<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 9, 1998
REGISTRATION NO. 333-46267
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
ITT EDUCATIONAL SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 36-2061311
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
5975 CASTLE CREEK PARKWAY NORTH DRIVE
P.O. BOX 50466
INDIANAPOLIS, INDIANA 46250-0466
(317) 594-9499
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
CLARK D. ELWOOD
SENIOR VICE PRESIDENT,
GENERAL COUNSEL AND SECRETARY
5975 CASTLE CREEK PARKWAY NORTH DRIVE
P.O. BOX 50466
INDIANAPOLIS, INDIANA 46250-0466
(317) 594-9499
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
JAMES A. ASCHLEMAN MORTON A. PIERCE
BAKER & DANIELS RICHARD D. PRITZ
300 NORTH MERIDIAN STREET DEWEY BALLANTINE LLP
SUITE 2700 1301 AVENUE OF THE AMERICAS
INDIANAPOLIS, INDIANA 46204 NEW YORK, NEW YORK 10019-6092
(317) 237-0300 (212) 259-8000
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
is practicable after the effective date of this Registration Statement.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
=================================================================================================================================
TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
SECURITIES TO AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
BE REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) FEE(3)
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
Common Stock, $.01 par
value...................... 12,650,000 shares $25.3125 $320,203,125 $94,460
=================================================================================================================================
</TABLE>
(1) Includes 1,650,000 shares as to which the Underwriters have been granted an
option to cover over-allotments, if any.
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(c) based on the average of the high and low sale prices of the
Common Stock on the New York Stock Exchange, Inc. on February 10, 1998.
(3) Amount previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
================================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED APRIL 9, 1998
11,000,000 SHARES
[ITT EDUCATIONAL SERVICES, INC. LOGO]
ITT EDUCATIONAL SERVICES, INC.
COMMON STOCK
($.01 par value)
------------------------
All of the shares of common stock, $.01 par value (the "Common Stock"), of ITT
Educational Services, Inc. (the "Company") offered hereby (the "Offering") are
being offered by the Selling Stockholder named herein under "Principal and
Selling Stockholder." The Company will not receive any of the proceeds from the
sale of shares of Common Stock by the Selling Stockholder.
The Common Stock of the Company is listed on the New York Stock Exchange, Inc.
(the "NYSE") under the symbol "ESI." On April 8, 1998, the last reported sale
price of the Common Stock on the NYSE was $27.25 per share. See "Price Range of
Common Stock."
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH
AN INVESTMENT IN THE COMMON STOCK, SEE "RISK FACTORS" BEGINNING ON PAGE 9.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE DISCOUNTS AND SELLING
TO PUBLIC COMMISSIONS STOCKHOLDER(1)
--------- ------------- --------------
<S> <C> <C> <C>
Per Share................................... $ $ $
Total(2).................................... $ $ $
</TABLE>
(1) Before deduction of expenses payable by the Company estimated to be
$1,000,000.
(2) The Selling Stockholder has granted the Underwriters an option, exercisable
for 30 days from the date of this Prospectus, to purchase a maximum of
1,650,000 additional shares from the Selling Stockholder to cover over-
allotments of shares. If the option is exercised in full, the total Price to
Public will be $ , Underwriting Discounts and Commissions will be
$ and proceeds to the Selling Stockholder will be $ .
The shares of Common Stock are offered by the several Underwriters when, as
and if delivered to and accepted by the Underwriters and subject to their right
to reject orders in whole or in part. It is expected that the shares of Common
Stock will be ready for delivery on or about , 1998, against
payment in immediately available funds.
CREDIT SUISSE FIRST BOSTON
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER
PROSPECTUS DATED , 1998
<PAGE> 3
[PHOTOGRAPHS OF INSTITUTES,
STUDENTS AND EQUIPMENT]
------------------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED
HEREBY, INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
2
<PAGE> 4
DOCUMENTS INCORPORATED BY REFERENCE
The Company hereby incorporates in this Prospectus by reference thereto and
makes a part hereof (i) the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997, (ii) the Company's Current Report on Form 8-K
dated March 10, 1998 and (iii) the Company's Current Report on Form 8-K dated
April 8, 1998.
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
after the date of this Prospectus and prior to the termination of the Offering
shall be deemed to be incorporated by reference in this Prospectus and to be a
part hereof from the date of filing such documents. Any statement contained in a
document incorporated by reference herein shall be deemed to be modified or
superseded for purposes of this Prospectus to the extent that a statement
contained herein, or in any other subsequently filed document that is also
incorporated or is deemed to be incorporated by reference herein, modifies or
supersedes such statement. Any such statement so modified or superseded shall
not be deemed, except as so modified or superseded, to constitute a part of this
Prospectus. Subject to the foregoing, all information appearing in this
Prospectus is qualified in its entirety by the information appearing in the
documents incorporated by reference.
The Company undertakes to provide without charge, upon written or oral
request, to each person to whom this Prospectus is delivered, a copy of any or
all such documents referenced above other than exhibits to such documents.
Requests for such copies should be directed to Clark D. Elwood, Senior Vice
President, General Counsel and Secretary, ITT Educational Services, Inc., 5975
Castle Creek Parkway North Drive, P.O. Box 50466, Indianapolis, Indiana
46250-0466, telephone (317) 594-9499.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and in accordance therewith files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). Such
reports, proxy statements and other information filed by the Company may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the Commission's regional offices located at 7 World Trade Center, Suite 1300,
New York, New York 10048, and Room 3190, Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such material may be
obtained from the Public Reference Section of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. In addition, material filed by the Company can be inspected and copied at
the offices of the NYSE, 20 Broad Street, New York, New York 10005. The
Commission maintains a site on the World Wide Web at http://www.sec.gov
containing reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission, including
the Company.
The Company has filed with the Commission a Registration Statement on Form
S-3 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the shares of Common Stock offered
hereby. This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules filed as a part thereof,
as permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock, reference is
hereby made to such Registration Statement, including the exhibits and schedules
filed as a part thereof. Statements contained in this Prospectus as to the
contents of any contract or other document referred to herein are not
necessarily complete and where such contract or other document is an exhibit to
the Registration Statement, each such statement is qualified in all respects by
the provisions of such exhibit, to which reference is hereby made for a full
statement of the provisions thereof. The Registration Statement, including the
exhibits and schedules filed as a part thereof, may be inspected without charge
at the public reference facilities maintained by the Commission as set forth in
the preceding paragraph. Copies of these documents may be obtained at prescribed
rates from the Public Reference Section of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
offices of the NYSE, 20 Broad Street, New York, New York 10005.
3
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Company's Financial Statements and Notes thereto included
elsewhere or incorporated by reference in this Prospectus. Prospective investors
should consider carefully, among other things, the information set forth under
"Risk Factors" in this Prospectus. Unless otherwise indicated, all information
in this Prospectus (i) gives effect to a three-for-two stock split of the Common
Stock effected as a stock dividend on April 15, 1996, (ii) gives effect to a
three-for-two stock split of the Common Stock effected as a stock dividend on
November 4, 1996 and (iii) assumes no exercise of the over-allotment option. As
used in this Prospectus, unless the context indicates otherwise, the term
"Company" refers to ITT Educational Services, Inc., including all of its
educational institutions; the term "Starwood" refers collectively to Starwood
Hotels & Resorts Worldwide, Inc., a Maryland corporation formerly known as
Starwood Lodging Corporation ("Starwood, Inc."), and Starwood Hotels & Resorts,
a Maryland real estate investment trust formerly known as Starwood Lodging Trust
or Starwood Hotels & Resorts Trust ("Starwood Trust"), and their subsidiaries
other than the Company; the term "ITT" refers to ITT Corporation, a Nevada
corporation, and its subsidiaries other than the Company; the terms "ITT
Technical Institutes," "technical institutes" or "institutes" (in singular or
plural form) refer to educational institutions owned and operated by the
Company; and the term "institution" means a main campus and its additional
locations or branch campuses, if any (hereinafter "campus group" in singular or
plural form).
THE COMPANY
OVERVIEW
ITT Educational Services, Inc. is a leading proprietary provider of
technology-oriented postsecondary degree programs in the United States based on
revenues and student enrollment. The Company offers associate, bachelor and
master degree programs and non-degree diploma programs to approximately 24,000
students through 63 ITT Technical Institutes located in 27 states. As of
December 31, 1997, approximately 97% of ITT Technical Institute students were
enrolled in a degree program, with approximately 74% enrolled in programs
relating to electronics engineering technology ("EET") and approximately 23%
enrolled in programs relating to computer-aided drafting technology ("CAD").
While most graduates of ITT Technical Institutes are initially employed by
numerous small, technology-oriented companies, employers have also included well
recognized corporations, such as AT&T, Boeing, Intel, MCI, Microsoft, Motorola,
IBM and General Electric, and many federal and local government agencies. The
Company has provided career-oriented education programs for 32 years and its
schools have graduated over 125,000 students since 1976.
The Company has experienced significant growth, acquiring three and
establishing 50 new technical institutes since January 1, 1981. Of the 63
institutes currently operating, 20 have been established since January 1, 1993.
The number of students attending ITT Technical Institutes has increased 32.1%
from 18,539 at December 31, 1992 to 24,498 at December 31, 1997. Total revenues
from the ITT Technical Institutes have increased 74.0% from $150.4 million
(excluding discontinued operations) in 1992 to $261.7 million in 1997. The
Company opened three new technical institutes in 1997 and one new technical
institute in March 1998. The Company intends to continue expanding by opening
new technical institutes (including five additional new institutes in the
remainder of 1998) and offering a broader range of programs at its institutes.
The Company expects that the demand for postsecondary education will
continue to increase over the next several years as a result of favorable
demographic, economic and social trends. These trends include, based on data
from the United States Department of Education and data collected in the Current
Population Survey conducted by the Bureau of the Census, (a) 24% projected
growth in the number of new high school graduates from approximately 2.5 million
in 1994 to approximately 3.1 million in 2004, (b) the relatively small
percentage of adults over age 25 who possess a bachelor degree (approximately
23% in 1995), (c) an increasing number of high school graduates attending
postsecondary educational institutions (65% in 1996 versus 53% in 1983) and (d)
a heightened recognition of the importance of postsecondary education to an
individual's career prospects.
4
<PAGE> 6
The Company believes that it is well positioned to take advantage of the
increasing demand for postsecondary education programs for the following
reasons:
Employment Oriented Education. ITT Technical Institutes offer
curricula designed to teach the technical knowledge and skills desired by
many employers for entry-level positions. Unlike many two-and four-year
colleges, each undergraduate curriculum offered by ITT Technical Institutes
has been designed, after consultation with employers, to help graduates
begin to prepare for careers in various fields involving technology. The
Company believes that the strength of its programs and career services is
reflected in its graduate employment rates. Based on information provided
by graduates and employers, approximately 88% of the ITT Technical
Institutes' 1996 graduates, other than graduates who continued in a
bachelor degree program at an ITT Technical Institute, had obtained
employment or were already employed in fields involving their programs of
study as of April 25, 1997, the end of the most recently completed
statistical year.
Programs Designed for the Convenience of Students. Each ITT Technical
Institute operates year-round and undergraduate programs are offered on a
quarterly basis, typically with four 12-week quarters during a year. This
year-round format allows students to complete their program of study and
enter the work force more rapidly than students attending traditional
colleges. Students are better able to be employed while attending ITT
Technical Institutes than while attending traditional colleges, because
classes are typically offered in four-hour sessions five days a week and
are generally available in the morning, afternoon and evening. Programs of
study are substantially standardized throughout the ITT Technical
Institutes, enabling students to transfer, if necessary, to the same
program offered at another ITT Technical Institute with less disruption to
their education.
Financial Strength and Regulatory Compliance. Management believes
that the Company's financial strength enables it to capitalize on expansion
opportunities and is an important factor in its ability to comply with
federal and state regulatory requirements.
BUSINESS STRATEGY
The Company has multiple opportunities for growth and has developed a
business plan to increase revenues by increasing the number of programs of study
and students at existing ITT Technical Institutes while adding additional
locations to enhance operating efficiencies throughout the Company. Principal
elements of this plan include the following:
ENHANCE RESULTS AT THE SCHOOL LEVEL
Increase Enrollments at Existing Schools. ESI has successfully
increased student enrollment. Total student enrollment at ITT Technical
Institutes open for more than 24 months increased 6.2% from December 31,
1996 to December 31, 1997 and 7.2% from December 31, 1995 to December 31,
1996. Management believes that current demographic trends will support
increased enrollment of high school graduates. In addition, the Company
intends to increase recruiting efforts aimed at increasing enrollments of
working adults.
Broaden Availability of Current Program Offerings. The Company
intends to continue to expand program offerings at existing schools with
the objective of offering at least three programs at each ITT Technical
Institute. Since January 1, 1993, the Company has increased the number of
institutes which offer three or more programs from 16 to 29. The Company
increased the number of program offerings at three existing ITT Technical
Institutes in March 1998 and intends to increase the number of program
offerings at approximately nine additional existing institutes in the
remainder of 1998. Management believes that the introduction of higher
level programs at additional ITT Technical Institutes will attract more
students and increase the number of students continuing their studies
beyond the associate degree level.
Develop or Acquire Additional Degree Programs. The Company also plans
to introduce programs in additional fields of study and at different degree
levels. ESI has introduced three new degree programs
5
<PAGE> 7
since December 1995, which had a total of 319 students enrolled at December
31, 1997. The Company believes that the development and introduction of new
programs attract a broader base of students and motivate current students
to extend their studies. ESI intends to test an associate degree program in
Computer Network Systems Technology ("CNS") at one institute in September
1998 to target the growing need for technically skilled personnel in the
computer systems field. The new CNS program will be considered for testing
at additional institutes thereafter.
Extend Total Program Time. By increasing the number of institutes
that offer graduates of the eight- and six-quarter associate degree
programs (which are the primary program offerings at most institutes) an
additional four or six quarters of study, respectively, in which they can
earn a bachelor degree, the Company has been able to extend the total
program time for which a student can enroll. As a result, the average total
program time for which an ITT Technical Institute student can enroll has
increased from 18 months in 1986 to 24 months in 1997. The Company expects
that the average total program time for which an ITT Technical Institute
student can enroll will increase further as additional bachelor degree
programs are added.
Improve Student Outcomes. The Company seeks to improve the graduation
and graduate employment rates of the undergraduate students at ITT
Technical Institutes by providing extensive academic services and career
services. From 1992 through 1996, the percent of ITT Technical Institute
graduates (other than graduates who continued in a bachelor degree program
at an ITT Technical Institute) who were employed in fields involving their
programs of study increased from 80% to 88%.
INCREASE THE NUMBER OF ITT TECHNICAL INSTITUTES
The Company plans to add new ITT Technical Institutes at sites
throughout the United States. The Company opened three new technical
institutes in 1997 and one new technical institute in March 1998 and
intends to open five additional new technical institutes in the remainder
of 1998. The Company also intends to continue to evaluate the acquisition
of schools located in markets where ITT Technical Institutes are not
presently located.
INCREASE MARGINS BY LEVERAGING FIXED COSTS AT SCHOOL AND HEADQUARTERS
LEVELS
By optimizing school capacity and class size, the Company has the
ability to gain additional revenues from increased enrollment without
incurring a proportionate increase in fixed costs at the institutes. In
addition, centralization of management functions and the implementation of
operational uniformity among its 63 institutes have resulted in substantial
operating efficiencies. Expenses incurred at headquarters (including the
district offices) declined as a percentage of revenues from 6.8% in 1993 to
5.3% in 1997 as a result of increased revenues and these operating
efficiencies.
RECENT DEVELOPMENTS
Starwood/ITT Merger. On February 23, 1998, Starwood completed the
acquisition of ITT in accordance with the Amended and Restated Agreement and
Plan of Merger dated as of November 12, 1997 (the "Merger Agreement") among
Starwood, Inc., Chess Acquisition Corp., a Nevada corporation and a subsidiary
of Starwood, Inc. ("Chess"), Starwood Trust and ITT. Pursuant to the Merger
Agreement, Chess was merged with and into ITT (the "Merger") and ITT became a
subsidiary of Starwood, Inc. Starwood is the largest hotel and gaming company in
the world in terms of revenue and owns, manages or franchises a geographically
diversified portfolio of approximately 650 hotel properties.
ITT holds 22,500,000 shares, or 83.3%, of the Company's outstanding Common
Stock. Accordingly, the Merger triggered a change in control of the Company and
its ITT Technical Institutes. As a result, each ITT Technical Institute campus
group became ineligible to participate in federal student financial aid programs
as of the date of the Merger. Effective March 20, 1998, the eligibility of each
ITT Technical Institute campus group to participate in federal student financial
aid programs was reinstated on a provisional basis by the U.S. Department of
Education ("DOE"). See "Risk Factors -- Potential Adverse Effects of Regulation
- --Change in Control."
6
<PAGE> 8
Starwood, Inc. has announced that it is exploring a range of disposition
strategies for the Company. To that end, the Offering is being made hereby.
Although the Offering will be considered a change in control by certain state
education authorities, it will not be considered a change in control by the DOE
or the two accrediting commissions that accredit the Company's institutes.
Future sales or transfers of shares of Common Stock by ITT could result in a
change in control of the Company. See "Risk Factors -- Potential Adverse Effects
of Regulation -- Change in Control."
THE OFFERING
Common Stock offered by the Selling
Stockholder......................... 11,000,000 shares
Common Stock outstanding.............. 26,999,952 shares(1)
NYSE Symbol........................... ESI
- ---------------
(1) Excludes (i) 810,000 shares of Common Stock issuable upon the exercise of
outstanding options (of which options for 266,250 shares are currently
exercisable) and (ii) an aggregate of 3,645,000 shares of Common Stock
reserved for issuance under the 1997 ITT Educational Services, Inc.
Incentive Stock Plan (the "1997 Stock Plan") and the ITT Educational
Services, Inc. 1994 Stock Option Plan (the "1994 Stock Option Plan" and,
together with the 1997 Stock Plan, the "Stock Plans").
7
<PAGE> 9
SUMMARY FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
The following table sets forth certain financial data for the Company. This
information should be read in conjunction with the Financial Statements and
Notes thereto appearing elsewhere or incorporated by reference in this
Prospectus. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Total revenue......................... $261,664 $232,319 $201,831 $186,907 $168,997
Operating income...................... 26,223 20,576 14,225 11,832 13,839
Interest income, net(1)............... 5,565 4,119 4,802 232 80
Income before income taxes............ 31,788 24,695 19,027 12,064 13,919
Net income............................ 19,123 14,851 11,391 7,162 8,314
Earnings per share (basic and
diluted)(2)......................... $.71 $.55 $.42 $.32 $.37
OTHER OPERATING DATA:
EBITDA(3)............................. $ 34,162 $ 28,069 $ 21,767 $ 18,687 $ 20,182
Operating losses from new technical
institutes before income taxes(4)... $ 3,165 $ 5,721 $ 7,123 $ 7,316 $ 2,914
Capital expenditures, net............. $ 11,465 $ 7,868 $ 8,206 $ 7,688 $ 6,679
Number of students at end of period... 24,498 22,633 20,618 20,668 19,860
Number of technical institutes at end
of period........................... 62 59 56 54 48
AT DECEMBER 31,
--------------------
1997 1996
-------- --------
BALANCE SHEET DATA:
Cash, restricted cash and cash
invested with ITT................... $ 98,689 $ 95,793
Total current assets.................. 112,958 108,449
Property and equipment less
accumulated depreciation............ 22,886 19,360
Total assets.......................... 145,914 135,749
Total current liabilities............. 55,946 65,405
Shareholders' equity.................. 87,815 68,692
</TABLE>
- ---------------
(1) See Note 3 of Notes to Financial Statements for information concerning
intercompany interest between the Company and ITT. Prior to the Company's
initial public offering in December 1994 (the "Initial Public Offering"),
the Company did not receive interest on the full amount of net cash balances
invested with ITT and was assessed an interest charge based on an allocation
of the consolidated debt of ITT. After the Initial Public Offering and until
February 5, 1998, the Company received interest from ITT on the amount of
any net cash balances invested with ITT and no longer was subject to an
interest charge based on such an allocation. Since February 5, 1998, the
Company has performed its own cash management functions and no longer has
any cash invested with ITT. Depending upon current interest rates on
short-term investments, the Company may not be able to obtain the same
yields on its cash balances that were being paid by ITT. Accordingly,
interest income, net may decrease in 1998.
(2) Earnings per share data are based on historical net income and the number of
shares of Common Stock outstanding during each period after giving
retroactive effect to the three-for-two stock splits in April and November
1996. Earnings per share for all years have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
(3) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization. The Company has included information
concerning EBITDA (which is not a measure of financial performance under
generally accepted accounting principles) because it understands that it is
used by certain investors as one measure of an issuer's financial
performance. EBITDA should not be construed as an alternative to operating
income (as determined in accordance with generally accepted accounting
principles) as an indicator of the Company's performance or cash flows from
operating activities (as determined in accordance with generally accepted
accounting principles) or as a measure of liquidity.
(4) Operating losses from new technical institutes before income taxes
represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first 24 months after
their first class start.
8
<PAGE> 10
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully in evaluating the Company
and its business before purchasing any shares of Common Stock offered hereby.
This Prospectus contains certain statements that constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act (and Section
21E of the Exchange Act). These forward-looking statements are based on the
beliefs of, as well as assumptions made by and information currently available
to, the Company's management. All statements which are not statements of
historical fact are intended to be such forward-looking statements. Such
statements reflect the current views of the Company or its management and are
subject to certain risks, uncertainties and assumptions, including, but not
limited to, those set forth in the following Risk Factors. Should one or more of
these risks or uncertainties materialize or should underlying assumptions prove
incorrect, the Company's actual results, performance or achievements in 1998 and
beyond could differ materially from those expressed in, or implied by, such
forward-looking statements.
POTENTIAL ADVERSE EFFECTS OF REGULATION
The Company and the ITT Technical Institutes are subject to extensive
regulation by federal and state governmental agencies and accrediting
commissions. At the federal level, the Higher Education Act of 1965, as amended
(the "HEA"), and the regulations promulgated thereunder by the DOE set forth
numerous and complex standards that schools must satisfy in order to participate
in the federal student financial aid programs under Title IV of the HEA ("Title
IV Programs"). These standards are designed to limit institutional dependence on
Title IV Program funds, prevent institutions with unacceptable student loan
default rates from participating in Title IV Programs and, in general, require
institutions to satisfy certain criteria related to educational value,
administrative capability and financial responsibility. Sixty of the 63 ITT
Technical Institutes currently participate in Title IV Programs, and the other
three institutes, which were recently opened, have begun the certification
process for participation in Title IV Programs. In 1997, the Company indirectly
derived approximately 70% of its revenues from Title IV Programs.
Proprietary providers of postsecondary education have been subjected to
increased scrutiny and regulation by the DOE and other regulatory authorities as
a result of concern about fraud and abuse of federal student financial aid
programs by certain proprietary institutions. The Company believes that the ITT
Technical Institutes are in substantial compliance with the HEA and its
implementing regulations. The Company cannot, however, predict with certainty
how all of the HEA provisions and the implementing regulations will be applied.
It is also possible that the HEA and its implementing regulations may be applied
in a way that could hinder the Company's operations or expansion plans. In the
event of a determination by the DOE that one of the ITT Technical Institutes
improperly disbursed Title IV Program funds or violated a provision of the HEA
or the implementing regulations, the affected institute could be required to
repay those funds, assessed an administrative fine, transferred to the
"reimbursement" system of receiving Title IV Program funds (which delays the
institute's receipt of such funds), and subjected to other civil and criminal
penalties. The failure by any of the ITT Technical Institutes to comply with
applicable federal, state or accrediting commission requirements could result in
the limitation, suspension or termination of that institution's ability to
participate in Title IV Programs or the loss of state authorization or
accreditation. Any such event could have a material adverse effect on the
Company's financial condition, results of operations or cash flows. There are no
proceedings for any such purposes pending, and the Company has no reason to
believe that any such proceeding by the DOE is contemplated. See
"Business -- Regulation of Federal Financial Aid Programs."
Significant factors relating to Title IV Programs that could adversely
affect the Company include the following:
Change in Control. The DOE, the two accrediting commissions that
accredit the ITT Technical Institutes (the "Accrediting Commissions") and
most of the state education authorities that regulate the ITT Technical
Institutes (the "SEAs") have laws, regulations and/or standards
("Regulations") pertaining to the change in ownership and/or control
(collectively "change in control") of educational institutions, but these
Regulations do not uniformly define what constitutes a change in control.
The DOE's Regulations describe certain transactions that constitute a
change in control, including the transfer of a controlling interest in the
voting stock of an institution or such institution's parent
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corporation. The DOE's standards also specify that a change in control of a
publicly traded corporation, such as the Company, occurs when there is an
event that obligates the corporation to file a Current Report on Form 8-K
with the Securities and Exchange Commission disclosing a change in control.
Upon the occurrence of a change in control under the DOE's Regulations, an
institution immediately becomes ineligible to participate in Title IV
Programs and can only receive and disburse certain Title IV Program funds
that were previously committed to its students, until it has applied for
certification and is reinstated by the DOE to continue Title IV Program
participation under such institution's new ownership and control. The time
required for the DOE to act on such an application can vary substantially
and may take several months. The DOE's Regulations also require that all of
the ITT Technical Institutes in a particular campus group have their state
authorizations and accreditations reaffirmed or reestablished before any
institute in that campus group can regain its eligibility from the DOE to
continue participation in Title IV Programs. The Regulations of the SEAs
and Accrediting Commissions vary widely with respect to what constitutes a
change in control, with most including the sale of a controlling interest
of common stock in the definition of a change in control, but those
Regulations are subject to varying interpretations as to whether a
particular transaction constitutes a change in control. Many of the SEAs,
including the California SEA which authorizes 11 ITT Technical Institutes,
require that a change in control of an institution be approved before it
occurs in order for the institution to maintain its SEA authorization.
