##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark one) [X]
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.
 For the Quarter Ended June 30, 2004 [  ]
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to Commission file number: 000-50846 Collegiate Funding Services, Inc.  Delaware
    
    04-3649118(State or other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)
 100 Riverside Parkway
Suite 125
Fredericksburg, Virginia 22406
(540) 374-1600
(Name, Address, Including Zip Code and Telephone Number, Including Area Code of Agent for Service) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.Yes   [  ]  No  [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act. Yes   [  ]  No  [X] Indicate the number of share outstanding of each of the issuers classes of
common stock, as of the latest practicable date 30,502,773 Shares of Common Stock, par value $.001 per share, were outstanding
as of July 30, 2004.




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Table of Contents PagePART I.  FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosure about Market Risk
    
    
    38Item 4. Controls and Procedures
    
    
    38PART II.  OTHER INFORMATION
    
    
    39Item 1. Legal Proceedings
    
    
    39Item 2. Changes in Securities and Use of Proceeds
    
    
    39Item 3. Defaults Upon Senior Securities
    
    
    39Item 4. Submission of Matters to a Vote of Security Holders
    
    
    39Item 5. Other Information
    
    
    39Item 6. Exhibits and Reports on Form 8-K
    
    
    39Signature
    
    
    40Exhibit IndexEX-31.1EX-31.2EX-32.1EX-32.2EX-99.1
  2




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PART I.  FINANCIAL INFORMATION 
 Item 1. Financial Statements COLLEGIATE FUNDING SERVICES, INC. CONSOLIDATED BALANCE SHEETS
(dollars in thousands) June 30,
    
    December 31,2004
    
    2003(unaudited)AssetsCash and cash equivalents
    
    $
    7,779
    
    
    $
    14,436Restricted cash
    
    
    144,086
    
    
    
    105,355Accounts receivable
    
    
    3,225
    
    
    
    2,624Student loans, net of allowance of $3,473 and $4,136, respectively
    
    
    3,735,516
    
    
    
    2,856,428Accrued interest receivable
    
    
    26,369
    
    
    
    17,923Income taxes receivable
    
    
    7,694
    
    
    
    7,694Property and equipment, net
    
    
    12,507
    
    
    
    12,095Goodwill
    
    
    193,084
    
    
    
    160,705Deferred financing costs, net
    
    
    16,410
    
    
    
    12,245Other assets
    
    
    13,399
    
    
    
    2,777Total assets
    
    $
    4,160,069
    
    
    $
    3,192,282Liabilities, preferred stock of consolidated subsidiary and
stockholders equityLiabilitiesAsset-backed notes and lines of credit
    
    $
    3,926,972
    
    
    $
    3,000,866Other debt obligations, net
    
    
    68,884
    
    
    
    40,531Capital lease obligations
    
    
    1,691
    
    
    
    1,896Accounts payable
    
    
    3,416
    
    
    
    2,234Accrued interest payable
    
    
    3,843
    
    
    
    2,385Other accrued liabilities
    
    
    15,805
    
    
    
    19,360Deferred income taxes
    
    
    17,378
    
    
    
    10,683Total liabilities
    
    
    4,037,989
    
    
    
    3,077,955Preferred stock of consolidated subsidiary
    
    
    93,444
    
    
    
    89,136Stockholders equityCommon stock  Class A  par value $0.001, 36,000,000 shares
authorized, 20,717,645 shares issued and outstanding
    
    
    21
    
    
    
    21Common stock  Class B  par value $0.001, 6,000,000 shares
authorized, 353,878 shares issued and outstanding
    
    
    
    
    
    
    Deferred compensation
    
    
    (97
    )
    
    
    (107
    )Notes receivable
    
    
    (328
    )
    
    
    (509
    )Additional paid-in capital
    
    
    20,555
    
    
    
    20,555Retained earnings
    
    
    8,485
    
    
    
    5,231Total stockholders equity
    
    
    28,636
    
    
    
    25,191Total liabilities, preferred stock of consolidated subsidiary
and stockholders equity
    
    $
    4,160,069
    
    
    $
    3,192,282
 See accompanying notes. 3




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COLLEGIATE FUNDING SERVICES, INC. CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data) (unaudited) For the three months
    
    For the six months endedended June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenueInterest income
    
    $
    31,194
    
    
    $
    13,971
    
    
    $
    58,058
    
    
    $
    24,155Interest expense
    
    
    15,518
    
    
    
    10,353
    
    
    
    28,596
    
    
    
    19,128Net interest income
    
    
    15,676
    
    
    
    3,618
    
    
    
    29,462
    
    
    
    5,027(Reversal of) provision for loan losses
    
    
    (1,467
    )
    
    
    (147
    )
    
    
    (540
    )
    
    
    199Net interest income after (reversal of) provision
for loan losses
    
    
    17,143
    
    
    
    3,765
    
    
    
    30,002
    
    
    
    4,828Fee income
    
    
    20,976
    
    
    
    11,631
    
    
    
    42,749
    
    
    
    43,009Net revenue
    
    
    38,119
    
    
    
    15,396
    
    
    
    72,751
    
    
    
    47,837ExpensesSalaries and related benefits
    
    
    16,172
    
    
    
    13,917
    
    
    
    30,153
    
    
    
    26,314Other selling, general and administrative expenses:Marketing and mailing costs
    
    
    10,887
    
    
    
    6,466
    
    
    
    17,312
    
    
    
    10,419Communications and data processing
    
    
    1,799
    
    
    
    1,862
    
    
    
    3,507
    
    
    
    3,470Management and consulting fees
    
    
    799
    
    
    
    875
    
    
    
    1,737
    
    
    
    1,438Professional fees
    
    
    1,374
    
    
    
    2,032
    
    
    
    2,429
    
    
    
    3,528Depreciation and amortization
    
    
    1,347
    
    
    
    1,142
    
    
    
    2,597
    
    
    
    1,697Other general and administrative
    
    
    2,645
    
    
    
    1,924
    
    
    
    5,054
    
    
    
    3,394Total other selling, general and administrative
expenses
    
    
    18,851
    
    
    
    14,301
    
    
    
    32,636
    
    
    
    23,946Swap interest
    
    
    2,023
    
    
    
    735
    
    
    
    3,605
    
    
    
    1,192Derivative mark-to-market (income) expense
    
    
    (5,888
    )
    
    
    (41
    )
    
    
    (6,114
    )
    
    
    2,912Total expenses
    
    
    31,158
    
    
    
    28,912
    
    
    
    60,280
    
    
    
    54,364Income (loss) before income tax provision
(benefit) and accretion of dividends on preferred
stock
    
    
    6,961
    
    
    
    (13,516
    )
    
    
    12,471
    
    
    
    (6,527
    )Income tax provision (benefit)
    
    
    2,705
    
    
    
    66
    
    
    
    4,909
    
    
    
    (920
    )Income (loss) before accretion of dividends
    
    
    4,256
    
    
    
    (13,582
    )
    
    
    7,562
    
    
    
    (5,607
    )Accretion of dividends on preferred stock
    
    
    2,192
    
    
    
    1,507
    
    
    
    4,308
    
    
    
    2,678Net income (loss)
    
    $
    2,064
    
    
    $
    (15,089
    )
    
    $
    3,254
    
    
    $
    (8,285
    )Earnings (loss) per common share, basic
    
    $
    0.10
    
    
    $
    (1.01
    )
    
    $
    0.15
    
    
    $
    (0.62
    )Earnings (loss) per common share, diluted
    
    $
    0.09
    
    
    $
    (1.01
    )
    
    $
    0.14
    
    
    $
    (0.62
    )Weighted average common shares outstanding, basic
    
    
    21,071,523
    
    
    
    14,920,358
    
    
    
    21,071,523
    
    
    
    13,403,517Weighted average common shares outstanding, diluted
    
    
    22,925,616
    
    
    
    14,920,358
    
    
    
    22,924,733
    
    
    
    13,403,517
 See accompanying notes. 4




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COLLEGIATE FUNDING SERVICES, INC. CONSOLIDATED STATEMENTS OF EQUITY

(dollars in thousands) (unaudited) Class A
    
    Class B
    
    Deferred
    
    
    
    
    
    Additionalcommon
    
    common
    
    compen-
    
    Notes
    
    paid-in
    
    Retainedstock
    
    stock
    
    sation
    
    receivable
    
    capital
    
    earnings
    
    TotalBalance, December 31, 2003
    
    $
    21
    
    
    $
    
    
    
    $
    (107
    )
    
    $
    (509
    )
    
    $
    20,555
    
    
    $
    5,231
    
    
    $
    25,191Proceeds from notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    181
    
    
    
    
    
    
    
    
    
    
    
    181Amortization of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Net income  January 1,
2004 through June 30, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,254
    
    
    
    3,254Balance, June 30, 2004
    
    $
    21
    
    
    $
    
    
    
    $
    (97
    )
    
    $
    (328
    )
    
    $
    20,555
    
    
    $
    8,485
    
    
    $
    28,636
 See accompanying notes. 5




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COLLEGIATE FUNDING SERVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands) (unaudited) Six months endedJune 30,2004
    
    2003Cash flows from operating activitiesNet income (loss)
    
    $
    3,254
    
    
    $
    (8,285
    )Adjustments to reconcile net income (loss) to net
cash provided by operating activities:Accretion of dividends on preferred stock
    
    
    4,308
    
    
    
    2,678Depreciation and amortization
    
    
    2,597
    
    
    
    1,697Loss on disposal of property and equipment
    
    
    70
    
    
    
    15Deferred income tax provision
    
    
    4,881
    
    

    
    (636
    )Amortization of deferred costs
    
    
    2,475
    
    
    
    2,449(Reversal of) provision for loan losses
    
    
    (540
    )
    
    
    199Changes in:Accrued interest receivable
    
    
    (8,445
    )
    
    
    (3,634
    )Accounts receivable and other assets
    
    
    (4,740
    )
    
    
    (486
    )Income taxes receivable
    
    
    
    
    
    
    (307
    )Accounts payable
    
    
    (153
    )
    
    
    (298
    )Accrued interest payable
    
    
    1,457
    
    
    
    297Other accrued liabilities
    
    
    (4,741
    )
    
    
    10,302Net cash provided by operating activities
    
    
    423
    
    
    
    3,991Cash flows from investing activitiesOriginations and purchases of student loans
    
    
    (977,838
    )
    
    
    (492,879
    )Net proceeds from student loan principal payments
    
    
    97,688
    
    
    
    50,897Acquisitions, net of cash acquired
    
    
    (34,957
    )
    
    
    (16,913
    )Purchases of property and equipment
    
    
    (2,648
    )
    
    
    (2,547
    )Net cash used in investing activities
    
    
    (917,755
    )
    
    
    (461,442
    )Cash flows from financing activitiesProceeds from asset-backed notes and lines of credit
    
    
    1,905,200
    
    
    
    838,775Payments on asset-backed notes and lines of credit
    
    
    (979,094
    )
    
    
    (13,565
    )Proceeds from other debt obligations
    
    
    34,000
    
    
    
    Payments on other debt obligations
    
    
    (5,750
    )
    
    
    (29,499
    )Payments on capital lease obligations
    
    
    (205
    )
    
    
    (147
    )Payment of financing costs
    
    
    (4,926
    )
    
    
    (4,194
    )Proceeds from notes receivable
    
    
    181
    
    
    
    204Proceeds from stock issuances
    
    
    
    
    
    
    10,500Change in restricted cash
    
    
    (38,731
    )
    
    
    (369,497
    )Net cash provided by financing activities
    
    
    910,675
    
    
    
    432,577Net (decrease) in cash and cash equivalents
    
    
    (6,657
    )
    
    
    (24,874
    )Cash and cash equivalents:Beginning
    
    
    14,436
    
    
    
    32,535Ending
    
    $
    7,779
    
    
    $
    7,661Supplemental disclosures:Cash payments for interest
    
    $
    23,423
    
    
    $
    15,676Cash payments for income taxes
    
    $
    28
    
    
    $
    22Non-cash financing and investing activities:Conversion of convertible notes
    
    $
    
    
    
    $
    5,365Capital lease of property and equipment
    
    $
    
    
    
    $
    2,257
 See accompanying notes. 6




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COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data) 1. Nature of the Business Collegiate Funding Services, Inc., formerly CFSL Holdings Corp. (the
Company), established in 2002, is a Delaware Corporation. The Company and a
wholly-owned subsidiary, CFSL Acquisition Corp. (CFSL Acquisition) were
established for the purpose of acquiring the operations of Collegiate Funding
Services, LLC (Predecessor or CFS). The Company continues the business of the
Predecessor, which was established in 1998. Collegiate Funding Services, Inc. is a vertically integrated education
finance company that markets, originates, finances and services education
loans. The Company markets education loans primarily through direct to consumer
programs, including targeted direct mail, telemarketing and the internet. Using
its direct-to-consumer platform, or DTC, along with other distribution
channels, and its origination capabilities, the Company assists consumers in
financing and refinancing the cost of undergraduate, graduate, professional,
career and continuing education training. The DTC marketing strategy is
supplemented with marketing through channels created by relationships with
membership organizations, alumni associations, universities and other entities
to reach customers and promote the Companys products under private label and
co-branded offerings. The Company finances, retains and services a substantial
portion of the loans it originates. Certain completed loan applications are sold to and funded by third party
lenders whereby the Company receives a fee for its services. Other completed
consolidation loan applications are funded through a subsidiary of the Company
and held and serviced by the Company. The Company has call centers located in
Virginia and Florida. The Company also has a loan-servicing center in
Mississippi and an affinity marketing subsidiary in Boston. In
April, 2004, the Company acquired Youth Media & Marketing
Networks, or Y2M, a company that provides affinity marketing of products and services,
with a focus on education finance products targeted at college student and
recent college graduates. The purchase price was approximately $35,662. Y2Ms
results of operations since April 21, 2004, are included in the Companys
results of operations for the quarter ended June 30, 2004. The following table summarizes the estimated fair values of the acquired
assets and assumed liabilities of Y2M at the date of acquisition: Cash and cash equivalents
    
    $
    705Accounts receivable
    
    
    1,034Property and equipment
    
    
    83Contractual relationships
    
    
    2,900Trademarks, copyrights, and domain names
    
    
    1,700Other assets
    
    
    1,198Total assets acquired
    
    
    7,620Accounts payable and other liabilities
    
    
    (2,523
    )Deferred income tax liability
    
    
    (1,814
    )Net assets acquired
    
    $
    3,283Allocation of the purchase price:Net assets acquired
    
    $
    3,283Goodwill
    
    
    32,379Total purchase price
    
    $
    35,662
 7




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COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 2. Initial Public Offering In July 2004, the Company completed its initial public offering of common
stock issuing 9,375,000 shares of common stock at $16.00 per share. The net
proceeds of the offering of $136,060 were used to pay the $93,951 liquidation
preference of all shares of the preferred stock issued by our subsidiary, and
the remaining $42,109 million was used repay a portion of the amounts
outstanding under the revolving line of credit. Immediately prior to the
consummation of the offering, the Company amended its amended and restated
certificate of incorporation to eliminate the Class A Common Stock and Class B
Common Stock in order to create a single class of common stock. As of the
closing of the offering, the Companys authorized capital stock consisted of
120,000,000 shares of common stock, par value $0.001 per share and 20,000,000
shares of preferred stock, par value $0.001 per share, of which 30,446,523
shares of common stock were issued and outstanding and no shares of preferred
stock were issued and outstanding. In addition, the Company issued 314,575
shares of restricted and unrestricted stock to management in connection with
the initial public offering. As of the closing of the offering the Company
had warrants to purchase 1,430,099 shares at an exercise price of $0.007 per
share. Also, options to purchase a total of 1,464,127 shares were outstanding
as of the closing of the offering. Of this total, there were options
to purchase 450,481 shares at an exercise price of $0.91 per share
and 1,013,646 shares at an exercise price of $16.00 per share. 3. Summary of Significant Accounting Policies Unaudited Interim Financial Statements The accompanying consolidated balance sheet as of June 30, 2004,
consolidated statements of operations for the three and six months ended June
30, 2004 and 2003, the consolidated statement of cash flows for the six months
ended June 30, 2004 and 2003 and the consolidated statement of equity for the
six months ended June 30, 2004, are unaudited. The unaudited financial
statements include all adjustments (consisting of normal recurring adjustments)
which are, in the opinion of management, necessary for a fair presentation of
such financial statements. The information disclosed in the notes to the
financial statements for these periods is unaudited. The results of operations
for the six months ended June 30, 2004 are not necessarily indicative of the
results to be expected for the entire fiscal year or for any future period and
should be read in conjunction with the Companys annual audited consolidated
financial statements and notes included in our registration statement on Form
S-1 dated July 15, 2004. Our quarterly results of operations have varied significantly in the past
and are expected to continue to vary significantly in the future. Our
quarterly results of operations in any period will be particularly affected by
the amount and timing of our loan sales. We give borrowers who complete loan
applications during the second quarter the option to fund their loans prior to
July 1, when the new rate is effective. Accordingly, if any years borrower
rate decreases over the prior years borrower rate, the origination of a
significant portion of the loan applications completed in the second quarter
will be shifted to the third quarter; conversely, if any years borrower rate
increases from the prior years borrower rate, a higher percentage of completed
applications will be originated in the second quarter. Stock Split In June 2004, the Company declared a 1.430099-for-one stock split in the
form of a stock dividend. Accordingly, all share and per share amounts have
been retroactively adjusted to give effect to this event. Estimates and assumptions The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Management believes that the estimates
utilized in preparing the financial statements are reasonable and prudent.
Actual results could differ from those estimates. Other accounting polices The remainder of our accounting policies are described in the Companys
annual audited consolidated financial statements. 8




