Nelnet, Inc. (NNI) 2006 Q2 法說會逐字稿

Good day everyone. Welcome to the Nelnet second quarter 2006 conference call.

[OPERATOR INSTRUCTIONS]

At this time Ms. Cheryl Watson, known as Chief Communications Officer will begin with opening remarks. Please go ahead, ma'am.

Thank you for joining us today. Nelnet's second quarter earnings release and financial supplement have been posted to the Investor Relations website at www.nelnet.net.

On today's call Steve Butterfield, co-Chief Executive Officer and Vice Chairman will provide an overview of our financial and operational results. Mike Dunlap, co-Chief Executive Officer and Chairman, will provide an update on the marketplace and Nelnet's competitive position. Jeffrey Noordhoek, President will discuss our merger and acquisition activities and Terry Heimes, Chief Financial Officer, will report on our financial results.

Before they begin their formal remarks, I would like to read the Safe Harbor statement. We would like to remind you that there will be forward-looking statements made during today's call.

The forward-looking statements may differ materially from actual results and are subject to certain risks and uncertainties that are detailed in the earnings release and in our filings with the SEC. The company does not intend to update any forward-looking statements made during the call.

During the course of this call we will refer to two non-GAAP financial measures which the Company defines at base net income and adjusted base net income. Please refer to our earnings release or to our website for the reconciliation of GAAP net income to base and adjusted base net income.

After Steve, Mike, Jeff, Terry have concluded their formal remarks, we will open up the call for questions. I would now like to turn the call over to Steve Butterfield. Steve?

Thank you Cheryl, and good morning, everyone.

I will report on our second quarter results as they relate to our long-term focus, asset generation, revenue diversification, and outlook information provided during 2006 Investor Day. Excluding a one time provision for loan loss reserves in first quarter, for the first six months into June 30, 2006, our adjusted base net income increased $7 million to $0.82 per share versus $0.68 per share for the same period in 2005, an increase of 21%.

As of June 30, 2006, student loan assets reached $22.4 billion, an increase of $2.1 billion, or 11% compared with the fourth quarter of 2005. This is in line with to slightly ahead of our expected student loan asset growth in the low double digits to high-teens for the year.

In terms of revenue diversification, our fee based revenues made up 43% of our total revenues during the first half of 2006 versus 35% for the same period of 2005. Fee based revenues including loan servicing, guarantee servicing, tuition payment plans, direct marketing, list management and software solutions totalled $133 million during first six months compared with $89 million for the same period a year ago, an increase of $44 million in revenues or 49%.

Our other fee based revenues include our list management, direct marketing and tuition payment plan businesses, revenues from these areas increased 176% to $34 million for the first two quarters of the year, from $12 million through June 3O, 2005. As anticipated, the seasonality of our fee based revenues lowered our earnings during second quarter as it relates to the school year and recognition of our other fee based revenues.

With regard to expense, as expected we devoted a significant amount to our direct to consumer activities. However, excluding the impact of acquisitions and the increase in asset generation costs, operating expenses have increased less than 4% over last year and less than 2% over the first quarter in terms of run rate.

Now I will turn the call over to Mike Dunlap to discuss our competitive position and market objectives in greater detail.

Thanks Steve, as I discuss the marketplace and Nelnet's competitive position, I will begin with the results of our direct to consumer channel.

At June 30, 2006, consolidation loans made up 65 % of our total portfolio. During the first six months of 2006 we originated nearly $2.1 billion of consolidation loans up from $1.15 billion in 2005.

During the current quarter we originated right around $1 billion of consolidation loans that resulted in approximately $478 million of new or additional loans on our books. At the same time we lost $311 million in loans to third parties in the current quarter and $581 million year to date.

This resulted in a net new consolidation gain of $167 million for the quarter and $488 million for the first six months. Much of you are loan loss is attributable to the former consolidation process called Super 2 Step which has since been eliminated.

As expected, the second quarter saw tremendous spike in loan applications prior to the July 1st interest rate reset, and we will expect to see the result of those loans funding in the second half of this year with an anticipated pipeline that exceeds $2.5 billion in gross volume that we anticipate will fund in the third and fourth quarters.

As we shared in our first quarter call, it was our expectation to increase consolidation marketing expenses in the second quarter. This accounted for approximately $0.03 per share in additional costs as we attempted to capture additional loan volume available since the repeal of a single holder rule.

We aggressively pursued this new asset opportunity in advance of your LIBOR interest rate change while continuing to focus on retaining our own portfolio. As we continue to grow our direct consumer channel we intend to increase our investment in our consumer brand building initiative as well as our website and on-line presence.

While each of these programs will require additional financial commitments we believe they are critical to the next phase of Nelnet's growth in the consumer marketplace. Within our school channel we also anticipated increase expenses related to our Grad Plus program and continue to move ahead with its promotion. We believe this is a tremendous opportunity to generate sale back-up.

The results of these efforts are expected to be more evident in the first quarter and second quarter of 2007 once schools have had time to prepare their internal systems, but we are pleased with our progress to date and securing support for Nelnet's program.

Specifically, we have established Grad Plus relationships with hundreds of schools including Creighton University, Tufts, the University of Texas, Stanford, Jacksonville University, the University of Wisconsin and a number of other outstanding schools.

During second quarter we did secure a number of new or expanded school relationships including University of Toledo medical school and graduate program, as well as Lynnwood University and Texas Tech. Expanding our college planning and career services to students is the objective Nelnet Enrollment Management Services. This new initiative is focused on helping education seeking families bridge the affordability gap while meeting their academic goals.

