Nelnet, Inc. 10-Q Summary: Period Ended June 30, 2007
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for Nelnet, Inc., a vertically-integrated education planning and financing company. The report covers the three and six months ended June 30, 2007. Nelnet operates through five segments: 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 is a large accelerated filer incorporated in Nebraska.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2007 | Six Months Ended June 30, 2006 |
|---|---|---|
| Net Income | $29.5 million | $97.8 million |
| Net Income (Continuing Ops) | $32.9 million | $95.2 million |
| Net Interest Income | $136.0 million | $172.3 million |
| Total Other Income | $164.6 million | $185.6 million |
| Total Operating Expenses | $241.9 million | $194.5 million |
| Provision for Loan Losses | $5.3 million | $11.8 million |
| Student Loans Receivable (Net) | $26.2 billion | $23.8 billion (Dec 31, 2006) |
| Total Assets | $28.9 billion | $26.8 billion (Dec 31, 2006) |
| Total Liabilities | $28.3 billion | $26.1 billion (Dec 31, 2006) |
| Shareholders' Equity | $611.2 million | $671.9 million (Dec 31, 2006) |
| Cash and Cash Equivalents | $106.0 million | $102.3 million (Dec 31, 2006) |
| Net Cash Provided by Operating Activities | $110.6 million | $110.3 million |
| Earnings Per Share (Diluted) | $0.59 | $1.80 |
Material Changes vs. Prior Period
- Significant Decline in Net Income: Net income dropped 69.6% year-over-year (from $97.8M to $29.5M). This was primarily driven by a reduction in derivative market value gains, the elimination of 9.5% special allowance payments following a Department of Education settlement, and a $9.0 million loss on the sale of discontinued operations (EDULINX).
- Net Interest Income Compression: Net interest income decreased $36.4 million. While the loan portfolio grew by $2.4 billion (10.0%), the yield was impacted by the loss of 9.5% special allowance payments and an increase in lower-yielding consolidation loans.
- Discontinued Operations: The company sold EDULINX Canada Corporation in May 2007, recognizing a net loss of $9.0 million. Results for this subsidiary are now reported as discontinued operations.
- Fee-Based Revenue Growth: Fee-based revenue increased significantly, representing 53% of total revenues for the six months ended June 30, 2007, compared to 37% in the prior year period, driven by acquisitions (Peterson's, CUnet) and organic growth in tuition payment plans.
- Shareholder Returns: The company repurchased 3.1 million shares of Class A common stock for $75.5 million and initiated quarterly cash dividends of $0.07 per share.
Guidance, Outlook, Risks, and Unusual Items
- Legislative Risk: Proposed legislation (College Cost Reduction Act of 2007 and Higher Education Access Act of 2007) could negatively impact revenues by reducing special allowance payments, eliminating the Exceptional Performer program, and increasing lender fees. Management estimates a potential $17-$18 million provision for loan losses if the Exceptional Performer program is eliminated.
- Regulatory Investigations: The company is cooperating with inquiries from the U.S. Senate HELP Committee and various state Attorneys General (NY, NJ, OH) regarding industry practices. Agreements with the Nebraska and New York Attorneys General resulted in commitments of $3.0 million total for student education funds and the adoption of Codes of Conduct.
- Department of Education Review: The Department of Education initiated a review of Nelnet's administration of the FFEL Program, specifically regarding inducement provisions and borrower choice of lenders.
- Derivative Volatility: GAAP results include significant volatility from the mark-to-market valuation of derivatives (interest rate swaps, cross-currency swaps) which do not qualify for hedge accounting. Management uses "Base Net Income" to exclude these unrealized gains/losses for internal performance evaluation.
- Unusual Items: A $2.1 million gain was recognized from the termination of interest rate floor contracts in January 2007.
Investor Verification Checklist
- Legislative Impact: Verify the final status of the College Cost Reduction Act and Higher Education Access Act to assess the risk of reduced special allowance payments and the elimination of the Exceptional Performer program.
- Derivative Exposure: Review the reconciliation between GAAP Net Income and "Base Net Income" to understand the magnitude of unrealized derivative gains/losses impacting reported earnings.
- Regulatory Outcomes: Monitor the outcomes of the Department of Education review and state Attorney General investigations for potential fines, sanctions, or forced business practice changes.
- Loan Portfolio Yield: Analyze the trend in the "Core Student Loan Spread" (1.28% for the six months ended June 30, 2007) to gauge the impact of consolidation loans and interest rate resets on profitability.
- Exceptional Performer Status: Confirm the renewal status of the company's Exceptional Performer designation, which is critical for maintaining 99% reimbursement on default claims.