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COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 4. Earnings Per Share SFAS No. 128, Earnings Per Share, requires the presentation of basic and
diluted earnings per share. Basic earnings (loss) per common share is computed
by dividing income (loss) attributable to common stockholders by the weighted
average number of common shares outstanding for the period. The diluted
earnings (loss) per common share data is computed using the weighted average
number of common shares outstanding plus the dilutive effect of common stock
equivalents, unless the common stock equivalents are anti-dilutive. The following details the computation of earnings (loss) per common share: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(unaudited)Net income (loss)
    
    $
    2,064
    
    
    $
    (15,089
    )
    
    $
    3,254
    
    
    $
    (8,285
    )Weighted average common shares calculation:Weighted average common shares outstanding,
basic
    
    
    21,071,523
    
    
    
    14,920,358
    
    
    
    21,071,523
    
    
    
    13,403,517Treasury stock effect of warrants and options
    
    
    1,854,093
    
    
    
    
    
    
    
    1,853,210
    
    
    
    Weighted average common shares
outstanding, diluted
    
    
    22,925,616
    
    
    
    14,920,358
    
    
    
    22,924,733
    
    
    
    13,403,517Earnings (loss) per common share:Earnings (loss) per common share, basic
    
    $
    0.10
    
    
    $
    (1.01
    )
    
    $
    0.15
    
    
    $
    (0.62
    )Earnings (loss) per common share, diluted
    
    $
    0.09
    
    
    $
    (1.01
    )
    
    $
    0.14
    
    
    $
    (0.62
    )
 For the three and six months ended June 30, 2003, the effect of
outstanding convertible notes converting into shares of common stock prior to
their conversion in April 2003 was not included in the computation of diluted
loss per common share as the effect would be anti-dilutive. In addition, the
treasury stock effect of warrants and options to purchase an aggregate of
1,880,580 shares of common stock that were outstanding as of June 30, 2003,
were excluded from the computation of diluted loss per common share as their
effect would be anti-dilutive. See Note 2 for shares outstanding after
completion of the Companys initial public offering in July, 2004. 5. Student Loans The Companys loan portfolio consists of loans originated under the
Federal Family Education Loan Program (FFEL Program or FFELP). The FFEL Program
is subject to comprehensive reauthorization every five years and to statutory
and regulatory changes. The most recent reauthorization was the Higher
Education Amendments of 1998, which is scheduled to expire on September 30,
2004. There are three principal categories of FFELP loans: consolidation loans,
Parent Loans for Undergraduate Students (PLUS) loans and Stafford loans.
Generally, Stafford loans and PLUS loans have repayment periods of between five
and ten years. Consolidation loans have repayment periods ranging from 12 to 30
years. At June 30, 2004 and December 31, 2003, the Company retained only FFELP
loans in its portfolio. The Companys FFELP loans are guaranteed against the borrowers default,
death, disability or bankruptcy. The guarantee on FFELP loans is provided by
certain state or nonprofit guarantee agencies, which are reinsured by the
federal government. The loans are 100% guaranteed in cases of death, disability
and bankruptcy and are guaranteed for 98% to 100% in other cases. The Company
accrues interest until receipt of proceeds from the guarantor. 9




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COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) The FFELP loans are also subject to regulatory requirements relating to
origination and servicing. In the event of default or the borrowers death,
disability or bankruptcy, the Company files a claim with the insurer or
guarantor of the loan, who, provided the loan has been properly originated and
serviced, pays the Company the unpaid principal balance and accrued interest on
the loan, less risk-sharing (in the case of defaults). Claims not immediately honored by the guarantor because of servicing or
origination defects are returned for remedial servicing, during which period
income is not earned. The Companys servicing experience with FFELP loans
resulted in one, zero, one and one outstanding rejected claims during the
three months ended June 30, 2004 and 2003 and the six months ended June 30,
2004 and 2003, respectively. The Company had no non-accrual loans at June 30,
2004 or December 31, 2003. The weighted average remaining term of student loans in the Companys
portfolio was approximately 23 years at both June 30, 2004 and December 31,
2003. 6. Allowance for Loan Losses The allowance for loan losses represents the amount estimated to absorb
probable losses inherent in the portfolio. The evaluation of the allowance for
loan losses is inherently subjective, as it requires material estimates that
may be susceptible to significant changes. The key estimates used to determine
the level of the allowance, include the probability of loss and the related
loss severity. In assessing the probabilities of default, management considers
the performance of their portfolio, including delinquency and charge-off
trends. In addition, because the portfolio has not matured to a point where
predictable loss patterns have developed, management reviews the published DOE
statistics and performance characteristics of the other lenders in developing
the Companys estimates of the probabilities of default. The primary factor
impacting our risk sharing rate is the existence of the 98% guarantee of
principal and interest on our loans. Generally, our loans carry a 98%
guarantee of principal and accrued interest. In May 2004, the Company was
notified by the DOE that it had been awarded Exceptional Performance status as
a servicer and thus its loss claims on loans it services at SunTech will be
paid to 100% of the unpaid principal and interest for the twelve month period
June 1, 2004 to May 31, 2005. As a result, the average risk-sharing rate used
in our allowance computation at June 30, 2004, was 1.52% compared to 2.00% at
December 31, 2003. The following table details the allowance for loan losses: Six months ended
    
    Year endedJune 30, 2004
    
    December 31, 2003Beginning balance
    
    $
    4,136
    
    
    $
    1,925(Reversal)/provision
    
    
    (540
    )
    
    
    2,357Charge-offs
    
    
    (123
    )
    
    
    (146
    )Ending balance
    
    $
    3,473
    
    
    $
    4,136
 A loan is placed on non-accrual status at the point at which a guarantee
claim is more than 60 days past due or it is concluded that collection of the
claim is in doubt. Loans are charged off upon receipt of the final claim
payment from the respective guarantor. 10




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 7. Debt Asset-backed notes and lines of credit The Company finances its loan originations through the sale of
asset-backed notes in the capital markets, using both public offerings and
private placements. Approximately 97% of the notes issued to date by the
Company have been structured to a AAA credit rating. The notes issued are
indexed to three month LIBOR or are auction rate based. After the initial
issuance, interest rates on the auction rate notes are reset every 28 days.
Fees are incurred at a rate equal to 0.26% per annum in connection with each
monthly auction. These fees are recorded as a component of interest expense.
The Company utilizes a warehouse credit facility principally to fund its
retention of FFELP loan originations, of which such loans collateralize the
associated borrowings. The Company pays the warehouse credit facility a credit
spread over the commercial paper rate, typically a 30-day rate, on the
warehouse credit facility. The principal balances outstanding, interest rates
and maturity dates are as follows: June 30, 2004
    
    December 31, 2003(unaudited)Principal
    
    
    
    Principaloutstanding
    
    Interest rate
    
    outstanding
    
    Interest rate
    
    Type
    
    Maturity date2004A SeriesClass A-1
    
    $
    249,000
    
    
    1.34%
    
    
    
    
    
    
    
    
    
    LIBOR
    
    December 2013Class A-2
    
    
    350,000
    
    
    1.46
    
    
    
    
    
    
    
    
    
    LIBOR
    
    June 2021Class A-3
    
    
    207,000
    
    
    1.50
    
    
    
    
    
    
    
    
    
    LIBOR
    
    September 2026Class A-4
    
    
    140,000
    
    
    1.63
    
    
    
    
    
    
    
    
    
    LIBOR
    
    September 2030Class A-5  6
    
    
    111,700
    
    
    1.47-1.53
    
    
    
    
    
    
    
    
    
    Auction
    
    December 2043Class B
    
    
    55,700
    
    
    1.47
    
    
    
    
    
    
    
    
    
    Auction
    
    December 20432003B Series
    
    
    
    
    
    
    
    
    Class A-1
    
    
    218,233
    
    
    1.69
    
    $
    249,000
    
    
    
    1.29
    %
    
    LIBOR
    
    September 2013Class A-2
    
    
    250,000
    
    
    1.85
    
    
    250,000
    
    
    
    1.45
    
    
    LIBOR
    
    March 2021Class A-3  7
    
    
    485,000
    
    
    1.40-1.50
    
    
    485,000
    
    
    
    1.19
    
    
    Auction
    
    December 2043Class B
    
    
    52,000
    
    
    1.53-1.55
    
    
    52,000
    
    
    
    1.25
    
    
    Auction
    
    December 20432003A SeriesClass A-1
    
    
    42,264
    
    
    1.65
    
    
    79,091
    
    
    
    1.23
    
    
    LIBOR
    
    March 2012Class A-2
    
    
    319,025
    
    
    1.89
    
    
    319,025
    
    
    
    1.47
    
    
    LIBOR
    
    September 2020Class A-3  6
    
    
    352,400
    
    
    1.35-1.50
    
    
    352,400
    
    
    
    1.18
    
    
    Auction
    
    March 2042Class B
    
    
    42,350
    
    
    1.45
    
    
    42,350
    
    
    
    1.32
    
    
    Auction
    
    March 20422002 SeriesClass A-8  15
    
    
    470,000
    
    
    1.41-1.56
    
    
    470,000
    
    
    
    1.24
    
    
    Auction
    
    July 2042Class B
    
    
    30,000
    
    
    1.50
    
    
    30,000
    
    
    
    1.33
    
    
    Auction
    
    July 20422001 SeriesClass A-1  7
    
    
    495,600
    
    
    1.45-1.55
    
    
    495,600
    
    
    
    1.25
    
    
    Auction
    
    December 2041Class B
    
    
    31,600
    
    
    1.65
    
    
    31,600
    
    
    
    1.33
    
    
    Auction
    
    December 2041Warehouse Facility
    
    
    25,100
    
    
    1.80
    
    
    144,800
    
    
    
    1.33
    
    
    
    
    July 2004 - 2006Total
    
    $
    3,926,972
    
    
    
    
    $
    3,000,866
 11




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) Other debt The Company entered into a revolving credit agreement on October 30, 2003.
Borrowings under this line bear interest at either LIBOR or prime rate at the
Companys option. On May 17, 2002, the Company also issued a fixed-rate note
to the sellers for $15,000 related to the acquisition of the predecessor
company by Lightyear Fund, L.P. (Lightyear) and its affiliates. June 30, 2004(unaudited)
    
    December 31, 2003Principal
    
    Interest
    
    Principal
    
    Interestoutstanding
    
    rate
    
    outstanding
    
    rate
    
    Maturity dateRevolving line of credit
    
    $
    54,500
    
    
    
    4.80
    %
    
    $
    26,250
    
    
    
    4.62
    %
    
    September 2006Fixed-rate note
    
    
    14,384
    
    
    
    4.47
    
    
    
    14,281
    
    
    
    4.47
    
    
    June 2007$
    68,884
    
    
    
    
    
    
    $
    40,531
 In July, the Company repaid $42,109 of the revolving line of credit and
the commitments were reduced to $30,000. 8. Derivative Financial Instruments The Company has not designated any of its derivatives as SFAS No. 133
hedge relationships and therefore records changes in their value as derivative
mark-to-market on the statement of income. The impact of the cash payments and
accruals are reported as swap interest on the statement of income. The fair
value of the derivatives that are positive is included with other assets on the
balance sheet and the fair value of the derivatives that are negative is
included in accrued liabilities on the balance sheet. The Company is exposed to interest rate risk as its asset-backed debt
notes are indexed to short-term indices (LIBOR and auction rates) and the
assets behave as fixed rate assets in the current interest rate environment.
Derivative instruments are utilized to reduce the Companys interest rate risk.
The key terms of the derivatives are as follows: June 30, 2004(unaudited)
    
    December 31, 2003Derivative type
    
    Notional amount
    
    Maturity date
    
    Pay  fixed rate
    
    Receive  floatingrate (LIBOR)
    
    Fair value
    
    Receive 
floatingrate (LIBOR)
    
    Fair valueSwap
    
    $
    500,000
    
    
    01/26/2005
    
    
    1.89
    %
    
    1.32%
    
    $
    (47
    )
    
    
    1.12
    %
    
    $
    (2,070
    )Swap
    
    
    225,000
    
    
    11/26/2004
    
    
    1.64
    
    
    1.30
    
    
    63
    
    
    
    1.12
    
    
    
    (606
    )Swap
    
    
    225,000
    
    
    11/26/2004
    
    
    1.64
    
    
    1.30
    
    
    63
    
    
    
    1.12
    
    
    
    (559
    )Cap (Sold)
    
    
    500,000
    
    
    01/26/2005
    
    
    2.09
    
    
    
    
    
    (268
    )
    
    
    
    
    
    
    (328
    )Swap
    
    
    550,000
    
    
    04/28/2005
    
    
    1.55
    
    
    1.32
    
    
    2,740Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,551
    
    
    
    
    
    
    $
    (3,563
    )
 The Company received $1,700 in proceeds from the sale of the Cap on
February 28, 2003. The amount is recorded as a derivative liability and is
marked-to-market over the term of the Cap. Payments on the Cap derivative will
be made only when the Commercial Paper rate exceeds 2.09%. No payments were
made in 2004 or 2003. The notional amounts of the Cap and the $500,000 swap
reduced to $250,000 each, on July 26, 2004. 9. Major Business Customers and Sources of Revenue Certain business customers generated significant amounts of the Companys
revenue. Fee income from one customer was $9,819, $5,974, $21,518, and $26,833
for the three months ended June 30, 2004, and June 30, 2003 and for the six
months ended June 30, 2004 and June 30, 2003, respectively. Fee income from a
second customer was $5,125, $2,160, $9,312, and $3,691 for the three months
ended June 30, 2004, and June 30, 2003 and for the six months ended June 30,
2004 and June 30, 2003, respectively. Fee income from a third customer was
$924, $1,128, $1,855, and $8,533 for the three months ended June 30, 2004, and
June 30, 2003 and for the six months ended June 30, 2004 and June 30, 2003,
respectively. 12




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued) 10. Stock Incentive Plan Effective May 17, 2002, the Company initiated the 2002 Stock Incentive
Plan to provide additional incentives to key personnel. The maximum aggregate
number of shares which may be issued is 1,001,070 shares of common stock. On
May 17, 2002, the Company granted 450,481 stock options with an exercise price
of $0.91 per common share, the fair market value of a share of common stock at
issuance. Subject to certain conditions, portions of the options may have
accelerated vesting to vest on the anniversary dates of the grants. At June
30, 2004, 81,087 shares were vested. For any year that the specified conditions
are not met, the options not then vesting will vest in 2009. In connection
with the execution of new employment agreements with management, options to
purchase 170,039 shares of common stock vested in July of 2004. In addition, in
connection with the initial public offering, the Company amended and restated
it stock incentive plan and increased the maximum number of shares which may be
issued to 2,788,250 shares of common stock. The fair value of the options under the Black-Scholes option pricing model
assumed: an interest rate of approximately 3%; no dividends; volatility of
approximately 25%; and an expected life of seven years. This options pricing
model requires the input of subjective assumptions. Using this model, the fair
value of the options as of the grant date was approximately $140. In
accordance with SFAS No. 123, the Company recognized the fair value of the
stock options as compensation expense, allocated over the vesting period. As
of June 30, 2004, the Company has recognized approximately $43 in compensation
expense. 13




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued) 11. Segment Data The Companys reportable segments are its loan origination operations and
its loan servicing operations. The Companys accounting policies for segments
are the same as those described in the Summary of Significant Accounting
Policies. Prior to the Company acquiring SunTech on April 15, 2003, the
Company operated in only one segment. The following table presents segment data for the three months ended June
30, 2004 (unaudited): Loan
    
    Loanorigination
    
    servicing
    
    Eliminations
    
    ConsolidatedNet revenueInterest income
    
    $
    31,108
    
    
    $
    86
    
    
    $
    
    
    
    $
    31,194Interest expense
    
    
    15,518
    
    
    
    
    
    
    
    
    
    
    
    15,518Net interest income
    
    
    15,590
    
    
    
    86
    
    
    
    
    
    
    
    15,676Reversal of loan losses
    
    
    (1,467
    )
    
    
    
    
    
    
    
    
    
    
    (1,467
    )Net interest income after reversal of loan losses
    
    
    17,057
    
    
    
    86
    
    
    
    
    
    
    
    17,143Fee income
    
    
    17,796
    
    
    
    4,506
    
    
    
    (1,326
    )
    
    
    20,976Net revenue
    
    
    34,853
    
    
    
    4,592
    
    
    
    (1,326
    )
    
    
    38,119ExpensesSalaries and related benefits
    
    
    13,740
    
    
    
    2,432
    
    
    
    
    
    
    
    16,172Other selling, general and administrative expenses:Marketing and mailing costs
    
    
    10,887
    
    
    
    
    
    
    
    
    
    
    
    10,887Communications and data processing
    
    
    1,379
    
    
    
    420
    
    
    
    
    
    
    
    1,799Management and consulting fees
    
    
    497
    
    
    
    302
    
    
    
    
    
    
    
    799Professional fees
    
    
    1,286
    
    
    
    88
    
    
    
    
    
    
    
    1,374Depreciation and amortization
    
    
    867
    
    
    
    480
    
    
    
    
    
    
    
    1,347Other general & administrative
    
    
    3,537
    
    
    
    434
    
    
    
    (1,326
    )
    
    
    2,645Total other selling, general and administrative expenses
    
    
    18,453
    
    
    
    1,724
    
    
    
    (1,326
    )
    
    
    18,851Swap interest
    
    
    2,023
    
    
    
    
    
    
    
    
    
    
    
    2,023Derivative mark-to-market (income)
    
