**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

**(MARK ONE)**

 
| **ý** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                             |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                |
|       |       | **For The Quarterly Period Ended March 31, 2005**                                                                                                                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                                          |
| ** ** | ** ** | **OR**                                                                                                                                                                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                                          |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                 |
|       |       |                                                                                                                                                                                                                |
|       |       | **For the transition period  from               to              ** |

 

**CommissionFile Number 001-31825**

 

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**The First Marblehead Corporation**

(Exact Name of Registrant asSpecified in Its Charter)

 

| **Delaware**                                                                      | ** ** | **04-3295311**                        |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or  Other Jurisdiction of  Incorporation or Organization)                  |       | (I.R.S. Employer  Identification No.) |
|                                                                              |       |                                  |
| **The Prudential Tower   800 Boylston Street, 34th Floor  Boston, Massachusetts** | ** ** | **02199-8157**                        |
| (Address of  Principal Executive Offices)                                         |       | (Zip Code)                            |
|                                                                              |       |                                  |
| Registrant’s  telephone number, including area code: **(617) 638-2000** |

 

Indicate bycheck mark whether the registrant: (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes ý No o

 

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Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o No ý

 

As of April 30, 2005, the registrant had66,113,757 shares of Common Stock, $0.01 par value per share, outstanding.

 

 

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

 

**Tableof Contents**

 
| Part I. Financial Information |                                                                                                                    |
|-------------------------------|-------------------------------------------------------------------------------------------------------------------------|
| Item 1—                  | Financial Statements                                                                                                    |   |
|                          | Condensed Consolidated Balance Sheets as of  March 31, 2005 and June 30, 2004                                 | 3 |
|                          | Condensed Consolidated Statements of Income  for the three and nine months ended March 31, 2005 and 2004           | 4 |
|                          | Condensed Consolidated Statement of Changes  in Stockholders’ Equity for the nine months ended March 31, 2005 | 5 |
|                          | Condensed Consolidated Statements of Cash  Flows for the nine months ended March 31, 2005 and 2004                 | 6 |
|                          | Notes to Unaudited  Condensed Consolidated Financial Statements                                                         | 7 |
| Item 2—                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                             | 15 |
| Item 3—                  | Quantitative and Qualitative Disclosures  About Market Risk                                                             | 44 |
| Item 4—                  | Controls and Procedures                                                                                                 | 44 |
| Part II. Other Information    |                                                                                                                    |
| Item 2—                  | Unregistered Sales of Equity Securities and  Use of Proceeds                                                            | 45 |
| Item  6—                 | Exhibits                                                                                                                | 45 |
| SIGNATURES                    | 46                                                                                                                      |
| EXHIBIT INDEX                 | 47                                                                                                                      |

 

2

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**Part I. Financial Information**

 

**Item 1-Financial Statements**

 

**THE FIRST MARBLEHEAD CORPORATION ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(unaudited)**

**(in thousands, except share and per share amounts)**

 
| ** **                                                                                                                                                                                                                                                       | ** ** | **March 31,  2005** | ** ** | **June 30,   2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                                                                                       | ** ** | ** **               | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                       |       |                     |       |                     |       |
| Cash and other short-term investments                                                                                                                                                                                                                            |       | $                        | 218,467    |                     | $          | 168,712 |   |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Service receivables:                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Structural advisory fees                                                                                                                                                                                                                                         |       | 42,767                   |       | 34,334                   |       |
| Residuals                                                                                                                                                                                                                                                        |       | 210,332                  |       | 108,495                  |       |
| Processing fees from The Education  Resources Institute (TERI)                                                                                                                                                                                                   |       | 8,358                    |       | 6,052                    |       |
|                                                                                                                                                                                                                                                             |       | 261,457                  |       | 148,881                  |       |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Property and equipment                                                                                                                                                                                                                                           |       | 42,810                   |       | 15,146                   |       |
| Less accumulated depreciation and  amortization                                                                                                                                                                                                                  |       | (8,874                   | )          | (4,315                   | )          |
| Property and equipment, net                                                                                                                                                                                                                                      |       | 33,936                   |       | 10,831                   |       |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Goodwill                                                                                                                                                                                                                                                         |       | 3,176                    |       | 3,176                    |       |
| Intangible assets, net                                                                                                                                                                                                                                           |       | 2,776                    |       | 3,180                    |       |
| Prepaid income taxes                                                                                                                                                                                                                                             |       | 17,115                   |       | 20,267                   |       |
| Other prepaid expenses                                                                                                                                                                                                                                           |       | 3,281                    |       | 2,763                    |       |
| Other assets                                                                                                                                                                                                                                                     |       | 3,466                    |       | 2,246                    |       |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Total assets                                                                                                                                                                                                                                                     |       | $                        | 543,674    |                     | $          | 360,056 |   |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                   |       |                     |       |                     |       |
| Liabilities:                                                                                                                                                                                                                                                     |       |                     |       |                     |       |
| Accounts payable and accrued expenses                                                                                                                                                                                                                            |       | $                        | 29,425     |                     | $          | 26,285 |   |
| Net deferred income tax liability                                                                                                                                                                                                                                |       | 70,416                   |       | 40,138                   |       |
| Notes payable and capital lease obligations                                                                                                                                                                                                                      |       | 7,452                    |       | 9,179                    |       |
| Notes payable to TERI                                                                                                                                                                                                                                            |       | 5,474                    |       | 6,004                    |       |
| Other liabilities                                                                                                                                                                                                                                                |       | 801                      |       | 314                      |       |
| Total liabilities                                                                                                                                                                                                                                                |       | 113,568                  |       | 81,920                   |       |
| Commitments and contingencies                                                                                                                                                                                                                                    |       |                     |       |                     |       |
| Stockholders’ equity:                                                                                                                                                                                                                                       |       |                     |       |                     |       |
| Preferred stock, par value $0.01 per share;  20,000,000 shares authorized; no shares issued or outstanding                                                                                                                                                       |       | —                   |       | —                   |       |
| Common stock, par value $0.01 per share;  150,000,000 and 100,000,000 shares authorized at March 31, 2005 and June 30,  2004, respectively; 66,113,757 and 63,975,000 shares issued and outstanding  at March 31, 2005 and June 30, 2004, respectively |       | 661                      |       | 640                      |       |
| Additional paid-in capital                                                                                                                                                                                                                                       |       | 202,516                  |       | 163,572                  |       |
| Retained earnings                                                                                                                                                                                                                                                |       | 230,541                  |       | 113,924                  |       |
| Deferred compensation                                                                                                                                                                                                                                            |       | (3,612                   | )          | —                   |       |
| Total stockholders’ equity                                                                                                                                                                                                                                  |       | 430,106                  |       | 278,136                  |       |
|                                                                                                                                                                                                                                                             |       |                     |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                  |       | $                        | 543,674    |                     | $          | 360,056 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3

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**THE FIRST MARBLEHEAD CORPORATION ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF****INCOME**

**(unaudited)**

**(in thousands, except per share amounts)**

 
| ** **                                         | ** ** | **Three months ended  March 31,** | ** ** | **Nine months ended  March 31,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **2005**                               | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                               |       |                                   |       |                             |       |   |   |   |   |
| Service revenue:                                   |       |                                   |       |                             |       |   |   |   |   |
| Structural advisory fees                           |       | $                                      | 62,942     |                             | $          | 484 |   | $ | 138,733 |   | $ | 39,184 |   |
| Residuals                                          |       | 35,153                                 |       | 2,253                            |       | 101,836 |   | 34,790 |   |
| Processing fees from TERI                          |       | 20,610                                 |       | 7,933                            |       | 54,547 |   | 22,917 |   |
| Administrative and other fees                      |       | 829                                    |       | 457                              |       | 2,660 |   | 1,228 |   |
| Total service revenue                              |       | 119,534                                |       | 11,127                           |       | 297,776 |   | 98,119 |   |
|                                               |       |                                   |       |                             |       |   |   |   |   |
| Operating expenses:                                |       |                                   |       |                             |       |   |   |   |   |
| Compensation and benefits                          |       | 17,322                                 |       | 8,835                            |       | 47,523 |   | 25,503 |   |
| General and administrative expenses                |       | 20,391                                 |       | 8,414                            |       | 51,702 |   | 22,423 |   |
| Total operating expenses                           |       | 37,713                                 |       | 17,249                           |       | 99,225 |   | 47,926 |   |
| Income (loss) from operations                      |       | 81,821                                 |       | (6,122                           | )     | 198,551 |   | 50,193 |   |
| Other (income) expense:                            |       |                                   |       |                             |       |   |   |   |   |
| Interest expense                                   |       | 131                                    |       | 225                              |       | 366 |   | 476 |   |
| Interest income                                    |       | (1,177                                 | )          | (303                             | )          | (2,532 | ) | (497 | ) |
| Net interest income                                |       | (1,046                                 | )          | (78                              | )          | (2,166 | ) | (21 | )  |
| Income (loss) before income tax expense  (benefit) |       | 82,867                                 |       | (6,044                           | )     | 200,717 |   | 50,214 |   |
| Income tax expense (benefit)                       |       | 35,429                                 |       | (2,478                           | )     | 84,100 |   | 20,219 |   |
| Net income (loss)                                  |       | $                                      | 47,438     |                             | $          | (3,566 | )  | $ | 116,617 |   | $ | 29,995 |   |
|                                               |       |                                   |       |                             |       |   |   |   |   |
| Net income (loss) per share, basic                 |       | $                                      | 0.72       |                             | $          | (0.06 | )  | $ | 1.80 |   | $ | 0.52 |   |
| Net income (loss) per share, diluted               |       | 0.71                                   |       | (0.06                            | )     | 1.74 |   | 0.47 |   |
| Weighted average shares outstanding, basic         |       | 65,684                                 |       | 61,856                           |       | 64,871 |   | 58,075 |   |
| Weighted average shares outstanding,  diluted      |       | 67,216                                 |       | 61,856                           |       | 66,937 |   | 63,441 |   |
|                                                    |            |                                        |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4

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** **

**THE FIRST MARBLEHEAD CORPORATION ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CHANGESIN STOCKHOLDERS’ EQUITY**

**(unaudited)**

**(in thousands)**

 
| ** **                                            | ** ** | **Common   Stock** | ** ** | **Additional  Paid-in Capital** | ** ** | **Retained    Earnings** | ** ** | **Deferred    Compensation** | ** ** | **Total**   | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|--------------------------|------------|------------------------------|------------|-------------|------------|
|                                                  |       |               |       |                            |       |                     |       |                         |       |        |       |
| Balances at June 30, 2004                        |       | $                  | 640        |                            | $          | 163,572                  |       | $                            | 113,924    |        | $          | — |   | $ | 278,136 |   |
|                                                  |       |               |       |                            |       |                     |       |                         |       |        |       |
| Options exercised                                     |       | 21                 |       | 3,653                           |       | —                   |       | —                       |       | 3,674       |       |
| Stock purchases through employee stock  purchase plan |       | —             |       | 899                             |       | —                   |       | —                       |       |  

899 |       |
| Tax benefit from employee stock options               |       | —             |       | 30,448                          |       | —                   |       | —                       |       | 30,448      |       |
| Grants of restricted stock units                      |       | —             |       | 3,944                           |       | —                   |       | (3,944                       | )          | —      |       |
| Amortization of deferred compensation                 |       | —             |       | —                          |       | —                   |       | 332                          |       | 332         |       |
| Net income                                            |       | —             |       | —                          |       | 116,617                  |       | —                       |       | 116,617     |       |
| Balances at March 31, 2005                       |       | $                  | 661        |                            | $          | 202,516                  |       | $                            | 230,541    |        | $          | (3,612 | ) | $ | 430,106 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5

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**THE FIRST MARBLEHEAD CORPORATION ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

**(in thousands)**
| ** **                                                                                   | ** ** | **Nine months ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                                         |       |                                  |       |   |   |
| Cash flows from operating activities:                                                        |       |                                  |       |   |   |
| Net income                                                                                   |       | $                                     | 116,617    |   | $ | 29,995 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                                |       | 5,524                                 |       | 2,264 |   |
| Deferred income tax expense                                                                  |       | 30,278                                |       | 13,866 |   |
| Tax benefit from employee stock options                                                      |       | 30,448                                |       | — |   |
| Stock-based compensation                                                                     |       | 332                                   |       | 1,642 |   |
| Change in assets/liabilities:                                                                |       |                                  |       |   |   |
| (Increase) in structural advisory fees                                                       |       | (8,433                                | )          | (14,684 | ) |
| (Increase) in residuals                                                                      |       | (101,837                              | )          | (34,790 | ) |
| (Increase) in processing fees from TERI                                                      |       | (2,306                                | )          | (437 | ) |
| Decrease in prepaid income taxes                                                             |       | 3,152                                 |       | — |   |
| (Increase) in other prepaid expenses                                                         |       | (518                                  | )          | (876 | ) |
| (Increase) in other assets                                                                   |       | (1,220                                | )          | (322 | ) |
| Increase (decrease) in accounts payable and  accrued expenses, and other liabilities         |       | 3,627                                 |       | (6,621 | ) |
| Net cash provided by (used in) operating  activities                                         |       | 75,664                                |       | (9,963 | ) |
| Cash flows from investing activities:                                                        |       |                                  |       |   |   |
| Purchases of property and equipment                                                          |       | (21,548                               | )          | (3,831 | ) |
| Payments to TERI for loan database updates                                                   |       | (561                                  | )          | (561 | ) |
| Net cash used in investing activities                                                        |       | (22,109                               | )          | (4,392 | ) |
| Cash flows from financing activities:                                                        |       |                                  |       |   |   |
| Repayment of notes payable and capital  lease obligations                                    |       | (7,843                                | )          | — |   |
| Repayment of notes payable to TERI                                                           |       | (530                                  | )          | (499 | ) |
| Proceeds from note payable                                                                   |       | —                                |       | 7,000 |   |
| Net proceeds from initial public offering                                                    |       | —                                |       | 115,107 |   |
| Issuances of common stock for benefit plans                                                  |       | 4,573                                 |       | 780 |   |
| Net cash (used in) provided by financing  activities                                         |       | (3,800                                | )          | 122,388 |   |
| Net increase in cash and other short-term  investments                                       |       | 49,755                                |       | 108,033 |   |
| Cash and other short-term investments,  beginning of period                                  |       | 168,712                               |       | 18,327 |   |
| Cash and other short-term investments, end  of period                                        |       | $                                     | 218,467    |   | $ | 126,360 |   |
|                                                                                         |       |                                  |       |   |   |
| Supplemental disclosures of cash flow  information:                                          |       |                                  |       |   |   |
| Interest paid                                                                                |       | $                                     | 616        |   | $ | 351 |   |
|                                                                                         |       |                                  |       |   |   |
| Income taxes paid, net                                                                       |       | $                                     | 20,221     |   | $ | 17,849 |   |
|                                                                                         |       |                                  |       |   |   |
| Supplemental disclosure of non-cash activities:                                              |       |                                  |       |   |   |
| Acquisition of property and equipment  through capital leases                                |       | $                                     | 6,116      |   | $ | — |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6

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**THE FIRST MARBLEHEAD CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO****UNAUDITED****CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1)****                                 Natureof Business and Summary of Significant Accounting Policies**

 

***Natureof Business***

 

The First Marblehead Corporation (FMC, andtogether with its subsidiaries, the Company), which was incorporated under thelaws of the State of Delaware on August 13, 1994, provides outsourcingservices for private education lending in the United States. The Company helpsmeet the growing demand for private education loans by providing national andregional financial institutions and educational institutions, as well asbusinesses and other enterprises, with an integrated suite of services fordesigning and implementing student loan programs for their respectivecustomers, students, employees and members. The Company focuses primarily onloan programs for undergraduate, graduate and professional education, and, to alesser degree, on the primary and secondary school market. The Company isentitled to receive structural advisory fees and residuals for its services inconnection with securitizations of loans generated by the loan programs that itfacilitates. The Company also receives fees for administrative services that itprovides to the discrete bankruptcy remote, special purpose trusts that theCompany forms for securitizations it facilitates.

 

***Basisof Presentation***

 

The accompanying unauditedcondensed consolidated financial statements of the Company have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America (GAAP) for interim financialinformation. Accordingly, they do not include all of the information andfootnotes required by GAAP for complete consolidatedfinancial statements. In the opinion of management, all adjustments (consistingof only normal recurring accruals) considered necessary for a fair statement ofthe results for the interim periods have been included. The preparation offinancial statements in conformity with GAAP requiresmanagement to make estimates and assumptions that affect the amounts reportedin the consolidated financial statements and accompanying notes. Interimresults are not necessarily indicative of results to be expected for the entirefiscal year. All significant intercompany balancesand transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and related notes for the year ended June 30, 2004 included inthe Company’s Annual Report on Form 10-K filed with the Securities and ExchangeCommission on September 15, 2004. Certain prior period amounts have beenreclassified to conform with current period presentation.

 

***StudentLoan Market Seasonality and Revenue Related to Securitization Transactions***

 

Origination of student loans is generallysubject to seasonal trends, with the volume of loan applications increasingwith the approach of tuition payment dates. In general, the Company processesthe greatest application volume during the summer months, as students and theirfamilies seek to borrow money in order to pay tuition costs for the fallsemester or the entire school year. The Company also tends to process an increasedvolume of loan applications during December and January, as students and theirfamilies seek to borrow money to pay tuition costs for the spring semester.This seasonality of loan originations impacts the amount of processing feesfrom TERI that the Company earns in a particular quarter.

 

The Company did not conduct a securitizationtransaction during the first quarter of either fiscal 2005 or fiscal 2004. TheCompany closed one securitization transaction in the second quarter, and twosecuritization transactions in the fourth quarter, of fiscal 2004. The Companyclosed one securitization transaction in the second quarter, and onesecuritization transaction in the third quarter, of fiscal 2005. The Company expectsto close two securitization transactions in the fourth quarter of the currentfiscal year.

 

***Concentrations***

 

**TERI**

 

The Education Resources Institute, Inc.(TERI) is a private, not-for-profit Massachusetts corporation as describedunder section 501(c)(3) of the Internal Revenue Code of 1986, as amended.Incorporated in 1985, TERI is the oldest and largest guarantor of alternative,or private, student loans. In its role as guarantor in the private educationlending market, TERI agrees to reimburse lenders for unpaid principal andinterest on defaulted loans. TERI is the exclusive third-party provider ofborrower default guarantees for the Company’s clients’ private student loans.As of March 31, 2005, TERI had a Baa3 counterparty rating from Moody’sInvestors Service, which is the lowest investment grade rating, and an insurerfinancial strength rating of A+ from Fitch Ratings. If these ratings arelowered, FMC’s clients may not wish to enter into guarantee arrangements withTERI. In addition, FMC may receive lower structural advisory fees because thecosts of obtaining financial guarantee insurance or structuring other creditenhancements in the asset-backed securitizations could increase.

 

7

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**PHEAA**

 

As of March 31, 2005, there were nineTERI-approved loan servicers to service new loan facilitation volume. As of March 31,2005, Pennsylvania Higher Education Assistance Agency (PHEAA) serviced amajority of the loans for which the Company facilitated origination. TheCompany’s use of third-party loan servicers allows the Company to increase thevolume of loans in its clients’ loan programs without incurring the overheadinvestment in servicing operations. As with any external service provider,there are risks associated with inadequate or untimely services. In addition,if the Company’s relationship with PHEAA terminates, the Company would eitherneed to expand or develop a relationship with another TERI-approved loanservicer, which could be time-consuming and costly.

 

***Significant Customers***

 

During the three and nine month periods endedMarch 31, 2005, processing fees from TERI represented approximately 17%and 18%, respectively, of total service revenue. Securitization-related feesfrom the National Collegiate Student Loan Trust 2005-1 (NCSLT2005-1) and National Collegiate Student Loan Trust 2004-2 (NCSLT2004-2) represented approximately 31% and 45%, respectively, of total servicerevenue for the first nine months of fiscal 2005. Securitization-related feesfrom NCSLT 2005-1 represented approximately 81% oftotal service revenue for the three months ended March 31, 2005. NCSLT 2005-1 and NCSLT 2004-2purchased approximately 93% of its private student loans from JP Morgan ChaseBank, N.A., as successor by merger to Bank One N.A., Bank of America N.A. andCharter One Bank N.A. The Company did not recognize more than 10% of totalservice revenue from any other customer.

 

***SignificantAccounting Policies and Estimates***

 

The preparation of the Company’s consolidatedfinancial statements requires the Company to make estimates, assumptions andjudgments that affect the reported amounts of assets and liabilities and thereported amounts of income and expenses during the reporting periods. TheCompany bases its estimates and judgments on historical experience and onvarious other factors, and actual results may differ from these estimates undervarying assumptions or conditions. On an ongoing basis, the Company evaluatesits estimates and judgments, particularly as they relate to accounting policiesthat the Company believes are most important to the portrayal of the Company’sfinancial condition and results of operations, such as its accounting policiesinvolving the recognition and valuation of the Company’s securitization-relatedservice revenue, and with respect to the determination of whether or not toconsolidate the securitization trusts that it facilitates.  See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Application of CriticalAccounting Policies and Estimates”.

 

**Cash and Other Short-term Investments**

 

Cash and other short-term investments atMarch 31, 2005 include $192.4 million held in a money market fund that investsin short-term obligations of the U.S. Treasury and repurchase agreements fullycollateralized by obligations of the U.S. Treasury. Included in cash and othershort-term investments are compensating balances of $17.7 million and $10.0million at March 31, 2005 and June 30, 2004, respectively, supporting variousfinancing arrangements.

 

**Income Taxes**

 

In determining a quarterly provision forincome taxes, the Company uses an estimated annual effective tax rate which isbased on its expected annual income, statutory tax rates and tax planningopportunities available to it in the various jurisdictions in which itoperates. The Company’s estimated annual effective tax rate also includes itsbest estimate of the ultimate outcome of tax audits. The Company has a netdeferred income tax liability because, under GAAP, itrecognizes residuals in book income earlier than they are recognized for taxpurposes.

 

**(2)****                                 StockOptions**

 

The Company uses the intrinsic value methodto account for stock options and provides pro forma net earnings disclosures asif the fair-value-based method had been applied.