In turn, Nelnet Enrollment Management can assist schools in enhancing their student recruitment and retention programs, a critical objective within higher education at this time.

Now I will turn the call over to Jeff.

Thanks Mike.

I'd like to provide an update regarding two new additions to our fee based revenue stream and the ongoing integration of our new partners. In June we announced an exciting new partnership with CUnet a leading performance based educational marketing and managed services company.

CUnet works with schools seeking branding lead generation and student recruitment services. The CUnet online portals reach over 1 million unique visitors each month.

CUnet is an excellent compliment to our own student recruitment and retention programs working with more than 1,000 campus locations and on-line schools for educational marketing and vendor management services.

We are also pleased to announce today that we have acquired Peterson a leading provider of education services and career guidance for $38 million. Like CUnet Peterson's provides long term value to pre-college student customer base by helping students select their educational experience, prepare for admissions tests and explore ways to pay for college.

Since 1966, Peterson's has helped connect individuals, educational institutions, and corporations through its critically acclaimed books, website, on-line products and admission services. Peterson's reaches over 100 million consumers annually with information about colleges and universities, distance learning, financial aid, test preparation and career exploration.

This transaction will further diversify Nelnet's fee-based revenue streams. However, a significant amount of revenue earned for the first several months post-acquisition will be differed and recognized in future periods. Therefore, the acquisition will have a dilutive affect of approximately $0.05 to $0.07 on Nelnet's base net income for the remainder of 2006.

This anticipated transaction will be accretive, although immaterial to Nelnet's base net income in fiscal 2007 and 2008. In addition to welcoming these new partners, we've also been focussed on leveraging our recent acquisition.

We are pleased with the progress we've made in sales and marketing collaboration as well as operational alignment and remain on track with our overall project plan. Aside from these acquisitions (inaudible) contribution to Nelnet's overall education life cycle product strategy and we are excited about the results we've seen today.

Now I'd like to turn the call over to Terry Heimes to discuss your financial results.

Thanks Jeff .

I will cover the financial information and operating results for the first six months of 2006 as well as the second quarter. But before I discuss some of the detailed numbers I'd like to highlight some events and information that should be considered in conjunction with my commentary and when reviewing earnings supplements.

First, excluding the legislative driven expense of $6.9 million in first quarter related related to loan loss reserves, our year to date adjusted base income is up 21% compared to the same period year ago. Second, seasonality of our fee based revenues and asset generation expenses impacted our second quarter just as we indicated in our Investor Day presentation in March and our first quarter earnings call.

The seasonality of our fee based revenues had a roughly $0.03 per share impact due to timing in the academic year. In addition, we saw the expected increase in expenses related to asset generation. Specifically related to consolidation activities that Mike mentioned earlier.

Next, our student loan growth remains solid at 11% since the beginning of the year bolstered by a portfolio acquisition right at the end of second quarter and tempered by significant consolidation activity.

The growth attributable to our internal organizations branding and forward flow partners is roughly 9%. From consolidation activities we generated an additional $1.1 billion in the first six months. Finally, we remain committed to long term sustainable value generation.

Our recent acquisitions will continue to move us in that direction adding significant value to our product line and diversifying our revenues. The transaction structure and how we account for the revenues generated will impact earnings contributions for the first couple of years, but we are excited about what these additional companies will help us achieve.

Turning to some detailed numbers for the first six months ended June 30, 2006 our adjusted base net income excluding the expense related to establishing the loan loss reserve in the first quarter was $0.82 per share, compared to $0.68 per share a year ago, or an increase of 21%.

Our adjusted base net income for the quarter ended June 30, 2006 was $0.37 per share, compared to $0.34 a year ago. Base net income for the first six months of 2006 and for the current quarter was nearly identical to last year at $63 million or $1.15 per share for the first six months and $32 million or $0.58 per share for the current quarter.

GAAP net income for the six months ended June 30, 2006, was $98 million or $1.80 per share compared with $66 million or $1.23 per share for the same period a year ago. For the current quarter GAAP net income was $46 million or $0.84 per share as compared to loss of nearly $2 million or $0.03 per share a year ago. The change in GAAP earnings was driven primarily by the mark to market on derivative instruments.

We continue to firmly believe that quality asset growth combined with diversification of revenues will be important to meeting our goal of long term sustainable value. At June 30th, our net student loan assets have increased $6.7 billion since last year, but more importantly, our student loans increased more than $2.1 billion or 11% since the beginning of the year including about 9% growth attributable to our internal brands and branding forward flow partners.

Our total channel acquisitions are up 27% year to date over last year including our internal brands and our direct to consumer channel which are up approximately 34% compared to the first six months of last year. Turning to the income statement, net interest income increased nearly $35 million excluding the special allowance yield adjustment of $24 million in the first six months of 2006 and $56 million in 2005, an increase of about 31%.

For the current quarter net interest income excluding the special allowance yield adjustment increased about 35%. The increase was driven primarily by the growth in our student loan portfolio.

Our core student loan spread contracted slightly to 1.49% for the three months ended June 30, 2006 but remains relatively stable at 1.51% year to date. We anticipate some continued compression as we move forward with changes in loan mix and the increased cost of acquisition.

Our fee based revenues have increased significantly since the second quarter 2005 driven by our focused efforts on diversification. Fee based revenues have increased nearly $18 million or 38% compared to the second quarter of 2005. Year to date our fee based revenues have increased $44 million or 49%.