Other SEAs will only review a change in control of an institution after it
occurs. The Accrediting Commissions will not reaccredit an institution
following a change in control until the institution submits a complete
application for reaccreditation, but may temporarily continue or reinstate
an institution's accreditation to allow time for the completion and review
of the application.
The DOE, the Accrediting Commissions and most of the SEAs (including
the California SEA) considered the Merger to constitute a change in control
of the Company and the ITT Technical Institutes under their respective
Regulations. As a result, effective upon the Merger, each ITT Technical
Institute campus group immediately became ineligible to participate in all
of the Title IV Programs. The Company obtained all prior approvals of the
Merger from the Accrediting Commission and the SEAs that required such
approval before the Merger occurred. Since the Merger, the Company has
obtained temporary approval of the Merger from the other Accrediting
Commission, final approvals of the Merger from some of the SEAs required
after a change in control occurs and continued authorization to operate
from the remaining SEAs. The Company is continuing to pursue final
approvals from such Accrediting Commission and SEAs. The DOE approved the
reinstatement of each ITT Technical Institute campus group's participation
in Title IV Programs effective March 20, 1998. The DOE's approval was on a
provisional basis, which is the DOE's practice for all institutions
following a change in control. As an additional condition of each
institute's provisional certification, the DOE directed the Company to
maintain an undefined sufficient level of cash or cash equivalents, and to
revise its current accounting treatment of direct marketing costs, revenue
recognition and amortization of direct marketing costs or provide evidence
that the Company's treatment of these items is in conformance with
Generally Accepted Accounting Principles ("GAAP"). The Company believes
that its treatment of these items is in accordance with GAAP and that it
maintains cash and cash equivalents in sufficient amounts to satisfy the
DOE, but there can be no assurance thereof. If the Company is required to
change its accounting treatment for any of the above items, management does
not believe that such change would have a material adverse effect on the
Company's financial condition or results of operations before the
cumulative effect of any change in accounting. Four campus groups each had
one additional condition placed on their provisional certification. See
"Business -- Regulation of Federal Financial Aid Programs -- Eligibility
and Certification Procedures" and "-- Change in Control."
The Offering will constitute a change in control under the Regulations
of certain SEAs, but not under the Regulations of the DOE or of either
Accrediting Commission. Thus, certain ITT Technical Institutes will be
subject to review by their applicable SEAs to reaffirm their authorization
as a result of the Offering. A significant delay in obtaining or the
failure to obtain SEA authorization of any ITT Technical Institute could
have a material adverse effect on the Company's financial condition or
results of operations. The Company does not believe it will experience any
material delay or difficulty in obtaining SEA authorization of any affected
institute.
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A change in control under the Regulations of the DOE, the Accrediting
Commissions and most of the SEAs could also occur as the result of certain
future transactions involving the ITT Technical Institutes, the Company or
a principal stockholder, including but not limited to ITT's disposition of
a significant portion of the shares of Common Stock that it retains after
the Offering, certain corporate reorganizations and certain changes in the
boards of directors of such corporations. Starwood, Inc. has announced that
it is exploring a range of disposition strategies for the Company. The
Company believes that if a future transaction results in a change in
control of the ITT Technical Institutes, the Company or a principal
stockholder, the Company will be able to obtain all necessary approvals
from the DOE, the SEAs and the Accrediting Commissions, with the possible
exception of the California SEA. There can be no assurance, however, that
all such approvals can be obtained in a timely manner. In particular,
obtaining such approval from the California SEA, which authorizes 11 ITT
Technical Institutes, could be adversely affected by a state statute that
prohibits the California SEA from approving a change in control application
by any applicant that has been found in any judicial or administrative
proceeding to have violated certain provisions of the California Education
Code ("CEC"). In October 1996, a state court jury determined that the
Company, through its ITT Technical Institute in San Diego, California,
violated those provisions of the CEC. The Company has appealed the jury's
verdict in that case. While the California SEA approved the change in
control application submitted by the Company with respect to the Merger,
there can be no assurance that it will approve any future change in control
application submitted by the Company. See "Business -- Change in Control"
and "Business -- Legal Proceedings."
A material adverse effect on the Company's financial condition,
results of operations and cash flows would result if a change in control of
the Company occurred and a material number of ITT Technical Institutes
failed, in a timely manner, to be reauthorized by their SEAs (including the
California SEA in particular), reaccredited by their Accrediting
Commissions or recertified by the DOE to participate in Title IV Programs.
See "Business -- Change in Control."
Risk of Legislative Action. Title IV Programs are subject to
significant political and budgetary pressures. The HEA is reauthorized by
the U.S. Congress approximately every six years, and the next
reauthorization is expected to be completed in 1998 or 1999. There can be
no assurance that funding for Title IV Programs will continue to be
available or maintained at current levels or that current requirements for
institutional participation and student eligibility will not change. A
reduction in Title IV Program funding levels or a limitation of the
Company's participation in Title IV Programs could result in lower
enrollments and require the Company to arrange for alternative sources of
financial aid for its students. Given the significant percentage of the
Company's revenues that are indirectly derived from Title IV Programs, any
significant reduction in Title IV Program funding or the ability of the ITT
Technical Institutes or their students to participate in Title IV Programs
could have a material adverse effect on the Company's financial condition
or results of operations. See "Business -- Regulation of Federal Financial
Aid Programs -- Risk of Legislative Action."
Student Loan Defaults. Under the HEA, an institution may lose its
eligibility to participate in some or all Title IV Programs if student
defaults on federal student loans exceed certain rates. An institution
whose cohort default rate on loans under the Federal Family Education Loan
("FFEL") programs and the Federal Direct Loan ("FDL") programs is 25% or
greater for three consecutive federal fiscal years loses eligibility to
participate in those programs for the remainder of the federal fiscal year
in which the DOE determines that the institution has lost its eligibility
and for the two subsequent federal fiscal years.
The ITT Technical Institute in Garland, Texas had FFEL/FDL cohort
default rates exceeding 25% for the 1993, 1994 and 1995 federal fiscal
years. The ITT Technical Institute in San Antonio, Texas had FFEL/FDL
cohort default rates exceeding 25% for the 1994 and 1995 federal fiscal
years but a cohort default rate below 25% for the 1993 federal fiscal year.
No other ITT Technical Institute campus group had an FFEL/FDL cohort
default rate equal to or greater than 25% for the 1995 federal fiscal year,
the latest year for which the DOE has published FFEL/FDL cohort default
rates. The ITT Technical Institutes in Garland and San Antonio, Texas,
which accounted for approximately 1.7% and 2.4%, respectively, of the
Company's revenues in its 1997 fiscal year, have initiated appeals of their
1995 FFEL/FDL cohort default rates with the DOE. There can be no assurance
that either institute's appeal
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will result in a recalculation of its 1995 FFEL/FDL cohort default rate to
less than 25%. If the Garland, Texas ITT Technical Institute's appeal does
not result in its 1995 FFEL/FDL cohort default rate being reduced to less
than 25%, such institute will immediately become ineligible to participate
in the FFEL and FDL programs. The Company has arranged for an unaffiliated
private funding source to provide loans to the students enrolled at the
Garland, Texas ITT Technical Institute in the event of such ineligibility.
Another alternative would be to stop enrolling new students in the Garland
institute, continue to teach the students already enrolled, and close the
institute once the students already enrolled had completed their programs
of study. If the San Antonio, Texas ITT Technical Institute's appeal does
not result in its 1995 FFEL/FDL cohort default rate being reduced to less
than 25% and such institute subsequently receives a 1996 FFEL/FDL cohort
default rate equal to or greater than 25% and cannot reduce that rate to
less than 25% through an appeal to the DOE, such institute will become
ineligible to participate in the FFEL and FDL programs. Loss of eligibility
to participate in the FFEL and FDL programs by both the Garland and San
Antonio, Texas ITT Technical Institutes (but not by either alone) could
have a material adverse effect on the Company's financial condition or
results of operations.
If an institution's FFEL/FDL cohort default rate is 25% or greater in
any of the three most recent federal fiscal years, or if an institution's
cohort default rate for loans under the Federal Perkins Loan ("Perkins")
program exceeds 15% for any federal award year, that institution may be
placed on provisional certification status by the DOE. When the Garland and
San Antonio, Texas ITT Technical Institutes were provisionally recertified
for participation in Title IV Programs following the Merger, one of the
conditions of the provisional certification for each of those institutes
was the institute's FFEL/FDL cohort default rate, which exceeded 25%.
Twenty-seven ITT Technical Institute campus groups (consisting of 53
institutes) had a Perkins cohort default rate in excess of 15% for students
who were scheduled to begin repayment in the 1995/1996 federal award year,
the most recent year for which such rate has been calculated. Thus, those
ITT Technical Institutes could be placed on provisional certification
status based on their Perkins cohort default rates. To date, no ITT
Technical Institute campus group has been placed on provisional
certification status because of its Perkins cohort default rate. See
"Business -- Regulation of Federal Financial Aid Programs -- Student Loan
Defaults," "-- Administrative Capability" and "-- Eligibility and
Certification Procedures."
Financial Responsibility Standards. The HEA and its implementing
regulations prescribe specific standards of financial responsibility that a
proprietary institution must satisfy to participate in Title IV Programs.
Under such standards, an institution must (a) have an acid test ratio
(defined as the ratio of cash, cash equivalents and current accounts
receivable to current liabilities) of at least 1:1 at the end of each
fiscal year, (b) have a positive tangible net worth at the end of each
fiscal year and (c) not have a cumulative net operating loss during its two
most recent fiscal years that results in a decrease of more than 10% of the
institution's tangible net worth at the beginning of such two-year period.
If the DOE determines that an institution does not satisfy each of these
numeric standards, that institution may establish its financial
responsibility on an alternative basis by posting a letter of credit in
favor of the DOE. Historically, the DOE has evaluated the financial
condition of the ITT Technical Institutes on a consolidated basis based on
the Company's financial statements. The DOE's regulations, however, permit
the DOE to examine the financial statements of each ITT Technical Institute
campus group, the Company, Starwood, Inc. and ITT. The Company has
calculated that its acid test ratio at December 31, 1997 was 1.94:1, and
the Company believes that it satisfied all the other standards of financial
responsibility at the Company level as of that date. As a part of the DOE's
review of the applications of the ITT Technical Institute campus groups to
have their eligibility to participate in Title IV Programs reinstated after
the Merger, the DOE evaluated the financial responsibility of all of the
ITT Technical Institute campus groups following the Merger. The DOE
determined that each of the campus groups satisfied the DOE's financial
responsibility standards following the Merger, but the DOE directed the
Company to address certain issues related to its financial condition and
financial statements. See "-- Potential Adverse Effects of
Regulation -- Change in Control" and "Business -- Change in Control."
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In November 1997, the DOE issued new regulations, to take effect July
1, 1998, which revised the DOE's standards of financial responsibility.
These new standards replace the numeric tests described above with three
different ratios: an equity ratio, a primary reserve ratio and a net income
ratio, which are weighted and added together to produce a composite score
for the institution. The Company applied these new regulations to the
Company's audited financial statements for its 1997 fiscal year and has
determined that it satisfied the new standards as of that date. The Company
does not believe, based on its current understanding of how the revised
financial responsibility standards will be applied, that these standards
will have a material adverse effect on the Company's financial condition or
results of operations or its expansion plans. See "Business -- Regulation
of Federal Financial Aid Programs -- Financial Responsibility Standards."
The "85/15 Rule." Under a provision of the HEA commonly referred to
as the "85/15 Rule," a proprietary institution, such as each ITT Technical
Institute campus group, becomes ineligible to participate in Title IV
Programs if more than 85% of its applicable revenues for a fiscal year are
derived from Title IV Programs. If any ITT Technical Institute campus group
were to violate the 85/15 Rule for any fiscal year, it would be ineligible
to participate in Title IV Programs as of the first day of the following
fiscal year and would be unable to apply to regain its eligibility until
the next fiscal year. For each of its 1996 and 1997 fiscal years, the
Company has calculated that no ITT Technical Institute campus group derived
more than 81% of its revenues from Title IV Programs, and for its 1997
fiscal year, the range for the campus groups was from approximately 61% to
approximately 80%. See "Business -- Regulation of Federal Financial Aid
Programs -- The '85/15 Rule'."
Additional Locations and Program Offerings of ITT Technical
Institutes. The HEA requires proprietary educational institutions, such as
the ITT Technical Institute campus groups, to be in full operation for two
years before the institution can qualify to participate in Title IV
Programs. The HEA and applicable regulations, however, permit an
institution that is already certified to participate in Title IV Programs
to establish additional locations that may, after review by the DOE, begin
to participate in Title IV Programs without satisfying the two-year
requirement so long as each such additional location satisfies all other
applicable requirements for institutional eligibility. The HEA and
applicable regulations also permit institutions participating in Title IV
Programs to offer additional programs without restricting the number or
delaying the introduction, but students can only obtain Title IV Program
funds to attend programs that satisfy all applicable requirements for
eligibility. Applicable accrediting commission standards and state laws and
regulations generally permit institutions to establish additional locations
and expand their program offerings under certain conditions. Although such
conditions limit the ability of the Company to establish additional
locations and expand program offerings in certain circumstances, the
Company does not believe, based on its current understanding of how the
accrediting standards and state laws and regulations will be applied, that
these limitations will have a material adverse effect on the Company's
expansion plans. The Company's expansion plans assume its continued ability
to (a) establish new ITT Technical Institutes as additional locations of
existing ITT Technical Institute main campuses and (b) expand the program
offerings at existing institutes. In its last three fiscal years, the
Company has: (i) established eight new additional locations, six of which
are participating in Title IV Programs and two of which are in the process
of obtaining certification to participate; and (ii) added 35 programs at
its existing ITT Technical Institutes. In addition, in March 1998 the
Company established one new additional location, which is in the process of
obtaining certification to participate in Title IV Programs. See
"Business -- Regulation of Federal Financial Aid Programs -- Additional
Locations and Program Offerings of ITT Technical Institutes."
Availability of Lenders and Guarantors. In the Company's 1997 fiscal
year, one lending institution provided approximately 62% of all federally
guaranteed student loans to ITT Technical Institute students and one
student loan guaranty agency guaranteed approximately 94% of all FFEL
program loans made to ITT Technical Institute students. The Company
believes that other lenders and guarantors would be willing to make and
guarantee, respectively, FFEL program loans to its students if such loans
or guarantees were no longer available from its primary lender or
guarantor, but there can be no assurance in this regard. See
"Business -- Regulation of Federal Financial Aid Programs -- Availability
of Lenders and Guarantors."
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State Authorization and Accreditation. Each ITT Technical Institute
must be authorized by the applicable state education authority(ies) to
operate and grant degrees or diplomas to its students. State authorization
and accreditation by an accrediting commission recognized by the DOE are
also required in order for an institution to become and remain eligible to
participate in Title IV Programs. Each ITT Technical Institute is subject
to extensive regulation by its state education authority(ies) and
accrediting commission, and the HEA specifies certain standards that each
recognized accrediting commission must utilize in reviewing institutions.
All 63 ITT Technical Institutes are currently authorized by one or more
state education authorities. Sixty of those institutes are accredited by a
recognized accrediting commission, and the other three institutes, which
were recently opened, have applied for accreditation. Two ITT Technical
Institutes (both additional locations) are on probation and four ITT
Technical Institutes (two main campuses and two additional locations) are
subject to a show cause order by their accrediting commission. An institute
on probation is required to demonstrate to the accrediting commission that
the institute has taken corrective action and is in continuous compliance
with accrediting commission standards. An institution subject to a show
cause order is required to demonstrate to the accrediting commission that
the institute's accreditation should not be revoked, conditioned or
otherwise adversely affected. If any ITT Technical Institute on probation
or subject to a show cause order by its accrediting commission fails to
make the applicable demonstration to the accrediting commission, the
accrediting commission may revoke, refuse to renew or otherwise condition
the institute's accreditation. Loss of state authorization or accreditation
by any ITT Technical Institute: (a) would render (i) only the affected
institute ineligible to participate in Title IV Programs, if the affected
institute was an additional location or (ii) the entire campus group
ineligible to participate in Title IV Programs, if the affected institute
was a main campus; and (b) could have a material adverse effect on the
Company's financial condition, results of operations and cash flows. Loss
of state authorization by any ITT Technical Institute would also force the
Company to close the institute, which could have a material adverse effect
on the Company's financial condition or results of operations. See
"Business -- State Authorization and Accreditation."
CONTROL BY ITT; RELATIONSHIP WITH ITT
Prior to the Offering, ITT holds 83.3% of the outstanding shares of Common
Stock. Consequently, ITT has had significant influence over the policies and
affairs of the Company. Effective upon the Merger, ITT became a wholly owned
subsidiary of Starwood, Inc. See "Relationship With Selling Stockholder and
Related Transactions," "Principal and Selling Stockholder" and "Description of
Capital Stock." Upon the completion of the Offering, Starwood, Inc., through its
wholly owned subsidiary ITT, will beneficially own 42.6% of the outstanding
shares of Common Stock (36.5% if the over-allotment option is exercised in
full). Accordingly, ITT will continue to be able to substantially influence the
outcome of corporate actions requiring stockholder approval, including the
election of Directors, the adoption of amendments to the Company's Restated
Certificate of Incorporation and the approval of mergers and sales of the
Company's assets.
At the time the Merger was consummated, four of the ten members of the
Board of Directors of the Company (Bette B. Anderson, Robert A. Bowman, Richard
S. Ward and Margita E. White, all of whom were directors and/or executive
officers of ITT prior to the Merger) resigned effective February 23, 1998. On
February 25, 1998, the remaining members of the Board of Directors of the
Company elected four individuals recommended by Starwood, Inc. (Tony Coelho,
Robin Josephs, Merrick R. Kleeman and Barry S. Sternlicht) to fill the vacancies
caused by such resignations and to serve as Directors for terms expiring at the
2000, 1999, 2000 and 1998 Annual Meeting of Shareholders, respectively, and
until such Director's successor is duly elected and qualified. Mr. Sternlicht
serves as chairman and a director of Starwood, Inc. and as chairman, chief
executive officer and a trustee of Starwood Trust. Mr. Sternlicht is also the
general manager of Starwood Capital Group, L.L.C., which, together with its
affiliates and Mr. Sternlicht, beneficially owns approximately 5.3% of the
outstanding paired shares of Starwood, Inc. common stock and Starwood Trust
beneficial interest. Mr. Kleeman is also a managing director of Starwood Capital
Group, L.L.C. Mr. Coelho and Ms. Josephs are not affiliated with ITT, Starwood,
Inc., Starwood Trust or Starwood Capital Group, L.L.C. See "Relationship with
Selling Stockholder and Related Transactions."
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Under agreements with the Company, since the Initial Public Offering in
December 1994, ITT has provided certain administrative, financial, treasury,
accounting, tax and other services to the Company and has made available certain
of its employee benefit plans to the Company's employees. In addition, ITT and
the Company are parties to a number of intercompany agreements covering matters
such as corporate governance, tax sharing arrangements, the use of the "ITT"
name and registration rights. For a description of certain changes in the
foregoing arrangements and other ongoing agreements with ITT after the Offering,
see "Relationship With Selling Stockholder and Related Transactions."
A future change in ownership by Starwood, Inc. or ITT resulting in a change
in control of the Company or the ITT Technical Institutes could have significant
adverse regulatory consequences for the Company at the state and federal levels
and could affect the accreditation of the ITT Technical Institutes. See "Risk
Factors -- Potential Adverse Effects of Regulation -- Change in Control."
Conflicts of interest between the Company and ITT or Starwood, Inc. could
arise with respect to business dealings between them, including potential
acquisitions of businesses or properties, the issuance or sale of additional
securities, other transactions involving the Company, the election of new or
additional directors and the payment of dividends by the Company. The Company
has not instituted any formal plan or arrangement to address potential conflicts
of interest that may arise between the Company and ITT or Starwood, Inc. The
Company's directors intend, however, to exercise reasonable judgment and take
such steps as they deem necessary to resolve any specific conflict of interest
that may occur and will determine what, if any, specific measures, such as the
retention of an independent advisor or independent counsel or the appointment of
a special committee, may be necessary or appropriate. There can be no assurance
that any conflicts will be resolved in favor of the Company.
MATERIAL LITIGATION
The Company is subject to several pending legal proceedings instituted by
or on behalf of former students alleging misrepresentations and statutory
violations. In October 1996, the Company had a judgment rendered against it in a
California state court for approximately $3.7 million, plus interest, in a
lawsuit brought by seven graduates of the hospitality program at the San Diego
ITT Technical Institute. The suit alleged, among other things,
misrepresentation, civil conspiracy and statutory violations of the state
education code by the Company, based on the plaintiffs' claims that the
defendants (a) made misrepresentations and engaged in deceptive acts in the
recruitment of the plaintiffs for, and/or in the promotion of, the program, (b)
provided inadequate instruction, (c) used inadequate facilities and equipment in
the program and inappropriate forms of contracts with the plaintiffs, (d) failed
to provide the plaintiffs with all required information and disclosures and (e)
misrepresented the plaintiffs' prospects for employment upon graduation, the
employment of the program's graduates and the plaintiffs' ability to transfer
program credits. The Company has appealed that decision. The Company has made no
provision (other than for the Company's legal expenses) for the awards.
Six other legal proceedings are pending in California state court involving
former students who attended the ITT Technical Institutes in California. The
three plaintiffs in one of these legal proceedings each attended one of three
different programs (i.e., hospitality, EET and CAD) and allege that the Company,
ITT and ten Company employees violated state education laws, based on the
plaintiffs' claims that the defendants (a) made misrepresentations and engaged
in deceptive acts in the recruitment of students for, and/or in the promotion
of, the programs offered in California, (b) failed to provide students with all
required information and disclosures and (c) misrepresented students' prospects
for employment upon graduation and the employment of the programs' graduates.
The request of the plaintiffs in that legal proceeding to have their action
certified as a class action has been denied by the court.
The 17 plaintiffs in the other five legal proceedings each attended the
hospitality program at the San Diego ITT Technical Institute and allege that the
Company, ITT and a Company employee committed intentional misrepresentation
and/or concealment, civil conspiracy and violations of state education, consumer
protection and trade practices laws, based on the plaintiffs' claims that the
defendants (a) made misrepresentations and engaged in deceptive acts in the
recruitment of the plaintiffs for, and/or in the promotion of, the program, (b)
used inadequate facilities and equipment in the program and inappropriate forms
of contracts
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with the plaintiffs, (c) failed to provide the plaintiffs with all required
information and disclosures and a fully executed copy of their contracts with
the Company and (d) misrepresented the plaintiffs' prospects for employment upon
graduation, the employment of the program's graduates and the plaintiffs'
externship portion of the program.
There can be no assurance as to the ultimate outcome of any of the
litigation involving the Company. An unsuccessful appeal of the California
judgment or judgments against the Company in the other California legal
proceedings or in other similarly based legal proceedings could have a material
adverse effect on the financial condition or results of operations of the
Company. See "Business -- Legal Proceedings."
COMPETITION
The postsecondary education market in the United States is highly
fragmented and competitive with no private or public institution enjoying a
significant market share. ITT Technical Institutes compete for students with
four-year and two-year degree granting institutions, which include non-profit
public and private colleges and proprietary institutions, as well as with
alternatives to higher education such as military service or immediate
employment. Management believes that competition among educational institutions
is based on the quality of the educational program, perceived reputation of the
institution, cost of the program and employability of graduates. Certain public
and private colleges may offer programs similar to those of the ITT Technical
Institutes at a lower tuition cost due in part to governmental subsidies,
government and foundation grants, tax deductible contributions or other
financial resources not available to proprietary institutions. Other proprietary
institutions also offer programs that compete with those of the ITT Technical
Institutes. Certain of the Company's competitors in both the public and private
sector have greater financial and other resources than the Company. There can be
no assurance that competitive pressures will not have a material adverse effect
on the financial condition or results of operations of the Company.
SEASONALITY IN RESULTS OF OPERATIONS
The Company's quarterly results of operations tend to fluctuate
significantly within a fiscal year because of differences in the number of weeks
of earned tuition revenue in each fiscal quarter and the timing of student
matriculations. The Company's first and third fiscal quarters have 13 weeks of
earned tuition revenue, while the second and fourth quarters have 11 weeks of
earned tuition revenue because of two-week vacation breaks in June and December.
In addition, revenues in the third and fourth fiscal quarters generally benefit
from increased student matriculations as the number of new students entering ITT
Technical Institutes tends to be substantially higher in June and September
because of the significant number of recent high school graduates entering ITT
Technical Institutes for the academic quarters beginning in those two months.
The Company's incurrence of costs, however, is generally not affected by the
academic schedule, and such costs do not fluctuate significantly on a quarterly
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Variations in Quarterly Results of Operations."
RISKS ASSOCIATED WITH CHANGES IN MARKET NEEDS AND TECHNOLOGY
Prospective employers of graduates of ITT Technical Institutes increasingly
demand that their entry-level employees possess appropriate technical skills.
The Company believes its management processes and information systems should
permit the Company to make changes in curricula content and supporting
technology in response to market needs. The inability of the Company to
adequately respond, however, to changes in market requirements due to financial
constraints, unusually rapid technological change or other factors could have a
material adverse effect on the Company's financial condition or results of
operations.
DEPENDENCE ON KEY EMPLOYEES
The Company's future performance will depend, in part, on the efforts and
abilities of the Company's executive officers and in particular Rene R.
Champagne, Chairman, President and Chief Executive Officer of the Company. The
loss of the services of Mr. Champagne or one or more other executive officers
could have an adverse effect on the Company's business. None of the Company's
executive officers is subject to an
16
<PAGE> 18
employment or non-competition agreement with the Company. The Company has no key
man life insurance on any of its employees.