 

For purposes of pro forma disclosures, theestimated fair value of the stock options is amortized to expense over thevesting period of the options. The Company’s consolidated pro forma net incomeand net income per share for the three and nine month periods ended March 31,2005 and 2004, had the Company elected to recognize compensation expense forthe granting of options under SFAS No. 123 using theBlack-Scholes option pricing model, are as follows:

 

8

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| ** **                                                                                                                      | ** ** | **Three months ended   March 31,**      | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| ** **                                                                                                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income (loss) —as reported                                                                                             |       | $                                            | 47,438     |   | $ | (3,566 | )  |
| Add: Total stock-based employee  compensation expense included in reported net income (loss), net of tax                        |       |                                         | 112        |   |   | — |   |
| Less: Total stock-based employee  compensation expense determined under the fair-value-based method for all  awards, net of tax |       | (239                                         | )          | (94 | ) |
|                                                                                                                            |       |                                         |       |   |   |
| Net income (loss) —pro forma                                                                                               |       | $                                            | 47,311     |   | $ | (3,660 | )  |
|                                                                                                                            |       |                                         |       |   |   |
| Net income (loss) per share—basic—as  reported                                                                        |       | $                                            | 0.72       |   | $ | (0.06 | )  |
| Net income (loss) per share—basic—pro forma                                                                           |       | $                                            | 0.72       |   | $ | (0.06 | )  |
| Net income (loss) per share—diluted—as  reported                                                                      |       | $                                            | 0.71       |   | $ | (0.06 | ) |
| Net income (loss) per share—diluted—pro  forma                                                                        |       | $                                            | 0.70       |   | $ | (0.06 | ) |

 
| ** **                                                                                                                      | ** ** | **Nine months ended   March 31,**       | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| ** **                                                                                                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income—as reported                                                                                                     |       | $                                            | 116,617    |   | $ | 29,995 |   |
| Add: Total stock-based employee  compensation expense included in reported net income, net of tax                               |       |                                         | 193        |   |   | 981 |   |
| Less: Total stock-based employee  compensation expense determined under the fair-value-based method for all  awards, net of tax |       | (1,084                                       | )          | (1,426 | ) |
|                                                                                                                            |       |                                         |       |   |   |
| Net income—pro forma                                                                                                       |       | $                                            | 115,726    |   | $ | 29,550 |   |
|                                                                                                                            |       |                                         |       |   |   |
| Net income per share—basic—as reported                                                                                |       | $                                            | 1.80       |   | $ | 0.52 |   |
| Net income per share—basic—pro forma                                                                                  |       | $                                            | 1.78       |   | $ | 0.51 |   |
| Net income per share—diluted—as reported                                                                              |       | $                                            | 1.74       |   | $ | 0.47 |   |
| Net income per share—diluted—pro forma                                                                                |       | $                                            | 1.73       |   | $ | 0.47 |   |

** **

**(3)****                                 ServiceReceivables**

 

Structural advisory fees and residualsreceivables represent the present value of future cash flows of additionalstructural advisory fees and residuals expected to be collected over the lifeof the student loans, net of prepayment, default, recovery and cost of fundingestimates. The fees are paid to the Company from the various separatesecuritization trusts established by The National Collegiate Trust (NCTtrusts), and from The National Collegiate Master Student Loan Trust I (NCMSLT), The National Collegiate Student Loan Trust 2003-1(NCSLT 2003), The National Collegiate Student LoanTrust 2004-1 (NCSLT 2004-1), NCSLT2004-2 and NCSLT 2005-1. Processing fees receivablefrom TERI represents amounts due from TERI for expenses incurred by FirstMarblehead Education Resources, Inc. (FMER), a whollyowned subsidiary of FMC, on TERI’s behalf.

 

The Company, on a quarterly basis, updatesits estimate of the present value of its structural advisory fees and residualsreceivables to reflect the passage of time, any change in discount rates usedto estimate their present value, and any changes to the trust performancemetrics that the Company considers in its present value estimates, such asdefault, recovery, prepayment and forward London InterbankOffered Rate (LIBOR) rates.

 

The Company made no changes in itsassumptions regarding default rates, prepayment rates and recovery rates duringthe first nine months of either fiscal 2005 or 2004 for any of thesecuritization trusts it has established.

 

The Company uses an implied forward LIBORcurve to estimate trust cash flows. During the nine months ended March 31, 2005,the implied forward LIBOR curve flattened. This flattening of the LIBOR curve increasedthe estimated fair value of the structural advisory fees receivable during thenine months ended March 31, 2005. The flattening of the curve improved the netexcess spread between the trust assets and liabilities, resulting in anincrease in the estimated fair 

 

9

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value of residuals receivableduring the period. During the nine months ended March 31, 2004, the rates alongthe implied forward LIBOR curve increased. These increases in rates resulted inan increase in the average life of the underlying trust assets, thereby havingthe effect of increasing the estimated fair value of the structural advisoryfees and residuals receivables during the period.

 

The Company bases the discount rate that ituses to calculate the present value of its additional structural advisory feeson the 10-year U.S. Treasury rate plus 200 basis points. From July 1, 2004to March 31, 2005, this rate decreased by 7 basis points from 6.58% to 6.51%.From July 1, 2003 to March 31, 2004, this rate increased by 51 basis pointsfrom 5.33% to 5.84%. A decrease in the 10-year U.S. Treasury rate has theeffect of increasing the estimated fair value of the Company’s structuraladvisory fees receivable, while an increase in the rate has the opposite effecton the Company’s estimate of their fair value. In determining an appropriatediscount rate for valuing residuals, we review the rates used by student loan securitizers, as well as rates used in the much broader asset-backedsecurities (ABS) market. We believe that the 12% discount rate we use isappropriate given the expected 24-year life of the trust assets and residuals.

 

The following table summarizes the changes inthe structural advisory fees receivable for the nine month periods ended March 31,2005 and 2004:

 
| ** **                                                     | ** ** | **Nine months ended   March 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                     | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**                | ** ** |
| Fair value of structural advisory fees at  beginning of period |       | $                                 | 24,084     | (1)  | $ | 10,785 |   |
| Additions from structuring new securitizations                 |       | 17,901                            |       | 5,925 |   |
| Fair value adjustments                                         |       | 782                               |       | 259 |   |
| Fair value of structural advisory fees at  end of period       |       | $                                 | 42,767     |   | $ | 16,969 | (1) |

----

(1) Excludes additionalup-front structural advisory fees received in July 2004 related to the December2003 securitization transaction. See Note 7(c) for additional information.

 

The following table summarizes the changes in the residuals receivablefor the nine month periods ended March 31, 2005 and 2004:

 
| ** **                                      | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)**               | ** ** |
| Fair value of residuals at beginning of  period |       | $                                | 108,495    |       | $ | 43,600 |   |
| Additions from structuring new  securitizations |       | 88,402                           |       | 29,730 |   |
| Fair value adjustments                          |       | 13,435                           |       | 5,060 |   |
| Fair value of residuals at end of period        |       | $                                | 210,332    |   | $ | 78,390 |   |

 

The effect on the fair value of thestructural advisory fees and residuals receivables based on variations of 10%or 20%, except for the forward LIBOR rates, which are based on variations of 1%and 2% from the forward LIBOR rates at March 31, 2005, and, for residuals only,changes in the assumed spread between one month LIBOR rates and the auctionrates which are based on .05% and .10% changes, from the assumed levels foreach key assumption are as follows:

 

**(dollarsin thousands)**

 
| **Structural  advisory fees receivables, March 31, 2005** | ** ** | $      | 42,767 |                  | ** ** |   |   |   |
|---------------------------------------------------------------------|------------|--------|--------|-----------------------|------------|--------|--------|--------|
|                                                                |       |   |   |                  |       |   |   |
| Default rate                                                        |       |   |   | Default rate          |       |   |   |
| +10%                                                                |       | $      | (214   | )                     | -10%       |   | $      | 214    |   |
| +20%                                                                |       | (429   | )      | -20%                  |       | 427    |   |
| Default  recovery rate                                              |       |   |   | Default recovery rate |       |   |   |
| +10%                                                                |       | — |   | -10%                  |       | (130   | )      |
| +20%                                                                |       | 142    |   | -20%                  |       | (130   | )      |
| Prepayment  rate                                                    |       |   |   | Prepayment rate       |       |   |   |
| +10%                                                                |       | (1,074 | )      | -10%                  |       | 1,131  |   |
| +20%                                                                |       | (2,092 | )      | -20%                  |       | 2,322  |   |
| Discount  rate                                                      |       |   |   | Discount rate         |       |   |   |
| +10%                                                                |       | (1,642 | )      | -10%                  |       | 1,728  |   |
| +20%                                                                |       | (3,207 | )      | -20%                  |       | 3,549  |   |
| Forward  LIBOR rates                                                |       |   |   | Forward LIBOR rates   |       |   |   |
| +1%                                                                 |       | 1,382  |   | -1%                   |       | (1,489 | )      |
| +2%                                                                 |       | 2,930  |   | -2%                   |       | (2,883 | )      |
|                                                                     |            |        |        |                       |            |        |        |        |  |

 

10

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**(dollarsin thousands)**

 
| **Residuals  receivables, March 31, 2005**     | ** ** | $       | 210,332      |                                                     | ** ** |    |   |   |
|----------------------------------------------------------|------------|---------|--------------|----------------------------------------------------------|------------|---------|--------|--------|
|                                                     |       |    |         |                                                     |       |    |   |
| Default rate                                             |       |    |         | Default rate                                             |       |    |   |
| +10%                                                     |       | $       |  (1,937 | )                                                        | - 10%      |    | $      | 1,274  |   |
| +20%                                                     |       | (5,616  | )            | - 20%                                                    |       | 2,466   |   |
| Default  recovery rate                                   |       |    |         | Default recovery rate                                    |       |    |   |
| +10%                                                     |       | 462     |         | - 10%                                                    |       | (529    | )      |
| +20%                                                     |       | 531     |         | - 20%                                                    |       | (1,280  | )      |
| Prepayment  rate                                         |       |    |         | Prepayment rate                                          |       |    |   |
| +10%                                                     |       | (9,902  | )            | - 10%                                                    |       | 10,370  |   |
| +20%                                                     |       | (19,349 | )            | - 20%                                                    |       | 21,253  |   |
| Discount  rate                                           |       |    |         | Discount rate                                            |       |    |   |
| +10%                                                     |       | (18,901 | )            | - 10%                                                    |       | 21,145  |   |
| +20%                                                     |       | (35,730 | )            | - 20%                                                    |       | 44,907  |   |
| Forward  LIBOR rates                                     |       |    |         | Forward LIBOR rates                                      |       |    |   |
| +1%                                                      |       | 8,521   |         | - 1%                                                     |       |    | (8,647 | )      |
| +2%                                                      |       | 16,846  |         | - 2%                                                     |       | (17,284 | )      |
| Change in  assumed spread between LIBOR and auction rate |       |    |         | Change in  assumed spread between LIBOR and auction rate |       |    |   |
| +.05%                                                    |       | (1,841  | )            | -.05%                                                    |       | 1,842   |   |
| +.10%                                                    |       | (3,681  | )            | -.10%                                                    |       | 3,685   |   |

 

**(4)****                                 RelatedParty Transaction**

At March 31, 2005 and June 30, 2004, theCompany had invested $192.4 million and $145.2 million, respectively, of cashand other short-term investments in a money market fund. The investment advisorfor this fund is Milestone Capital Management (MCM),an institutional money management firm. At the time of this filing members ofthe immediate family of one of the Company’s directors own approximately 65% ofMCM’s outstanding equity. This money market fund heldtotal assets of $2.0 billion and $2.3 billion at March 31, 2005 and June 30,2004, respectively.

**(5)****                                 Borrowingsfrom Related Parties**

***(a)  Line of Credit***

The Company entered into a $975,000 revolvingline of credit with a bank effective April 24, 2002. The line of credit maturedon April 24, 2003 and was renewed through December 31, 2003 subject to the sameterms and conditions, with interest payable at the greater of 6% or 1% abovethe highest published *Wall Street Journal*primerate. The terms of the line of credit required that: the Company maintainaccurate books and records; the assets be free of all liens, encumbrances andfinancing not approved by the lender; and when there was a balance outstandingunder the line, no dividends or payments of principal and interest on any loansheld by any guarantor, officer, director or stockholder could be made. A memberof the board of directors of the Company is also a director and significantstockholder of a company that owns the bank. The Company believes that the lineof credit was on substantially the same terms as those prevailing at the sametime for comparable transactions with third parties. The Company did not renewthis credit facility upon expiration. The Company had no amounts outstandingunder this line of credit at June 30, 2003 or any time thereafter.

 

***(b)  Notes Payable to TERI***

 

In connection with the Company’s acquisitionof TERI’s loan processing operations in June 2001, the Company entered into anote payable agreement with TERI on June 20, 2001, amounting to$3.9 million, $2.0 million of which related to the acquisition of TERI’ssoftware and network assets and $1.9 million of which related to theCompany’s acquisition of a workforce-in-place. Principal and interest at anannual rate of 6% are payable in 

 

11

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120 monthly installmentsof $43,298 commencing on July 20, 2001 and ending on June 20, 2011.The note payable is secured by the software and network assets. The outstandingbalance of this note payable at March 31, 2005 and June 30, 2004 amounted to$2.7 million and $3.0 million, respectively.

 

The Company also entered into a second notepayable with TERI on June 20, 2001, amounting to $4.0 million, to fund theCompany’s acquisition of TERI’s loan database in June 2001. Principal andinterest at an annual rate of 6% are payable in 120 monthly installmentsof $44,408 commencing on July 20, 2001 and ending on June 20, 2011.The note payable is secured by the loan database. The outstanding balance ofthis note payable was approximately $2.8 and $3.0 million at March 31, 2005 andJune 30, 2004, respectively.

 

**(6)****                                 OtherBorrowings**

 

***(a)   Revolving Line of Credit***

On August 28, 2003, the Company entered intoan agreement with Fleet National Bank to establish a revolving line of creditin the amount of $10 million, which includes a sub-limit for letters ofcredit. Fleet National Bank was subsequently acquired by Bank of America, andour agreement has been assigned to Bank of America. The revolving creditfacility matures on August 28, 2005, with interest currently payable, atthe Company’s option, at the bank’s prime rate or LIBOR plus 2%. The revolvingcredit line contains financial covenants, including minimum trailing 12-monthup-front structural advisory fees, minimum tangible net worth, maximumliabilities to net worth ratios and minimum cash flow to debt service ratios,as well as certain financial reporting covenants. This agreement restricts theCompany’s ability to pay cash dividends in the event it is in default. Noamounts were outstanding under this revolving line of credit at March 31, 2005or June 30, 2004. Borrowings, if any, under the revolving credit facility willbe used for working capital and general corporate purposes. Bank of America hasalso issued on the Company’s behalf a letter of credit in the amount of $0.5million in lieu of security deposits for the lease of office space. Third partybeneficiaries have not drawn upon this letter of credit, which reduces theamount the Company may borrow under the revolving credit facility.

***(b)   Equipment Financing Lease***

 

InJanuary 2005, the Company entered into an equipment financing lease agreementwhich will be used to finance the purchases of furniture and equipment. Theagreement allows the Company to finance up to $20 million of furniture andequipment purchased before December 30, 2005. The Company expects to repayamounts drawn down from the lease in terms ranging from three to five years. Asof March 31, 2005, the Company had $5.1 million outstanding under thisequipment line of credit. Interest expense on amounts outstanding will accrueat annual rates ranging from 3.4% to 4.0%.

 

***(c)   Note Payable Related to December 2003Securitization***

 

In December 2003, the Company received$7.0 million upon the issuance of a $7.25 million note to the lead underwriterof the Company’s December 2003 securitization transaction.  The Company agreed to repay this note withthe first $7.25 million of the up-front structural advisory fee that itreceived in July 2004 in connection with the December 2003securitization. This July 2004 up-front structural advisory fee payment was inaddition to the $24.5 million up-front structural advisory fee payment receivedat the time of the December 2003 securitization transaction and, at December31, 2003, was estimated to be $8.5 million. Because the performance of thetrust created by the December 2003 securitization transaction during its firstsix months was better than anticipated at December 31, 2003, the Companyreceived an additional $1.75 million in July 2004 resulting in a total second up-frontstructural advisory fee payment of $10.25 million. The note was furthercollateralized by the first $6.3 million of residual cash flow from the December 2003securitization as well as $700,000 of restricted cash. The note was paid infull in July 2004.

 

**(7)****                                 Stockholders’Equity**

 

***InitialPublic Offering***

 

In November 2003, an aggregate of14,375,000 shares of the Company’s common stock were sold in an initial publicoffering at a price of $16.00 per share, including:

 

•                  7,906,250shares sold by the Company; and

 

•                  6,468,750shares sold by the Company’s selling stockholders.

 

Net proceeds of the initial public offeringto the Company, after underwriting discounts and offering expenses, wereapproximately $115.1 million. The Company did not receive any of the proceedsfrom the sale of shares by the selling stockholders.

 

***Follow-on Offerings***

 

In June 2004, an aggregate of 7,406,312shares of the Company’s common stock were sold in a follow-on public offeringat a price of $36.50 per share. The Company did not sell any shares in thisoffering and therefore did not receive any proceeds from the sale of stock.Immediately prior to the follow-on offering, employees participating in theoffering exercised options to purchase 2,044,390 shares of common stock whichwere then sold in the offering. The Company received approximately $3.0 millionin the 

 

12

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aggregate in payment of theexercise prices for these options. The Company incurred approximately $1.0million in offering costs related to this offering, which were recorded asgeneral and administrative expenses during the fourth quarter of fiscal 2004.

 

In January 2005, an aggregate of3,933,605 shares of the Company’s common stock were sold in a follow-on publicoffering at a price of $57.40 per share. The Company did not sell any shares inthis offering and therefore did not receive any proceeds from the sale ofstock. Immediately prior to the follow-on offering, an employee participatingin the offering exercised an option to purchase 1,012,980 shares of commonstock which were then sold in the offering. The Company received approximately$1.9 million in payment of the exercise price for this option. The Company incurredapproximately $0.3 million in offering costs related to this offering, which wererecorded as general and administrative expenses during the second and thirdquarter of fiscal 2005.

 

***EquityTransactions***

 

A former executive officer of the Company hadan agreement with two principal stockholders of the Company relating to sharesof common stock of the Company owned by these stockholders. Pursuant to thisagreement, the former executive officer earned non-cash compensation ofapproximately $1.6 million during the first quarter of fiscal 2004. On September 30,2003, the agreement was terminated in exchange for vested options issued bythese two principal stockholders.

 

***AuthorizedShares***

 

On August 10, 2004, the Board of Directorsapproved, and on November 18, 2004 the Company’s stockholders approved, anincrease in the total number of authorized shares of common stock from100,000,000 to 150,000,000. Also, see “Stock Splits” below.

 

***2002 Director Stock Plan***

 

In September 2002, the Board ofDirectors approved, and in August 2003, the Company’s stockholdersapproved, the 2002 Director Stock Plan and reserved 200,000 shares of commonstock for issuance to the Company’s non-employee directors.  As of March 31, 2005, options to purchase64,000 shares of common stock have been issued under this plan.

 

***2003Stock Incentive Plan***

 

In September 2003, the Board ofDirectors and stockholders approved the 2003 Stock Incentive Plan and reserved1,200,000 shares of common stock for issuance under this plan. As of March 31,2005, 79,000 restricted stock units have been granted under this plan.

 

 

***StockSplits***

 

In August 2003, the stockholdersapproved a 10-for-1 stock split which became effective on August 25, 2003.In October 2003, the Board of Directors approved a 4-for-1 stock split tobe effected as a stock dividend immediately prior to the Company’s initialpublic offering. On October 29, 2003, the stockholders became entitled topayment of such stock dividend. All prior period share data have beenretroactively adjusted to reflect these stock splits.

 

***Share Repurchase Program***

 

On April 29, 2005, the Board of Directorsauthorized the repurchase of up to 1,000,000 shares of the Company’s commonstock from time to time on the open market or in privately negotiatedtransactions. The Company has engaged Goldman, Sachs & Co. to administerthe repurchase program, which is funded using its working capital. As of April29, 2005, the Company had begun to repurchase shares pursuant to the repurchaseprogram.

 

***2003Employee Stock Purchase Plan***

 

In October 2003, the Board of Directorsand stockholders approved the 2003 Employee Stock Purchase Plan (Stock PurchasePlan). A total of 400,000 shares of common stock are authorized for issuanceunder this plan. The Stock Purchase Plan permits eligible employees to purchaseshares of common stock at the lower of 85% of the fair market value of the commonstock at the beginning or at the end of each six-month offering period.Employees who own 5% or more of the Company’s common stock are not eligible toparticipate in the Stock Purchase Plan. Participation is voluntary. During July 2004and January 2005, a total of 40,499 and 10,050 shares, respectively, wereissued under the Stock Purchase Plan.