Our other fee based revenues consisting primarily of tuition payment plans and list management revenue is up 176% since last year. Our fee based revenues made up 43% of our total revenue during the first six months of 2006 versus 35% for the six months ended June 30, 2005.

As we've indicated in the past our fee based revenues do not have the same leverage capacity as our core operations. The increase in fee based revenues will be largely accompanied by or associated with an increase in operating expenses as well.

Operating expenses excluding amortization increased $36 million or 49% compared to the second quarter of last year. The combination of an increase in fee based revenues, the acquisition of LoanSTAR and Cello portfolios and their related operations and an increase in consolidation related costs have driven the substantial majority of the increase here.

Acquisitions accounted for roughly $30 million of that increase. Excluding the impact of acquisitions for comparability purposes, our operating expenses increased about 8% compared last year driven primarily by the seasonality of and increase in our marketing and asset generation costs.

Excluding the increase in asset generation related expenses, our core operating costs are up about 4% compared to 2005 and less than 2% compared to first quarter. Our acquisition activities will also impact our future operations as Jeff indicated with the acquisition of CUnet and Peterson's.

Our focus and emphasis remain on generating long term value for our customers, but it's important to understand the impact on our short term results. Transaction structure and business operations can impact how the acquisitions are reflected in our statement of operations.

By way of example, our year to date operating results include approximately $1.1 million of non-cash compensation and valuation adjustments of equity contracts related to our prior transactions. CUnet and Peterson's will have an even more dramatic impact then some of historical acquisitions.

CUnet includes a provision for continued payments based upon future performance of the organization as well as employment stipulations for key members of management. And will be recognized as compensation expense in future periods rather than an adjustment to purchase price.

Thus the success of the transaction could result in significant payments being recognized as compensation charges which is why we indicated the transaction may not be accretive for the first three years. We will likely adjust base earnings to account for this similar to the amortization of an intangible asset as would have been the treatment if it were not tied to employment.

Peterson's is a transaction that will be acutely important to the development of our enrollment management services. While the transaction is anticipated to be cash flow positive right away and accretive to our long term plans and income contribution, generally accepted accounting principles require to firm it in recognition of income over the period of--that services are provided.

Because of this required deferral of income, Peterson's will like be dilutive to 2006 earnings by $0.05 to $0.07 as we defer and recognize revenue on 2006 contracts and 2007 and some of the 2007 contract revenue in 2008. We are very excited by the ability to leverage the product and services to our existing and future offerings but earnings will lag slightly in terms of recognition and our statement of operations.

Our shareholder equity topped $750 million at quarter end, our weighted average shares outstanding increased from 53.7 million shares a year ago to 54.3 million shares during the first quarter as a result of shares issued under our various stock ownership plans and in connection with recent acquisitions.

During the quarter we also acquired approximately 329,000 shares under our previously announced share repurchase program. We anticipate continuing to evaluate when the repurchase of share provides long term value and when we may want to stabilize the number of shares issued and outstanding. With that, I'll turn it over to Steve for closing comments.

Before we open up the call to questions I would like to reiterate excluding a one time provision for loan losses in the first quarter, for the first six months ended June 30, 2006 our adjusted base net income increased by 21% per share compared to the same period in 2005. As of June 30, 2006 student loan assets up 11% to $22.4 billion compared with the fourth quarter of 2005.

In terms of revenue diversification our fee based revenues make up 43% of our total revenues during 2006 versus 35% for the same period of 2005. Finally, total fee based revenues including loan servicing, guarantee servicing, tuition payment plans, direct marketing, list management and software solutions increased by 49% to $133 million during the first six months comparing with the same period a year ago.

While the seasonality of fee based revenues is new to us, it does not change our long term targets for high-teens to low-20% growth in our adjusted base net income and student loan assets with the 2006 loan asset growth target in the double digits to high teens percent.

Industry remains strong, our team's committed, and our family's in need of continued support in making their educational dreams come true.

At this time operator we'd open it up to take any questions that people may have.

Thank you.

[OPERATOR INSTRUCTIONS]

We'll go first to Kenneth Hoexter at Morgan Stanley.

Good morning, I've got a couple of questions. First, in the press release you noted a $12 million special allowance payment. I'm wondering if you can just remind me where this comes from and is this a recurring payment or is it a one time payment? If so, what do these come from again?

Sure, Ken, this is Terry, the $12 million special allowance yield adjustment that we referenced in the press release relates to our portfolio of loans that has been previously financed with tax exempt obligations.

That is a -- that portfolio is now set. It's in runoff mode. We continue to earn that excess special allowance yield adjustment as interest rates rise the amount of that excess goes down, but that is a recurring earnings stream on that portfolio previously financed loans.

So is that the 9.5% portfolio?

Yes, it is.

Okay, great. Then the second question, you talked about excluding the compensation related--or I guess earn out type costs from the base earnings, metrics and i mean, if you exclude enough things from the base earnings numbers, I'm sure they'll be quite good.

Right.

I just question that logic. Help me understand why that's the right thing to do.

Sure, Ken, and what we will probably do is disclose that amount as what the compensation related charges are. Because of generally accepted accounting principles and SEC guidance any time an earnout is tied to employment that is recorded as compensation charge. If it were not tied to employment it would be treated at purchase price, so that's the distinction that we want to make sure that we allow people to recognize.

Okay, and then one last question. You mentioned a couple of acquisitions, and I know that the diversification into the C generating business is essential to your strategy. I guess the two issues with the acquisitions at least for me, some of these fee businesses are a little bit more difficult for me to understand, I'm not familiar with the space as much.