POTENTIAL ADVERSE EFFECT OF SHARES ELIGIBLE FOR FUTURE SALE
No predictions can be made as to the effect, if any, that future sales of
shares of Common Stock, or the availability of shares of Common Stock for future
sale, will have on the market price of the Common Stock prevailing from time to
time. Sales of substantial amounts of Common Stock in the public market
following the Offering, or the perception that such sales could occur, could
adversely affect the market price of the Common Stock and may make it more
difficult for the Company to sell its equity securities in the future at a time
and price which it deems appropriate.
Immediately after the Offering, the Company will continue to have
outstanding 26,999,952 shares of Common Stock. The shares of Common Stock sold
in the Offering will be freely tradeable without restriction or further
registration under the Securities Act except for any of those shares of Common
Stock that are beneficially owned at any time by an "affiliate" of the Company
within the meaning of Rule 144 under the Securities Act (which sales will be
subject to the timing, volume and manner of sale limitations of Rule 144). The
11,500,000 outstanding shares of Common Stock that will be held by the Selling
Stockholder after the Offering (9,850,000 shares if the over-allotment option is
exercised in full) are "restricted" securities within the meaning of Rule 144
under the Securities Act and may not be publicly resold, except in compliance
with the registration requirements of the Securities Act or pursuant to an
exemption from registration, including that provided by Rule 144 under the
Securities Act. The Selling Stockholder has certain registration rights with
respect to the shares of Common Stock owned by it. See "Relationship with
Selling Stockholder and Related Transactions."
The Company, its executive officers, ITT and Starwood, Inc. have agreed
that they will not offer, sell, contract to sell, announce any intention to
sell, pledge or otherwise dispose of, directly or indirectly, or file with the
Commission a registration statement under the Securities Act relating to, any
shares of Common Stock or securities or other rights convertible into or
exchangeable or exercisable for any shares of Common Stock, without the prior
written consent of Credit Suisse First Boston Corporation, for a period of 180
days after the date of this Prospectus; provided, however, that such
restrictions will not affect the ability of the Company to grant stock options
for Common Stock pursuant to the Stock Plans, or to issue Common Stock pursuant
to the exercise of stock options currently outstanding or granted pursuant to
the Stock Plans. See "Shares Eligible for Future Sale" and "Underwriting."
ANTI-TAKEOVER PROVISIONS
Certain provisions of Delaware law, the Company's Restated Certificate of
Incorporation and the Company's By-Laws could have the effect of making it more
difficult for a third party to acquire, or discouraging a third party from
attempting to acquire, control of the Company. Such provisions could limit the
price that certain investors might be willing to pay in the future for shares of
Common Stock. These provisions of Delaware law, the Company's Restated
Certificate of Incorporation and the Company's By-Laws may also have the effect
of discouraging or preventing certain types of transactions involving an actual
or threatened change of control of the Company (including unsolicited takeover
attempts), even though such a transaction may offer the Company's stockholders
the opportunity to sell their stock at a price above the prevailing market
price. Certain of these provisions authorize the issuance of "blank check"
preferred stock, divide the Board of Directors into three classes expiring in
rotation, require advance notice for stockholder proposals and nominations,
prohibit stockholders from calling a special meeting and prohibit stockholder
action by written consent. These provisions may make it more difficult for
stockholders to take certain corporate actions and could have the effect of
delaying or preventing a change in control of the Company. See "Description of
Capital Stock -- Preferred Stock," "-- Provisions of Restated Certificate of
Incorporation and By-Laws Affecting Change in Control" and "-- Delaware General
Corporation Law."
17
<PAGE> 19
PRICE RANGE OF COMMON STOCK
The Common Stock is listed on the NYSE under the trading symbol "ESI." The
prices set forth below reflect the high and low sale prices of the Common Stock
during the periods indicated, as reported in the consolidated transaction
reporting system of the NYSE. These prices have been restated to reflect the
following adjustments to the market price of the Common Stock: (a) on April 16,
1996 to reflect the three-for-two Common Stock split declared by the Company on
March 22, 1996 and effected by payment of a stock dividend on April 15, 1996;
and (b) on November 15, 1996 to reflect the three-for-two Common Stock split
declared by the Company on October 8, 1996 and effected by payment of a stock
dividend on November 4, 1996.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
1996
First Quarter............................................ $15.109 $11.063
Second Quarter........................................... 22.750 14.891
Third Quarter............................................ 25.672 17.500
Fourth Quarter........................................... 26.078 18.250
1997
First Quarter............................................ $27.000 $21.500
Second Quarter........................................... 25.000 19.375
Third Quarter............................................ 26.750 19.000
Fourth Quarter........................................... 26.000 20.750
1998
First Quarter ........................................... $28.375 $21.375
Second Quarter (through April 8, 1998)................... $29.125 $27.250
</TABLE>
On April 8, 1998, the last reported sale price of the Common Stock on the
NYSE was $27.25 per share. There were approximately 200 holders of record, and
approximately 1,500 beneficial owners, of the Common Stock on April 4, 1998.
DIVIDEND POLICY
No cash dividends were declared by the Company in 1996 or 1997. The Company
anticipates that it will not pay any cash dividends on the Common Stock for the
foreseeable future and that it will retain its earnings to finance future
growth. The declaration and payment of dividends by the Company are subject to
the discretion of its Board of Directors and compliance with applicable law. Any
determination as to the payment of dividends in the future will depend on, among
other things, general business conditions, the effect of such payment on the
Company's financial condition and other factors the Company's Board of Directors
may in the future consider to be relevant.
18
<PAGE> 20
CAPITALIZATION
The following table sets forth the capitalization of the Company at
December 31, 1997. The Company will not receive any of the proceeds from the
Offering. See "Principal and Selling Stockholder." This table should be read in
conjunction with the Financial Statements and Notes thereto included elsewhere
in this Prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
(DOLLARS IN THOUSANDS)
<S> <C>
Long-term debt.............................................. $ 0
Shareholders' equity:
Preferred Stock, $.01 par value; 5,000,000 shares
authorized; none issued and outstanding................ --
Common Stock, $.01 par value; 50,000,000 shares
authorized; 26,999,952 issued and outstanding(1)....... 270
Capital surplus........................................... 32,513
Retained earnings......................................... 55,032
-------
Total shareholders' equity........................ 87,815
-------
Total capitalization...................................... $87,815
=======
</TABLE>
- ---------------
(1) Excludes 4,455,000 shares of Common Stock which may be issued pursuant to
the Company's Stock Plans, under which options to purchase an aggregate of
405,000 shares of Common Stock were outstanding on December 31, 1997.
19
<PAGE> 21
SELECTED FINANCIAL AND OPERATING DATA
The following selected financial data of the Company are qualified by
reference to and should be read in conjunction with the Financial Statements and
Notes thereto and other financial data included elsewhere or incorporated by
reference herein. The statement of income data set forth for each of the three
years in the period ended December 31, 1997 and the balance sheet data as of
December 31, 1997 and 1996 have been derived from the Financial Statements of
the Company which have been audited by Price Waterhouse LLP, independent
accountants, whose report thereon is included elsewhere in this Prospectus. The
statement of income data for each of the two years in the period ended December
31, 1994 and the balance sheet data as of December 31, 1995, 1994 and 1993 have
been derived from audited financial statements of the Company not included in
this Prospectus. These historical results are not necessarily indicative of the
results to be expected in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Tuition................................................ $222,457 $196,692 $171,936 $159,575 $144,908
Other educational(1)................................... 39,207 35,627 29,895 27,332 24,089
-------- -------- -------- -------- --------
Total revenues................................... 261,664 232,319 201,831 186,907 168,997
-------- -------- -------- -------- --------
Cost of educational services............................. 163,053 145,197 130,338 121,594 108,075
Student services and administrative expenses............. 72,388 66,546 57,268 53,481 47,083
-------- -------- -------- -------- --------
Total costs and expenses......................... 235,441 211,743 187,606 175,075 155,158
Operating income......................................... 26,223 20,576 14,225 11,832 13,839
Interest income, net(2).................................. 5,565 4,119 4,802 232 80
-------- -------- -------- -------- --------
Income before income taxes............................... 31,788 24,695 19,027 12,064 13,919
Income taxes............................................. 12,665 9,844 7,636 4,902 5,605
-------- -------- -------- -------- --------
Net income............................................... $ 19,123 $ 14,851 $ 11,391 $ 7,162 $ 8,314
======== ======== ======== ======== ========
Earnings per common share (basic and diluted)(3)......... $ .71 $ .55 $ .42 $ .32 $ .37
-------- -------- -------- -------- --------
OTHER OPERATING DATA:
EBITDA(4)................................................ $ 34,162 $ 28,069 $ 21,767 $ 18,687 $ 20,182
Operating losses from new technical institutes before
income taxes(5)........................................ $ 3,165 $ 5,721 $ 7,123 $ 7,316 $ 2,914
Capital expenditures, net................................ $ 11,465 $ 7,868 $ 8,206 $ 7,688 $ 6,679
Number of students at end of period...................... 24,498 22,633 20,618 20,668 19,860
Number of technical institutes at end of period.......... 62 59 56 54 48
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, restricted cash and cash invested with ITT......... $ 98,689 $ 95,793 $ 77,517 $ 66,810 $ 51,064
Total current assets..................................... 112,958 108,449 87,567 76,460 61,383
Property and equipment less accumulated depreciation..... 22,886 19,360 18,985 18,321 17,488
Total assets............................................. 145,914 135,749 114,284 102,899 87,305
Total current liabilities................................ 55,946 65,405 58,766 57,646 50,247
Shareholders' equity..................................... 87,815 68,692 53,841 42,450 35,288
</TABLE>
- ---------------
(1) Other educational revenue is comprised of laboratory and application fees
and textbook sales.
(2) See Note 3 of Notes to Financial Statements for information concerning
intercompany interest between the Company and ITT. Prior to the Initial
Public Offering in December 1994, the Company did not receive interest on
the full amount of net cash balances invested with ITT and was assessed an
interest charge based on an allocation of the consolidated debt of ITT.
After the Initial Public Offering and until February 5, 1998, the Company
received interest from ITT on the amount of any net cash balances invested
with ITT and no longer was subject to an interest charge based on such an
allocation. Since February 5, 1998, the Company has performed its own cash
management functions and no longer has any cash invested with ITT. Depending
upon current interest rates on short-term investments, the Company may not
be able to obtain the same yields on its cash balances that were being paid
by ITT. Accordingly, interest income, net may decrease in 1998.
(3) Earnings per share data are based on historical net income and the number of
shares of Common Stock outstanding during each period after giving
retroactive effect to the three-for-two stock splits in April and November
1996. Earnings per share for all years have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
(4) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization. The Company has included information
concerning EBITDA (which is not a measure of financial performance under
generally accepted accounting principles) because it understands that it is
used by certain investors as one measure of an issuer's financial
performance. EBITDA should not be construed as an alternative to operating
income (as determined in accordance with generally accepted accounting
principles) as an indicator of the Company's performance or cash flows from
operating activities (as determined in accordance with generally accepted
accounting principles) or as a measure of liquidity.
(5) Operating losses from new technical institutes before income taxes
represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first 24 months after
their first class start.
20
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Selected
Financial and Operating Data appearing elsewhere in this Prospectus and the
Financial Statements and Notes thereto included elsewhere in this Prospectus.
GENERAL
The Company operates 63 ITT Technical Institutes in 27 states which provide
technology-oriented postsecondary education to approximately 24,000 students.
The Company derives its revenue almost entirely from tuition, textbook sales,
fees and charges paid by, or on behalf of, its students. Most students at the
ITT Technical Institutes rely on funds received under various
government-sponsored student financial aid programs, especially the federal
student financial aid programs under Title IV of the Higher Education Act of
1965, as amended ("Title IV Programs"), to pay a substantial portion of their
tuition and other education-related expenses. In 1997, the Company indirectly
derived approximately 70% of its revenues from Title IV Programs.
The Company's revenue varies based on the aggregate student population,
which is influenced by the number of students attending ITT Technical Institutes
at the beginning of a fiscal period, by the number of new first-time students
entering and former students re-entering ITT Technical Institutes during such
period and by student retention rates. New students generally enter ITT
Technical Institutes at the beginning of an academic quarter that commences in
March, June, September and December. The Company believes that the size of its
student population is affected to some extent by general economic conditions,
and that, in the absence of countervailing factors, student enrollments and
retention rates tend to increase as opportunities for immediate employment for
high school graduates decline and decrease as such opportunities increase. The
establishment of new ITT Technical Institutes and the introduction of additional
program offerings at existing ITT Technical Institutes have been significant
factors in increasing the aggregate student population in recent years.
A new technical institute must be authorized by the state in which it will
operate, accredited by an accrediting commission that has been recognized by the
U.S. Department of Education ("DOE"), and certified by the DOE to participate in
Title IV Programs. The approval processes for accreditation and DOE
certification cannot commence until the first students begin classes. Such
accreditation and DOE certification processes generally take approximately one
year from the first class start date. Certain direct costs incurred with respect
to a new technical institute prior to the first class start ("institute start-up
costs") are deferred and amortized over the first year of operation after the
first class start. Since the beginning of 1993, the Company has opened 20 new
technical institutes (six of which started classes in 1996 or 1997 and one of
which started classes in 1998). New technical institutes historically incur a
loss during the 24-month period after the first class start date. These losses
during the year by institutes in their first two years of operation, together
with the amortization of institute start-up costs, are referred to as "operating
losses from new technical institutes." Such operating losses from new technical
institutes totaled $3.2 million, $5.7 million and $7.1 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
The Company earns tuition revenue on a weekly basis, pro rata over the
length of each of four, twelve-week academic quarters in each fiscal year. Under
federal and state regulations and accrediting commission standards, the Company
generally is required to refund a portion of the tuition payments received from
a student who withdraws from an ITT Technical Institute during an academic
quarter. The amount of tuition, if any, that may be retained by the Company
after payment of any refund is immediately recognized in the Company's statement
of income. Other educational revenue is comprised of textbook sales and
laboratory and application fees.
The Company incurs expenses throughout a fiscal period in connection with
the operation of the ITT Technical Institutes. The cost of educational services
includes faculty and administrative salaries, cost of books sold, occupancy
costs, depreciation and amortization of equipment costs and leasehold
improvements and certain other administrative costs incurred by the ITT
Technical Institutes.
21
<PAGE> 23
Student services and administrative expenses include direct marketing costs
(which are marketing expenses directly related to new student recruitment),
indirect marketing expenses, an allowance for doubtful accounts and
administrative expenses incurred at corporate headquarters. Direct marketing
costs include salaries and employee benefits for recruiting representatives and
direct solicitation advertising expenses. Direct marketing costs, excluding
advertising expenses, are capitalized and amortized on an accelerated basis over
the average course length of 24 months commencing on the class start date.
Marketing costs that do not relate to the direct solicitation of potential
students are expensed as incurred.
Until February 5, 1998, all cash receipts of the Company were forwarded to
ITT for investment on a daily basis after, in the case of certain receipts, the
lapse of applicable regulatory restrictions. Cash disbursements of the Company
were generally funded by ITT out of the cash balances of the Company held and
invested for the Company by ITT. Net interest income represents principally
interest paid or received from ITT and miscellaneous interest paid or received
from other parties. Commencing in 1995, ITT has paid the Company interest on the
full amount of any net cash balances invested for the Company by ITT at an
interest rate that was set for a six- or twelve-month period and was 30 basis
points over the most recently published rate for six-or twelve-month treasury
bills, as appropriate, and no longer assessed interest charges on the Company
except with respect to funds actually advanced to the Company in excess of cash
invested with ITT. ITT performed a number of other services for the Company,
including the administration of certain employee benefit plans, for which it
received compensation from the Company. The Company intends to perform
substantially all of these services after the Offering. Since February 5, 1998,
the Company has performed its own cash management functions and no longer has
any cash invested with ITT. Depending upon current interest rates on short-term
investments, the Company may not be able to obtain the same yields on its cash
balances that were being paid by ITT. Accordingly, interest income, net may
decrease in 1998.
VARIATIONS IN QUARTERLY RESULTS OF OPERATIONS
The Company's quarterly results of operations tend to fluctuate
significantly within a fiscal year because of differences in the number of weeks
of earned tuition revenue in each fiscal quarter and the timing of student
matriculations. The Company's first and third fiscal quarters have 13 weeks of
earned tuition revenue, while the second and fourth quarters have 11 weeks of
earned tuition revenue because of two-week vacation breaks in June and December.
In addition, revenue in the third and fourth fiscal quarters generally benefits
from increased student matriculations as the number of new students entering ITT
Technical Institutes tends to be substantially higher in June (31% of all new
students in 1997) and September (36% of all new students in 1997) because of the
significant number of recent high school graduates entering ITT Technical
Institutes for the academic quarters beginning in those two months. The
Company's incurrence of costs, however, is generally not affected by the
academic schedule, and such costs do not fluctuate significantly on a quarterly
basis.
The following table sets forth the Company's revenue in each quarter during
the three prior fiscal years.
QUARTERLY REVENUE OF ITT TECHNICAL INSTITUTES
(Dollars in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
THREE-MONTH ------------------ ------------------ ------------------
PERIOD ENDED AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------ -------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
March 31.............................. $ 64,476 25% $ 57,103 25% $ 51,169 25%
June 30............................... 58,412 22 51,568 22 44,969 22
September 30.......................... 73,060 28 65,113 28 56,017 28
December 31........................... 65,716 25 58,535 25 49,676 25
-------- --- -------- --- -------- ---
Total for Year...................... $261,664 100% $232,319 100% $201,831 100%
======== === ======== === ======== ===
</TABLE>
22
<PAGE> 24
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain
statement of income data to tuition and other educational revenue for the
periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Tuition and other educational revenue....................... 100.0% 100.0% 100.0%
Cost of educational services................................ 62.3 62.5 64.6
Student services and administrative expenses................ 27.7 28.6 28.4
----- ----- -----
Operating income............................................ 10.0 8.9 7.0
Interest income, net........................................ 2.1 1.7 2.4
----- ----- -----
Income before income taxes.................................. 12.1% 10.6% 9.4%
===== ===== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Revenue. Revenue increased by $29.4 million, or 12.7%, to $261.7 million
for the year ended December 31, 1997 from $232.3 million for the year ended
December 31, 1996 primarily due to (i) a 9.8% increase in the total student
enrollment at January 1, 1997 compared to January 1, 1996 (22,633 at January 1,
1997 compared to 20,618 at January 1, 1996), (ii) a 5% increase in tuition rates
in September 1997 and 1996, (iii) a 2.3% increase in the number of new
first-time students commencing their attendance at ITT Technical Institutes
(19,911 in 1997 compared to 19,464 in 1996) and (iv) the opening of new
institutes (two in March 1996, one in September 1996, one in June 1997 and two
in December 1997). Student retention rates did not change materially in the two
years. The three new ITT Technical Institutes beginning classes in 1997
accounted for 140 new students.
Cost of Educational Services. Cost of educational services increased by
$17.9 million, or 12.3%, to $163.1 million in 1997 from $145.2 million in 1996
principally as a result of increased costs related to the introduction of
additional programs, an increase in salaries and occupancy costs at ITT
Technical Institutes opened prior to 1995, costs at the two new institutes
opened in 1995, costs at the three new institutes opened in 1996, costs at the
three new institutes opened in 1997, and, to a lesser extent, as a result of an
increase in the costs of books sold related to the increased student population.
Provisions for legal expenses increased by $1.9 million to $3.2 million in 1997
($1.7 million in fourth quarter) from $1.3 million in 1996 ($1.0 million in
fourth quarter) as a result of the legal actions associated with the California
and Florida hospitality programs. See "Business -- Legal Proceedings." Cost of
educational services decreased to 62.3% of revenues in 1997 compared to 62.5% in
1996, primarily because the greater revenues did not cause an increase in the
fixed portion of rent, administrative salaries and other costs included in the
cost of educational services. Excluding the provisions for the legal expenses,
cost of educational services decreased to 61.1% of revenues in 1997 compared to
61.9% in 1996.
Student Services and Administrative Expenses. Student services and
administrative expenses increased by $5.9 million, or 8.9%, to $72.4 million in
1997 from $66.5 million in 1996 principally as a result of a $5.0 million
increase in marketing costs. This increase was due to (i) an increase in the
marketing costs for the two new technical institutes opened in 1995 and the
three new technical institutes opened in 1996, (ii) the commencement of
marketing costs for the three new technical institutes opened in 1997 and (iii)
the increased marketing costs for ITT Technical Institutes opened prior to 1995.
The Company's media advertising expenses increased by 10.9% in 1997 from 1996.
Administrative expenses at the corporate headquarters increased by $0.3 million
in 1997 from 1996 levels primarily due to increased headquarters staff. The
provision for doubtful accounts in 1997 was approximately $0.6 million more than
in 1996 principally because of increased revenue and a regulatory change that
delays the Company's receipt of funds under the Title IV Programs (e.g., the
students withdrew before they could secure their federal student financial aid
with which they could pay their obligations to the Company). See "-- Liquidity
and Capital Resources" for a further description of the regulatory changes
affecting when the Company receives Title IV Program funds after June 30, 1997.
Student services and administrative expenses decreased to 27.7% of revenues in
1997
23
<PAGE> 25
compared to 28.6% in 1996, primarily because the greater revenues did not cause
an increase in the fixed portion of the marketing and headquarters expenses.
Interest Income. Interest income increased by $1.4 million in 1997 because
of the increase in the interest rate earned on the cash invested by the Company
with ITT (i.e., 6.3% in 1997 compared to 5.5% in 1996) and the increase in cash
invested with ITT.
Net Income. Net income increased $4.2 million, or 28.2%, to $19.1 million
for 1997 from $14.9 million for 1996, principally due to the 27.4% increase in
operating income ($3.4 million after tax).
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
Revenue. Revenue increased by $30.5 million, or 15.1%, to $232.3 million
for the year ended December 31, 1996 from $201.8 million for the year ended
December 31, 1995 primarily due to a 17.7% increase in the number of new
first-time students commencing their attendance at ITT Technical Institutes
(19,464 in 1996 compared to 16,539 in 1995), a 5% increase in tuition rates in
September 1995 and 1996, and the opening of new institutes (two in September
1995, two in March 1996 and one in September 1996). The number of students
attending ITT Technical Institutes at January 1, 1996 was approximately the same
as at January 1, 1995. Student retention rates did not change materially in the
two years. The three new ITT Technical Institutes beginning classes in 1996
accounted for 348 new students.
Cost of Educational Services. Cost of educational services increased by
$14.9 million, or 11.4%, to $145.2 million in 1996 from $130.3 million in 1995
principally as a result of increased costs related to the introduction of
additional programs, an increase in salaries and occupancy costs at ITT
Technical Institutes opened prior to 1994, costs at the six new institutes
opened in 1994, costs at the two new institutes opened in 1995, costs at the
three new institutes opened in 1996, and, to a lesser extent, as a result of an
increase in the costs of books sold related to the increased student population.
Provisions for legal expenses increased by $1.2 million in 1996 from 1995
levels. This increase was principally a result of a $1.3 million provision in
1996 ($1.0 million in fourth quarter and $0.3 million in third quarter) for the
legal actions in Eldredge, et al. v. ITT Educational Services, Inc., et al. (the
"Eldredge Case"). (See Note 10 of Notes to Financial Statements for a further
description.) Cost of educational services decreased to 62.5% of revenues in
1996 compared to 64.6% in 1995, primarily because of greater revenues being
spread over the fixed portion of cost of educational services.
Student Services and Administrative Expenses. Student services and
administrative expenses increased by $9.2 million, or 16.1%, to $66.5 million in
1996 from $57.3 million in 1995 principally as a result of a $7.9 million
increase in marketing costs. This increase was due to (i) an increase in the
marketing costs for the six new technical institutes opened in 1994 and the two
new technical institutes opened in 1995, (ii) the commencement of marketing
costs for the three new technical institutes opened in 1996 and (iii) the
increased marketing costs for ITT Technical Institutes opened prior to 1994.
Administrative expenses at the corporate headquarters increased by $0.7 million
in 1996 from 1995 levels primarily due to increased headquarters staff. The
provision for doubtful accounts in 1996 was approximately $0.6 million more than
in 1995 principally because of increased revenue and a delay in the DOE's
certification of the new institutes opened in 1995 and 1996 to participate in
the Title IV Programs (e.g., the delay resulted in a greater number of students
who withdrew or were terminated from the institutes before they could secure
federal student financial aid with which they could pay their obligations to the
Company). Student services and administrative expenses increased to 28.6% of
revenues in 1996 as compared to 28.4% in 1995, because of increased television
advertising.
Interest Income. Interest income decreased by $0.7 million in 1996 because
of the reduction in the interest rate earned on the cash invested by the Company
with ITT (i.e., 5.5% in 1996 compared to 7.5% in 1995).
Net Income. Net income increased $3.5 million, or 30.7%, to $14.9 million
for 1996 from $11.4 million for 1995, principally due to the 44.6% increase in
operating income ($3.8 million after tax).
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<PAGE> 26
LIQUIDITY AND CAPITAL RESOURCES
In 1997, the Company indirectly derived approximately 70% of its revenues
from Title IV Programs. Federal regulations dictate the timing of disbursements
of funds under Title IV Programs. Students must apply for a new loan for each
academic year (three academic quarters). Loan funds are generally provided by
lenders in three disbursements for each academic year. The first disbursement is
usually received either 30 days after (in the case of students commencing a
program of study) or 10 days before the start of the first academic quarter of a
student's academic year, and the second and third disbursements are typically
received 10 days before the start of the second and third academic quarters of a
student's academic year, respectively. While the timing of loan disbursements to
the Company is subject to a student's directions to the lender and to existing
regulatory requirements regarding such disbursements, which last changed
effective July 1, 1997, the Company has typically received student loan funds
upon their disbursement by the lender.