    
    (5,888
    )
    
    
    
    
    
    
    
    
    
    
    (5,888
    )Total expenses
    
    
    28,328
    
    
    
    4,156
    
    
    
    (1,326
    )
    
    
    31,158Income before income taxes and accretion of dividends
on preferred stock
    
    $
    6,525
    
    
    $
    436
    
    
    $
    
    
    
    $
    6,961Total assets
- June 30, 2004
    
    $
    4,141,302
    
    
    $
    18,767
    
    
    $
    
    
    
    $
    4,160,069Total assets
- December 31, 2003
    
    $
    3,172,067
    
    
    $
    20,215
    
    
    $
    
    
    
    $
    3,192,282
 Intercompany transactions of $1,326 in other operating expenses in the
loan origination segment were paid as fee income to the loan servicing segment
and are eliminated in the consolidated financial statements. 14




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued) The following table presents segment data for the three months ended June
30, 2003 (unaudited): Loan
    
    Loanorigination
    
    servicing
    
    Eliminations
    
    ConsolidatedNet revenueInterest income
    
    $
    13,935
    
    
    $
    36
    
    
    $
    
    
    
    $
    13,971Interest expense
    
    
    10,353
    
    
    
    
    
    
    
    
    
    
    
    10,353Net interest income
    
    
    3,582
    
    
    
    36
    
    
    
    
    
    
    
    3,618Reversal of loan losses
    
    
    (147
    )
    
    
    
    
    
    
    
    
    
    
    (147
    )Net interest income after reversal of loan losses
    
    
    3,729
    
    
    
    36
    
    
    
    
    
    
    
    3,765Fee income
    
    
    9,189
    
    
    
    2,855
    
    
    
    (413
    )
    
    
    11,631Net revenue
    
    
    12,918
    
    
    
    2,891
    
    
    
    (413
    )
    
    
    15,396ExpensesSalaries and related benefits
    
    
    11,964
    
    
    
    1,953
    
    
    
    
    
    
    
    13,917Other selling, general and administrative expenses:Marketing and mailing costs
    
    
    6,452
    
    
    
    14
    
    
    
    
    
    
    
    6,466Communications and data processing
    
    
    1,630
    
    
    
    232
    
    
    
    
    
    
    
    1,862Management and consulting fees
    
    
    563
    
    
    
    312
    
    
    
    
    
    
    
    875Professional fees
    
    
    1,918
    
    
    
    114
    
    
    
    
    
    
    
    2,032Depreciation and amortization
    
    
    719
    
    
    
    423
    
    
    
    
    
    
    
    1,142Other general & administrative
    
    
    1,981
    
    
    
    356
    
    
    
    (413
    )
    
    
    1,924Total other selling, general and administrative expenses
    
    
    13,263
    
    
    
    1,451
    
    
    
    (413
    )
    
    
    14,301Swap interest
    
    
    735
    
    
    
    
    
    
    
    
    
    
    
    735Derivative mark-to-market (income)
    
    
    (41
    )
    
    
    
    
    
    
    
    
    
    
    (41
    )Total expenses
    
    $
    25,921
    
    
    $
    3,404
    
    
    $
    (413
    )
    
    $
    28,912Income (loss) before income taxes and accretion of
dividends on preferred stock
    
    $
    (13,003
    )
    
    $
    (513
    )
    
    $
    
    
    
    $
    (13,516
    )
 Intercompany transactions of $413 in other operating expenses in the loan
origination segment were paid as fee income to the loan servicing segment and
are eliminated in the consolidated financial statements. 15




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued) The following table presents segment data for the six months ended June
30, 2004 (unaudited): Loan
    
    Loanorigination
    
    servicing
    
    Eliminations
    
    ConsolidatedNet revenueInterest income
    
    $
    57,806
    
    
    $
    252
    
    
    $
    
    
    
    $
    58,058Interest expense
    
    
    28,596
    
    
    
    
    
    
    
    
    
    
    
    28,596Net interest income
    
    
    29,210
    
    
    
    252
    
    
    
    
    
    
    
    29,462Reversal of loan losses
    
    
    (540
    )
    
    
    
    
    
    
    
    
    
    
    (540
    )Net interest income after reversal of loan losses
    
    
    29,750
    
    
    
    252
    
    
    
    
    
    
    
    30,002Fee income
    
    
    36,369
    
    
    
    9,103
    
    
    
    (2,723
    )
    
    
    42,749Net revenue
    
    
    66,119
    
    
    
    9,355
    
    
    
    (2,723
    )
    
    
    72,751ExpensesSalaries and related benefits
    
    
    25,398
    
    
    
    4,755
    
    
    
    
    
    
    
    30,153Other selling, general and administrative expenses:Marketing and mailing costs
    
    
    17,312
    
    
    
    
    
    
    
    
    
    
    
    17,312Communications and data processing
    
    
    2,635
    
    
    
    872
    
    
    
    
    
    
    
    3,507Management and consulting fees
    
    
    1,060
    
    
    
    677
    
    
    
    
    
    
    
    1,737Professional fees
    
    
    2,252
    
    
    
    177
    
    
    
    
    
    
    
    2,429Depreciation and amortization
    
    
    1,639
    
    
    
    958
    
    
    
    
    
    
    
    2,597Other general & administrative
    
    
    6,909
    
    
    
    868
    
    
    
    (2,723
    )
    
    
    5,054Total other selling, general and administrative expenses
    
    
    31,807
    
    
    
    3,552
    
    
    
    (2,723
    )
    
    
    32,636Swap interest
    
    
    3,605
    
    
    
    
    
    
    
    
    
    
    
    3,605Derivative mark-to-market (income)
    
    
    (6,114
    )
    
    
    
    
    
    
    
    
    
    
    (6114
    )Total expenses
    
    
    54,696
    
    
    
    8,307
    
    
    
    (2,723
    )
    
    
    60,280Income (loss) before income taxes and accretion of
dividends on preferred stock
    
    $
    11,423
    
    
    $
    1,048
    
    
    $
    
    
    
    $
    12,471Total assets
- June 30, 2004
    
    $
    4,141,302
    
    
    $
    18,767
    
    
    $
    
    
    
    $
    4,160,069Total assets
- December 31, 2003
    
    $
    3,172,067
    
    
    $
    20,215
    
    
    $
    
    
    
    $
    3,192,282
 Intercompany transactions of $2,723 in other operating expenses in the
loan origination segment were paid as fee income to the loan servicing segment
and are eliminated in the consolidated financial statements. 16




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##### Table of Contents



COLLEGIATE FUNDING SERVICES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued) The following table presents segment data for the six months ended June
30, 2003 (unaudited): Loan
    
    Loanorigination
    
    servicing
    
    Eliminations
    
    ConsolidatedNet revenueInterest income
    
    $
    24,119
    
    
    $
    36
    
    
    $
    
    
    
    $
    24,155Interest expense
    
    
    19,128
    
    
    
    
    
    
    
    
    
    
    
    19,128Net interest income
    
    
    4,991
    
    
    
    36
    
    
    
    
    
    
    
    5,027Provision for loan losses
    
    
    199
    
    
    
    
    
    
    
    
    
    
    
    199Net interest income after provision for loan losses
    
    
    4,792
    
    
    
    36
    
    
    
    
    
    
    
    4,828Fee income
    
    
    40,567
    
    
    
    2,855
    
    
    
    (413
    )
    
    
    43,009Net revenue
    
    
    45,359
    
    
    

    2,891
    
    
    
    (413
    )
    
    
    47,837ExpensesSalaries and related benefits
    
    
    24,361
    
    
    
    1,953
    
    
    
    
    
    
    
    26,314Other selling, general and administrative expenses:Marketing and mailing costs
    
    
    10,405
    
    
    
    14
    
    
    
    
    
    
    
    10,419Communications and data processing
    
    
    3,238
    
    
    
    232
    
    
    
    
    
    
    
    3,470Management and consulting fees
    
    
    1,126
    
    
    
    312
    
    
    
    
    
    
    
    1,438Professional fees
    
    
    3,414
    
    
    
    114
    
    
    
    
    
    
    
    3,528Depreciation and amortization
    
    
    1,274
    
    
    
    423
    
    
    
    
    
    
    
    1,697Other general & administrative
    
    
    3,451
    
    
    
    356
    
    
    
    (413
    )
    
    
    3,394Total other selling, general and administrative expenses
    
    
    22,908
    
    
    
    1,451
    
    
    
    (413
    )
    
    
    23,946Swap interest
    
    
    1,192
    
    
    
    
    
    
    
    
    
    
    
    1,192Derivative mark-to-market
    
    
    2,912
    
    
    
    
    
    
    
    
    
    
    
    2,912Total expenses
    
    
    51,373
    
    
    
    3,404
    
    
    
    (413
    )
    
    
    54,364Income (loss) before income taxes and accretion of
dividends on preferred stock
    
    $
    (6,014
    )
    
    $
    (513
    )
    
    $
    
    
    
    $
    (6,527
    )
 Intercompany transactions of $413 in other operating expenses in the loan
origination segment were paid as fee income to the loan servicing segment and
are eliminated in the consolidated financial statements. 17




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our results of operations and
financial condition for the three and six months ended June 30, 2004 and 2003
should be read in conjunction with the Companys audited consolidated financial
statements and the notes to those statements. Our discussion contains
forward-looking statements based upon current expectations that involve risks
and uncertainties, such as our plans, objectives, expectations and intentions.
Actual results and the timing of events could differ materially from those
anticipated in these forward-looking statements as a result of a number of
factors. Our results of operations, our financial condition, and the price of
our common stock may be affected by many factors, some of which are outside of
our control. For a discussion of certain of these factors, see Exhibit 99.1 to
this report, which is incorporated herein by reference. Overview We are a vertically integrated education finance company that markets,
originates, finances and services education loans. We originated or facilitated

the origination of $4.2 billion in education loans in 2003 and we believe we
are one of the more significant originators of federal and private education
loans in the United States. Of our total loan originations for the full year
2003 and the six months ended June 30, 2004, $4.0 billion and $1.6 billion,
respectively, were federally guaranteed consolidation student loans made
through the Federal Family Education Loan Program, which we refer to as the
FFEL Program or FFELP. Beginning in May 2003, we increased our focus on
private education loans and, for the full year 2003 and the six months ended
June 30, 2004, we originated or facilitated the origination of $199.6 million
and $99.0 million, respectively, of these loans. As of June 30, 2004, we also
serviced approximately $9.9 billion in student loans made to over 396,000
customers. We commenced operations in 1998 through our predecessor company,
Collegiate Funding Services, LLC. On May 17, 2002, certain investors led by
Lightyear along with members of the management of Collegiate Funding Services,
LLC through the Company acquired all of the outstanding member interests in
Collegiate Funding Services, LLC for aggregate consideration of $162.6 million,
consisting of $147.6 million in cash and $15.0 million in principal amount of
subordinated debt. Funds for the acquisition were obtained from the issuance by
us and our subsidiary of common stock and preferred stock, along with warrants
to purchase common stock, convertible debt and debt securities. As a result of
the acquisition, all of our assets and liabilities were recorded at their
estimated fair value. The excess of the purchase price over the fair value of
net assets acquired was recorded as an increase of $7.0 million to student
loans, $0.9 million to debt discount and $151.6 million to goodwill. For
purposes of analyzing the results of operations for the year ended December 31,
2002, we have added the applicable amount for the periods prior to, and after,
the date of the acquisition by Lightyear. In 2002, we adopted a strategy of retaining a larger portion of the
federally guaranteed loans we originate, which has resulted in our holding a
portfolio of loans that has grown from $973.1 million at December 31, 2002 to
$3.7 billion at June 30, 2004. Prior to 2002, we sold substantially all of our
completed loan applications to third parties and received fees for those
applications at the time of sale. We believe that retaining FFELP loans in our portfolio benefits the
Company because it generally provides greater long-term value to the Company
than selling these loans, although our net income in current periods has been
lower than it would have been had we sold a larger percentage of the FFELP
loans we originate. Among the benefits of retaining loans is our ability to
take advantage of these loans limited credit risk, their duration and other
characteristics which allow us to realize a greater revenue stream over the
life of the loan. Selling the remainder of our originated loan applications
permits us to maintain a diversified source of funding for loan processing and
origination and build our relationships with financial institutions that
purchase our loans. We have sold and will continue to sell a portion of the
FFELP loan applications we originate in order to capitalize upon market
opportunities, provide sources of funding for loan processing and origination
expenses and generate additional operating cash flow. We do not currently fund
or retain any private loans. 18




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##### Table of Contents



The following table sets forth for the three and six months ended June 30,
2004 and 2003 our loan applications sold and retained and the loans in our
portfolio. Loan Originations and Portfolio Three months ended June 30,
    
    Six months ended June 30,2004
    
    2003
    
    2004
    
    2003Dollars
    
    %
    
    Dollars
    
    %
    
    Dollars
    
    %
    
    Dollars
    
    %(dollars in millions)FFELP consolidation, PLUS, Stafford loans:Sold(1)
    
    $
    321.5
    
    
    
    49.5
    %
    
    $
    200.4
    
    
    
    39.4
    %
    
    $
    701.9
    
    
    
    43.0
    %
    
    $
    1,000.7
    
    
    
    67.5
    %Retained
    
    
    328.5
    
    
    
    50.5
    
    
    
    308.1
    
    
    
    60.6
    
    
    
    930.1
    
    
    
    57.0
    
    
    
    482.5
    
    
    
    32.5Total FFELP loans originated(2)
    
    
    650.0
    
    
    
    100.0
    %
    
    
    508.5
    
    
    
    100.0
    %
    
    
    1632.0
    
    
    
    100.0
    %
    
    
    1,483.2
    
    
    
    100.0
    %Private loans:Sold(3)(4)
    
    
    53.7
    
    
    
    100.0
    %
    
    
    28.9
    
    
    
    100.0
    %
    
    
    99.7
    
    
    
    100.0
    %
    
    
    62.4
    
    
    
    100.0
    %Retained
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total private loans originated
    
    
    53.7
    
    
    
    100.0
    %
    
    
    28.9
    
    
    
    100.0
    %
    
    
    99.7
    
    
    
    100.0
    %
    
    
    62.4
    
    
    
    100.0
    %Total loans originated
    
    $
    703.7
    
    
    
    
    
    
    $
    537.4
    
    
    
    
    
    
    $
    1,731.7
    
    
    
    
    
    
    $
    1,545.6Portfolio of loans (all FFELP):(5)Monthly average for period
    
    $
    3,578.6
    
    
    
    
    
    
    $
    1,266.3
    
    
    
    
    
    
    $
    3,341.0
    
    
    
    
    
    
    $
    1,141.1Period end
    
    $
    3,703.0
    
    
    
    
    
    
    $
    1,401.2
    
    
    
    
    
    
    $
    3,703.0
    
    
    
    
    
    
    $
    1,401.2
    (1)
    
    Reflects the principal balance of loans with respect to which we sold the
originated applications.  (2)
    
    For the three months ended June 30, 2004 and 2003 and the six months
ended June 30, 2004 and 2003 includes $649.6 million, $508.5 million, $1.6
billion and $1.5 billion, respectively, of FFELP consolidation loans.  (3)
    
    Reflects the principal balance of loans with respect to which we
facilitated the origination by third party lenders.  (4)
    
    Includes Health Education Assistance consolidation loans which equaled
$0.2 million and $2.3 million for the three months ended June 30, 2004 and
2003, respectively and $0.7 million and $7.2 million for the six months
ended June 30, 2004 and 2003, respectively.  (5)
    
    Substantially all the loans in our portfolio are FFELP consolidation
loans. Currently, our portfolio does not contain any private loans.
Amounts reflect principal balance of loans without adjustments for
deferred loan costs which, as of June 30, 2004 and 2003, totaled $36.0
million and $14.8 million, respectively. Amounts also do not reflect the
allowance for loan losses of $3.5 million and $2.0 million as of June 30,
2004 and 2003, respectively. In April 2003, we acquired SunTech and began generating revenue from
servicing activities. Prior to this acquisition, SunTech serviced many of the
loans we originated and we paid SunTech a fee for loans in our portfolio
serviced by them. We currently service substantially all the loans in our
portfolio, as well as loans held by third-party lenders. We seek to obtain the
servicing rights for a majority of the loan originations we sell, which
accounts for a significant portion of our third-party servicing volume. In April 2004, we acquired Youth Media & Marketing Networks, or Y2M, for
approximately $35.7 million. Of the purchase price, $32.4 million was
allocated to goodwill, $4.7 million to other intangible assets and a net of $(1.4) million to other assets and payables. Y2M provides
affinity marketing of products and services, with a focus on education finance
products and services targeted at college students and recent college
graduates. Y2M uses direct mail, the Internet and print media in its marketing
efforts, which it complements by publishing online college newspapers. From the
launch of its education finance marketing efforts in May 2003 to December 2003,
Y2M facilitated the origination of $210 million of FFELP consolidation loans.
Y2M generates revenue from the loans originated through affinity marketing
agreements and advertising fees from its online college newspaper publishing
operations. Y2M will supplement our affinity marketing strategy through which
we market and originate loans through relationships with certain alumni
associations and industry groups with whom we co-brand our loan products. We finance the loans in our portfolio through asset-backed securitizations
and a secured warehouse facility and we record the obligations related to these
facilities as debt on our consolidated balance sheet. To date, we have
completed five securitizations that have provided $4.0 billion of funding. We
also have several forward purchase agreements, under which financial
institutions have agreed to purchase, or require that we sell to them, a
portion of the loans we market and originate. 19