Then there's the question of what they're doing to the earnings, and the financial implications, so I'm wondering if you could mention the two acquisitions, remind us what these companies do, and is it possible to give us the purchase price and the earnings, the underlying earnings of these companies so we can come to judgments about how these affect the financial statements going forward?

Ken, let me try to answer this question, and if I don't answer it completely, ask additional questions. We tried to structure these transactions to maximize long-term cash flow.

When we structure a purchase, what we're trying to do is put the purchase price in a situation where we can expense as much of it as possible. That's why if you look at the way CUnet is set up and the purchase, we are buying it and using the compensation as an expense that will increase our long term cash flow.

When we look at the question on what does CUnet do, they help schools find students primarily through the web. They are connecting schools to students. They get paid a fee for this list management of helping schools find students, and they are very, very good at it.

From a revenue standpoint and from an income standpoint, Terry, do you want to talk a little bit about CUnet?

From a standpoint of the revenue I believe, Ken, I don't have those numbers specifically right in front of me, and I can get back with you on some of the historicals. We do not anticipate that the income contribution is going to be material, but it will be accretive as we go forward.

The one thing that will not make it accretive or could cause it to not be accretive in the first couple of years is this compensation related charge related to the income statement. So we don't think it's going to have a material impact in terms of our amount.

In terms of how we analyze that and disclose that, that's one thing that we will continue to evaluate in terms of how these new fee related businesses will impact our segment reporting, and we anticipate continuing to review our segment reporting throughout the end of this year and look at it at year-end to see what type of additional changes we can make to our segment reporting which will make it easier for you to look at and analyze.

With respect to Peterson's I was going to have Jeff talk a little bit about Peterson's.

Sure, hey, Ken. Peterson's is primarily known for helping students find schools and prepare to get into schools. They are very well known in the test preparation market.

Also has a bunch of other products and services that it offers that relate to students, helping get into school and helping to get jobs. They do touch, through their various products over a hundred million consumers annually, and we think that's a great entree with other products be able to be bundled together as it relates to helping families and students prepare and pay for college.

As far as the earnings go on Peterson's I think Terry mentioned when he was talking that the first year in 2006, because of the way the cash flow works on the contracts and the way this acquisition was made it will be dilutive into 2006 to the tune of --

$0.05 to $0.07

$0.05 to $0.07 this year. Going forward in 2007 and 2008 it will be accretive and again that goes back to our goal to create long term cash flow.

When we look at each one of these different acquisitions and we say that they are not material, each one by itself is not material, but when we take these different fee based incomes in total and add them together, they are going to be major material for our income going forward in the next two, three, four, five years as we grow this piece of our income.

So, even though we tend to individual one is not material, this is a big part of what we we're going to be as a company going forward.

I think it would just be helpful as you look at your segment disclosures for us to be able to understand something about the earnings potential of these units because what we're hearing is about dilution, at least in the short term and we're hearing about immaterial revenue streams. I think it's going to be hard for people to evaluate the marginal economics without a little bit more data. At least for me speaking for myself.

Understand.

From a 500,000 foot view, Ken, from a general perspective our goal is to get a high-teens return on our investments. So we look at long term and we're looking at it over the next five to ten years that's kind of what our goal is, I don't know if that helps out any.

Thank you.

We will go next to Sameer Gokhale with Bear Stearns.

Hi, good morning, I'm just wondering if you could talk about the acquisitions from the other channel. Maybe you mentioned it, I might have missed it. It seems like the dollar amount $425 million was probably the largest quarterly amount at least going back to 2003.

I think these are spot purchases. Maybe you can clarify why the amount was so large, did you get better pricing. Some color on that?

Sure, Sameer, this is Terry. That was the large portfolio, really the $425 million it was about a--right in that neighborhood of portfolio that we acquired right at the end of the quarter.

It was a portfolio that was service that we were able to acquire. That's where that channel came in. That was a spot purchase.

Okay, and can you give us a sense on the pricing of that portfolio compared to, say, pricing on spot purchases last year, at least based on some data from one of your competitors it seems like pricing has gotten very expensive for these sort of spot purchases, so could you talk about profitability of these purchases perhaps?

Sure, the competition has gone up. The price associated that would have been consistent with the large portfolio acquisitions that we did in the fourth quarter of last year.

Okay, and then you provided some--you said I think $0.03 of the EPS impact was from the additional cost of marketing, some consolidation loans, and the work of the math seems to be it's about $2.5 million or so pre-tax in expenses. Now, were these marketing expenses in your other expense line item?

If you adjust for this increase in marketing expenses it looks like the other expenses actually went down. Can you just provide some color on how we should think about that expense line item? Is it decrease in other expenses because of decrease in other fee based income perhaps?

Sure, Sameer, this is Terry again. That increase in marketing costs was a combination of salaries and other costs. A large portion of that was in the salaries line item as we added people to the call centers, etc. to deal with that and the total amount was in that $2.6 to $3 million range.

Okay. That's helpful. Then also the last question, this is something I asked one of your competitors also. Can you provide some sense for how many net new schools you may have added compared to the same period last year? As we go into this third quarter academic season?

We don't disclose the exact number of schools that we've added. But we've added a number of new schools. And--that's not something that we have provided in the past.

Is it fair to say that on a net basis you had net additions in terms of schools? Can you provide directional sense there?

Definitely. We have been making progress in a positive way.

Okay, that's very helpful. Thank you.