 

13

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# **(8)**                                 Net Income (Loss) per Share

Thefollowing table sets forth our computation of basic and diluted net income (loss)per share of the Company’s stock:
| ** **                                                           | ** ** | **Three  months ended   March 31,**           | ** ** | **Nine  months ended   March 31,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                      | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                 |       | **(in  thousands, except per share amounts)** |       |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Net income (loss)                                                    |       | $                                             | 47,438     |                               | $          | (3,566 | )  | $ | 116,617 |   | $ | 29,995 |   |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Shares used in computing net income per  common share –basic    |       | 65,684                                        |       | 61,856                             |       | 64,871 |   | 58,075 |   |
| Effect of dilutive securities:                                       |       |                                          |       |                               |       |   |   |   |   |
| Stock options                                                        |       | 1,519                                         |       | —                             |       | 2,063 |   | 5,366 |   |
| Restricted stock units                                               |       | 13                                            |       | —                             |       | 3 |   | — |   |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Dilutive potential common shares                                     |       | 1,532                                         |       | —                             |       | 2,066 |   | 5,366 |   |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Shares used in computing net income per  common share – diluted |       | 67,216                                        |       | 61,856                             |       | 66,937 |   | 63,441 |   |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Net income (loss) per common share:                                  |       |                                          |       |                               |       |   |   |   |   |
| Basic                                                                |       | $                                             | 0.72       |                               | $          | (0.06 | )  | $ | 1.80 |   | $ | 0.52 |   |
|                                                                 |       |                                          |       |                               |       |   |   |   |   |
| Diluted                                                              |       | $                                             | 0.71       |                               | $          | (0.06 | )  | $ | 1.74 |   | $ | 0.47 |   |

 

***(9) Pension Plan***

*** ***

FMERhas a non-contributory defined benefit pension plan that covers substantiallyall FMER employees. During the second quarter offiscal 2005, the Company recorded a net curtailment gain of $655,000 as thebenefits under the plan were frozen. The following table sets forth the amountsrecognized related to FMER’s defined benefit pensionplan in the Company’s condensed consolidated financial statements for the threeand nine month periods ended March 31, 2005 and 2004:

 
| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** | **Nine months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**                    | ** ** |
| **Components of net periodic pension cost:**         |       |                                   |       |                                  |       |   |   |   |   |
| Service cost                                         |       | $                                      | —     |                                  | $          | 149 |   | $ | 315 |   | $ | 447 |   |
| Interest on projected benefit obligations            |       | 40                                     |       | 53                                    |       | 163 |   | 158 |   |
| Loss recognized                                      |       | —                                 |       | 17                                    |       | 18 |   | 52 |   |
| Expected return on plan assets                       |       | (50                                    | )          | (34                                   | )          | (134 | ) | (103 | ) |
| Net periodic pension (gain) cost before  curtailment |       | (10                                    | )     | 185                                   |       | 362 |   | 554 |   |
| Curtailment gain                                     |       | —                                 |       | —                                |       | (655 | ) | — |   |
| Net periodic pension (gain) cost                     |       | $                                      | (10        | )                                     | $          | 185 |   | $ | (293 | ) | $ | 554 |   |

 

***Employer Contributions***

 

During thenine months ended March 31, 2005, the Company made contributions of $312,000 toFMER’s defined benefit pension plan. The Company doesnot expect to make any additional contributions during the remainder of fiscal2005.

 

**(10)****                          NewAccounting Pronouncements**

 

On December 16, 2004, the FinancialAccounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment”(Statement 123R), which is a revision of FASBStatement No. 123, “Accounting for Stock-Based Compensation.” Statement 123Rsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” andamends FASB Statement No. 95, “Statement of CashFlows.” Statement 123R requires an entity to measure the cost of employeeservices received in exchange for an award of equity instruments, includingstock options and restricted stock units, based on the grant-date fair value ofthe award, with limited exceptions. That cost will be recognized over theperiod during which the employee is required to provide service in exchange forthe award, which is typically the vesting period. Statement 123R eliminates thealternative to use Opinion 25’s intrinsic value method of accounting for stockoptions that was provided in Statement 123 as originally issued.

 

The Company expects to adopt Statement 123Ron July 1, 2005. Statement 123R permits public companies to adopt itsrequirements using one of two methods:

 

1.                                     A“modified prospective” method in which compensation cost is recognizedbeginning with the effective date (a) based on the requirements of Statement 123Rfor all share-based payments granted after the effective date and (b) based onthe requirements of Statement 123 for all awards granted to employees prior tothe effective date of Statement 123R that remain unvested on the effectivedate.

 

2.                                       A“modified retrospective” method which includes the requirements of the modifiedprospective method described above, but also permits entities to restate theirpreviously issued financial statements to include in their income 

 

14

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statement amounts previously recognized underStatement 123 for purposes of pro forma disclosures for either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.

 

The Company plans to adopt Statement 123R using the modified prospectivemethod.

 

As permittedby Statement 123, the Company currently accounts for share-based payments toemployees using Opinion 25’s intrinsic value method and, as such, generallyrecognizes no compensation cost for employee stock options. The adoption ofStatement 123R’s fair-value method will impact the Company’s results ofoperations, although the impact of adoption of Statement 123R cannot bepredicted at this time because it will depend on levels of share-based paymentsgranted in the future. However, had the Company adopted Statement 123R in priorperiods, the impact of that standard would have had approximately the same impactas Statement 123, as described in the disclosure of pro forma net income andearnings per share in Note 2 to these financial statements. Statement 123R alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption. While the Company cannot estimate what the impact on the cash flowstatement will be in the future (because they depend on, among other things,when employees exercise stock options and the amount of expense recognizedrelated to the value of stock options), the amount of operating cash flowsrecognized in prior periods for such excess tax deductions were $30.4 millionduring the nine months ended March 31, 2005 and $29.9 million during the yearended June 30, 2004.

 

Beginning July 1, 2003, and forsecuritization trusts created after January 31, 2003, the Company applied FASB Interpretation (FIN) No. 46, “Consolidation ofVariable Interest Entities, an interpretation of ARBNo. 51,” in assessing consolidation. FIN No. 46 provided a newframework for identifying variable interest entities and determining when acompany should include the assets, liabilities, non-controlling interests andresults of activities of a variable interest entity in its consolidatedfinancial statements.

 

On December 24, 2003, the FASB issued FIN No. 46 (revised December 2003), “Consolidationof Variable Interest Entities” (FIN No. 46R), which addressed how a businessenterprise should evaluate whether it has a controlling interest in an entitythrough means other than voting rights and accordingly should consolidate theentity.  FIN No. 46R has replaced FIN No.46.  At March 31, 2005, thesecuritization trusts created after January 31, 2003 have either met thecriteria to be a qualified special-purpose entity (QSPE),as defined in paragraph 35 of FASB StatementNo. 140, “Accounting for the Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” or the Company has determined that it isnot the primary beneficiary of the securitization trusts, as defined by FINNo. 46R. Accordingly, the Company did not consolidate these existingsecuritization trusts in these financial statements. In addition, thesecuritization trusts created prior to January 31, 2003 have been amendedin order for them to be considered QSPEs. Theadoption of FIN No. 46R, which the Company began to apply in December 2003,did not have a material impact on the Company’s consolidated financialcondition, results of operations, earnings per share or cash flows.

 

The FASB issued anExposure Draft, “Qualifying Special-Purpose Entities and Isolation ofTransferred Assets—an amendment of FASB StatementNo. 140.” This proposal would, among other things, change the requirementsthat an entity must meet to be considered a QSPE. TheFASB has announced that it expects to issue in the thirdcalendar quarter of 2005 a revised exposure draft that would include all of theproposed amendments to FASB Statement No. 140.  The Company is monitoring the status of this exposuredraft to assess its impact on its consolidated financial statements.

 

**Item 2-Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

*You should read thefollowing discussion and analysis of our financial condition and results ofoperations together with our condensed consolidated financial statements andaccompanying notes included elsewhere in this filing. In addition to thehistorical information, the discussion contains certain forward-looking statementsthat involve risks and uncertainties. Our actual results could differmaterially from those expressed or implied by the forward-looking statementsdue to our critical accounting policies and factors including, but not limitedto, those set forth under “Factors That May Affect Future Results” below.*

 

**Executive Summary**

 

***Overview***

 

We provide outsourcing services for privateeducation lending in the United States. We provide services in connection witheach of the five typical phases of the student loan lifecycle, offering ourclients a single point of interface for:

 

**•**                  programdesign and marketing;

 

**•**                  borrowerinquiry and application;

 

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**•**                  loanorigination and disbursement;

 

**•**                  loansecuritization; and

 

**•**                  loanservicing.

 

We receive fees for the services we provide in connection with bothprocessing our clients’ private student loans and structuring and administeringsecuritizations of those loans. Securitization refers to the technique ofpooling loans and selling them to a special purpose, bankruptcy remote entity,typically a trust, which issues securities to investors backed by those loans.

 

We do not take a direct ownership interest inthe loans our clients generate, nor do we serve as a lender or guarantor withrespect to any loan programs that we facilitate. We assist the lenders in ourloan programs in selecting the underwriting criteria used in deciding whether astudent loan will be made to an applicant. However, each lender has ultimatecontrol over the selection of these criteria, and in providing our services, weare obligated by contract to observe them. Lenders who wish to have their loansguaranteed by The Education Resources Institute, or TERI, are required to meetTERI’s underwriting criteria. Although we oversee loan servicing as a componentof our administrative duties, we do not act as a loan servicer.

 

We currently focus on facilitating privatestudent loans for undergraduate, graduate and professional education, althoughwe also provide service offerings for continuing education programs, primaryand secondary schools, career training and study abroad programs. During thefirst nine months of fiscal 2005, we processed approximately 678,000 loanapplications and facilitated $2.2 billion in loans at over 5,100 schools.During fiscal 2004, we processed over 560,000 loan applications and facilitated$1.8 billion in loans at over 4,800 schools. We have provided structural,advisory and other services for 24 securitization transactions since ourformation in 1991.

 

We offer services in connection with twoprimary loan products:

 

*Private label* programs that:

 

**•**                  lendersmarket directly to prospective student borrowers and their families;

 

**•**                  lendersmarket directly to educational institutions;

 

**•**                  thirdparties who are not themselves lenders design and market directly toprospective student borrowers and their families; loans under these programsare made by referral lenders;

 

**•**                  thirdparties who are not themselves lenders design and market directly toeducational institutions; loans under these

programs are made by referral lenders; and

 

**•**                  businesses,unions, affinity groups and other organizations offer to their employees ormembers.

 

*Guaranteed Access to Education*,or *GATE*, programs that educationalinstitutions offer directly to their students.

 

During fiscal 2004, we securitized bothprivate label loans and GATE loans. During the first nine months of fiscal2005, we facilitated two securitization transactions of private label loans. Weexpect to securitize GATE loans, including those we have facilitated during thefirst nine months of our current fiscal year, in the fourth fiscal quarter. Duringfiscal 2004, our private label programs, including the processing fees fromTERI, contributed $191.1 million, or 96%, of our total service revenue, whileour GATE programs contributed $8.2 million, or 4%, of our total servicerevenue.

 

In June 2001, we significantly enhanced our riskmanagement and loan processing capabilities through a strategic relationshipwith TERI, the nation’s oldest and largest guarantor of private student loans.We acquired TERI’s loan processing operations, including its historicaldatabase, but not its investment assets or guarantee liabilities. In connectionwith this acquisition, 161 members of TERI’s staff became our employees. Inaddition, we entered into a master servicing agreement pursuant to which TERIengages us to provide loan origination and processing services with respect tothe loans generated through the private label programs we facilitate, as wellas other TERI-guaranteed loans. TERI reimburses us for the expenses we incur inproviding these services. Under the terms of a master loan guaranty agreementthat we entered into with TERI in 2001, we also agreed to provide a beneficialinterest for TERI of 25% of the residual value of TERI-guaranteed loans ownedby the securitization trusts that purchase the loans, and a right of firstrefusal to guarantee our private label clients’ existing and future loanprograms. In October 2004, we renewed our master servicing agreement,master loan guaranty agreement and certain additional agreements with TERI, ineach case for an additional term through June 2011.  In addition, we entered into a supplement tothe master loan guaranty agreement, under 

 

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which we granted to TERI aright to elect once each fiscal year to increase the amount of itsadministration fees by 25 basis points, with a corresponding reductionfrom 25% to 20% in TERI’s ownership of the residual value of theTERI-guaranteed loans purchased during that year by the securitization trustsand a resulting increase from 75% to 80% in our residual ownership.  TERI has made such an election for the fiscalyear ending June 30, 2005.

 

The primary driver of our results ofoperations and financial condition is the volume of loans for which we provideoutsourcing services from loan origination through securitization. Wefacilitated the securitization of $1.25 billion of student loans duringfiscal 2004, up from $560 million during fiscal 2003.

 

The following table shows the volume of loansfacilitated during the first nine months of fiscal 2005 and 2004, and duringfiscal 2004:

 
| ** **                                                                                               | ** ** | **Nine months ended March 31,** | ** ** | **Year ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| ** **                                                                                               | ** ** | **2005**                        | ** ** | **2004**                | ** ** | **2004** | ** ** |
| Approximate number of loans facilitated                                                                  |       | 255,000                         |       | 166,000                 |       | 200,000 |   |
| Aggregate principal amount of loans  facilitated                                                         |       | $2.2 billion                    |       | $1.5 billion            |       | $1.8 billion |   |
| Aggregate principal amount of loans  facilitated above that were also available to us for securitization |       | $1.8 billion                    |       | $1.1 billion            |       | $1.4 billion |   |

 

The dollar volume of the loans that wefacilitated in the first nine months of fiscal 2005 increased 52% as comparedto the first nine months of fiscal 2004. The loans that we facilitated that wereavailable to us for securitization increased 62% in the first nine months offiscal 2005 as compared to the first nine months of fiscal 2004.

 

Although we offer our clients a fullyintegrated suite of outsourcing services, we do not charge separate fees formany of these services. Moreover, although we receive fees for providing loanprocessing services to TERI in connection with TERI-guaranteed loans, thesefees represent reimbursement of the direct expenses we incur. Accordingly, we donot earn a profit on these fees. Although we provide these various serviceswithout charging a separate fee, or at “cost” in the case of TERI-guaranteedloans, we generally enter into agreements with the private label lenders, andBank of America, N.A. in the case of GATE programs, giving us the exclusiveright to securitize the loans that they do not intend to hold, and we receivestructural advisory fees and residuals for facilitating securitizations ofthese loans. Our level of profitability depends on these structural advisoryfees and residuals. We discuss the manner in which we recognize them as revenuein greater detail below. We may in the future enter into arrangements withprivate label lenders under which we provide outsourcing services, but do nothave the exclusive right to securitize the loans that they originate.

 

Changes in any of the following factors canmaterially affect our financial results:

 

**•**                  thedemand for private education financing;

 

 

**•**                  thecompetition for providing private education financing;

 

**•**                  theeducation financing preferences of students and their families;

 

•                  applicablelaws and regulations, which may affect the terms upon which our clients agreeto make private student loans and the cost and complexity of our loan facilitationoperations;

 

**•**                  theprivate student loan securitization market, including the costs or availabilityof financing;

 

**•**                  the general interest rate environment,including its effect on our discount rates;

 

**•**                  ourcritical accounting policies and estimates;

 

**•**                  borrowerdefault rates and our ability to recover principal and interest from suchborrowers; and

 

**•**                  prepaymentrates on private student loans, including prepayments through loanconsolidation.

 

***Securitizations andRelated Revenue***

 

We structure and facilitate securitizationtransactions for our clients through a series of bankruptcy remote, qualifiedspecial 

 

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purpose statutory trusts. Thetrusts purchase private student loans from the originating lenders, whichrelinquish to the trust their ownership interest in the loans. The debtinstruments that the trusts issue to finance the purchase of these studentloans are obligations of the trusts, rather than our obligations or those oforiginating lenders. As of March 31, 2005, we have utilized the followingspecial purpose entities for the securitizations we have structured:

 

**•**                  *The National Collegiate Student Loan Trust 2005-1*,or *NCSLT**2005-1*, was formed in February 2005 topurchase exclusively TERI-guaranteed private label loans.

 

**•**                  *The National Collegiate Student Loan Trust 2004-2*,or *NCSLT**2004-2*, was formed in October 2004to purchase exclusively TERI-guaranteed private label loans.

 

**•**                  *The National Collegiate Student Loan Trust 2004-1*,or *NCSLT**2004-1*, was formed in May 2004 topurchase exclusively TERI-guaranteed private label loans.

 

**•**                  *The National Collegiate Student Loan Trust 2003-1*,or *NCSLT**2003*, was formed in December 2003 topurchase exclusively TERI-guaranteed private label loans.

 

**•**                  *The National Collegiate Master Student Loan Trust I*,or *NCMSLT*,was formed in November 2001 to purchase exclusively TERI-guaranteed privatelabel loans.

 

**•**                  *The National Collegiate Trust*, or *NCT*, was formed in fiscal 1993 and hasestablished separate securitization trusts, which we refer to as the NCTtrusts, that have purchased primarily GATE loans and a limited number ofTERI-guaranteed and other loans.

 

In the future, we may securitize privatelabel or GATE loans using new trust vehicles.

 

Under the terms of some of our contracts withkey lender clients, we have an obligation to securitize periodically, typicallytwice per year, the private student loans that these clients originate, and wemay agree with other lenders to securitize more frequently in the future. If wedo not honor our obligations to these lenders, we may be required to payliquidated damages, generally not exceeding an amount equal to 1% of the faceamount of the loans available for securitization.

 

We receive several types of fees inconnection with our securitization services:

 

*Structural advisory fees*.  We charge structural advisory fees that arepaid in two portions:

 

**•**                  *Up-front*. We receive a portion of the structural advisory fees at the time thesecuritization trust purchases the loans, or soon thereafter. For these fees,we structure the securities sold in the securitization, coordinate theattorneys, accountants, trustees, loan servicers, loan originators and othertransaction participants and prepare the cash flow modeling for rating agenciesand financial guarantee insurers, as needed. In securitizations we facilitatedin fiscal

2005 and 2004, these fees have ranged from 5.6%to 8.1% of the principal and accrued interest of the loans securitized; and

 

**•**                  *Additional*.  We receive a portion of the structuraladvisory fees over time, based on the amount of loans outstanding in the trustfrom time to time over the life of the trust. This portion accumulates monthlyfrom the date of a securitization transaction at a rate of 15 basis pointsper year. We begin to receive this additional portion, plus interest, once theratio of trust assets to trust liabilities, which we refer to as the “parityratio,” reaches a stipulated

level, which ranges from 103.0% to 105.0%.The level applicable to a particular trust is determined at securitization. Wecurrently expect to receive the additional fees beginning five to seven yearsafter the date of a particular securitization transaction.

 

*Residuals*.  We also have the right to receive a portionof the residual interests that these trusts create. This interest is junior inpriority to the rights of the holders of the debt sold in the securitizationsand entitles us to receive:

 

**•**                  inconnection with the securitizations in NCSLT 2005-1and NCSLT 2004-2, 80% of the residual cash flows oncea parity ratio of 103.0% is reached and maintained;

 

**•**                  inconnection with the securitizations in NCSLT 2004-1and NCSLT 2003, 75% of the residual cash flows once aparity ratio of 103.0% is reached and maintained;

 

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**•**                  inconnection with securitizations in NCMSLT, 75% of theresidual cash flows once a parity ratio of 103.5% is reached and maintained;and

 

**•**                  inconnection with securitizations in the NCT trusts, our share of residual cashflows once all of the debtholders of thesecuritization trust have been repaid, plus, in the case of securitized GATEloans, an additional 10% of the residual cash flows.

 

Our residual interest derives almostexclusively from the services we perform in connection with each securitizationrather than from a direct cash contribution to the securitization trust. Inconnection with the three most recent securitizations of GATE loans in the NCTtrusts, in order to accommodate a limited number of schools, we invested in theaggregate approximately one-third of our GATE-related up-front structuraladvisory fees to eliminate the risk exposure of those schools. Theseinvestments, which reduced our up-front structural advisory fees that wouldhave been recognized in these periods, totaled $1.3 million,$2.0 million and $1.8 million in fiscal 2004, 2003 and 2002,respectively. In fiscal 2004, our investment comprised 1.5% of our totalup-front structural advisory fees. In exchange for these investments, wereceived the rights to the residual interest that these schools would otherwisehold in the trust and accounted for these rights as residuals, consistent withthe manner in which we account for our other residuals. The value of these residualinterests is primarily affected by the loan performance at each school. In thecase of securitizations in NCSLT 2005-1, NCSLT 2004-2, NCSLT 2004-1, NCSLT 2003 and NCMSLT, wecurrently expect to receive the residuals beginning approximately five to sixyears after the date of a particular securitization. In the case ofsecuritizations in the NCT trusts, we currently expect to receive the residualsbeginning 12 to 15 years after the date of a particular securitization.

 

*Administrative and other fees*.  Our administrative and other fees representprimarily the administrative fees we receive from the trusts for their dailymanagement and for the services we provide in obtaining information from theloan servicers and reporting this and other information to the parties relatedto the securitization. We receive fees ranging from 5 to 20 basis pointsper year of the student loan balance in the trust. In addition, in connectionwith some securitizations, we receive other fees from originating lenders whentheir loans are purchased by the securitization trust, although these fees havenot been material and we do not expect them to be material in the future. Wealso record as administrative and other fees the reimbursement we receive forcertain call center costs. These fees were approximately $0.5 million and $0.2million for the first nine months of fiscal 2005 and fiscal 2004, respectively.The increase in these fees is primarily due to the increase in loanfacilitations.

 

***Processing Fees fromTERI***

 

We provide outsourcing services to TERI,including loan origination, customer service, default prevention, defaultprocessing and administrative services under a master servicing agreementbetween TERI and us. We recognize as revenue the monthly reimbursement thatTERI provides us for the expenses we incur in providing these services.

 

***Recognition andValuation of Service Revenue***

 

We recognize up-front structural advisoryfees as revenue at the time the securitization trust purchases the loans. Inorder for the securitization trust to purchase the loans, all of the applicableservices must be performed, rating agencies must deliver their ratings letters,transaction counsel must deliver the required legal opinions and theunderwriters must receive the debt securities created by the securitizationtrust. These events indicate that the securitization transaction has beenproperly structured and loans have been properly sold to the securitizationtrust.

 

As required under accounting principlesgenerally accepted in the United States, or GAAP, wealso recognize additional structural advisory fees and residuals as revenue atthat time, as they are deemed to be earned at the time of the securitizationand before we actually receive payment. These amounts are deemed earned becauseevidence of an arrangement exists, we have provided the services, the fee isfixed and determinable based upon a discounted cash flow analysis, there are nofuture contingencies or obligations and collection is reasonably assured. Weestimate the present value of the additional structural advisory fees andresiduals based on certain assumptions we make about the timing and amount ofpayment.

 

We are required to measure the additionalstructural advisory fees and residuals like investments in debt securitiesclassified as available-for-sale or trading, similar to retained interests insecuritizations. Accordingly, we record additional structural advisory fees andresiduals receivables on our balance sheet at fair value using a discountedcash flow model. We estimate the fair value both initially and at eachsubsequent quarter and reflect the change in value in earnings for that period.