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We currently operate in two reportable segments as follows: Loan origination.Includes marketing, origination and financing of loans,
including Youth Media & Marketing Networks since its acquisition in April 2004. Loan servicing.Includes servicing for our portfolio of loans and
third-party loans. Prior to our acquisition of SunTech in April 2003, we operated in a single
segment, loan origination, and all loans in our portfolio were serviced by
third-party servicers, one of which was SunTech. For additional information
relating to our segments, see note 11 of the notes to our consolidated
financial statements. We generate revenue primarily from three sources, which are described in
greater detail below. In our loan origination segment, we generate revenue from
fees we receive from the sale of originated loan applications and for marketing
loans for third parties, which we refer to collectively as fees on loan sales.
We also generate net interest income on our loan portfolio and cash balances in
our loan origination segment. In our loan servicing segment, we primarily
generate revenue from fees we receive for disbursement on loan applications and
for servicing loans. Our revenue in any period is directly affected by the amount of loans we
originate and service, as well as the percentage of those originated loan
applications that we decide to retain. We currently plan to retain in our
portfolio approximately 50% of the FFELP loans we originate this year. We will
periodically review our allocation of FFELP loan originations between loans we
retain and loan applications we sell, and, accordingly, our allocation may
change from period to period. Our reasons for altering our loan retention
target may include the characteristics of the loans we originate, the interest
rate environment, the status of our arrangements with financial institutions
which acquire loan applications from us and the volume of consolidation loan
applications originated during the period. Moreover, because we set this
targeted allocation on an annual, rather than quarterly, basis, our quarterly
allocations may fluctuate, sometimes significantly. Our fee income in any period will be directly affected by the volume of
originated loan applications we are able to complete and that we elect to sell
to third parties and the pricing we receive on those sales. We expect that the
percentage of our net revenue earned from fees on loan sales to decrease as we
continue to retain in our portfolio a significant percentage of the loans we
originate. We expect the amount of our fees on loan sales from private
education loans to increase as a result of an increase in the number of private
education loans that we originate or facilitate for origination. Our net interest income in any period will be affected by the size of our
retained loan portfolio and by the extent to which the interest income we earn
on our loan portfolio and cash balances exceeds our interest expense on the
debt we incur to finance our portfolio of loans and operating expenses. In
general, increases in interest rates will decrease our interest income, while
decreases in interest rates will increase our interest income. More
specifically, should interest rates rise, as expected in the near term, we will
no longer receive the additional yield on our loans which we refer to as fixed
rate floor income. Fixed rate floor income is the additional net interest
income we earn as a result of a decline in short-term interest rates from the
rates used to fix the borrowers rate on a consolidation loan. As a result of
the decline in short-term interest rates over the last three years, we have
earned fixed rate floor income during the past three years. We believe that a significant driver of the growth in consolidation loan
originations during the past three years has been the increased awareness of
consolidation loans on the part of many borrowers who have been out of school
for more than one year, as well as on the part of more recent graduates. This
recent increase in awareness is a result of extensive marketing efforts by us
and other lenders in this market coupled with the effects of the recent low
interest rate environment that has heightened interest in these products among
both borrowers and lenders. As an increasing percentage of borrowers who have
been out of school for more than one year have consolidated their loans in the
past several years, we believe that the pool of borrowers seeking to
consolidate their loans will decrease. In addition, as a result of two recent
regulatory interpretations, the overall consolidation loan market may decrease
because we currently cannot consolidate some loans originated under the Federal
Direct Loan Program that we were previously consolidating under the FFELP
consolidation loan program. We believe our reallocation of marketing resources
to other types of borrowers may mitigate the effects of any decrease in the
consolidation loan market. We also believe that consolidation of loans by
recent graduates with increased debt loads may mitigate the decline in total
consolidation loan originations in the market. Our consolidation loan
origination volume, accordingly, will decrease unless we increase our share of
the consolidation loan origination market. We believe that our recent addition
of Youth Media & Marketing Networks should contribute to our ability to
increase our market share. We 20




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##### Table of Contents



also expect that as the demand grows in financing to bridge the gap
between the cost of higher education and government-backed financial aid, the
amount of private loans we market or originate in the future will increase
through expanded use of our direct-to-consumer marketing platform. The most significant components of our operating expenses in our loan
origination segment are salaries and benefits and marketing expenses.
Substantially all of our marketing expenses and a majority of our salaries and
benefits in this segment are incurred in anticipation of generating loan
originations. Although such expenses are variable, if our marketing campaigns
are not successful, we may require one to two quarters to adjust our expenses
and our results of operations will be reduced due to these expenditures. We
believe that we are able to increase the amount of loans we service by up to
approximately 30% without significantly increasing our fixed expenses. We increased our marketing expenses from $10.4 million for the first six
months of 2003 to $17.3 million for the first six months of 2004. We expect
our marketing expenses to be higher in the second half of 2004, in part as a
result of our marketing of new products, our acquisition of Y2M and seasonal
fluctuations in marketing activities. We expect that our expenses also will
increase as a result of becoming a public company. The third quarter of 2004,
the period in which we consummated our initial public offering, will include
charges for bonuses paid in connection with the offering, with an aggregate
value of $1.4 million and the grant of options and restricted stock to
management with an aggregate value of $8.2 million, which will be amortized
over four years. Quarterly Fluctuations Our quarterly results of operations have varied significantly in the past
and are expected to continue to vary significantly in the future. Our quarterly
results of operations in any period will be particularly affected by the amount
and timing of our loan sales. Because we target a percentage of our loan
originations to be retained on an annual, rather than quarterly basis, our
quarterly results of operations will fluctuate. A number of additional factors,
some of which are outside of our control, will cause our quarterly results to
fluctuate, including:  
    
    an increase in loan consolidation in November and December,
as a result of the expiration of the six-month grace period;
    
    the effects of the July 1 reset in borrower interest rates.
We give borrowers who complete loan applications during the second
quarter the option to fund their loans prior to July 1, when the old
rate is effective, or after July 1, when the new rate is effective.
Accordingly, if any years borrower rate decreases over the prior
years borrower rate the origination of a significant portion of the
loan applications completed in the second quarter will be shifted to
the third quarter; conversely, if any years borrower rate increases
from the prior years borrower rate, a higher percentage of
completed applications will be originated in the second quarter.
    
    seasonal patterns affecting private in-school loans,
primarily an increase in private in-school loan originations in the
third and fourth quarter as students obtain loans to pay tuition,
and a decrease in private in-school loan activity in the second
quarter;
    
    seasonal patterns affecting marketing expenses, as we
generally market most heavily in the second and third quarters of
the year in an effort to inform recent college graduates of their
consolidation options and offer private in-school loans to students
paying tuition;
    
    the impact of general economic conditions;
    
    changes in interest rates; and
    
    the introduction of new product offerings. Components of Net Revenue We have two primary categories of revenue: net interest income and fee
income, which since April 2003 has included servicing fee income. 21




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##### Table of Contents



Net Interest Income Our net interest income is the excess of interest income we earn on our
loan portfolio and cash balances over our interest expense on the debt we incur
to finance our portfolio of loans and for general operating purposes. We define
net portfolio margin as being equal to the weighted average yield on our loans
and restricted cash less the interest expense on the debt we incur to finance
our retained loans. The current and future interest rate environment can and
will affect our net interest income and net portfolio margin. Interest income.Substantially all the loans in our portfolio are FFELP
consolidation loans which bear interest at a fixed rate. In addition, in
certain interest rate environments we may earn amounts on FFELP loans in excess
of the fixed rate of interest due from the borrower. Specifically, the
Department of Education will pay us the amount by which a federally determined
floating rate exceeds the fixed borrower rate. This amount is a Special
Allowance Payment, or SAP, and is based on a formula with respect to FFELP
loans held in our portfolio. SAPs, with respect to our FFELP consolidation
loans, are generally paid whenever the average of the 91-day financial
commercial paper rate in a calendar quarter plus a spread of 2.64% exceeds the
rate of interest which the borrower is obligated to pay. With respect to the
Stafford loans in repayment status and PLUS loans in our portfolio, SAPs are
generally paid whenever the average of the 91-day financial commercial paper
rate in a calendar quarter plus a spread of 2.34% or 2.64%, respectively
exceeds the borrower rate. Should interest rates rise as expected, we would
receive SAPs on loans in our portfolio. Our interest income is presented net of amortized origination fees. We pay
a one-time loan fee of 0.50% to the DOE on origination of consolidation,
Stafford and PLUS loans, which is amortized over the expected life of the loan.
This origination fee is required by the DOE to be paid by all lenders upon the
origination of FFELP loans. Our interest income is also reduced by a rebate
fee, which is required by the DOE to be paid to the DOE by all holders of FFELP
consolidation loans on a monthly basis at a rate equal to 1.05% per annum on
the FFELP consolidation loans we hold at the end of the month. Our interest income will also be reduced
by incentives we offer to borrowers that are designed to attract new borrowers
and improve their payment behavior. One incentive program reduces a borrowers
interest rate by 0.25% per annum for so long as the borrower makes monthly
payments through automatic deductions from his or her checking or savings
account. Approximately 30% of our borrowers currently participate in this
program. In addition, we offer borrowers an on-time incentive program that

reduces their interest rates by 1.00% per annum for so long as they make their
first 36 payments on time and continue to make subsequent payments on time.
Because we have implemented this program only recently, it has not resulted to
date in any significant reduction in interest income. However, we expect the
on-time incentive program to reduce the interest income we earn on our loan
portfolio commencing in 2005, particularly with respect to loans of borrowers
participating in the automatic deduction programs. We also earn interest income from unrestricted cash as well as restricted
cash held in our special purpose entities for our asset-backed securitizations. Interest expense.We have three categories of interest expense: interest
on our warehouse facility, interest on our asset-backed securitizations and
interest on our other debt obligations. Interest on our warehouse facility is based on the amount outstanding
under the facility plus a fee on unused capacity under the facility. The amount
outstanding under the warehouse facility is affected by the amount of loans we
originate in such period and the timing of securitizations. Deferred financing
costs associated with the warehouse facility are amortized using a method that
approximates the effective interest method and are recorded as interest
expense. Interest on our asset-backed securitizations is based on the principal
amount of notes outstanding under the facilities as well as the method of
determining the interest rate for each securitization tranche. All of our
asset-backed securitizations accrue interest at a variable rate. The rate
varies based upon when the notes were issued, the fixed spread above an index,
the index used and, in certain cases, auction results. The notes issued are
either indexed off of three-month LIBOR or at a rate determined at auction.
Interest rates on the auction rate notes are generally reset every 28 days. The
relative proportion of our asset-back securitizations that accrue interest
based on auction rates and on fixed spreads above an index will affect our cost
of funds. Broker-dealer and auction agent fees are incurred monthly at a rate
per annum of 0.26% in connection with the periodic auction for the auction rate
notes and are reflected in interest expense. Deferred financing costs
associated with issuing the asset-backed notes are amortized using the
effective interest method and are recorded as interest expense. 22




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Interest expense on other obligations relates to interest expense on items
not associated with financing our loan portfolio. Net portfolio margin and net interest income.In certain interest rate
environments, part of our net portfolio margin includes fixed rate floor
income. Fixed rate floor income is the additional net portfolio margin we
receive as a result of a decline in short-term interest rates from the rates
used to fix the borrowers rate on a consolidation loan. Fixed rate floor
income represents the amount by which interest income, determined at the
borrowers fixed rate, exceeds the amount determined using the DOE computed
variable rate. As a result of the decline in short-term interest rates over the
last three years, we have earned fixed rate floor income during the past three
years. Fixed rate floor income is reduced, and can be eliminated, in a rising
interest rate environment. (Reversal of) provision for loan losses.We record periodic provisions
for loan losses to maintain an allowance for loan losses which management
believes is sufficient to cover probable losses in the portfolio. The allowance
is an estimate based on the level of guarantee on our loans, the historical
experience of losses and the delinquency rates on our portfolio. Moreover,
since our portfolio is relatively new, we also review industry loss data in
assessing probabilities of loan default. In May 2004, we were notified by the DOE that we had been awarded
Exceptional Performance status as a servicer and thus our loss claims on loans
we service at SunTech will be paid to 100% of the unpaid principal and interest
for the twelve month period June 1, 2004 to May 31, 2005. Our loan loss
allowance was adjusted during the quarter ended June 30, 2004 to reflect this
status. The evaluation of the allowance for loan losses is inherently subjective,
as it requires material estimates that may be subject to significant changes.
The provision for loan losses reflects activity for the applicable period and
provides an allowance at a level that our management believes is adequate to
cover probable losses inherent in the loan portfolio. A loan is placed on non-accrual status at the point at which its guarantee
claim is more than 60 days past due or it is concluded that collection of the
claim is in doubt. Through June 30, 2004, no loans had been placed on
non-accrual status. Fee Income Fees on loan sales.In our loan origination segment, we receive fees for
selling FFELP consolidation and private consolidation loan applications to
third parties and for marketing private in-school loans for third parties. We
receive a fixed fee for each completed FFELP application we sell to third
parties. Generally, the amount of the fee is set forth in forward purchase
agreements with third parties which are negotiated for between one- and
three-year terms and apply to an aggregate number of loan applications sold
during each year of the agreement. We also receive fee income from third
parties to whom we sell completed private consolidation loan applications and
for whom we market private in-school loans. We are paid when a private lender
funds a loan that we referred to that lender or its originating partner.
Generally, the fee is calculated based on a percentage of the funded amount of
the loan. This rate is set forth in agreements with the third parties which
have a term of one year, with respect to private consolidation loans, and three
years, with respect to private loans, and applies to an aggregate amount of
loans funded each year. We recognize revenue from the loan sales when the loans
are funded. Fees for servicing.Since acquiring SunTech in April 2003, we have
received fee income for performing loan servicing activities for third parties
pursuant to servicing agreements. Servicing fees under these agreements are
calculated based on the number of accounts serviced for each client and
specific activities such as disbursement or filing claims with guarantee
agencies. The fees are billed monthly. The terms of the agreements vary from
one year to the life of the applicable loan portfolio. The intracompany
servicing fees paid to our servicer for servicing our own portfolio are
eliminated in our consolidated financial statements. Servicing rights recorded
on our balance sheet total $0.9 million at June 30, 2004 and relate to the
remaining unamortized balance recorded in connection with our acquisition of
SunTech. Because we were not the owner of any loans that we currently service
for third parties, nor have we paid for the right to service any other loan, we
do not have any other servicing rights recorded on our balance sheet. 23




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Expenses The majority of our operating expenses consist of salaries and related
benefits and marketing expenses. Salaries and related benefits include expenses
related to granting incentive stock options to our employees, which we expense
in accordance with SFAS No. 123. Marketing expenses include the cost of direct
mail campaigns, postage, list development, collateral printing, internet
marketing, affinity partner fees and school channel expenditures. The amount of
marketing expenses and a portion of the amount of salaries and benefits is
directly affected by the scope of our marketing campaigns and the amount of
loans we originate or facilitate for origination by other lenders. In addition,
our expenses include communications and data processing expenses, professional
fees, management and consulting fees, depreciation and amortization and other
general and administrative expenses. Debt extinguishment expenses.The costs associated with obtaining
financing are generally capitalized and recorded as deferred financing costs,
which are amortized over the life of the related financing. If we repay the
associated financing prior to its anticipated repayment schedule, we are
required to write off the remaining deferred financing costs, which is recorded
as debt extinguishment expenses. Derivatives.In connection with financing our portfolio, we enter into
interest rate swap and cap agreements from time to time. Generally, these
agreements have maturities of no more than 24 months. We record expenses
relating to payments we make under the swaps and caps and mark-to-market gains
and losses based on changes in their fair values from period to period. These
expenses and gains and losses are not reflected as part of net interest income. Critical Accounting Policies This Managements Discussion and Analysis of Financial Condition and
Results of Operations discusses our consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America, or GAAP. The preparation of these financial
statements requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the reported amounts of
income and expenses during the reporting periods. We base our estimates and
judgments on historical experience and on various other factors that we believe
are reasonable under the circumstances. Actual results may differ from these
estimates under varying assumptions or conditions. On an on-going basis, management evaluates its estimates and judgments,
particularly as they relate to accounting policies that management believes are
most critical  that is, they are most important to the portrayal of our
financial condition and results of operations and they require managements
most difficult, subjective or complex judgments, often as a result of the need
to make estimates about the effect of matters that are inherently uncertain.
These accounting policies include accounting for derivatives, determining the
level of the allowance for loan losses and accounting for business combinations
and goodwill. Accounting for derivatives We account for derivative and certain financial instruments in accordance
with SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, which requires that every derivative instrument, including certain
derivative instruments embedded in other contracts, be recorded at fair value
on the balance sheet as either an asset or liability. SFAS No. 133 requires that changes in the fair value of derivative
instruments be recognized currently in earnings unless specific hedge
accounting criteria as specified by SFAS No. 133 are met. We believe that our
derivatives are effective economic hedges through their respective maturity
dates. Other than the derivatives having shorter maturities than our
floating-rate debt, the derivatives variable indices are the same as the debt
and the notional amounts are less than the balance of the outstanding debt. We
do not hedge the exposure related to all amounts of floating-rate debt
outstanding. For three asset-backed securitizations that have bonds that
require variable interest payments based on LIBOR, we entered into interest
rate swaps with fixed-rate payments and, in turn, receive payments based on a
floating rate (equal to one-month LIBOR) from an investment grade-rated
counterparty. These swaps minimize the adverse impact of increased interest
expense that may result from a rise in short-term interest rates during the
initial months of the related securitization transaction. For an increase in
LIBOR, the swaps provide a direct offset to increasing interest expense for an
amount of debt equivalent to the swaps then-outstanding notional amounts. 24