We will go next to Matt Snowling at Friedman, Billings, Ramsey.

Yeah, good morning. Just to go back to the loan acquisition, it seems that the Stafford plus volume through your direct channel is down about 12.5% year-over-year. There was also a significant drop in your branding or your branding partner channel. I'm just wondering are there schools that you've lost that are more material than others? What exactly is going on there?

Matt, this is Terry, I don't have any specifics as to what is necessarily going on there in terms of the branding and forward flow we have been able to shift some of our branding to internal brands. For example the acquisition of Union Bank and Trust internal brand is one of those. We continue to look at ways we can expand our branding and forward flow partners, but there's nothing specifically imbedded in terms of the first six months numbers.

I think the largest thing would be Union Bank and Trust.

I'm sorry, but to that point with Union Bank, now included in your direct channel, wouldn't that mean we would expect volumes to be up, not down? I'm talking about 151 million in the Stafford and Plus direct that you acquired during the quarter and that compares to about 240 million the year before.

Matt, I'm going to have to look into that. I don't have anything specific that I can give you at this point.

The numbers--the numbers I'm looking at are showing that we've gone from 327 million in Stafford and Plus loan originations in 2005 to 457 million for 2006.

I'm talking about the second quarter.

Second quarter could just be timing. Sometimes the schools will process in one quarter versus the other quarter. When you get into the quarter to quarter comparisons I think you can get some funky aberrations in numbers.

We should theoretically see that slight back up again?

Yeah, I think you're just looking at a quarter abberation, it may be one school processed at the end of last year, at the end of the quarter versus the first part of the quarter this year.

Okay. Another technical question here. It seems that the portfolio run off of the 9.5% portfolio really spiked up during the quarter. Was that seasoning or is that related to consolidation or reconsolidation with the two step?

I think a big chunk of that was related to the Super 2 Step. I think we saw a bigger impact there than what we anticipated.

Do you have any sense as to how much is in the pipeline that may consolidate away to the 9.5% portfolio?

As of this last quarter, you can't do Super 2 Steps anymore, so we think that we are just about done with the Super 2 Step continuing. Prior to that I think we're on a runoff rate that approximated 100 million a quarter.

Okay. And we keep hearing about how origination fees, everyone is waiving the origination fees the cost of acquiring loans going forward is increasing. I'm just wondering what the spread of your new FFELP product is that's coming on the books today rather than your existing portfolio?

Last year the O fee was 3%. As of July first it went to 2%. That's actually has gone down some for us going forward in the future compared to the last 12 months. So, from that perspective, we've made some improvement.

Well, let me ask it a different way. One of your competitors talked about how eventually they could see that FFELP spread getting down to the 100 to 105 basis point level. With a lack of floor income and assuming no 9.5% subsidy and all these borrower benefits, it just seems to me that that's roughly the level that these new loans are coming on the books at.

Matt, this is Terry, I do think we'll continue to see compression of that margin. One way to think about is if the growth spread on repayment Stafford loan 2.34% and it costs us, just to be able to do the math easy 24 basis points in terms of cost of funds that takes you down to 210 basis points.

If you have a cost of a acquisition that starts to inch up above that 3% to 4% range, you have a 4% range over a 5 to 7 year average life, you're going to have 80 basis points that's going to come off that 210 basis point core yield which is going to take you down into that 130 to 140 range.

That would be one way to look at the new assets that are coming on the books. You would then have to temper that with a portion of your portfolio is going to be in school. That's going to earn at 174 basis points versus the 234 basis points.

If you have a 20% in-school component there, that's going to take you down into the 120 to 130 basis point range. Depending upon your cost of acquisition depending upon the loan mix that you've got, depending on the consolidation, you're going to continue to bring that down into that 120 to 130 range and it could go lower.

Could go lower if you end up competing on borrowed benefits?

Correct.

Thanks. Helpful.

Our next question comes from Mike Tejano with UBS.

Good afternoon. Couple questions. On the acquisition, just want to clarify, when you guys do your calculation as to how much is going to be dilutive or accretive, do you factor in the potential synergies that you could potentially get, for example, like with Peterson's I assume they have a pretty significant database of current and future students that potentially you guys could market to or that you could help schools market to. Do you guys factor that into your numbers?

It depends on the situation and the acquisition. With Peterson we looked at what synergies they were going to bring to the table.

With other acquisitions, for example with CUnet where we have an earnout in place over a three year time frame, we did not include additional synergies in place because of the lack of having the goal of a hundred percent aligned. With Peterson's we did include that in the equation.

That's in terms of our analysis going forward. In terms of the dilutive impact in the first or in the last half of 2006, we did not include any type of synergies given the short period of time, etc. that we would be looking at.

Okay, so just to be clear so the synergys are in the 2007 and 2008 accretion estimate?

Yes, as we go out. And go out.

Okay. And then another question on the consolidation volume in the quarter. It seems like--I guess obviously you guys were impacted by the Super 2 Step. But was there a little bit of a change in the timing of consolidation volume this year? Was it more concentrated in the second quarter last year relative to this year? Because it seems like you did a little bit more volume in the first quarter this year than you 've done in prior first quarters.

When we look at our volume for the first six months, we did $2.1 billion in 2006 and we did $1.5 billion in 2005, the way that worked out, I think we ended up doing a little bit more in the first quarter than the second quarter.

A lot of the loans that we did in the June time frame are going to fund in the third and fourth quarters. A lot of the work we did in the second quarter won't fund until the third and fourth quarter because of the huge influx of calls and applications that we took we were focused on meeting the customer demand on the sales side.

