payable 350,226 258,949 91,277
------------ ------------ ----------
Net interest income 68,324 86,252 (17,928)
Provision for loan losses 2,753 9,618 (6,865)
Net interest income after
------------ ------------ ----------
provision for loan losses $ 65,571 76,634 (11,063)
============ ============ ==========
Net interest income decreased $11.1 million for the three months ended March 31,
2007 compared to the three months ended March 31, 2006. Net interest income for
the three months ended March 31, 2006 included $18.4 million of 9.5% special
allowance payments. In accordance with the Company's Settlement Agreement with
the Department in January 2007, there were no 9.5% special allowance payments in
2007. Excluding the 9.5% special allowance payments, net interest income before
the allowance for loan losses increased $0.5 million. This increase was the
result of a 18% increase in average student loans and was offset by a decrease
in the Company's student loan yield and the increase in interest expense as a
result of additional issuances of unsecured debt used to fund operating
activities of the Company. The provision for loan losses decreased $6.9 million
as a result of the Company recognizing $6.9 million in expense for provision of
loan losses as a result of HERA's enactment in February 2006. Additional
analysis of net interest income is included in the Company's operating segment
discussion under the Asset Generation and Management operating segment.
25
OTHER INCOME
Three months ended March 31,
----------------------------
2007 2006 $ Change
------------ ----------- ---------
Loan and guaranty servicing income $ 49,445 47,074 2,371
Other fee-based income 40,029 18,155 21,874
Software services income 5,748 3,409 2,339
Other income 6,931 1,987 4,944
Derivative market value, foreign currency,
and put option adjustments (12,130) 39,263 (51,393)
Derivative settlements, net 4,240 4,744 (504)
------------ ----------- ---------
Total other income $ 94,263 114,632 (20,369)
============ =========== =========
Loan and guaranty servicing income increased due to an increase in Canadian loan
servicing income and guaranty servicing income offset by a decrease in FFELP
loan servicing income. Other fee-based income increased largely due to business
acquisitions. In addition, the Company experienced an increase in borrower late
fee income related to loan portfolio growth, an increase in the number of
managed tuition payment plans, and an increase in list sales volume which also
contributed to the growth in other fee-based income. Software services income
increased due to new customers and increased usage fees for existing customers.
The increase in other income is from an increase in the gain on sale of loans
and a gain resulting from the termination of certain derivative contracts during
the first quarter 2007. Additional analysis of the increase in other income for
the three months ended March 31, 2007 compared to 2006 is included in the
discussion of the results of operations for each of the Company's operating
segments. The change in derivative market value, foreign currency, and put
option adjustments was caused by a change in the fair value of the Company's
derivative portfolio and foreign currency rate fluctuations which are further
discussed in Item 3, "Quantitative and Qualitative Disclosures about Market
Risk."
OPERATING EXPENSES
Three months Net change Three months
ended Impact of after ended
March 31, 2006 acquisitions acquistions March 31, 2007
-------------- ------------- ------------ -------------
Salaries and benefits $ 57,684 6,111 6,214 70,009
Other expenses 44,930 13,320 1,009 59,259
Amortization of
intangible assets 5,633 1,385 (100) 6,918
-------------- ------------- ------------ -------------
Total operating
expenses $ 108,247 20,816 7,123 136,186
============== ============= ============ =============
Operating expenses increased $20.8 million as a result of recent business
acquisitions. Excluding the impact of acquisitions, salaries and benefits and
other expenses increased $7.2 million, or 7.0%. This increase was a result of
(i) increased costs to develop systems to support a larger organizational
structure and (ii) organic growth of the organization. The Company's costs to
develop its corporate structure include projects such as recruitment,
development, and retention of intellectual capital, technology enhancements to
support a larger, more diversified customer and employee base, and increased
emphasis on marketing services and products and developing the Company's brand.
Additional analysis of the increase in operating expenses for the three months
ended March 31, 2007 compared to 2006 is included in the discussion of the
results of operations for each of the Company's operating segments.
INCOME TAXES
The Company's effective tax rate was 37.5% for the three months ended March 31,
2007 compared to 37.0% for the same period in 2006. The effective tax rate
increased due to the increased expense recognized by the Company during the
first quarter 2007 compared to 2006 related to its outstanding put options which
are not deductible for tax purposes.
The Company adopted the provisions of Financial Accounting Standards Board
Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES--AN
INTERPRETATION OF FASB STATEMENT NO. 109 ("FIN 48") as discussed in note 9 in
the notes to the consolidated financial statements included in this Report. The
adoption of FIN 48 could increase the volatility to the Company's effective tax
rate because FIN 48 requires that any change in judgment or change in
measurement of a tax position taken in a prior period be recognized as a
discrete event in the period in which it occurs.
26
FINANCIAL CONDITION AS OF MARCH 31, 2007 COMPARED TO DECEMBER 31, 2006
As of As of Change
March 31, December 31, ------------------------
2007 2006 Dollars Percent
------------ ------------ ------------ ----------
Assets:
Student loans receivable, net $ 25,013,045 23,789,552 1,223,493 5.1 %
Cash, cash equivalents, and investments 1,342,093 1,777,494 (435,401) (24.5)
Goodwill 191,214 191,420 (206) (0.1)
Intangible assets, net 154,176 162,994 (8,818) (5.4)
Fair value of derivative instruments 140,831 146,099 (5,268) (3.6)
Other assets 765,433 729,314 36,119 5.0
------------ ------------ ------------ ----------
Total assets $ 27,606,792 26,796,873 809,919 3.0 %
============ ============ ============ ==========
Liabilities:
Bonds and notes payable $ 26,537,482 25,562,119 975,363 3.8 %
Fair value of derivative instruments 8,934 27,973 (19,039) (68.1)
Other liabilities 449,258 534,931 (85,673) (16.0)
------------ ------------ ------------ ----------
Total liabilities 26,995,674 26,125,023 870,651 3.3
Shareholders' equity 611,118 671,850 (60,732) (9.0)
------------ ------------ ------------ ----------
Total liabilities and
shareholders' equity $ 27,606,792 26,796,873 809,919 3.0 %
============ ============ ============ ==========
The Company's total assets increased during 2007 primarily due to an increase in
student loans receivable and related assets. The Company originated or acquired
$1.7 billion in student loans which was offset by repayments and loan sales. The
Company financed the increase of student loans through the issuance of bonds and
notes payable. Total equity increased $14.8 million as a result of net income
for the three months ended March 31, 2007 but was offset by the repurchase of
3.1 million shares of the Company's Class A Common Stock for $75.5 million under
its existing share repurchase program.
OPERATING SEGMENTS
The Company has five operating segments as defined in SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION ("SFAS No. 131"), as
follows: Asset Generation and Management, Student Loan and Guaranty Servicing,
Tuition Payment Processing and Campus Commerce, Enrollment Services and List
Management, and Software and Technical Services. The Company's operating
segments are defined by the products and services they offer or the types of
customers they serve, and they reflect the manner in which financial information
is currently evaluated by management. During 2006, the Company changed the
structure of its internal organization in a manner that caused the composition
of its operating segments to change. As a result, the presentation of segment
financial information for the three months ended March 31, 2006, has been
restated to conform to the current operating segment presentation. The
accounting policies of the Company's operating segments are the same as those
described in the summary of significant accounting policies included in the
Company's consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2006. Intersegment revenues
are charged by a segment to another segment that provides the product or
service. The amount of intersegment revenue is based on comparable fees charged
in the market. Intersegment revenues and expenses are included within each
segment consistent with the income statement presentation provided to
management. Changes in management structure or allocation methodologies and
procedures may result in changes in reported segment financial information.
The management reporting process measures the performance of the Company's
operating segments based on the management structure of the Company as well as
the methodology used by management to evaluate performance and allocate
resources. Management, including the Company's chief operating decision maker,
evaluates the performance of the Company's operating segments based on their
profitability. As discussed further below, management measures the profitability
of the Company's operating segments based on "base net income." Accordingly,
information regarding the Company's operating segments is provided based on
"base net income." The Company's "base net income" is not a defined term within
GAAP and may not be comparable to similarly titled measures reported by other
companies. Unlike financial accounting, there is no comprehensive, authoritative
guidance for management reporting.
"Base net income" is the primary financial performance measure used by
management to develop the Company's financial plans, track results, and
establish corporate performance targets and incentive compensation. While "base
net income" is not a substitute for reported results under GAAP, the Company
relies on "base net income" in operating its business because "base net income"
permits management to make meaningful period-to-period comparisons of the
operational and performance indicators that are most closely assessed by
management. Management believes this information provides additional insight
into the financial performance of the core business activities of the Company's
operating segments.
27
Accordingly, the tables presented below reflect "base net income" which is
reviewed and utilized by management to manage the business for each of the
Company's operating segments. Reconciliation of the segment totals to the
Company's consolidated operating results in accordance with GAAP are also
included in the tables below. Included below under "Non-GAAP Performance
Measures" is further discussion regarding "base net income" and its limitations,
including a table that details the differences between "base net income" and
GAAP net income by operating segment.
Three Months Ended March 31, 2007
-----------------------------------------------------------------------------------------------------
Student Tuition Enrollment "Base Net
Asset Loan Payment Services Software Corporate Eliminations income"
Generation and Processing and and Activity and adjustments GAAP
and Guaranty and Campus List Technical Total and Reclassifi- to GAAP Results of
Management Servicing Commerce Management Services Segments Overhead cations results Operations
---------- -------- -------- ----------- ------- --------- -------- ---------- -------- ----------
Total interest income $ 414,490 2,315 1,010 87 18 417,920 3,801 (3,171) -- 418,550
Interest expense 341,658 -- 5 2 -- 341,665 11,732 (3,171) -- 350,226
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Net interest income 72,832 2,315 1,005 85 18 76,255 (7,931) -- -- 68,324
Less provision for
loan losses 2,753 -- -- -- -- 2,753 -- -- -- 2,753
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Net interest income
after provision
for loan losses 70,079 2,315 1,005 85 18 73,502 (7,931) -- -- 65,571
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Other income (expense):
Loan and guarantee
servicing income -- 49,445 -- -- -- 49,445 -- -- -- 49,445
Other fee-based income 3,311 -- 11,771 24,947 -- 40,029 -- -- -- 40,029
Software services
income -- -- -- 130 5,618 5,748 -- -- -- 5,748
Other income 4,829 58 3 -- -- 4,890 2,041 -- -- 6,931
Intersegment revenue -- 16,464 152 750 3,832 21,198 2,016 (23,214) -- --
Derivative market
value,
foreign currency,
and put option
adjustments -- -- -- -- -- -- -- -- (12,130) (12,130)
Derivative
settlements, net (424) -- -- -- -- (424) 4,664 -- -- 4,240
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Total other
income (expense) 7,716 65,967 11,926 25,827 9,450 120,886 8,721 (23,214) (12,130) 94,263
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Operating expenses:
Salaries and benefits 7,279 31,309 4,918 9,369 6,475 59,350 12,706 (2,524) 477 70,009
Other expenses 8,265 15,353 2,160 14,559 784 41,121 18,138 -- 6,918 66,177
Intersegment expenses 16,636 3,318 374 156 -- 20,484 206 (20,690) -- --
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Total operating
expenses 32,180 49,980 7,452 24,084 7,259 120,955 31,050 (23,214) 7,395 136,186
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- ---------
Income (loss)
before
income taxes 45,615 18,302 5,479 1,828 2,209 73,433 (30,260) -- (19,525) 23,648
Income tax expense
(benefit) (a) 17,105 6,863 2,055 686 828 27,537 (12,031) -- (6,638) 8,868
---------- -------- -------- -------- -------- ---------- -------- ---------- ---------- --------
Net income (loss) $ 28,510 11,439 3,424 1,142 1,381 45,896 (18,229) -- (12,887) 14,780
========== ======== ======== ======== ======== ========== ======== ========== ========== ========
(a) Income taxes are based on a percentage of net income before tax for
the individual operating segment.
28
Three Months Ended March 31, 2006
--------------------------------------------------------------------------------------------------------
Student Tuition Enrollment "Base Net
Asset Loan Payment Services Software Corporate Eliminations income" GAAP
Generation and Processing and and Activity and adjustments Results
and Guaranty and Campus List Technical Total and Reclassifi- to GAAP of
Management Servicing Commerce Management Services Segments Overhead cations results Operations
--------------------------------------------------------------------------------------------------------
Total interest income $ 341,976 1,873 882 83 18 344,832 535 (166) -- 345,201
Interest expense 253,833 -- 1 -- -- 253,834 5,281 (166) -- 258,949
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Net interest income 88,143 1,873 881 83 18 90,998 (4,746) -- -- 86,252
Less provision for
loan losses 9,618 -- -- -- -- 9,618 -- -- -- 9,618
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Net interest income
after provision
for loan losses 78,525 1,873 881 83 18 81,380 (4,746) -- -- 76,634
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Other income (expense):
Loan and guarantee
servicing income -- 47,074 -- -- -- 47,074 -- -- -- 47,074
Other fee-based income 2,899 -- 9,654 5,602 -- 18,155 -- -- -- 18,155
Software services income 50 -- -- 6 3,353 3,409 -- -- -- 3,409
Other income 1,642 21 -- -- -- 1,663 324 -- -- 1,987
Intersegment revenue -- 14,513 -- 752 3,920 19,185 41 (19,226) -- --
Derivative market value,
foreign currency,
and put option
adjustments -- -- -- -- -- -- -- -- 39,263 39,263
Derivative
settlements, net 4,744 -- -- -- -- 4,744 -- -- -- 4,744
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Total other
income (expense) 9,335 61,608 9,654 6,360 7,273 94,230 365 (19,226) 39,263 114,632
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Operating expenses:
Salaries and benefits 11,771 28,054 3,955 1,178 4,716 49,674 10,183 (2,491) 318 57,684
Other expenses 12,045 15,053 2,048 1,393 735 31,274 13,656 -- 5,633 50,563
Intersegment expenses 12,876 3,157 -- -- -- 16,033 702 (16,735) -- --
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Total operating
expenses 36,692 46,264 6,003 2,571 5,451 96,981 24,541 (19,226) 5,951 108,247
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Income (loss)
before income
taxes 51,168 17,217 4,532 3,872 1,840 78,629 (28,922) -- 33,312 83,019
Income tax expense
(benefit) (a) 18,933 6,370 1,677 1,432 680 29,092 (11,242) -- 12,861 30,711
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Net income (loss)
before minority
interest 32,235 10,847 2,855 2,440 1,160 49,537 (17,680) -- 20,451 52,308
Minority interest in
subsidiary income -- -- (242) -- -- (242) -- -- -- (242)
---------- -------- -------- -------- -------- ---------- -------- -------- ---------- --------
Net income (loss) $ 32,235 10,847 2,613 2,440 1,160 49,295 (17,680) -- 20,451 52,066
========== ======== ======== ======== ======== ========== ======== ======== ========== ========
(a) Income taxes are based on a percentage of net income before tax for
the individual operating segment.