 

Because there are no quoted market prices forour additional structural advisory fees and residuals receivables, we usecertain key assumptions to estimate their values. See “Application of CriticalAccounting Policies and Estimates—Service Revenue.”

 

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We recognize administrative and other fees,as well as processing fees from TERI, as revenue at the time that we performthe underlying services.

 

***QuarterlyFluctuations***

 

Our quarterly revenue, operating results andprofitability have varied and are expected to continue to vary on a quarterlybasis primarily because of the timing of the securitizations that we structure.In fiscal 2004, we facilitated one securitization in the second quarter and twosecuritizations in the fourth quarter, but none in the first or third quarters.Thus far in fiscal 2005, we have facilitated one securitization in the secondquarter and one securitization in the third quarter, and we expect to close twoadditional securitization transactions in the fourth quarter of fiscal 2005.The following tables set forth our quarterly service revenue and net income(loss) for each of the first, second and third quarters of fiscal 2005 and foreach of the quarters of fiscal 2004:

 
| ** **        | ** ** | **2005 fiscal quarter** | ** ** |
|-------------------|------------|-------------------------|------------|
| ** **        | ** ** | **First**               | ** ** | **Second** | ** ** | **Third** | ** ** |
| ** **        | ** ** | **(in thousands)**      | ** ** |
| Service revenue   |       | $                       | 22,404     |   | $ | 155,837 |   | $ | 119,534 |   |
| Net income (loss) |       | (5,352                  | )          | 74,530 |   | 47,438 |   |
|                   |            |                         |            |  |  |  |  |  |  |  |

 
| ** **        | ** ** | **2004 fiscal quarter** | ** ** |
|-------------------|------------|-------------------------|------------|
| ** **        | ** ** | **First**               | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **        | ** ** | **(in thousands)**      | ** ** |
| Service revenue   |       | $                       | 9,469      |   | $ | 77,523 |   | $ | 11,127 |   | $ | 101,141 |   |
| Net income (loss) |       | (3,077                  | )          | 36,639 |   | (3,566 | ) | 45,276 |   |
|                   |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

***Application ofCritical Accounting Policies and Estimates***

 

Our consolidated financial statements havebeen prepared in accordance with accounting principles GAAP.The preparation of these financial statements requires us to make estimates,assumptions and judgments that affect the reported amounts of assets and liabilitiesand the reported amounts of income and expenses during the reporting periods.We base our estimates, assumptions and judgments on historical experience andon various other factors that we believe are reasonable under thecircumstances. Actual results may differ from these estimates under varyingassumptions or conditions.

 

Our significant accounting policies are morefully described in Note 2 of the notes to the audited consolidated financialstatements for the year ended June 30, 2004, which are included in our annualreport on Form 10-K filed with the Securities and Exchange Commission on September15, 2004. On an ongoing basis, we evaluate our estimates and judgments,particularly as they relate to accounting policies that we believe are mostimportant to the portrayal of our financial condition and results ofoperations.

We regard an accountingestimate or assumption underlying our financial statements to be a “criticalaccounting estimate” where:

 

**•**                  thenature of the estimate or assumption is material due to the level ofsubjectivity and judgment necessary to account for highly uncertain matters orthe susceptibility of such matters to change; and

 

**•**                  theimpact of the estimates and assumptions on our financial condition or operatingperformance is material.

 

We have discussed our accounting policieswith the audit committee of our Board of Directors, and we believe that ourestimates relating to the recognition and valuation of oursecuritization-related revenue, as described below, fit the definition ofcritical accounting estimates.  Inaddition, as described under the caption “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in our annual reporton Form 10-K for the fiscal year ended June 30, 2004, we consider our policywith respect to the determination of whether or not to consolidate thesecuritization trusts that we facilitate to be a critical accounting policy.

 

***Service Revenue***

 

For a discussion of our revenue recognitionpolicies, see “—Recognition and Valuation of Service Revenue.”

 

Because there are no quoted market prices forour additional structural advisory fees and residuals receivables, we use thefollowing key assumptions to estimate their values:

 

**•**                  thediscount rate, which we use to calculate the present value of our additionalstructural advisory fees and residuals;

 

**•**                  theannual compound rate of student loan prepayments, which we refer to as theconstant prepayment rate, or CPR;

 

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**•**                  thetrend of interest rates over the life of the loan pool, including the forwardLondon Interbank Offered Rate, or LIBOR, and thespread between LIBOR and auction rates; and

 

**•**                  expecteddefaults, net of recoveries.

 

We base these estimates on our proprietaryhistorical data, third-party data and our industry experience, adjusting forspecific program and borrower characteristics such as loan type and borrowercreditworthiness. We analyze creditworthiness in several tiers, and selectappropriate loan performance assumptions based on these tiers. We also monitortrends in loan performance over time, and make adjustments we believe arenecessary to value properly our receivables balances. We recognize the revenueassociated with our processing fees from TERI and our administrative and otherfees as we perform these services.

 

The following table shows the loanperformance assumptions for the life of each trust at March 31, 2005:

 
| ** **   | ** ** | ** **     | ** ** | **Percentage rate** | ** ** | **Discount rate** | ** ** |
|--------------|------------|----------------|------------|---------------------|------------|-------------------|------------|
| **Trust**    | ** ** | **Loan type**  | ** ** | **Default**         | ** ** | **Recovery**      | ** ** | **CPR** | ** ** | **Structural advisory fees** | ** ** | **Residuals** | ** ** |
| NCSLT 2005-1 |       | Private  label |       | 8.62                | %          | 40                | %          | 7 | % | 6.51 | % | 12 | % |
| NCSLT 2004-2 |       | Private  label |       | 9.12                |       | 40                |       | 7 |   | 6.51 |   | 12 |   |
| NCSLT 2004-1 |       | Private  label |       | 8.76                |       | 40                |       | 7 |   | 6.51 |   | 12 |   |
| NCSLT 2003   |       | Private  label |       | 9.06                |       | 40                |       | 7 |   | 6.51 |   | 12 |   |
| NCMSLT       |       | Private  label |       | 8.08                |       | 40                |       | 7 |   | 6.51 |   | 12 |   |
| NCT trusts   |       | Private  label |       | 7.11                |       | 46                |       | 7 |   | 6.51 |   | 12 |   |
| NCT trusts   |       | GATE           |       | 23.23               |       | 47                |       | 4 |   | 6.51 |   | 12 |   |

 

Our private label loan programs, under whichapproximately 80% of the borrowers have creditworthy co-borrowers, typically afamily member, have an extensive credit underwriting process. In fiscal 2003,some of our private label clients introduced a new product line which includesco-signed loans for which the co-signer has a Fair, Isaac and Company, or FICO,credit score that is lower than the FICO score required for our other tieredproducts. We have worked in consultation with TERI and our bank clients tostructure and price this loan product to reflect its increased default risk,and we have taken the increased default risk and the loan mix into account inestimating our private label loan performance assumptions. GATE programs had aborrower approval rate of approximately 95% in fiscal 2004 as a result of thecredit support provided by the participating schools. Accordingly, we believethat borrowers in our private label programs will prepay at a higher rate anddefault at a lower rate than borrowers in our GATE programs.

 

At March 31, 2005, we used a 6.51% discountrate for valuing structural advisory fees, as compared to a 6.58% discount rateat June 30, 2004. Based on the priority payment status of structuraladvisory fees in the flow of funds out of the securitization trust, we believethese fees are comparable to 10 year spreads on triple-B rated structuredfinance and corporate debt securities. Based on market quotes on suchsecurities, we believe a spread over comparable maturity U.S. Treasury Notes of200 basis points is an appropriate discount rate in valuing theseprojected cash flows. 

 

To our knowledge, there have been no markettransactions to determine the market price of residuals generated by a pool ofsecuritized student loans. In determining an appropriate discount rate forvaluing residuals, we review the rates used by student loan securitizersas well as rates used in the much broader asset-backed securities, or ABS,market. We believe that the 12% discount rate we use is appropriate given themaximum 24-year life of the trust assets and residuals.

 

Two trusts, NCMSLTand NCSLT 2003, have issued senior auction ratenotes. At March 31, 2005, we used a 10 basis point spread over LIBOR to projectthe future cost of funding of the senior auction rate notes in the trusts. Sinceinception of the NCMSLT, the average spread overLIBOR for the senior auction rate notes of that trust has been 8.5 basis points.Since the inception of NCSLT 2003, the average spreadover LIBOR for the senior auction rate notes of that trust has been 9.7 basis points.

 

Other than changes in the discount rate to beapplied to structural advisory fees, we did not change any other loanperformance assumptions regarding default rates, recovery rates, CPR rates ordiscount rates in valuing these projected cash flows during the first ninemonths of fiscal 2005.

 

*Sensitivity analysis*

 

Increases in our estimates of defaults,prepayments and discount rates, increases in the spread between LIBOR andauction rates, as well as decreases in default recovery rates and themulti-year forward estimates of LIBOR would have a negative effect on the valueof our additional structural advisory fees and residuals. Student loanprepayments include either full or partial payments by a borrower in advance ofthe maturity schedule specified in the note, including payments as aresult of loan consolidation activity. Because essentially all credit defaultsare reimbursable by third parties, increases in defaults generally have thesame effect as increases in prepayments. If defaults increase beyond the levelof expected third party reimbursement, then these changes will have an 

 

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additional negative effect onthe value of our additional structural advisory fees and residuals. Forpurposes of this sensitivity analysis, we have assumed no amounts in excess ofthe pledge fund established at the time of each securitization of private labelloans are available to reimburse the trust for defaults. Also, in the case ofsecuritizations of GATE loans in which we have invested a portion of ourup-front structural advisory fees, increases in estimates of defaults wouldreduce the value of our residual interests because amounts that we wouldotherwise receive as residual interests would be applied to the defaults. LIBORis the reference rate for the loan assets and, we believe, a reasonable indexfor borrowings of the trusts. Because the trusts’ student loan assets earninterest based on LIBOR and some trusts have outstanding securities that payinterest based on the results of auction rates, changes in the spread betweenLIBOR and the auction rate can affect the performance of the trust.

 

The following tables show the estimatedchange in our structural advisory fees and residuals receivables balances at March31, 2005 based on changes in these loan performance assumptions:

 
| ** **                             | ** ** | **Percentage change in assumptions** | ** ** | **Receivables balance**    | ** ** | **Percentage change in assumptions** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|--------------------------------------|------------|
| **Structural advisory fees**           | ** ** | **Down 20%**                         | ** ** | **Down 10%**               | ** ** | ** **                           | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                             | ** ** | ** **                           | ** ** | **(dollars in thousands)** | ** ** | ** **                           | ** ** |
| Default rate:                          |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 37,999     |                       | $          | 37,869                               |       | $ | 37,737 |   | $ | 37,605 |   | $ | 37,473 |   |
| GATE loan trusts(1)                    |       | 5,195                                |       | 5,112                      |       | 5,030                                |       | 4,948 |   | 4,865 |   |
| Total                                  |       | $                                    | 43,194     |                       | $          | 42,981                               |       | $ | 42,767 |   | $ | 42,553 |   | $ | 42,338 |   |
| Change in receivables balance:         |       | 1.00                                 | %          | 0.50                       | %          |                                 |       | (0.50 | )% | (1.00 | )% |
| Default recovery rate:                 |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 37,737     |                       | $          | 37,737                               |       | $ | 37,737 |   | $ | 37,737 |   | $ | 37,737 |   |
| GATE loan trusts(1)                    |       | 4,900                                |       | 4,900                      |       | 5,030                                |       | 5,030 |   | 5,172 |   |
| Total                                  |       | $                                    | 42,637     |                       | $          | 42,637                               |       | $ | 42,767 |   | $ | 42,767 |   | $ | 42,909 |   |
| Change in receivables balance:         |       | (0.31                                | )%         | (0.31                      | )%         |                                 |       | 0.00 | % | 0.33 | % |
| Annual constant prepayment rate (CPR): |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 39,849     |                       | $          | 38,764                               |       | $ | 37,737 |   | $ | 36,764 |   | $ | 35,844 |   |
| GATE loan trusts(1)                    |       | 5,240                                |       | 5,134                      |       | 5,030                                |       | 4,929 |   | 4,831 |   |
| Total                                  |       | $                                    | 45,089     |                       | $          | 43,898                               |       | $ | 42,767 |   | $ | 41,693 |   | $ | 40,675 |   |
| Change in receivables balance:         |       | 5.43                                 | %          | 2.64                       | %          |                                 |       | (2.51 | )% | (4.89 | )% |
| Discount rate:                         |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 40,896     |                       | $          | 39,275                               |       | $ | 37,737 |   | $ | 36,277 |   | $ | 34,890 |   |
| GATE loan trusts(1)                    |       | 5,420                                |       | 5,220                      |       | 5,030                                |       | 4,848 |   | 4,670 |   |
| Total                                  |       | $                                    | 46,316     |                       | $          | 44,495                               |       | $ | 42,767 |   | $ | 41,125 |   | $ | 39,560 |   |
| Change in receivables balance:         |       | 8.30                                 | %          | 4.04                       | %          |                                 |       | (3.84 | )% | (7.50 | )% |
|                                        |            |                                      |            |                            |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                     | ** ** | **Change in assumption**       | ** ** | **Receivables balance**        | ** ** | **Change in assumption** | ** **                   |
|--------------------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------------|------------------------------|
| **Structural advisory fees**   | ** ** | **Down 200 basis points** | ** ** | **Down 100 basis points** | ** ** | ** **               | **Up 100 basis points** | ** ** | **Up 200 basis points** | ** ** |
| ** **                     | ** ** | ** **                     | ** ** | **(dollars in thousands)**     | ** ** | ** **               | ** **                   |
| Forward LIBOR rates:           |       |                           |       |                           |       |                     |                         |   |   |   |   |
| Private label loan trusts      |       | $                              | 35,179     |                           | $          | 36,447                   |                         | $ | 37,737 |   | $ | 39,047 |   | $ | 40,385 |   |
| GATE loan trusts(1)            |       | 4,705                          |       | 4,831                          |       | 5,030                    |                         | 5,102 |   | 5,312 |   |
| Total                          |       | $                              | 39,884     |                           | $          | 41,278                   |                         | $ | 42,767 |   | $ | 44,149 |   | $ | 45,697 |   |
| Change in receivables balance: |       | (6.74                          | )%         | (3.48                          | )%         |                     |                         | 3.23 | % | 6.85 | % |

 

----

(1)                                  GATEloan trusts include approximately $367.9 million of GATE loans and $40.6million of TERI-guaranteed loans.

 

 

22

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| ** **                             | ** ** | **Percentage change in assumptions** | ** ** | **Receivables balance**    | ** ** | **Percentage change in assumptions** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|--------------------------------------|------------|
| **Residuals**                          | ** ** | **Down 20%**                         | ** ** | **Down 10%**               | ** ** | ** **                           | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                             | ** ** | ** **                           | ** ** | **(dollars in thousands)** | ** ** | ** **                           | ** ** |
| Default rate:                          |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 208,322    |                       | $          | 206,934                              |       | $ | 205,473 |   | $ | 203,352 |   | $ | 199,757 |   |
| GATE loan trusts(1)                    |       | 4,476                                |       | 4,672                      |       | 4,859                                |       | 5,043 |   | 4,959 |   |
| Total                                  |       | $                                    | 212,798    |                       | $          | 211,606                              |       | $ | 210,332 |   | $ | 208,395 |   | $ | 204,716 |   |
| Change in receivables balance:         |       | 1.17                                 | %          | 0.61                       | %          |                                 |       | (0.92 | )% | (2.67 | )% |
| Default recovery rate:                 |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 204,927    |                       | $          | 205,319                              |       | $ | 205,473 |   | $ | 205,558 |   | $ | 205,573 |   |
| GATE loan trusts(1)                    |       | 4,125                                |       | 4,484                      |       | 4,859                                |       | 5,236 |   | 5,290 |   |
| Total                                  |       | $                                    | 209,052    |                       | $          | 209,803                              |       | $ | 210,332 |   | $ | 210,794 |   | $ | 210,863 |   |
| Change in receivables balance:         |       | (0.61                                | )%         | (0.25                      | )%         |                                 |       | 0.22 | % | 0.25 | % |
| Annual constant prepayment rate (CPR): |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 226,520    |                       | $          | 215,742                              |       | $ | 205,473 |   | $ | 195,674 |   | $ | 186,326 |   |
| GATE loan trusts(1)                    |       | 5,065                                |       | 4,960                      |       | 4,859                                |       | 4,756 |   | 4,657 |   |
| Total                                  |       | $                                    | 231,585    |                       | $          | 220,702                              |       | $ | 210,332 |   | $ | 200,430 |   | $ | 190,983 |   |
| Change in receivables balance:         |       | 10.10                                | %          | 4.93                       | %          |                                 |       | (4.71 | )% | (9.20 | )% |
| Discount rate:                         |       |                                 |       |                       |       |                                 |       |   |   |   |   |
| Private label loan trusts              |       | $                                    | 248,711    |                       | $          | 225,849                              |       | $ | 205,473 |   | $ | 187,271 |   | $ | 170,974 |   |
| GATE loan trusts(1)                    |       | 6,528                                |       | 5,628                      |       | 4,859                                |       | 4,160 |   | 3,628 |   |
| Total                                  |       | $                                    | 255,239    |                       | $          | 231,477                              |       | $ | 210,332 |   | $ | 191,431 |   | $ | 174,602 |   |
| Change in receivables balance:         |       | 21.35                                | %          | 10.05                      | %          |                                 |       | (8.99 | )% | (16.99 | )% |
|                                        |            |                                      |            |                            |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                     | ** ** | **Change in assumption**        | ** ** | **Receivables balance**         | ** ** | **Change in assumption** | ** **                    |
|--------------------------------|------------|---------------------------------|------------|---------------------------------|------------|--------------------------|-------------------------------|
| **Residuals**                  | ** ** | **Down 200  basis points** | ** ** | **Down 100  basis points** | ** ** | ** **               | **Up 100  basis points** | ** ** | **Up 200  basis points** | ** ** |
| ** **                     | ** ** | ** **                      | ** ** | **(dollars in thousands)**      | ** ** | ** **               | ** **                    |
| Forward LIBOR rates:           |       |                            |       |                            |       |                     |                          |   |   |   |   |
| Private label loan trusts      |       | $                               | 188,628    |                            | $          | 197,080                  |                          | $ | 205,473 |   | $ | 213,766 |   | $ | 221,946 |   |
| GATE loan trusts(1)            |       | 4,420                           |       | 4,605                           |       | 4,859                    |                          | 5,087 |   | 5,232 |   |
| Total                          |       | $                               | 193,048    |                            | $          | 201,685                  |                          | $ | 210,332 |   | $ | 218,853 |   | $ | 227,178 |   |
| Change in receivables balance: |       | (8.22                           | )%         | (4.11                           | )%         |                     |                          | 4.05 | % | 8.01 | % |

 
| ** **                                                 | ** ** | **Percentage change in assumptions** | ** ** | **Receivables balance**          | ** ** | **Percentage change in assumptions** | ** **                     |
|------------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|--------------------------------------|--------------------------------|
| **Residuals**                                              | ** ** | **Tighten 10  basis points**    | ** ** | **Tighten 5  basis points** | ** ** | ** **                           | **Widen 5  basis points** | ** ** | **Widen 10  basis points** | ** ** |
| ** **                                                 | ** ** | ** **                           | ** ** | **(dollars in thousands)**       | ** ** | ** **                           | ** **                     |
| Change in assumed spread between LIBOR and  auction rates: |       |                                 |       |                             |       |                                 |                           |   |   |   |   |
| Private label loan trusts                                  |       | $                                    | 209,159    |                             | $          | 207,316                              |                           | $ | 205,473 |   | $ | 203,633 |   | $ | 201,793 |   |
| GATE loan trusts(1)                                        |       | 4,858                                |       | 4,858                            |       | 4,859                                |                           | 4,858 |   | 4,858 |   |
| Total                                                      |       | $                                    | 214,017    |                             | $          | 212,174                              |                           | $ | 210,332 |   | $ | 208,491 |   | $ | 206,651 |   |
| Change in receivables balance:                             |       | 1.75                                 | %          | 0.88                             | %          |                                 |                           | (0.88 | )% | (1.75 | )% |

 

----

(1)                                  GATEloan trusts include approximately $367.9 million of GATE loans and $40.6million of TERI-guaranteed loans.

 

Thesesensitivities are hypothetical and should be used with caution. The effect ofeach change in assumption must be calculated independently, holding all otherassumptions constant. Because the key assumptions may not in fact beindependent, the net effect of simultaneous adverse changes in key assumptionsmay differ from the sum of the individual effects above.

 

**Recent Development**

 

On April 29, 2005, we announced that ourBoard of Directors had authorized the repurchase of up to 1,000,000 shares ofour common stock from time to time on the open market or in privatelynegotiated transactions. We have engaged Goldman, Sachs & Co. to administerthe repurchase program, which is funded using our working capital. As of April29, 2005, we had begun to repurchase shares pursuant to the repurchase program.

 

**Results of Operations**

 

***Three and ninemonths ended March 31, 2005 and 2004***

 

***Revenue Related toSecuritization Transactions***

 

The following table sets forth for the first nine months of fiscal year2005 and 2004 (by dollar amount and as a percentage of the total volume ofloans securitized):

 

•                                          thetotal volume of loans securitized by loan type and the securitization-relatedservice revenue components, other than administrative and other fees; and

 

23

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•                                          updatesto reflect any fair value adjustment to additional structural advisory fees andresiduals for prior trusts.

 

                Duringthe three months ended March 31, 2005, we securitized $715 million of privatestudent loans, which generated $93.4 million in securitization-relatedrevenue.  We did not conduct asecuritization transaction in the third quarter of fiscal 2004 and thereforedid not generate any up-front structural advisory fees, additional structuraladvisory fees or residual fee revenues from new securitization transactionsduring that period.

