Nelnet, Inc. (NNI) 2009 Q4 法說會逐字稿

Good day, everyone, and welcome to the Nelnet fourth-quarter earnings 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.

Thanks, Anthony. Good morning and welcome to Nelnet's 2009 fourth-quarter earnings conference call. On today's call we have Jeff Noordhoek, the 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 fourth-quarter 2009 supplemental earnings disclosure, which is posted on our investor relations website at 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.

Thanks, Phil, and good morning, everyone. We are extremely pleased with our operating results for 2009. We had a great quarter and a terrific year.

We have reported base net income of $3.94 per share in 2009, compared with $1.65 in 2008. With our strong results for 2009, we have moved from a defensive posture to a more opportunistic outlook. Primarily we are focused on the growth of our fee-for-service businesses. Our core businesses operations include servicing, payment processing, and lead generation. Our products make the delivery of education easier and more efficient for students, families, schools, and financial institutions.

We continue to have significant growth opportunities as demand for education increases, the education process becomes more complex and schools look to become more efficient. As we close 2009 and move into 2010, our financial strength has significantly improved in four areas.

One, revenue diversification -- during 2009, 66% of our revenue was generated from fee-for-service businesses. Two, cash flow -- in 2009 we generated $325 million of cash flow from operations. Three, liquidity -- although our liquidity needs were fairly high in 2008, they are virtually zero at this point in time. Four, equity -- our capital position is currently better than it ever has been at any point in our corporate history.

Since we went public in 2003, shareholders' equity has grown at an average annual rate of 17%. This financial strength has put us in a fortunate position to be able to capitalize on opportunities in our markets as they arise.

We know an important topic related to our Company is the president's proposal to eliminate the FFEL program. In July, the House passed a bill similar to the president's proposal but the Senate has yet to introduce student loan reform legislation. The bottom line is there is no new news.

Regardless of the outcome of the FFEL industry, we have positioned our company to be successful. We have growing, stable, well-established fee-for-service businesses with recurring revenue. We are generating significant cash flow from operations and our student loan portfolio. So as they look to 2010 and beyond, we are encouraged and well positioned for growth in a very dynamic education services market.

Now I will turn the call over to Terry to discuss our financial results in more detail.

Thanks, Jeff. Despite the market disruption and uncertainty at the beginning of the year, we finished 2009 in record fashion. Our base net income excluding impairment and restructuring charges was $3.94 for the year and $1.64 per share for the fourth quarter. This compares to $1.65 per share for 2008 and $0.32 per share for the fourth quarter of last year.

GAAP net income was $2.78 per share for the year and at $1.18 per share for the fourth quarter. The fourth quarter included the following significant items -- a gain on sale of loans of $27 million or $0.35 per share; a gain on the repurchase of debt of $23 million or $0.30 per share; and a non-cash impairment charge of $33 million or $0.43 per share related to our (technical difficulty) list management business.

Our total fee-based revenues increased 13% compared to last year. Our payment processing and lead generation revenues grew more than 18%. Our customer retention and satisfaction is extremely strong in these businesses and we are continuing to develop and expand our product offerings.

We also saw growth in our loan and guaranty servicing revenue during 2009 and we are starting to see a significant increase in loan volume from the Department of Education. You'll recall at the end of the third quarter call but we are servicing $177 million for the Department. At year-end we were up to $3.4 billion and we are currently servicing in excess of $6.3 billion, of which $4.3 billion is incremental volume that is new to our operation.

Our core student loan spread improved to 144 basis points during the fourth quarter, compared to 127 basis points for the third quarter. This increase was driven by a narrowing of the CP LIBOR spread and the extremely low interest rate environment. The CP LIBOR spread was as wide as 27 basis points in the third quarter when compared to the rates at which our debt reset during the quarter.

During the fourth quarter, the spread narrowed to 8 basis points and currently the spread is 6 basis points. Given the sustained low interest-rate environment, we would expect to continue to earn significant floor income. We are hedging this portfolio with fixed rate swaps and we will continue to evaluate our position going forward.

Finally, as it relates to our operating expenses, run rate operating expenses were down 14% for the year and 12% for the quarter. We would expect operating expenses to grow slightly as we increase volume under government contract, as evidenced by the slight growth in operating expenses compared to the third quarter.

As we consider our historical results during 2009, we have consistently increased our equity through earnings, as evidenced by the 17% average annual growth rate since we went public in 2003. As we look to the future, 2010 and beyond, we have significant value related to our portfolio which is not yet recognized in our financial statements.

Our strong business model focused on diversification is working and our fee-based revenues are growing. We have eliminated our liquidity needs and have capacity available for the future. And our expenses and infrastructure are well-positioned for growth.