NON-GAAP PERFORMANCE MEASURES
In accordance with the Rules and Regulations of the Securities and Exchange
Commission ("SEC"), the Company prepares financial statements in accordance with
generally accepted accounting principles ("GAAP"). In addition to evaluating the
Company's GAAP-based financial information, management also evaluates the
Company's operating segments on a non-GAAP performance measure referred to as
"base net income" for each operating segment. While "base net income" is not a
substitute for reported results under GAAP, the Company relies on "base net
income" to manage each operating segment because management believes these
measures provide additional information regarding the operational and
performance indicators that are most closely assessed by management.
"Base net income" is the primary financial performance measure used by
management to develop financial plans, allocate resources, track results,
evaluate performance, establish corporate performance targets, and determine
incentive compensation. Accordingly, financial information is reported to
management on a "base net income" basis by operating segment, as these are the
measures used regularly by the Company's chief operating decision maker. The
Company's board of directors utilizes "base net income" to set performance
targets and evaluate management's performance. The Company also believes
analysts, rating agencies, and creditors use "base net income" in their
evaluation of the Company's results of operations. While "base net income" is
not a substitute for reported results under GAAP, the Company utilizes "base net
income" in operating its business because "base net income" permits management
to make meaningful period-to-period comparisons by eliminating the temporary
volatility in the Company's performance that arises from certain items that are
primarily affected by factors beyond the control of management. Management
believes "base net income" provides additional insight into the financial
performance of the core business activities of the Company's operations.
29
LIMITATIONS OF "BASE NET INCOME"
While GAAP provides a uniform, comprehensive basis of accounting, for the
reasons discussed above, management believes that "base net income" is an
important additional tool for providing a more complete understanding of the
Company's results of operations. Nevertheless, "base net income" is subject to
certain general and specific limitations that investors should carefully
consider. For example, as stated above, unlike financial accounting, there is no
comprehensive, authoritative guidance for management reporting. The Company's
"base net income" is not a defined term within GAAP and may not be comparable to
similarly titled measures reported by other companies. Investors, therefore, may
not be able to compare the Company's performance with that of other companies
based upon "base net income". "Base net income" results are only meant to
supplement GAAP results by providing additional information regarding the
operational and performance indicators that are most closely monitored and used
by the Company's management and board of directors to assess performance and
information which the Company believes is important to analysts, rating
agencies, and creditors.
Other limitations of "base net income" arise from the specific adjustments that
management makes to GAAP results to derive "base net income" results. These
differences are described below.
The adjustments required to reconcile from the Company's "base net income"
measure to its GAAP results of operations relate to differing treatments for
derivatives, foreign currency transaction adjustments, and certain other items
that management does not consider in evaluating the Company's operating results.
The following table reflects adjustments associated with these areas by
operating segment and corporate activities and overhead for the three months
ended March 31, 2007 and 2006:
Three Months Ended March 31, 2007
-------------------------------------------------------------------------------------
Student Tuition Enrollment
Asset Loan Payment Services Software Corporate
Generation and Processing and and Activity
and Guaranty and Campus List Technical and
Management Servicing Commerce Management Services Overhead Total
----------- ----------- ----------- ----------- ----------- ----------- ---------
Derivative market value, foreign currency,
and put option adjustments $ 6,214 -- -- -- -- 5,916 12,130
Amortization of intangible assets 1,985 1,324 1,469 1,810 330 -- 6,918
Non-cash stock based compensation related
to business combinations -- -- -- -- -- 477 477
Variable-rate floor income -- -- -- -- -- -- --
Net tax effect (a) (3,116) (503) (558) (688) (125) (1,648) (6,638)
----------- ----------- ----------- ----------- ----------- ----------- ---------
Total adjustments to GAAP $ 5,083 821 911 1,122 205 4,745 12,887
=========== =========== =========== =========== =========== =========== =========
Three Months Ended March 31, 2006
-------------------------------------------------------------------------------------
Student Tuition Enrollment
Asset Loan Payment Services Software Corporate
Generation and Processing and and Activity
and Guaranty and Campus List Technical and
Management Servicing Commerce Management Services Overhead Total
----------- ----------- ----------- ----------- ----------- ----------- ---------
Derivative market value, foreign currency,
and put option adjustments $ (39,795) -- -- -- -- 532 (39,263)
Amortization of intangible assets 2,227 1,501 1,175 610 120 -- 5,633
Non-cash stock based compensation related
to business combinations -- -- -- -- -- 318 318
Variable-rate floor income -- -- -- -- -- -- --
Net tax effect (a) 14,276 (570) (446) (232) (46) (121) 12,861
----------- ----------- ----------- ----------- ----------- ----------- ---------
Total adjustments to GAAP $ (23,292) 931 729 378 74 729 (20,451)
=========== =========== =========== =========== =========== =========== =========
(a) Tax effect computed at 38%. The change in the value of the put option
(included in Corporate Activity and Overhead) is not tax effected as this is not
deductible for income tax purposes.
DIFFERENCES BETWEEN GAAP AND "BASE NET INCOME"
Management's financial planning and evaluation of operating results does not
take into account the following items because their volatility and/or inherent
uncertainty affect the period-to-period comparability of the Company's results
of operations. A more detailed discussion of the differences between GAAP and
"base net income" follows.
30
DERIVATIVE MARKET VALUE, FOREIGN CURRENCY, AND PUT OPTION ADJUSTMENTS: "Base net
income" excludes the periodic unrealized gains and losses that are caused by the
change in fair value on derivatives in which the Company does not qualify for
"hedge treatment" under GAAP. Statement of Financial Accounting Standards No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No.
133"), requires that changes in fair value of derivative instruments be
recognized currently in earnings unless specific hedge accounting criteria, as
specified by SFAS No. 133, are met. The Company maintains an overall interest
rate risk management strategy that incorporates the use of derivative
instruments to reduce the economic effect of interest rate volatility.
Derivative instruments primarily used by the Company include interest rate
swaps, basis swaps, interest rate floor contracts, and cross-currency interest
rate swaps. Management has structured all of the Company's derivative
transactions with the intent that each is economically effective. However, the
Company does not qualify its derivatives for "hedge treatment" as defined by
SFAS No. 133, and the stand-alone derivative must be marked-to-market in the
income statement with no consideration for the corresponding change in fair
value of the hedged item. Since the Company plans to hold all derivative
instruments until their maturity, the Company believes these point-in-time
estimates of asset and liability values that are subject to interest rate
fluctuations make it difficult to evaluate the ongoing results of operations
against its business plan and affect the period-to-period comparability of the
results of operations. Included in "base net income" are the economic effects of
the Company's derivative instruments, which includes any cash paid or received
being recognized as an expense or revenue upon actual derivative settlements.
These settlements are included in "Derivative market value, foreign currency,
and put option adjustments and derivative settlements, net" on the Company's
consolidated statements of income.
"Base net income" excludes the foreign currency transaction gains or losses
caused by the re-measurement of the Company's Euro-denominated bonds to U.S.
dollars. In connection with the issuance of the Euro-denominated bonds, the
Company has entered into cross-currency interest rate swaps. Under the terms of
these agreements, the principal payments on the Euro-denominated notes will
effectively be paid at the exchange rate in effect at the issuance date of the
bonds. The cross-currency interest rate swaps also convert the floating rate
paid on the Euro-denominated bonds (EURIBOR index) to an index based on LIBOR.
Included in "base net income" are the economic effects of any cash paid or
received being recognized as an expense or revenue upon actual settlements of
the cross-currency interest rate swaps. These settlements are included in
"Derivative market value, foreign currency, and put option adjustments and
derivative settlements, net" on the Company's consolidated statements of income.
However, the gains or losses caused by the re-measurement of the
Euro-denominated bonds to U.S. dollars and the change in market value of the
cross-currency interest rate swaps are excluded from "base net income" as the
Company believes the point-in-time estimates of value that are subject to
currency rate fluctuations related to these financial instruments make it
difficult to evaluate the ongoing results of operations against the Company's
business plan and affect the period-to-period comparability of the results of
operations. The re-measurement of the Euro-denominated bonds correlates with the
change in fair value of the cross-currency interest rate swaps. However, the
Company will experience unrealized gains or losses related to the cross-currency
interest rate swaps if the two underlying indices (and related forward curve) do
not move in parallel.
"Base net income" also excludes the change in fair value of put options issued
by the Company for certain business acquisitions. The put options are valued by
the Company each reporting period using a Black-Scholes pricing model.
Therefore, the fair value of these options is primarily affected by the strike
price and term of the underlying option, the Company's current stock price, and
the dividend yield and volatility of the Company's stock. The Company believes
these point-in-time estimates of value that are subject to fluctuations make it
difficult to evaluate the ongoing results of operations against the Company's
business plans and affects the period-to-period comparability of the results of
operations.
The gains and/or losses included in "Derivative market value, foreign currency,
and put option adjustments and derivative settlements, net" on the Company's
consolidated statements of income are primarily caused by interest rate and
currency volatility, changes in the value of put options based on the inputs
used in the Black-Scholes pricing model, as well as the volume and terms of put
options and of derivatives not receiving hedge treatment. "Base net income"
excludes these unrealized gains and losses and isolates the effect of interest
rate, currency, and put option volatility on the fair value of such instruments
during the period. Under GAAP, the effects of these factors on the fair value of
the put options and the derivative instruments (but not the underlying hedged
item) tend to show more volatility in the short term.
AMORTIZATION OF INTANGIBLE ASSETS: "Base net income" excludes the amortization
of acquired intangibles, which arises primarily from the acquisition of definite
life intangible assets in connection with the Company's acquisitions, since the
Company feels that such charges do not drive the Company's operating performance
on a long-term basis and can affect the period-to-period comparability of the
results of operations.
NON-CASH STOCK BASED COMPENSATION RELATED TO BUSINESS COMBINATIONS: The Company
has structured certain business combinations in which the stock consideration
paid has been dependent on the sellers' continued employment with the Company.
As such, the value of the consideration paid is recognized as compensation
expense by the Company over the term of the applicable employment agreement.
"Base net income" excludes this expense because the Company believes such
charges do not drive its operating performance on a long-term basis and can
affect the period-to-period comparability of the results of operations. If the
Company did not enter into the employment agreements in connection with the
acquisition, the amount paid to these former shareholders of the acquired entity
would have been recorded by the Company as additional consideration of the
acquired entity, thus, not having an effect on the Company's results of
operations.
31
VARIABLE-RATE FLOOR INCOME: Loans that reset annually on July 1 can generate
excess spread income compared with the rate based on the special allowance
payment formula in declining interest rate environments. The Company refers to
this additional income as variable-rate floor income. The Company excludes
variable rate floor income from its "base net income" since its timing and
amount (if any) is uncertain, it has been eliminated by legislation for all
loans originated on and after April 1, 2006, and it is in excess of expected
spreads. In addition, because variable rate floor income is subject to the
underlying rate for the subject loans being reset annually on July 1, it is a
factor beyond the Company's control which can affect the period-to-period
comparability of results of operations. There was no variable-rate floor income
in the periods presented.
ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT - RESULTS OF OPERATIONS
The Asset Generation and Management segment includes the acquisition,
management, and ownership of the Company's student loan assets. Revenues are
primarily generated from net interest income on the student loan assets. The
Company generates student loan assets through direct origination or through
acquisitions. The student loan assets are held in a series of education lending
subsidiaries designed specifically for this purpose.
In addition to the student loan portfolio, all costs and activity associated
with the generation of assets, funding of those assets, and maintenance of the
debt transactions are included in this segment. This includes derivative
activity and the related derivative market value and foreign currency
adjustments. The Company is also able to leverage its capital market expertise
by providing investment advisory services and other related services to third
parties through a licensed broker dealer subsidiary. Revenues and expenses for
those functions are also included in the Asset Generation and Management
segment.
STUDENT LOAN PORTFOLIO
The table below outlines the components of the Company's student loan portfolio:
As of March 31, 2007 As of December 31, 2006
------------------------ -------------------------
Dollars Percent Dollars Percent
------------- --------- -------------- ---------
Federally insured:
Stafford $ 6,096,393 24.4 % $ 5,724,586 24.1 %
PLUS/SLS 460,575 1.8 365,112 1.5
Consolidation 17,835,192 71.3 17,127,623 72.0
Non-federally insured 224,870 0.9 197,147 0.8
------------- --------- -------------- ---------
Total 24,617,030 98.4 23,414,468 98.4
Unamortized premiums and deferred
origination costs 422,239 1.7 401,087 1.7
Allowance for loan losses:
Allowance - federally insured (7,859) (0.0) (7,601) (0.0)
Allowance - non-federally insured (18,365) (0.1) (18,402) (0.1)
------------- --------- -------------- ---------
Net $25,013,045 100.0 % $23,789,552 100.0 %
============= ========= ============== =========
The Company's net student loan assets have increased $1.2 billion, or 5.1%, to
$25.0 billion as of March 31, 2007 compared to $23.8 billion as of December 31,
2006.