 

 
| **First nine months of fiscal year:** | ** ** | **Total volume of loans securitized(1)** | ** ** | **Up-front structural advisory  fees** | ** ** | **Additional structural advisory fees** | ** ** | **Total structural advisory fees** | ** ** | **Residuals** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------|------------|------------------------------------|------------|---------------|------------|
| ** **                                      | ** ** | **(dollars in thousands)**               | ** ** |
| 2005                                            |       |                                     |       |                                   |       |                                         |       |                               |       |          |       |   |   |   |   |   |   |
| Private  label loans                            |       | $                                        | 1,522,254  |                                   | $          | 119,095                                      |       | 7.8                                | %          | $             | 17,901     |   | 1.2 | % | $ | 136,996 |   | $ | 88,402 |   | 5.8 | % |
| Trust  updates (2)                              |       | —                                   |       | —                                 |       |                                         |       | 782                                |       |          |       | 782 |   | 13,434 |   |   |   |
| Other (3)                                       |       | —                                   |       | 955                                    |       |                                         |       | —                             |       |          |       | 955 |   | — |   |   |   |
| Total                                           |       | $                                        | 1,522,254  |                                   | $          | 120,050                                      |       |                               |       | $             | 18,683     |   |   |   | $ | 138,733 |   | $ | 101,836 |   |   |   |
|                                            |       |                                     |       |                                   |       |                                         |       |                               |       |          |       |   |   |   |   |   |   |   |   |   |   |   |
| 2004                                            |       |                                     |       |                                   |       |                                         |       |                               |       |          |       |   |   |   |   |   |   |
| Private  label loans                            |       | $                                        | 532,336    |                                   | $          | 33,000                                       |       | 6.2                                | %          | $             | 5,925      |   | 1.1 | % | $ | 38,925 |   | $ | 29,730 |   | 5.6 | % |
| Trust  updates (2)                              |       | —                                   |       | —                                 |       |                                         |       | 259                                |       |          |       | 259 |   | 5,060 |   |   |   |
| Total                                           |       | $                                        | 532,336    |                                   | $          | 33,000                                       |       |                               |       | $             | 6,184      |   |   |   | $ | 39,184 |   | $ | 34,790 |   |   |   |

 

----

(1)                                  Representstotal principal and accrued interest.

 

(2)                                  Trustupdates reflect changes resulting from the passage of time, which results inaccretion of the discounting inherent in the present value estimates ofadditional structural advisory fees and residuals, as well as changes in theassumptions, if any, underlying our estimates of the fair value of theseservice revenue components.

 

(3)                                  Representsthe receipt of funds from various trusts’ cost of issuance accounts once it isdetermined that the trust no longer needs such cost of issuance funds.

 

Our privatelabel loan products are marketed through two marketing channels: direct toconsumer, which generally refers to programs that lenders, businesses, unions,affinity groups or other organizations market directly to prospective borrowersand school channel, which refers to programs that lenders or third partiesmarket directly to educational institutions. Our estimates of the allocation bymarketing channel of our securitization revenues for the first nine months offiscal 2005 and 2004, expressed as a percentage of the student loan balancessecuritized in each channel, are as follows:

 
| **Fiscal  2005** |                                  | **Marketing channel** |                                         | **Volume of loans securitized** |             | **Percentage yield** |   |
|------------------|---------------------------------------|-----------------------|----------------------------------------------|---------------------------------|------------------|----------------------|--------|
|             | **Up-front structural advisory fees** | ** **            | **Additional structural advisory fees** | ** **                      | **Residuals**    |                 |
| NCSLT 2005-1     |                                  | Direct to consumer    |                                         | $                               |    445 |                 | 9.6    | % |   | 1.1 | % |   | 6.1 | % |   |
|             |                                  | School channel        |                                         | 270                             |             | 4.4                  |   |   | 1.1 |   |   | 1.4 |   |   |
|             |                                  | Total                 |                                         | $                               |   715       |                 |   |   |   |   |   |   |   |   |   |
|             |                                  | Blended Yield         |                                         |                            |             | 7.6                  | %      |   | 1.1 | % |   | 4.4 | % |   |
|             |                                  |                  |                                         |                            |             |                 |   |   |   |   |   |   |   |   |
| NCSLT 2004-2     |                                  | Direct to consumer    |                                         | $                               |   744       |                 | 8.4    | % |   | 1.2 | % |   | 7.5 | % |   |
|             |                                  | School channel        |                                         | 63                              |             | 4.3                  |   |   | 1.0 |   |   | 2.2 |   |   |
|             |                                  | Total                 |                                         | $                               |   807       |                 |   |   |   |   |   |   |   |   |   |
|             |                                  | Blended yield         |                                         |                            |             | 8.1                  | %      |   | 1.2 | % |   | 7.1 | % |   |
|             |                                  |                  |                                         |                            |             |                 |   |   |   |   |   |   |   |   |
| **Fiscal  2004** |                                  |                  |                                         |                            |             |                 |   |   |   |   |   |   |   |   |
| NCSLT 2003-1     |                                  | Direct to consumer    |                                         | $                               |   487       |                 | 6.4    | % |   | 1.1 | % |   | 5.8 | % |   |
|             |                                  | School channel        |                                         | 45                              |             | 3.8                  |   |   | 0.9 |   |   | 3.3 |   |   |
|             |                                  | Total                 |                                         | $                               |   532       |                 |   |   |   |   |   |   |   |   |   |
|             |                                  | Blended yield         |                                         |                            |             | 6.2                  | %      |   | 1.1 | % |   | 5.6 | % |   |

 

                These yieldsby marketing channel represent an allocation of revenues based on variousestimates and assumptions regarding the relative profitability of these loans,and should be read with caution. Furthermore, these yields are dependent on anumber of factors, including the mix of loans between marketing channels thatare included in a particular securitization as well as the average life ofloans, which can be impacted by the 

 

24

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time of year that loans are securitized and the relative mix of loansfrom students with various expected terms until graduation, along with a numberof other factors. Readers are cautioned that the blended yields and yields bymarketing channel above may not be indicative of yields that we may be able toachieve in future securitizations. 

 

The principal balance of loans facilitatedand available to us for later securitization at March 31, 2005 and June 30,2004 totaled $574.8 million and $276.1 million, respectively.

 

*Structural advisory fees*

 

Structural advisory feesincreased to $138.7 million for the first nine months of fiscal 2005 from $39.2million for the first nine months of fiscal 2004. Structural advisory fees forthe three months ended March 31, 2005 were $62.9 million compared to $0.5million for the three months ended March 31, 2004. The increases in structuraladvisory fees in the 2005 periods compared to the 2004 periods were primarily aresult of an increase in securitization volume, as well as increased blendedadvisory fee yields.

*Up-frontstructural advisory fees*

 

The up-front component ofstructural advisory fees increased to $120.1 million for the first nine monthsof fiscal 2005 from $33.0 million for the first nine months of fiscal 2004. Theincrease in up-front structural advisory fees was primarily a result of anincrease in loan facilitation volume, which enabled us to securitize a greateramount of loans in the first nine months of fiscal 2005 compared to the firstnine months of fiscal 2004, including a securitization transaction in the thirdquarter of fiscal 2005. An increase in up-front structural advisory fees as apercentage of the loan volume securitized, or up-front structural advisory feeyield, also resulted in an increase in our revenue in the first nine months offiscal 2005.  We believe that thisincrease in the up-front structural advisory fee yield is due in part to moreefficient securitization transactions as the balance of student loanssecuritized increased, a change in the mix of student loans securitized and theintroduction of new securitization structures. We do not currently expect further significant improvement in the fee yieldwe are able to earn on future securitization transactions.

 

The following table reflects the increases in up-front structuraladvisory fees attributable to the increases in securitization volume andchanges in the fee yield and loan mix: 

 
| ** **                                                                       | ** ** | **Up-front structural advisory  fees** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                       | ** ** | **Total volume of loans  securitized** | ** ** | **Change attributable to increased  securitization volume** | ** ** | **Change attributable to change  in yield and loan mix** | ** ** | **Total increase** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**                     | ** ** |
| Nine months  ended March 31, 2005 vs. nine months ended March 31, 2004 |       | $                                      | 1,522,254  |   | $ | 61,366 |   | $ | 25,684 |   | $ | 87,050 |   |
|                                                                                  |            |                                        |            |  |  |  |  |  |  |  |  |  |  |

 

Up-front structuraladvisory fees for the three months ended March 31, 2005 were $55.0 million. Wehad no up-front structural advisory fees for the three months ended March 31,2004 as we did not conduct a securitization transaction during that period.

*Additional structural advisory fees*

 

The additional componentof structural advisory fees increased to $18.7 million for the first nine monthsof fiscal 2005 from $6.2 million for the first nine months of fiscal 2004 andincreased to $7.9 million for the three months ended March 31, 2005 compared to$0.5 million for the three months ended March 31, 2004. The increases inadditional structural advisory fees in the 2005 periods compared to the 2004periods were primarily a result of an increase in securitization volume.

25

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The following tables summarize the changes in the fair value of thestructural advisory fees receivable for the three and nine months ended March31, 2005 and 2004: 

 
| ** **                                            | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                            | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(in thousands)**                | ** ** |
|                                                  |       |                              |       |   |   |
| Fair value  at beginning of period                    |       | $                                 | 34,825     |   | $ | 16,485 |   |
| Revenue  recognized during period                     |       |                              |       |   |   |
| Additions  from structuring new securitizations       |       | 7,970                             |       | — |   |
| Fair value  adjustments                               |       | (28                               | )     | 484 |   |
| Total  additional structural advisory fees recognized |       | 7,942                             |       | 484 |   |
| Fair value  at end of period                          |       | $                                 | 42,767     |   | $ | 16,969 | (1) |

 
| ** **                                            | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(in thousands)**               | ** ** |
|                                                  |       |                             |       |   |   |
| Fair value  at beginning of period                    |       | $                                | 24,084     | (1) | $ | 10,785 |   |
| Revenue  recognized during period                     |       |                             |       |   |   |
| Additions  from structuring new securitizations       |       | 17,901                           |       | 5,925 |   |
| Fair value  adjustments                               |       | 782                              |       | 259 |   |
| Total  additional structural advisory fees recognized |       | 18,683                           |       | 6,184 |   |
| Fair value  at end of period                          |       | $                                | 42,767     |   | $ | 16,969 | (1) |

 

----

(1) Excludes the structural advisory fee receivable from the December 2003securitization that we collected in July 2004, which was estimated to be$8.5 million at March 31, 2004 and $10.25 million at June 30, 2004.

 

During the first nine months of fiscal 2005, the fair value adjustmentsof our additional structural advisory fees resulted in an increase ofapproximately $0.8 million. This increase was primarily due to the accretion ofthe discounting inherent in these present value estimates. During the first ninemonths of fiscal 2004, the fair value adjustments of our additional structuraladvisory fees resulted in an increase of approximately $0.3 million, as theaccretion of the discounting inherent in these present value estimates was partiallyoffset by the effect of increases in the discount rate during the period.

 

During the three months ended March 31, 2005, the fair valueadjustments of our additional structural advisory fees resulted in a decreaseof approximately $28,000. This decrease was primarily due to the increase inthe discount rate during the period. During the three months ended March 31,2004, the fair value adjustments of our additional structural advisory feesresulted in an increase of approximately $0.5 million. This increase was primarilydue to a decrease in the discount rate during the period.

 

On a quarterly basis, we update our estimateof the present value of our additional structural advisory fees, which weexpect to begin to receive approximately five to seven years after the date ofa particular securitization transaction. In doing so, we give effect to thepassage of time, which results in the accretion of the discounting inherent inthese present value estimates, and we also adjust for any change in thediscount rate that we use in estimating the present value of these receivables.For a discussion of the assumptions we make in estimating our additionalstructural advisory fees, see “—Application of Critical Accounting Policies andEstimates—Service Revenue.”

 

We base the discount rate that we use tocalculate the present value of our additional structural advisory fees on the10-year U.S. Treasury note rate plus 200 basis points. We applied adiscount rate of 6.51% at March 31, 2005, 6.22% at December 31, 2004, 6.58% at June30, 2004, 5.84% at March 31, 2004, 6.25% at December 31, 2003, and 5.33% at June30, 2003. A decrease in the 10-year U.S. Treasury note rate has the effect ofincreasing the estimated fair value of our structural advisory fees receivable,while an increase in the rate has the opposite effect on our estimate of theirfair value.

 

On an ongoing basis, we monitor theperformance of trust assets, including default, recovery, prepayment andforward LIBOR rates experience, which we also consider in our estimates. We usean implied forward LIBOR curve to estimate trust cash flows. During the firstnine months of fiscal 2005, the implied forward LIBOR curve flattened. Thisflattening increased the estimated fair value of additional structural advisoryfees receivable during the period. During the first nine months of fiscal 2004, the rates along the impliedforward LIBOR curve increased.  Theseincreases in rates resulted in an increase in the average life of theunderlying trust assets, thereby increasing the estimated fair value of the structuraladvisory fees receivable during the period.  For a discussion of the assumptions we make inestimating our additional structural advisory fees receivable, see “—Application of Critical Accounting Policies and Estimates—Service Revenue.”

 

We made no changes in our assumptionsregarding default rates, prepayment rates and recovery rates during either thefirst nine months of fiscal 2005 or 2004.

 

*Residuals*

 

Residualsincreased to $101.8 million for the first nine months of fiscal 2005 from $34.8million for the first nine months of fiscal 2004 and increased to $35.2 millionfor the three months ended March 31, 2005 compared to $2.3 million for thethree months 

 

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ended March 31, 2004. Theincreases in residuals in the 2005 periods compared to the 2004 periods wereprimarily a result of an increase in securitization volume. We used a discountrate of 12% throughout the first nine months of fiscal 2005 and all of fiscal2004.

 

The following table reflects the increases in residuals attributable tothe increase in securitization volume and the change attributable to updates toprior trusts: 
| ** **                                                                       | ** ** | ** **                            | ** ** | **Residuals**                                                                      | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Total volume of loans securitized** | ** ** | **Change attributable to increased  securitization volume and change in loan mix** | ** ** | **Change attributable to trust  updates(1)** | ** ** | **Total increase** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**                    | ** ** |
| Nine months  ended March 31, 2005 vs. nine months ended March 31, 2004 |       | $                                     | 1,522,254  |                                                                               | $          | 58,672 |   | $ | 8,374 |   | $ | 67,046 |   |
|                                                                                  |            |                                       |            |                                                                                    |            |  |  |  |  |  |  |  |  |

 

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(1)          The change attributableto trust updates in fiscal 2005 and 2004 was primarily the result of thepassage of time and the resulting accretion of the discounting inherent inthese present value estimates of residuals, rather than changes in ourassumptions.

 

The following tables summarize the changes in the fair value of theresiduals receivable for the three and nine months ended March 31, 2005 and2004: 
| ** **                                      | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                | ** ** |
|                                            |       |                              |       |   |   |
| Fair value  at beginning of period              |       | $                                 | 175,178    |   | $ | 76,138 |   |
| Revenue  recognized during period               |       |                              |       |   |   |
| Additions  from structuring new securitizations |       | 31,345                            |       | — |   |
| Fair value  adjustments                         |       | 3,809                             |       | 2,253 |   |
| Total  residuals fees recognized                |       | 35,154                            |       | 2,253 |   |
| Fair value  at end of period                    |       | $                                 | 210,332    |   | $ | 78,391 |   |
| ** **                                      | ** ** | ** **                        | ** ** |
| ** **                                      | ** ** | **Nine months ended  March 31,**  | ** ** |
| ** **                                      | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                | ** ** |
|                                            |       |                              |       |   |   |
| Fair value  at beginning of period              |       | $                                 | 108,495    |   | $ | 43,600 |   |
| Revenue  recognized during period               |       |                              |       |   |   |
| Additions  from structuring new securitizations |       | 88,402                            |       | 29,730 |   |
| Fair value  adjustments                         |       | 13,435                            |       | 5,060 |   |
| Total  residuals fees recognized                |       | 101,837                           |       | 34,790 |   |
| Fair value  at end of period                    |       | $                                 | 210,332    |   | $ | 78,390 |   |

 

During the first ninemonths of fiscal 2005 and the first nine months of fiscal 2004, the fair valueadjustments of our residuals receivable resulted in an increase of approximately$13.4 million and $5.1 million, respectively. During the three months endedMarch 31, 2005 and March 31, 2004, the fair value adjustments of our residualsreceivable resulted in an increase of approximately $3.8 million and $2.3million, respectively.  The increases inthe 2005 periods compared to the 2004 periods were due primarily to the passageof time and the impact of movement in the implied forward LIBOR curve. Theamounts of the fair value adjustments also increased between periods as theunderlying receivables balances increased. As we conduct more securitizationtransactions, we expect that adjustments for the passage of time will continueto increase and thereby add to the residual revenues that we discount topresent value.

 

As we do with our additional structuraladvisory fees, on a quarterly basis, we update our estimate of the presentvalue of our residuals. In doing so, we give effect for the passage of time,which results in the accretion of the discounting inherent in these presentvalue estimates, and we also adjust for any change in the discount rate that weuse in estimating the present value of these receivables. We used a 12% discountfactor during the first nine months of fiscal 2005 and throughout fiscal 2004.We also monitor the performance of trust assets, including default, recovery,prepayment and forward LIBOR rates experience, which we also consider in ourestimates. We use an implied forward LIBOR curve to estimate trust cash flows.During the first nine months of fiscal 2005, the 

 

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implied forward LIBOR curve flattened. The flattening of the curveimproved the net excess spread between the trust assets and liabilities,resulting in an increase in the estimated fair value of residuals receivableduring the period. During the first nine months of fiscal 2004, the rates alongthe implied forward LIBOR curve increased. These increases in rates resulted in an increase in the average life ofthe underlying trust assets, thereby increasing the estimated fair value of theresiduals receivable during the period.  Inaddition, actual LIBOR rates in effect during a period can differ from thoseimplied by forward LIBOR rates at the beginning of a period.  These differences can affect the net excessspread between trusts assests and liabilitiesexperienced during the period.  Duringthe three months ended March 31, 2005, actual LIBOR rates increased generally ata faster rate than those implied by the forward LIBOR curve at the beginning ofthe quarter.  This had a negative impacton the net excess spread between trust assets and liabilities during thequarter, and thereby reduced the value of the residuals.  During the three months ended March 31, 2004,the movement in LIBOR rates did not have a material impact on the fair value ofthe residuals.  For a discussion of theassumptions we make in estimating our residuals, see “—Application of CriticalAccounting Policies and Estimates—Service Revenue.”

 

In determining an appropriate discount ratefor valuing residuals, we review the rates used by student loan securitizers, as well as rates used in the much broader ABSmarket. We believe that the 12% discount rate we use is appropriate given themaximum 24-year life of the trust assets and residuals.

 

For a discussion of the assumptions we makein estimating our residuals, see “—Application of Critical Accounting Policiesand Estimates—Service Revenue.”

 

*Processing fees from TERI*

 

Processing fees from TERI increased to $54.5million for the first nine months of fiscal 2005 from $22.9 million for thefirst nine months of fiscal 2004 and increased to $20.6 million for the threemonths ended March 31, 2005 from $7.9 million for the three months ended March31, 2004. The increases in the 2005 periods compared to the 2004 periods were primarilydue to increased reimbursed expenses required to process the volume of privatelabel loans that we facilitated during the fiscal 2005 periods, which increasedto $2.1 billion for the first nine months of fiscal 2005 from $1.4 billion forthe first nine months of fiscal 2004 and to $585.4 million for the three monthsended March 31, 2005 from $445.7 million for the three months ended March 31, 2004.

 

*Administrative and other fees*

 

Administrative and other fees increased to $2.7million for the first nine months of fiscal 2005 from $1.2 million for thefirst nine months of fiscal 2004 and increased to $0.8 million for the threemonths ended March 31, 2005 from $0.5 million for the three months ended March31, 2004. The increases in the 2005 periods compared to the 2004 periods weredue primarily to increasing student loan balances in the securitization trustsduring the fiscal 2005 periods compared to the fiscal 2004 periods. We expectthat our administrative and other fees will continue to increase as the studentloan balances in the securitization trusts continue to increase.

 

 

***Operating Expenses***

 

Total operating expenses increased to $99.2million for the first nine months of fiscal 2005 from $47.9 million for thefirst nine months of fiscal 2004 and increased to $37.7 million in the threemonths ended March 31, 2005 from $17.2 million in the three months ended March31, 2004. Compensation and benefits increased to $47.5 million for the firstnine months of fiscal 2005 from $25.5 million for the first nine months offiscal 2004, and increased to $17.3 million in the three months ended March 31,2005 from $8.8 million in the three months ended March 31, 2004. General andadministrative expenses increased to $51.7 million for the first nine months offiscal 2005 from $22.4 million for the first nine months of fiscal 2004, andincreased to $20.4 million in the three months ended March 31, 2005 from $8.4million in the three months ended March 31, 2004.

 

Compensation and benefits and general andadministrative expenses increased in the 2005 periods compared to the 2004periods primarily as a result of an increase in personnel. We hired additionalpersonnel to meet the operating requirements from our growing loan processingand securitization activities. As our financial performance improves, weanticipate awarding higher performance-based compensation to our employees.

 

General and administrative expenses alsoincreased in the 2005 periods compared to the 2004 periods as a result ofincreases in consulting fees, professional fees, external call center costs andoccupancy costs. Consulting fees increased to $11.7 million in the first ninemonths of fiscal 2005 from $2.8 million in the first nine months of fiscal 2004,and increased to $4.6 million for the three months ended March 31, 2005 from $1.3million for the three months ended March 31, 2004, primarily as a result of thehiring of experts to assist us in our redesign efforts for our loan originationsystems. Professional fees increased to $5.8 million in the first nine monthsof fiscal 2005 from $2.9 million in the first nine months of fiscal 2004, and increasedto $2.1 million for the three months ended March 31, 2005 from $1.0 million forthe three months ended March 31, 2004. These expenses increased primarily as aresult of increased legal, audit and investor relations expenses as a result ofbeing a public company including costs related to our compliance with theSarbanes-Oxley Act. External call center costs increased to $4.2 million forthe first nine months of fiscal 2005 from $2.0 million in the first nine monthsof fiscal 2004, and increased to $0.9 million for the three months ended March31, 2005 from $0.5 million for the three months ended March 31, 2004. Theincreases in external call center costs were primarily due to increases in thevolume of loans facilitated during the 2005 periods. Occupancy expenses increasedto $7.7 million in the first nine months of fiscal 

 

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2005 from $2.9 million in the first nine months of fiscal 2004, and  increased to $3.3 million for the three monthsended March 31, 2005 from $1.3 million for the three months ended March 31, 2004as a result of increased office space under lease in the 2005 periods and, to alesser degree, higher lease rates following relocation of our corporateheadquarters in 2004, and expansion of our loan processing operations comparedto the 2004 periods.