The DOE issued new regulations in November 1996, which became effective
July 1, 1997, that revised the procedures governing how an institution
participating in Title IV Programs requests, maintains, disburses and otherwise
manages Title IV Program funds. These new regulations require the Company to
receive Title IV Program loan funds in three equal quarterly disbursements
rather than the two disbursements previously permitted. The Company estimates
that this change decreased 1997 net cash provided by operating activities (a
one-time effect) by approximately $15.0 million, and decreased 1997 interest
income (an ongoing effect) by $0.2 million. The Company estimates that this
change will decrease 1998 interest income (an ongoing effect) by $0.8 million to
$1.0 million.
The principal uses of cash are to pay salaries, occupancy and equipment
costs, recruiting and marketing expenses, administrative expenses and taxes,
including pre-opening expenses for new institutes. Until February 5, 1998, cash
receipts of the Company were forwarded to ITT on a daily basis after, in the
case of certain receipts, the lapse of applicable regulatory restrictions, and
cash disbursements of the Company were generally funded by ITT out of the cash
balances of the Company invested with ITT. The Company's net cash balances of
the cash invested with ITT increased from $89.8 million at December 31, 1996 to
$94.8 million at December 31, 1997 and ranged from a low of $65.2 million in May
1997 to a high of $103.3 million in November 1997. Since February 5, 1998, the
Company has performed its own cash management functions and no longer has any
cash invested with ITT.
The Company has generated positive cash flows from operations for the past
five years. Cash flows from operations decreased by $11.7 million in 1997 to
$14.4 million from $26.1 million in 1996. This decrease is primarily due to the
decrease in deferred tuition revenue resulting from the July 1, 1997 regulatory
change affecting when the Company receives federal student loan funds, as
discussed above. Cash flows from operations in 1996 was $26.1 million, an
increase of $7.2 million from $18.9 million in 1995. This increase was primarily
due to the increases in operating income and deferred tuition revenue resulting
from increased student enrollment.
At December 31, 1997, the Company had positive working capital of $57.0
million. Deferred tuition revenue, which represents the unrecognized portion of
tuition revenue received from students, was $30.9 million at December 31, 1997.
An educational institution may lose its eligibility to participate in some
or all Title IV Programs if student defaults on federal student loans exceed
certain rates. Two ITT Technical Institutes, located in Garland and San Antonio,
Texas, are in danger of losing their eligibility to participate in the Federal
Family Education Loan ("FFEL") and the Federal Direct Loan ("FDL") programs due
to their default rates. See "Business -- Regulation of Federal Financial Aid
Programs -- Student Loan Defaults." Loss of eligibility to participate in the
FFEL and FDL programs by both the Garland and San Antonio, Texas ITT Technical
Institutes (but not by either alone) could have a material adverse effect on the
Company's financial condition or results of operations. The Company has arranged
for an unaffiliated, private funding source ("PFS") to provide loans to the
students enrolled at the Garland, Texas ITT Technical Institute in the event
this institute loses its eligibility to participate in the FFEL and FDL
programs. This alternative source of student financial aid requires the Company
to guarantee repayment of the PFS loans. Based on the Company's experience with
the repayment of Title IV Program loans by students who attended the Garland,
Texas ITT Technical Institute,
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<PAGE> 27
the Company believes that such guaranty should not result in a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
The DOE, the Accrediting Commissions and most of the SEAs considered the
Merger to constitute a change in control of the Company and the ITT Technical
Institutes under their respective Regulations. As a result, effective upon the
Merger, each ITT Technical Institute campus group immediately became ineligible
to participate in Title IV Programs. The Company obtained all prior approvals of
the Merger from the Accrediting Commission and the SEAs that required such
approval before the Merger occurred. Since the Merger, the Company has obtained
temporary approval of the Merger from the other Accrediting Commission, final
approvals of the Merger from some of the SEAs required after a change in control
occurs and continued authorization to operate from the remaining SEAs. The
Company is continuing to pursue final approvals from such Accrediting Commission
and SEAs. The DOE approved the reinstatement of each ITT Technical Institute
campus group's participation in Title IV Programs effective March 20, 1998. The
DOE's approval was on a provisional basis, which is the DOE's practice for all
institutions following a change in control. As an additional condition of each
institute's provisional certification, the DOE directed the Company to maintain
an undefined sufficient level of cash or cash equivalents, and to revise its
current accounting treatment of direct marketing costs, revenue recognition and
amortization of direct marketing costs or provide evidence that the Company's
treatment of these items is in conformance with GAAP. The Company believes that
its treatment of these items is in accordance with GAAP and that it maintains
cash and cash equivalents in sufficient amounts to satisfy the DOE, but there
can be no assurance thereof. If the Company is required to change its accounting
treatment for any of the above items, management does not believe that such
change would have a material adverse effect on the Company's financial condition
or results of operations before the cumulative effect of any change in
accounting.
The Offering will not constitute a change in control under the DOE's
Regulations. Any corporate reorganization of, or future disposition of the
Common Stock by, ITT could, however, constitute a change in control of the
Company and the ITT Technical Institutes. See "Business -- Change in Control."
A material adverse effect on the Company's financial condition, results of
operations and cash flows would result if a change in control of the Company
occurred and a material number of ITT Technical Institutes failed, in a timely
manner, to be reauthorized by their SEAs, reaccredited by their Accrediting
Commissions or recertified by the DOE to participate in Title IV Programs.
The Company's capital assets consist primarily of classroom and laboratory
equipment (such as computers, electronic equipment and robotic systems),
classroom and office furniture and leasehold improvements. All building
facilities are leased. Capital expenditures totaled $11.5 million during 1997
and included expenditures of $1.6 million for new technical institutes, $1.9
million to expand curricula offerings at existing institutes, $7.3 million to
replace or add furniture or equipment at existing institutes and $0.7 million on
leasehold improvements. Leasehold improvements represent part of a continuing
effort by the Company to maintain its existing facilities in excellent
condition. Capital expenditures increased by $3.6 million to $11.5 million in
1997 from $7.9 million in 1996, principally due to the expenditure of
approximately $3.0 million for the acquisition of new computers in 1997
(required to accommodate a software upgrade for the Company's computer-aided
drafting technology curriculum). New institutes have large capital additions in
the first two years. To date, cash generated from operations has been sufficient
to meet capital expenditures.
The Company plans to continue to upgrade and expand current facilities and
equipment. The Company expects that the 1998 capital expenditures will be
approximately $10.0 million. The capital additions for a new institute are
approximately $0.4 million and the capital expenditures for each new curriculum
at an existing institute are approximately $0.2 million. The Company anticipates
that its planned capital additions can be funded from cash flows from
operations. Cash flows from operations on a long-term basis is highly dependent
upon the receipt of funds from federal financial aid programs and the amount of
funds spent on new institutes, curricula additions at existing institutes and
possible acquisitions.
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YEAR 2000 COMPLIANCE
The Company has made and will continue to make certain investments in its
software systems and applications to ensure the Company is year 2000 compliant.
The financial impact to the Company to ensure year 2000 compliance has not been
and is not anticipated to be material to its business, financial condition or
results of operations. There can be no assurance, however, that the institutions
or governmental agencies with which the Company transacts business will not
experience problems in year 2000 compliance that could adversely affect the
financial condition or results of operations of the Company.
SFAS PUBLICATIONS WITH FUTURE EFFECTIVE DATES
The Company is required to adopt the Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information," and begin
reporting the financial information required thereunder beginning with the
Company's 1998 fiscal year. The Company's adoption of these standards will not
have a material impact on the financial information it will report in future
periods.
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<PAGE> 29
BUSINESS
Unless the context indicates otherwise, the term "Company" refers to ITT
Educational Services, Inc., including all of its educational institutions; the
term "Starwood" refers collectively to Starwood Hotels & Resorts Worldwide,
Inc., a Maryland corporation formerly known as Starwood Lodging Corporation
("Starwood, Inc."), and Starwood Hotels & Resorts, a Maryland real estate
investment trust formerly known as Starwood Lodging Trust or Starwood Hotels &
Resorts Trust ("Starwood Trust"), and their subsidiaries other than the Company;
the term "ITT" refers to ITT Corporation, a Nevada corporation, and its
subsidiaries other than the Company; the terms "ITT Technical Institutes,"
"technical institutes" or "institutes" (in singular or plural form) refer to
educational institutions owned and operated by the Company; and the term
"institution" means a main campus and its additional locations or branch
campuses, if any (hereinafter "campus group" in singular or plural form).
BACKGROUND
Prior to its Initial Public Offering, which was consummated on December 27,
1994, the Company was a wholly owned subsidiary of ITT Corporation, formerly a
Delaware corporation and now known as ITT Industries, Inc., an Indiana
corporation ("Old ITT"). On September 29, 1995, ITT succeeded to the interests
of Old ITT in the beneficial ownership of 83.3% of the Common Stock of the
Company, as part of the division of Old ITT's businesses among itself and two of
its wholly owned subsidiaries (including ITT) and distribution of all the
outstanding common stock of ITT and the other subsidiary to the shareholders of
Old ITT, which occurred on December 19, 1995. On February 23, 1998, ITT became a
wholly owned subsidiary of Starwood, Inc. Starwood is the largest hotel and
gaming company in the world in terms of revenue and owns, manages or franchises
a geographically diversified portfolio of approximately 650 hotel properties.
The Company is a Delaware corporation incorporated in 1946. Old ITT
acquired a predecessor of the Company in 1966, and the Company changed its name
to ITT Educational Services, Inc. in 1969. The principal executive offices of
the Company are located at 5975 Castle Creek Parkway, North Drive, Indianapolis,
Indiana 46250, and its telephone number is (317) 594-9499.
OVERVIEW
ITT Educational Services, Inc. is a leading proprietary provider of
technology-oriented postsecondary degree programs in the United States based on
revenues and student enrollment. The Company offers associate, bachelor and
master degree programs and non-degree diploma programs to approximately 24,000
students through 63 ITT Technical Institutes located in 27 states. The education
programs are designed, after consultation with employers, to help graduates
begin to prepare for careers in various fields involving technology. As of
December 31, 1997, approximately 97% of ITT Technical Institute students were
enrolled in a degree program, with approximately 74% enrolled in programs
relating to electronics engineering technology ("EET") and approximately 23%
enrolled in programs relating to computer-aided drafting technology ("CAD").
While most graduates of ITT Technical Institutes are initially employed by
numerous small, technology-oriented companies, employers have also included well
recognized corporations, such as AT&T, Boeing, Intel, MCI, Microsoft, Motorola,
IBM and General Electric. Additionally, the institutes' graduates have been
hired by many federal and local government agencies, including the Federal
Bureau of Investigation and the Central Intelligence Agency. The Company has
provided career-oriented education programs for 32 years and its schools have
graduated over 125,000 students since 1976.
The Company has experienced significant growth, acquiring three and
establishing 50 new technical institutes since January 1, 1981. Of the 63
institutes currently operating, 20 have been established since January 1, 1993.
The number of students attending ITT Technical Institutes has increased 32.1%
from 18,539 at December 31, 1992 to 24,498 at December 31, 1997. Total revenues
from the ITT Technical Institutes have increased 74.0% from $150.4 million
(excluding discontinued operations) in 1992 to $261.7 million in 1997. The
Company opened three new technical institutes in 1997 and one new technical
institute in March 1998. The Company intends to continue expanding by opening
new technical institutes (including five additional new institutes in the
remainder of 1998) and offering a broader range of programs at its institutes.
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The Company expects that the demand for postsecondary education will
continue to increase over the next several years as a result of favorable
demographic, economic and social trends. These trends include, based on data
from the United States Department of Education and data collected in the Current
Population Survey conducted by the Bureau of the Census, (a) 24% projected
growth in the number of new high school graduates from approximately 2.5 million
in 1994 to approximately 3.1 million in 2004, (b) the relatively small
percentage of adults over age 25 who possess a bachelor degree (approximately
23% in 1995), (c) an increasing number of high school graduates attending
postsecondary educational institutions (65% in 1996 versus 53% in 1983) and (d)
a heightened recognition of the importance of postsecondary education to an
individual's career prospects.
The Company believes that it is well positioned to take advantage of the
increasing demand for postsecondary education programs for the following
reasons:
Employment Oriented Education. ITT Technical Institutes offer
curricula designed to teach the technical knowledge and skills desired by
many employers for entry-level positions. Unlike many two-and four-year
colleges, each undergraduate curriculum offered by ITT Technical Institutes
has been designed, after consultation with employers, to help graduates
begin to prepare for careers in various fields involving technology.
Curricula are reviewed on a regular basis by headquarters curriculum
managers, as well as by advisory committees comprised of representatives of
employers, to respond to changes in technology and industry needs. The
Company believes that the strength of its programs and career services is
reflected in its graduate employment rates. Based on information provided
by graduates and employers, approximately 88% of the ITT Technical
Institutes' 1996 graduates, other than graduates who continued in a
bachelor degree program at an ITT Technical Institute, had obtained
employment or were already employed in fields involving their programs of
study as of April 25, 1997, the end of the most recently completed
statistical year.
Programs Designed for the Convenience of Students. ITT Technical
Institute programs are designed to provide students flexibility in
scheduling classes. Each ITT Technical Institute operates year-round and
undergraduate programs are offered on a quarterly basis, typically with
four 12-week quarters during a year. This year-round format allows students
to complete their program of study and enter the work force more rapidly
than students attending traditional colleges. Students are better able to
be employed while attending ITT Technical Institutes than while attending
traditional colleges, because classes are typically offered in four-hour
sessions five days a week and are generally available in the morning,
afternoon and evening. Programs of study are substantially standardized
throughout the ITT Technical Institutes, providing greater uniformity and
enabling students to transfer, if necessary, to the same program offered at
another ITT Technical Institute with less disruption to their education.
Financial Strength and Regulatory Compliance. Management believes
that the Company's financial strength enables it to capitalize on expansion
opportunities and is an important factor in its ability to comply with
federal and state regulatory requirements.
BUSINESS STRATEGY
The Company has multiple opportunities for growth and has developed a
business plan to increase revenues by increasing the number of programs of study
and students at existing ITT Technical Institutes while adding additional
locations to enhance operating efficiencies throughout the Company. Principal
elements of this plan include the following:
ENHANCE RESULTS AT THE SCHOOL LEVEL
Increase Enrollments at Existing Schools. ESI has successfully
increased student enrollment. Total student enrollment at ITT Technical
Institutes open for more than 24 months increased 6.2% from December 31,
1996 to December 31, 1997 and 7.2% from December 31, 1995 to December 31,
1996. Management believes that current demographic trends will support
increased enrollment of high school graduates. In addition, the Company
intends to increase recruiting efforts aimed at increasing enrollments of
working adults.
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Broaden Availability of Current Program Offerings. The Company
intends to continue to expand program offerings at existing schools with
the objective of offering at least three programs at each ITT Technical
Institute. The Company's 63 institutes provide significant potential for
the introduction of existing programs to a broader number of ITT Technical
Institutes. Since January 1, 1993, the Company has increased the number of
institutes which offer three or more programs from 16 to 29. In 1998, the
Company increased the number of program offerings at three existing ITT
Technical Institutes in March 1998 and intends to increase the number of
program offerings at approximately nine additional existing institutes in
the remainder of 1998. Management believes that the introduction of higher
level programs at additional ITT Technical Institutes will attract more
students and increase the number of students continuing their studies
beyond the associate degree level.
Develop or Acquire Additional Degree Programs. The Company also plans
to introduce programs in additional fields of study and at different degree
levels. ESI has introduced three new degree programs since December 1995,
which had a total of 319 students enrolled at December 31, 1997. The
Company believes that the development and introduction of new programs
attract a broader base of students and motivate current students to extend
their studies. ESI intends to test an associate degree program in Computer
Network Systems Technology ("CNS") at one institute in September 1998 to
target the growing need for technically skilled personnel in the computer
systems field. The new CNS program will be considered for testing at
additional institutes thereafter.
Extend Total Program Time. By increasing the number of institutes
that offer graduates of the eight- and six-quarter associate degree
programs (which are the primary program offerings at most institutes) an
additional four or six quarters of study, respectively, in which they can
earn a bachelor degree, the Company has been able to extend the total
program time for which a student can enroll. As a result, the average total
program time for which an ITT Technical Institute student can enroll has
increased from 18 months in 1986 to 24 months in 1997. The Company expects
that the average total program time for which an ITT Technical Institute
student can enroll will increase further as additional bachelor degree
programs are added.
Improve Student Outcomes. To attract new students and enhance student
retention, the Company seeks to improve the graduation and graduate
employment rates of the undergraduate students at ITT Technical Institutes
by providing extensive academic services and dedicating significant
administrative resources to career services. From 1992 through 1996, the
percent of ITT Technical Institute graduates (other than graduates who
continued in a bachelor degree program at an ITT Technical Institute) who
were employed in fields involving their programs of study increased from
80% to 88%.
INCREASE THE NUMBER OF ITT TECHNICAL INSTITUTES
The Company plans to add new ITT Technical Institutes at sites
throughout the United States. The Company opened three new technical
institutes in 1997 and one new technical institute in March 1998 and
intends to open five additional new technical institutes in the remainder
of 1998. The Company also intends to continue to evaluate the acquisition
of schools located in markets where ITT Technical Institutes are not
presently located.
INCREASE MARGINS BY LEVERAGING FIXED COSTS AT SCHOOL AND HEADQUARTERS
LEVELS
By optimizing school capacity and class size, the Company has the
ability to gain additional revenues from increased enrollment without
incurring a proportionate increase in fixed costs at the institutes. In
addition, the Company has controlled its administrative costs through the
centralization of management functions and the implementation of
operational uniformity among its 63 institutes. Centralization and
uniformity have resulted in substantial operating efficiencies. Between
1993 and 1997, expenses incurred at headquarters (including the district
offices) declined as a percentage of revenues from 6.8% in 1993 to 5.3% in
1997 as a result of increased revenues and these operating efficiencies.
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PROGRAMS OF STUDY
The Company offers 14 degree programs and several diploma programs in
various fields of study. All ITT Technical Institutes offer a degree or diploma
program in EET and 54 ITT Technical Institutes offer a degree or diploma program
in CAD. Together the EET and CAD programs comprise the core of the ITT Technical
Institutes' program offerings. The table below sets forth information regarding
the programs of study offered by the Company as of December 31, 1997.
PROGRAMS OF STUDY OFFERED AT ITT TECHNICAL INSTITUTES
<TABLE>
<CAPTION>
NUMBER OF TECHNICAL INSTITUTES
OFFERING AT NUMBER OF STUDENTS ENROLLED AT
DECEMBER 31, 1997 DECEMBER 31, 1997
--------------------------------------- ------------------------------------------------
MASTER BACHELOR ASSOCIATE MASTER BACHELOR ASSOCIATE
PROGRAM TITLE DEGREE DEGREE DEGREE DIPLOMA DEGREE DEGREE DEGREE DIPLOMA TOTAL
------------- ------ -------- --------- ------- ------ -------- --------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Project Management.................. 1 -- -- -- 115 -- -- -- 115
Electronics Engineering
Technology........................ -- 17 61 1 -- 833 16,539 322 17,694
Computer-Aided Drafting
Technology........................ -- -- 52 2 -- -- 4,858 227 5,085
Automated Manufacturing
Technology(1)..................... -- 5 -- -- -- 304 -- -- 304
Tool Engineering Technology(2)...... -- -- 3 -- -- -- 193 -- 193
Architectural Engineering
Technology(2)..................... -- -- 3 -- -- -- 173 -- 173
Industrial Design(2)................ -- 3 -- -- -- 121 -- -- 121
Computer Visualization
Technology(2)..................... -- 4 -- -- -- 114 -- -- 114
Chemical Technology................. -- -- 2 -- -- -- 106 -- 106
Telecommunications Engineering
Technology(1)..................... -- 2 -- -- -- 99 -- -- 99
Hospitality Management.............. -- 1 1 -- -- 26 62 -- 88
Other Programs of Study(3).......... -- -- 3 2 -- -- 239 167 406
--- ----- ------ --- ------
Total........................... 115 1,497 22,170 716 24,498
</TABLE>
- ---------------
(1) EET related program.
(2) CAD related program.
(3) Other programs consist of Business Technology and Administration, Business
Management and Accounting, Automotive Service Technology and Heating/Air
Conditioning/Refrigeration.
Students enrolled in programs related to EET and CAD represent
approximately 74% and 23%, respectively, of the ITT Technical Institute student
population as of December 31, 1997. The Company's EET programs are designed to
help graduates begin to prepare for careers in various fields involving EET by
providing students a practical education with respect to specific electronic
circuits and specialized techniques and, in the case of the bachelor degree
program, offering a broader foundation in EET through the study of subjects such
as circuit analysis, computer programming, computer operating systems and
advanced communications systems. Graduates of the programs have obtained a
variety of entry-level positions in various fields involving EET, such as
electronics product design and fabrication, communications, computer technology,
industrial electronics, instrumentation, telecommunications and consumer
electronics. The Company's CAD program is designed to help graduates prepare for
careers in various fields involving CAD through the teaching of computer-aided
drafting techniques and conventional drafting methods. Graduates have obtained a
variety of entry-level positions in various fields involving CAD, such as
computer-aided drafting, electrical and electronics drafting, mechanical
drafting, architectural and construction drafting, civil drafting, interior
design and landscape architecture.
The academic schedule of undergraduate programs at the ITT Technical
Institutes is generally organized on the basis of four 12-week quarters of
instruction with new students beginning at the start of each academic quarter.
Associate degree programs can be completed in eight academic quarters or less,
and bachelor degree
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<PAGE> 33
programs can typically be completed in 12 academic quarters (including academic
quarters completed as part of a related associate degree program). Classes are
typically offered in four-hour sessions five days a week and, depending on
student enrollment, sessions are generally available in the morning, afternoon
and evening. This class schedule generally affords flexibility to students to
pursue part-time employment opportunities. Based on student surveys, the Company
believes that a substantial majority of ITT Technical Institute students work at
least part-time during their programs of study.
The academic schedule of the Master of Project Management ("MPM") program,
currently the Company's only graduate degree program of study, is organized on a
non-term basis pursuant to which one- to six-week courses are taken sequentially
one at a time. The MPM program can be completed in 21 months. Classes are
typically offered in four-hour sessions one night a week, which generally
accommodates students working full-time jobs. Students may generally begin the
MPM program once the minimum number of applicants necessary to begin a new class
has been assembled. The MPM program is presently offered by one technical
institute in Indiana, but at various sites throughout the state. The Company's
ability to offer the MPM program at other ITT Technical Institutes is currently
limited by the scope of the DOE's recognition of the accrediting commission that
accredits most of the ITT Technical Institutes. This accrediting commission
intends to petition the DOE to expand its scope of recognition by the DOE to
include master degree programs.
ITT Technical Institute programs of study blend traditional academic
content with applied learning concepts and have the objective of helping
graduates begin to prepare for a changing economic and technological
environment. A significant portion of a typical student's day in an associate
degree program at an ITT Technical Institute involves practical study in a lab
environment.
The content of technical courses in each program of study is substantially
standardized among the ITT Technical Institutes to provide greater uniformity
and to better enable students to transfer among the ITT Technical Institutes
offering the same programs with less disruption to their education. Each
curriculum is regularly reviewed to respond to changes in technology and
industry needs. The ITT Technical Institutes have established advisory
committees comprised of representatives of local employers for each field of
study. These advisory committees assist the ITT Technical Institutes in
assessing and updating curricula, equipment and laboratory design. In addition
to courses directly related to a student's program of study, degree programs may
also include general education courses, such as economics, humanities, oral and
written communications, environmental science and social psychology.
Tuition for a student entering an undergraduate program in December 1997
for three consecutive academic quarters (the equivalent of an academic year at
traditional two- and four-year colleges) is $7,145 for the EET program and
$8,456 for the CAD program. A student's tuition cost for a program of study is
set at the time of a student's enrollment in the program, provided the student
remains continually enrolled in the program and does not repeat any courses. The
majority of students attending an ITT Technical Institute lived in such
institute's metropolitan area prior to enrollment. The Company does not provide
any student housing.
STUDENT RECRUITMENT
The Company seeks to attract students with the motivation and ability to
complete the career-oriented educational programs offered by the ITT Technical
Institutes. To generate interest among potential students, the Company engages
in a broad range of activities to inform potential students and their parents
about the ITT Technical Institutes and the programs offered. These activities
include television and other media advertising, direct mailings and high school
visits.
The Company's television advertising is centrally coordinated and
developed. Television advertising is directed at a combination of both the
national market and the local markets in which ITT Technical Institutes are
located. The Company's television commercials generally include a toll free
telephone number for direct responses and information about the location of ITT
Technical Institutes in the area. Direct responses to television advertising are
centrally received, tracked and promptly forwarded to the appropriate ITT
Technical Institute representatives to contact prospective students and schedule
interviews. Responses to direct mail campaigns, which are targeted at high
school students and other potential postsecondary students, are also centrally
received, tracked and forwarded to the appropriate ITT Technical Institute
representatives.
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The Company employs a director of recruitment at each institute, who
reports to the director of such institute. Recruiting policies and procedures,
as well as standards for hiring and training representatives, are established
centrally but are implemented at the local level. The Company employs
approximately 80 high school coordinators who make thousands of presentations to
students at high schools annually. These coordinators promote ITT Technical
Institutes and obtain information about high school juniors and seniors who may
be interested in attending the ITT Technical Institutes. The Company employed
approximately 485 other representatives as of December 31, 1997 to assist in
local recruiting efforts. As of December 31, 1997, approximately 230
representatives performed their services solely in student recruitment offices
located at each institute, while approximately 255 representatives worked
outside these offices and visited the homes of high school seniors and other
prospective students.
Local representatives of an ITT Technical Institute pursue expressions of
interest from potential undergraduate students by contacting prospective
students and arranging for interviews either at such institute or at prospective
students' homes. The interview is designed to establish a prospective student's
qualifications, academic background, interests, motivation and goals for the
future. Prospective undergraduate students are generally shown a video providing
information about the ITT Technical Institutes and the programs of study.