ORIGINATION AND ACQUISITION
The Company originates and acquires loans through various methods and channels
including: (i) direct-to-consumer channel (in which the Company originates
student loans directly with student and parent borrowers), (ii) campus based
origination channels, and (iii) spot purchases.
The Company will originate or acquire loans through its campus based channel
either directly under one of its brand names or through other originating
lenders. In addition to its brands, the Company acquires student loans from
lenders to whom the Company provides marketing and/or origination services
established through various contracts. Branding partners are lenders for which
the Company acts as a marketing agent in specified geographic areas. A forward
flow lender is one for whom the Company provides origination services but
provides no marketing services or whom simply agrees to sell loans to the
Company under forward sale commitments. The table below sets forth the activity
of loans originated or acquired through each of the Company's channels:
32
Three months ended March 31,
----------------------------
2007 2006
------------- ---------------
Beginning balance $ 23,414,468 $ 19,912,955
Direct channel:
Consolidation loan originations 1,064,238 1,024,835
Less consolidation of existing portfolio (473,795) (433,900)
------------ -------------
Net consolidation loan originations 590,443 590,935
Stafford/PLUS loan originations 354,827 306,148
Branding partner channel (a) (b) 202,290 230,150
Forward flow channel 375,941 351,812
Other channels (b) 205,918 243,953
------------ -------------
Total channel acquisitions 1,729,419 1,722,998
Repayments, claims, capitalized
interest, and other (235,807) (365,158)
Consolidation loans lost to external parties (239,404) (270,400)
Loans sold (51,646) (37,176)
------------ -------------
Ending balance $ 24,617,030 $ 20,963,219
============ =============
(a) Included in the branding partner channel are private loan originations
of $44.3 million and $10.5 million for the three months ended March 31,
2007 and 2006, respectively.
(b) Included in other channels for the three months ended March 31, 2006 is
$190.1 million of acquisitions that were previously presented as
branding partner channel acquisitions. This reclassification was made
for comparative purposes due to the nature of the transactions.
The Company has extensive and growing relationships with many large financial
and educational institutions that are active in the education finance industry.
Loss of a relationship with an institution from which the Company directly or
indirectly acquires a significant volume of student loans could result in an
adverse effect on the volume derived from its various channels.
Nova Southeastern University ("Nova"), a school-as-lender customer, has elected
not to renew their existing contract with the Company, which expired in December
2006. Total loans acquired from Nova were $11.2 million and $40.1 million for
the three months ended March 31, 2007 and 2006, respectively, and $275.6 million
for the year ended December 31, 2006. Loans acquired from Nova are included in
the forward flow channel in the above table.
As part of the Company's asset management strategy, the Company periodically
sells student loan portfolios to third parties. During the three months ended
March 31, 2007 and 2006, the Company sold $51.6 million (par value) and $37.2
million (par value), respectively of student loans resulting in the recognition
of a gain of $1.8 million and $0.5 million, respectively.
ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents the periodic expense of maintaining an
allowance sufficient to absorb losses, net of recoveries, inherent in the
portfolio of student loans. An analysis of the Company's allowance for loan
losses is presented in the following table:
33
Three months ended March 31,
--------------------------
2007 2006
------------ ------------
Balance at beginning of period $ 26,003 13,390
Provision for loan losses:
Federally insured loans 1,453 7,268
Non-federally insured loans 1,300 2,350
------------ ------------
Total provision for loan losses 2,753 9,618
Charge-offs, net of recoveries:
Federally insured loans (1,195) (291)
Non-federally insured loans (166) (492)
------------ ------------
Net charge-offs (1,361) (783)
Sale of non-federally insured loans (1,171) --
------------ ------------
Balance at end of period $ 26,224 22,225
============ ============
Allocation of the allowance for loan losses:
Federally insured loans $ 7,859 7,075
Non-federally insured loans 18,365 15,150
------------ ------------
Total allowance for loan losses $ 26,224 22,225
============ ============
Net loan charge-offs as a percentage of
average student loans 0.023 % 0.015 %
Total allowance as a percentage of
average student loans 0.110 % 0.110 %
Total allowance as a percentage of
ending balance of student loans 0.107 % 0.106 %
Non-federally insured allowance as a
percentage of the ending balance
of non-federally insured loans 8.167 % 9.259 %
Average student loans $23,844,815 20,237,068
Ending balance of student loans 24,617,030 20,963,219
Ending balance of non-federally insured loans 224,870 163,624
During the three months ended March 31, 2006, the Company recognized a $6.9
million provision on its federally insured portfolio as a result of HERA which
was enacted into law on February 8, 2006.
Delinquencies have the potential to adversely impact the Company's earnings
through increased servicing and collection costs and account charge-offs. The
table below shows the Company's student loan delinquency amounts:
As of March 31, 2007 As of December 31, 2006
-------------------------- -------------------------
Dollars Percent Dollars Percent
--------------- -------- -------------- --------
Federally Insured Loans:
Loans in-school/grace/deferment(1) $ 7,133,076 $ 6,271,558
Loans in forebearance(2) 2,407,314 2,318,184
Loans in repayment status:
Loans current 13,149,220 88.6 % 12,944,768 88.5 %
Loans delinquent 31-60 days(3) 535,613 3.6 623,439 4.3
Loans delinquent 61-90 days(3) 363,759 2.4 299,413 2.0
Loans delinquent 91 days or greater(4) 803,178 5.4 759,959 5.2
--------------- -------- -------------- --------
Total loans in repayment 14,851,770 100.0 % 14,627,579 100.0 %
--------------- ======== -------------- ========
Total federally insured loans $ 24,392,160 $ 23,217,321
=============== ==============
Non-Federally Insured Loans:
Loans in-school/grace/deferment(1) $ 112,486 $ 83,973
Loans in forebearance(2) 5,818 6,113
Loans in repayment status:
Loans current 101,035 94.8 % 101,084 94.4 %
Loans delinquent 31-60 days(3) 2,186 2.1 2,681 2.5
Loans delinquent 61-90 days(3) 1,402 1.3 1,233 1.2
Loans delinquent 91 days or greater(4) 1,943 1.8 2,063 1.9
--------------- -------- -------------- --------
Total loans in repayment 106,566 100.0 % 107,061 100.0 %
--------------- ======== -------------- ========
Total non-federally insured loans $ 224,870 $ 197,147
=============== ==============
----------
(1) Loans for borrowers who still may be attending school or engaging in other
permitted educational activities and are not yet required to make payments
on the loans, E.G., residency periods for medical students or a grace period
for bar exam preparation for law students.
(2) Loans for borrowers who have temporarily ceased making full payments due to
hardship or other factors, according to a schedule approved by the servicer
consistent with the established loan program servicing procedures and
policies.
(3) The period of delinquency is based on the number of days scheduled payments
are contractually past due and relate to repayment loans, that is,
receivables not charged off, and not in school, grace, deferment, or
forbearance.
34
(4) Loans delinquent 91 days or greater include loans in claim status, which are
loans which have gone into default and have been submitted to the guaranty
agency for FFELP loans, or, if applicable, the insurer for non-federally
insured loans, to process the claim for payment.
STUDENT LOAN SPREAD ANALYSIS
The following table analyzes the student loan spread on the Company's portfolio
of student loans and represents the spread on assets earned in conjunction with
the liabilities and derivative instruments used to fund the assets:
Three months ended March 31,
-------------------------------
2007 2006
-------------- --------------
Student loan yield 7.90 % 7.68 %
Consolidation rebate fees (0.79) (0.71)
Premium and deferred origination
costs amortization (0.36) (0.44)
-------------- --------------
Student loan net yield 6.75 6.53
Student loan cost of funds (a) (5.46) (4.63)
-------------- --------------
Student loan spread 1.29 1.90
Special allowance yield adjustment, net of
settlements on derivatives (b) -- (0.36)
-------------- --------------
Core student loan spread 1.29 % 1.54 %
============== ==============
Average balance of student loans $ 23,844,815 $ 20,237,068
Average balance of debt outstanding 25,378,267 21,796,549
(a) The student loan cost of funds includes the effects of net settlement
costs on the Company's derivative instruments used to hedge the
Company's student loan portfolio.
(b) The special allowance yield adjustment represents the impact on net
spread had certain 9.5% loans earned at statutorily defined rates under
a taxable financing. The special allowance yield adjustment includes net
settlements on derivative instruments that were used to hedge this loan
portfolio earning the excess yield. As previously disclosed, on January
19, 2007, the Company entered into a Settlement Agreement with the
Department to resolve the audit by the OIG of the Company's portfolio of
student loans receiving 9.5% special allowance payments. Under the terms
of the Agreement, all 9.5% special allowance payments were eliminated
for periods on and after July 1, 2006. The Company had been deferring
recognition of 9.5% special allowance payments related to those loans
subject to the OIG audit effective July 1, 2006 pending satisfactory
resolution of this issue.
The compression of the Company's core student loan spread has been primarily due
to (i) an increase in lower yielding consolidation loans and an increase in the
consolidation rebate fees; (ii) the elimination of 9.5% special allowance
payments on non-special allowance yield adjustment student loans as a result of
the Settlement Agreement with the Department; and (iii) the mismatch in the
reset frequency between the Company's floating rate assets and floating rate
liabilities. The Company's core student loan spread benefited in the rising
interest rate environment during the first quarter of 2006 because the Company's
cost of funds reset periodically on a discrete basis, in advance, while the
Company's student loans received a yield based on the average daily interest
rate over the period. As interest rates remained relatively flat in the first
quarter 2007, as compared to the same period in 2006, the Company did not
benefit from the rate reset discrepancy of its assets and liabilities
contributing to the compression.
As noted in Item 3, "Quantitative and Qualitative Disclosures about Market
Risk", the Company has a portfolio of student loans that are earning interest at
a fixed borrower rate which exceeds the statutorily defined variable lender rate
creating floor income which is included in its core student loan spread. The
majority of these loans are consolidation loans that earn the greater of the
borrower rate or 2.64% above the average commercial paper rate during the
calendar quarter. The Company estimates that its core student loan spread for
the three months ended March 31, 2007 and 2006, included approximately six basis
points and 19 basis points, respectively, related to this floor income. When
excluding floor income, the Company's core student loan spread was 1.23% and
1.35% for the three months ended March 31, 2007 and 2006, respectively.
35
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
Three months ended March 31,
----------------------------
2007 2006 $ Change
------------ ------------- ----------
Net interest income after the provision
for loan losses 70,079 78,525 (8,446)
Other fee-based income 3,311 2,899 412
Software services income -- 50 (50)
Other income 4,829 1,642 3,187
Derivative settlements, net (424) 4,744 (5,168)
------------ ------------- ----------
Total other income 7,716 9,335 (1,619)
Salaries and benefits 7,279 11,771 (4,492)
Other expenses 8,265 12,045 (3,780)
Intersegment expenses 16,636 12,876 3,760
------------ ------------- ----------
Total operating expenses 32,180 36,692 (4,512)
------------ ------------- ----------
"Base net income" before
income taxes 45,615 51,168 (5,553)
Income tax expense 17,105 18,933 (1,828)
------------ ------------- ----------
"Base net income" 28,510 32,235 (3,725)
============ ============= ==========
After Tax Operating Margin 36.65% 36.69%
NET INTEREST INCOME AFTER THE PROVISION FOR LOAN LOSSES. Net interest income
decreased primarily as a result of the compression in the Company's core student
loan spread and the loss of the 9.5% special allowance payments as a result of
the Settlement Agreement with the Department. A summary of the changes in net
interest income follows:
Three months ended March 31, Change
-------------------------- -----------------------
2007 2006 Dollars Percent
----------- ------------ ----------- ----------
Loan interest $ 464,533 383,067 81,466 21.27 %
Consolidation rebate fees (46,420) (35,545) (10,875) 30.60
Amortization of loan premiums and
deferred origination costs (21,059) (21,862) 803 (3.67)
----------- ------------ ----------- ----------
Total loan interest 397,054 325,660 71,394 21.92
Investment interest 17,436 16,316 1,120 6.86
----------- ------------ ----------- ----------
Total interest income 414,490 341,976 72,514 21.20
----------- ------------ ----------- ----------
Interest on bonds and notes payable 338,487 253,787 84,700 33.37
Intercompany interest 3,171 46 3,125
Provision for loan losses 2,753 9,618 (6,865) (71.38)
----------- ------------ ----------- ----------
Net interest income after provision for
loan losses $ 70,079 78,525 (8,446) (10.76)%
=========== ============ =========== ==========
Total loan interest income increased $71.4 million for the three months ended
March 31, 2007 compared to the three months ended March 31, 2006 as follows:
o Loan interest for the three months ended March 31, 2006 included
$18.4 million of 9.5% special allowance payments. The Company
received no 9.5% special allowance payments for the three months
ended March 31, 2007 as a result of the Settlement Agreement
with the Department.
o The average student loan portfolio increased $3.6 billion, or
18%, for the three months ended March 31, 2007 compared to the
same period in 2006. Student loan yield, excluding 9.5% special
allowance payments, increased to 7.90% in 2007 from 7.31% in
2006. The increase in student loan yield is a result of a higher
interest rate environment and is offset by an increase in the
percentage of lower yielding consolidation loans to the total
portfolio. Loan interest income, excluding 9.5% special
allowance payments, increased $99.9 million as a result of these
factors.