 

We expect that our operating expenses willcontinue to increase as we devote additional resources to the expectedincreasing loan volumes facilitated for our existing and new clients and as aresult of increased space under lease.

 

The following table summarizes the componentsof operating expenses, both those reimbursed and not reimbursed by TERI underour Master Servicing Agreement, for the three and nine month periods ended March31, 2005 and 2004:

 
| ** **                            | ** ** | **Operating expenses**             | ** ** |
|---------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **Expenses reimbursed by TERI**    | ** ** | **Expenses not reimbursed by TERI** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Compensation and benefits** | ** ** | **General and administrative expenses** | ** ** | **Subtotal operating expenses** | ** ** | **Compensation and benefits** | ** ** | **General and administrative expenses** | ** ** | **Subtotal operating expenses** | ** ** | **Total operating expenses** | ** ** |
| ** **                            | ** ** | **(in thousands)**                 | ** ** |
| **Three  months ended March 31,**     |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2005                                  |       | $                                  | 10,271     |   | $ | 10,293 |   | $ | 20,564 |   | $ | 7,051 |   | $ | 10,098 |   | $ | 17,149 |   | $ | 37,713 |   |
| 2004                                  |       | 4,550                              |       | 3,377 |   | 7,927 |   | 4,285 |   | 5,037 |   | 9,322 |   | 17,249 |   |
|                                  |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Nine months  ended March 31,** |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2005                                  |       | $                                  | 27,418     |   | $ | 27,024 |   | $ | 54,442 |   | $ | 20,105 |   | $ | 24,678 |   | $ | 44,783 |   | $ | 99,225 |   |
| 2004                                  |       | 12,184                             |       | 10,713 |   | 22,897 |   | 13,319 |   | 11,710 |   | 25,029 |   | 47,926 |   |

 

***Other (Income)Expense***

 

*Interest income*

 

Net interest income increased to $2.2 millionfor the first nine months of fiscal 2005 from net interest income of $21,000for the first nine months of fiscal 2004. Net interest income during the threemonths ended March 31, 2005 increased to $1.0 million from net interest incomeduring the three months ended March 31, 2004 of $78,000. The increases ininterest income in the 2005 periods compared to the 2004 periods resulted fromincreases in cash and other short-term investment balances as a result ofreceipt of cash from securitization transactions in February 2005, October 2004and June 2004. Interest expense for all periods was primarily attributable to$7.9 million of notes issued in June 2001 to TERI as a part of thepurchase price for TERI’s loan processing operations as described below in“—Financial Condition, Liquidity and Capital Resources” and, for the 2005periods, capital lease obligations. We had approximately $7.5 million ofoutstanding capital lease obligations at March 31, 2005.

 

***Income Tax Expense(Benefit)***

 

Income tax expense increased to $84.1 millionfor the first nine months of fiscal 2005 from $20.2 million for the first ninemonths of fiscal 2004. Income tax expense increased to $35.4 million for thethird quarter of fiscal 2005 from an income tax benefit of $2.5 million for thethird quarter of fiscal 2004. The increases in income tax expense in the 2005periods compared to the 2004 periods were primarily the result of an increasein the amount of income before income tax expense between periods.

 

**Financial Condition, Liquidity and CapitalResources**

 

Our liquidity requirements have historicallyconsisted, and we expect that they will continue to consist, of capitalexpenditures, working capital, business development expenses, general corporateexpenses and potential acquisitions.

 

On November 5, 2003, we completed aninitial public offering of our common stock at a price to the public of $16.00per share, in which we sold 7,906,250 shares and selling shareholders sold6,468,750 shares. Net proceeds of the initial public offering to us wereapproximately $115.1 million. We did not receive any of the proceeds ofthe sale of the shares sold by the selling stockholders. In June 2004,selling stockholders sold an aggregate of 7,406,312 shares of our common stockin a follow-on public offering at a price of $36.50 per share. In January 2005,selling stockholders sold an aggregate of 3,933,605 shares of our common stockin a follow-on public offering at a price of $57.40 per share. We did not sellany shares in the June 2004 and January 2005 offerings and thereforedid not receive any proceeds from the sale of stock. We did, however, receiveapproximately $3.0 million in connection with the June 2004 offering, andapproximately $1.9 million in connection with the January 2005 offering,from certain selling stockholders who exercised options and then sold theresulting shares in the offerings.

 

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***Short-term FundingRequirements***

 

We expect to fund our short-term liquidityrequirements through cash flow from operations and the proceeds of our initialpublic offering. We believe, based on our current operating plan and theproceeds of our initial public offering, that our current cash and othershort-term investments will be sufficient to fund our operations through atleast fiscal 2006.

 

***Long-term FundingRequirements***

 

We expect to fund the growth of our businessthrough cash flow from operations and through issuances of common stock,promissory notes or other securities. We expect to assess our financingalternatives periodically and access the capital markets opportunistically. Ifour existing resources are insufficient to satisfy our liquidity requirements,or if we enter into an acquisition or strategic arrangement with anothercompany, or if we otherwise believe that raising additional capital would be inour best interests and the best interests of our stockholders, we may selladditional equity or debt securities. Any sale of additional equity or debtsecurities may result in additional dilution to our stockholders, such asincurring additional debt, making capital expenditures or paying dividends. Wecannot be certain that additional public or private financing will be availablein amounts or on terms acceptable to us, if at all. If we are unable to obtainthis additional financing, we may be required to delay, reduce the scope of, oreliminate one or more aspects of our business development activities, whichcould harm the growth of our business.

 

From our inception, we have raisedapproximately $147.0 million from the sale of common stock and promissorynotes, including approximately $115.1 million in net proceeds from our initialpublic offering.

 

Our actual liquidity and capital fundingrequirements may depend on numerous factors, including:

 

•                  our facilitiesexpansion needs;

 

•                  the extent towhich our services gain increased market acceptance and remain competitive;

 

•                  the timing, sizeand composition of the loan pools of the securitization transactions that we structure;and

 

•                  the costs andtiming of acquisitions of complementary businesses.

 

If we are not able to obtain adequate fundingwhen needed, we may have to delay further expansion of our business.

 

***Cash and OtherShort-term Investments***

 

At March 31, 2005, we had $218.5 million incash and other short-term investments, and at June 30, 2004, we had $168.7 millionin cash and other short-term investments. The increase resulted primarily fromour receipt of up-front structural advisory fees in connection with our February2005 and October 2004 securitization transactions. Cash and other short-terminvestments include primarily funds deposited in a money market fund thatinvests in short-term obligations of the U.S. Treasury and repurchaseagreements fully collateralized by obligations of the U.S. Treasury.

 

***Structural AdvisoryFees and Residuals Receivables***

 

Our structural advisory fees and residualsreceivables increased to $253.1 million at March 31, 2005 from $142.8 millionat June 30, 2004, primarily as a result of the structural advisory feesand residuals generated from the February 2005 and October 2004 securitizationtransactions. This increase in structural advisory fees and residualsreceivables was partially offset by the receipt of $10.25 million in structuraladvisory fees in July 2004. In the December 2003 securitization, wecollected $24.5 million of the up-front structural advisory fee in December 2003,at the time the securitization transaction closed, and we received a secondpayment of $10.25 million in July 2004 from this December 2003securitization transaction (of which $7.25 million was used to repay anoutstanding note payable). The $10.25 million second payment was recordedas a structural advisory fee receivable at June 30, 2004.

 

***Property andEquipment, Net***

 

During the first nine months of fiscal 2005,our property and equipment, net increased by $23.1 million, as we spent $27.7 millionon the expansion of our processing facilities and corporate headquarters, whichwas partially offset by $4.6 million of depreciation expense recorded duringthe period. Included in capital additions for the first nine months of fiscal2005 are capitalized software development costs of $6.6 million which areprimarily related to the improvement of our loan processing systems. During thefirst nine months of fiscal 2005, we financed the acquisition of $6.1 millionin property and equipment through capital leases.

 

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***Prepaid Income Taxes***

 

We had prepaid income taxes of $17.1 millionat March 31, 2005 and $20.3 million at June 30, 2004. At March 31, 2005, thisbalance was primarily derived from a tax benefit of $30.4 million from employeestock option exercises, principally in connection with a stock option exerciseat the time of our follow-on offering in January 2005. At June 30, 2004, thisbalance was primarily derived from a tax benefit of $29.9 million from employeestock option exercises, principally in connection with stock option exercisesat the time of our follow-on offering in June 2004. These benefits, afteroffsetting accrued income taxes, resulted in the net prepaid income taxesbalance.

 

***Other Prepaid Expenses***

 

We had other prepaid expenses of $3.3 millionat March 31, 2005 and $2.8 million at June 30, 2004. The increase in otherprepaid expenses was due to an increase in prepaid insurance and the timing ofthe prepayment of services.

 

***Other Assets***

 

We had other assets of $3.5 million at March31, 2005 and $2.2 million at June 30, 2004. The increase in other assets isprimarily due to an increase in prepaid fees to be reimbursed to us from trustscreated in future securitization transactions of $0.5 million and a deposit of$0.5 million made, related to a maintenance agreement we recently executed. 

 

In connection with our facilitation of thesecuritization of GATE loans in June 2004, six schools participating in ourGATE program faced limits on the amount of surety coverage that the GATEprogram’s current surety provider was willing to provide to the NCT trust ontheir behalf. We provided the NCT trust with an additional aggregate cash suretydeposit of approximately $1.8 million on behalf of these six schools. Thisdeposit is included in other assets at March 31, 2005 and June 30, 2004. Thesurety coverage and our cash deposit provides the NCT trust bondholders withassurance that the pledge commitment that these school clients make toreimburse the NCT trusts for defaults by their student borrowers will befulfilled.

 

Our cash deposit with the NCT trust on behalfof these schools will earn interest at the prevailing short-term interestrates. We will also earn a surety fee equal to 150 basis points of theinitial notional amount of the pledge commitment which our cash depositsupports. As schools reimburse the NCT trusts for student defaults, the amountof their pledge commitment is reduced. We are entitled to withdraw amounts inthe surety reserve account, including earned interest and surety fees, to theextent the balance in the surety reserve account exceeds the pledge commitment.Once the NCT trust bondholders have been paid in full, we will receive theentire amount remaining in the surety reserve account.

 

***Accounts Payable andAccrued Expenses***

 

We had accounts payable and accrued expensesof $29.4 million at March 31, 2005 and $26.3 million at June 30, 2004. Accruedbonuses were approximately $4.2 million higher at March 31, 2005 as compared toJune 30, 2004, primarily due to an increase in the number of our employees andthe adoption of our executive incentive compensation plan by our stockholdersin November 2004. Our accounts payable were $2.3 million higher at March 31,2005 as compared to June 30, 2004, primarily due to the timing of the receiptand payment of invoices. At March 31, 2005, we had accrued an additional $2.4million as compared to June 30, 2004 in consulting costs related to theimprovement of our loan processing operations. These increases were offset by adecrease in accruals related to tax withholdings. In July 2004, we paid approximately$8.2 million of withholding taxes that we had collected from employees relatedto their exercise of non-qualified stock options in our follow-on offering in June2004.

 

***Net Deferred IncomeTax Liability***

 

We had a net deferred income tax liability of$70.4 million at March 31, 2005 and $40.1 million at June 30, 2004. We have anet deferred tax liability because, under accounting principles GAAP, we recognize residuals in book income earlier thanthey are recognized for tax purposes. Our deferred tax liability increasedprimarily as a result of the increase in residual revenue recognized during thefirst nine months of fiscal 2005. This increase was partially offset by therecognition of tax income as a result of these residual interests.

 

***Notes Payable***

 

We had notes payable and capital leaseobligations of $7.5 million at March 31, 2005 and $9.2 million at June 30,2004. During the second quarter of fiscal 2004, we received $7.0 million uponthe issuance of a $7.25 million note to the lead underwriter of our December 2003securitization. We repaid this note with the first $7.25 million of thesecond up-front structural advisory fee that we received in July 2004 inconnection with the December 2003 securitization. This decrease in notespayable was offset by an increase in capital lease obligations of $6.1 millionduring the first nine months of fiscal 2005 as we financed the acquisition ofproperty and equipment, primarily for our expanded loan processing operations. Wehad notes payable to TERI of $5.5 million at March 31, 2005 and $6.0 million atJune 30, 2004. This balance relates to two acquisition notes we issued toacquire TERI’s loan 

 

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processing operations in 2001.

 

***Deferred Compensation***

 

We recorded deferred compensation during thesecond and third quarter of fiscal 2005 as we granted 79,000 restricted stockunits to certain senior managers and executive officers. The deferredcompensation recorded represents the value of these units on the date of grant netof amortization expense recognized. Deferred compensation is amortized ratablyinto expense over the respective service period related to each grant.

 

***ContractualObligations***

 

As of March 31, 2005, our contractual obligations hadnot changed materially from those described under the caption “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations-Contractual Obligations” in our annual report on Form 10-K forthe fiscal year ended June 30, 2004. During the first ninemonths of fiscal 2005:

 

•                  We entered into a lease forapproximately 26,000 square feet of office space in Boston, Massachusetts, onthe terms disclosed in the annual report on Form 10-K;

 

•                  We exercised our right to renew ourdatabase sale and supplementation agreement, as well as several otheragreements with TERI, for additional five-year terms through June 2011.Beginning in July 2007, monthly payments pursuant to the database sale andsupplementation agreement will be reduced to approximately $21,000;

 

•                  We entered into a lease forapproximately 25,000 additional square feet of office space for our loanprocessing operations in Boston, Massachusetts for basic annual rent between$745,000 and $872,000 through 2014;

 

•                  We entered into an operating leasefor the use of a corporate aircraft for basic annual rent of approximately $1.4million through 2009, which was structured to be treated as a capital asset fortax purposes; and

 

•                  We entered into an equipmentfinancing lease agreement which we will use to finance the purchases offurniture and equipment. The agreement allows us to finance up to $20.0 millionworth of furniture and equipment purchased before December 30, 2005. Weexpect to repay amounts drawn down on the lease in terms ranging from three tofive years. As of March 31, 2005, we had $5.1 million outstanding under thisline of credit.

 

***Cash Flows***

 

Our net cash provided by operating activitiesincreased to $75.7 million for the first nine months of fiscal 2005, comparedto cash used in operations of $10.0 million for the first nine months of fiscal2004. Cash provided by operations resulted primarily from net income of $116.6million, an increase in our deferred income tax liability of $30.2 million andthe tax benefit from employee stock options of $30.4 million, partially offsetby an increase in residuals of $101.8 million and an increase in structuraladvisory fees of $8.4 million.

 

We used $22.1 million of net cash ininvesting activities during the first nine months of fiscal 2005. The principaluse of net cash was capital expenditures related to the expansion of our loanprocessing facilities and corporate headquarters and, to a lesser extent,payments for loan database updates from TERI.

 

We used net cash of $3.8 million in financingactivities during the first nine months of fiscal 2005. Cash used in financingactivities primarily related to the repayment of the $7.25 million note that weissued to the lead underwriter of the Company’s December 2003securitization, offset in part by the exercise of employee stock options.

 

We expect that our capital expenditurerequirements for the remainder of fiscal 2005 will be approximately $5.3million. We plan to utilize our equipment line of credit to finance a portionof these costs. We expect to use these funds primarily for the expansion of ourloan processing operations and the purchase of computer and office equipment.We currently have capital expenditure commitments over the next 12 monthsof approximately $4.2 million.

 

***Borrowings***

 

In June 2001, we issued two acquisitionnotes to TERI totaling $7.9 million to acquire TERI’s loan processingoperations. Principal and interest at an annual rate of 6% is payable on thesenotes in 120 monthly payments of an aggregate of $87,706 commencing on July 20,2001 and ending on June 20, 2011. At March 31, 2005, outstanding principalon these notes totaled $5.5 million as compared to $6.0 million at June 30,2004.

 

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In August 2003, we entered into a $10 millionrevolving credit facility with Fleet National Bank. Fleet National Bank wassubsequently acquired by Bank of America, and our agreement related to thisfacility has been assigned to Bank of America. The revolving credit facilitymatures on August 28, 2005, with interest currently payable, at ouroption, at the bank’s prime rate, or LIBOR plus 2%. The revolving credit linecontains financial covenants, including:

 

•                  minimum trailing12-month up-front structural advisory fees of not less than $25 to$30 million;

 

•                  minimum tangiblenet worth of not less than the sum of 100% of consolidated tangible net worthplus 85% of consolidated net income;

 

•                  a maximumliabilities to net worth ratio of not greater than 1.15 to 1.00; and

 

•                  a minimum cashflow to debt service ratio of not less than 1.50 to 1.00,

 

as well as certain financial reporting covenants. We expect to be ableto meet these financial and reporting requirements during the term of therevolving credit facility and are in compliance with these covenants as of thedate of this report. This agreement restricts our ability to pay cash dividendsin the event we are in default. As of March 31, 2005, we had no balanceoutstanding under the revolving credit facility. The maximum annual commitmentfee is $25,000. Bank of America has issued on our behalf a letter of credit inthe amount of $0.5 million in lieu of security deposits for the lease of officespace. Third party beneficiaries have not drawn upon this letter of credit,which reduces the amount that we may borrow under the revolving creditfacility.

 

In December 2003, we issued a$7.25 million note to the lead underwriter of our December 2003securitization to monetize a substantial portion of the second up-frontstructural advisory fee payment which we received in July 2004. We repaidthe note in full with the first $7.25 million of that payment.

 

In January 2005, we entered into an equipmentfinancing lease agreement which we will use to finance the purchases offurniture and equipment. The agreement allows us to finance up to $20.0 millionworth of furniture and equipment purchased before December 30, 2005. Weexpect to repay amounts drawn down on the lease in terms ranging from three tofive years. As of March 31, 2005, we had $5.1 million outstanding under thisline of credit.

 

**Off-Balance Sheet Transactions**

 

We structure and facilitate thesecuritization of loans for our clients through a series of bankruptcy remote,qualified special purpose trusts. We do not utilize these trusts as a means totransfer assets or liabilities from our balance sheet to those of the trustsbecause we are not the originator of the securitized student loans or theissuer of the related debt. We do not serve as lender, guarantor or loanservicer. Specifically, these trusts purchase such student loans fromthird-party financial institutions, the financing of which is provided throughthe issuance of asset-backed securities.

 

The principal uses of these trusts are to:

 

•                  generate sourcesof liquidity for our clients’ assets sold into such trusts and to reduce theircredit risk;

 

•                  make availablemore funds to students and colleges; and

 

•                  leverage thecapital markets to reduce borrowing costs to students.

 

See “Application of Critical AccountingPolicies and Estimates—Consolidation” for a discussion of our determination tonot consolidate these securitization trusts.

 

**Inflation**

 

Inflation was not a material factor in eitherrevenue or operating expenses during the periods presented.

 

 

**Factors That May Affect Future Results**

 

This quarterlyreport on Form 10-Q includes forward-looking statements within the meaningof Section 21E of the Securities Exchange Act of 1934, as amended, or theExchange Act. For this purpose, any statements contained herein regarding ourstrategy, future operations, financial position, future revenues, projectedcosts, prospects, plans and objectives of management, other than statements ofhistorical facts, are forward-looking statements. The words “anticipates,”“believes,” “estimates,” “expects,” “intends,” 

 

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“may,” “plans,” “projects,”“will,” “would” and similar expressions are intended to identifyforward-looking statements, although not all forward-looking statements containthese identifying words. We cannot guarantee that we actually will achieve theplans, intentions or expectations expressed or implied in our forward-lookingstatements. There are a number of important factors that could cause actualresults, levels of activity, performance or events to differ materially fromthose expressed or implied in the forward-looking statements we make. Theseimportant factors include our “critical accounting estimates” and the riskfactors set forth below. Although we may elect to update forward-lookingstatements in the future, we specifically disclaim any obligation to do so,even if our estimates change, and readers should not rely on thoseforward-looking statements as representing our views as of any date subsequentto the date of this quarterly report.

 

**Risk Factors**

 

***We derive asignificant portion of our revenue and substantially all of our income fromstructuring securitization transactions; our financial results and futuregrowth would be adversely affected if we are unable to structure securitizations.***

 

Securitization refers to the technique ofpooling loans and selling them to a special purpose, bankruptcy remote entity,typically a trust, which issues securities to investors backed by those loans.As of the date of this Quarterly Report, we have provided structural advisoryand other services for 24 loan securitizations since our formation in 1991, andwe receive fees for these services. In connection with securitizations, wereceive compensation in the form of structural advisory fees, residuals andadministrative fees for management of the trusts. The amount and timing of thefees we recognize are affected, in part, by the size and composition of loanpools to be securitized, the return expectations of investors and assumptionswe make regarding loan portfolio performance, including defaults, recoveries,prepayments and the cost of funding. Revenue from new securitizationsconstituted 76% of our total service revenue for the first nine months offiscal 2005, 78% of our total service revenue for fiscal 2004, 73% of our totalservice revenue for fiscal 2003 and 64% of our total service revenue in fiscal2002. Substantially all of our net income in those fiscal periods wasattributable to securitization-related revenue.