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Our derivative instruments, the swaps and one interest rate cap, do not
meet the criteria to qualify for hedge accounting pursuant to SFAS No. 133, and
therefore the Company records changes in their value as derivative
mark-to-market expense on the statement of income. The impact of the cash
payments and accruals are reported as swap interest expense on the statement of
income. The fair value of the derivatives that are positive is included with
other assets on the balance sheet and the fair value of the derivatives that
are negative is included with accrued liabilities on the balance sheet. Allowance for loan losses The allowance for loan losses represents managements estimate of probable
losses on loans as of the reporting date. This evaluation process is conducted
periodically and is subject to numerous estimates and judgments. The two
primary estimates required in developing the appropriate level of the allowance
are the probability of default and the loss severity of such defaults. In
assessing the probability of defaults, we consider the performance of our
portfolio, including delinquency and charge-off trends. We also review the
published DOE statistics and the performance characteristics of other lenders.
In determining the allowance level we estimate the percentage of our portfolio
that we believe would default. The primary factor impacting our severity rate
is the existence of the 98% guarantee of principal and interest on our loans.
Generally, our loans carry a 98% guarantee of principal and accrued interest.
In May 2004, the Company was notified by the DOE that it had been awarded
Exceptional Performance status as a servicer and thus its loss claims on loans
it services at SunTech will be paid to 100% of the unpaid principal and
interest for the twelve month period June 1, 2004 to May 31, 2005. As a
result, the risk sharing estimate used in our allowance computation at June 30,
2004, was 1.52% as compared to 2.00% in prior periods. Our estimates of
default probabilities are subject to more variability than our severity
estimates, as the probability estimates are based on historical information and
trends that may not hold true into the future. We update our default
probabilities annually, or when trends in the portfolio or industry statistics
indicate interim revisions are required. As we expect our student loan
portfolio to continue to grow, even if our estimates do not change, we expect
our allowance for loan losses to increase over time. Such increases will result
from periodic loan loss provisions recorded through the income statement. A loan is charged off at the end of the month in which a final
determination has been received from the guaranty agency, either in the form of
a claim check or an uncurable rejected claim request. Business
combinations and goodwill Our predecessor was acquired in a business combination by CFS. We acquired
SunTech in April 2003 and Youth Media and Marketing Networks in April 2004. We
follow the guidance in SFAS No. 141 in accounting for business combinations.
The standard requires that the purchase consideration be recorded at fair value
and that the purchase price be allocated to assets and liabilities at their
fair values with any unallocated purchase price attributed to goodwill.
Judgments and estimates are required in these fair value determinations and the
fair value determinations can affect our results of operations. For example, in
the acquisition of our predecessor, a discount on the note issued to the
sellers as part of the purchase consideration was recorded to recognize the
liability at its fair value. Such discount is being amortized over the life of
the note as an adjustment to interest expense. Similarly, in our acquisition of
SunTech, we recorded fair value adjustments for certain assets acquired
including servicing rights that are amortized as expense in future periods. We
may make additional acquisitions in the future. The effect of the estimates of
fair value in any future acquisition will be dependent upon the nature of the
specific assets acquired and liabilities assumed. In the acquisition of our predecessor, the acquisition of SunTech and
the acquisition of Y2M, a significant portion of the purchase price was
allocated to goodwill. We had $193.1 million of goodwill at June 30, 2004 and $
160.7 million at December 31, 2003. We follow the guidance in SFAS No. 142 in
accounting for goodwill. The standard requires that we perform annual
impairment tests of our goodwill. The goodwill impairment test is a two-step
process. The first step is to make an estimate of the fair value of each
reporting unit and to compare the valuation to the carrying value of the
reporting unit including the goodwill. We have used third parties to assist us
in deriving estimates for the fair values used in our assessments. The result
of our first step has been that the estimated fair values exceed the carrying
amounts of the related reporting units indicating that no impairment exists. As
a result, we have not been required to perform the second step of the
impairment test to determine the amount of any impairment. We will continue to
perform the impairment assessment each year. The calculation of fair value in
accordance with SFAS No. 142 requires judgments and estimates, including
projections of future income and cash flows, the identification of appropriate
market multiples and the choice of an appropriate discount rate. Our estimates
of anticipated future income and cash flows could be reduced in the future due
to changes in 25




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circumstances. As a result, the carrying amount of our goodwill could be
reduced through impairment charges in the future. Changes in other estimates
could also affect the determination of fair value and could impact the carrying
amount of our goodwill. Results of Operations Three months ended June 30, 2004 compared to three months ended June 30,
2003 Net revenue.Net revenue was $38.1 million for the three months ended
June 30, 2004, an increase of 147.4% from net revenue of $15.4 million for the
three months ended June 30, 2003. The increase in net revenue was primarily the
result of an increase in interest income on student loans and fee income on
loan originations, offset by an increase in interest expense on asset-backed
securitizations. Net interest income Interest income.Interest income increased by $17.2 million, or 122.9%,
to $31.2 million for the three months ended June 30, 2004 compared to $14.0
million for the three months ended June 30, 2003. This increase was the result
of an increase in the average balance of loans in our portfolio, which grew to
$3.6 billion in the three months ended June 30, 2004 from $1.3 billion for the
comparable period of 2003. The amount of loan originations retained increased
to $328.5 million in the 2004 period compared to $308.1 million in the 2003
period. The impact of our increased portfolio was partially offset by changes
in interest rates and in the characteristics of our loan assets. The average
yield on our loan portfolio decreased to 4.59% for the three months ended June
30, 2004 from 5.09% for the comparable period of 2003 due to the inclusion in
the 2004 period of consolidation loans originated with a fixed rate in the
lower interest rate environment from July 1, 2003 to June 30, 2004. We received
SAPs totaling $1.7 million and $0.1 million for the 2004 and 2003 periods,
respectively. We received fixed rate floor income of $6.4 million and $3.9
million for the three months ended June 30, 2004 and 2003, respectively. The
increase in fixed rate floor income was primarily the result of the increase in
the average balance of loans in our portfolio and decreases in applicable
interest rates. Interest income on restricted cash decreased $1.3 million to
$0.3 million for the 2004 period compared to $1.6 million for the 2003 period
due primarily to a decrease in the amount of restricted cash. The decline in
restricted cash was the result of funds from asset-backed securitizations being
more quickly invested in loans or used to pay down securitization debt. Other
interest income was $0.1 million for both the three months ended June 30, 2004
and 2003. Interest expense.Interest expense increased by $5.1 million, or 49.0%,
to $15.5 million for the three months ended June 30, 2004 from $10.4 million
for the comparable period of 2003. Our average debt balance under our warehouse
and asset-backed securitizations increased by $1.9 billion to $3.8 billion for
the 2004 period from $1.9 billion for the 2003 period. Interest expense on
this debt increased $6.9 million to $14.5 million in the three months ended
June 30, 2004 compared to $7.6 million in the three months ended June 30, 2003.
Our average cost of funds was 1.54% for the 2004 period and 1.66% for the 2003
period. Interest expense on other debt obligations decreased to $1.0 million
in the three months ended June 30, 2004 compared to $2.7 million in the
comparable three months of 2003, primarily as a result of a change in the
composition of other debt obligations. In October 2003, we entered into a
revolving line of credit and borrowed $40.0 million which was used in
combination with the issuance of common and preferred stock to repay the senior
notes that had been issued to finance our acquisition by Lightyear. The new
revolving line of credit was at a substantially lower interest rate than the
senior notes. (Reversal of) provision for loan losses.We reversed a portion of the
allowance for loan losses in the amount of $1.9 million and recorded a
provision of $0.4 million for the three months ended June 30, 2004 compared to
a reversal of $0.8 million and a provision of $0.7 million in the three months
ended June 30, 2003. The reversal in 2004 resulted from the Company being
awarded Exceptional Performance status by the DOE and claims being guaranteed
at 100% for the period June 1, 2004 to May 31, 2005. Net portfolio margin and net interest income after (reversal of)
provision for loan losses.Net portfolio margin increased to 1.75% for the
three months ended June 30, 2004 from 1.37% for the three months ended June 30,
2003 primarily due to an increase in our average student loan balance relative
to restricted cash, partially offset by a decrease in the average yield on our
student loans. A reconciliation of net portfolio margin to the most comparable
information which has been prepared in accordance with GAAP is provided below.
See Net Portfolio Margin Analysis. As a result of the foregoing, net
interest income after (reversal of) provision for loan losses increased by
$13.3 million to $17.1 million for the 2004 period compared to $3.8 million for
the 2003 period. 26




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Fee income. Fees on loan sales.Fees on loan sales increased to $17.8 million for the
three months ended June 30, 2004 from $9.2 million for the three months ended
June 30, 2003, primarily reflecting the higher percentage and increased
volume of loans originated which were sold to third parties during the
2004 period compared to the 2003 period, as well as better pricing for
the sale of completed loan applications under our forward purchase agreements.
The amount of loans originated that were sold to, or marketed for, third
parties increased to $375.2 million in the 2004 period from $229.3 million for
the 2003 period. Included in our fees on loan sales were fees for marketing
private-in-school loans, which increased to $1.8 million for the 2004 period
from $0.2 million in the comparable period of 2003. Fees for servicing.We generated $3.2 million in loan servicing fees on a
consolidated basis for the three months ended June 30, 2004, compared to $2.5
million in the comparable 2003 period, due to the April 2003 acquisition of
SunTech. On a separate segment basis, we recorded loan servicing income for the
2004 and 2003 periods of $4.5 million and $2.9 million, respectively, including
$1.3 million and $0.4 million, respectively from the servicing of loans in our
portfolio. As of June 30, 2004 SunTech serviced $9.9 billion of loans, an
increase of 3.1% from the amount of loans serviced at March 31, 2004 and an
increase of 38.3 % from the amount of loans serviced at June 30, 2003. Expenses.Total expenses (excluding derivative related expenses)
increased $6.8 million, or 24.1%, to $35.0 million for the three months ended
June 30, 2004 compared to $28.2 million for the three months ended June 30,
2003, primarily as a result of increased salaries and related benefits, higher
marketing expenses, the April 2003 acquisition of SunTech and the April 2004
acquisition of Y2M. Salaries and benefits increased $2.3 million, or 16.5%, to $16.2 million
for the 2004 period compared to $13.9 million for the 2003 period. Salaries
and benefits increased due to increased salaries
in our loan origination segment primarily from the acquisition of Y2M and increased health care costs. Marketing expenses increased $4.4 million, or 67.7%, to $10.9 million for
the three months ended June 30, 2004 compared to $6.5 million for the three
months ended June 30, 2003, due to an increase in marketing activities across
all our product lines, including an increased focus on marketing private loans,
and the acquisition of Y2M. In addition, as a result of the introduction of the
national do not call list in September 2003, we significantly increased our
direct mail and internet advertising efforts. Communications
and data processing expense decreased $0.1 million for the
three months ended June 30, 2004 compared to the comparable period of 2003
primarily due to lower postage and delivery expenses. Management and consulting
fees decreased to $0.8 million for the 2004 period from $0.9 million for the
2003 period. Professional fees decreased $0.6 million, or 30.0%, to $1.4
million for the three months ended June 30, 2004 compared to $2.0 million for
the three months ended June 30, 2003 as a result of a reduction in advisory
fees. Other general and administrative expenses increased $0.7 million, or
36.8%, for the three months ended June 30, 2004 compared to the same period of
2003 as a result of increased travel, higher trust expenses related to two additional trusts and expenses related
to moving functions between offices. Depreciation and amortization increased
$0.2 million to $1.3 million in the 2004 period compared to $1.1 million in the
2003 period, primarily as a result of the acquisition of additional computer
equipment, other property and software in 2003 and 2004. Derivatives.Our interest rate swaps and cap resulted in aggregate swap
interest of $2.0 million for the three months ended June 30, 2004 and $0.7
million for the three months ended June 30, 2003 and derivative mark-to-market
income of $5.9 million for the 2004 period compared to less than $0.1 million
income for the comparable 2003 period due to higher notional amounts
outstanding. Income tax provision.Income tax provision increased by $2.6 million to a
$2.7 million provision for the three months ended June 30, 2004 compared to a
$0.1 million provision for the three months ended June 30, 2003 due to higher
earnings and the increase in our effective tax rate. Included in our net loss
for 2003 were non-deductible expenses, which caused our 2003 effective tax rate
to be at a rate below the statutory rate. Net income (loss).Net income (loss) increased to net income of $2.1
million for the three months ended June 30, 2004 from a net loss of $15.1
million for the three months ended June 30, 2003, primarily as result of the
increase in interest and fee income and the derivative mark-to-market gain as
described above. 27




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Six months ended June 30, 2004 compared to six months ended June 30, 2003 Net revenue.Net revenue was $72.8 million in the six months ended June
30, 2004, an increase of 52.3% from net revenue of $47.8 million in the six
months ended June 30, 2003. The increase in net revenue was primarily the
result of an increase in interest income on student loans and fee income from
loans serviced by SunTech, which was acquired in April 2003, offset in part by
an increase in interest expense on asset-backed securitizations. Net interest income. Interest income.Interest income increased by $33.9 million to $58.1
million in the first six months of 2004 compared to $24.2 million in the
comparable period in 2003. This increase was the result of an increase in the
average balance of loans in our portfolio, which grew to $3.3 billion in the
2004 period from $1.1 million in 2003 period, as we continued to retain a
greater portion of the federally guaranteed consolidation loans we originated.
The amount of loan originations retained increased to $930.1 million in six
months ended June, 30 2004 from $482.5 million in the first six months of June
30, 2003. The impact of our increased portfolio was partially offset by changes
in interest rates and in the pricing characteristics of our loan assets. The
average yield on our loan portfolio decreased to 4.57% in the 2004 period from
5.02% in the 2003 period due to the addition of consolidation loans originated
with a fixed rate in the lower interest rate environment from July 1, 2003 to
June 30, 2004. We received SAPs totaling $2.8 million in the first six months
of 2004 and $0.2 million in the first six months of 2003. We received fixed
rate floor income of $12.9 million in the six months ended June 30, 2004 and
$6.6 million in the comparable period of 2003, primarily as a result of the
increase in the average balance of loans in our portfolio and decreases in
applicable interest rates. Interest income on restricted cash decreased $1.8
million, or 75.0%, to $0.6 million in the first six months of 2004 due to a
decrease in the amount of restricted cash and lower interest rates. The decline
in restricted cash was the result of funds from asset-backed securitizations
being more quickly invested in loans or used to repay securitization debt.
Other interest income increased $0.2 million to $0.3 million in the first half
of 2004 compared to $0.1 million in the first half of 2003. Interest expense.Interest expense increased by $9.5 million, or 49.7%,
to $28.6 million in the first six months of 2004 from $19.1 million in the
first six months of 2003. Our average debt balance under our warehouse and
asset-backed securitizations increased by $2.0 billion to $3.6 billion in the
first half of 2004 from $1.6 billion in the first half of 2003. Interest
expense on this debt increased $14.0 million, or 107.7%, to $27.0 million in
the 2004 period compared to $13.0 million in 2003 period. The reduction in
short-term interest rates, together with a reduction in the portion of
asset-backed securitizations funded with auction rate notes, decreased our
average cost of funds to 1.54% for the six months ended June 30, 2004 from 1.64
% for the six months ended June 30, 2003. Interest expense on other
indebtedness decreased to $1.6 million in the 2004 period compared to $6.1
million in the 2003 period, primarily as a result of a change in the
composition of other debt obligations. In October 2003, we entered into a
revolving line of credit and borrowed $40.0 million, which in combination with
proceeds from the issuance of common and preferred stock, was used to repay our
senior notes that had been issued to finance our acquisition by Lightyear. The
new revolving line of credit was at a substantially lower interest rate than
the senior notes. (Reversal of) provision for loan losses.We reversed a portion of the
allowance for loan losses in the amount of $1.9 million and recorded a
provision of $1.4 million for the six months ended June 30, 2004 compared to a
reversal of $0.8 million and a provision of $0.1 million in the six months
ended June 30, 2003. The reversal in the 2004 period resulted from the Company
being awarded Exceptional Performance status by the DOE. Our allowance for
loan losses as a percentage of outstanding loans at quarter end decreased to
0.09% in the first six months of 2004 from 0.14% in the first six months of
2003. Net portfolio margin and net interest income after (reversal of) provision
for loan losses.Net portfolio margin increased to 1.76% in the six months
ended June 30, 2004 from 1.39% in the first six months of 2003 primarily due to
lower rates of interest on indebtedness used to finance our portfolio,
increased interest income and an increase in the average yield on our student
loans. Net interest income after provision for loan losses increased by $25.2
million to $30.0 million in the 2004 period compared to net interest income
after (reversal of) provision for loan losses of $4.8 million in the 2003
period. Fee income. Fees on loan sales.Fees on loan sales decreased to $36.4 million in the
first half of 2004 from $40.6 million in the first half of 2003, primarily
reflecting the lower percentage of loans originated which were sold to third
parties, offset in part by better pricing for the sale of completed loan
applications under our forward purchase 28