I will now turn it over to the operator for questions.

(Operator Instructions) Sameer Gokhale, KBW.

Thank you. Just on a discussion about the spread, Terry, you gave us some information about that, but just wanted to get your take on expectations for Q1, what you think the spread could be.

One of the things we noticed this quarter, your net settlements on your derivatives were pretty minimal, so next quarter should we expect there to be some sort of payment on the derivatives, putting downward pressure on the spread? What are some of the dynamics specifically you can talk about there and what you expect for your spread to be in Q1?

Sure, Sameer, and appreciate the question. From a standpoint of expectations for Q1, obviously the nominal rates have stayed extremely low. We have put on with three-month LIBOR probably in the 27 basis points range. The fixed rate hedges that we've put on average just around 50, so we would probably be slightly underwater. So you can expect some settlement payments there.

But overall CP LIBOR has narrowed, as I said, to about six basis points so far during the first quarter. So we are going to expect significant floor income to continue into the first quarter. We would expect CP LIBOR to stay narrow and we would expect some slight payments under the derivatives that we've got given the current three-month LIBOR is at 27 and the averages that we have got those on is just above 50.

So when you net all those things out, just to simplify, are you expecting maybe some modest downward pressure in the margin in Q1 given all the offsetting benefits, but at the end of the day the margins aren't going to move that -- the spread is not going to move that much compared to Q4? Is that essentially what's going to happen?

Yes, I would expect it to move significantly.

Okay, that's very helpful. Then the other question was as it relates to your enrollment services business, during the quarter if you look at it sequentially the revenues increased and yet your expenses decreased. I was wondering if there were -- what dynamics were in play there that would cause that to happen?

Some of that is going to be timing in terms of service is provided. The other is going to be the operating leverage that we've been able to gain in terms of our operations. So it's going to be somewhat cyclical in terms of the revenues, but not significantly. So I think the primary basis there is improvement in margin.

Okay, and then just a last question. You know, you have a table where you show some of your business results by segment and use a tax rate there of 38%. And during the quarter you used a lower tax rates. So do you have any expectations at this point for tax rate going into 2010? Should we be using something like 38% again or maybe something lower than that when modeling out your earnings?

We would expect our tax rate to be in that 38% range. The lower tax rate experience in the fourth quarter was resolution of certain outstanding tax issues.

Okay, so just kind of one-time items there.

Right.

Okay, that's helpful. Thank you.

Moshe Orenbuch, Credit Suisse.

Great, thanks. The first one is just a quick follow-up on the swaps that you put on. How long-lived are they?

They are relatively short-lived, Moshe. You can see that most of them mature in 2010 and we will continue to layer those on as we move forward.

Got you, okay. Separately, could you talk about the cash flows that you are projecting for the FFEL portfolio, talk about the changes from the last time you kind of put them out? Maybe we can go through that.

Well, the biggest -- I mean, the cash flows are a projection of the model using a forward yield curve.

The biggest change in terms of -- that we've got from the last time we published it in the Q3 is we added all of our new deals to make sure we had a complete set and updated it for the forward yield curve. So it's going to change slightly based on changes in the forward yield curve and as rates continue to stay low we are going to benefit from the floor income that we've got in that portfolio.

Could you maybe identify how much of it -- how much of that change would have been from that benefit? I guess it's a big number. It's like a couple hundred million dollars, right?

It went from about $1.34 billion to $1.43 billion over the life of the portfolio.

Right, $100 million.

And the life of the portfolio is going to be anywhere from 10 to 15 years I think in terms of as we show it and we added in a couple of new deals. So --

So you said that was the biggest piece of it.

The combination of those things.

Right, okay. Thank you.

Mike Taiano, Sandler O'Neill.

Congrats on a good quarter and a good year in a tough environment. I guess first question is what do you think in terms of the political situation, the odds of there not being an extension of ECASLA? If that doesn't happen, sort of what is the timeframe over which you will have to commit to schools to lend beyond June 30?

Sure, it's very difficult handicap because it's such a fluid situation. So at this point in time, I would put it at 50-50 is our best determinant and it is obviously extremely tied to healthcare. That seems to be very fluid also.

So as it relates to commitment to schools, it depends on the situation if we are going to -- it's going to stay in FFELP if ECASLA does go away. It depends on what's going on in the capital markets. It depends on what volume is left available in the market. It depends with schools are left in. All those factors are at play.

But as you can imagine, many schools are transferring over into the direct loan program given the uncertainty with the legislation in the market. So we continue to see that but we're going to make our determination once we have the definitive answer if ECASLA is or is not going to be extended and then -- right now we haven't made that decision.