 

***The timing of oursecuritization activities will greatly affect our quarterly financial results.***

 

Our quarterly revenue, operating results andprofitability have varied and are expected to continue to vary significantly ona quarterly basis. During the first nine months of fiscal 2005, we recognized8%, 52% and 40% of our total service revenue in the respective fiscal quartersof fiscal 2005. In fiscal 2004, we recognized 5%, 39%, 5% and 51% of our totalservice revenue in the respective fiscal quarters of 2004. In fiscal 2003, we recognized7%, 36%, 17% and 40% of our total service revenue in the respective fiscalquarters of 2003. Our quarterly revenue varies primarily because of the timingof the securitizations that we structure. In fiscal 2004, we facilitated onesecuritization in the second quarter and two securitizations in the fourthquarter, but none in the first or third quarters. Thus far in fiscal 2005, wefacilitated one securitization in the second quarter and one securitization inthe third quarter. The timing of our securitization activities is affected tosome degree by the seasonality of student loan applications and loanoriginations. Origination of student loans is generally subject to seasonaltrends, with the volume of loan applications increasing with the approach oftuition payment dates. In fiscal 2004, we processed 34% of our total loanfacilitation volume in the first quarter ended September 30, 2003, and20%, 27% and 19% of our total loan facilitation volume in the respectivesuccessive quarters.

 

***A number of factors,some of which are beyond our control, may adversely affect our securitizationactivities and thereby adversely affect our results of operations.***

 

Our financial performance and future growthdepend in part on our continued success in structuring securitizations. Severalfactors may affect both our ability to structure securitizations and therevenue we generate for providing our structural advisory and other services,including the following:

 

•                  degradation of the credit quality and performance inthe loan portfolios of the trusts we structure could reduce or eliminateinvestor demand for securitizations that we facilitate in the future;

 

•                  prolonged volatility in the capital marketsgenerally or in the student loan sector specifically, which could restrict ordelay our access to the capital markets;

 

•                  unwillingness of financial guarantee providers to offercredit insurance in the securitizations that we structure or in studentloan-backed securitizations generally;

 

•                  adverse performance of, or other problems with,student loan-backed securitizations that other parties facilitate could impactpricing or demand for our securitizations; and

 

•                  any material downgrading or withdrawal of ratingsgiven to securities previously issued in securitizations that we structuredcould reduce demand for additional securitizations that we structure.

 

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A portion ofthe securities issued since 1998 in securitization transactions that westructured were sold to asset-backed commercial paper conduits. If these orsimilar asset-backed conduits cease to purchase securities in thesecuritizations that we structure, we may experience a delay in the timing ofour securitizations as we seek to find alternate channels of distribution.

Under theterms of some of our contracts with key lender clients, we have an obligationto securitize loans originated by those lenders periodically, typically twiceper year. We may agree with other lenders to securitize more frequently in thefuture. If we do not honor these obligations, we may be required to payliquidated or other damages, which could adversely affect our results ofoperations.

***In connectionwith our recognition of revenue from securitization transactions, if theestimates we make, and the assumptions on which we rely, in preparing ourfinancial statements prove inaccurate, our actual results may vary from thosereflected in our financial statements.***

        Wereceive structural advisory fees for our services in connection withsecuritization transactions. We receive an up-front portion of these structuraladvisory fees when the securitization trust purchases the loans or soonthereafter. We receive an additional portion of these structural advisory feesover time, based on the amount of loans outstanding in the trust from time totime over the life of the trust. We also have the right to receive a portion ofthe residual interests that the trust creates. As required under GAAP, we recognize as revenue the present value of the additionalportion of the structural advisory fees and residuals at the time thesecuritization trust purchases the loans because they are deemed to be earnedbefore they are actually paid to us. We record additional structural advisoryfees and residuals as receivables on our balance sheet at fair value.Accounting rules require that these receivables be marked-to-market. Weestimate the fair value both initially and in each subsequent quarter andreflect the change in value in earnings for that period. Our key assumptions toestimate the value include prepayment and discount rates, interest rate trends,the spread between LIBOR and the auction rates on our senior auction ratenotes,  the expected credit losses fromthe underlying securitized loan portfolio, net of recoveries, and the expectedtiming of cash flows from the trusts’ underlying student loan assets. If ourassumptions are wrong, the additional structural advisory fees and residualsthat we receive from the trusts could be significantly less than reflected inour current financial statements, and we may incur a material negativeadjustment to our earnings in the period in which our assumptions change. For adiscussion of the sensitivity of the additional structural advisory fees andresiduals to variations in our assumptions and estimates, see"Management's Discussion and Analysis of Financial Condition and Resultsof Operations—Executive Summary—Application of Critical Accounting Policies andEstimates—Service Revenue-Sensitivity Analysis."

 

        Ourresiduals in each securitization we have facilitated are subordinate tosecurities issued to investors in such securitizations and may fail to generateany revenue for us if the securitized assets only generate enough revenue topay the investors. 

 

***Ourfinancial results could be adversely affected if we were required toconsolidate the financial results of the entities that we use forsecuritizations that we facilitate.***

We providestructural advisory and other services for loan securitizations undertakenthrough Delaware statutory trusts. We do not consolidate the financial resultsof the trusts with our own financial results. For a discussion of our decisionnot to consolidate, see “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Executive Summary—Application of CriticalAccounting Policies and Estimates—Consolidation” included in this QuarterlyReport. Some of the relevant accounting rules are in the process of beingamended. If we were required to consolidate the financial results of one ormore trusts with our own financial results as a result of amendments or changesin accounting rules, or if the SEC or other accounting authorities do not agreewith our current approach, our financial results could be adversely affected,particularly in the early years of a trust when the trust typically experienceslosses.

***Instructuring and facilitating securitizations of our clients’ loans and asholders of rights to receive residual cash flows in those trusts, we may incurliabilities to investors in the asset-backed securities those trusts issue.***

We have facilitated and structured a numberof different special purpose trusts that have been used in securitizations tofinance student loans that our clients originate. Under applicable state andfederal securities laws, if investors incur losses as a result of purchasing asset-backedsecurities that those trusts issue, we could be deemed responsible and could beliable to those investors for damages. If we failed to cause the trusts todisclose adequately all material information regarding an investment in theasset-backed securities or if the trust made statements that were misleading inany material respect in information delivered to investors, it is possible thatwe could be held responsible for that information or omission. In addition,under various agreements entered into with underwriters or financial guaranteeinsurers of those asset-backed securities, we are contractually bound toindemnify those persons if investors are successful in seeking to recoverlosses from those parties and the trusts are found to have made materiallymisleading statements or to have omitted material information.

 

We do not maintain reserves or insuranceagainst this potential liability. If we are liable for losses investors incurin any of the securitizations that we facilitate or structure, ourprofitability or financial position could be materially adversely affected.

 

***If our relationshipswith key clients terminate, our revenue and results of operations would beadversely affected.***

 

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We structure and support private student loanprograms for commercial banks, including JP Morgan Chase Bank, N.A., assuccessor by merger to Bank One, N.A. and Bank of America, N.A. We alsostructure and support private student loan programs for marketing partners thatrefer their borrowers to a particular lending source, such as Charter One Bank,N.A. We refer to these lenders as referral lenders. Structural advisory feesand residuals from securitization of JP Morgan Chase Bank private label loansrepresented approximately 31% of our total service revenue for the first ninemonths of fiscal 2005 and approximately 43% of our total service revenue forfiscal 2004. Structural advisory fees and residuals from securitization of Bankof America private label loans represented approximately 14% of total servicerevenue for the first nine months of fiscal 2005 and approximately 9% of totalservice revenue for fiscal 2004. In addition, Bank of America is the exclusivelender for our GATE program clients. Our GATE programs contributed 4% of ourtotal service revenue in fiscal 2004. Structural advisory fees andresiduals from securitization of private label loans funded by Charter Onerepresented approximately 24% of our total service revenue for the first ninemonths of fiscal 2005 and approximately 17% of our total service revenue infiscal 2004.

 

We have agreements with these commercialbanks that govern the purchase of loans for securitization. Our agreement with JPMorgan Chase Bank, as successor by merger to Bank One, is scheduled toterminate in April 2007. Our agreement with Charter One is scheduled toterminate in May 2006, except with respect to loans marketed by CollegiateFunding Services, L.L.C. and funded by Charter One,in which case our agreement has a term through July 2007. Our agreement withBank of America governing the purchase of school channel loans can beterminated at any time upon 180 days notice. Of our two agreements with Bank ofAmerica that govern the purchase of GATE loans, one may terminate at any timeupon 120 days notice and the other may terminate as early as May 2006. Ouragreement with Bank of America governing the purchase of direct-to-consumer loansmay terminate as early as May 2006. Each client above has the right toterminate their agreement on short notice, generally 30 days or less, ifwe materially breach our agreement, including our failure to perform at servicelevels specified in those contracts. In addition, under the terms of our lenderclients’ guaranty agreements with TERI, both the lender and TERI may proposemodifications to loan program guidelines during the first calendar quarter ofeach year. If the parties are unable to agree on a proposed modification, suchas an adjustment of the guaranty fees, the party proposing the modification hasthe option of terminating the guaranty agreement, effective as of May 1 ofthat calendar year. Under its master loan guaranty agreement with us, TERI maynot propose a change to program guidelines without our consent. Similarly,under our agreements with lenders that have multi-year terms, the lender cannotchange the program guidelines without our consent, which we cannot unreasonablywithhold.

 

A significant decline in services to JPMorgan Chase, Bank of America or Charter One, or the termination of guarantyagreements between those lenders and TERI, could reduce the overall volume ofloans we facilitate, which could be difficult to replace through arrangementswith other lenders. Our revenue, business and financial results could suffer asa result.

 

***If our relationshipwith TERI terminates, our business could be adversely affected.***

 

In June 2001, we purchased the loanprocessing operations of TERI and entered into a series of agreements to governfuture securitizations of TERI-guaranteed loans. TERI continues to provideprivate student loan guarantee, education information and counseling servicesfor students, and is the exclusive third party provider of borrower defaultguarantees for our clients’ private label loans. We have entered into anagreement to provide various services for TERI and received fees from TERI forservices performed of $54.5 million, or 18% of total service revenue, for the firstnine months of fiscal 2005, $22.9 million, or 23% of total service revenue, forthe first nine months of fiscal 2004 and $35.1 million, or 18% of totalservice revenue, for fiscal 2004. In addition, we have agreed to undertake on abest-efforts basis to arrange or facilitate securitizations for a limitedcategory of TERI-guaranteed loans and have the right to receive structuraladvisory and other fees in connection with these securitizations. We also haveentered into an agreement to receive from TERI updated information about theperformance of the student loans it has guaranteed to allow us to supplementour database. Each of these agreements with TERI had an initial term through June 2006.In October 2004, we exercised our option to renew each agreement for anadditional five-year term, through June 2011. If our agreements with TERIterminate for any reason, or if TERI fails to comply with its obligations, ourbusiness would be adversely affected and the value of our intangible assetscould be impaired for the following reasons:

 

•                  we may not be able to offer our clients guaranteeservices from another guarantor and, accordingly, our access to loans and ouropportunities to structure securitization transactions may diminishsignificantly;

 

•                  we may not be successful in establishing anarrangement with a third party to provide the warranties that TERI currentlyprovides to lenders related to origination services. In such case, we may berequired to provide such warranties; and

 

•                  if TERI is unable to provide guarantee services, thefinancial guarantee insurance coverage we obtain in securitization transactionscould be more costly, if it is available at all.

 

In such events, demand for our services, including opportunities tostructure and facilitate securitization transactions, could decline, whichwould adversely affect our business. In addition, the value of the loan poolsin the securitization transactions we 

 

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facilitate could decline andthe value of our residuals could be reduced.

 

***Ourbusiness could be adversely affected if TERI’s ratings are downgraded, if TERIfails to maintain its not-for-profit status or if TERI’s not-for-profit statusceased to be a competitive advantage.***

In its role asguarantor in the private education lending market, TERI agrees to reimburselenders for unpaid principal and interest on defaulted loans. TERI is theexclusive provider of borrower default guarantees for our clients’ privatestudent loans. As of March 31, 2005, TERI had a Baa3 counterparty rating fromMoody’s Investors Service, which is the lowest investment grade rating, and aninsurer financial strength rating of A+ from Fitch Ratings. If these ratingsare lowered, our clients may not wish to enter into guarantee arrangements withTERI. In addition, we may receive lower structural advisory fees because thecosts of obtaining financial guarantee insurance for the asset-backedsecuritizations that we structure could increase. In such case, our businesswould be adversely affected.

TERI is anot-for-profit organization and, as a result, borrowers have been deemed unableto discharge in bankruptcy proceedings loans that TERI guarantees. If TERIloses its not-for-profit status, and TERI-guaranteed student loans becomedischargeable in bankruptcy, recovery rates on these loans could decline. Insuch event, our business could be adversely affected for the following reasons:

•                  our residuals in the securitization trusts coulddecline because of increased default rates and collection costs; and

 

•                  the securitization transactions that we structurecould be on less favorable terms because investors and financial guaranteeinsurers could become more concerned with default and recovery rates.

 

Assuming that TERI retains its not-for-profitstatus, TERI’s position as the leading provider of private education loan guaranteesmay be adversely affected by recent amendments to the U.S. federal bankruptcylaws. As a result of these amendments:

 

•      lenders whocurrently seek a guarantee from a not-for-profit entity such as TERI in orderfor their private student loans for higher education expenses to becomenon-dischargeable in bankruptcy may cease to do so; and accordingly

 

•      TERImay cease to have a competitive advantage over potential for-profit providersof guarantees of private student loans for higher education expenses.

 

As a result, lenders may be less inclined toutilize the TERI-guaranteed private label loan programs, which could, in turnharm our business and results of operations.

 

***Our business couldbe adversely affected if PHEAA fails to provide adequate or timely services orif our relationship with PHEAA terminates.***

 

As of March 31, 2005, Pennsylvania HigherEducation Assistance Agency, or PHEAA, serviced a majority of loans whoseorigination we facilitate. This arrangement allows us to increase the volume ofloans in our clients’ loan programs without incurring the overhead investmentin servicing operations. As with any external service provider, there are risksassociated with inadequate or untimely services. We regularly monitor theservicing portfolio reports, including delinquencies and defaults. Asubstantial increase in the delinquency rate could adversely affect our abilityto access profitably the securitization markets for our clients’ loans. Inaddition, if our relationship with PHEAA terminates, we would either need toexpand or develop a relationship with another TERI-approved loan servicer,which could be time consuming and costly. In such event, our business could beadversely affected. Although we periodically review the costs associated withestablishing servicing operations to service loans, we have no plans toestablish and perform servicing operations at this time.

 

***Suretylimits that some of our GATE school clients face may lead us to make depositsin the securitization trusts established by The National Collegiate Trust onbehalf of such schools.***

We haveutilized several special purpose entities for the securitizations we havestructured. One of these special purpose entities, The National CollegiateTrust, has established separate securitization trusts, which we refer to as theNCT trusts, that have purchased primarily GATE loans. Some of the schoolclients participating in our GATE program face limits on the amount of suretycoverage which our current insurance vendor is willing to provide on theirbehalf. This surety coverage provides NCT trust bondholders with assurance thatthe pledge commitment these school clients make to reimburse the NCT trusts fordefaults by their 

 

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student borrowers will befulfilled. We can provide no assurance that in NCT trusts established in thefuture, our current insurance vendor will provide adequate surety coverage forall schools participating in the GATE program.

 

As thesesurety coverage limits are reached, we will consider various options forproviding NCT trust bondholders in NCT trusts with additional creditenhancement so that school clients may continue to participate in the GATEprogram. For example, in our June 2004 securitization, we made a cashdeposit with the NCT trust on behalf of six schools, in an amount adequate tocover the additional surety amount required beyond what the GATE program’scurrent surety provider was willing to provide on the schools’ behalf. Ouraggregate cash surety deposit on behalf of these schools was $1.8 million.We could lose some or all of this deposit and future deposits we make on behalfof schools should such schools breach their commitments to reimburse the NCTtrusts for defaults by their student borrowers.

***Theoutsourcing services market for education lending is highly competitive, and ifwe are not able to compete effectively, our revenue and results of operationsmay be adversely affected.***

We assist national and regional financialinstitutions and educational institutions, as well as businesses and otherenterprises, in structuring and supporting their private education loanprograms. In providing our services, we receive fees for services we provideprimarily in connection with the securitization of our clients’ loans. Theoutsourcing services market in which we operate includes a large number ofservice providers, some of which have greater financial, technical andmarketing resources, larger customer bases, greater name recognition and moreestablished relationships with their clients than we have. Larger competitorswith greater financial resources may be better able to respond to the need fortechnological changes, compete for skilled professionals, build uponefficiencies based on a larger volume of loan transactions, fund internalgrowth and compete for market share generally. We may face competition from ourclients if they choose to provide directly the services that we currentlyprovide, and from third parties who decide to expand their services to includethe suite of services that we provide. We are aware of two principal competitors,SLM Corporation, or Sallie Mae, and Servus Financial Corporation, an affiliateof Wells Fargo Company, that offer a similar range of services to lenders. Ourbusiness could also be adversely affected if Sallie Mae’s recently announcedprogram to market private student loans directly to consumers becomessuccessful or if Sallie Mae seeks to market more aggressively to third partiesthe full range of services for private loan programs that we provide. If we arenot able to compete effectively, our revenue and results of operations may beadversely affected. In addition, if third parties choose to provide the rangeof services that we provide, pricing for our services may become morecompetitive, which could lower our profitability.

 

In addition, there has been significantconsolidation within the banking industry. For example, Charter One Financial,Inc., the publicly traded parent company of Charter One Bank, N.A., wasrecently acquired by Citizens Financial Group, Inc., and Bank One Corporationrecently merged with J.P. Morgan Chase & Co.  In addition, Sallie Mae recently acquired ourclient, Southwest Student Services Corporation, resulting in termination of ourrelationship with that client. Further consolidation could result in a loss ofbusiness if one or more of our clients were acquired by a competitor or alender that is not our client.

 

Historically, lenders in the education loanmarket have focused their lending activities on federal loans because of therelative size of the federal loan market and because the federal governmentguarantees repayment of these loans, thereby significantly limiting thelenders’ credit risk. The demand for our services could decline if lendersplace additional emphasis on the private education loan market and offer theservices we provide.

 

***The growth of ourbusiness could be adversely affected if annual and aggregate limitations underfederal student loan programs increase.***

 

We focus our business exclusively on themarket for private education loans, and more than 90% of our business isconcentrated in loan programs for post-secondary education. The availability ofloans that the federal government originates or guarantees affects the demandfor private student loans because students and their families often rely onprivate loans to bridge the gap between available funds, including familysavings, grants and federal and state loans, and the costs of post-secondaryeducation. The federal government currently places both annual and aggregatelimitations on the amount of federal loans that any student can receive, andthese limitations are adjusted in connection with funding authorizations fromthe United States Congress for programs under the Higher Education Act. Thelimitations on federal student loans have not been adjusted since 1992, andCongress is currently considering proposals that could increase the limitationsin the future. If Congress materially increases either the annual or aggregateloan limitations, or otherwise increases the funding available under federalstudent loan programs, demand for private student loans could weaken, whichcould adversely affect the volume of private loans and the securitizationtransactions that we facilitate and structure and, as a result, the growth ofour business.

 

***Access toalternative means of financing the costs of education may reduce demand forprivate student loans.***

 

The demand for private student loans couldweaken if student borrowers use other vehicles to bridge the gap betweenavailable funds and costs of post-secondary education. These vehicles include,among others:

 

•                  home equity loans, under which families borrow moneybased on the value of their real estate;

 

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•                  pre-paid tuition plans, which allow students to paytuition at today’s rates to cover tuition costs in the future;

 

•                  529 plans, which are state-sponsored investmentplans that allow a family to save funds for education expenses; and

 

•                  education IRAs, now known as Coverdell EducationSavings Accounts, under which a holder can make annual contributions foreducation savings.

 

If demand for private student loans weakens,we would experience reduced demand for our services, which would seriously harmour financial results.

 

***If competitorsacquire or develop a student loan database or advanced loan informationprocessing systems, our business could be adversely affected.***

 

We own a proprietary database of historicalinformation on private student loan performance that we use to help usestablish the pricing provisions of new loan programs, determine the terms ofsecuritization transactions and establish the present value of the structuraladvisory fees and residuals that we recognize as revenue. We also havedeveloped a proprietary loan information processing system to enhance ourapplication processing and loan origination capabilities. Our student loan databaseand loan information processing system provide us with a competitive advantagein offering our services. Third parties could create or acquire databases andsystems such as ours. For example, as lenders and other organizations in thestudent loan market originate or service loans, they compile over timeinformation for their own student loan performance database. If a third partycreates or acquires a student loan database or develops a loan informationprocessing system, our competitive positioning, ability to attract new clientsand business could be adversely affected.

 

***If our clients donot successfully market and sell student loans, our business will be adverselyaffected.***

 

We provide outsourcing services to lenders,marketing partners and educational institutions, as well as businesses andother organizations, in structuring and supporting their private education loanprograms. We rely on our clients to market and sell education loans to studentborrowers. If they do not devote sufficient time and resources to theirmarketing efforts, or if they are otherwise not successful in these efforts,then we may experience a reduction in the volume of loans that we process andsecuritize, and our business will be adversely affected.

 

***Changes in interest ratescould affect the value of our additional structural advisory fees and residualsreceivables, as well as demand for private student loans and our services.***

 

Student loans typically carry floatinginterest rates. Higher interest rates would increase the cost of the loan tothe borrower, which in turn, could lessen demand for our services and cause anincrease in prepayment and default rates for outstanding student loans. If thisoccurs, we may experience a decline in the value of our additional structuraladvisory fees and residuals receivables in connection with the securitizationsthat we facilitate. In addition, most of the student loans that our clientsoriginate carry floating rates of interest tied to prevailing short-terminterest rates. An increase in interest rates could reduce borrowing foreducation generally, which, in turn, could cause the overall demand for ourservices to decline.

 

***If we are unable toprotect the confidentiality of our proprietary database and information systemsand processes, the value of our services and technology will be adverselyaffected.***

 

We rely on trade secret laws and restrictionson disclosure to protect our proprietary database and information systems andprocesses. We have entered into confidentiality agreements with third partiesand with some of our employees to maintain the confidentiality of our tradesecrets and proprietary information. These methods may neither effectivelyprevent disclosure of our confidential information nor provide meaningfulprotection for our confidential information if there is unauthorized use ordisclosure.

