Earnings Transcript for NNI - Q3 Fiscal Year 2009

Executives: Jeff Noordhoek - President Terry Heimes - Chief Financial Officer Phil Morgan - Head of Investor Relations

Analysts: Sameer Gokhale - Keefe, Bruyette & Woods Mike Taiano - Sandler O’Neill

Operator: Good day everyone and welcome to the Nelnet’s third quarter 2009 conference call. Today’s call is being recorded and broadcast live over the internet. At this time, Mr. Phil Morgan, Nelnet’s Head of Investor Relations will begin with opening remarks. Please go ahead, sir.

Phil Morgan: Thanks, Kaira. Good afternoon and welcome to Nelnet’s 2009 third quarter earnings conference call. On today’s call, we have Jeff Noordhoek, President; and Terry Heimes, Chief Financial Officer. Please note that during the conference call, we may discuss predictions and expectations and may make other forward-looking statements. Actual results may differ from those discussed here based on a variety of factors. These factors are discussed in the company’s Form 10-K and other filings with the SEC. The company does not intend to update any forward-looking statements made during the call. During the course of the call, we will refer to our non-GAAP financial measure, which the company defines as base net income. A description of base net income and a reconciliation of GAAP net income to base net income are included in our third quarter 2009 supplemental earnings disclosure, which is posted on our Investor Relations website at www.nelnetinvestors.com. After Terry and Jeff have concluded their formal remarks, we will open up the call for questions. Thank you. I will now turn the call over to Jeff.

Jeff Noordhoek: Thanks, Phil and good morning everyone. We are extremely pleased with our operating results for the third quarter of 2009. I hope we are not begun to sound like a broken record, however, once again we had a great quarter and we are optimistic about the future. Our fee based revenues continue to grow, net interest margins has increased, expenses have decreased, our liquidity needs are virtually zero, our capital position continues to strengthen and given our strong cash flow, we continue to opportunistically repurchases outstanding debt to create significant tangible value for our shareholders. We considered stopping here for questions, but we’ll continue for a bit longer to get more details about the third quarter. In the third quarter, we reported base net income $1.01 per share, compared to $0.47 in the third quarter of 2008. We continue our transformation to a fee for service processing company that we look forward we are focused on meeting our primary objectives of growing and diversifying our fee for service businesses and maximizing the value of our existing portfolio. We remain quite optimistic about the remainder of 2009 and the foreseeable future. In September, we began servicing loan to the federal government under the new contract. Given our relative size, this contract will become a significant in recurring source of revenue for the company. We look forward to growing this important new business line in 2010 and beyond by providing the best possible service to students and schools under the contract. We know an ongoing important topic related to our company is the President’s budget proposal to eliminate FFEL program. In July, the House passed the bill similar to the President’s proposal with the senate has yet to debate legislation. Regardless of the outcome other budget proposal, we have positioned our business to be successful by helping families, schools, international institutions, navigate increasing complex education system. We have no doubt. The fundamentals of our business model remain strong. We are stable, well established, fee for service businesses with recurring revenue. We’re generating significant cash flow from our businesses and our student loan portfolio. We believe we are well positioned for growth in a very dynamic education services market. Now, I’ll turn the call over to Terry, to discuss our financial results. Terry.