36
o Consolidation rebate fees increased due to the $4.0 billion, or
29.0%, increase in the consolidation loan portfolio.
o The amortization of loan premiums and deferred origination costs
decreased due to the $21.7 million write-off of premiums in
December 2006 on loans earning 9.5% special allowance payments
as the result of the Settlement Agreement with the Department.
For the three months ended March 31, 2006, the Company
recognized premium amortization of $1.8 million related to these
loans. This decrease was offset by an increase in amortization
of loan premiums and deferred origination costs as a result of
the growth in the student loan portfolio.
o Investment interest income has increased as a result of an
increase in cash, cash equivalents, and investments from student
loan growth, and as a result of a higher interest rate
environment.
Interest expense increased $87.8 million due to the $3.6 billion, or 16.4%,
increase in average debt for the three months ended March 31, 2007 compared to
the same period in 2006. In addition, the Company's cost of funds (excluding net
derivative settlements) increased to 5.46% for the three months ended March 31,
2007 compared to 4.72% for the same period a year ago.
The provision for loan losses decreased because the Company recognized a $6.9
million provision in the first quarter of 2006 on its federally insured
portfolio as a result of HERA which was enacted into law on February 8, 2006.
OTHER FEE-BASED INCOME. Borrower late fees increased $0.4 million as a result of
the increase in the average student loan portfolio.
OTHER INCOME. Other income increased $3.2 million for the three months ended
March 31, 2007 compared to the same period in 2006. During the three months
ended March 31, 2007, the Company recognized a $1.8 million gain on the sale of
loans compared to $0.5 million in the same period in 2006. In addition, a $2.1
million gain was recognized as a result of the termination of the Company's
interest rate floor contracts in January 2007.
OPERATING EXPENSES. Operating expenses decreased $4.5 million, or 12.3%, for the
three months ended March 31, 2007 compared to the same period in 2006. The
Company has reduced its cost to service loans by converting loan volume acquired
during certain 2005 acquisitions from third party servicers to the Company's
servicing platform resulting in approximately $2.0 million in savings. In
addition, the Company has leveraged its marketing efforts such that these
operations benefit multiple operating segments in the current period. In
previous periods these efforts were focused on primarily asset generation which
resulted in higher costs for this operating segment.
STUDENT LOAN AND GUARANTY SERVICING OPERATING SEGMENT - RESULTS OF OPERATIONS
The Student Loan and Guaranty Servicing segment provides for the servicing of
the Company's student loan portfolios and the portfolios of third parties and
servicing provided to guaranty agencies. The servicing activities include loan
origination activities, application processing, borrower updates, payment
processing, due diligence procedures, and claim processing. These activities are
performed internally for the Company's portfolio in addition to generating fee
revenue when performed for third-party clients. The guaranty servicing and
servicing support activities include providing systems software, hardware and
telecommunications support, borrower and loan updates, default aversion tracking
services, claim processing services, and post-default collection services to
guaranty agencies.
Through its subsidiary, EDULINX, the Company provides student loan
administrative services in Canada. EDULINX provides student loan administrative
services, including loan disbursement, in-study account management, loan
consolidation, repayment management, customer contact, default prevention, and
portfolio management services. In Canada, the principal market for these
services consists of the federal government and various provincial governments
who deliver their student loans through direct-financing programs as well as
financial institutions who participate in either government-guaranteed and/or
risk-shared loan programs.
The broad category of products and percentage of total external loan and
guaranty servicing revenue provided by each during the three months ended March
31, 2007 and 2006 is as follows:
1. Origination and servicing of FFEL Program loans (28.6% and
36.3%);
2. Origination and servicing of non-federally insured student loans
(4.7% and 4.6%);
3. Servicing and support outsourcing for guaranty agencies (28.3%
and 23.4%); and
4. Origination and servicing of loans under the Canadian government
sponsored student loan program (38.4% and 35.6%).
37
STUDENT LOAN SERVICING VOLUMES
As of March 31,
-----------------------------------------------------------------------
2007 2006
--------------------------------- ------------------------------------
Company Third party Total Company Third party Total
---------- ------------ --------- ---------- ------------ -----------
(dollars in millions)
FFELP and private loans $ 23,274 8,935 32,209 18,017 10,626 28,643
Canadian loans (in U.S. $) (a) -- 9,266 9,266 -- 8,388 8,388
---------- ------------ --------- ---------- ------------ -----------
Total $ 23,274 18,201 41,475 18,077 19,014 37,031
========== ============ ========= ========== ============ ===========
(a) As previously disclosed, EDULINX announced that the Government of Canada
decided to award a competitive contract to provide support of the Canada
and Integrated Student Loan Programs (CSLP) upon the expiration of the
current EDULINX contract for such services to another service provider.
The Government of Canada is EDULINX's largest customer. This contract is
scheduled to expire on March 31, 2008. As a result of this decision,
EDULINX will be required to transition the existing CSLP portfolio it
services to the selected service provider. As of March 31, 2007, the
Company serviced $8.0 billion of CSLP loans.
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
Three months ended March 31,
----------------------------
2007 2006 $ Change
------------- ------------ ----------
Net interest income after the
provision for loan losses $ 2,315 1,873 443
Loan and guaranty servicing income 49,445 47,074 2,371
Software services income -- -- --
Other income 58 21 37
Intersegment revenue 16,464 14,513 1,951
------------- ------------ ----------
Total other income 65,967 61,608 4,359
Salaries and benefits 31,309 28,054 3,255
Other expenses 15,353 15,053 300
Intersegment expenses 3,318 3,157 161
------------- ------------ ----------
Total operating expenses 49,980 46,264 3,716
------------- ------------ ----------
"Base net income" before
income taxes 18,302 17,217 1,086
Income tax expense 6,863 6,370 493
------------- ------------ ----------
"Base net income" $ 11,439 10,847 593
============= ============ ==========
After Tax Operating Margin 16.8% 17.1%
LOAN AND GUARANTY SERVICING INCOME. Loan and guaranty servicing income increased
$2.4 million for the three months ended March 31, 2007 compared to the three
months ended March 31, 2006 as follows:
Three months ended March 31, 2006 $ 47,074
Increase in guaranty servicing income 3,004
Increase in Canadian loan servicing revenue (a) 2,194
Decrease in U.S. loan servicing revenue (b) (3,115)
Other 288
----------
Three months ended March 31, 2007 $ 49,445
==========
(a) The increase in loan servicing revenue is the result of the recognition
of $2.4 million of performance based revenue for meeting certain
servicing criteria under the Company's agreement with the Government of
Canada to provide financial and related administrative services to
support the CSLP.
38
(b) The decrease in loan servicing revenue from U.S. operations is the
result of a decrease in the volume of loans serviced by the Company.
OPERATING EXPENSES. Operating expenses increased as a result of the Company's
efforts to integrate and reorganize entities acquired over the prior two years.
TUITION PAYMENT PROCESSING AND CAMPUS COMMERCE OPERATING SEGMENT - RESULTS OF
OPERATION
The Company's Tuition Payment Processing and Campus Commerce operating segment
provides products and services to help institutions and education seeking
families manage the payment of education costs during the pre-college and
college stages of the education life cycle. The Company provides actively
managed tuition payment solutions, online payment processing, detailed
information reporting, financial needs analysis, and data integration services
to K-12 and post-secondary educational institutions, families, and students. In
addition, the Company provides customer-focused electronic transactions,
information sharing, and account and bill presentment to colleges and
universities.
Effective June 1, 2005, the Company purchased 80% of the capital stock of FACTS
Management Co. ("FACTS"). FACTS provides actively managed tuition payment
solutions, online payment processing, detailed information reporting, and data
integration services to educational institutions, families, and students. In
addition, FACTS provides financial needs analysis for students applying for aid
in private and parochial K-12 schools. This acquisition was accounted for under
purchase accounting and the results of operations have been included in the
consolidated financial statements from the effective date of acquisition.
Effective January 31, 2006, the Company purchased the remaining 20% interest in
FACTS.
Effective January 31, 2006, the Company purchased the remaining 50% interest in
infiNET Integrated Solutions, Inc. ("infiNET"). The Company owned 50% of this
entity and accounted for it under the equity method of accounting prior to the
transaction. infiNET provides customer-focused electronic transactions,
information sharing, and account and bill presentment to colleges and
universities. This acquisition was accounted for under purchase accounting and
the results of operations have been included in the consolidated financial
statements from the effective date of acquisition.
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
Three months ended March 31,
--------------------------
2007 2006 $ Change
------------ ------------ ----------
Net interest income after the
provision for loan losses $ 1,005 881 124
Other fee-based income 11,771 9,654 2,117
Other income 3 -- 3
Intersegment revenue 152 -- 152
------------ ------------ ----------
Total other income 11,926 9,654 2,272
------------ ------------ ----------
Salaries and benefits 4,918 3,955 963
Other expenses 2,160 2,048 112
Intersegment expenses 374 -- 374
------------ ------------ ----------
Total operating expenses 7,452 6,003 1,449
------------ ------------ ----------
"Base net income" before
income taxes 5,479 4,532 947
Income tax expense 2,055 1,677 378
------------ ------------ ----------
"Base net income" before
minority interest 3,424 2,855 569
Minority interest -- (242) 242
------------ ------------ ----------
"Base net income" $ 3,424 2,613 811
============ ============ ==========
After Tax Operating Margin 26.5% 27.1%
39
OTHER FEE-BASED INCOME. Other fee-based income increased due to acquisitions and
an increase in the number of tuition payment plans managed by the Company as
follows:
Three months ended March 31, 2006 $ 9,654
Acquisition of campus commerce operations 653
Increase in tuition payment plan fees 1,464
---------
Three months ended March 31, 2007 $ 11,771
=========
OPERATING EXPENSES. Operating expenses increased $0.5 million due to the timing
of acquisitions. The remaining increase is the result of the increase in the
number of tuition payment plans managed by the Company.
ENROLLMENT SERVICES AND LIST MANAGEMENT OPERATING SEGMENT - RESULTS OF OPERATION
The Company's Enrollment Services and List Management operating segment provides
products and services to help institutions and education seeking families
primarily during the pre-college phase of the education lifecycle. The Company
helps families plan and prepare for college by providing products and services
such as a college planning center, practice tests, and scholarship searches.
Focused on planning/preparation, lead generation, and ultimately retention,
products and services offered by the Enrollment Services and List Management
segment also help schools and businesses reach the middle school, high school,
college, and young adult market places.
On June 30, 2006, the Company purchased 100% of the membership interests of
CUnet. CUnet provides campus locations and online schools with performance-based
educational marketing, web-based marketing, lead generation, and vendor
management services to enhance their brands and improve student recruitment and
retention.
On July 27, 2006, the Company purchased certain assets and assumed certain
liabilities (hereafter referred to as "Peterson's") from Thomson Learning Inc.
Peterson's provides a comprehensive suite of education and career-related
solutions in the areas of education search, test preparation, admissions,
financial aid information (including scholarship search), and career assistance.
Peterson's delivers these services through a variety of media including print
(i.e. books) and online. Peterson's reaches an estimated 105 million consumers
annually with its publications and online information about colleges and
universities, career schools, graduate programs, distance learning, executive
training, private secondary schools, summer opportunities, study abroad,
financial aid, test preparation, and career exploration resources.
Management believes the Company's Enrollment Services and List Management
operating segment will enhance the Company's position as a vertically-integrated
industry leader with a strong foundation for growth. The Company has focused on
growing and organically developing its product and service offerings as well as
enhancing them through various acquisitions. A key aspect of each transaction is
its impact on the Company's prospective organic growth and the development of
its integrated platform of services.
The above acquisitions were accounted for under purchase accounting and the
results of operations have been included in the consolidated financial
statements from the date of acquisition.
40
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
Three months ended March 31,
---------------------------
2007 2006 $ Change
------------- ------------ ----------
Net interest income after the provision
for loan losses $ 85 83 2
Other fee-based income 24,947 5,602 19,345
Software services income 130 6 124
Intersegment revenue 750 752 (2)
------------- ------------ ----------
Total other income 25,827 6,360 19,467
Salaries and benefits 9,369 1,178 8,191
Other expenses 14,559 1,393 13,166
Intersegment expenses 156 -- 156
------------- ------------ ----------
Total operating expenses 24,084 2,571 21,513
------------- ------------ ----------
"Base net income" before income taxes 1,828 3,872 (2,044)
Income tax expense 686 1,432 (746)
------------- ------------ ----------
"Base net income" $ 1,142 2,440 (1,298)
============= ============ ==========
After Tax Operating Margin 4.4% 37.9%
OTHER FEE-BASED INCOME. Other fee-based income increased primarily as the result
of acquisitions. The 2006 acquisitions of CUnet and Peterson's resulted in a
$19.3 million increase in other-fee based income. In addition, the Company
experienced an increase in list sales volume resulting in a $1.0 million
increase in other-fee based income. Finally, revenue from merchandise sales
decreased due to the timing of merchandise shipments. A summary of these changes
is as follows:
Three months ended March 31, 2006 $ 5,602
Acquisition of Cunet 11,790
Acquisition of Petersons 7,478
Increased list sales 1,018
Decreased merchandise sales (941)
----------
Three months ended March 31, 2007 $ 24,947
==========
OPERATING EXPENSES. Total operating expenses increased $21.5 million. Operating
expenses increased $18.8 million as a result of the acquisitions of CUnet and
Peterson's. In addition, there was a $0.5 million increase related to the
increased list sales. The remaining increase in costs is related to business
development and integration costs.
SOFTWARE AND TECHNICAL SERVICES OPERATING SEGMENT - RESULTS OF OPERATION
The Software and Technical Services segment develops loan servicing software and
also provides this software to third-party student loan holders and servicers.