Expressions of interest from potential graduate students are pursued by
contacting them and arranging for their attendance at an informational seminar
providing information about the institute and the MPM program.
The Company monitors the effectiveness of its various marketing efforts and
seeks to determine the extent to which each of its marketing efforts results in
student enrollments. The Company estimates that in 1997 television advertising
produced 39% of student enrollments at ITT Technical Institutes, high school
coordinators accounted for 14%, referrals accounted for 15%, direct mail
campaigns accounted for 11%, associate degree graduates enrolling in a bachelor
degree program accounted for 6% and the remaining 15% were classified as
miscellaneous.
Student recruitment activities are subject to substantial regulation at
both the state and federal level. Most states have bonding and licensing
requirements that apply to many of the Company's representatives. The
implementation of recruitment policies and procedures is overseen by the
Company's National Director of Recruitment and the directors of field
recruitment and training. In addition, the Company's internal audit department
generally reviews the recruiting practices relating to the execution and
completion of enrollment agreements at each ITT Technical Institute on an annual
basis.
STUDENT ADMISSIONS AND RETENTION
The Company seeks to ensure that incoming students have the necessary
academic background to complete their chosen programs of study. All applicants
for admission to any of the ITT Technical Institutes' associate degree or
diploma programs are required to have a high school diploma or a recognized
equivalent and also must pass an admissions examination. Students interested in
bachelor degree programs or the MPM program must satisfy additional admissions
criteria that generally require, among other things: (a) in the case of bachelor
degree programs, the student first earn an associate degree, complete an
equivalent level program or complete an equivalent number of credit hours of
coursework in the same or related subject matter; and (b) in the case of the MPM
program, the student first earn a bachelor degree and possess at least three
years' full-time work experience. ITT Technical Institute students are of
varying ages and backgrounds. At December 31, 1997, approximately 93% of the
students were high school graduates and the remaining students possessed the
recognized equivalent of a high school diploma. In addition, approximately 34%
of the students had some postsecondary educational experience prior to entering
an ITT Technical Institute for the first time. Approximately 35% of the students
were 19 years of age or younger, 34% were between 20 and 24 years of age, 19%
were between 25 and 30 years of age and 12% were age 31 or over. Male students
accounted for approximately 88% of total enrollment as of December 31, 1997,
while total minority enrollment at the ITT Technical Institutes (based on
applicable federal classifications) was approximately 38%.
ITT Technical Institute faculty and staff strive to help students overcome
obstacles to the completion of their programs of study. As is the case in other
postsecondary institutions, however, students often fail to complete their
programs for a variety of personal, financial or academic reasons. Student
withdrawals prior to
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program completion not only affect the student, they also have a negative
regulatory, financial and marketing effect on the institute. To minimize student
withdrawals, each ITT Technical Institute devotes staff resources to assist and
advise students regarding academic and financial matters. Academic advising and
tutoring are encouraged in the case of undergraduate students experiencing
academic difficulties. Assistance and advice are also offered to undergraduate
students looking for part-time employment and housing. In addition, factors
relating to student retention are considered in the performance evaluation of
every instructor.
Students are most likely to withdraw before they begin their second
academic quarter of study at an ITT Technical Institute. Of all students who
enroll in ITT Technical Institutes, approximately 22% withdraw before their
second academic quarter of study and approximately 23% withdraw at some point
after the start of their second quarter. As a result, new technical institutes
generally have higher withdrawal rates than institutes which have been open for
five or more years. Approximately 70% of all students who continue their
education past their first academic quarter complete their education at an ITT
Technical Institute.
GRADUATE EMPLOYMENT
ITT Technical Institutes have graduated over 125,000 students since 1976.
The Company believes that the success of graduates from undergraduate programs
who begin their careers in various fields involving their programs of study is
critical to the ability of the ITT Technical Institutes to continue to recruit
undergraduate students. The Company seeks to obtain data on the number of
undergraduate students employed following graduation. The reliability of such
data is largely dependent on information that students and employers report to
the Company. Based on information from students and employers, the Company
believes that students graduating from ITT Technical Institute undergraduate
programs during the prior five years obtained employment or were already
employed in various fields involving their programs of study as of June 30 or
earlier of the year following graduation, as set forth below:
GRADUATE EMPLOYMENT STATISTICS
<TABLE>
<CAPTION>
PERCENT OF EMPLOYABLE
GRADUATES WHO OBTAINED
EMPLOYMENT OR WERE ALREADY
GRADUATING NUMBER OF EMPLOYABLE EMPLOYED IN FIELDS INVOLVING
CLASSES GRADUATES(1) THEIR PROGRAMS OF STUDY
---------- -------------------- -----------------------------
<S> <C> <C>
1996........................... 8,422 88%
1995........................... 8,005 87%
1994........................... 7,459 85%
1993........................... 7,015 83%
1992........................... 6,878 80%
</TABLE>
- ---------------
(1) Employable graduates exclude graduates who continue in a bachelor degree
program at an ITT Technical Institute.
Each ITT Technical Institute employs personnel to offer students and
graduates of undergraduate programs career services, including job search
assistance and soliciting employment opportunities from employers. In addition,
undergraduate students receive instruction during their programs of study on
such job search techniques as the identification of potential employment
opportunities, the use of relevant reference materials, the composition of
resumes and letters of introduction and the appropriate preparation, appearance
and conduct for interviews. No career services are offered to students in the
graduate program of study. The increase in employment rates set forth in the
table above may also be due in part to improved conditions in the economy as a
whole.
Based on information from students and employers who responded to inquiries
from the Company, the Company estimates that average annual starting salaries
reported for 1996 graduates of certain programs
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<PAGE> 36
offered by the ITT Technical Institutes who obtained employment or were already
employed in fields involving their programs of study were as follows:
AVERAGE STARTING SALARIES
<TABLE>
<CAPTION>
NUMBER OF AVERAGE ANNUAL
EMPLOYABLE SALARY UPON
PROGRAM GRADUATES GRADUATION
- ---------------------------------------------------------- ---------- ---------------
<S> <C> <C>
Automated Manufacturing Technology (Bachelor Degree)...... 331 $26,472
Electronics Engineering Technology (Bachelor Degree)...... 716 $24,636
Industrial Design (Bachelor Degree)....................... 47 $25,668
Computer-Aided Drafting Technology, Tool Engineering
Technology and Architectural Engineering Technology
(Associate Degree and Diploma).......................... 2,368 $19,859
Electronics Engineering Technology (Associate Degree
and Diploma)............................................ 4,548 $20,976
</TABLE>
Average annual salaries upon graduation for ITT Technical Institute
graduates may vary significantly among ITT Technical Institutes depending on
local employment conditions and each graduate's background. Initial employers of
graduates from ITT Technical Institute undergraduate programs include both
small, technology-oriented companies and well recognized corporations.
FEDERAL AND OTHER FINANCIAL AID PROGRAMS
In 1997, the Company indirectly derived approximately 70% of its revenues
from federal financial aid programs under Title IV ("Title IV Programs") of the
Higher Education Act of 1965, as amended ("HEA"), although ITT Technical
Institute students also rely on state financial aid programs, family
contributions, personal savings, employment and other resources to pay their
educational expenses. Students at the ITT Technical Institutes receive grants
and loans to fund the cost of their education under the following Title IV
Programs: (a) the Federal Pell Grant program, which accounted in aggregate for
approximately 11% of the Company's revenues in 1997; (b) the Federal
Supplemental Educational Opportunity Grant ("SEOG") program, which accounted in
aggregate for less than 1% of the Company's revenues in 1997; (c) the Federal
Family Education Loan ("FFEL") programs (consisting of the Federal Stafford Loan
program, Federal PLUS Loan program and Federal Consolidation Loan program),
which accounted in aggregate for approximately 55% of the Company's revenues in
1997; (d) the Federal Perkins Loan ("Perkins") program, which accounted in
aggregate for less than 1% of the Company's revenues in 1997; (e) the Federal
Work-Study ("Work-Study") program, under which federal funds are made available
to provide part-time employment to students and pursuant to which the ITT
Technical Institutes employed approximately 500 students and paid $957,000 in
student wages in 1997; and (f) the Federal Direct Loan ("FDL") programs
(consisting of the Federal Direct Stafford Loan program, Federal Direct PLUS
Loan program and Federal Direct Consolidation Loan program), which accounted in
aggregate for approximately 3% of the Company's revenues in 1997. The SEOG,
Perkins and Work-Study programs each require the institution to make a matching
contribution in the amount of 25% of all federal funds the institution receives
from the DOE each year. In 1997, the Company's 25% matching contribution
amounted to $17,000 for the SEOG program, $33,000 for the Perkins program and
$360,000 for the Work-Study program.
In 1997, approximately 2% of the Company's revenues were indirectly derived
from state financial aid programs and the Company awarded $738,000 in
institutional scholarships. The Company also provides tuition discounts to
full-time employees of the Company and their dependents to attend ITT Technical
Institutes. For 1997, the cost of these employee educational discounts was
$639,000.
REGULATION OF FEDERAL FINANCIAL AID PROGRAMS
In order to participate in Title IV Programs, an institution must comply
with numerous and complex standards set forth in the HEA and the regulations
promulgated thereunder by the U.S. Department of Education ("DOE"). These
standards are designed to limit institutional dependence on Title IV Program
funds, prevent institutions with unacceptable student loan default rates from
participating in Title IV Programs and, in general, require institutions to
satisfy certain criteria related to educational value,
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<PAGE> 37
administrative capability and financial responsibility. These standards are
applied primarily on an institutional basis, with an institution defined as a
main campus and its additional locations or branch campuses, if any. Among the
63 ITT Technical Institutes, 30 are considered to be main campuses and 33 are
considered to be additional locations. The HEA standards require an institution
to obtain and periodically renew its certification by the DOE as an "eligible
institution" that has been authorized by the relevant state education
authority(ies) and accredited by an accrediting commission recognized by the
DOE. Sixty of the 63 ITT Technical Institutes currently participate in Title IV
Programs, and the other three institutes, which were recently opened, have begun
the certification process for participation in Title IV Programs.
Proprietary providers of postsecondary education have been subjected to
increased scrutiny and regulation by the DOE and other regulatory authorities as
a result of concern about fraud and abuse of federal student financial aid
programs by certain proprietary institutions. The Company believes that the ITT
Technical Institutes are in substantial compliance with the HEA and its
implementing regulations. The Company cannot, however, predict with certainty
how all of the HEA provisions and the implementing regulations will be applied.
As described below, the violation of Title IV Program requirements by the
Company or any ITT Technical Institute could have a material adverse effect on
the Company's financial condition, results of operations or cash flows. In
addition, it is possible that the HEA and its implementing regulations may be
applied in a way that could hinder the Company's operations or expansion plans.
Significant factors relating to Title IV Programs that could adversely
affect the Company include the following:
Risk of Legislative Action. Title IV Programs are subject to
significant political and budgetary pressures. The HEA is reauthorized by
the U.S. Congress approximately every six years, and the next
reauthorization is expected to be completed in 1998 or 1999. There can be
no assurance that funding for Title IV Programs will continue to be
available or maintained at current levels or that current requirements for
institutional participation and student eligibility will not change. A
reduction in Title IV Program funding levels or a limitation of the
Company's participation in Title IV Programs could result in lower
enrollments and require the Company to arrange for alternative sources of
financial aid for its students. Given the significant percentage of the
Company's revenues that are indirectly derived from Title IV Programs, any
significant reduction in Title IV Program funding or the ability of the ITT
Technical Institutes or their students to participate in Title IV Programs
could have a material adverse effect on the Company's financial condition
or results of operations.
If an ITT Technical Institute lost its eligibility to participate in
Title IV Programs, or if the amount of available Title IV Program funding
was reduced, the Company would seek to arrange or provide alternative
sources of financial aid for that institute's students. There are a number
of private organizations that provide loans to students. Although the
Company believes that one or more private organizations would be willing to
provide loans to students attending an ITT Technical Institute, there is no
assurance that this would occur or that the interest rate and other terms
of such loans would be as favorable as for Title IV Program loans. In
addition, the Company would be required to guarantee all or part of this
assistance and might incur other additional costs in connection with
securing alternative sources of student financial aid. If the Company
provided more direct financial assistance to ITT Technical Institute
students, it would incur additional costs and assume increased credit
risks.
Student Loan Defaults. Under the HEA, an institution may lose its
eligibility to participate in some or all Title IV Programs if student
defaults on federal student loans exceed certain rates. These rates are
calculated on an institutional basis and represent the number of students
who have defaulted, not the dollar amount of such defaults. An
institution's cohort default rate is calculated on an annual basis as the
rate at which borrowers scheduled to begin repayment on their loans in one
year default on those loans by the end of the next year. For each year
through federal fiscal year 1994, each institution participating in the
FFEL programs received an FFEL cohort default rate. Beginning with federal
fiscal year 1995, the DOE also included loans under the FDL programs in the
calculation of an institution's cohort default rate, and each institution
received an FFEL/FDL cohort default rate based solely on FFEL program
loans, solely on FDL program loans or on a weighted average of both FFEL
and FDL
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<PAGE> 38
program loans, depending on whether the institution participated in the
FFEL programs only, the FDL programs only or both FFEL and FDL programs,
respectively. An institution whose FFEL/FDL cohort default rate is 25% or
greater for three consecutive federal fiscal years loses eligibility to
participate in the FFEL and FDL programs for the remainder of the federal
fiscal year in which the DOE determines that the institution has lost its
eligibility and for the two subsequent federal fiscal years, unless it
successfully appeals such disqualification under the procedures provided by
the HEA and its implementing regulations. During the pendency of any such
appeal, the institution retains its eligibility to participate in the FFEL
and FDL programs. An institution whose FFEL/FDL cohort default rate for any
federal fiscal year exceeds 40% may have its eligibility to participate in
all Title IV Programs limited, suspended or terminated.
One ITT Technical Institute campus group, consisting of the institute
in Garland, Texas, had FFEL/FDL cohort default rates of 25% or greater for
three consecutive federal fiscal years: 27.7%, 36.8% and 28.4% for the
1993, 1994 and 1995 federal fiscal years, respectively. Another ITT
Technical Institute campus group, consisting of the institute in San
Antonio, Texas, had FFEL/FDL cohort default rates of 25% or greater for two
consecutive federal fiscal years: 25.6% and 26.1% for the 1994 and 1995
federal fiscal years, respectively. No other ITT Technical Institute campus
group had an FFEL/FDL cohort default rate equal to or greater than 25% for
the 1995 federal fiscal year, the latest year for which the DOE has
published FFEL/FDL cohort default rates. The ITT Technical Institutes in
Garland and San Antonio, Texas, which accounted for approximately 1.7% and
2.4%, respectively, of the Company's revenues in its 1997 fiscal year, have
initiated appeals of their 1995 FFEL/FDL cohort default rates with the DOE
based on the servicing and collection of the loans included in such rates
and erroneous data used to calculate such rates. The Company expects that
these appeals will be resolved in 1998. There can be no assurance that
either institute's appeal will result in a recalculation of its 1995
FFEL/FDL cohort default rate to less than 25%. If the Garland, Texas ITT
Technical Institute's appeal does not result in its 1995 FFEL/FDL cohort
default rate being reduced to less than 25%, such institute will
immediately become ineligible to participate in the FFEL and FDL programs.
If the San Antonio, Texas ITT Technical Institute's appeal does not result
in its 1995 FFEL/FDL cohort default rate being reduced to less than 25% and
such institute subsequently receives a 1996 FFEL/FDL cohort default rate
equal to or greater than 25% and cannot reduce that rate to less than 25%
through an appeal to the DOE, such institute will become ineligible to
participate in the FFEL and FDL programs. Loss of eligibility to
participate in the FFEL and FDL programs by both the Garland and San
Antonio, Texas ITT Technical Institutes (but not by either alone) could
have a material adverse effect on the Company's financial condition or
results of operations.
The Company has arranged for an unaffiliated, private funding source
("PFS") to provide loans to the students enrolled at the Garland, Texas ITT
Technical Institute in the event this institute loses its eligibility to
participate in the FFEL and FDL programs. This alternative source of
student financial aid requires the Company to guarantee repayment of the
PFS loans. Based on the Company's experience with the repayment of Title IV
Program loans by students who attended the Garland, Texas ITT Technical
Institute, the Company believes that such guaranty should not result in a
material adverse effect on the Company's financial condition, results of
operations or cash flows. Another alternative would be to stop enrolling
new students in the Garland institute, continue teaching the students
already enrolled, and close the institute once the students already
enrolled had completed their programs of study.
If an institution's FFEL/FDL cohort default rate is 25% or greater in
any of the three most recent federal fiscal years, or if its cohort default
rate for loans under the Perkins program exceeds 15% for any federal award
year (i.e., July 1 through June 30), that institution may be placed on
provisional certification status by the DOE. When the Garland and San
Antonio, Texas ITT Technical Institutes were provisionally recertified for
participation in Title IV Programs following the Merger, one of the
conditions of the provisional certification for each of those institutes
was the institute's FFEL/FDL cohort default rate, which exceeded 25%.
Twenty-seven ITT Technical Institute campus groups (consisting of 53
institutes) had a Perkins cohort default rate in excess of 15% for students
who were scheduled to begin repayment in the 1995/1996 federal award year,
the most recent year for which such
37
<PAGE> 39
rate has been calculated. Thus, these ITT Technical Institutes could be
placed on provisional certification status based on their Perkins cohort
default rates. To date, no ITT Technical Institute campus group has been
placed on provisional certification status because of its Perkins cohort
default rate.
The HEA requires an institution with a Perkins cohort default rate of
15% or greater to establish a default management plan, and each ITT
Technical Institute has developed such a plan. Twenty-four ITT Technical
Institute campus groups (consisting of 46 institutes) had a Perkins cohort
default rate of 20% or greater for the 1995/1996 federal award year. The
HEA subjects institutions with a Perkins cohort default rate of 20% or
greater to a "default penalty" that reduces the amount of additional
federal funds allocated annually to the institution for use in the Perkins
program by: (a) 10%, if the rate is at least 20% but less than 25%; (b)
30%, if the rate is at least 25% but less than 30%; or (c) 100%, if the
rate is 30% or greater. The Perkins loans disbursed to ITT Technical
Institute students amounted to less than 1% of the Company's revenues in
1997, and less than half of the ITT Technical Institutes disburse their
entire annual allocation. As a result, the Company does not believe that
its financial condition or results of operations will be materially
affected by any reduction of additional federal funds allocated to the ITT
Technical Institute campus groups for use in the Perkins program. See "--
Administrative Capability" and "-- Eligibility and Certification
Procedures."
A substantial factor in controlling FFEL/FDL cohort default rates is
the servicing and collection efforts of student loan lenders and guaranty
agencies, which are independent of the Company. The Company supplements
such efforts by attempting to contact students who are delinquent in making
payments to advise them of their responsibilities and any deferment or
forbearance for which they may qualify. The Company has also contracted
with third-party servicers to provide additional assistance in reducing
defaults under the FFEL, FDL and Perkins programs by delinquent students
who attended certain ITT Technical Institutes.
Financial Responsibility Standards. The HEA and its implementing
regulations prescribe specific and detailed financial responsibility
standards that an institution must satisfy to participate in Title IV
Programs. Among the most significant of these standards is a requirement
that proprietary institutions have an acid test ratio (defined as the ratio
of cash, cash equivalents and current accounts receivable to current
liabilities) of at least 1:1 at the end of each of the institution's fiscal
years. In addition, an institution must (a) have a positive tangible net
worth at the end of each fiscal year and (b) not have a cumulative net
operating loss during its two most recent fiscal years that results in a
decrease of more than 10% of the institution's tangible net worth at the
beginning of such two-year period. If the DOE determines that an
institution does not satisfy each of these numeric standards, that
institution may establish its financial responsibility on an alternative
basis by (i) posting a letter of credit in an amount equal to 50% of the
total Title IV Program funds received by students enrolled at such
institution during the most recent year for which the DOE has data or (ii)
posting a letter of credit in an amount equal to 10% of such prior year's
Title IV Program funds and agreeing to receive Title IV Program funds under
an arrangement other than the DOE's standard advance funding arrangement.
Another significant financial responsibility standard requires institutions
to post a letter of credit with the DOE in an amount equal to 25% of the
total dollar amount of refunds paid by the institution in its most recent
fiscal year, if the institution has not paid refunds timely in its two most
recent fiscal years.
Historically, the DOE has evaluated the financial condition of the ITT
Technical Institutes on a consolidated basis based on the Company's
financial statements. The DOE's regulations, however, permit the DOE to
examine the financial statements of each ITT Technical Institute campus
group, the Company, Starwood, Inc. and ITT. The Company has calculated that
its acid test ratio at December 31, 1997 was 1.94:1 and the Company
believes that it satisfied all the other standards of financial
responsibility at the Company level as of that date. As a part of the DOE's
review of the applications of the ITT Technical Institute campus groups to
have their eligibility to participate in Title IV programs reinstated after
the Merger, the DOE evaluated the financial responsibility of all of the
ITT Technical Institute campus groups following the Merger. The DOE
determined that each of the campus groups satisfied the DOE's financial
responsibility standards following the Merger, but the DOE directed the
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<PAGE> 40
Company to address certain issues related to its financial condition and
financial statements. See "--Change in Control."
In November 1997, the DOE issued new regulations, to take effect July
1, 1998, which revised the DOE's standards of financial responsibility.
These new standards replace the acid test ratio, the tangible net worth
standard and the operating loss test described above with three different
ratios: an equity ratio, a primary reserve ratio and a net income ratio.
The equity ratio measures the institution's capital resources, ability to
borrow and financial viability. The primary reserve ratio measures the
institution's ability to support current operations from expendable
resources. The net income ratio measures the ability of an institution to
operate at a profit. The results of each ratio are assigned a strength
factor on a scale from negative 1.0 to positive 3.0, with negative 1.0
reflecting financial weakness and 3.0 reflecting financial strength. An
institution's strength factors are then weighted based on an assigned
weighting percentage for each ratio. The weighted scores for the three
ratios are then added together to produce a composite score for the
institution. The composite score must be at least 1.5 for the institution
to be deemed financially responsible by the DOE without the need for
further oversight. The Company has calculated that the application of these
new regulations to the Company's audited financial statements for its 1997
fiscal year results in a composite score of 3.0. The Company does not
believe, based on its current understanding of how the revised financial
responsibility standards will be applied, that these standards will have a
material adverse effect on the Company's financial condition, results of
operations or expansion plans.
The "85/15 Rule." Under a provision of the HEA commonly referred to
as the "85/15 Rule," a proprietary institution, such as each ITT Technical
Institute campus group, becomes ineligible to participate in Title IV
Programs if, on a cash accounting basis, more than 85% of its applicable
revenues for a fiscal year are derived from Title IV Programs. If any ITT
Technical Institute campus group were to violate the 85/15 Rule for any
fiscal year, it would be ineligible to participate in Title IV Programs as
of the first day of the following fiscal year and would be unable to apply
to regain its eligibility until the next fiscal year. Furthermore, if an
ITT Technical Institute campus group violated the 85/15 Rule and became
ineligible to participate in Title IV Programs but continued to disburse
Title IV Program funds, the DOE would consider all Title IV Program funds
disbursed to the institution after the effective date of the loss of
eligibility to be a liability subject to repayment by the institution. For
each of its 1996 and 1997 fiscal years, the Company has calculated that no
ITT Technical Institute campus group derived more than 81% of its revenues
from Title IV Programs, and for its 1997 fiscal year, the range for the
campus groups was from approximately 61% to approximately 80%.
The Company believes that, due to the expansion and increased
availability of funding under certain Title IV Programs resulting from the
1992 reauthorization of the HEA, students have increasingly relied, and
probably will continue to rely, on Title IV Programs to finance their
education, thereby increasing the prospect that a greater percentage of ITT
Technical Institute revenues will be indirectly derived from Title IV
Programs. In an effort to prevent any future loss of Title IV Program
eligibility by any ITT Technical Institute campus group as a result of the
85/15 Rule, the Company has implemented various measures to reduce the
percentage of applicable revenues indirectly derived from Title IV
Programs. Some of these alternatives require the Company to incur costs not
associated with Title IV Programs.
Additional Locations and Program Offerings of ITT Technical
Institutes. The Company's expansion plans assume its continued ability to
(a) establish new ITT Technical Institutes as additional locations of
existing ITT Technical Institute main campuses and (b) expand the program
offerings at existing institutes. In its last three fiscal years, the
Company has: (i) established eight new additional locations, six of which
are participating in Title IV Programs and two of which are in the process
of obtaining certification to participate; and (ii) added 35 programs at
its existing ITT Technical Institutes. In addition, in March 1998 the
Company established one new additional location, which is in the process of
obtaining certification to participate in Title IV Programs. The HEA
requires proprietary educational institutions, such as the ITT Technical
Institute campus groups, to be in full operation for two years before the
institution can qualify to participate in Title IV Programs. The HEA and
applicable regulations, however, permit an institution that is already
certified to participate in Title IV Programs to
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<PAGE> 41
establish additional locations that may, after review by the DOE, begin to
participate in Title IV Programs without satisfying the two-year
requirement so long as each such additional location satisfies all other
applicable requirements for institutional eligibility.
The HEA and applicable regulations permit students to use Title IV
Program funds only to pay the cost of attending eligible programs offered
by institutions participating in Title IV Programs. The HEA and applicable
regulations do not, however, restrict the number or delay the introduction
of educational programs that an institution may offer, but students can
only obtain Title IV Program funds to attend programs that satisfy all
applicable requirements for eligibility.