Terry Heimes: Thanks, Jeff. We did have a very strong quarter. We’ll proactive in our approach and decisions at the beginning of the financial crisis and while there are still challenges on our economy today. Those challenges will present opportunities for growth and diversification, and we are well positioned to capitalize on those opportunities. Our base net income excluding certain restructuring and liquidity related charges was just over $50 million of $1.01 per share, as compared to $23.4 million, or $0.47 per share a year ago. Year-to-date, our base net income excluding restructuring activities was $114 million, or $2.30 per share, compared to $65.2 million, or $1.33 per share a year ago. The financial highlights related to our third quarter that I want to discuss today, include our fee based businesses our operating costs our portfolio and our liquidity. First, as it relates to fee-for-service businesses and revenue diversification. Our fee-for-service revenues may cut more than 50% Nelnet’s total revenues. These businesses have high customer retention have opportunities to grow revenues from existing customers and to grow our market share by adding new customers. The expanding volume on to the government servicing contract will provide additional leverage in growth opportunities, while our total fee-for-service revenues were relatively flat for the quarter, our revenues from Tuition Payment plans, Campus Commerce and Lead Generation product lines grew more than 17% or $5 million when comparing to last year. During the quarter, we also started servicing loans under the government contract. We are currently servicing more than $2.5 billion in contract volume, but perhaps more importantly $740 million is volume that we did not have on our servicing system previously. These businesses are not capital intensive, they are generating significant cash flow in earnings and have opportunities for growth and leverage. Needless to we’re optimistic about their future. Second, related to operating cost, excluding restructuring charges and direct cost are certainly generation activities. Our run rate expenses were down almost $17 million or 20%, compared to the same period a year ago and 9% sequentially. These reductions are the direct results of proactive changes to our business model, because of legislative and economic conditions. We will continue to look for efficiencies and manage our operating cost. However, as we grow our fee based businesses and increase our volume under the government servicing contract, we would expect operating expenses to stabilize. Moving to the portfolio, almost all of our loan assets are financed to turn at rates we estimate will generate more than $1.3 billion of future cash flow. We expanded the disclosure related to our portfolio to emphasize the value of this annuity stream. Our core student loan spread, continue to improve in the third quarter, increasing to 127 basis points. CP LIBOR spreads have narrowed and historically low interest rate environment increased current period earnings and finally as it relates to our liquidity. Last quarter, we announced a new $500 million revolving warehouse facility that will provide funding through July of 2012. We also recently issued a $430 million securitization of consolidation loans in attractive rates. We have access to funding for current year originations and with the ability to put these loans to the federal government. We have no short term liquidity issues related to our portfolio. Accordingly, we were able to use our strong performance in cash flow to reduce our outstanding debt to repurchase activities. In the third quarter, we’ve repurchased approximately $183 million of debt generating a gain of just over $5 million. Subsequent to quarter end, we were able to buy an additional $140 million in debt, which will generate again of approximately $14 million in the fourth quarter. Based on our strong quarterly results and substantial resolution of our liquidity concerns, the board recently announced the reinstatement of $0.07 per share quarterly dividend. For the current quarter, we paid on December, 15 to shareholders of record as of December, 1. So when we recap the quarter from a financial perspective, I would focus on the following

Operator: (Operator Instructions) Your first question comes from Sameer Gokhale - Keefe, Bruyette & Woods.

Sameer Gokhale - Keefe, Bruyette & Woods: Just a few here; the first one is one of your competitor talked about exploring the sale of the federally guaranteed student loan portfolio. Have you also been in similar discussions perhaps with potential acquirers? Is that something you’re considering now given that you broken out and provide more details about the future cash flow stream from your portfolio or is that something still off the table at this point?

Jeff Noordhoek: Obviously, we’re going to continue to look at all the options. We’ve got a very valuable annuity stream that we financed to term. It’s not necessarily high on our priority list right now, but we will continue to look at organizational opportunities to make sure we capture the maximum value of the portfolio, as well as the maximum value of our fee based businesses.

Sameer Gokhale - Keefe, Bruyette & Woods: Is it fair to say that you haven’t reached the point, where you’re actually talking to other potential acquirers and right now you’re just exploring initially or are you further along in that process of maybe talking to some potential buyers? Could you share that with us today?

Jeff Noordhoek: No, we’re not talking to any potential buyers. At this point, we’re exploring opportunities.

Sameer Gokhale - Keefe, Bruyette & Woods: Then the other thing is on the operating expenses. I know there’s some commentary about outlook for OpEx and how they might stabilize, but let’s say the FFELP were completely eliminated. How much more in additional cost? Could you takeout of your system related to FFEL Program going forward?

Terry Heimes: Sameer, this is Terry. I mean obviously, we will pretty proactive in our approach when the legislation changed. So we’ve taken a substantial cut at our operating expenses, given the change in our business operations. We will probably be able to eliminate some additional marketing and origination cost, but I don’t think it would be substantial.