 

We own nopatents and have filed no patent applications with respect to our proprietarydatabase or loan information processing systems. Accordingly, our technology isnot covered by patents that would preclude or inhibit competitors from enteringour market. Monitoring unauthorized use of the systems and processes that wedeveloped is difficult, and we cannot be certain that the steps that we havetaken will prevent unauthorized use of our technology. Furthermore, others mayindependently develop substantially equivalent proprietary information andtechniques or otherwise gain access to our proprietary information. If we areunable to protect the confidentiality of our proprietary information andknow-how, the value of our technology and services will be adversely affected.

***Aninterruption in or breach of our information systems may result in lostbusiness.***

We relyheavily upon communications and information systems to conduct our business. Aswe implement our growth 

 

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strategy and increase ourvolume of business, that reliance will increase. Any failure or interruption,or breach in security, of our information systems or the third partyinformation systems on which we rely could cause underwriting or other delaysand could result in fewer loan applications being received, slower processingof applications and reduced efficiency in loan processing. A failure,interruption or breach in security could also result in an obligation to notifyclients in states such as California that require such notification, withpossible civil liability resulting from such failure, interruption or breach.We cannot assure you that such failures, interruptions or breaches will notoccur, or if they do occur that we or the third parties on which we rely willadequately address them. We have implemented precautionary measures to avoidsystems outages and to minimize the effects of any data or telephone systemsinterruptions, but we have not instituted fully redundant systems. Theoccurrence of any failure, interruption or breach could significantly harm ourbusiness.

 

***If we experience a data security breach andconfidential customer information is disclosed, we may be subject to penaltiesimposed by regulators, civil actions for damages and negative publicity, whichcould affect our customer relationships and have a material adverse effect onour business.  In addition, current stateand federal legislative proposals, if enacted, may impose additionalrequirements on us to safeguard confidential customer information, which mayresult in increased compliance costs.***

Recently, data security breaches suffered bywell-known companies and institutions have attracted a substantial amount ofmedia attention, prompting state and federal legislative proposals addressingdata privacy and security.  If some ofthe current proposals are adopted, we may be subject to more extensive requirementsto protect the borrower information that we process in connection with theloans.  Implementation of systems andprocedures to address these requirements would increase our compliancecosts.  If we were to experience alarge-scale data security breach, such breach could generate negative publicityabout us and could adversely affect our relationships with our clients,including the lenders and educational institutions with which we dobusiness.  This could have a materialadverse effect on our business. In addition, pending legislative proposals, ifadopted, likely would result in substantial penalties for unauthorizeddisclosure of confidential consumer information.  

 

***Theloan origination process is becoming increasingly dependent upon technologicaladvancement, and we could lose clients and market share if we are not able tokeep pace with rapid changes in technology.***

Our ability to handle an increasing volume oftransactions is based in large part on the advanced systems and processes wehave implemented and developed. The loan origination process is becomingincreasingly dependent upon technological advancement such as the ability toprocess loans over the Internet, accept electronic signatures and provideprocess updates instantly. Our future success depends in part on our ability todevelop and implement technology solutions that anticipate and keep pace withthese and other continuing changes in technology, industry standards and clientpreferences. We may not be successful in anticipating or responding to thesedevelopments on a timely basis. If competitors introduce products, services,systems and processes that are better than ours or that gain greater marketacceptance, those that we offer or use may become obsolete or noncompetitive.Any one of these circumstances could have a material adverse effect on ourability to obtain and retain key clients.

 

We may be required to expend significantfunds to develop or acquire new technologies. If we cannot offer newtechnologies as quickly as our competitors, we could lose clients and marketshare. We also could lose market share if our competitors develop more costeffective technologies than those we offer or develop.

 

***We have expanded ouroperations rapidly in recent years, and if we fail to manage effectively ourgrowth, our financial results could be adversely affected.***

 

The number of our employees increased to 813regular employees and 18 seasonal and part time employees as of March 31, 2005from 345 regular employees and 12 seasonal employees as of March 31, 2004. Manyof these employees have very limited experience with us and a limitedunderstanding of our systems and controls. From our inception to March 31, 2005,our assets have grown to $543.7 million. Our revenue increased to $297.8million for the first nine months of fiscal 2005 from $98.1 million for thefirst nine months of fiscal 2004. Our revenue increased to $199.3 millionin fiscal 2004 from $91.4 million for fiscal 2003 and $41.3 millionfor fiscal 2002. Our growth may place a strain on our management, systems andresources. We must continue to refine and expand our business developmentcapabilities, our systems and processes and our access to financing sources. Aswe grow, we must continue to hire, train, supervise and manage new employees.We cannot assure you that we will be able to:

 

•                  expand our systems effectively;

 

•                  allocate our human resources optimally;

 

•                  identify and hire qualified employees; or

 

•                  incorporate effectively the components of anybusiness that we may acquire in our effort to achieve growth.

 

If we areunable to manage our growth, our operations and our financial results could beadversely affected.

 

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***We may be subject to state registration orlicensing requirements in jurisdictions where we are not currently registeredor licensed.  If we determine that we aresubject to the registration or licensing requirements of any jurisdiction, ourcompliance costs could increase significantly and other adverse consequencesmay result.***

 

Basedon the advice of counsel and, in some states, additional informal advice fromstate regulators, we have been operating on the basis that no registrations orlicenses for loan brokers and loan arrangers are required of us, except inPennsylvania, where local counsel had advised us that we needed to register asa “loan broker” with the Pennsylvania Department of Banking.  Although we believe that our priorconsultations with national and local counsel identified all material registration,licensing and other regulatory requirements then applicable, we are conductinga nationwide review of state registration and licensing requirements that maybe applicable to us now, based on the expansion of the scope of the services weprovide and the time elapsed since the initial review.  As a result of this review, we may determinethat registration and licensing are required in jurisdictions where we are notcurrently registered or licensed.  Evenif we are not physically present in a state, its regulators may take theposition that registration or licensing is required because we provide servicesby mail, telephone, the Internet or other remote means.  If we identify any states in whichregistration or licensing is required, we will proceed with registration orlicensing in the affected state. If any state asserts jurisdiction over ourbusiness, we will consider whether to challenge the assertion or proceed withregistration or licensing in the affected state. Compliance with suchrequirements could involve additional costs, which could have a materialadverse effect on our business.  Ourfailure to comply with these laws could lead to, among other things: (a)curtailment of our ability to continue to conduct business in the relevantjurisdiction, pending processing of registration or a license application, (b)administrative enforcement actions, (c) class action lawsuits, (d) theassertion of legal defenses delaying or otherwise affecting the enforcement ofloans, and (e) criminal as well as civil liability.  This could have a material adverse effect onour business.

 

***If the regulatory exemptions or rulingsthat allow us to conduct our business without registration or licensing aremodified or revoked, or the statutory and regulatory requirements change in thefuture, our compliance costs could increase substantially.***** **

** **

TheMassachusetts Division of Banks ruled that our business with TERI is notsubject to licensing because, as a provider of loan origination outsourcingservices, we do not conduct a lending business with consumers in our own nameand our processing centers are not generally open to the public.  The Massachusetts Small Loan Act requires anyperson that is engaged, for compensation, in the business of making smallloans, or in aiding or assisting the borrower or the lender in procuring ormaking such loans, to obtain a license. Under the statute, the business ofmaking small loans includes the making of loans of $6,000 or less with interestrates and expenses of more than 12% per year. The TERI-guaranteed loans that wefacilitate include amounts as small as $1,000, and a small portion of thoseloans have combined interest rates and fees exceeding 12%.  We couldtherefore become subject to the Small Loan Act with respect to these loans ifthe Massachusetts Division of Banks revokes its previous determination that ouroperations are exempt or determines that our activities exceed the scope of thedetermination.

 

Wecould also become subject to registration or licensing requirements due tochanges in existing federal and state laws and regulations. The Massachusettslegislature could, for example, modify the statutory requirements under theSmall Loan Act. If the Massachusetts legislature, or any other state or federalregulatory authority, changes existing laws and rules, or enacts new laws orrules, we could be forced to make changes in our relationships with lenders,educational institutions, guarantors, servicers or the trusts involved in thesecuritizations that we facilitate. Specifically, changes in existing laws and rules could also require usto implement additional or different programs and information technologysystems and could impose licensing, capital and reserve requirements andadditional costs, including administrative, compliance and third-party servicecosts.

 

***We may be exposed to liability for failuresof third parties with which we do business to comply with the registration,licensing and other requirements that apply to them.***

 

Thirdparties with which we do business, including federal and state chartered financialinstitutions as well as TERI, are subject to registration, licensing andextensive governmental regulations, including Truth-in-Lending laws and otherconsumer protection laws and regulations. As a result of the activities that weconduct for our clients, it may be asserted that we have some responsibilityfor their compliance with the laws and regulations applicable to them, whetheron contractual or other grounds. If it is determined that we have failed tocomply with our obligations with respect to these third parties, we could besubject to civil or criminal liability.

 

***We could also become subject toregistration or licensing and other regulatory requirements in Massachusettsand other states by expanding the scope or extent of our services.***

 

We are in the process of expanding the scope of theservices we provide on behalf of lenders to include certain advertising andmarketing functions. As a result of this expansion of our services, or if weexpand our services in the future to include, among others, loan guarantees,our current exemption from the Massachusetts Small Loan Act could beinvalidated, and consequently, we may need to obtain a license from theMassachusetts Division of Banks.  Inaddition, we may become subject to the laws and regulations of other statesgoverning such expanded services.  We mayalso become subject to state regulatory requirements if the extent of theactivities that we conduct in a particular state expands.  Compliance with such requirements could involve additional costs, whichcould have a material adverse effect on our business.  

 

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***Failure to comply with consumer protectionlaws could subject us to civil and criminal penalties and have a materialadverse effect on our business.***

 

Thefederal government and state governments regulate extensively the financialinstitutions and other entities that originate loans in the student loanmarket. These regulations include bankruptcy, tax, usury, disclosure, creditreporting, identity theft, privacy, fraud and abuse and other laws to protectborrowers. Changes in consumer protection laws or related regulations, or inthe prevailing interpretations thereof, may expose us to litigation, adverselyaffect the collection of balances due on the loan assets held by securitizationtrusts or otherwise adversely affect our business.  Moreover, changes in the consumer protectionlaws and related regulations, or in the prevailing interpretations thereof,could invalidate or call into question the legality of certain of our servicesand business practices.  Recent or futurechanges in federal and state bankruptcy and debtor relief laws may increasecredit losses on the loans held by securitization trusts and relatedadministrative expenses.  Violations ofthe laws or regulations governing our operations, or the operations of TERI orour other clients, could result in the imposition of civil or criminalpenalties, the cancellation of our contracts to provide services or ourexclusion from participating in education loan programs. These penalties orexclusions, were they to occur, would negatively impair our ability to operateour business. In addition, the loan assets held by securitization trusts thatwe have structured could be adversely impacted by violation of tax or consumerprotection laws. In such event, the value of our residual interests could alsobe adversely impacted. In some cases, such violations may render the loanassets unenforceable.

*** ***

***Recent litigation has sought to recharacterize“payday loan” and other originators as lenders; if litigation on similartheories were successful against us or any third party marketer, the loans thatwe securitize would be subject to individual state consumer protectionlaws. ***

 

Weprovide financial and educational institutions, as well as other organizations,with an integrated suite of services in support of private student loanprograms.  The lenders with which we workare federally-insured banks and, therefore, are not subject to many state consumerprotection laws, including limitations on interest rates, fees and othercharges.  In providing our services, wedo not act as a lender, guarantor or loan servicer, and the terms of the loansthat we securitize are regulated in accordance with the laws and regulationsapplicable to the lenders.

 

Theassociation between loan marketers and out-of-state national banks has comeunder recent scrutiny, specifically in the context of high-interest “paydayloans”.  Recent litigation asserts that payday loan marketers useout-of-state lenders in order to evade the usury and interest rate caps, andother consumer protection laws, imposed by the states where they dobusiness.  Such litigation has sought, successfully in some instances, torecharacterize the loan marketer as the lender for purposes of state consumerprotection law restrictions.  Similar civil actions have been brought inthe context of gift cards.  Webelieve that our activities, and the activities of third parties whosemarketing on behalf of lenders is coordinated by us, are distinguishable fromthe activities involved in these cases.  

 

Although we do not make, guarantee or servicethe loans and our activities are done in the name of and under the control andsupervision of lenders, additional state consumer protection laws would beapplicable to the loans if we, or any third party loan marketer whoseactivities we coordinate, were recharacterized as a lender, and the loans (orthe provisions governing interest rates, fees and other charges) could beunenforceable.  In addition, we could besubject to claims by consumers, as well as enforcement actions byregulators.  Even if we were not requiredto cease doing business with residents of certain states or to change ourbusiness practices to comply with applicable laws and regulations, we could berequired to register or obtain licenses or regulatory approvals that couldimpose a substantial cost on us.  Todate, there have been no actions taken or threatened against us on the theorythat we have engaged in unauthorized lending. However, such actions could  havea material adverse effect on our business.

 

***The price of ourcommon stock may be volatile.***

 

The trading price of our common stock mayfluctuate substantially, depending on many factors, some of which are beyondour control and may not be related to our operating performance. Thesefluctuations could cause you to lose part or all of your investment in ourshares of common stock. Those factors that could cause fluctuations include,but are not limited to, the following:

 

•                  difficulties we may encounter in the securitizationsthat we structure or the loss of opportunities to structure securitizationtransactions;

 

•                  price and volume fluctuations in the overall stockmarket from time to time;

 

•                  significant volatility in the market price andtrading volume of financial services and process outsourcing companies;

 

•                  actual or anticipated changes in our earnings orfluctuations in our operating results or in the expectations of securitiesanalysts;

 

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•                  general economic conditions and trends;

 

•                  negative publicity about the student loan marketgenerally or us specifically;

 

•                  major catastrophic events;

 

•                  loss of a significant client or clients;

 

•                  sales of large blocks of our stock; or

 

•                  departures of key personnel.

 

In the past, following periods of volatilityin the market price of a company’s securities, securities class actionlitigation has often been brought against that company. Due to the potentialvolatility of our stock price, we may therefore be the target of securitieslitigation in the future. Securities litigation could result in substantialcosts and divert management’s attention and resources from our business.

 

***Ifa substantial number of shares become available for sale and are sold in ashort period of time, the market price of our common stock could decline.***

We have onlybeen a public company since October 2003. For the twelve month periodended March 31, 2005, the average daily trading volume of our common stock onthe New York Stock Exchange was approximately 375,000 shares. As a result,future sales of a substantial number of shares of our common stock in thepublic market, or the perception that such sales may occur, could adverselyaffect the then-prevailing market price of our common stock.

                Asof April 30, 2005, we had 66,113,757 shares of common stock outstanding. Inconnection with our follow-on offering completed in January 2005, 31,955,605shares were subject to lock-up agreements with the underwriters of theoffering. These lock-up agreements expired on April 12, 2005.  Subject to limitations under federalsecurities laws, including in some cases the holding period requirements andvolume limitations of Rule 144, these shares are eligible for sale in thepublic market.  The market price ofshares of our common stock may drop significantly if our existing stockholderssell a substantial number of shares that had previously been subject to lock-upagreements.  A decline in the price ofshares of our common stock might impede our ability to raise capital throughthe issuance of additional shares of our common stock or other equitysecurities.

 

***Insidershave substantial control over us and could limit your ability to influence theoutcome of key transactions, including a change of control.***

Our directors and executive officers, andentities affiliated with them, beneficially own approximately 51% of theoutstanding shares of our common stock. As a result, these stockholders, if actingtogether, would be able to influence or control matters requiring approval byour stockholders, including the election of directors and the approval ofmergers or other extraordinary transactions. They may also have interests thatdiffer from yours and may vote in a way with which you disagree and which maybe adverse to your interests. The concentration of ownership may have theeffect of delaying, preventing or deterring a change of control of our company,could deprive our stockholders of an opportunity to receive a premium for theircommon stock as part of a sale of our company and might ultimately affect themarket price of our common stock.

 

***Some provisions inour certificate of incorporation and by-laws may deter third parties fromacquiring us.***

 

Our certificate of incorporation and by-lawscontain provisions that may make the acquisition of our company more difficultwithout the approval of our board of directors, including the following:

 

•                  only our board of directors, the chairman of ourboard of directors or our president may call special meetings of ourstockholders;

 

•                  our stockholders may take action only at a meetingof our stockholders and not by written consent;

 

•                  we have authorized undesignated preferred stock, theterms of which may be established and shares of which may be issued withoutstockholder approval;

 

•                  our directors may be removed only for cause by theaffirmative vote of a majority of the directors present at a meeting duly heldat which a quorum is present, or the holders of 75% of the votes that allstockholders would be entitled to cast 

 

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in the election of directors; and

 

•                  we impose advance notice requirements forstockholder proposals.

 

These anti-takeover defenses coulddiscourage, delay or prevent a transaction involving a change in control of ourcompany. These provisions could also discourage proxy contests and make it moredifficult for you and other stockholders to elect directors of your choosingand cause us to take other corporate actions you desire.

 

***Section 203 ofthe Delaware General Corporation Law may delay, defer or prevent a change incontrol that our stockholders might consider to be in their best interests.***

 

We are subject to Section 203 of theDelaware General Corporation Law which, subject to certain exceptions,prohibits “business combinations” between a Delaware corporation and an“interested stockholder,” which is generally defined as a stockholder whobecomes a beneficial owner of 15% or more of a Delaware corporation’s votingstock, for a three-year period following the date that such stockholder becamean interested stockholder. Section 203 could have the effect of delaying,deferring or preventing a change in control that our stockholders might considerto be in their best interests.

 

**Item 3—Quantitative and Qualitative Disclosures About Market Risk**

 

***General***

 

Market risk is the risk of change in fairvalue of a financial instrument due to changes in interest rates, equityprices, creditworthiness, foreign exchange rates or other factors. We manageour market risk through a conservative investment policy, the primary objectiveof which is preservation of capital. At March 31, 2005, cash and othershort-term investments consisted of balances in money market funds. As aresult, we do not believe a change in interest rate would have a materialimpact on the fair value of cash and other short-term investments.

 

***Risks Related toStructural Advisory Fees and Residuals***

 

Because there are no quoted market prices forour additional structural advisory fees and residuals receivables, we useassumptions to estimate their values. We base these estimates on ourproprietary historical data, third party data and our industry experience,adjusting for specific program and borrower characteristics such as loan typeand borrower creditworthiness. Increases in our estimates of defaults,prepayments and discount rates, increases in the spread between LIBOR andauction rates, as well as decreases in default recovery rates and themulti-year forward estimates of the LIBOR rate, which is the reference rate forthe loan assets and borrowings of the securitization trusts, would have anegative effect on the value of our additional structural advisory fees andresiduals. For an analysis of the estimated change in our structural advisoryfees and residuals receivables balances at March 31, 2005 based on changes inthese loan performance assumptions, see “—Application of Critical AccountingPolicies and Estimates—Service Revenue—Sensitivity Analysis.”

 

**Item 4—Controls and Procedures**

 

                Ourmanagement, with the participation of the our chief executive officer and chieffinancial officer, evaluated the effectiveness of the our disclosure controlsand procedures as of March 31, 2005.  Theterm “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC's rules and forms.  Disclosurecontrols and procedures include, without limitation, controls and procedures designedto ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure.  Management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Basedon the evaluation of our disclosure controls and procedures as of March 31,2005, our chief executive officer and chief financial officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.  

 

                Nochange in our internal control over financial reporting (as defined in Rules13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscalquarter ended March 31, 2005 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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**Part II. Other Information**

 

**Item 2—Unregistered Sales of Equity Securities and Use of Proceeds**

 

***(b) Use of Proceeds fromRegistered Securities***

 

In our initial public offering, we sold 7,906,250shares of common stock, including an over-allotment option of 1,031,750 shares,pursuant to a registration statement on Form S-1 (FileNo. 333-108531) that was declared effective by the Securities and ExchangeCommission on October 30, 2003. We received aggregate net proceeds ofapproximately $115.1 million, after deducting underwriting discounts and commissionsof approximately $8.9 million and expenses of the offering of approximately$2.5 million. From the effective date of the registration statement through March31, 2005, we have not spent any of the net proceeds of the IPO, which have beeninvested in cash and other short-term investments. Accordingly, none of the netproceeds of the IPO has been paid by us, directly or indirectly, to anydirector, officer or general partner of us, or any of their associates, or toany person owning ten percent or more of any class of our equity securities, orany of our affiliates.

 

In June 2004, we completed a follow-on publicoffering of 7,406,312 shares of our common stock, including an over-allotmentoption of 966,041 shares, pursuant to a registration statement on Form S-1(File No. 333-116142) that was declared effective by the SEC on June 22,2004. All of these shares were offered by selling stockholders, and we did notreceive any proceeds from the offering.

 

In January 2005, we completed a follow-on publicoffering of 3,933,605 shares of our common stock, including an over-allotmentoption of 513,078 shares, pursuant to a registration statement on Form S-3(File No. 333-120740) that was declared effective by the SEC on January 12,2005. All of these shares were offered by selling stockholders, and we did notreceive any proceeds from the offering.

 

**Item6—Exhibits**

 

See the Exhibit Index on the page immediatelypreceding the exhibits for a list of exhibits filed as part of this quarterlyreport, which Exhibit Index is incorporated herein by this reference.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| ** **         | **THE FIRST MARBLEHEAD CORPORATION** |
|--------------------|--------------------------------------|
| ** **         | ** **                           |
| Date: May 13, 2005 | By:                                  | /s/ Donald  R. Peck |   |
|               |                                 | Donald R. Peck |   |
|               |                                 | *Executive Vice President,* |   |
| * *           |                                 | *Chief Financial Officer, Treasurer and Secretary* |   |
| * *           |                                 | * * |   |
| * *           |                                 | *(Duly authorized officer and principal financial officer)* |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                               |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                    |
| 31.1                |       | Chief Executive Officer — Certification  pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                  |
| 31.2                |       | Chief Financial Officer — Certification  pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                  |
| 32.1                |       | Chief Executive Officer — Certification  pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2                |       | Chief Financial Officer — Certification  pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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