Fifty-seven ITT Technical Institutes are accredited by the Accrediting
Commission of Career Schools and Colleges of Technology ("ACCSCT"), and
three are accredited by the Accrediting Council for Independent Colleges
and Schools ("ACICS"). The ACCSCT standards generally permit an
institution's main campus to establish an additional location, if the main
campus: (a) is not on probation; (b) is not subject to a show cause order;
(c) is not subject to outcomes reporting, or, if subject to outcomes
reporting, has been expressly permitted by the ACCSCT to establish an
additional location; (d) has not applied for accreditation for an
additional location within the past two years; and (e) has not undergone a
change in control for at least one year, but this requirement generally
does not apply to an accreditation application for an additional location
submitted prior to the change in control. Prior to the change in control
caused by the Merger, the Company submitted applications for accreditation
to the ACCSCT for all additional locations that the Company anticipates
opening in 1998 and for most of the additional locations that the Company
anticipates opening in 1999. The ACICS standards generally permit an
institution's main campus to establish a branch campus (referred to herein
as an "additional location") if: (i) the main campus is not on probation;
(ii) neither the main campus nor any of its additional locations is subject
to a show cause order; (iii) neither the main campus nor any of its
additional locations is subject to a financial or outcomes review, or, if
subject to a financial or outcomes review, has been expressly permitted by
the ACICS to establish an additional location; and (iv) the main campus
does not have any additional location awaiting final accreditation.
The ACCSCT standards generally permit an institution's main campus and
its additional locations to expand their program offerings if (a) the
institute is not on probation and (b) the institute is not subject to a
show cause order. The ACICS standards generally permit an institution's
main campus and its additional locations to expand their program offerings
if: (i) the institute is not on probation; and (ii) neither the main campus
nor any of its additional locations is subject to a financial or outcomes
review or, if subject to an outcomes review, has been expressly permitted
by the ACICS to expand its program offerings.
Two ITT Technical Institutes (both additional locations) accredited by
the ACCSCT are on probation, four ITT Technical Institutes (two main
campuses and two additional locations) accredited by the ACCSCT are subject
to a show cause order and 23 ITT Technical Institutes (14 main campuses and
nine additional locations) accredited by the ACCSCT are subject to outcomes
reporting. No ITT Technical Institute accredited by the ACICS is on
probation, subject to a show cause order or subject to a financial or
outcomes review. The ACCSCT may place an institution's main campus or
additional location on probation, or subject it to a show cause order or
outcomes reporting, for a variety of reasons. All of the ITT Technical
Institutes that are on probation, or are subject to a show cause order or
outcomes reporting, by the ACCSCT received such status because the ACCSCT
determined that the student completion rates for certain programs of study
offered by these ITT Technical Institutes are not reasonable. Under the
ACCSCT and the ACICS standards, as applicable, an institution's main campus
or additional location that is: (a) placed on probation is required to
demonstrate to the accrediting commission that the institute has taken
corrective action and is in continuous compliance with accrediting
commission standards; (b) subject to a show cause order is required to
demonstrate to the accrediting commission that the institute's
accreditation should not be revoked, conditioned or otherwise adversely
affected; (c) subject to outcomes reporting is required to periodically
report its results in such areas to the accrediting commission; or (d)
subject to a financial or outcomes review is required to report its results
in such areas to the accrediting commission. Although the ACCSCT and the
ACICS standards
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limit the ability of the Company to establish additional locations and
expand the programs offered at an institute in certain circumstances, the
Company does not believe, based on its current understanding of how the
accrediting standards will be applied, that these limitations will have a
material adverse effect on the Company's expansion plans.
State laws and regulations generally treat each ITT Technical
Institute location as a separate institution and do not distinguish between
main campuses and additional locations. Thus, ITT Technical Institutes that
are recognized as additional locations by the DOE and their respective
accrediting commissions are, for the most part, recognized as separate,
unaffiliated institutions by their respective state education authorities.
State laws and regulations generally do not limit the number of
institutions that can be established within the state or the number of
programs that can be offered by an institution, so long as each institution
satisfies all requirements to obtain the requisite state authorization(s).
The requirements to obtain the requisite state authorization(s) limit the
ability of the Company in certain states to establish new institutes and
offer new programs, and the process of obtaining the requisite state
authorization(s) can delay the opening of new institutes or the offering of
new programs. Although state laws and regulations limit the ability of the
Company to establish new ITT Technical Institutes and expand the programs
offered at an institute, the Company does not believe, based on its current
understanding of how the state laws and regulations in effect in the states
where the Company is located or anticipates establishing a new location
will be applied, that these limitations will have a material adverse effect
on the Company's expansion plans. See "-- State Authorization and
Accreditation."
Administrative Capability. The HEA directs the DOE to assess the
administrative capability of each institution to participate in Title IV
Programs. The DOE has issued regulations that require each institution to
satisfy a series of separate standards. Failure to satisfy any of the
standards may lead the DOE to determine that the institution lacks
administrative capability and, therefore, is not eligible to continue its
participation in Title IV Programs or must be placed on provisional
certification status as a condition of such continued participation. One
standard that is applicable to certain programs with the stated objective
of preparing students for employment requires the institution to show a
reasonable relationship between the length of the program and the
entry-level job requirements of the relevant field of employment. Other
standards provide that an institution lacks administrative capability if
its FFEL/FDL cohort default rate equals or exceeds 25% for any of the three
most recent federal fiscal years for which FFEL/FDL cohort default rates
are available, or if its Perkins cohort default rate exceeds 15% for any
federal award year. Two ITT Technical Institute campus groups (each
consisting of one institute) had a FFEL/FDL cohort default rate equal to or
greater than 25% for at least one of the three most recent federal fiscal
years for which FFEL/FDL cohort default rates are available. Twenty-seven
ITT Technical Institute campus groups (consisting of 53 institutes) had a
Perkins cohort default rate in excess of 15% for the most recent federal
award year for which such rate has been calculated. When the Garland and
San Antonio, Texas ITT Technical Institutes were provisionally recertified
for participation in Title IV Programs following the Merger, one of the
conditions of the provisional certification for each of these institutes
was the institute's FFEL/FDL cohort default rate, which exceeded 25%. To
date, no ITT Technical Institute campus group has been placed on
provisional certification status because of its Perkins cohort default
rate. See "-- Student Loan Defaults" and "-- Eligibility and Certification
Procedures."
An additional standard in the HEA prohibits an institution from
providing any commission, bonus or other incentive payment based directly
or indirectly on success in securing enrollments or financial aid to any
person or entity engaged in any student recruitment, admission or financial
aid awarding activity. The DOE has provided only limited guidance
respecting compliance with this requirement. ITT Technical Institute
employees involved in student recruitment, admissions or financial aid
receive only a salary. The Company believes that its method of compensating
these employees complies with the requirements of the HEA. The regulations
do not, however, establish clear standards for compliance, and there can be
no assurance that the DOE will not find deficiencies in the Company's
present or former methods of compensation.
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Under new regulations issued by the DOE in November 1996, starting
January 1, 1998 each institution must utilize certain electronic processes
provided by the DOE in order to be considered administratively capable.
Although the Company will have to adjust some of its current practices in
order for its institutes to comply fully with this new requirement, the
Company does not believe, based on its current understanding of how this
new requirement will be applied, that the Company's financial condition
will be materially affected by this new standard.
Eligibility and Certification Procedures. Under the HEA and its
implementing regulations, each institution is required to periodically
reapply to the DOE for continued eligibility to participate in Title IV
Programs. Each institution deemed to be in compliance with the HEA and the
DOE's regulations is recertified for a period not to exceed four years,
before which time it must apply again for continued recertification. In
1997, 13 ITT Technical Institute campus groups (consisting of 20
institutes) were required by the DOE to apply for recertification to
participate in Title IV Programs. The DOE combined each of these campus
groups' applications for recertification with their applications for
reinstatement of participation in Title IV Programs following the change in
control caused by the Merger. The DOE normally requires an institution to
submit an updated application for institutional eligibility and
certification when it opens an additional location that offers a full
educational program or raises its level of program offering.
An institution may be placed on provisional certification status for a
period not to exceed three years, if the DOE finds that the institution
does not fully satisfy all the eligibility and certification standards. If
an institution successfully participates in the Title IV Programs during
its period of provisional certification but fails to satisfy the full
certification criteria, the DOE may renew the institution's provisional
certification. An institution's provisional certification may be withdrawn
by the DOE without advance notice if the DOE determines that the
institution is not fulfilling all applicable requirements, and an
institution that is provisionally certified may be subjected to closer
review by the DOE if it applies for approval to open a new location or some
other significant change in its eligibility, but provisional certification
does not otherwise limit an institution's access to Title IV Program funds.
Further, any institution seeking eligibility to participate in Title IV
Programs after a change in control will be provisionally certified for a
limited period, following which the institution will be required to reapply
for continued eligibility. No ITT Technical Institute campus group was
provisionally certified by the DOE prior to the Merger. As a result of the
Merger, each ITT Technical Institute campus group was recertified to
participate in Title IV Programs on a provisional basis for a three-year
period. As an additional condition of each institute's provisional
certification, the DOE directed the Company to address certain issues
related to its financial condition and financial statements. Four campus
groups each had one additional condition placed on their provisional
certification, as follows: (a) the Garland and San Antonio, Texas ITT
Technical Institutes were each cited for having an FFEL/FDL cohort default
rate equal to or greater than 25% for at least one of the three most recent
federal fiscal years for which such rates are available, and each was told
that it would stay on provisional certification status until its rates for
the three most recent federal fiscal years for which such rates are
available were all below 25%; (b) the San Diego, California ITT Technical
Institute was cited for having a pending DOE program review, and was told
it would stay on provisional certification status until all liabilities
identified in the program review were paid and all deficiencies identified
in the program review were resolved; and (c) the Youngstown, Ohio ITT
Technical Institute campus group was cited because its accrediting
commission, the ACICS, had only temporarily extended the campus group's
accreditation following the Merger and had not yet formally reaccredited
the campus group. See "-- Change in Control."
Title IV Program Funds Management. The DOE issued new regulations in
November 1996 which became effective July 1, 1997 and which revised the
procedures governing how an institution participating in Title IV Programs
requests, maintains, disburses and otherwise manages Title IV Program
funds. One significant change is the requirement that institutions disburse
all Title IV Program funds by payment period, which, in the case of the ITT
Technical Institutes, corresponds to an academic quarter. This regulation
increases the number of disbursements of federal student loans that
institutions on a quarter system, like the ITT Technical Institutes, must
make and, therefore, delays each institute's receipt and
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disbursement of federal student loan funds. Other significant changes
include expanding the requirements for institutions to notify Title IV
Program fund recipients of certain information and reducing the time by
which an institution must return undisbursed Title IV Program funds. These
new regulations materially affect the Company's cash flow and increase the
Company's administrative burden, but they will not have a material adverse
effect on the Company's financial condition or results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Availability of Lenders and Guarantors. For a variety of reasons,
including the high default rates of students attending certain proprietary
institutions, the growth of the FDL programs and the potential assertion of
claims against holders of student loans, the number of lenders willing to
make federally guaranteed student loans to students at certain proprietary
institutions has declined. To date, however, the availability of lenders
has not affected the ability of ITT Technical Institute students to obtain
FFEL program loans. In the Company's 1997 fiscal year, one lending
institution provided approximately 62% of all federally guaranteed student
loans to ITT Technical Institute students. The Company believes that other
lenders would be willing to make FFEL program loans to its students if such
loans were no longer available from any of its current lenders, but there
can be no assurance in this regard. In addition, the HEA requires the
establishment of lenders of last resort in every state to make loans to
students at any school that cannot otherwise identify lenders willing to
make federally guaranteed loans to its students. Using a lender of last
resort may delay the receipt of FFEL program loans by ITT Technical
Institute students and slightly reduce the total loan access for ITT
Technical Institute students, but it should not have a material adverse
effect on the Company. The lenders of last resort will not provide PLUS
loans, which accounted for 11% of the Company's revenues in 1997, and are
not required to provide any unsubsidized Stafford loans, which accounted
for 23% of the Company's revenues in 1997.
In the Company's 1997 fiscal year, one student loan guaranty agency
guaranteed approximately 94% of all FFEL program loans made to ITT
Technical Institute students. The Company believes that other guaranty
agencies would be willing to guarantee FFEL program loans to ITT Technical
Institute students if that guaranty agency ceased guaranteeing such loans
or reduced the volume of loans guaranteed, but there can be no assurance in
this regard. Most states have a designated guaranty agency that the Company
believes would guarantee most, if not all, FFEL program loans made to ITT
Technical Institute students in that state. In addition, the HEA's lender
of last resort program provides for the guarantee of FFEL program loans
made by lenders of last resort. Thus, any reduction in the volume of FFEL
program loans for ITT Technical Institute students guaranteed by the
institutes' primary guaranty agency should not have a material adverse
effect on the Company's financial condition, results of operations or cash
flows. Neither ITT, Starwood, Inc. nor any of their subsidiaries or
affiliates (including the Company) makes or guarantees any Title IV Program
loans to any student attending any ITT Technical Institute.
Compliance with Regulatory Standards and Effect of Regulatory
Violations. The Company maintains an internal audit department that
reviews the compliance of the ITT Technical Institutes with Title IV
Program requirements. The Company's audit plan provides for an annual
on-site compliance review of each ITT Technical Institute. The review
addresses numerous compliance areas, including student tuition refunds,
student academic progress, student admissions, graduate employment, student
attendance, student financial aid applications and implementation of prior
audit recommendations.
The ITT Technical Institutes are subject to audits or program
compliance reviews by various external agencies, including the DOE, state
agencies, guaranty agencies and accrediting commissions. The HEA and its
implementing regulations also require that an institution's administration
of Title IV Program funds be audited annually by an independent accounting
firm. If the DOE or another regulatory agency were to determine that an ITT
Technical Institute had improperly disbursed Title IV Program funds or had
violated a provision of the HEA or the implementing regulations, the
affected institute could be required to repay such funds to the DOE or the
appropriate state agency or lender and could be assessed an administrative
fine. The DOE could also transfer the institute from the advance system of
receiving Title IV Program funds to the reimbursement system, under which a
school must disburse its
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own funds to students and document the students' eligibility for Title IV
Program funds before receiving such funds from the DOE. Violations of Title
IV Program requirements could also subject an institute or the Company to
other civil and criminal penalties. In addition, significant violations of
regulatory standards governing Title IV Programs by the Company or any of
the ITT Technical Institutes could be the basis for a proceeding by the DOE
to limit, suspend or terminate the participation of the affected institutes
in Title IV Programs. If the DOE terminates the eligibility of an
institution to participate in Title IV Programs, the institution in most
circumstances must wait 18 months before requesting a reinstatement of its
participation. An institution that loses its eligibility to participate in
the FFEL and FDL programs due to high cohort default rates for three
consecutive years normally may not apply to resume participation in those
programs for at least two federal fiscal years. An institution that loses
its eligibility to participate in Title IV Programs due to a violation of
the 85/15 Rule may not apply to resume participation in Title IV Programs
for at least one year.
The DOE recently completed a program review of the ITT Technical
Institute in San Diego, California that began in 1994. In closing that
program review, the DOE directed the Company to (a) remit a nominal amount
of money to lenders and the DOE and (b) adopt a policy of refunding late
disbursement amounts directly to students, instead of to students' lenders
for the purpose of reducing students' Title IV Program loan balances. These
requirements will not have a material adverse effect on the Company's
financial condition, results of operations or cash flows. There is no
proceeding pending to fine, limit, suspend or terminate any ITT Technical
Institute's participation in Title IV Programs, and the Company has no
reason to believe that any such proceeding is contemplated. If such a
proceeding were initiated and resulted in a substantial curtailment of the
Company's participation in Title IV Programs, the Company would be
materially adversely affected, even if the Company could arrange or provide
alternative sources of student financial aid. If an institute lost its
eligibility to participate in Title IV Programs and the Company could not
arrange for alternative sources of financial aid for the institute's
students, the Company probably would have to close that institute.
STATE AUTHORIZATION AND ACCREDITATION
The Company is subject to extensive and varying regulation in each of the
27 states in which an ITT Technical Institute currently operates and in four
other states in which the institutes recruit students. Each ITT Technical
Institute must be authorized by the applicable state education authority(ies) to
operate and grant degrees or diplomas to its students. In addition, certain
states require an institute to be in operation for a period of up to two years
before such institute can be authorized to award degrees. All 63 ITT Technical
Institutes are currently authorized by one or more state education authorities.
ITT Technical Institutes that confer bachelor or master degrees must, in
most cases, meet additional regulatory standards. Raising the curricula of
existing ITT Technical Institutes to the bachelor and/or master degree level
requires the approval of state education authorities and accrediting
commissions. State education laws and regulations affect the Company's
operations and may limit the ability of the Company to introduce degree programs
or to obtain authorization to operate in certain states. If any ITT Technical
Institute lost its state authorization, the institute would be unable to offer
postsecondary education and the Company would be forced to close the institute.
Closing an ITT Technical Institute could have a material adverse effect on the
Company's financial condition or results of operations.
The HEA specifies a series of standards that each recognized accrediting
commission must utilize in reviewing institutions. For example, accrediting
commissions must assess the length of each academic program and the tuition
charged by each institution in relation to the subject matters taught and the
objectives of the degrees or diplomas offered. Further, accrediting commissions
must evaluate each institution's success with respect to student achievement, as
measured by rates of program completion, passing of state licensing examinations
and job placement. In 1997, seven ITT Technical Institutes were reviewed and
reaccredited by their respective accrediting commission and one ITT Technical
Institute obtained its initial accreditation.
State authorization and accreditation by a recognized accrediting
commission are required in order for an institution to become and remain
eligible to participate in Title IV Programs. In addition, some states require
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institutions operating therein to be accredited as a condition of state
authorization. Fifty-seven ITT Technical Institutes are accredited by the ACCSCT
and three are accredited by the ACICS, both of which are accrediting commissions
recognized by the DOE. The other three institutes, which were recently opened,
have applied for accreditation. Two ITT Technical Institutes (both additional
locations) accredited by the ACCSCT are on probation, four ITT Technical
Institutes (two main campuses and two additional locations) accredited by the
ACCSCT are subject to a show cause order and 23 ITT Technical Institutes (14
main campuses and nine additional locations) accredited by the ACCSCT are
subject to outcomes reporting. No ITT Technical Institute accredited by the
ACICS is on probation, subject to a show cause order or subject to a financial
or outcomes review. Under the ACCSCT and the ACICS standards, as applicable, an
institution's main campus or additional location may be placed on probation,
subject to a show cause order, subject to outcomes reporting or subject to a
financial or outcomes review for a variety of reasons. All of the ITT Technical
Institutes that are on probation, or are subject to a show cause order or
outcomes reporting, by the ACCSCT received such status because the ACCSCT
determined that the student completion rates for certain programs of study
offered by these ITT Technical Institutes are not reasonable. Under the ACCSCT
and the ACICS standards, as applicable, an institution's main campus or
additional location that is: (a) placed on probation is required to demonstrate
to the accrediting commission that the institute has taken corrective action and
is in continuous compliance with accrediting commission standards; (b) subject
to a show cause order is required to demonstrate to the accrediting commission
that the institute's accreditation should not be revoked, conditioned or
otherwise adversely affected; (c) subject to outcomes reporting is required to
periodically report its results in such areas to the accrediting commission; or
(d) subject to a financial or outcomes review is required to report its results
in such areas to the accrediting commission. If any ITT Technical Institute on
probation or subject to a show cause order by the ACCSCT fails to make the
applicable demonstration to the ACCSCT, the ACCSCT may revoke, refuse to renew
or otherwise condition the institute's accreditation. The loss of accreditation
by an existing ITT Technical Institute or the failure of a new technical
institute to obtain full accreditation: (a) would render (i) only the affected
institute ineligible to participate in Title IV Programs, if the affected
institute was an additional location or (ii) the entire campus group ineligible
to participate in Title IV Programs, if the affected institute was a main
campus; and (b) could have a material adverse effect on the Company's financial
condition, results of operations and cash flows.
CHANGE IN CONTROL
The DOE, the ACCSCT and the ACICS (collectively, the "Accrediting
Commissions") and most of the state education authorities that regulate the ITT
Technical Institutes (the "SEAs") have laws, regulations and/or standards
(collectively "Regulations") pertaining to changes in ownership and/or control
(collectively "change in control") of educational institutions, but these
Regulations do not uniformly define what constitutes a change in control. The
DOE's Regulations describe certain transactions that constitute a change in
control, including the transfer of a controlling interest in the voting stock of
an institution or such institution's parent corporation. The DOE's standards
also specify that a change in control of a publicly traded corporation, such as
the Company, occurs when there is an event that obligates the corporation to
file a Current Report on Form 8-K with the Securities and Exchange Commission
disclosing a change in control. Most of the SEAs and the Accrediting Commissions
include the sale of a controlling interest of common stock in the definition of
a change in control. The change in control Regulations adopted by the DOE, the
Accrediting Commissions and the SEAs are subject to varying interpretations as
to whether a particular transaction constitutes a change in control.
Upon the occurrence of a change in control under the DOE's Regulations, an
institution immediately becomes ineligible to participate in Title IV Programs,
cannot commit additional Title IV Program funds to its students, and can only
receive and disburse certain Title IV Program funds that were previously
committed to its students. Thereafter, the institution must file a complete
application with the DOE in order to have its eligibility to participate in
Title IV Programs reinstated. Reinstatement of an institution's certification to
participate in Title IV Programs is dependent on the DOE's determination that
the institution, under its new ownership and control, is in compliance with
specified DOE requirements for institutional eligibility. The time required for
the DOE to act on an application for certification under new ownership and
control can vary substantially and may take several months. To be complete,
among other things, such application must
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demonstrate that, following the change in control, the main campus and all of
the additional locations and branch campuses that comprise the institution are
authorized by the appropriate state educational authority(ies) and accredited by
an accrediting commission recognized by the DOE.
The Accrediting Commissions will not reaccredit an institution following a
change in control until the institution submits a complete application for
reaccreditation, which requires (among other things) documentation that the
institution has been reauthorized, or continues to be authorized, by the
appropriate SEA(s). The standards of the ACCSCT (which accredits 57 ITT
Technical Institutes) provide that, during the 30 days immediately preceding the
change in control, the ACCSCT will determine whether to temporarily continue the
institution's accreditation for a period of six months after the change to allow
time for the completion and review of the application. The standards of the
ACICS (which accredits three ITT Technical Institutes) provide that, generally
within five business days after an institution documents (among other things)
that it has been reauthorized, or continues to be authorized, by the appropriate
SEA(s) following a change in control, the ACICS will determine whether to
temporarily reinstate the institution's accreditation for an undefined period to
allow for the completion and review of the application.
Many of the SEAs, including the California SEA which authorizes 11 ITT
Technical Institutes, require that a change in control of an institution be
approved before it occurs in order for the institution to maintain its SEA
authorization. Other SEAs will only review a change in control of an institution
after it occurs.
The DOE, the Accrediting Commissions and most of the SEAs (including the
California SEA) considered the Merger to constitute a change in control of the
Company and the ITT Technical Institutes under their respective Regulations. As
a result, effective upon the Merger, each ITT Technical Institute campus group
immediately became ineligible to participate in all of the Title IV Programs.
The Company obtained all prior approvals of the Merger from the ACCSCT and the
SEAs that required such approval before the Merger occurred. Since the Merger,
the Company has obtained temporary approval of the Merger from the ACICS, final
approvals of the Merger from some of the SEAs required after a change in control
occurs and continued authorization to operate from the remaining SEAs. The
Company is continuing to pursue final approvals from the ACICS and SEAs. The DOE
approved the reinstatement of each ITT Technical Institute campus group's
participation in Title IV Programs effective March 20, 1998. The DOE's approval
was on a provisional basis, which is the DOE's practice for all institutions
following a change in control. As an additional condition of each institute's
provisional certification, the DOE directed the Company to maintain an undefined
sufficient level of cash or cash equivalents, and to revise its current
accounting treatment of direct marketing costs, revenue recognition and
amortization of direct marketing costs or provide evidence that the Company's
treatment of these items is in conformance with GAAP. The Company believes that
its treatment of these items is in accordance with GAAP and that it maintains
cash and cash equivalents in sufficient amounts to satisfy the DOE, but there
can be no assurance thereof. If the Company is required to change its accounting
treatment for any of the above items, management does not believe that such
change would have a material adverse effect on the Company's financial condition
or results of operations before the cumulative effect of any change in
accounting. See "-- Regulation of Federal Financial Aid Programs -- Eligibility
and Certification Procedures."
The Offering will constitute a change in control under the Regulations of
certain SEAs, but not under the Regulations of the DOE or of either Accrediting
Commission. Thus, certain ITT Technical Institutes will be subject to review by
their applicable SEAs to reaffirm their authorization. A significant delay in
obtaining or the failure to obtain SEA authorization of any ITT Technical
Institute could have a material adverse effect on the Company's financial
condition or results of operations. The Company does not believe it will
experience any material delay or difficulty in obtaining SEA authorization for
any affected institute. The Company will obtain all prior approvals of the
Offering from the SEAs required before the Offering occurs.
A change in control under the Regulations of the DOE, the Accrediting
Commissions and most of the SEAs could also occur as a result of certain future
transactions involving the ITT Technical Institutes, the Company or a principal
stockholder, including but not limited to ITT's disposition of a significant
portion of the shares of Common Stock that it retains after the Offering,
certain corporate reorganizations and certain
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changes in the boards of directors of such corporations. Starwood, Inc. has
announced that it is exploring a range of disposition strategies for the
Company.