In addition, this segment provides information technology products and services,
with core areas of business in student loan software solutions for schools,
lenders, and guarantors; technical consulting services; and enterprise content
management.
41
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2006
Three months ended March 31,
-----------------------------
2007 2006 $ Change
------------ ------------ ----------
Net interest income after the
provision for loan losses $ 18 18 --
Software services income 5,618 3,353 2,265
Intersegment revenue 3,832 3,920 (88)
------------ ------------ ----------
Total other income 9,450 7,273 2,177
------------ ------------ ----------
Salaries and benefits 6,475 4,716 1,759
Other expenses 784 735 49
------------ ------------ ----------
Total operating expenses 7,259 5,451 1,808
------------ ------------ ----------
"Base net income" before
income taxes 2,209 1,840 369
Income tax expense 828 680 148
------------ ------------ ----------
"Base net income" $ 1,381 1,160 221
============ ============ ==========
After Tax Operating Margin 14.6% 15.9%
SOFTWARE SERVICES INCOME. Software services income increased $2.3 million for
the three months ended March 31, 2007 compared to the three months ended March
31, 2006 due to new customers and increased usage fees for existing customers.
OPERATING EXPENSES. The increase in operating expenses was driven by an increase
in costs to generate additional income.
LIQUIDITY AND CAPITAL RESOURCES
The Company utilizes operating cash flow, operating lines of credit, and secured
financing transactions to fund operations and student loan and business
acquisitions. The Company has also used its common stock to partially fund
certain business acquisitions. In addition, the Company has a universal shelf
registration statement with the Securities and Exchange Commission ("SEC") which
allows the Company to sell up to $750 million of securities that may consist of
common stock, preferred stock, unsecured debt securities, warrants, stock
purchase contracts, and stock purchase units. The terms of any securities are
established at the time of the offering.
The Company is limited in the amounts of funds that can be transferred from its
subsidiaries through intercompany loans, advances, or cash dividends. These
limitations result from the restrictions contained in trust indentures under
debt financing arrangements to which the Company's education lending
subsidiaries are parties. The Company does not believe these limitations will
significantly affect its operating cash needs. The amounts of cash and
investments restricted in the respective reserve accounts of the education
lending subsidiaries are shown on the balance sheets as restricted cash and
investments.
OPERATING LINES OF CREDIT
The Company uses its line of credit agreements primarily for general operating
purposes, to fund certain asset and business acquisitions, and to repurchase
stock under the Company's stock repurchase program. As of March 31, 2007 the
Company had outstanding a $500.0 million unsecured line of credit with no
outstanding borrowings. On May 8, 2007, the Company amended this agreement to
increase the line of credit to $750 million. The amended agreement terminates in
May 2012. In addition, EDULINX has a credit facility agreement with a Canadian
financial institution for approximately $1.7 million ($2.0 million in Canadian
dollars) that is cancelable by either party upon demand. The Company had no
borrowings under the EDULINX facility as of March 31, 2007.
On January 24, 2007, the Company established a $475 million unsecured commercial
paper program. Under the program, the Company may issue commercial paper for
general corporate purposes. The maturities of the notes issued under this
program will vary, but may not exceed 397 days from the date of issue. Notes
issued under this program will bear interest at rates that will vary based on
market conditions at the time of issuance. As of March 31, 2007, the Company had
$141.6 million outstanding under this program with a weighted average interest
rate of 5.38%.
42
SECURED FINANCING TRANSACTIONS
The Company relies upon secured financing vehicles as its most significant
source of funding for student loans on a long-term basis. The net cash flow the
Company receives from the securitized student loans generally represents the
excess amounts, if any, generated by the underlying student loans over the
amounts required to be paid to the bondholders, after deducting servicing fees
and any other expenses relating to the securitizations. The Company's rights to
cash flow from securitized student loans are subordinate to bondholder interests
and may fail to generate any cash flow beyond what is due to bondholders. The
Company's secured financing vehicles are loan warehouse facilities and
asset-backed securitizations.
LOAN WAREHOUSE FACILITIES
Student loan warehousing allows the Company to buy and manage student loans
prior to transferring them into more permanent financing arrangements. The
Company uses its warehouse facilities to pool student loans in order to maximize
loan portfolio characteristics for efficient financing and to properly time
market conditions for movement of the loans. Generally, loans that best fit
long-term financing vehicles are selected to be transferred into long-term
securitizations. Because transferring those loans to a long-term securitization
includes certain fixed administrative costs, the Company maximizes its economies
of scale by executing large transactions.
In August 2006, the Company established a $5.0 billion loan warehouse program
through its wholly-owned subsidiary, Nelnet Student Asset Funding Extendible CP,
LLC ("Nelnet SAFE"), under which Nelnet SAFE may issue one or more short-term
extendable secured liquidity notes (the "Secured Liquidity Notes"). Each Secured
Liquidity Note will be issued at a discount or an interest-bearing basis having
an expected maturity of between 1 and 307 days (each, an "Expected Maturity")
and a final maturity of 90 days following the Expected Maturity. The Secured
Liquidity Notes issued as interest-bearing notes may be issued with fixed
interest rates or with interest rates that fluctuate based upon a one-month
LIBOR rate, a three-month LIBOR rate, a commercial paper rate, or a federal
funds rate. The Secured Liquidity Notes are not redeemable by the Company nor
subject to voluntary prepayment prior to the Expected Maturity date. The Secured
Liquidity Notes are secured by FFELP loans purchased in connection with the
program. As of March 31, 2007, the Company had $3.4 billion of Secured Liquidity
Notes outstanding and an additional $1.6 billion authorized for future issuance
under this warehouse program.
The Company also utilizes bank supported commercial paper conduit programs for
loan warehousing. The Company had a loan warehousing capacity of $4.3 billion as
of March 31, 2007, of which $3.6 billion was outstanding and $0.7 billion was
available for future use, under these programs. The conduit programs terminate
in 2007. In addition, they must be renewed annually by underlining liquidity
providers. Historically, the Company has been able to renew its commercial paper
conduit programs, including the underlying liquidity agreements, and therefore
the Company does not believe the renewal of these contracts presents a
significant risk to its liquidity.
Management believes the Company's warehouse facilities allow for expansion of
liquidity and capacity for student loan growth and should provide adequate
liquidity to fund the Company's student loan operations for the foreseeable
future.
ASSET-BACKED SECURITIZATIONS
Of the $26.5 billion of debt outstanding as of March 31, 2007, $18.9 billion was
issued under asset-backed securitizations. Depending on market conditions, the
Company anticipates continuing to access the asset-backed securities market.
Securities issued in the securitization transactions are generally priced based
upon a spread to LIBOR or set under an auction procedure. During 2006, the
Company completed asset-backed securities transactions that included certain
notes issued with initial spreads to the 3-month EURIBOR. The interest rate on
student loans being financed is generally set based upon a spread to commercial
paper or U.S. Treasury bills.
UNIVERSAL SHELF OFFERINGS
In May 2005, the Company consummated a debt offering under its universal shelf
consisting of $275.0 million in aggregate principal amount of Senior Notes due
June 1, 2010 (the "Notes"). The Notes are unsecured obligations of the Company.
The interest rate on the Notes is 5.125%, payable semiannually. At the Company's
option, the Notes are redeemable in whole at any time or in part from time to
time at the redemption price described in the Company's prospectus supplement.
On September 27, 2006 the Company consummated a debt offering under its
universal shelf consisting of $200.0 million aggregate principal amount of
Junior Subordinated Hybrid Securities ("Hybrid Securities"). The Hybrid
Securities are unsecured obligations of the Company. The interest rate on the
Hybrid Securities from the date they were issued through the optional redemption
date, September 28, 2011, is 7.40%, payable semi-annually. Beginning September
29, 2011 through September 29, 2036, the "scheduled maturity date", the interest
rate on the Hybrid Securities will be equal to three-month LIBOR plus 3.375%,
payable quarterly. The principal amount of the Hybrid Securities will become due
on the scheduled maturity date only to the extent that the Company has received
43
proceeds from the sale of certain qualifying capital securities prior to such
date (as defined in the Hybrid Securities' prospectus). If any amount is not
paid on the scheduled maturity date, it will remain outstanding and bear
interest at a floating rate as defined in the prospectus, payable monthly. On
September 15, 2061, the Company must pay any remaining principal and interest on
the Hybrid Securities in full whether or not the Company has sold qualifying
capital securities. At the Company's option, the Hybrid Securities are
redeemable in whole at any time or in part from time to time at the redemption
price described in the prospectus supplement.
The proceeds from these unsecured debt offerings were or will be used by the
Company to fund general business operations, certain asset and business
acquisitions, and the repurchase of stock under the Company's stock repurchase
plan. As of March 31, 2007, the Company has $275.0 million remaining under its
universal shelf.
The following table summarizes the Company's bonds and notes outstanding as of
March 31, 2007:
Interest rate
Carrying Percent of range on carrying Final
amount total amount maturity
------------- --------- ------------------ --------------------
Variable-rate bonds and notes (a):
Bond and notes based on indices $ 15,092,310 56.9 % 3.70% - 6.06% 04/01/07 - 05/01/42
Bonds and notes based on EURIBOR 1,034,060 3.9 3.86% - 3.95% 08/25/36 - 01/26/37
Bond and notes based on auction 2,435,820 9.2 3.58% - 5.40% 11/01/09 - 07/01/43
------------- ---------
Total variable-rate bonds and notes 18,562,190 70.0
Commerical paper and other 6,922,096 26.1 5.32% - 5.59% 05/11/07 - 11/28/07
Fixed-rate bonds and notes (a) 376,394 1.4 5.20% - 6.68% 11/01/09 - 05/01/29
Unsecured fixed-rate debt 475,000 1.8 5.13% - 7.40% 06/01/10 - 09/29/36
Unsecured line of credit 141,619 0.5 5.36% - 5.40% 4/27/07
Other borrowings 60,183 0.2 5.10% - 5.78% 06/29/07 - 11/01/15
------------- ---------
Total $ 26,537,482 100.0 %
============= =========
--------------------------------
(a) Issued in securitization transactions.
The Company is committed under non-cancelable operating leases for certain
office and warehouse space and equipment. The Company's contractual obligations
as of March 31, 2007 were as follows:
Less than More than
Total 1 year 1 to 3 years 3 to 5 years 5 years
------------- ------------ ------------- ----------- -----------
Bonds and notes payable $ 26,537,482 7,254,395 167,957 332,168 18,782,962
Operating lease obligations 40,088 12,042 15,649 8,453 3,944
Other 24,188 1,300 22,888 -- --
------------- ------------ ----------- ----------- ------------
Total $ 26,601,758 7,267,737 206,494 340,621 18,786,906
============= ============ =========== =========== ============
The Company had a $10.8 million reserve as of March 31, 2007 for uncertain
income tax positions related to the adoption of FIN 48. This obligation is not
included in the above table as the timing and resolution of the income tax
positions cannot be reasonably estimated at this time.
The Company's bonds and notes payable due in less than one year include $6.9
billion under its loan warehouse facilities. Historically, the Company has been
able to renew its commercial paper conduit programs, including the underlying
liquidity agreements, and therefore the Company does not believe the renewal of
these contracts presents a significant risk to its liquidity.
The Company has commitments with its branding partners and forward flow lenders
which obligate the Company to purchase loans originated under specific criteria,
although the branding partners and forward flow lenders are typically not
obligated to provide the Company with a minimum amount of loans. Branding
partners are those entities from whom the Company acquires student loans and
provides marketing and origination services. Forward flow lenders are those
entities from whom the Company acquires student loans and provides origination
services. These commitments generally run for periods ranging from one to five
years and are generally renewable. Commitments to purchase loans under these
arrangements are not included in the table above.
As a result of the Company's recent acquisitions, the Company has certain
contractual obligations or commitments as follows:
o LoanSTAR - As part of the agreement for the acquisition of the
capital stock of LoanSTAR from the Greater Texas Foundation
("Texas Foundation"), the Company agreed to sell student loans
in an aggregate amount sufficient to permit the Texas Foundation
to maintain a portfolio of loans equal to no less than $200
million through October 2010. The sales price for such loans is
the fair value mutually agreed upon between the Company and the
Texas Foundation. To satisfy this obligation, the Company sells
loans to the Texas Foundation on a quarterly basis.
44
o SMG/NHR - Contingent payments of $4.0 million to $24.0 million
payable in annual installments through April 2008 based on the
operating results of SMG and NHR. As of March 31, 2007, the
Company has made payments of $6 million related to this
contingency and has accrued an additional $6.9 million which is
included in the table above.
o infiNET - Stock price guarantee of $104.8375 per share on 95,380
shares of Class A Common Stock issued as part of the original
purchase price. The obligation to pay this guaranteed stock
price is due February 28, 2011 and is not included in the table
above.
o FACTS - 238,237 shares of Class A Common Stock issued as part of
the original purchase price is subject to a put option
arrangement whereby during the 30-day period beginning February
28, 2010, the holders of such shares can require the Company to
repurchase all or part of the shares at a price of $83.95 per
share. The value of this put option as of March 31, 2007 was
$11.9 million and is included in "other" in the above table.
o CUnet - Contingent payments not to exceed $80.0 million due in
annual installments through December 2010 based on the aggregate
cumulative net income before taxes of CUnet. In partial
satisfaction of the contingent consideration, the Company will
issue shares of Class A Common Stock. These contingency payments
are not included in the table above.
o 5280 - 258,760 shares of Class A Common Stock issued as part of
the original purchase price is subject to a put option
arrangement whereby during the 30-day period ending November 30,
2008, the holders may require the Company to repurchase all or
part of the shares at a price of $37.10 per share. The value of
this put option as of March 31, 2007 was $3.1 million and is
included in "other" in the above table.