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agreements. The amount of loans originated that were sold to, or marketed
for, third parties decreased to $801.6 million
for the six months ended June 30, 2004, from $1,063.1 million
for the six months ended June 30, 2003.
Included in our fees on loan sales were fees for marketing private in-school
loans, which increased to $3.3 million in the first six months of 2004 from
$0.4 million in the comparable 2003 period. This increase primarily reflected
the launch in May 2003 of our program for private loan products targeted at
in-school students. Fees for servicing.We generated $6.4 million in loan servicing fees on a
consolidated basis for the first six months of 2004 compared to $2.5 million in
the first six months of 2003, in which SunTech was acquired in May 2003. On a
separate segment basis, we recorded loan servicing fees for the 2004 and 2003
periods of $9.1 million and $2.9 million, respectively, including $2.7 million
and $0.4 million, respectively from the servicing of loans in our portfolio. As
of June 30, 2004 SunTech serviced $9.9 billion of loans, an increase of 11.2%
from the amount of loans serviced at December 31, 2003 and an increase of 38.3%
from the amount of loans services at June 30, 2003. Expenses.Total expenses (excluding derivative related expenses)
increased $12.5 million, or 24.9%, to $62.8 million in the first six months of
2004 compared to $50.3 million in the first six months of 2003, primarily as a
result of increased salary and benefit expenses, increased marketing expenses,
the April 2003 acquisition of SunTech and the April 2004 acquisition of Y2M. Salaries and benefits increased $3.9 million, or 14.8%, to $30.2 million
in the six months ended June 30, 2004 compared to $26.3 million in the six
months ended June 30, 2003. Salaries and benefits increased in our loan
origination segment by $1.0 million and in our loan servicing segment by $2.8
million. Increases were due to increased health care costs and the acquisitions of SunTech in April 2003 and Y2M in
April 2004. Our salary and benefits attributable to our stock incentive plan
were negligible in the first six months of 2004 and 2003. Marketing expenses increased $6.9 million, or 66.3%, to $17.3 million in
the first six months of 2004 compared to $10.4 million in the first six months
of 2003 due to an increase in marketing activities across all our product
lines, including an increased focus on marketing private loans, increased
direct mail and internet advertising in response to the national do not call
list introduced in September 2003, and the acquisition of Y2M. Communications and data processing expense was approximately the same in
the 2004 and 2003 periods. Management and consulting fees increased to $1.7
million in the 2004 period from $1.4 million in the 2003 period. Professional
fees decreased $1.1 million to $2.4 million in the first half of 2004 compared
to $3.5 million in the first half of 2003 as a result of lower consultant
expenses. Other general and administrative expenses increased $1.7 million, or
50.0%, in the first six months of 2004 compared to the first six months of 2003
as a result of increased travel, franchise taxes supplies, office relocation
and corporate insurance. Depreciation and amortization increased $0.9 million to
$2.6 million in the 2004 period compared to $1.7 million in the 2003 period,
primarily as a result of the acquisition of additional computer equipment,
other property and software in 2003. Derivatives.Our interest rate swaps and interest rate cap resulted in
swap interest expense of $3.6 million in the first half of 2004 versus $1.2
million in the first half of 2003 and derivative mark-to-market income of $6.1
million in the first half of 2004 and expense of $2.9 million in the first half
of 2003. Income tax provision (benefit).Income tax provision increased by $5.8
million to a provision of $ 4.9 million for the six months ended June 30, 2004
compared to a benefit of $0.9 million for the six months ended June 30, 2003
due to the increase in income before taxes compared to a loss in 2003 and the
increased effective tax rate. Our effective tax rate was 39.4% for the first
six months of 2004 compared to (14.1)% for the first six months of 2003.
Included in our net loss for 2003 were non-deductible expenses, which caused
our 2003 effective tax rate to be at a rate below the statutory rate. Net income (loss).Net income (loss) increased to net income of $3.3
million for the first half of 2004 from a net loss of $8.3 million for the
first half of 2003, as a result of the factors discussed above, offset in part
by an increase in the accretion of dividends on preferred stock. 29




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Financial Condition At June 30, 2004 compared to December 31, 2003 Total assets increased $1.0 billion to $4.2 billion at June 30, 2004 from
$3.2 billion at December 31, 2003. This was due primarily to an increase in our loan
portfolio of approximately $0.8 billion, to $3.7 billion at June 30, 2004 from
$2.9 billion at December 31, 2003. All of the loans in our portfolio are FFELP
loans and over 99% are consolidation loans. Total liabilities increased $0.9 billion to $4.0 billion at June 30, 2004
from $3.1 billion at December 31, 2003. The growth in liabilities was a result
of an increase in debt incurred to finance our loan portfolio. Preferred stock of our consolidated subsidiary increased $4.3 million to
$93.4 million at June 30, 2004 from $89.1 million at December 31, 2003 as a
result of the accretion of dividends on the preferred stock of our subsidiary.
The liquidation preference of all preferred stock was paid in July 2004
from the net proceeds of the initial public offering in connection with the merger of the subsidiary into its parent in accordance with the plan of liquidation for federal tax purposes. As a result, there will
be no further accretion or payment of preferred dividends. Stockholders equity increased $3.4 million to $28.6 million at June 30,
2004 from $25.2 million at December 31, 2003 primarily as a result of net
income for the first half of 2004. Liquidity and Capital Resources We finance our operations through operating cash flow and borrowings under
a warehouse facility, asset-backed securitizations and a revolving line of
credit. Operating activities provided net cash of $0.4 million in the first six
months of 2004, a decrease of $3.6 million from the net cash provided by
operating activities of $4.0 million in the first six months of 2003. The
primary reason for this decrease was the change in our business strategy from
selling substantially all of our FFELP loans to third parties for fee income to
retaining a significant percentage of our FFELP loan originations in our
portfolio and funding this growth through secured financing arrangements,
primarily asset-backed securitizations. Net cash used in investing activities
increased to $917.8 million in the first six months of 2004 from $461.4 million
in the first six months of 2003 primarily as a result of the increase in size
of our retained portfolio. Net cash provided by financing activities increased
to $910.7 million in the first six months of 2004 from $432.6 million in the
first six months of 2003, primarily as a result of the increased financing for
our retained portfolio. We believe that the use of our warehousing capacity,
continued access to the asset-backed securitization market and forward purchase
agreements will provide adequate liquidity to fund our operations, loan
processing and originations and capital expenditures for the foreseeable
future. On October 30, 2003, we obtained from two national financial institutions
a three-year $45.0 million revolving credit facility, which was increased to
$62.5 million pursuant to an amendment on April 21, 2004 to acquire Youth Media
and Marketing Networks. The revolving line of credit bears interest, payable
quarterly, at LIBOR plus 3.50%. We are also required to pay a commitment fee of
0.50% on undrawn amounts under the facility. The facility is secured by
substantially all of our non-student loan assets, including the outstanding
capital stock or limited liability company membership interests of all of our
wholly-owned operating subsidiaries other than subsidiaries that hold our loan
portfolio. The credit facility contains certain mandatory prepayment and
commitment reduction provisions and event of default provisions (including
relating to a change of control), as well as affirmative and negative
covenants, which include restrictions on the payment of dividends, incurrence
of additional debt and capital expenditures. In addition, we are subject to,
and in compliance with, certain financial covenants including ratios related to
fixed charges coverage, interest coverage and leverage. We and certain of our
subsidiaries have guaranteed all of our obligations under the credit agreement.
We drew $40.0 million initially under the facility to retire a portion of the
senior notes that had been issued to help finance our acquisition by Lightyear
in May 2002. On April 21, 2004, we borrowed $34.0 million in order to fund the
acquisition of Youth Media & Marketing Networks. As of June 30, 2004,
approximately $54.5 million was outstanding on this revolving line of credit.
Upon completion of the initial public offering, approximately $42.1 million of
the net proceeds were used to repay a portion of the indebtedness outstanding
under the revolving line of credit, at which time the amount of the facility
was reduced to $30.0 million pursuant to a second amendment which became
effective at such time. As amended pursuant to the second amendment, the
facility will terminate in July 2005. 30




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In July 2003, we obtained a one-year, $500.0 million conduit warehouse
financing facility, through a special purpose company, to fund our loan
originations. In February 2004, we requested and received a temporary increase
in this facility to permit financing up to $1.0 billion to permit us to finance
additional loans prior to issuing asset-backed securities in April 2004, and as
of the end of April 2004 capacity under the facility returned to $500.0
million. We use the warehouse facility to fund our loan originations until such
time as we accumulate sufficient loans to effectively access the asset-backed
securitization market and we may seek to expand our warehouse availability from
time to time in order to continue to most efficiently access that market,
although we do not have a contractual right to increase this facility at this
time. We pay a fee of 0.15% per annum on the unused portion of the facility
and, accordingly, have maintained availability at levels we believe are
appropriate to fund our loan originations. The ability to draw on the facility
expires in July 2005 unless extended. It must be repaid in full by July 2006
unless extended. The warehouse facility is provided by a commercial paper
conduit with liquidity support provided by a national financial institution.
The facility is secured by our portfolio of loans financed under the facility.
The interest rate on funds advanced by the conduit lender is calculated based
on the commercial paper rate plus a margin and for funds advanced by the
liquidity provider at the Eurodollar rate plus 1.0% or the alternate base rate.
The interest rate on amounts outstanding under the warehouse facility on June
30, 2004 was 1.58%. As of June 30, 2004, $25.1 million was outstanding under
our warehouse facility. The conduit facility contains certain affirmative and
negative covenants as well as reporting requirements and covenants relating to
loan servicing. The affirmative covenants require us to, among other things,
preserve the federal guarantee on our FFELP loan portfolio. An event of default
under the conduit facility will occur if, among other things, the federal
guarantee on FFELP loans is reduced, the excess spread on the loans in our
portfolio drops below a certain rate or the default rate of loans in our
portfolio exceeds a certain percentage. In April 2004 and in 2003 and 2002 we issued $1.1 billion, $1.9 billion
and $500.0 million, respectively, of asset-backed notes in order to retain
loans on our balance sheet. These secured financings were issued primarily in
the domestic capital markets and are secured by separate pools of FFELP loans.
Securities issued in our securitizations accrue interest based on a rate of a
spread to LIBOR or set under an auction procedure related to the securities as
more fully described below. The securitization transactions require certain
levels of cash reserves and require we distribute cash flows to the
bondholders on a priority basis. Other than cash paid for servicing and administration, all of the
cash flows from our securitized assets have been paid to the bondholders and,
therefore, have not been available to us for business operations. As part of our securitization transactions, we borrowed funds in excess of
the principal balance of the loans included in the applicable securitization
transactions. A portion of these additional funds was used to repay our other
indebtedness and fund our operations. The timing of future cash flows may be
affected by the amount of loans in our portfolio in grace or deferment status
or with respect to which we have granted forbearance and the level of
delinquencies. In the first six months of 2004, we made $67.6 million in
principal payments and in the comparable 2003 period, we made $13.6 million
principal payments on our asset-backed securitizations. Our rights to cash
flows from securitized loans are subordinate to noteholders interests and these
loans may fail to generate any cash flows beyond what is due to pay the
noteholders. We anticipate continuing to access the domestic asset-backed
securitization market in 2004 and subsequent years. The timing of future
issuances will depend on market conditions. On May 17, 2002, in connection with our acquisition by Lightyear and its
affiliates, CFSL Acquisition Corp. issued a 4.47% subordinated note, due June
30, 2007, in the principal amount of $15.0 million to the previous owners of
the Company. The note may be redeemed at any time at the option of the Company,
and must be redeemed in the event of a change of control of the Company. 31




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##### Table of Contents



The following tables summarize our indebtedness and capital leases
outstanding as of June 30, 2004 and December 31, 2003: As of June 30, 2004Principal
    
    
    
    
    
    Interestamount
    
    Percent of total
    
    rate range
    
    Final maturity(2)(dollars in millions)07/20/04 -Warehouse facility
    
    $
    25.1
    
    
    
    0.6
    %
    
    
    1.58
    %
    
    07/18/06(3)Asset-backed notes:(1)Notes based on LIBOR
    
    
    1,775.5
    
    
    
    44.4
    
    
    
    1.34% - 1.89
    %
    
    03/01/12 - 03/28/21Notes based on auction rates
    
    
    2,126.4
    
    
    
    53.2
    
    
    
    1.35% - 1.65
    %
    
    12/01/41 - 12/01/43Total asset-backed notes and warehouse facility
    
    
    3,927.0
    
    
    
    98.2Revolving line of credit
    
    
    54.5
    
    
    
    1.4
    
    
    
    4.80
    %
    
    09/30/06Fixed-rate notes
    
    
    14.3
    (4)
    
    
    0.5
    
    
    
    4.47
    %
    
    06/30/07Fixed-rate capital leases
    
    
    1.7
    
    
    
    0.1
    
    
    
    6.34% - 7.82
    %
    
    04/01/08Total
    
    $
    3,997.5
    
    
    
    100.0
    %
 As of December 31, 2003Principal
    
    Percent
    
    Interestamount
    
    of total
    
    rate range
    
    Final maturity(2)(dollars in millions)07/20/04 -Warehouse facility
    
    $
    144.8
    
    
    
    4.7
    %
    
    
    1.52
    %
    
    07/18/06(3)Asset-backed notes:(1)Notes based on LIBOR
    
    
    897.1
    
    
    
    29.5
    
    
    
    1.23% - 1.47
    %
    
    03/01/12 - 03/28/21Notes based on auction rates
    
    
    1,959.0
    
    
    
    64.4
    
    
    
    1.18% - 1.33
    %
    
    12/01/41 - 12/01/43Total asset-backed notes and warehouse facility
    
    
    3,000.9
    
    
    
    98.6Revolving line of credit
    
    
    26.3
    
    
    
    0.8
    
    
    
    4.62
    %
    
    09/30/06Fixed-rate notes
    
    
    14.2
    (4)
    
    
    0.3
    
    
    
    4.47
    %
    
    06/30/07Fixed-rate capital leases
    
    
    1.9
    
    
    
    0.1
    
    
    
    6.34% - 7.82
    %
    
    04/01/08Total
    
    $
    3,043.3
    
    
    
    100.0
    %
   (1)
    
    Issued in securitization transactions.(2)
    
    The final maturity date is the stated legal maturity of the applicable
class of notes. However, the principal of the notes is paid based on the
receipt of principal payments under the applicable pools of loans and is
expected to be paid prior to the final maturity date.(3)
    
    The warehouse facility may be drawn upon to July 2005, unless it is
extended, and must be repaid by July 18, 2006.(4)
    
    Balances are net of unamortized discount of $0.6 million and $0.8 million
as of June 30, 2004 and December 31, 2003, respectively. 32




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Payments on outstanding indebtedness and capital and operating lease
obligations are due after June 30, 2004 in varying amounts as follows: Total
    
    < 1 year
    
    1 - 3 years
    
    3 - 5 years
    
    > 5 years(dollars in millions)Warehouse facility
    
    $
    25.1
    
    
    $
    25.1
    
    
    
    
    
    
    
    
    
    
    
    Asset-backed notes(1)
    
    
    3,901.9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,901.9Other indebtedness(2)
    
    
    68.8
    
    
    
    41.9
    
    
    
    26.9
    
    
    
    
    
    
    
    Capital lease obligations
    
    
    1.7
    
    
    
    0.4
    
    
    
    1.0
    
    
    
    0.3
    
    
    
    Operating lease obligations
    
    
    9.9
    
    
    
    1.9
    
    
    
    2.9
    
    
    
    2.4
    
    
    
    2.7Total
    
    $
    4,007.4
    
    
    $
    69.3
    
    
    $
    30.8
    
    
    $
    2.7
    
    
    $
    3,904.6
   (1)
    
    Principal on our asset-backed notes will be paid based on receipt of
principal payments under the applicable pools of loans and is expected to
be paid prior to final maturity date of the notes.(2)
    
    Includes $54.5 million outstanding under our revolving line of credit and
$14.3 million of our fixed-rate notes outstanding. In addition, we have forward purchase agreements under which we are
obligated to sell a minimum amount of FFELP loan applications, refer private
education loan applications and sell all of the funded private consolidation
loan applications we originate. These commitments generally run for between one
and three years. As of June 30, 2004 and December 31, 2003, we were obligated
to sell $902.7 million and $1.2 billion, respectively, in loan applications at
contractual rates under various agreements through December 31, 2004. Off Balance Sheet Arrangements We do not have any off balance sheet arrangements. As described above, all
of our asset-backed securitizations are treated as indebtedness on our balance
sheet. Loan Portfolio The table below describes the components of our loan portfolio as of June
30, 2004 and December 31, 2003: As of June 30,
    
    As of December 31,2004
    
    2003(dollars in millions)Percent
    
    
    
    
    
    PercentPrincipal(1)
    
    of total
    
    Principal(1)
    
    of totalFFELP loans:Consolidation
    
    $
    3,699.4
    
    
    
    99.9
    %
    
    $
    2,830.9
    
    
    
    99.9
    %PLUS
    
    
    2.5
    
    
    
    0.1
    
    
    
    2.9
    
    
    
    0.1Stafford
    
    
    1.1
    
    
    
    
    
    
    
    0.3
    
    
    
    Total
    
    $
    3,703.0
    
    
    
    100.0
    %
    
    $
    2,834.1
    
    
    
    100.0
    %
   (1)
    
    Amounts reflect principal balance of loans without adjustments for deferred
loan costs which, as of June 30, 2004, totaled $36.0 million and as of December
31, 2003 totaled $26.4 million, respectively. Amounts also exclude the
allowance for loan losses of $3.5 million as of June 30, 2004 and $4.1 million
as of December 31, 2003. 33




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##### Table of Contents



The table below shows the repayment status of loans and delinquency
amounts as of June 30, 2004 and 2003 and December 31, 2003. Delinquencies have
the potential to adversely impact our earnings through increased servicing and
collection costs and write-offs. As of June 30,
    
    As of December 31,2004
    
    2003Percent of
    
    Percent of
    
    
    
    
    
    Percent of
    
    Percent ofloan
    
    loans in
    
    
    