So we may not have got as many loans processed in the second quarter this year as we did last year. Our new loans for 2006, gross new loans, 1.1 billion versus 2005 was 812 million. We've already mentioned what our net new loans were earlier.

And on the impact of the single holder rule, did that have any significant impact also on the quarter either from a positive or a negative standpoint?

Well, the single holder rule changed I think right at the end of the quarter July 1st, so that impact I think is going to be felt going forward in the future, not in the second quarter. Those numbers wouldn't show up there yet.

Okay. Last question. I think you guys had given guidance at your Investor Day of the split between earnings between first half of the year and second half of the year. You thought 40% to 45% would come in the first half. Could you give us a sense of how you guys think you are tracking relative to that? Are you at the low end or high end? Any color on that?

We are consistent with that. We haven't changed any guidance within that regard.

Okay. Thanks.

Next Carl Drake with SunTrust Robinson Humphrey.

My question is in terms of single holder rule you mentioned Mike, what would be the impact going forward, I know there's not much impact in second quarter, but if you could comment on what you expect the opportunity or positive or negative for Nelnet going forward on the single holder rule?

Wherever there's change there's opportunity and we hope to turn it into positive opportunity. I think before if you look nationally my best guess is between 20% and 35% of loans are potentially singly held.

Those loans are now available for us to try to consolidate. On the other side of the equation in our own portfolio it was roughly between 20% and 30% of our loans were singly held, and so now people can consolidate our loans away from us, where as before they couldn't consolidate away except using different methods like the Super 2 Step or something effective like that.

So, we look forward to turning this into an opportunity to continue to grow our consolidation portfolio and think it is an opportunity that opens up the market another roughly 30% that didn't exist for us to go after before. We look at it as a net positive to us.

Looking at our market share and our ability to grow. If we had 35% of the market, I would not have wanted to see the single holder rule go away. With a smaller market share I think we have a real opportunity.

That's helpful. Last question on the seasonality. We should look at the 40% to 45% and 55% to 60% seasonality that you're sticking to you're really looking at $0.81 core EPS?

Yes.

Any updates on the Edulinks contract? I think that was coming in August or September, any update there?

We don't have any new information on that at this point in time.

Okay. Is -- what about the timing of the OIG investigation? Any update there, Mike?

We're still waiting for a response from them to come back to us with a report -- the final report or JAF report. I think our best guess is we will probably see something in the fall.

Okay. And then last question is in terms of could you provide some color on the organic growth rate of your fee based revenues?

Given all these acquisitions it's very difficult to track. Should we assume that it's growing at a faster rate, the net interest income, and if you could provide some color. I know there's the loan and guaranteed servicing income is not growing nearly as fast as the other fee based income, but if you could give us some guidance on the growth rates there we should expect organically.

Because of the acquisitions we 've made and the ramp-up of some of these things, the fee based income is growing in some ways not at a nice clean number. I can tell you that our companies that we have integrated and leveraged in the organization, our goal is we want to grow those companies in the high-teens to low-20% area. When you add an acquisition that presents lumpiness in what your fee based net income is and your fee based revenue . I think on the revenue side we were up what 176%, Terry?

In our other fee based revenues.

In our other fee based revenues and so our income would be correlated to that. But going forward once we get these things integrated and our plan is to manage our businesses to grow the net income in the high-teens to low-20s.

Okay. Thank you all.

Next Mark Sproule with Thomas Weisel Partners.

Just a couple quick questions more on sort of your outlook on the core spread side. As you look to remove single holder rule and some aggressive activities by other players do you think that has a sort of negative impact as we go forward for the back half?

And then when you also look and when you couple that with some of the buy rates that we've seen initially on the Grad Plus side that are bringing those rates down to 6.5% you've seen on competitor stuff, how do you look at the impact on those as we go up?

I guess general comment is in whatever industry you 're in whether it's the student loan industry or some other industry, I don't think there's been a time when competition has become less. Competition continues to increase. We are ready to meet the challenge. We see opportunity to grow our business and grow our net income.

As far as our margins go, if you look at our margins and our portfolio they've continued to trend down since we have been public for sure, but for the last 15 years you've seen margins trend down. I assume you 're going to see them trend down in the future. We still see opportunity to grow this business and it's a good business to be in.

And the key component on the trending margins, as the margins trend down, that's why we want to focus on diversification of our fee income and continue to focus on efficiency of our internal operations and that's where we're going to combat those contracting margins.

I know you mentioned that Q1 Q2 '07 starts to be where you finally see the benefit coming in on the plus side, and I know you mentioned in the past the sort of 30% transition of those grad students over to plus to private. Do you think that's being overly conservative, or is there a core group of students that you think will still retain into that private market that kind of slows that transition a little bit more?

I think will time will tell what happens. From a student standpoint, and from an interest rate standpoint, they're better off to get the Grad Plus loan in most all instances. You'd think that over time the trend would go towards where it's least expensive cost to the student which would be Grad Plus.

I don't think it will be 100% assimilation, but I do think it will probably be in the 70% to 80% of the student will switch over to the Grad Plus, on the one side.

On the other side of the equation I think the private loan marketplace if I was going private loan marketplace in total I think it's still going to continue--it may flat line for a year but then after that it will continue to grow just because of the gap that needs to be filled and the rise in the cost of education.

Got you. Thanks a lot.

Our next questions comes from Jordan Hymowitz at Philadelphia Financial.