The Company believes that if a future transaction results in a change in
control of the ITT Technical Institutes, the Company or a principal stockholder,
the Company will be able to obtain all necessary approvals from the DOE, the
SEAs and the Accrediting Commissions, with the possible exception of the
California SEA. There can be no assurance, however, that all such approvals can
be obtained in a timely manner that would not unreasonably delay the
availability of Title IV Program funds to ITT Technical Institute students or
prevent certain ITT Technical Institute students from receiving Title IV Program
funds for which they would otherwise be eligible. Obtaining such approval from
the California SEA, which authorizes 11 ITT Technical Institutes, could be
adversely affected by a state statute that prohibits the California SEA from
approving a change in control application by any applicant that has been found
in any judicial or administrative proceeding to have violated Chapter 7
(formerly Chapter 3) of the California Education Code ("Chapter 7"). In October
1996, the jury in the Eldredge Case determined that the Company, through its ITT
Technical Institute in San Diego, California, violated Chapter 7. The Company
has appealed the jury's verdict in the Eldredge Case. While the California SEA
approved the change in control application submitted by the Company with respect
to the Merger, there can be no assurance that it will approve any future change
in control application submitted by the Company. See "Business -- Legal
Proceedings."
A material adverse effect on the Company's financial condition, results of
operations and cash flows would result if a change in control of the Company
occurred and a material number of ITT Technical Institutes failed to timely: (a)
obtain the approvals of the SEAs required prior to a change in control,
including the California SEA in particular; (b) obtain the requisite
reauthorizations from the SEAs which review a change in control after it occurs;
(c) regain accreditation (or have their accreditation temporarily continued or
reinstated) by the Accrediting Commissions; or (d) regain eligibility to
participate in Title IV Programs from the DOE. In addition, the time of year at
which a change in control of the Company occurs, coupled with the length of time
required by the ITT Technical Institutes to regain their eligibility to
participate in Title IV Programs, could have a material adverse effect on the
amount of Title IV Program funds students can obtain to pay the education costs
of attending the ITT Technical Institutes and, accordingly, on the Company's
business, financial condition and results of operations.
FEDERAL INCOME TAX RELIEF
Federal income tax relief in the form of tax credits, tax deductions and
income exclusions is available to students and their families beginning in 1998
under the Taxpayer Relief Act of 1997 ("TRA"). The TRA provides: (a) an annual
Hope Scholarship tax credit of up to $1,500 for tuition and related expenses
incurred on or after January 1, 1998 for each of a student's first two years of
postsecondary education; (b) an annual Lifetime Learning tax credit of up to
$1,000 in 1998 through 2002 and up to $2,000 in subsequent years for tuition and
related expenses incurred on or after July 1, 1998, but the Lifetime Learning
tax credit is not available in any tax year in which the taxpayer is claiming
the Hope Scholarship tax credit; (c) an annual tax deduction, ranging from up to
$1,000 in 1998 to up to $2,500 in 2001 and thereafter, for interest paid during
the first 60 months in which interest payments are required on any student
loan(s); and (d) an annual income exclusion of up to $5,250 for undergraduate
educational expenses incurred on or after January 1, 1998 and before June 1,
2000 that are paid by the student's employer. The TRA also allows taxpayers to
establish Education IRAs, for taxable years beginning on or after January 1,
1998, that can be funded with non-deductible contributions of up to $500
annually for any child up to the age of 18 years, and the earnings on those
accounts are tax-free if the funds are used to pay for qualified higher
education expenses. The tax benefits provided by the TRA may help reduce the
effective cost of postsecondary education to the student and his or her family
and may, as a result, lead to higher enrollments at ITT Technical Institutes,
decreased student dependence on Title IV Program funds and fewer Title IV
Program loan defaults. Educational institutions are required to submit certain
information about the student and the student's family to the Internal Revenue
Service ("IRS") in order for the student and the student's family to qualify for
some of the tax benefits under the TRA. The Company's administrative burden will
increase as a result of these IRS
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reporting requirements, but such compliance will not have a material adverse
effect on the Company's financial condition or results of operations.
FACULTY
Faculty members are hired in accordance with criteria established by the
Company, the Accrediting Commissions and the SEAs. The Company strives to hire
faculty with related work experience and academic credentials to teach most
technical subjects. Faculty members typically include education supervisors, who
act as department heads for a program of study, and various categories of
instructors. As of December 31, 1997, the ITT Technical Institutes employed 997
full-time faculty members and 167 part-time faculty members. The ratio of the
number of all ITT Technical Institute students to all ITT Technical Institute
full-time instructors is approximately 25 to 1.
ADMINISTRATION AND EMPLOYEES
Each ITT Technical Institute is administered by a director who has overall
responsibility for the management of the institute. The administrative staff of
each ITT Technical Institute also includes a director of recruitment, a director
of career services, a director of finance and a director of education. The
Company employs approximately 160 people at its corporate headquarters in
Indianapolis, Indiana. As of December 31, 1997, the Company had approximately
2,750 full-time and regular part-time employees. In addition, the Company
employed approximately 600 students as laboratory assistants and in other
part-time positions at that date. None of the Company's employees is represented
by labor unions.
The Company's headquarters provides centralized services to all ITT
Technical Institutes in the following areas: accounting, marketing, public
relations, curricula development, purchasing, human resources, regulatory and
legislative affairs and real estate. In addition, national directors of each
major technical institute function (i.e., recruiting, finance, education and
career services) reside at the headquarters and develop policies and procedures
to guide these functions at the technical institutes. Managers located at the
headquarters closely monitor the operating results of each ITT Technical
Institute and frequently conduct on-site reviews.
COMPETITION
The postsecondary education market in the United States is highly
fragmented and competitive with no private or public institution enjoying a
significant market share. ITT Technical Institutes compete for students with
four-year and two-year degree granting institutions, which include nonprofit
public and private colleges and proprietary institutions, as well as with
alternatives to higher education such as military service or immediate
employment. Competition among educational institutions is believed to be based
on the quality of the educational program, perceived reputation of the
institution, cost of the program and employability of graduates. Certain public
and private colleges may offer programs similar to those of the ITT Technical
Institutes at a lower tuition cost due in part to government subsidies,
foundation grants, tax deductible contributions or other financial resources not
available to proprietary institutions. Other proprietary institutions offer
programs that compete with those of the ITT Technical Institutes. Certain of the
Company's competitors in both the public and private sector have greater
financial and other resources than the Company.
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<PAGE> 50
PROPERTIES
All ITT Technical Institute facilities are leased by the Company, except
for a parking lot adjacent to the Houston (North), Texas ITT Technical Institute
that is owned by the Company. The average lease term is approximately eight
years. The table below sets forth certain information regarding the ITT
Technical Institute facilities leased by the Company as of March 31, 1998.
ITT TECHNICAL INSTITUTE FACILITIES LEASES
<TABLE>
<CAPTION>
AREA IN
LOCATION (METROPOLITAN AREA) SQUARE FEET
- --------------------------------- -----------
<S> <C>
Birmingham, Alabama.............. 23,907
Phoenix, Arizona................. 25,900
Tucson, Arizona.................. 17,818
Little Rock, Arkansas............ 22,766
Anaheim, California (Los
Angeles)....................... 35,646
Hayward, California (San
Francisco)..................... 20,009
Lathrop, California (Stockton)... 13,274(1)
Oxnard, California (Los
Angeles)....................... 27,098
Rancho Cordova, California
(Sacramento)................... 27,020
San Bernardino, California
(Los Angeles).................. 33,551
San Diego, California............ 34,360
Santa Clara, California
(San Francisco)................ 24,390
Sylmar, California (Los
Angeles)....................... 30,000
Torrance, California (Los
Angeles)....................... 30,000
West Covina, California
(Los Angeles).................. 36,382
Aurora, Colorado (Denver)........ 23,450(2)
Thornton, Colorado (Denver)...... 27,076
Fort Lauderdale, Florida......... 16,341
Jacksonville, Florida............ 25,200
Maitland, Florida (Orlando)...... 32,418
Miami, Florida................... 21,347
Tampa, Florida................... 35,000
Boise, Idaho..................... 27,978
Burr Ridge, Illinois (Chicago)... 21,000(1)
Hoffman Estates, Illinois
(Chicago)...................... 24,000
Matteson, Illinois (Chicago)..... 19,058
Fort Wayne, Indiana.............. 67,000
Indianapolis, Indiana............ 58,692
Newburgh, Indiana (Evansville)... 20,000
Louisville, Kentucky............. 20,232
St. Rose, Louisiana (New
Orleans)....................... 21,000(3)
Framingham, Massachusetts
(Boston)....................... 19,938
Grand Rapids, Michigan........... 25,000
Troy, Michigan (Detroit)......... 32,000
Arnold, Missouri (St. Louis)..... 21,000(1)
Earth City, Missouri (St.
Louis)......................... 29,360
<CAPTION>
AREA IN
LOCATION (METROPOLITAN AREA) SQUARE FEET
- --------------------------------- -----------
<S> <C>
Omaha, Nebraska.................. 22,400
Henderson, Nevada (Las Vegas).... 11,166(1)
Albuquerque, New Mexico.......... 21,588
Albany, New York................. 21,000(3)
Getzville, New York (Buffalo).... 22,765
Liverpool, New York (Syracuse)... 21,000(3)
Dayton, Ohio..................... 45,591
Norwood, Ohio (Cincinnati)....... 21,272
Strongsville, Ohio (Cleveland)... 21,548
Youngstown, Ohio................. 22,500
Portland, Oregon................. 39,600
Mechanicsburg, Pennsylvania
(Harrisburg)................... 21,000
Monroeville, Pennsylvania
(Pittsburgh)................... 23,791
Pittsburgh, Pennsylvania......... 19,232
Greenville, South Carolina....... 22,065
Knoxville, Tennessee............. 30,000
Memphis, Tennessee............... 21,648
Nashville, Tennessee............. 34,690
Arlington, Texas................. 19,600
Austin, Texas.................... 25,480
Garland, Texas (Dallas).......... 21,138
Houston (North), Texas........... 22,695
Houston (South), Texas........... 22,954
Houston (West), Texas............ 36,413
Richardson, Texas (Dallas)....... 23,500(3)
San Antonio, Texas............... 25,000
Murray, Utah (Salt Lake City).... 33,600
Norfolk, Virginia................ 25,572
Richmond, Virginia............... 21,000(3)
Bothell, Washington (Seattle).... 27,800
Seattle, Washington.............. 30,316
Spokane, Washington.............. 16,378
Greenfield, Wisconsin
(Milwaukee).................... 29,650
</TABLE>
- ---------------
(1) Institutes in the first year of operation.
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<PAGE> 51
(2) Facility under lease from which the Company relocated the ITT Technical
Institute to Thornton, Colorado. While the Company remains subject to the
lease for the Aurora facility, an ITT Technical Institute is no longer
located in this facility.
(3) Facility under lease at which the Company plans to open a new ITT Technical
Institute.
ITT Technical Institutes are generally located in suburban areas near major
population centers. Campus facilities are generally situated in modern, air
conditioned buildings, which include classrooms, laboratories, student break
areas and administrative offices. ITT Technical Institutes have accessible
parking facilities and are generally near a major highway. Approximately 32 ITT
Technical Institutes occupy an entire building. New ITT Technical Institutes
typically lease facilities for a six to 11 year term. If desirable or necessary,
a facility may be relocated to a new location reasonably near the existing
facility at the end of the lease term.
The Company leases approximately 41,100 square feet of office space in its
headquarters building in Indianapolis, Indiana. As of December 31, 1997, the
lease requires payments of approximately $3.5 million over the remaining term of
the lease, which expires in 2003.
The Merger was, and the Offering will be, deemed a change in control under
certain of the Company's leases and, absent the consent of the landlord, will
cause such leases to be in default. The Company has obtained all such consents.
LEGAL PROCEEDINGS
The Company is subject to litigation in the ordinary course of its
business. Among the legal actions currently pending are:
1. Eldredge, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 689376) (the "Eldredge Case"), was filed on June 8, 1995 in
the Superior Court of San Diego County in San Diego, California by
seven graduates of the hospitality program at the San Diego ITT
Technical Institute. The suit alleged, among other things,
misrepresentation, civil conspiracy and statutory violations of the
California Education Code ("CEC"), California Business and Professions
Code ("CBPC") and California Consumer Legal Remedies Act ("CCLRA") by
the Company, ITT and three employees of the Company. The plaintiffs
claimed that the defendants (a) made misrepresentations and engaged in
deceptive acts in the recruitment of the plaintiffs for, and/or in the
promotion of, the program, (b) provided inadequate instruction to the
plaintiffs, (c) used inadequate facilities and equipment in the program
and inappropriate forms of contracts with the plaintiffs, (d) failed to
provide the plaintiffs with all required information and disclosures
and (e) misrepresented the plaintiffs' prospects for employment upon
graduation, the employment of the program's graduates and the
plaintiffs' ability to transfer program credits. The jury rendered a
verdict against the Company and ITT in this action in October 1996.
General damages of approximately $0.2 million were assessed against the
Company and ITT, jointly, on the plaintiffs' misrepresentations and CEC
claims. Exemplary damages of $2.6 million and $4.0 million were
assessed against the Company and ITT, respectively. The judge also
awarded the plaintiffs attorney's fees and costs in the amount of
approximately $0.9 million. Prejudgment interest was assessed on the
general damages award and post-judgment interest was assessed on the
entire award. The plaintiffs' CBPC and CCLRA claims and their claims
against the Company employees were dismissed, and the judge vacated the
jury verdict against ITT. The Company is seeking to overturn the awards
and has appealed the decision. Although the Company is optimistic that
it may be able to reverse or reduce the verdict, there can be no
assurance thereof. Management, based on the advice of counsel, believes
it is probable that it will prevail in its appeal and, thus, no
provision (other than the Company's legal expenses) for these awards
has been made. If the Company's appeal of the judgment in the Eldredge
Case is unsuccessful, a charge to earnings would be taken at that time
in the amount of the awards, including the general and exemplary
damages assessed against the Company, the plaintiffs' attorney's fees
and costs and the prejudgment and post-judgment interest assessed
thereon. In addition, a California statute prohibits the Company's
California regulator from approving an application for a change in
control of any institution submitted by an applicant that has been
found in any judicial or
50
<PAGE> 52
administrative proceeding to have violated Chapter 7 (formerly Chapter
3) of the CEC ("Chapter 7"). Since the jury in the Eldredge Case
determined that the Company violated Chapter 7, it is questionable
whether the Company's California regulator will approve any subsequent
application for a change in control submitted by the Company for any of
the 11 ITT Technical Institutes in California; however, the California
regulator has approved the Company's applications for a change in
control of the 11 ITT Technical Institutes in California necessitated
by the Merger. There can be no assurance that the California regulator
will approve any subsequent application for a change in control of an
ITT Technical Institute in California submitted by the Company. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Other legal proceedings (such as the actions discussed below) have
resulted and may continue to result from other persons alleging similar
claims of misrepresentation and violations of certain statutory
provisions.
2. Robb, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 00707460), was filed on January 24, 1997 in the Superior Court of
San Diego County in San Diego, California by four graduates of the San
Diego ITT Technical Institute. The suit, as originally filed, alleged,
among other things, statutory violations of the CEC and CBPC by the
Company and ten employees of the Company. The plaintiffs in the
original complaint sought compensatory damages, civil penalties,
injunctive relief, disgorgement of ill-gotten gains, restitution
(including return of educational costs) on behalf of plaintiffs and all
other persons similarly situated, attorney's fees and costs, and to
have the action certified as a class action. The plaintiffs amended
their complaint on August 14, 1997. The amended complaint deletes three
and adds two named plaintiffs. Each of the three plaintiffs was a
student who attended one of three different programs (i.e.,
hospitality, EET and CAD) at an ITT Technical Institute in California.
The plaintiffs in the amended complaint allege only violations of the
CEC, based on the plaintiffs' claims that the defendants (a) made
misrepresentations and engaged in deceptive acts in the recruitment of
students for, and/or in the promotion of, the programs offered in
California, (b) failed to provide students with all required
information and disclosures and (c) misrepresented students' prospects
for employment upon graduation and the employment of the programs'
graduates. The plaintiffs seek (a) a refund of an unspecified amount
representing all consideration paid to the Company by the plaintiffs
and all other persons similarly situated who attended any of the
programs in California at any time from January 1, 1991 through
December 31, 1996, (b) a civil penalty equal to two times the refund
amount, (c) injunctive relief and (d) an unspecified amount of
attorney's fees and costs. The plaintiffs' request to have this action
certified as a class action has been denied.
3. Iverson, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 00707705); Ohrt v. ITT Educational Services, Inc., et al. (Civil
Action No. 00707706); Sayers v. ITT Educational Services, Inc., et al.
(Civil Action No. 00707707); Barrent, et al. v. ITT Educational
Services, Inc., et al. (Civil Action No. 00707708); and Kellum, et al.
v. ITT Educational Services, Inc., et al. (Civil Action No. 00707709),
were each filed on January 31, 1997 in the Superior Court of San Diego
County in San Diego, California. Each of the five actions (involving,
in total, 17 former students who attended the hospitality program at
the San Diego ITT Technical Institute) alleges statutory violations of
the CEC, the CBPC and the California Consumer Contract Awareness Act of
1990, intentional misrepresentation and/or concealment, and civil
conspiracy by the Company, ITT and a Company employee. The plaintiffs
claim that the defendants (a) made misrepresentations and engaged in
deceptive acts in the recruitment of the plaintiffs for, and/or in the
promotion of, the program, (b) used inadequate facilities and equipment
in the program and inappropriate forms of contracts with the
plaintiffs, (c) failed to provide the plaintiffs with all required
information and disclosures and a fully executed copy of their
contracts with the Company and (d) misrepresented the plaintiffs'
prospects for employment upon graduation, the employment of the
program's graduates and the plaintiffs' externship portion of the
program. The plaintiffs in each action seek various forms of recovery,
including (a) an unspecified amount for compensatory damages,
disgorgement of ill-gotten gains, restitution, attorney's fees and
costs, (b) civil penalties equal to two times actual damages,
51
<PAGE> 53
(c) injunctive relief and (d) $10 million in exemplary damages. These
actions are currently at the discovery stage.
4. DeBattista, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 97-1366-CA-15-W), was filed on June 25, 1997 in the Circuit
Court of Seminole County in Orlando, Florida by three former students
who attended the hospitality program at the Maitland ITT Technical
Institute. The suit alleged violations of the Florida Deceptive and
Unfair Trade Practices Act, the Florida Civil Remedies for Criminal
Practices Act and Florida statutes prohibiting misleading advertising,
common law fraud and/or concealment, civil conspiracy and rescission by
the Company, ITT and seven employees of the Maitland ITT Technical
Institute. The plaintiffs claimed that the defendants (a) made
misrepresentations and engaged in deceptive acts in the recruitment of
students for, and/or in the promotion of, the program and (b)
misrepresented students' prospects for employment upon graduation, the
employment of the program's graduates and the students' externship
portion of the program. The plaintiffs sought various forms of
recovery, including an unspecified amount for (a) actual damages,
statutory penalties equal to three times actual damages, exemplary
damages and equitable rescission on behalf of the plaintiffs and all
other persons similarly situated who attended the program at the
Maitland ITT Technical Institute at any time from January 1, 1991
through December 31, 1995 and (b) attorney's fees, interest and costs.
The plaintiffs also sought to have the action certified as a class
action. The plaintiffs dismissed this action without prejudice in April
1998.
On September 22, 1997, the Company received an inquiry from the staff of
the U.S. Federal Trade Commission requesting information relating to the
Company's offering and promotion of vocational or career training. The Company
has since responded to this inquiry and provided the requested information.
While there can be no assurance as to the ultimate outcome of any
litigation involving the Company, management does not believe any pending legal
proceeding will result in a judgment or settlement that will have a material
adverse effect on the Company's financial condition, results of operations or
cash flows. Any litigation alleging violations of education or consumer
protection laws and/or regulations, misrepresentation, fraud or deceptive
practices, however, may subject the affected ITT Technical Institute to
additional regulatory scrutiny.
52
<PAGE> 54
MANAGEMENT
EXECUTIVE OFFICERS
The following table sets forth certain information about the Company's
current executive officers.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Rene R. Champagne................... 56 Chairman, President and Chief Executive Officer
Gene A. Baugh....................... 55 Senior Vice President and Chief Financial Officer
Clark D. Elwood..................... 37 Senior Vice President, General Counsel and Secretary
Edward G. Hartigan.................. 58 Senior Vice President
Thomas W. Lauer..................... 51 Senior Vice President
</TABLE>
RENE R. CHAMPAGNE has served as Chairman of ESI since October 1994,
President and Chief Executive Officer of ESI since September 1985 and a Director
of ESI since October 1985.
GENE A. BAUGH has served as Chief Financial Officer of ESI since December
1996 and Senior Vice President of ESI since January 1993. From 1981 through
November 1996 he served as Treasurer and Controller of ESI.
CLARK D. ELWOOD has served as Senior Vice President of ESI since December
1996, Secretary of ESI since October 1992 and General Counsel of ESI since May
1991. From January 1993 through November 1996, he served as Vice President of
ESI.
EDWARD G. HARTIGAN has served as Senior Vice President of ESI since January
1993.
THOMAS W. LAUER has served as Senior Vice President of ESI since January
1993.
PRINCIPAL AND SELLING STOCKHOLDER
The following table sets forth certain information concerning the
beneficial ownership by Starwood, Inc. of the Common Stock, and as adjusted to
reflect consummation of the Offering.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR OWNED AFTER
TO THE OFFERING THE OFFERING(1)
NAME AND ADDRESS -------------------- SHARES --------------------
OF BENEFICIAL OWNER NUMBER PERCENT BEING OFFERED(1) NUMBER PERCENT
------------------- ---------- ------- ---------------- ---------- -------
<S> <C> <C> <C> <C> <C>
Starwood Hotels & Resorts Worldwide,
Inc.(2)............................... 22,500,000 83.3% 11,000,000 11,500,000 42.6%
2231 E. Camelback Road,
Suite 400
Phoenix, Arizona 85016
</TABLE>
- ---------------
(1) Assumes the underwriters' over-allotment option for 1,650,000 shares is not
exercised. If the over-allotment option is exercised in full, Starwood, Inc.
would beneficially own 9,850,000 shares after the Offering (36.5% of the
shares outstanding).
(2) The shares are held of record by ITT, a wholly owned subsidiary of Starwood,
Inc. since the Merger. ITT is the Selling Stockholder.
53
<PAGE> 55
RELATIONSHIP WITH SELLING STOCKHOLDER AND RELATED TRANSACTIONS
GENERAL
Prior to the Offering, ITT holds 83.3% of the outstanding shares of Common
Stock. In addition, prior to the Merger of ITT with Starwood, Inc. on February
23, 1998, three directors of the Company (Rand V. Araskog, Robert A. Bowman and
Richard S. Ward) served as executive officers of ITT and three other directors
of the Company (Bette B. Anderson, Vin Weber and Margita E. White) served on
ITT's board of directors. Mr. Araskog and Mr. Bowman also served on ITT's board
of directors. Mrs. Anderson, Mr. Bowman, Mr. Ward and Mrs. White resigned from
the Company's Board of Directors, effective February 23, 1998. On February 25,
1998, the remaining members of the Board of Directors of the Company elected
four individuals recommended by Starwood, Inc. (Tony Coelho, Robin Josephs,
Merrick R. Kleeman and Barry S. Sternlicht) to fill the vacancies caused by such
resignations and to serve as Directors for terms expiring at the 2000, 1999,
2000 and 1998 Annual Meeting of Shareholders, respectively, and until such
Director's successor is duly elected and qualified. Mr. Sternlicht serves as
chairman and a director of Starwood, Inc. and as chairman, chief executive
officer and a trustee of Starwood Trust. Mr. Sternlicht is also the general
manager of Starwood Capital Group, L.L.C., which, together with its affiliates
and Mr. Sternlicht, beneficially owns approximately 5.3% of the outstanding
paired shares of Starwood, Inc. common stock and Starwood Trust beneficial
interest. Mr. Kleeman is also a managing director of Starwood Capital Group,
L.L.C. Mr. Coelho and Ms. Josephs are not affiliated with ITT, Starwood, Inc.,
Starwood Trust or Starwood Capital Group, L.L.C.
SERVICES
Set forth below are descriptions of certain services provided by ITT to the
Company since the Initial Public Offering. As described below and in "--
Agreements With Selling Stockholder," there have been changes in such
arrangements in connection with the Merger and this Offering.
Treasury and Financing Services. Until February 5, 1998, ITT provided the
Company with centralized treasury and financing services. As part of these
functions, surplus cash receipts of the Company were remitted to ITT, and ITT
advanced cash, as necessary, to the Company. For 1997, the net amount of cash
transferred from the Company to ITT, exclusive of payments for the services
described below, was $24,293,000 and aggregate payments for the services
described below were $20,472,000. ITT paid interest to the Company on the
average net cash balances of the Company held by ITT. For 1997, the Company
received net interest income from ITT in the amount of $5,682,000. Since
February 5, 1998, the Company manages and invests its own cash. Depending upon
current interest rates on short-term investments, the Company may not be able to
obtain the same yields on its cash balances that were being paid by ITT.
Accordingly, interest income, net may decrease in 1998.
General and Administrative Services. Under agreements in place since the
Initial Public Offering, ITT periodically provides advice and assistance to the
Company with regard to certain risk management, accounting, tax and other
management services. The fee for such services (the "contract service charge")
is 0.25% of the Company's annual revenues. For 1997, the contract service charge
was $654,000. The Company ceased utilizing substantially all of these services
at the time of the Merger.
Pension Plan. The Company participates in the Retirement Plan for Salaried
Employees of ITT Corporation (the "Pension Plan"), a non-contributory defined
benefit pension plan which covers substantially all employees of the Company.