DIVIDENDS
On February 7, 2007, the Company's Board of Directors approved a cash dividend
of $0.07 per share on the Company's Class A and Class B Common Stock which was
paid on March 15, 2007 to shareholders of record as of March 1, 2007. The
Company intends to continue making a quarterly dividend payment in the future.
CRITICAL ACCOUNTING POLICIES
This Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the reported amounts of income and expenses during the reporting
periods. The Company bases its estimates and judgments on historical experience
and on various other factors that the Company believes are reasonable under the
circumstances. Actual results may differ from these estimates under varying
assumptions or conditions. Note 2 of the consolidated financial statements,
which are included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2006, includes a summary of the significant accounting
policies and methods used in the preparation of the consolidated financial
statements.
On an on-going basis, management evaluates its estimates and judgments,
particularly as they relate to accounting policies that management believes are
most "critical" -- that is, they are most important to the portrayal of the
Company's financial condition and results of operations and they require
management's most difficult, subjective, or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain. Management has identified the following critical accounting policies
that are discussed in more detail below: allowance for loan losses, student loan
income, and purchase price accounting related to business and certain asset
acquisitions.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management's estimate of probable
losses on student loans. This evaluation process is subject to numerous
estimates and judgments. The Company evaluates the adequacy of the allowance for
loan losses on its federally insured loan portfolio separately from its
non-federally insured loan portfolio.
Management bases the allowance for the federally insured loan portfolio on
periodic evaluations of the Company's loan portfolios considering past
experience, trends in student loan claims rejected for payment by guarantors,
changes to federal student loan programs, current economic conditions, and other
relevant factors. Should any of these factors change, the estimates made by
management would also change, which in turn would impact the level of the
Company's future provision for loan losses.
On February 8, 2006, HERA was enacted into law. HERA effectively reauthorized
the Title IV provisions of the FFEL Program through 2012. One of the provisions
of HERA resulted in lower guarantee rates on FFELP loans, including a decrease
in insurance and reinsurance on portfolios receiving the benefit of Exceptional
45
Performance designation by 1%, from 100% to 99% of principal and accrued
interest (effective July 1, 2006) and a decrease in insurance and reinsurance on
portfolios not subject to the Exceptional Performance designation by 1%, from
98% to 97% of principal and accrued interest (effective for all loans first
disbursed on and after July 1, 2006). As a result, during the year ended
December 31, 2006, the Company applied the new provisions to its evaluation of
the adequacy of the allowance for loan losses on its federally insured loan
portfolio.
In determining the adequacy of the allowance for loan losses on the
non-federally insured loans, the Company considers several factors including:
loans in repayment versus those in a nonpaying status, months in repayment,
delinquency status, type of program, and trends in defaults in the portfolio
based on Company and industry data. Should any of these factors change, the
estimates made by management would also change, which in turn would impact the
level of the Company's future provision for loan losses. The Company places a
non-federally insured loan on nonaccrual status and charges off the loan when
the collection of principal and interest is 120 days past due.
The allowance for federally insured and non-federally insured loans is
maintained at a level management believes is adequate to provide for estimated
probable credit losses inherent in the loan portfolio. This evaluation is
inherently subjective because it requires estimates that may be susceptible to
significant changes.
STUDENT LOAN INCOME
The Company recognizes student loan income as earned, net of amortization of
loan premiums and deferred origination costs. Loan income is recognized based
upon the expected yield of the loan after giving effect to borrower utilization
of incentives such as principal reductions for timely payments ("borrower
benefits") and other yield adjustments. The estimate of the borrower benefits
discount is dependent on the estimate of the number of borrowers who will
eventually qualify for these benefits. For competitive purposes, the Company
frequently changes the borrower benefit programs in both amount and
qualification factors. These programmatic changes must be reflected in the
estimate of the borrower benefit discount. Loan premiums, deferred origination
costs, and borrower benefits are included in the carrying value of the student
loan on the consolidated balance sheet and are amortized over the estimated life
of the loan in accordance with SFAS No. 91, ACCOUNTING FOR NON-REFUNDABLE FEES
AND COSTS ASSOCIATED WITH ORIGINATING OR ACQUIRING LOANS AND INITIAL DIRECT
COSTS OF LEASES. The most sensitive estimate for loan premiums, deferred
origination costs, and borrower benefits is the estimate of the constant
repayment rate ("CPR"). CPR is a variable in the life of loan estimate that
measures the rate at which loans in a portfolio pay before their stated
maturity. The CPR is directly correlated to the average life of the portfolio.
CPR equals the percentage of loans that prepay annually as a percentage of the
beginning of period balance. A number of factors can affect the CPR estimate
such as the rate of consolidation activity and default rates. Should any of
these factors change, the estimates made by management would also change, which
in turn would impact the amount of loan premium and deferred origination cost
amortization recognized by the Company in a particular period.
PURCHASE PRICE ACCOUNTING RELATED TO BUSINESS AND CERTAIN ASSET ACQUISITIONS
The Company has completed several business and asset acquisitions which have
generated significant amounts of goodwill and intangible assets and related
amortization. The values assigned to goodwill and intangibles, as well as their
related useful lives, are subject to judgment and estimation by the Company.
Goodwill and intangibles related to acquisitions are determined and based on
purchase price allocations. Valuation of intangible assets is generally based on
the estimated cash flows related to those assets, while the initial value
assigned to goodwill is the residual of the purchase price over the fair value
of all identifiable assets acquired and liabilities assumed. Thereafter, the
value of goodwill cannot be greater than the excess of fair value of the
Company's reportable unit over the fair value of the identifiable assets and
liabilities, based on an annual impairment test. Useful lives are determined
based on the expected future period of the benefit of the asset, the assessment
of which considers various characteristics of the asset, including historical
cash flows. Due to the number of estimates involved related to the allocation of
purchase price and determining the appropriate useful lives of intangible
assets, management has identified purchase price accounting as a critical
accounting policy.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS ("SFAS
No. 157"). This Statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. The provisions of SFAS No. 157 are
effective as of the beginning of the first fiscal year that begins after
November 15, 2007. As of the filing of this Report, management believes that
SFAS No. 157 will not have a material effect on the financial position and
results of operations of the Company.
In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES - INCLUDING AN AMENDMENT OF FASB
STATEMENT NO. 115 ("SFAS. No. 159"), which permits entities to choose to measure
many financial instruments at fair value. The Statement allows entities to
achieve an offset accounting effect for certain changes in fair value of related
assets and liabilities without having to apply complex hedge accounting
provisions, and is expected to expand the use of fair value measurement
consistent with the Board's long-term objectives for financial instruments. This
Statement is effective as of the beginning of an entity's first fiscal year that
begins after November 15, 2007. Early adoption is permitted. Retrospective
application to fiscal years preceding the effective date (or early adoption
date) is prohibited. Management is currently evaluating SFAS No. 159 to assess
its impact on the Company's financial statements.
46
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company's primary market risk exposure arises from fluctuations in its
borrowing and lending rates, the spread between which could impact the Company
due to shifts in market interest rates. Because the Company generates a
significant portion of its earnings from its student loan spread, the interest
sensitivity of the balance sheet is a key profitability driver.
The Company's portfolio of FFELP loans originated prior to April 1, 2006 earns
interest at the higher of a variable rate based on the special allowance payment
(SAP) formula set by the Department and the borrower rate. The SAP formula is
based on an applicable index plus a fixed spread that is dependent upon when the
loan was originated, the loan's repayment status, and funding sources for the
loan. As a result of one of the provisions of HERA, the Company's portfolio of
FFELP loans originated on or after April 1, 2006 earns interest at a variable
rate based on the SAP formula. For the portfolio of loans originated on or after
April 1, 2006, when the borrower rate exceeds the variable rate based on the SAP
formula, the Company must return the excess to the Department.
The following table sets forth the Company's loan assets and debt instruments by
rate characteristics:
As of March 31, 2007 As of December 31, 2006
------------------------ -----------------------
Dollars Percent Dollars Percent
------------- --------- ------------- ---------
Fixed-rate loan assets $ 764,996 3.1 % $ 787,378 3.4 %
Variable-rate loan assets 23,852,034 96.9 22,627,090 96.6
------------- --------- ------------- --------
Total $ 24,617,030 100.0 % $ 23,414,468 100.0 %
============= ========= ============= ========
Fixed-rate debt instruments $ 851,394 3.2 % $ 878,431 3.4 %
Variable-rate debt instruments 25,686,088 96.8 24,683,688 96.6
------------- --------- ------------- --------
Total $ 26,537,482 100.0 % $ 25,562,119 100.0 %
============= ========= ============= ========
The following table shows the Company's student loan assets currently earning at
a fixed rate as of March 31, 2007:
Borrower/ Estimated
lender variable Current
Fixed interest weighted conversion balance of
rate range average yield rate (a) fixed rate assets
---------------- ------------- ---------------- ---------------
8.0 - 9.0% 8.23% 5.59% $ 362,919
> 9.0% 9.05 6.41 402,077
--------------
$ 764,996
==============
-------------------
(a) The estimated variable conversion rate is the estimated short-term
interest rate at which loans would convert to variable rate.
Historically, the Company has followed a policy of funding the majority of its
student loan portfolio with variable-rate debt. In a low interest rate
environment, the FFELP loan portfolio yields excess income primarily due to the
reduction in interest rates on the variable-rate liabilities that fund student
loans at a fixed borrower rate and also due to consolidation loans earning
interest at a fixed rate to the borrower. This excess income is referred to as
"floor income." Therefore, absent utilizing derivative instruments, in a low
interest rate environment, a rise in interest rates will have an adverse effect
on earnings. For the three months ended March 31, 2007, loan interest income
includes approximately $3.5 million of floor income. In higher interest rate
environments, where the interest rate rises above the borrower rate and the
fixed-rate loans become variable rate and are effectively matched with
variable-rate debt, the impact of rate fluctuations is substantially reduced.
The Company attempts to match the interest rate characteristics of pools of loan
assets with debt instruments of substantially similar characteristics,
particularly in rising interest rate environments. Due to the variability in
duration of the Company's assets and varying market conditions, the Company does
not attempt to perfectly match the interest rate characteristics of the entire
loan portfolio with the underlying debt instruments. The Company has adopted a
policy of periodically reviewing the mismatch related to the interest rate
characteristics of its assets and liabilities and the Company's outlook as to
current and future market conditions. Based on those factors, the Company will
periodically use derivative instruments as part of its overall risk management
strategy to manage risk arising from its fixed-rate and variable-rate financial
instruments. Derivative instruments used as part of the Company's interest rate
risk management strategy include interest rate swaps, basis swaps, interest rate
floor contracts, and cross-currency interest rate swaps.
47
INTEREST RATE SWAPS - LOAN PORTFOLIO
The following table summarizes the outstanding interest rate derivative
instruments as of March 31, 2007 used by the Company to hedge the fixed-rate
student loan portfolio:
Weighted average
Notional fixed rate paid by
Maturity values the Company
----------- ----------- ------------------
2008 $ 462,500 3.76 %
2009 312,500 4.01
----------- -------------
Total $ 775,000 3.86 %
=========== =============
In addition to the interest rate swaps with notional values of $0.8 billion
summarized above, as of March 31, 2007, the Company had $376.4 million of
fixed-rate debt (excluding the Company's fixed-rate unsecured debt of $475
million) that was used by the Company to hedge fixed-rate student loan assets.
The weighted average interest rate paid by the Company on the $376.4 million of
debt as of March 31, 2007 was 6.01%.
INTEREST RATE SWAPS - OTHER
As discussed under Item 2, "Management's Discussion and Analysis of Financial
Condition and Results of Operation", the Company entered into a Settlement
Agreement with the Department to resolve the audit by the OIG of the Company's
portfolio of student loans receiving the 9.5% special allowance payments. Under
the terms of the Agreement, the Company will no longer receive 9.5% special
allowance payments.
In consideration of not receiving the 9.5% special allowance payments on a
prospective basis, the Company entered into a series of off-setting interest
rate swaps that mirror the $2.45 billion in pre-existing interest rate swaps
that the Company had utilized to hedge its loan portfolio receiving 9.5% special
allowance payments against increases in interest rates. The net effect of the
new offsetting derivatives is to lock in a series of future income streams on
underlying trades through their respective maturity dates. The following table
summarizes these derivatives as of March 31, 2007:
Weighted Weighted
average fixed average fixed
Notional rate paid by Notional rate received by
Maturity Amount the Company Amount the Company
------------ ------------- --------------- ----------- ----------------
2007 $ 512,500 3.42 % $ 512,500 5.25 %
2010 1,137,500 4.25 1,137,500 4.75
2012 275,000 4.31 275,000 4.76
2013 525,000 4.36 525,000 4.80
------------- --------------- ----------- ----------------
$ 2,450,000 4.11 % $ 2,450,000 4.87 %
============= =============== =========== ================
BASIS SWAPS
On May 1, 2006, the Company entered into three, ten-year basis swaps with
notional values of $500.0 million each in which the Company receives three-month
LIBOR and pays one-month LIBOR less a spread as defined in the agreements. The
effective dates of these agreements were November 25, 2006, December 25, 2006,
and January 25, 2007.
On April 4, 2007, the Company entered into three, 2-year swaps with notional
amounts of $1.0 billion each. For each swap, the Company receives three-month
LIBOR set discretely in advance and pays a daily weighted average three-month
LIBOR less a spread as defined in the agreements. The effective dates of theses
agreements are May 27, 2008, June 25, 2008, and July 25, 2008. The Company
entered into theses derivatives instruments to better match the interest rate
characteristics on its student loan assets and the debt funding such assets.