Sameer Gokhale - Keefe, Bruyette & Woods: We just looked at your revenues that you disclosed in the 10-Q from that government servicing contract, the new one that you got. If you take those revenues and you divide them by that servicing portfolio that you also received and what sort of your 20 basis points? Is that a revenue margin as a percentage of the portfolio? Is there something that is not being counted in the third quarter revenue number that would be counted in future quarter? So that the 20 basis points is actually higher or is 20 basis points a run rate for revenue as a percentage of that portfolio?

Terry Heimes: Sameer, I think the key point is the timing of when it come on, it came on very late in a quarter.

Sameer Gokhale - Keefe, Bruyette & Woods: So is there more specific as you can give us and we see late in the quarter when was it in September or maybe…?

Terry Heimes: It was in late September and it will continue to grow as we move into the fourth quarter. We’ll continue to provide additional information as we add volume under that contract and as we gain additional visibility to that line.

Operator: Your final question comes from Mike Taiano - Sandler O’Neill

Mike Taiano - Sandler O’Neill: Couple of questions, I guess first on the servicing contract. Could you maybe share with us the portion that was not originally on your servicing platform, the $740 million? How did the government determine to give you that volume? Was it basically allocated equally amongst four servicers? Any context you can give us for how that was divided up?

Jeff Noordhoek: The way its working is, if you originate the assets are on your system and you put those assets, you retain the servicing if you’re one of the four servicers, then all of the additional volume, it’s not in the four servicers at this point in time and it put the government. We believe that methodology is that it’s being split by quarters so forth everyone at this point in time. That said, we expected a large amount of volume to come on to our system as that foots grow over the end of the fourth quarter and first quarter of next year, and then also as time goes tenure performance measurements amongst the servicers, we expect that more volume will go to those that are performing better and that is that we’re sorry about that.

Mike Taiano - Sandler O’Neill: So there has been a formal declaration by the department as to sort of the go forward volume allocation at this point yet?

Jeff Noordhoek: Not at this point yet.

Mike Taiano - Sandler O’Neill: Second question relates to the pending legislation and I think, you made a comment in the supplement about expecting it to potentially linger on into 2010. Just curious like what makes you feel like that that’s the case. Do you think, you still will probably go through the budget reconciliation path, or are there something other things that make you believe that, this probably isn’t going to get resolved in 2009?

Jeff Noordhoek: Share just a few things on the legislation, I’d point out that. For one, its history serves as a guide, then as the legislation gets near to completion, we expect the gloves to come off and prepare ourselves for much thing against the industry and for the politically motivated to use their power and attempt to tarnish the industry. That said, we are currently sitting our bill in the Senate health committee behind the healthcare debate. So we first believe there has a resolution on healthcare before education, because reconciliation can only be used once it have the combined together if they’re going to use reconciliation on either one. So, we expect the healthcare debate to play out and that’s anybody’s guess, when that will occur, it it’s at the end of this year or next year. Again that said, as an industry, as you know we have provided a plan that gives the government all the savings of profit they’re going to generate under their pharma plan. It will save ten to thousands of jobs across the entire industry and it will retain the competition of a public plan and a private plan. It also eliminates the transition risk of forcing thousands of schools and millions of students from one program to the other. So from our perspective, we can’t understand why anyone wouldn’t vote for the alternative plan, because it gives everything that the first plan does and does a lot more.

Mike Taiano - Sandler O’Neill: Just last question, in terms of the asset-backed securities you repurchased I guess subsequent till the end of the quarter. What are you’re buying, are those just mostly like AAA securities, can you maybe give us context with of what the components are there?

Terry Heimes: It will vary based on opportunities that we see in the market to buy back different pieces of debt that make sense for us given the performance, so it will vary by type.

Operator: There are no further questions. I’ll turn it back to Jeff Noordhoek for any closing remarks.

Jeff Noordhoek: In closing, I want to reemphasize that our business model has and will continue to deliver great operating results. We have stable, well established fee generating businesses with recurring revenue. Our business generates significant cash flow from operations and from our portfolio. We are well positioned for growth in a very dynamic market. I want to thank you for your participation in the call and want you to have a great day.

Operator: Ladies and gentlemen, that does conclude our conference today. Again, thank you for your participation.