Okay, then just on the fee-based businesses, just try to get a better sense of what's a margin potential there. You've talked a lot about operating leverage over time and maybe could you give us some sense of in the different businesses kind of where you are or are you just scratching the surface in terms of what you think your operating leverage is or is there just maybe a slight upside from here?

And then maybe give us a sense of on the corporate overhead piece and if we assume a worst-case scenario, if FFELP were to go away, is it fair to just assume that that corporate overhead would stay pretty much where it is and that will have to be allocated amongst the different feed-based businesses?

Sure, Mike. This is Terry. If you think about it, our loan and guaranty servicing is a relatively mature business. We've added new activity with the government contract, but it is a relatively mature business. Our tuition payments and campus commerce is also a more mature business. You can see that we've gained a little bit in terms of operating leverage over the past year, but not significantly. Our enrollment services probably is our least mature business in terms of opportunities to continue to look for leverage areas, etc.

As it relates to the corporate overhead, we've made significant improvements this past year in terms of reducing that corporate overhead to the changes in the business environment. We will continue to look for ways that we can drive that down. As the changes in legislation continue to become clear, we will continue to look for opportunities or ways that we can either reduce or redeploy resources into revenue generation activities.

Okay, thank you.

(Operator Instructions) Andrew Vindigni, General American.

Is there a way that -- or have you guys considered locking in, say, a portion of the floor income if it makes sense economically? Because my guess is rates aren't going to go much lower and who knows if they are going to go higher or when or what not, and if the markets would discount that very quickly when it happens. So if it was up to me, if it made economic sense, I wouldn't mind locking in, say, a portion of that floor income.

Also you guys are generating a lot of cash and you're doing a great job of buying in ABS and debt. I was wondering how much more is there available to do that and what's the potential for share repurchase in the future?

Obviously you have some uncertainty with regard to what the government is going to do and there has to be factored in, because the market doesn't seem to be giving you a lot of respect for your free cash flow yield.

Andrew, thanks for the question. This is Terry. Let me try to take them in order.

First as it relates to the floor income, we have started to layer in fixed rate swaps. We have got about 70% of what we believe is hedgeable at this point in time locked in.

We will continue to look for ways that we can layer that on longer in the future. Right now the forward yield curve doesn't -- we don't think allows us to economically lock in more than what we have done so far, so we will continue to evaluate that.

As it relates to the repurchase of debt, we will continue to look for opportunities where the market is irrational and deploy the resources that we have available to buy that back. It's hard to say what that will look like going forward, but we continue to evaluate that daily and we will continue to do so.

As it relates to how do we use our free cash flow --

Andrew, it's Jeff. I would say as we've talked about the past, we look at all the options that are available to us to deploy the cash and that at any point in time might be repurchase of debt, repurchase of stock, issue of dividend, or redeployment of that cash in the business to grow it into the future.

So you are right. We have -- we are in a fortunate position to be able to evaluate all those things and determine what is the best return for our shareholders. Being that we are all large shareholders also, I think you know our interests are aligned on that front. So we are looking to generate the best return possible for you all.

What is roughly the cost to lock in that 70% hedge?

Well, it would vary on the term, but we have been doing that relatively short at this point in time, but we will continue to look at what the forward yield curve would look like going out.

Okay, thank you very much.

(Operator Instructions) With no further questions in the queue, Mr. Noordhoek, I like to turn the conference back over to you for any additional or closing remarks, sir.

Thank you. I was recently reviewing some of our old investor presentations from 2003, when we took the Company public.

The six key points in our 2003 presentation on our operating philosophy that differentiated us from our competition were we would not use gain-on-sale accounting in order to increase earnings; we would not issue stock options in order to avoid management taking unnecessary risks for short-term gain; we take minimal credit risk; we would diversify our revenue streams; we would provide transparency in our financial reporting; and we promised we would focus on long-term cash generation versus quarterly earnings.

Now let me summarize a few key numbers from 2003 and 2009. In 2003 our shareholders' equity was $305 million. In 2009 it was $785 million. In 2003 our book value per share was $5.70. In 2009 it was $15.73.

In 2003 our base net income was $28 million. In 2009 it was $195 million. In 2003 we generated $153 million in cash flow from operations. In 2009 it was $325 million. In 2003, the vast majority of our business was subject to political risk. In 2009, 66% of our revenue is from fee-for-service businesses.

Our key management principles have served us well over the years we pledge that we will continue with them into 2010 and beyond. Once again, thank you for trusting us with your investment in our company and have a great day.

This does conclude today's presentation. We thank everyone for their participation.