    
    
    total loan
    
    Loans inPrincipal
    
    portfolio
    
    repayment
    
    Principal(1)
    
    portfolio
    
    repayment(dollars in millions)Loans in school/grace/deferment(2)
    
    $
    420.9
    
    
    
    11.3
    %
    
    
    
    
    
    $
    275.7
    
    
    
    9.7
    %Loans in forbearance(3)
    
    
    239.8
    
    
    
    6.5
    
    
    
    
    
    
    
    167.4
    
    
    
    5.9Loans in repayment status:Current
    
    
    2,818.2
    
    
    
    76.1
    
    
    
    92.6
    %
    
    
    2,276.7
    
    
    
    80.3
    
    
    
    95.1
    %Delinquent 31-60 days(4)
    
    
    110.2
    
    
    
    3.0
    
    
    
    3.6
    
    
    
    54.0
    
    
    
    1.9
    
    
    
    2.3Delinquent 61-90 days
    
    
    36.4
    
    
    
    1.0
    
    
    
    1.2
    
    
    
    21.4
    
    
    
    0.8
    
    
    
    0.9Delinquent over 90 days(5)
    
    
    77.5
    
    
    
    2.1
    
    
    
    2.6
    
    
    
    38.9
    
    
    
    1.4
    
    
    
    1.7Total loans in repayment
    
    
    3,042.3
    
    
    
    82.2
    
    
    
    100.0
    %
    
    
    2,391.0
    
    
    
    84.4
    
    
    
    100.0
    %Total loan portfolio
    
    $
    3,703.0
    
    
    
    100.0
    %
    
    
    
    
    
    $
    2,834.1
    
    
    
    100.0
    %
   (1)
    
    Amounts reflect principal balance of loans without adjustments for
deferred loan costs, which, as of June 30, 2004 and December 31, 2003
totaled $36.0 million, and $26.4 million, respectively. Amounts also do
not reflect the allowance for loan losses of $3.5 million and $4.1 million
as of June 30, 2004 and December 31, 2003, respectively.(2)
    
    Loans for borrowers who still may be attending school or engaging in
other permitted educational activities and are not yet required to make
payments on the loans, e.g., residency periods for medical students or a
grace period for bar exam preparation.(3)
    
    Loans for borrowers who have temporarily ceased making full payments due
to hardship or other factors, according to a schedule approved by the
servicer consistent with the established loan program servicing procedures
and policies.(4)
    
    The period of delinquency is based on the number of days scheduled
payments are contractually past due and relate to loans in repayment
status, that is, receivables not charged off, and not in school, grace,
deferment or forbearance.(5)
    
    Includes loans of $4.6 million and $1.9 million as of June 30, 2004 and
December 31, 2003, respectively, in claim status, which are loans that are
over 270 days past due, which have gone into default and have been
submitted to the guaranty agency for FFELP loans to process the claim for
payment. Net Portfolio Margin Analysis The following table sets forth the net portfolio margin on average student
loans and restricted cash for the periods indicated. We define net portfolio
margin as being equal to the weighted average yield on our loans and restricted
cash after amortization of capitalized origination costs and purchase
accounting adjustments, less the weighted average interest expense on the debt
we incur to finance our loans. Management believes that net portfolio margin
provides investors with information that is useful in evaluating the earnings
performance of our loan portfolio. 34




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##### Table of Contents



Three months ended June 30,
    
    Six months ended June 30,2004
    
    2003
    
    2004
    
    2003Dollars
    
    %
    
    Dollars
    
    %
    
    Dollars
    
    %
    
    Dollars
    
    %(dollars in thousands)Student loan and
restricted cash
yield
    
    $
    41,591
    
    
    
    4.40
    %
    
    $
    17,877
    
    
    
    3.90
    %
    
    $
    77,422
    
    
    
    4.42
    %
    
    $
    31,115
    
    
    
    3.91
    %DOE rebate(1)
    
    
    (9,581
    )
    
    
    (1.01
    )
    
    
    (3,475
    )
    
    
    (0.76
    )
    
    
    (18,068
    )
    
    
    (1.03
    )
    
    
    (6,169
    )
    
    
    (0.77
    )Amortization(2)
    
    
    (936
    )
    
    
    (0.10
    )
    
    
    (492
    )
    
    
    (0.11
    )
    
    
    (1,601
    )
    
    
    (0.09
    )
    
    
    (914
    )
    
    
    (0.11
    )Net student loan
and restricted cash
yield
    
    
    31,074
    
    
    
    3.29
    
    
    
    13,910
    
    
    
    3.03
    
    
    
    57,753
    
    
    
    3.30
    
    
    
    24,032
    
    
    
    3.03Asset-backed notes
and lines of credit
    
    
    (14,546
    )
    
    
    (1.54
    )
    
    
    7,610
    )
    
    
    (1.66
    )
    
    
    (26,952
    )
    
    
    (1.54
    )
    
    
    (13,043
    )
    
    
    (1.64
    )Net portfolio margin
    
    $
    16,528
    
    
    
    1.75
    %
    
    $
    6,300
    
    
    
    1.37
    %
    
    $
    30,801
    
    
    
    1.76
    %
    
    $
    10,989
    
    
    
    1.39
    %Average balance of
student loans and
restricted cash
    
    $
    3,802,536
    
    
    
    
    
    
    $
    1,839,764
    
    
    
    
    
    
    $
    3,522,548
    
    
    
    
    
    
    $
    1,606,336
   (1)
    
    Reflects the 1.05% per annum rebate fee on FFELP consolidation loans that
is paid monthly divided by the average balance of student loans and
restricted cash.(2)
    
    Represents the amortization of capitalized origination costs and purchase
accounting adjustments, including the 0.50% fee payable to the DOE on the
origination of FFELP loans. The following table sets forth, for the periods indicated, information
regarding the total amounts and rates of interest income from interest-earning
assets and interest expense from interest-bearing liabilities. This table also
provides a reconciliation of net portfolio margin to net interest income, which
has been prepared using the interest income and interest expense amounts
included in the Companys historical income statements. Three months ended June 30,2004
    
    2003Average
    
    
    
    
    
    
    
    
    
    AverageInterest
    
    rate
    
    
    
    
    
    Interest
    
    rateAverage
    
    income/
    
    earned/
    
    Average
    
    income/
    
    earned/balance
    
    expense
    
    paid
    
    balance
    
    expense
    
    paid(dollars in thousands)Interest-earning assets:Cash and cash equivalents
    
    $
    11,994
    
    
    $
    120
    
    
    
    4.02
    %
    
    $
    20,241
    
    
    $
    61
    
    
    
    1.21
    %Restricted cash
    
    
    189,097
    
    
    
    348
    
    
    
    0.74
    
    
    
    559,396
    
    
    
    1,613
    
    
    
    1.16Student loans
    
    
    3,613,439
    
    
    
    41,243
    
    
    
    4.59
    
    
    
    1,280,368
    
    
    
    16,264
    
    
    
    5.09DOE rebate(1)
    
    
    
    
    
    
    (9,581
    )
    
    
    (1.07
    )
    
    
    
    
    
    
    (3,475
    )
    
    
    (1.09
    )Amortization(2)
    
    
    
    
    
    
    (936
    )
    
    
    (0.10
    )
    
    
    
    
    
    
    (492
    )
    
    
    (0.15
    )Student loans after DOE rebate and
amortization
    
    
    3,613,439
    
    
    
    30,726
    
    
    
    3.42
    
    
    
    1,280,368
    
    
    
    12,297
    
    
    
    3.85Total interest-earning assets
    
    $
    3,814,530
    
    
    
    31,194
    
    
    
    3.29
    %
    
    $
    1,860,005
    
    
    
    13,971
    
    
    
    3.01
    %Interest-bearing liabilities:Asset-backed notes and lines of credit
    
    $
    3,845,178
    
    
    
    14,546
    
    
    
    1.52
    %
    
    $
    1,862,584
    
    
    
    7,610
    
    
    
    1.64
    %Other debt obligations, net
    
    
    60,858
    
    
    
    931
    
    
    
    6.15
    
    
    
    78,930
    
    
    
    2,727
    
    
    
    13.86Capital lease obligations
    
    
    1,752
    
    
    
    41
    
    
    
    9.41
    
    
    
    1,242
    
    
    
    16
    
    
    
    5.17Total interest-bearing liabilities
    
    $
    3,907,788
    
    
    
    15,518
    
    
    
    1.60
    
    
    $
    1,942,756
    
    
    
    10,353
    
    
    
    2.14Net interest income and margin
    
    
    
    
    
    $
    15,676
    
    
    
    1.65
    %(3)
    
    
    
    
    
    $
    3,618
    
    
    
    0.78
    %(3)Reconciliation to net portfolio margin:Net interest income
    
    
    
    
    
    $
    15,676
    
    
    
    
    
    
    
    
    
    
    $
    3,618Less: interest income on cash and cash
equivalents
    
    
    
    
    
    
    (120
    )
    
    
    
    
    
    
    
    
    
    
    (61
    )Plus: interest expense on other debt
obligations, net
    
    
    
    
    
    
    931
    
    
    
    
    
    
    
    
    
    
    
    2,727Plus: interest expense on capital
lease obligations
    
    
    
    
    
    
    41
    
    
    
    
    
    
    
    
    
    
    
    16Net portfolio margin
    
    
    
    
    
    $
    16,528
    
    
    
    
    
    
    
    
    
    
    $
    6,300
 35




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##### Table of Contents



Six months ended June 30,2004
    
    2003Average
    
    
    
    
    
    
    
    
    
    AverageInterest
    
    rate
    
    
    
    
    
    Interest
    
    rateAverage
    
    income/
    
    earned/
    
    Average
    
    income/
    
    earned/balance
    
    expense
    
    paid
    
    balance
    
    expense
    
    paid(dollars in thousands)Interest-earning assets:Cash and cash equivalents
    
    $
    13,158
    
    
    $
    305
    
    
    
    4.65
    %
    
    $
    26,949
    
    
    $
    123
    
    
    
    0.92
    %Restricted cash
    
    
    149,358
    
    
    
    574
    
    
    
    0.77
    
    
    
    451,860
    
    
    
    2,394
    
    
    
    1.07Student loans
    
    
    3,373,190
    
    
    
    76,848
    
    
    
    4.57
    
    
    
    1,154,476
    
    
    
    28,721
    
    
    
    5.02DOE rebate(1)
    
    
    
    
    
    
    (18,068
    )
    
    
    (1.07
    )
    
    
    
    
    
    
    (6,169
    )
    
    
    (1.08
    )Amortization(2)
    
    
    
    
    
    
    (1,601
    )
    
    
    (0.10
    )
    
    
    
    
    
    
    (914
    )
    
    
    (0.16
    )Student loans after DOE rebate and
amortization
    
    
    3,373,190
    
    
    
    57,179
    
    
    
    3.40
    
    
    
    1,154,476
    
    
    
    21,638
    
    
    
    3.78Total interest-earning assets
    
    $
    3,535,706
    
    
    
    58,058
    
    
    
    3.29
    
    
    $
    1,633,285
    
    
    
    24,155
    
    
    
    2.98Interest-bearing liabilities:Asset-backed notes and lines of credit
    
    $
    3,562,787
    
    
    
    26,952
    
    
    
    1.52
    %
    
    $
    1,624,387
    
    
    
    13,043
    
    
    
    1.62
    %Other debt obligations, net
    
    
    52,147
    
    
    
    1,570
    
    
    
    6.04
    
    
    
    89,312
    
    
    
    6,067
    
    
    
    13.70Capital lease obligations
    
    
    1,809
    
    
    
    74
    
    
    
    8.20
    
    
    
    710
    
    
    
    18
    
    
    
    5.11Total interest-bearing liabilities
    
    $
    3,616,743
    
    
    
    28,596
    
    
    
    1.59
    
    
    $
    1,714,409
    
    
    
    19,128
    
    
    
    2.25Net interest income and margin
    
    
    
    
    
    $
    29,462
    
    
    
    1.67
    %(3)
    
    
    
    
    
    $
    5,027
    
    
    
    0.62
    %(3)Reconciliation to net portfolio margin:Net interest income
    
    
    
    
    
    $
    29,462
    
    
    
    
    
    
    
    
    
    
    $
    5,027Less: interest income on cash and cash
equivalents
    
    
    
    
    
    
    (305
    )
    
    
    
    
    
    
    
    
    
    
    (123
    )Plus: interest expense on other debt
obligations, net
    
    
    
    
    
    
    1,570
    
    
    
    
    
    
    
    
    
    
    
    6,067Plus: interest expense on capital
lease obligations
    
    
    
    
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    18Net portfolio margin
    
    
    
    
    
    $
    30,801
    
    
    
    
    
    
    
    
    
    
    $
    10,989
   (1)
    
    Reflects the 1.05% per annum rebate fee on FFELP consolidation loans that
is paid monthly divided by the average balance of student loans.(2)
    
    Represents the amortization of capitalized origination costs and purchase
accounting adjustments, including the 0.50% fee payable to the DOE on the
origination of FFELP loans.(3)
    
    Net interest margin is net interest income divided by the average total
interest-earning assets. Interest Rate Risk Because we expect to generate a significant portion of our earnings from
the difference, or spread, between the yield we receive on our loan portfolio
of student loans and the cost of financing these loans, our results of
operations are sensitive to interest rates. We fund our loan portfolio with
variable-rate debt. In the current low interest rate environment, our loan
portfolio is yielding excess net interest income, which is referred to as fixed
rate floor income, as a result of a decline in short-term rates from the rates
used to fix the borrowers rate on a consolidation loan. See Risk Factors
described in Exhibit 99.1 to this report which is incorporated by reference
herein. Interest rate sensitivity refers to the change in earnings that may result
from changes in the level of interest rates. Our net interest income is
affected by changes in various interest rates, including LIBOR and the
commercial paper rate. In higher interest rate environments, an increasing
portion of the FFELP consolidation loans in our portfolio will earn interest at
a variable rate. Loans in our portfolio earn interest at a variable rate when
the floating rate based on the special allowance payment formula exceeds the
fixed borrower rate. At this time, the loans will be effectively matched with
variable-rate debt, and the impact of interest rate fluctuations will be
substantially reduced. As a result of the decline in short-term interest rates over the last
three years, we have earned fixed rate floor income during the past three
years. Fixed rate floor income is reduced and can be eliminated in a rising
interest rate environment. For example, for the six months ended June 30, 2004,
our student loan portfolio had a weighted average interest rate of 4.57%. FFELP
consolidation loans with a fixed borrower rate of 3.87% stop generating fixed
rate floor income when the 91-day commercial paper rate exceeds 1.23%. 36




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##### Table of Contents



One objective when financing our loan portfolio is to manage interest rate risk through:  
    
    match-funding of loan assets with associated secured borrowings and
    
    utilizing interest rate swaps and other derivative
instruments (described below) to minimize the adverse effect of
interest rate fluctuations in the near term. During 2003 and 2004, we entered into certain derivative instrument
contracts to help manage our interest rate risk. The table below summarizes the
derivative instruments to which we were a party at June 30, 2004: June 30, 2004(unaudited)
    
    December 31, 2003Receive 
    
    
    
    
    
    Receive Derivative
    
    Notional
    
    Maturity
    
    Pay 
    
    floating rate
    
    
    
    
    
    floating rate
    
    Fairtype
    
    amount
    
    Date
    
    fixed rate
    
    (LIBOR)
    
    Fair value
    
    (LIBOR)
    
    value(3)Swap(1)
    
    $
    500,000
    
    
    
    01/26/2005
    
    
    
    1.89
    %
    
    
    1.32
    %
    
    $
    (47
    )
    
    
    1.12
    %
    
    $
    (2,070
    )Swap(1)
    
    
    225,000
    
    
    
    11/26/2004
    
    
    
    1.64
    
    
    
    1.30
    
    
    
    63
    
    
    
    1.12
    
    
    
    (606
    )Swap(1)
    
    
    225,000
    
    
    
    11/26/2004
    
    
    
    1.64
    
    
    
    1.30
    
    
    
    63
    
    
    
    1.12
    
    
    
    (559
    )Cap (Sold)
    
    
    500,000
    
    
    
    01/26/2005
    
    
    
    
    (2)
    
    
    
    
    
    
    (268
    )
    
    
    
    
    
    
    (328
    )Swap
    
    
    550,000
    
    
    
    04/28/2005
    
    
    
    1.55
    
    
    
    1.32
    
    
    
    2,740Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,551
    
    
    
    
    
    
    $
    (3,563
    )
   (1)
    
    Under the interest rate swaps, we agree to pay a fixed rate in exchange
for a floating rate. The interest rate swap effectively converts a portion
of our variable-rate debt to a fixed rate for a period of time thereby
fixing the relative spread between a portion of our loan assets equal to
the size of the swap notional amount.(2)
    
    The Company received $1.7 million in proceeds from the sale of the cap on
February 28, 2003. The amount is recorded as a derivative liability and is
marked to market over the term of the cap. Payments on the cap will be
made only when the 91-day commercial paper rate exceeds 2.09%. No payments
were made in 2003. The notional amounts of the cap and the $500 million
swap will reduce to $250 million each on July 26, 2004.(3)
    