48
INTEREST RATE FLOOR CONTRACTS
In June 2006, the Company entered into interest rate floor contracts in which
the Company received an upfront fee of $8.6 million. These contracts were
structured to monetize on an upfront basis the potential floor income associated
with certain consolidation loans. On January 30, 2007, the Company paid $8.1
million to terminate these contracts and recognized a gain of $2.1 million.
CROSS-CURRENCY INTEREST RATE SWAPS
See "Foreign Currency Exchange Risk".
FINANCIAL STATEMENT IMPACT OF DERIVATIVE INSTRUMENTS
The Company accounts for its derivative instruments in accordance with SFAS No.
133. SFAS No. 133 requires that changes in the fair value of derivative
instruments be recognized currently in earnings unless specific hedge accounting
criteria as specified by SFAS No. 133 are met. Management has structured all of
the Company's derivative transactions with the intent that each is economically
effective. However, the Company's derivative instruments do not qualify for
hedge accounting under SFAS No. 133; consequently, the change in fair value of
these derivative instruments is included in the Company's operating results.
Changes or shifts in the forward yield curve and fluctuations in currency rates
can significantly impact the valuation of the Company's derivatives.
Accordingly, changes or shifts to the forward yield curve and fluctuations in
currency rates will impact the financial position and results of operations of
the Company. The net decrease in fair value of the Company's derivatives are
included in "derivative market value, foreign currency, and put option
adjustments and derivative settlements, net" in the Company's consolidated
statements of income and resulted in a gain of $3.6 million and $50.3 million
for the three months ended March 31, 2007 and 2006, respectively.
The following summarizes the derivative settlements included in "derivative
market value, foreign currency, and put option adjustments and derivative
settlements, net" on the consolidated statements of income:
Three months ended March 31,
----------------------------
2007 2006
------------- --------------
Interest rate and basis swap
derivatives- loan portfolio $ 2,895 1,732
Interest rate swap derivatives- other (a) 4,664 --
Special allowance yield adjustment derivatives (a) -- 4,164
Cross-currency interest rate swaps (3,319) (1,152)
------------- --------------
Derivative settlements, net $ 4,240 4,744
============= ==============
(a) Derivative settlements for interest rate swaps "other" include
settlements on the portfolio of derivatives that the Company had used to
hedge 9.5% special allowance payments and the portfolio of off-setting
interest rate swaps the Company entered into during the fourth quarter
2006. The new derivatives mirror the 9.5% special allowance payment
derivatives. Settlements on the 9.5% special allowance derivatives were
classified as special allowance yield adjustment derivatives through
September 30, 2006.
SENSITIVITY ANALYSIS
The following tables summarize the effect on the Company's earnings, based upon
a sensitivity analysis performed by the Company assuming a hypothetical increase
and decrease in interest rates of 100 basis points and an increase in interest
rates of 200 basis points while funding spreads remain constant. The effect on
earnings was performed on the Company's variable-rate assets and liabilities.
The analysis includes the effects of the Company's interest rate swaps, basis
swaps, and interest rate floor contracts in existence during these periods. As a
result of the Company's interest rate management activities, the Company expects
such a change in pre-tax net income resulting from a 100 basis point increase or
decrease or a 200 basis point increase in interest rates would not result in a
proportional decrease in net income.
49
Three months ended March 31, 2007
----------------------------------------------------------------------------------
Change from decrease of 100 Change from increase of Change from increase of
basis points 100 basis points 200 basis points
------------------------- ------------------------ -------------------------
Dollar Percent Dollar Percent Dollar Percent
------------- ---------- ------------- --------- ------------ -----------
Effect on earnings:
Increase in pre-tax net income before
impact of derivative settlements $ 7,029 29.7 % $ 228 0.9 % $ 1,593 6.7 %
Impact of derivative settlements (1,911) (8.1) 1,911 8.1 3,822 16.2
------------- ---------- ------------- --------- ------------ ---------
Increase in net income before taxes $ 5,118 21.6 % $ 2,139 9.0 % $ 5,415 22.9 %
============= ========== ============= ========= ============ =========
Increase in basic and diluted
earning per share $ 0.06 $ 0.03 $ 0.07
============= ============= ============
Three months ended March 31, 2006
----------------------------------------------------------------------------------
Change from decrease of 100 Change from increase of Change from increase of
basis points 100 basis points 200 basis points
------------------------- ------------------------ -------------------------
Dollar Percent Dollar Percent Dollar Percent
------------- ---------- ------------- --------- ----------- -----------
Effect on earnings:
Increase (decrease) in pre-tax
net income before
impact of derivative settlements $ 9,812 11.8 % $ (8,444) (10.2)% $ (13,879) (16.7)%
Impact of derivative settlements (9,462) (11.4) 9,462 11.4 18,925 22.8
---------- ---------- ------------- --------- ----------- -----------
Increase in net income before taxes $ 350 0.4 % $ 1,018 1.2 % $ 5,046 6.1 %
========== ========== ============= ========= =========== ===========
Increase in basic and diluted
earning per share $ -- $ 0.01 $ 0.06
========== ============= ==========
FOREIGN CURRENCY EXCHANGE RISK
The Company purchased EDULINX in December 2004. EDULINX is a Canadian
corporation that engages in servicing Canadian student loans. As a result of
this acquisition, the Company is exposed to market risk related to fluctuations
in foreign currency exchange rates between the U.S. and Canadian dollars. The
Company has not entered into any foreign currency derivative instruments to
hedge this risk. However, the Company does not believe fluctuations in foreign
currency exchange rates will have a significant effect on the financial
position, results of operations, or cash flows of the Company.
During 2006, the Company completed separate debt offerings of student loan
asset-backed securities that included 420.5 million and 352.7 million
Euro-denominated notes with interest rates based on a spread to the EURIBOR
index. As a result of this transaction, the Company is exposed to market risk
related to fluctuations in foreign currency exchange rates between the U.S. and
Euro dollars. The principal and accrued interest on these notes is re-measured
at each reporting period and recorded on the Company's balance sheet in U.S.
dollars based on the foreign currency exchange rate on that date. Changes in the
principal and accrued interest amounts as a result of foreign currency exchange
rate fluctuations are included in the "derivative market value, foreign
currency, and put option adjustments and derivative settlements, net" in the
Company's consolidated statements of income.
The Company entered into cross-currency interest rate swaps in connection with
the issuance of the Euro Notes. Under the terms of these derivative instrument
agreements, the Company receives from a counterparty a spread to the EURIBOR
index based on notional amounts of (euro)420.5 million and (euro)352.7 million
and pays a spread to the LIBOR index based on notional amounts of $500.0 million
and $450.0 million, respectively. In addition, under the terms of these
agreements, all principal payments on the Euro Notes will effectively be paid at
the exchange rate in effect as of the issuance of the notes. The Company did not
qualify these derivative instruments as hedges under SFAS No. 133; consequently,
the change in fair value is included in the Company's operating results.
For the three months ended March 31, 2007, the Company recorded an expense of
$13.7 million as a result of re-measurement of the Euro Notes and income of
$11.2 million for the change in the fair value of the related derivative
instrument. Both of these amounts are included in "derivative market value,
foreign currency, and put option adjustments and derivative settlements, net" on
the Company's consolidated statement of income.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Under supervision and with the participation of certain members of the Company's
management, including the co-chief executive officers and the chief financial
officer, the Company completed an evaluation of the effectiveness of the design
and operation of its disclosure controls and procedures (as defined in SEC Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on
this evaluation, the Company's co-chief executive officers and chief financial
officer believe that the disclosure controls and procedures were effective as of
the end of the period covered by this Quarterly Report on Form 10-Q with respect
to timely communication to them and other members of management responsible for
preparing periodic reports and material information required to be disclosed in
this Quarterly Report on Form 10-Q as it relates to the Company and its
consolidated subsidiaries.
50
The effectiveness of the Company's or any system of disclosure controls and
procedures is subject to certain limitations, including the exercise of judgment
in designing, implementing, and evaluating the controls and procedures, the
assumptions used in identifying the likelihood of future events, and the
inability to eliminate misconduct completely. As a result, there can be no
assurance that the Company's disclosure controls and procedures will prevent all
errors or fraud or ensure that all material information will be made known to
appropriate management in a timely fashion. By their nature, the Company's or
any system of disclosure controls and procedures can provide only reasonable
assurance regarding management's control objectives.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change in the Company's internal control over financial reporting
during the Company's last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
GENERAL
The Company is subject to various claims, lawsuits, and proceedings that arise
in the normal course of business. These matters principally consist of claims by
borrowers disputing the manner in which their loans have been processed and
disputes with other business entities. On the basis of present information,
anticipated insurance coverage, and advice received from counsel, it is the
opinion of the Company's management that the disposition or ultimate
determination of these claims, lawsuits, and proceedings will not have a
material adverse effect on the Company's business, financial position, or
results of operations.
DEPARTMENT OF EDUCATION SETTLEMENT
In June 2005, the Office of Inspector General of the U.S. Department of
Education (the "OIG") commenced an audit of the portion of the Company's student
loan portfolio receiving special allowance payments at a minimum 9.5% interest
rate based on provisions of the Higher Education Act and regulations and
guidance of the U.S. Department of Education (the "Department") and related
interpretations. On September 29, 2006, the Company received a final audit
report from the OIG where the OIG found that an increase in the amount of 9.5%
special allowance payments received by the Company was based on what the OIG
deemed to be ineligible loans.
On January 19, 2007, the Company entered into a Settlement Agreement with the
Department to resolve the OIG audit of the Company's portfolio of student loans
receiving 9.5% special allowance payments. Under the terms of the Settlement
Agreement, the Company is permitted to retain the 9.5% special allowance
payments that it received from the Department prior to July 1, 2006. In
addition, the Settlement Agreement eliminates all 9.5% special allowance
payments with respect to the Company's portfolios of student loans for periods
on and after July 1, 2006.
The Company disagrees with the OIG audit report, and continues to believe that
it billed for the 9.5% special allowance payments in accordance with applicable
laws, regulations, and the Department's previous guidance. As a part of the
Settlement Agreement, the Company and the Department acknowledge a dispute
exists related to guidance previously issued by the Department and the
application of the existing laws and regulations related to the Company
receiving certain 9.5% special allowance payments, and that the Settlement
Agreement is based in part on the parties' desire to avoid costly litigation
regarding that dispute. The new guidance provided to the Company in the
Settlement Agreement eliminates all future 9.5% special allowance payments for
the Company. These loans will continue to receive special allowance payments
using other applicable special allowance formulas.
The Settlement Agreement does not preclude any other government agency from
reviewing the issues raised in the OIG audit report. The Company was informed by
the Department that a civil attorney with the Department of Justice has opened a
file regarding this issue which the Company understands is common procedure
following an OIG audit report. The Company believes that any claim related to
this issue has no merit.
INVESTIGATION BY THE NEW YORK ATTORNEY GENERAL'S OFFICE
As previously reported in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2006, on January 11, 2007 the Company received a
letter from the New York Attorney General requesting certain information and
documents from the Company in connection with the New York Attorney General's
investigation into preferred lender list activities. Since that time other state
attorneys general and the U.S. Senate Committee on Health, Education, Labor, and
Pensions have announced or reportedly have initiated broad inquiries or
investigations of the activities of various participants in the student loan
industry, including activities which may involve perceived conflicts of
interest. Such inquiries or investigations, including the investigation by the
New York Attorney General, are discussed immediately below.
51
INDUSTRY INVESTIGATIONS
Since January 2007, a number of state attorneys general and the U.S. Senate
Committee on Health, Education, Labor, and Pensions have announced or are
reportedly conducting broad inquiries or investigations of the activities of
various participants in the student loan industry, including activities which
may involve perceived conflicts of interest. The general focus of the inquiries
or investigations to date has primarily been on any financial arrangements among
student loan lenders and other industry participants which may facilitate
increased volumes of student loans for particular lenders. Like many other
student loan lenders, the Company has received informal requests for information
from certain state attorneys general and the Chairman of the U.S. Senate
Committee on Health, Education, Labor, and Pensions in connection with their
inquiries or investigations. In addition, the Company has received subpoenas for
information from the New York Attorney General and the New Jersey Attorney
General. In each case the Company is cooperating with the requests and subpoenas
for information that it has received.
On April 20, 2007, the Company announced that it had agreed with the Nebraska
Attorney General to voluntarily adopt a Nelnet Student Loan Code of Conduct,
post a review of the Company's business practices on its website, and commit $1
million to help educate students and families on how to plan and pay for their
education. While the Company cannot predict the ultimate outcome of any other
inquiry or investigation, it is possible these inquiries or investigations may
result in additional agreements. The Company currently believes that the
ultimate resolution of these inquiries or investigations will not have a
material adverse effect on the Company's financial condition or ongoing
operations.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors described in Nelnet's
Annual Report on Form 10-K for the year ended December 31, 2006 in response to
Item 1A of Part I of such Form 10-K except as set forth below.
CHANGES IN LEGISLATION AND REGULATIONS COULD HAVE A NEGATIVE IMPACT UPON THE
COMPANY'S BUSINESS AND MAY AFFECT ITS PROFITABILITY.
Funds for payment of interest subsidy payments, special allowance payments, and
other payments under the FFEL Program are subject to annual budgetary
appropriations by Congress. Federal budget legislation has in the past contained
provisions that restricted payments made under the FFEL Program to achieve
reductions in federal spending. Future federal budget legislation may adversely
affect expenditures by the Department, and the financial condition of the
guaranty agencies.
Furthermore, Congressional amendments to the Higher Education Act or other
relevant federal laws, and rules and regulations promulgated by the Secretary of
Education, may adversely impact holders of FFELP loans. For example, changes
might be made to the rate of interest paid on FFELP loans, to the level of
insurance provided by guaranty agencies, or to the servicing requirements for
FFELP loans. Such changes could have a material adverse effect on the Company
and its results of operations.