Hey, guys, I just want to follow-up on Matt Snowling's question, I think you did a good job of answering that. You said it's the marginal spread on the FFELP loans is 120 to 130 which is just what Sallie May said, but Sallie May said the marginal spread on the consolidation loans is closer to 90 basis points. Is yours similar in that regard too?

Yeah, I mean, I think when you take into cost of acquisition into that, the key will be whether you capitalize that cost of acquisition or expense the cost of acquisition in the period you incur it and the difference there would be whether it's marketing or whether you have to pay to get that consolidation loan in. So to the extent that you have a higher cost of acquisition that will drive down your spread on the consolidation loans to that less than a 100 basis points.

Okay. Now given your mix and Sallie's are almost identical at about 65 to 35 consolidation, that means your marginal spread is also about 105 basis points versus the 149 you're reporting.

So if I just run that through a model if your entire portfolio turned over you would be running about a $0.10 rate versus $0.37 you reported so the bet you guys are making as this stuff runs off and replaces with lower spreads you'll be able to either buy back stock or grow fee income or make acquisitions like Peterson's enough to off set that? Is that correct?

That is correct. A couple things though in terms of making sure we verify the difference between the new acquisitions that we're putting on in terms of consolidation and the blended rate that you mention, it depends on our cost of acquisition associated with those consolidation loans.

We're generating the vast majority of our consolidation loans internally. Therefore we can only capitalize the 50 base point origination fee and the direct cost of origination. Our cost of origination is probably going to be that we are capitalizing is only in that 1% range at this point in time which is going to increase our future net spread on our consolidation loans.

Okay. And then so the other way to look at it is that if you're running it on a marginal spread at $0.10 a quarter that you have the 9.5% loans that are also worth about $3.00 to $4.00 if the DOJ reports it and you also have the present value of the extra $0.30 in earnings from what you're doing over probably 5 years which is probably worth another $3.00 to $4.00 to your stock. Is that fair?

Well, we have the value associated with that 9.5% portfolio that's running off and we'd also have the value of the other fixed rate loans that we've got currently hedged that we are replacing at lower rates, but those are fixed and running off in future periods as well.

Just from a general standpoint I would say our goal has been to build a long term business where we can grow our earnings in the high-teens to low-20% year-over-year for the long term.

We think we have a strategy in place that's working. We are going to be able to do that going forward. That's our goal.

Thank you.

Next we will go to Charles Morefield at Noonday Asset Management.

Could you put some numbers around how large you think the size of the Grad Plus opportunity is for you and how you see that ramping up over time?

I think in total if you look at the Grad Plus opportunity, I think I've mentioned this before, we think the total close opportunity is around 5 billion.

70% to 80% of the kids go into that, you're looking at $3.5 to $4 billion. Once all the schools ramp-up and once all the kids that wanted to use Grad Plus go into that business, if you look at from a market share perspective, I think our market share is in the 5% to 6% area.

You could look at a $4 billion market and a 5% to 10% market share opportunity. Looking at $200 to $400 million if I did the math right for us.

And how do you see that ramping up over time?

We think the '06 is going to start off a little bit slow because not all the schools were necessarily ready or maybe the education to the student community was done. I think by 2007 July--by July 2007 we go into the next academic year it will be pretty well ramped up into that 70% area. That's our best guess.

Okay. And do you model internally what your spread is excluding all of your fixed rate loans and all of your derivative hedges? And if so can you tell us what that is?

No, I do not have that information at this point.

Okay. And what's your cash on cash acquisition return criteria? What sort of rate of return do you look for?

We look at a discounted cash flow model and I think I mentioned earlier that our goal is get into the high-teens and low-20s. It's very consistent with what our other goals are. And that's over the long term. That doesn't mean next year we're going to get that return.

We look at how we can take that business and leverage it and grow it. Our goal is to get high-teens to low-20% return on our investment on discounted cash flow model.

Okay. Great. Those are all my questions. Thank you.

We'll now take a follow-up from Kenneth Posner with Morgan Stanley.

I wanted to ask about the derivative gains, if I added up the numbers right you had close to $36 million in derivative gains in the second quarter. Now, from an earnings run rate most people will ignore that and you take it out of your base and adjusted base earnings. But is it fair to think about that as an offset to some of the pressure on the reported net interest margin?

Ken, it's--you can look at the derivative settlements, the net settlements, that's actually our cash income that we receive off that, and that is going to be an offset. But the $28.8 million mark to market, that is just the mark to market of the derivatives that run through our income statement that doesn't qualify for hedge accounting treatment.

Right, but to extend those derivatives are worth more on a mark to market basis, that's value that is presumably offsetting interest rate pressure on the net interest margin.

If we were to unwind them, yes.

That's right.

On a run basis I really think the cash settlements is kind of the offset. Interest rates have actually come down a little bit since the first of the month. So the mark to market is going to go up and down every quarter, but the cash settlements are what we really focus in on Ken.

And when you talk about the course student loan spread of 159 or 149 or whatever it was, does that include the cash settlements or does that exclude the cash settlements?

It does include the cash settlements.

But not the mark to market?

Correct.

Okay, thank you very much.

We'll take a follow-up from Sameer Gokhale with Bear Stearns.

Hi, thanks, I just wanted to get your thoughts on how you think about these newer acquisitions from a strategic perspective. You talked about at Investor Day and you talked about how you kind of want to be the nexus of helping students pay for higher education.

But any data points you can share with us that might suggest that building these relationships early on with parents and students does in fact translate into higher loan volume or other types of income streams further down the road?