    Reflects the value to the Company of the interest rate swaps and the cap
assuming the applicable swap or cap was terminated as of June 30, 2004 or
December 31, 2003. We have not designated any of these derivative instruments to meet the
criteria for hedge accounting. See Critical Accounting PoliciesAccounting
for Derivatives. Forward interest rate sensitivity.The following table shows the changes
in net interest income, swap interest expense, derivative mark-to-market
expense and income before tax provision (benefit) and accretion of dividends on
preferred stock for a 12-month period based on an increase or decrease in
interest rates in effect on July 1, 2004, which is maintained for the entire
period shown and applied to our interest-earning assets and interest-bearing
liabilities as of June 30, 2004, assuming normal portfolio payment patterns for
the periods presented and no additional originations. We held five derivative contracts as of June 30, 2004 to help mitigate the
economic impact of changing interest rates. With respect to swap interest
expense and derivative mark-to-market expense, we have applied the change to
interest rates in effect on July 1, 2004 through the maturity date of the
applicable derivative. Because the derivatives are not accounted for as
accounting hedges under SFAS No. 133, we present their effect in a separate
line item, swap interest expense, in the income statement. 37




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##### Table of Contents



Twelve months beginning July 1, 2004Decrease of
    
    Increase of
    
    Increase of
    
    Increase of100 basis
    
    100 basis
    
    200 basis
    
    300 basispoints
    
    points
    
    points
    
    points(dollars in millions)Estimated increase (decrease) in net interest income
    
    $
    26.4
    
    
    $
    (12.7
    )
    
    $
    (20.7
    )
    
    $
    (25.2
    )Estimated decrease (increase) in swap interest expense(1)
    
    
    (8.0
    )
    
    
    7.8
    
    
    
    14.1
    
    
    
    20.5Estimated decrease (increase) in derivative
mark-to-market expense(1)(2)
    
    
    (2.6
    )
    
    
    (2.6
    )
    
    
    (2.6
    )
    
    
    (2.6
    )Increase (decrease) in income before income tax
provision (benefit) and accretion of dividends on
preferred stock
    
    $
    15.8
    
    
    $
    (7.5
    )
    
    $
    (9.2
    )
    
    $
    (7.3
    )
   (1)
    
    Our derivative instruments in effect as of June 30, 2004 mature on
November 26, 2004, April 28, 2005 and January 26, 2005, respectively.(2)
    
    Represents the aggregate mark-to-market liability as of June 30, 2004
based on the maturity of the derivatives in place at that time. Cautionary Notice Regarding Forward-looking Statements This report on Form 10-Q includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements include statements concerning our plans, objectives, goals,
strategies, future events, future revenue or performance, future loan
originations, capital expenditures, financing needs, plans or intentions
relating to acquisitions, business trends and other information that is not
historical information. When used in this report, the words estimates,
expects, anticipates, projects, plans, intends, believes,
forecasts, or future or conditional verbs, such as will, should, could
or may, and variations of such words or similar expressions are intended to
identify forward-looking statements. All forward-looking statements, including,
without limitation, managements examination of historical operating trends and
data are based upon our current expectations and various assumptions. Our
expectations, beliefs and projections are expressed in good faith, and we
believe there is a reasonable basis for them. However, there can be no
assurance that managements expectations, beliefs and projections will be
achieved. There are a number of risks and uncertainties that could cause our actual
results to differ materially from the forward-looking statements contained in
this report. Important factors that could cause our actual results to differ
materially from the forward-looking statements we make in this report are set
forth in Exhibit 99.1 to this report, which is incorporated herein by
reference. All forward-looking statements attributable to us or persons acting
on our behalf apply only as of the date of this report and are expressly
qualified in their entirety by the cautionary statements included in this
report. We undertake no obligation to update or revise forward-looking
statements which may be made to reflect events or circumstances that arise
after the date made or to reflect the occurrence of unanticipated events unless
we have an obligation to do so under the federal securities laws. With respect
to forward-looking statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995. 
 Item 3. Quantitative and Qualitative Disclosure about Market Risk Included within Item 2, Managements Discussion and Analysis of Financial
Condition and Results of Operations. 
 Item 4. Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our reports under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commissions rules and
forms, and that such 38




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##### Table of Contents



information is accumulated and communicated to our management, including
our Chief Executive Officer our Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosures. Any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as of June 30, 2004. Based upon that
evaluation and subject to the foregoing, our Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of our disclosure
controls and procedures provided reasonable assurance that the disclosure
controls and procedures are effective to accomplish their objectives. There was no change in our internal control over financial reporting that
occurred during the quarter ended June 30, 2004 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting. 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings We are involved in litigation in the ordinary course of business, both as a
defendant and as a plaintiff. While we cannot predict the outcome of any
pending or future litigation, examination or investigation, we do not believe
that any pending matter will have a material adverse effect on our
cash flows, financial condition or results of operations. 
 Item 2. Changes in Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information None. 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: See the Exhibit Index on the page immediately preceding the exhibits for a list
of exhibits filed as part of this quarterly report, which Exhibit Index is
incorporated herein by reference. (b) Reports on Form 8-K: None. 39




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##### Table of Contents



Signature Pursuant to the requirements of the Securities Exchange Act of l934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. COLLEGIATE FUNDING SERVICES, INC.(Registrant)Date: August 20, 2004
    
    By: /s/ Kevin A. LandgraverName: Kevin A. LandgraverTitle: Executive Vice President and Chief
Financial Officer(on behalf of the Registrant and as
Principal Financial Officer)
 40




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description of Exhibit2.1
    
    Agreement relating to Acquisition of Youth Media & Marketing
Networks, dated as of April 21, 2004, among Collegiate Funding
Services, LLC, Affinity Acquisition Corp., Members Connect Inc.
and the companys stockholders (incorporated by reference to
Exhibit 2.1 to the registration statement on Form S-1 (Reg. No.
333-114466))3.1
    
    Amended and Restated Certificate of Incorporation of Collegiate
Funding Services, Inc. (incorporated by reference to Exhibit 3.1
to the registration statement on Form S-1 (Reg. No. 333-114466))3.2
    
    Amended and Restated By-Laws of Collegiate Funding Services,
Inc. (incorporated by reference to Exhibit 3.2 to the
registration statement on Form S-1 (Reg. No. 333-114466))4.1 ü
    
    Stockholders Agreement, dated May 17, 2002, by and among CFSL
Holdings Corp., CFSL Acquisition Corp. and the investors listed
on Schedule A thereto (incorporated by reference to Exhibit 4.1
to the registration statement on Form S-1 (Reg. No. 333-114466))4.2
    
    Form of Certificate of Common Stock (incorporated by reference
to Exhibit 4.2 to the registration statement on Form S-1 (Reg.
No. 333-114466))4.3
    
    Indenture of Trust from Collegiate Funding Services Education
Loan Trust I and U.S. Bank National Association, as Eligible
Lender Trustee to U.S. Bank National Association, as Indenture
Trustee, dated as of November 1, 2001, together with First
Supplemental Indenture of Trust, dated November 1, 2001 and
Second Supplemental Indenture of Trust, dated July 1, 2002
(incorporated by reference to Exhibit 4.3 to the registration
statement on Form S-1 (Reg. No. 333-114466))4.4
    
    Indenture of Trust between Collegiate Funding Services Education
Loan Trust 2003-A and U.S. Bank National Association, as
Eligible Lender Trustee and as Trustee, dated as of February 1,
2003 (incorporated by reference to Exhibit 4.4 to the
registration statement on Form S-1 (Reg. No. 333-114466))4.5
    
    Indenture of Trust between Collegiate Funding Services Education
Loan Trust 2003-B and U.S. Bank National Association, as
Eligible Lender Trustee and as Trustee, dated as of November 1,
2003 (incorporated by reference to Exhibit 4.5 to the
registration statement on Form S-1 (Reg. No. 333-114466))4.6
    
    Indenture of Trust between Collegiate Funding Services Education
Loan Trust 2004-A and U.S. Bank National Association, as
Eligible Lender Trustee and as Trustee, dated as of April 1,
2004 (incorporated by reference to Exhibit 4.6 to the
registration statement on Form S-1 (Reg. No. 333-114466))4.7
    
    Subordinated Note of CFSL Acquisition Corp., dated May 17, 2002,
issued to NOBS Capital Ventures, L.L.C. (incorporated by
reference to Exhibit 4.7 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.1
    
    Warehouse Financing Indenture, dated as of July 23, 2003, by and
among Collegiate Funding Services Resources I, LLC, as Issuer,
the conduit lenders parties thereto, certain financial
institutions parties thereto, as Committed Lenders, Citicorp
North America, Inc., as Agent, U.S. Bank National Association,
as Indenture Trustee and Eligible Lender Trustee, Collegiate
Funding Portfolio Administration, L.L.C., as Administrator and
Collegiate Funding Master Servicing, L.L.C., as Master Servicer,
together with the Amendment No. 1, dated as of October 30, 2003
and the Amendment No. 2, dated as of February 17, 2004
(incorporated by reference to Exhibit 10.1 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.1.1
    
    Amendment No. 3 the Warehouse Financing Indenture, dated as of
July 19, 2004, by and among Collegiate Funding Services
Resources I, LLC, as Issuer, the conduit lenders parties
thereto, certain financial institutions parties thereto, as
Committed Lenders, Citicorp North America, Inc., as Agent, U.S.
Bank National Association, as Indenture Trustee and Eligible
Lender Trustee, Collegiate Funding Portfolio Administration,
L.L.C., as Administrator and Collegiate Funding Master
Servicing, L.L.C., as Master Servicer (incorporated by reference
to Exhibit 10.1.1 to the registration statement on Form S-1
(Reg. No. 333-114466))10.2
    
    Consolidation Loan Origination Responsibility Agreement, dated
November 15, 1999, by and between Collegiate Funding Services,
LLC and Citibank as Trustee for the Student Loan Corporation,
together with the First Amendment, dated March 1, 2001, the
Second Amendment, dated November 1, 2001, the Third Amendment,
dated May 7, 2002, the Fourth Amendment, dated July 25, 2002 and
the Fifth Amendment, dated August 20, 2002 (incorporated by
reference to Exhibit 10.2 to the registration statement on Form
S-1 (Reg. No. 333-114466))




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##### Table of Contents



Exhibit No.
    
    Description of Exhibit10.2.0
    
    Sixth Amendment Agreement, dated April 3, 2003, by and between
Citibank (New York State), as Trustee for the Student Loan
Corporation, the Student Loan Corporation and Collegiate Funding
Services, LLC (incorporated by reference to Exhibit 10.2.0 to
the registration statement on Form S-1 (Reg. No. 333-114466))10.2.1
    
    Seventh Amendment Agreement, dated May 20, 2004, by and between
Citibank, N.A., as Trustee for the Student Loan Corporation, the
Student Loan Corporation and Collegiate Funding Services, LLC
(incorporated by reference to Exhibit 10.2.1 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.3
    
    Consolidation Loan Origination Responsibility Agreement, dated
December 3, 2002, by and between Collegiate Funding Services,
LLC and The Brazos Higher Education Service Corporation, Inc.,
together with the First Email Agreement, dated September 3,
2003, the Second Email Agreement, dated September 26, 2003 and
the First Amendment Agreement, dated January 1, 2004
(incorporated by reference to Exhibit 10.3 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.4
    
    Real World Consolidation Loan Origination Responsibility
Agreement, dated April 1, 2003, by and between Collegiate
Funding Services, LLC and Mississippi Higher Education
Assistance Corporation (incorporated by reference to Exhibit
10.4 to the registration statement on Form S-1 (Reg. No.
333-114466))10.5
    
    Origination, Disbursement, Interim Sub-Servicing and Purchasing
Master Agreement, dated February 19, 2004, by and between
Collegiate Funding Services, LLC and the Higher Education Loan
Authority of the State of Missouri (incorporated by reference to
Exhibit 10.5 to the registration statement on Form S-1 (Reg. No.
333-114466))10.6
    
    Private Consolidation Loan Origination Responsibility Agreement,
dated June 12, 2001, by and between Collegiate Funding Services,
LLC and First Union National Bank of Delaware (incorporated by
reference to Exhibit 10.6 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.7
    
    Amendment Agreement, dated August 1, 2001, among First Union
National Bank of Delaware, The Education Resources Institute,
SunTech, Inc. and Collegiate Funding Services, LLC, together
with the Amendment Agreement, dated February 20, 2002
(incorporated by reference to Exhibit 10.7 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.8
    
    Amendment Agreement, dated November 7, 2003, by and between
Collegiate Funding Services, LLC, ClassNotes Inc. (d/b/a
Educaid) and Wachovia Bank of Delaware (as successor in interest
to First Union National Bank of Delaware), together with the
Amendment Agreement, dated March 17, 2004 (incorporated by
reference to Exhibit 10.8 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.9ü
    
    Credit Agreement, dated as of October 30, 2003 between
Collegiate Funding Services, LLC, as Borrower, CFSL Holdings
Corp. and CFSL Acquisition Corp., as Parent Guarantors, the
Subsidiary Guarantors referred to therein, as Subsidiary
Guarantors, the lenders named therein, as lenders and JPMorgan
Chase Bank, as Administrative Agent, together with Amendment No.
1 dated as of April 21, 2004 (incorporated by reference to
Exhibit 10.9 to the registration statement on Form S-1 (Reg. No.
333-114466))10.9.1
    
    Amendment No. 2 to Credit Agreement, dated as of July 7, 2004
between Collegiate Funding Services, LLC, as Borrower,
Collegiate Funding Services, Inc. and CFSL Acquisition Corp., as
Parent Guarantors, the Subsidiary Guarantors referred to
therein, as Subsidiary Guarantors, the lenders named therein, as
lenders and JPMorgan Chase Bank, as Administrative Agent
(incorporated by reference to Exhibit 10.9.1 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.10
    
    Underwriting Agreement, dated February 25, 2003, by and among
Salomon Smith Barney Inc., UBS PaineWebber Inc., UBS Warburg
LLC, Collegiate Funding of Delaware, LLC and Collegiate Funding
Services, LLC (incorporated by reference to Exhibit 10.10 to the
registration statement on Form S-1 (Reg. No. 333-114466))10.11
    
    Underwriting Agreement, dated November 25, 2003, by and among
Banc of America Securities LLC, J.P. Morgan Securities Inc.,
Citigroup Global Markets Inc., Collegiate Funding of Delaware,
LLC and Collegiate Funding Services, LLC (incorporated by
reference to Exhibit 10.11 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.12
    
    Underwriting Agreement, dated April 16, 2004, by and among
Citigroup Global Markets Inc., J.P. Morgan Securities Inc., UBS
Securities LLC, Collegiate Funding of Delaware, LLC and
Collegiate Funding Services, LLC (incorporated by reference to
Exhibit 10.12 to the registration statement on Form S-1 (Reg.
No. 333-114466))
 2




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##### Table of Contents



Exhibit No.
    
    Description of Exhibit10.13ü
    
    Warrant Agreement, dated May 17, 2002, by and among CFSL
Holdings Corp. and the purchasers party thereto (incorporated by
reference to Exhibit 10.13 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.14
    
    Stock Incentive Plan of Collegiate Funding Services, Inc.
(incorporated by reference to Exhibit 10.14 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.15
    
    Employment Agreement by and between Collegiate Funding Services,
Inc. and J. Barry Morrow (incorporated by reference to Exhibit
10.15 to the registration statement on Form S-1 (Reg. No.
333-114466))10.16
    
    Form of Employment Agreement for Executive Vice Presidents of
Collegiate Funding Services, Inc. (incorporated by reference to
Exhibit 10.16 to the registration statement on Form S-1 (Reg.
No. 333-114466))10.17
    
    Employment Agreement by and between Collegiate Funding Services,
Inc. and John T. Fees (incorporated by reference to Exhibit
10.17 to the registration statement on Form S-1 (Reg. No.
333-114466))10.18ü
    
    Management Agreement, dated May 17, 2002, by and between
Lightyear Capital, LLC, CFSL Holdings Corp., CFSL Acquisition
Corp. and Collegiate Funding Services, LLC (incorporated by
reference to Exhibit 10.18 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.18.1ü
    
    First Amendment Agreement, dated April 15, 2003, by and between
Lightyear Capital, LLC, CFSL Holdings Corp., CFSL Acquisition
Corp. and Collegiate Funding Services, LLC, together with the
Second Amendment Agreement, dated June 18, 2004 (incorporated by
reference to Exhibit 10.18.1 to the registration statement on
Form S-1 (Reg. No. 333-114466))10.19ü
    
    Consulting Services Agreement, dated May 17, 2002, between NOBS
Capital Ventures, LLC and CFSL Holdings Corp. (incorporated by
reference to Exhibit 10.19 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.20
    
    Consulting Agreement, dated March 31, 2003, among Collegiate
Funding Services, LLC, EdPro, LLC and Malcolm B. Lightsey
(incorporated by reference to Exhibit 10.20 to the registration
statement on Form S-1 (Reg. No. 333-114466))10.21
    
    Form of Broker-Dealer Agreement in connection with Collegiate
Funding Services Education Loan Trust I (incorporated by
reference to Exhibit 10.21 to the registration statement on Form
S-1 (Reg. No. 333-114466))10.22
    
    Form of Broker-Dealer Agreement in connection with Collegiate
Funding Services Education Loan Trust 2003-A, Collegiate Funding
Services Education Loan Trust 2003-B, and Collegiate Funding
Services Education Loan Trust 2004-A (incorporated by reference
to Exhibit 10.22 to the registration statement on Form S-1
(Reg. No. 333-114466))31.1*
    
    Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer31.2*
    
    Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer32.1**
    
    Section 1350 Certification by Chief Executive Officer32.2**
    
    Section 1350 Certification by Chief Financial Officer99.1*
    
    Risk Factors relating to the Registrant
   ü
    
    CFSL Holdings Corp. has subsequently changed its name to Collegiate Funding Services, Inc.
    
    Confidential treatment has been granted for certain portions of this Exhibit pursuant to Rule 406 promulgated under the
Securities Act.*
    
    Filed herewith**
    
    Furnished herewith 3