HERA was enacted into law on February 8, 2006 and effectively reauthorized the
Title IV provisions of the FFEL Program through 2012. HERA did not reauthorize
the entire Higher Education Act, which is set to expire on June 30, 2007 (as a
result of the Third Higher Education Extension Act of 2006). Therefore, further
action will be required by Congress to either extend or reauthorize the
remaining titles of the Higher Education Act.
52
The Company does not anticipate a negative impact from the reauthorization of
the remaining titles of the Higher Education Act. However, it cannot predict the
outcome of this or any other legislation impacting the FFEL Program, and
recognizes that a level of political and legislative risk always exists within
the industry. This could include changes in legislation further impacting lender
margins, fees paid to the Department, new policies affecting the competition
between the FDL Program and FFEL Programs, or additional lender risk sharing.
See Part I, Item I, "Business - Recent Developments Related to the Higher
Education Act."
In addition to changes to the FFEL Program and the Higher Education Act, various
state laws targeted at student lending companies have been proposed or are in
the process of being enacted. Many of these laws propose or require changes to
lending and business practices of student lenders. These laws could have a
negative impact on the Company's operations by requiring changes to the
Company's business practices and operations. Changes to privacy and direct mail
legislation could also negatively impact the Company, in particular the
Company's lead generation activities. Changes in such legislation could restrict
the Company's ability to collect information for its lead generation activities
and its ability to use the information it collects. In addition, changes to
privacy and direct mail legislation could cause the Company to incur expenses
related to implementation of any required changes to the Company's compliance
programs.
THE COMPANY COULD BE SANCTIONED IF IT CONDUCTS ACTIVITIES WHICH ARE CONSIDERED
PROHIBITED INDUCEMENTS UNDER THE HIGHER EDUCATION ACT.
The Higher Education Act generally prohibits a lender from providing certain
inducements to educational institutions or individuals in order to secure
applicants for FFELP loans. The Company has structured its relationships and
product offerings in a manner intended to comply with the Higher Education Act
and the available communications and guidance from the Department. If the
Department were to change its position on any of these matters, the Company may
have to change the way it markets products and services and a new marketing
strategy may not be as effective. If the Company fails to respond to the
Department's change in position, the Department could potentially impose
sanctions upon the Company that could negatively impact the Company's business.
On January 11, 2007, the Company received a letter from the Office of the New
York State Attorney General ("NYAG") requesting certain information and
documents from the Company in connection with the NYAG's investigation into
preferred lender list activities. "Preferred lender lists" are lists of lenders
recommended by college and university financial aid departments to students
seeking financial aid. On February 1, 2007, the NYAG announced that the NYAG's
office is conducting an investigation of the student loan industry to determine
if there are conflict of interest issues relating to lenders being placed on the
preferred lender lists at colleges and universities, and that the NYAG had sent
similar requests to other lenders and is also seeking information from a number
of colleges and universities nationwide. On May 3, 2007, the NYAG announced that
it had expanded its investigation to include college and university alumni
associations having affinity relationships with the Company. The Company is
cooperating with the NYAG's investigation and believes its practices comply with
all applicable laws and regulations.
CERTAIN PARTICIPANTS IN THE COMPANY'S STOCK COMPENSATION AND BENEFIT PLANS MAY
HAVE RESCISSION RIGHTS WITH RESPECT TO SHARES OF STOCK ACQUIRED UNDER THOSE
PLANS.
The Company recently discovered that as a result of inadvertent issues related
to the delivery of documents to participants, certain participants in the
Company's Employee Share Purchase Plan, Restricted Stock Plan, and Employee
Stock Purchase Loan Plan, may not have during certain time frames actually
received all of the information required to constitute a fully compliant
prospectus under the Securities Act of 1933. While the issuance of shares under
those plans has been registered with the Securities and Exchange Commission
under registration statements on Form S-8, it is a violation of Section 5 of the
Securities Act of 1933 to sell a security for which a registration statement has
been filed unless accompanied or preceded by a prospectus that meets the
requirements of Section 10 of the Securities Act of 1933.
Section 12 of the Securities Act of 1933 generally provides for a one-year
rescission right for an investor who acquires a security from a seller who does
not comply with the prospectus delivery requirements of Section 5 of the
Securities Act of 1933. As such, an investor successfully asserting a rescission
right during the one-year time period has the right to require an issuer to
repurchase the securities acquired by the investor at the price paid by the
investor for the securities (or if such security has been disposed of, to
receive damages with respect to any loss on such disposition), plus interest
from the date of acquisition. These rights may apply to affected participants in
the Company's plans. The Company believes that its potential liability for
rescission claims or other damages is not material to the Company's financial
condition; however, the Company's potential liability could become material to
results of operations for a particular period if, during the one-year period
following non-compliant sales, the market price of the shares of Class A common
stock falls significantly below the affected participants' acquisition prices.
53
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes the repurchases of Class A common stock during
the first quarter of 2007 by the Company or any "affiliated purchaser" of the
Company, as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of
1934.
Total number of Maximum number
shares purchased of shares that may
Total number Average as part of publicly yet be purchased
of shares price paid announced plans under the plans
Period purchased (1) per share or programs (2) (3) or programs (4)
------------------------------ -------------- ------------- ------------------- -------------------
January 1 - January 31, 2007 -- $ -- -- 4,403,312
February 1 - February 28, 2007 3,060,662 24.65 3,060,662 6,440,588
March 1 - March 31, 2007 410 26.51 410 6,549,624
-------------- ------------- -------------------
Total 3,061,072 $ 24.65 3,061,072
============== ============= ===================
(1) The total number of shares includes: (i) shares purchased
pursuant to the 2006 Plan discussed in footnote (2) below; and
(ii) shares repurchased pursuant to the 2006 ESLP discussed in
footnote (3) below, of which there were none for the months of
January, February, or March 2007. Shares purchased pursuant to
the 2006 Plan in February included: (i) 2,725,000 shares of Class
A common stock purchased from certain members of management of
the Company in private transactions; (ii) 780 shares of Class A
common stock purchased from an employee upon termination of
employment with the Company whose shares were originally acquired
pursuant to the 2006 ESLP; and (iii) 82 shares of Class A common
stock purchased from employees whose shares were originally
acquired pursuant to the Company's matching provisions in the
Company's 401(k) plan. Shares purchased pursuant to the 2006 Plan
in March included 410 shares of Class A common stock purchased
from employees whose shares were originally acquired pursuant to
the Company's matching contribution provisions in the Company's
401(k) plan.
(2) On May 25, 2006, the Company publicly announced that its Board of
Directors had authorized a stock repurchase program to buy back
up to a total of five million shares of the Company's Class A
common stock (the "2006 Plan"). The 2006 Plan has an expiration
date of May 24, 2008 (not January 31, 2008 as indicated in the
press release dated May 25, 2006 which announced the program). On
February 7, 2007, the Company's Board of Directors increased the
total shares the Company is allowed to buy back to 10 million.
(3) On May 25, 2006, the Company publicly announced that the
shareholders of the Company approved an Employee Stock Purchase
Loan Plan (the "2006 ESLP") to allow the Company to make loans
to employees for the purchase of shares of the Company's Class A
common stock either in the open market or directly from the
Company. A total of $40 million in loans may be made under the
2006 ESLP, and a total of one million shares of Class A common
stock are reserved for issuance under the 2006 ESLP. Shares may
be purchased directly from the Company or in the open market
through a broker at prevailing market prices at the time of
purchase, subject to any conditions or restrictions on the
timing, volume or prices of purchases as determined by the
Compensation Committee of the Board of Directors and set forth
in the Stock Purchase Loan Agreement with the participant. The
2006 ESLP shall terminate May 25, 2016.
54
(4) The maximum number of shares that may yet be purchased under the
plans is calculated below. There are no assurances that any
additional shares will be repurchased under either the 2006 Plan
or the 2006 ESLP. Shares under the 2006 ESLP may be issued by the
Company rather than purchased in open market transactions.
(B/C) (A+D)
Approximate Approximate Approximate
dollar value of Closing price number of number of
Maximum shares that may on the last shares that may shares that may
number of shares yet be trading day of yet be yet be
that may yet be purchased the Company's purchased purchased
purchased under under the 2006 Class A under the 2006 under the 2006
the 2006 Plan ESLP common stock ESLP Plan and 2006
As of (A) (B) (C) (D) ESLP
------------------- -----------------------------------------------------------------------------------
January 31, 2007 3,059,800 $ 37,175,000 $ 27.67 1,343,512 4,403,312
February 28, 2007 4,999,138 37,175,000 25.79 1,441,450 6,440,588
March 31, 2007 4,998,728 37,175,000 23.97 1,550,896 6,549,624
WORKING CAPITAL AND DIVIDEND RESTRICTIONS/LIMITATIONS
The Company's credit facilities, including its revolving line of credit which is
available through May of 2012, impose restrictions on the Company's minimum
consolidated net worth, the ratio of the Company's Adjusted EBITDA to corporate
debt interest, the indebtedness of the Company's subsidiaries, and the ratio of
Non-FFELP loans to all loans in the Company's portfolio. In addition, trust
indentures and other financing agreements governing debt issued by the Company's
education lending subsidiaries may have general limitations on the amounts of
funds that can be transferred to the Company by its subsidiaries through cash
dividends.
On September 27, 2006 the Company consummated a debt offering of $200.0 million
aggregate principal amount of Junior Subordinated Hybrid Securities ("Hybrid
Securities"). So long as any Hybrid Securities remain outstanding, if the
Company gives notice of its election to defer interest payments but the related
deferral period has not yet commenced or a deferral period is continuing, then
the Company will not, and will not permit any of its subsidiaries to:
o declare or pay any dividends or distributions on, or redeem,
purchase, acquire or make a liquidation payment regarding, any
of the Company's capital stock;
o except as required in connection with the repayment of
principal, and except for any partial payments of deferred
interest that may be made through the alternative payment
mechanism described in the Hybrid Securities indenture, make any
payment of principal of, or interest or premium, if any, on, or
repay, repurchase, or redeem any of the Company's debt
securities that rank PARI PASSU with or junior to the Hybrid
Securities; or
o make any guarantee payments regarding any guarantee by the
Company of the subordinated debt securities of any of the
Company's subsidiaries if the guarantee ranks PARI PASSU with or
junior in interest to the Hybrid Securities.
In addition, if any deferral period lasts longer than one year, the limitation
on the Company's ability to redeem or repurchase any of its securities that rank
PARI PASSU with or junior in interest to the Hybrid Securities will continue
until the first anniversary of the date on which all deferred interest has been
paid or cancelled.
If the Company is involved in a business combination where immediately after its
consummation more than 50% of the surviving entity's voting stock is owned by
the shareholders of the other party to the business combination, then the
immediately preceding sentence will not apply to any deferral period that is
terminated on the next interest payment date following the date of consummation
of the business combination.
However, at any time, including during a deferral period, the Company will be
permitted to:
o pay dividends or distributions in additional shares of the
Company's capital stock;
o declare or pay a dividend in connection with the implementation
of a shareholders' rights plan, or issue stock under such a
plan, or redeem or repurchase any rights distributed pursuant to
such a plan; and
o purchase common stock for issuance pursuant to any employee
benefit plans.
55
ITEM 6. EXHIBITS
10.1+* Nelnet, Inc. Employee Stock Purchase Loan Plan, Effective
February 28, 2007.
10.2+* Nelnet, Inc. Restricted Stock Plan, As amended through March 22,
2007.
10.3 Amended and Restated Credit Agreement dated as of May 8, 2007
among Nelnet, Inc., JPMorgan Chase Bank, N.A., individually and
as Administrative Agent, Citibank, N.A., individually and as
Syndication Agent, and various lender parties thereto, filed as
Exhibit 10.1 to the registrant's Current Report on Form 8-K
filed on May 10, 2007 and incorporated herein by reference.
10.4 Settlement Agreement dated January 19, 2007 between Nelnet, Inc.
and the United States Department of Education, filed as Exhibit
10.1 to the registrant's Current Report on Form 8-K filed on
January 19, 2007 and incorporated herein by reference.
10.5 Commercial Paper Dealer Agreement between Nelnet, Inc. and Banc
of America Securities LLC dated as of December 29, 2006, filed
as Exhibit 10.2 to the registrant's Current Report on Form 8-K
filed on January 30, 2007 and incorporated herein by reference.
10.6 Commercial Paper Issuing and Paying Agent Agreement between
Nelnet, Inc. and Deutsche Bank Trust Company Americas dated as
of December 29, 2006, filed as Exhibit 10.3 to the registrant's
Current Report on Form 8-K filed on January 30, 2007 and
incorporated herein by reference.
10.7 Commercial Paper Dealer Agreement between Nelnet, Inc. and
SunTrust Capital Markets, Inc. dated as of December 29, 2006,
filed as Exhibit 10.1 to the registrant's Current Report on Form
8-K filed on January 30, 2007 and incorporated herein by
reference.
31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 of Co-Chief Executive Officer Michael S. Dunlap.
31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 of Co-Chief Executive Officer Stephen F. Butterfield.
31.3* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 of Chief Financial Officer Terry J. Heimes.
32.** Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith
** Furnished herewith
+ Indicates a compensatory plan or arrangement.
56
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NELNET, INC.
Date: May 10, 2007 By: /s/ MICHAEL S. DUNLAP
------------------------------------------
Name: Michael S. Dunlap
Title: Chairman and Co-Chief Executive Officer
By: /s/ STEPHEN F. BUTTERFIELD
--------------------------------------------
Name: Stephen F. Butterfield
Title: Vice-Chairman and Co-Chief Executive
Officer
By: /s/ TERRY J. HEIMES
---------------------------------------------
Name: Terry J. Heimes
Title: Chief Financial Officer
57