Our goal in these businesses that we are working on is to help the education seeking family, not just figure out where they qualify academically but can also qualify from an affordability standpoint to go to school. And the businesses to some degree, we want them to stand on their own and make fee income that's going to cover their costs.

To the extent that that can lead to more loan volume in the future, we look at that as gravy. Also from a brand recognition standpoint, if you were to do a cross section of the country and ask them if they've ever heard of Nelnet, probably going to be a low response answer at this point in time.

Some of these acquisitions we think are going to help a lot with the brand recognition which will turn into higher loan volume, but again, when we analyze these businesses for the most part we are looking at what is the business they are in? Can they create fee income? And the extra loan growth is gravy on the transaction for us.

Okay. That's helpful. Then the other thing that I noticed it seems like not a lot of companies talk about is the increase in the loan limits in the FFELP loan limits for 2007.

It seems like on average if you average it out it's something like potentially a 15% growth in originations just from the increase in loan limits in '07 and you layer that on top of the kind of the low double digit growth and origination volumes on a core basis, it seems like everyone in the industry should have spectacular loan growth in '07, and I don't know if I'm missing something, it just seems like companies don't say much about that.

When you look at the loan growth for --where they increase the loan limit thee's still a limit on the total amount that can be borrowed. People are probably hesitant to wait and see how that affects the numbers going forward.

Freshman can borrow another $1,000. Sophomores can borrow a little bit more. But the total amount that can be borrowed is still in that same ballpark. People are hesitant to make a guess on what's going to happen, and we'll wait and see what happens in the next 12 months.

I thought even with the increase in loan limits you were still at about 19,000 for the full four years compared to the total loan limit of 23,000. So it seems like even with the increase in loan limits for year one and year two and year three and year four staying flat, the aggregate borrowing should increase. I don't know, maybe I 'm missing something there.

I think it will increase. I think the question is how much. Because a lot of kids spend more than four years to go to school also. I think the industry is probably hesitant to make that prediction until we see what happens and how the numbers roll out.

Okay. Thank you very much.

Thanks.

Next we will go to Ed Kosnik at Hunter Global Investors.

Mike, actually it's Duke Buchan.

Hi Duke.

Could you talk a little bit more about the buy back? If my math is correct since you announced the buy back in call it early June you bought back about 10% of the stock that traded if I heard you correctly that you guys bought 329,000 shares in the quarter?

That's correct.

And just sort of I guess within that context, how much cash do you--based on this year's street estimates are you generating and how much do you expect to spend on acquisitions and then the follow-up question to that is if you consider how much over capitalized you are how are you thinking about that capital? That's all in the context of acquisitions and buy backs, etc.

As you know acquisitions are hard to predict. Sometimes you have opportunities and sometimes you don't have opportunities. There's a balancing act between how much cash is generated, acquisition opportunities, and stock buy backs.

There's also some limits when you buy stock in open market on how much shares we can buy back on a daily basis. That all figures into the equation.

As far as predicting on the acquisition side, I think we've said there's always a half dozen or a dozen different things that we are taking a look at. If we can get them bought at the right price and they fit in to the business model we will go after those.

When we look at our capital position where we're at today, if you look at it just from a loan asset stand point you might say we are significantly over capitalized. When you look at all the other businesses we have and the capital that we have used to buy some of these businesses we've made some significant investments.

So at this point in time I wouldn't look at our capital and say that we are significantly overly capitalized for the business that we are building and trying to run from a global perspective. If you looked at just the loan assets we've got significantly more capital than some of our larger competitors on a percentage basis.

Looking at where we are at today and where we're going, time will tell where we have opportunities with acquisitions. We're generating significant cash flow.

If we have opportunities to invest that in acquisitions or invest that internally we are going to do it either by buying back stock or by building businesses. Buying back the stock to some degree is going to be determined by what the opportunity is on the acquisition front.

As you know with CUnet and Peterson's we just made two acquisitions this last quarter we spent quite a bit of cash to do that. Going forward as we generate cash we will look at our cash situation our equity situation and look for opportunities to buy back stock when we have extra cash.

Mike, is it fair to say that -- I mean, you have an appetite to buy back stock currently?

If you look in today's market, my appetite is more than it was yesterday.

Okay. That's what I wanted to hear. Because you 're buying back stock in the high-30's in the month of June. Now your stock is in the low-30's. I would assume that's a more attractive investment to you.

Yes, it is. Just to reiterate. There's certain things that we have to follow being a public company, and when we can buy back shares and when we can't buy back shares. There are different black out periods that affect us. Just wanted to make sure that you understood that.

I understand it clearly. I guess what I'm hearing is that you bought back 10% of what traded in the month of June at--who knows what the average price was.

Let's call it around 38 to 40. Now your stock is significantly below that price. All I wanted to hear was that your appetite is greater now than it was in the month of June.

To the degree that we can make investments that make sense, we 're going to do that. We have some limitations when we make open market purchases on what we can buy and can't buy, how much we can buy.

Right. Okay. Thanks.

And with no further questions in the queue, I would like to turn the conference back over to management for any additional or closing remarks.

Thank you for joining us today. We continue to believe we are making progress and our goals of high-teens to low-20's income generation and are pleased to add Peterson's and CUnet to our family of companies. We thank all you for participating today.

Thank you for your time. Look forward to talking with you at our next quarterly call. Thank you very much.

This does conclude today's conference, ladies and gentlemen, we thank you for your participation and you may now disconnect.