ITT determines the aggregate amount of pension expense on a consolidated basis
based on actuarial calculations, and such expense is allocated to participating
units on the basis of compensation covered by the plan. Prior to December 19,
1995, the Company participated in the Retirement Plan for Salaried Employees of
Old ITT (the "Old Pension Plan"), which was substantially identical to the terms
of the Pension Plan. For 1997, pension expense as a percentage of covered
compensation for employees over age 21 who had more than one year of service was
6.84%, which resulted in charges to the Company of $4,458,000. Federal
legislation limits the amount of benefits that can be paid and compensation that
may be recognized under a tax-qualified retirement plan. ITT has adopted a
non-qualified unfunded retirement plan ("Excess Pension Plan") for payment of
those benefits at retirement that cannot be paid from the qualified
54
<PAGE> 56
Pension Plan. The practical effect of the Excess Pension Plan is to continue
calculation of retirement benefits to all employees on a uniform basis. Benefits
for the Company's employees under the Excess Pension Plan will generally be paid
directly by the Company. Any "excess" benefit accrued to any such employee will
be immediately payable in the form of a single discounted lump sum payment upon
the occurrence of a change in corporate control (as defined in the Excess
Pension Plan). The approval by ITT's shareholders of the Merger between ITT and
Starwood, Inc. constituted a change in corporate control as defined in the
Excess Pension Plan, which resulted in a distribution of all of the accrued
benefits under the Excess Pension Plan to the participants. After the Offering,
the Company will implement its own pension and excess pension plans.
Retirement Savings Plan. The Company participates in The ITT 401k
Retirement Savings Plan (the "Savings Plan"), a defined contribution pension
plan which covers substantially all employees of the Company. Employees can
contribute (subject to certain Internal Revenue Service limitations) amounts
ranging from 2% to 16% of base pay. The Company contributes 1% of the employee's
covered pay and matches the employee's contributions at the rate of 50% up to a
maximum of 5% of covered pay, amounting to a maximum matching contribution of
2.5% of the employee's covered pay. The Company's non-matching and matching
contributions were, prior to the Merger, in the form of common shares of ITT and
are, since the Merger, in the form of paired shares of Starwood, Inc. common
stock and Starwood Trust beneficial interest. Federal legislation limits the
annual contributions which an employee may make to the Savings Plan, a tax-
qualified retirement plan. Accordingly, ITT adopted, and the Company
participated in, prior to the Merger, an ITT Excess Savings Plan (the "Excess
Savings Plan"), a non-qualified retirement plan, which enables employees who are
precluded by these limitations from contributing 5% of their salary to the
tax-qualified plan to make up the shortfall through salary deferrals and,
thereby, receive the 1% non-matching company contribution and the 2.5% matching
company contribution otherwise allowable under the tax-qualified plan. Salary
deferrals, company contributions and imputed earnings are entered into a book
reserve account maintained by ITT for each participant. The costs of the
Company's non-matching and matching contributions are charged by ITT to the
Company. For 1997, the costs of providing this benefit (including an allocation
of the administrative costs of the plan) were $2,104,000. The Company has
adopted its own 401(k) and excess savings plans that will become effective on
the closing of the Offering.
Group Medical and Life Benefits. During 1997, the Company's employees were
provided certain medical benefits and life insurance through ITT. In 1998, the
Company began providing all of its own medical and life insurance benefits to
its employees, but the Company continues to utilize ITT's services in the
administration of the Company's indemnity medical plan. The Company is
responsible for all claims incurred under its indemnity plan, subject to stop
loss coverage for individual medical claims greater than $50,000, for which the
Company pays an allocated share of all claims in excess of $50,000 for all ITT
subsidiaries in the United States. The Company also pays its share of the
administrative and stop loss pooling expenses incurred by ITT with respect to
these services. For 1997, payments by the Company to ITT for medical and life
insurance claims totaled $1,783,000.
Worker's Compensation and General Liability. The Company is self-insured
with respect to worker's compensation and general liability. The Company
participates in the ITT claims program which provides stop loss protection for
claims greater than $100,000. Amounts equal to actual claims applicable to the
Company under $100,000 plus an allocation of the estimated total ITT claims in
excess of $100,000 are paid to ITT. For 1997, payments by the Company for
worker's compensation and general liability claims were $1,074,000. After the
Offering, the Company will service its own claims and obtain similar stop loss
protection.
Federal Income Taxes. Prior to the Offering, the Company has been included
in the consolidated U.S. federal income tax return of ITT. Under an agreement
with ITT, income taxes are allocated among affiliates of ITT based upon the
amounts they would pay or receive if they filed a separate income tax return.
For 1997, the Company's allocated federal income taxes were $10,399,000. After
the Offering, the Company will no longer be included in the consolidated return
of ITT.
55
<PAGE> 57
AGREEMENTS WITH SELLING STOCKHOLDER
In connection with the Offering, the Company contemplates entering into
several new agreements with ITT or its affiliates. These agreements are expected
to include a new registration rights agreement, trade name and service mark
license agreement, tax sharing agreement, stockholder agreement and employee
benefits agreement.
The registration rights agreement will govern ITT's rights to require
registration of the shares of Common Stock held by ITT or its transferees after
the Offering. The trade name and service mark license agreement will govern the
Company's use of the "ITT" name after the Offering and the tax sharing agreement
will allocate tax liabilities and filing and other responsibilities between the
Company and ITT.
It is anticipated that the stockholder agreement will cover, among other
things, such matters as the size of the Company's Board of Directors, the
representation of ITT and its affiliates (the "ITT Group") on the Company's
Board and the nominating committee, limitations on the Company's ability to
restrict the transferability or voting rights of the Common Stock held by the
ITT Group or its transferees and certain indemnification obligations. The
employee benefits agreement is expected to provide for the allocation and
assignment of the respective rights and obligations of the Company and ITT
before and after the Offering with respect to employee benefit and welfare plans
for current and former employees of the Company.
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 50,000,000 shares of
Common Stock and 5,000,000 shares of preferred stock, $.01 par value (the
"Preferred Stock"). As of March 31, 1998, 26,999,952 shares of Common Stock
(including the shares of Common Stock being offered by the Selling Stockholder)
were outstanding. No shares of Preferred Stock have been issued.
COMMON STOCK
All outstanding shares of the Common Stock are validly issued, fully paid
and non-assessable. Each outstanding share of Common Stock is entitled to such
dividends as may be declared from time to time by the Company's Board of
Directors consistent with the provisions of the Company's Restated Certificate
of Incorporation, By-Laws and applicable law. See "Dividend Policy." Each
outstanding share is entitled to one vote on all matters submitted to a vote of
stockholders. There are no cumulative voting rights, and therefore, the holders
of a majority of the shares voting for the election of the classified Board of
Directors can elect all of the Directors in any class up for election, if they
so choose. In the event of liquidation, dissolution or winding up of the
Company, holders of Common Stock are entitled to receive on a pro rata basis any
assets remaining after provision for payment of creditors and after payment of
any liquidation preferences to holders of Preferred Stock. Holders of Common
Stock have no conversion rights or preemptive rights to purchase or subscribe
for additional Common Stock or any other securities of the Company. The rights,
preferences and privileges of holders of shares of Common Stock are subject to,
and may be adversely affected by, the rights of the holders of shares of any
series of Preferred Stock the Company may designate and issue in the future.
PREFERRED STOCK
The authorized Preferred Stock of the Company is available for issuance
from time to time at the discretion of the Board of Directors of the Company
without stockholder approval. The Board of Directors has the authority to
prescribe for each series of Preferred Stock it establishes the number of shares
in that series, the consideration (not less than its par value) for such shares
in that series and the designations, powers, preferences and relative,
participating, optional or other special rights, and the qualifications,
limitations or restrictions thereof. Depending upon the rights of such Preferred
Stock, the issuance of Preferred Stock could have an adverse effect on holders
of Common Stock by delaying or preventing a change in control of the Company,
making removal of the present management of the Company more difficult or
resulting in restrictions upon the payment of dividends and other distributions
to the holders of Common Stock. The Company currently has no intention to issue
any shares of any class or series of its Preferred Stock.
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<PAGE> 58
CERTAIN EFFECTS OF AUTHORIZED BUT UNISSUED STOCK
Immediately after the Offering, there will continue to be approximately
23,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock
available for future issuance. Delaware law does not require stockholder
approval for any issuance of authorized shares. However, the listing
requirements of the NYSE, which would apply so long as the Common Stock remained
listed on the NYSE, require stockholder approval of certain issuances equal to
or exceeding 20% of the then-outstanding voting power of the Company. These
additional shares may be used for a variety of corporate purposes, including
future public offerings to raise additional capital or to facilitate corporate
acquisitions. The Company currently does not have any plans to issue additional
shares of Common Stock or Preferred Stock.
If the Company did not have a controlling stockholder, one of the effects
of the existence of unissued and unreserved Common Stock and Preferred Stock may
be to enable the Board of Directors to issue shares to persons friendly to
current management, which issuance could render more difficult or discourage an
attempt to obtain control of the Company by means of a merger, tender offer,
proxy contest or otherwise, and thereby protect the continuity of the Company's
management and possibly deprive the stockholders of opportunities to sell their
shares of Common Stock at prices higher than prevailing market prices. Such
additional shares also could be used to dilute the stock ownership of persons
seeking to obtain control of the Company pursuant to the operation of a
stockholders' rights plan or otherwise.
PROVISIONS OF RESTATED CERTIFICATE OF INCORPORATION AND BY-LAWS AFFECTING CHANGE
IN CONTROL
The Restated Certificate of Incorporation and By-Laws provide that the
Board of Directors will be divided into three classes of directors, each class
to be as nearly equal in number as possible. The term of office of one class of
directors expires each year in rotation so that one class is elected at each
annual meeting of stockholders for a full three-year term. Under Delaware law,
members of a classified Board of Directors can be removed by stockholders only
for "cause" unless a corporation's certificate of incorporation provides
otherwise. The Company's Restated Certificate of Incorporation does not provide
for removal without cause. The Restated Certificate of Incorporation provides
that the Board of Directors shall consist of not less than three nor more than
20 members. The number of directors will be fixed from time to time by
resolution of the Board of Directors. The affirmative vote of the holders of a
majority of the outstanding shares of capital stock of the Company entitled to
vote is required to amend, alter, change or repeal the classified board of
directors provisions of the Restated Certificate of Incorporation or to remove a
director with cause prior to the expiration of his or her term. Under the
classified board of directors provisions described above, it would take at least
two elections of directors for any individual or group to gain control of the
Board of Directors. Accordingly, these provisions would tend to discourage
unfriendly takeovers.
The Company's By-Laws also contain provisions that may limit or restrict
the ability of stockholders to effect changes in control. Under the Company's
By-Laws, stockholders do not have the right to call special meetings of
stockholders. In addition, stockholders must comply with the advance notice
provisions of the Company's By-Laws to make nominations for members of the Board
of Directors and to submit matters for a vote at meetings of stockholders.
DELAWARE GENERAL CORPORATION LAW
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"). In general, Section 203 provides that a corporation may not
engage in a "business combination" with an "interested stockholder" for a period
of three years from the date that such person became an interested stockholder
unless (a) the transaction that results in the person's becoming an interested
stockholder, or the business combination, is approved by the board of directors
of the corporation before the person becomes an interested stockholder, (b) upon
consummation of the transaction which results in the stockholder becoming an
interested stockholder, the interested stockholder owns 85% or more of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding shares owned by persons who are directors and officers, and
shares owned by employee stock plans or (c) on or after the date the person
becomes an interested stockholder, the business combination is approved by the
corporation's board of directors and by
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<PAGE> 59
holders of at least two-thirds of the corporation's outstanding voting stock,
excluding shares owned by the interested stockholder, at a meeting of
stockholders. Under Section 203, an "interested stockholder" is defined as any
person, other than the corporation and any direct or indirect majority-owned
subsidiaries, that is (a) the owner of 15% or more of the outstanding voting
stock of the corporation or (b) an affiliate or associate of the corporation and
the owner of 15% or more of the outstanding voting stock of the corporation at
any time within the three-year period immediately prior to the date on which it
is sought to be determined whether such person is an interested stockholder or
(c) an affiliate or associate of such person. Section 203 defines a "business
combination" to include, without limitation, mergers, consolidations, stock
sales and asset based transactions and other transactions resulting in a
financial benefit to the interested stockholder.
Under certain circumstances, Section 203 makes it more difficult for a
person who would be an "interested stockholder" to effect various business
combinations with a corporation for a three-year period, although the
stockholders may elect to exclude a corporation from the restrictions imposed
thereunder. The Company's Restated Certificate of Incorporation does not exclude
the Company from the restrictions imposed under Section 203. The provisions of
Section 203 may encourage companies interested in acquiring the Company to
negotiate in advance with the Company's Board of Directors, because the
stockholder approval requirement would be avoided if a majority of the directors
then in office approve either the business combination or the transaction which
results in the stockholder becoming an interested stockholder. Such provisions
also may have the effect of preventing changes in the management of the Company.
It is possible that such provisions could make it more difficult to accomplish
transactions which stockholders may otherwise deem to be in their best
interests.
Section 203 excludes from the definition of "interested stockholder" any
stockholder of the Company that owned over 15% of the Company's outstanding
voting stock on December 23, 1987, so long as such holder continues to own over
15% of outstanding voting stock of the Company. Accordingly, ITT is not subject
to the restrictions of Section 203.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar of the Company's Common Stock is The Bank
of New York.
SHARES ELIGIBLE FOR FUTURE SALE
No predictions can be made as to the effect, if any, that future sales of
shares of Common Stock, or the availability of shares of Common Stock for future
sale, will have on the market price of the Common Stock prevailing from time to
time. Sales of substantial amounts of the Common Stock in the public market
following the Offering, or the perception that such sales could occur, could
adversely affect the market price of the Common Stock and may make it more
difficult for the Company to sell its equity securities in the future at a time
and price which it deems appropriate.
Immediately after the Offering, the Company will continue to have
outstanding 26,999,952 shares of Common Stock. The Shares sold in the Offering
will be freely tradeable without restriction or further registration under the
Securities Act except for any of those Shares that are beneficially owned at any
time by an "affiliate" of the Company (an "Affiliate") within the meaning of
Rule 144 under the Securities Act (which sales will be subject to the timing,
volume and manner of sale limitations of Rule 144). The 11,500,000 outstanding
shares of Common Stock held by the Selling Stockholder after the Offering
(9,850,000 shares if the over-allotment option is exercised in full) are
"restricted" securities within the meaning of Rule 144 under the Securities Act
and may not be publicly resold, except in compliance with the registration
requirements of the Securities Act or pursuant to an exemption from
registration, including that provided by Rule 144 under the Securities Act. The
Selling Stockholder has certain registration rights with respect to the shares
of Common Stock owned by it. See "Relationship with Selling Stockholder and
Related Transactions."
In general, under Rule 144 as currently in effect, if one year has elapsed
since the date of acquisition of beneficial ownership of restricted shares of
Common Stock from the Company or any Affiliate, the acquiror or subsequent
holder thereof is entitled to sell within any three-month period a number of
such shares that does
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<PAGE> 60
not exceed the greater of 1% of the then outstanding shares of Common Stock or
the reported average weekly trading volume of the Common Stock on national
securities exchanges during the four calendar weeks preceding such sale. Sales
under Rule 144 are also subject to certain provisions regarding the manner of
sale, notice requirements and the availability of current public information
about the Company. If two years have elapsed since the date of acquisition of
restricted shares of Common Stock from the Company or any affiliate and the
acquiror or subsequent holder is not deemed to have been an Affiliate of the
Company for at least 90 days prior to a proposed transaction, such person would
be entitled to sell such shares under Rule 144 without regard to the limitations
described above.
The Company, its executive officers, ITT and Starwood, Inc. have agreed
that they will not offer, sell, contract to sell, announce the intention to
sell, pledge or otherwise dispose of, directly or indirectly, or file with the
Commission a registration statement under the Securities Act relating to, any
shares of Common Stock or securities or other rights convertible into or
exchangeable or exercisable for any shares of Common Stock, without the prior
written consent of Credit Suisse First Boston Corporation, for a period of 180
days after the date of this Prospectus; provided, however, that such
restrictions will not affect the ability of the Company to grant options for
Common Stock pursuant to the Stock Plans, or to issue Common Stock pursuant to
the exercise of stock options currently outstanding or granted pursuant to the
Stock Plans.
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<PAGE> 61
UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated , 1998 (the "Underwriting Agreement"), the
underwriters named below (the "Underwriters"), for whom Credit Suisse First
Boston Corporation, Bear, Stearns & Co. Inc., BT Alex. Brown Incorporated,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co.
Incorporated are acting as the representatives (the "Representatives"), have
severally but not jointly agreed to purchase from the Selling Stockholder the
following respective numbers of shares of Common Stock:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation......................
Bear, Stearns & Co. Inc. ...................................
BT Alex. Brown Incorporated.................................
Merrill Lynch, Pierce, Fenner & Smith.......................
Incorporated
Morgan Stanley & Co. Incorporated...........................
----------
Total.................................................. 11,000,000
==========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all the shares of Common Stock
offered hereby (other than those shares covered by the over-allotment option
described below) if any are purchased. The Underwriting Agreement provides that,
in the event of a default by an Underwriter, in certain circumstances the
purchase commitments of nondefaulting Underwriters may be increased or the
Underwriting Agreement may be terminated.
The Selling Stockholder has granted to the Underwriters an option, expiring
at the close of business on the 30th day after the date of this Prospectus, to
purchase up to 1,650,000 additional shares from the Selling Stockholder at the
public offering price, less the underwriting discounts and commissions, all as
set forth on the cover page of this Prospectus. Such option may be exercised
only to cover over-allotments in the sale of the shares of Common Stock offered
hereby. To the extent such option is exercised, each Underwriter will become
obligated, subject to certain conditions, to purchase approximately the same
percentage of such additional shares of Common Stock as it was obligated to
purchase pursuant to the Underwriting Agreement.
The Company and the Selling Stockholder have been advised by the
Representatives that the Underwriters propose to offer shares of Common Stock to
the public initially at the public offering price set forth on the cover page of
this Prospectus and, through the Representatives, to certain dealers at such
price less a concession of $ per share, and the Underwriters and such
dealers may allow a discount of $ per share on sales to certain other
dealers. After the initial public offering, the public offering price and
concession and discount to dealers may be changed by the Representatives.
At the request of the Company, the Underwriters are reserving shares of
Common Stock from the Offering for sale to certain persons identified by the
Company. Any sales to such persons will be at the public offering price. Any
shares of Common Stock not purchased in this reserve program will be sold to the
general public in the Offering.
The Company, its executive officers, ITT and Starwood, Inc. have agreed
that they will not offer, sell, contract to sell, announce an intention to sell,
pledge or otherwise dispose of, directly or indirectly, or file with the
Commission a registration statement under the Securities Act relating to, any
shares of Common Stock or securities or other rights convertible into or
exchangeable or exercisable for any shares of Common Stock, without the prior
written consent of Credit Suisse First Boston Corporation, for a period of 180
days after the date of this Prospectus; provided, however, that such
restrictions will not affect the ability of the Company to
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<PAGE> 62
grant options for Common Stock pursuant to the Stock Plans or to issue Common
Stock, pursuant to the exercise of stock options currently outstanding or
granted pursuant to the Stock Plans.
The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including civil liabilities under the
Securities Act, or contribute to payments that the Underwriters may be required
to make in respect thereof.
The Common Stock is listed on the NYSE under the symbol "ESI."
The Representatives, on behalf of the Underwriters, may engage in
over-allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act.
Over-allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase shares of Common Stock so long as the stabilizing bids do not exceed a
specified maximum. Syndicate covering transactions involve purchases of shares
of Common Stock in the open market after the distribution has been completed in
order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when the
shares of Common Stock originally sold by such syndicate member are purchased in
a syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions and penalty bids may
cause the price of the shares of Common Stock to be higher than it would
otherwise be in the absence of such transactions. These transactions may be
effected on the NYSE or otherwise and, if commenced, may be discontinued at any
time.
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the Common Stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company and the
Selling Stockholder prepare and file a prospectus with the securities regulatory
authorities in each province where trades of the Common Stock are effected.
Accordingly, any resale of the Common Stock in Canada must be made in accordance
with applicable securities laws which will vary depending on the relevant
jurisdiction, and which may require resales to be made in accordance with
available statutory exemptions or pursuant to a discretionary exemption granted
by the applicable Canadian securities regulatory authority. Purchasers are
advised to seek legal advice prior to any resale of the Common Stock.
REPRESENTATIONS OF PURCHASERS
Each purchaser of Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company, the Selling Stockholder
and the dealer from whom such purchase confirmation is received that (a) such
purchaser is entitled under applicable provincial securities laws to purchase
such Common Stock without the benefit of a prospectus qualified under such
securities laws, (b) where required by law, that such purchaser is purchasing as
principal and not as agent, and (c) such purchaser has reviewed the text above
under "Resale Restrictions."
RIGHTS OF ACTION (ONTARIO PURCHASERS)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available, including
common law rights of action for damages or rescission of rights of action under
the civil liability provisions of the U.S. federal securities laws.
ENFORCEMENT OF LEGAL RIGHTS
All of the issuer's directors and officers as well as the experts named
herein and the Selling Stockholder may be located outside of Canada and, as a
result, it may not be possible for Canadian purchasers to effect
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<PAGE> 63
service of process within Canada upon the issuer, such persons or the Selling
Stockholder. All or a substantial portion of the assets of the issuer, such
persons and the Selling Stockholder may be located outside of Canada and, as a
result, it may not be possible to satisfy a judgment against the issuer, such
persons or the Selling Stockholder in Canada or to enforce a judgment obtained
in Canadian courts against the issuer, such persons or the Selling Stockholder
outside of Canada.
NOTICE TO BRITISH COLUMBIA RESIDENTS
A purchaser of Common Stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
Common Stock acquired by such purchaser pursuant to the Offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of Common Stock acquired on the same date
and under the same prospectus exemption.
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of Common Stock should consult their own legal and tax
advisers with respect to the tax consequences of an investment in the Common
Stock in their particular circumstances and with respect to the eligibility of
the Common Stock for investment by the purchaser under relevant Canadian
legislation.
CERTAIN U.S. FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
The following is a general discussion of certain United States ("U.S.")
federal income and estate tax consequences of the ownership and disposition of
Common Stock applicable to a beneficial owner thereof that is a "Non-U.S.
Holder." As used herein, the term "Non-U.S. Holder" means a person or entity
other than (a) a citizen or individual resident of the United States, (b) a
corporation or partnership created or organized in or under the laws of the
United States or any political subdivision thereof, (c) an estate the income of
which is subject to U.S. federal income tax regardless of its source, or (d) in
general, a trust if (i) a court within the United States is able to exercise
primary supervision over the administration of the trust and (ii) one or more
United States persons have the authority to control all substantial decisions of
the trust.
This discussion is based on the Internal Revenue Code of 1986, as amended
(the "Code"), existing and proposed regulations promulgated thereunder and
administrative and judicial interpretations thereof, all as of the date hereof,
and all of which are subject to change, possibly with retroactive effect. This
discussion does not address all aspects of U.S. federal income and estate
taxation that may be important to Non-U.S. Holders in light of their particular
circumstances (including tax consequences applicable to certain former citizens
or long-term residents of the United States and to certain Non-U.S. Holders that
are, or hold interests in Common Stock through, partnerships or other fiscally
transparent entities, including "hybrid entities") and does not address United
States state and local or non-United States tax consequences. PROSPECTIVE
NON-U.S. HOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE
PARTICULAR UNITED STATES FEDERAL INCOME AND ESTATE TAX CONSEQUENCES TO THEM OF
OWNING AND DISPOSING OF COMMON STOCK, AS WELL AS THE TAX CONSEQUENCES ARISING
UNDER THE LAWS OF ANY OTHER TAXING JURISDICTION.
DIVIDENDS
The Company anticipates that it will not pay dividends on shares of Common
Stock for the foreseeable future. See "Dividend Policy." In the event, however,
that the Company does pay dividends on shares of Common Stock, a Non-U.S. Holder
of Common Stock generally will be subject to withholding of U.S. federal income
tax at a rate of 30% of the gross amount of the dividend, or such lower rate as
may be specified by an income tax treaty between the United States and a foreign
country of which the Non-U.S. Holder is treated as a resident within the meaning
of the applicable tax treaty. Under currently effective United States treasury
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regulations, dividends paid to an address in a foreign country are presumed to
be paid to a resident of that country for purposes of the withholding discussed
above (unless the payor has knowledge to the contrary), and, under the current
interpretation of United States Treasury regulations, for purposes of
determining the applicability of a lower rate of withholding tax provided by a
tax treaty. Under United States Treasury regulations published on October 14,
1997, as modified by IRS Notice 98-16 released on March 27, 1998 (the "New
Withholding Regulations"), a Non-U.S. Holder of Common Stock who wishes to claim
the benefit of an applicable treaty rate (and avoid backup withholding as
discussed below) generally will be required to satisfy specified certification
and other requirements with respect to dividends paid after December 31, 1999
(and, in certain circumstances, may be required to satisfy such certification
and other requirements with respect to dividends paid after December 31, 1998).
In addition, the New Withholding Regulations contain special rules regarding the
availability of treaty benefits for payments made to (a) foreign intermediaries,
(b) U.S. or foreign wholly-owned entities that are disregarded for U.S. federal
income tax purposes and (c) partnerships and other entities that are treated as
fiscally transparent in the United States, the applicable income tax treaty
jurisdiction, or both. Prospective investors should consult their own tax
advisors as to the effect, if any, of the New Withholding Regulations on an
investment in the Common Stock.
Dividends paid to a Non-U.S. Holder that are either (a) effectively
connected with the Non-U.S. Holder's conduct of a trade or business within the
United States or (b) if a tax treaty applies, attributable to a permanent
establishment maintained by the Non-U.S. Holder, will not be subject to the
withholding tax (provided in either case the Non-U.S. Holder files the
appropriate documentation with the Company or its agent), but, instead, will be
subject to regular U.S. federal income tax at the graduated rates in the same
manner as if the Non-U.S. Holder were a U.S. resident. In addition to such
graduated tax, in the case of a Non-U.S. Holder that is a corporation,
effectively connected dividends or, if a tax treaty applies, dividends
attributable to a U.S. permanent establishment of the corporate Non-U.S. Holder,
may be subject to a "branch profits tax" which is imposed, under certain
circumstances, at a rate of 30% (or such lower rate as may be specified by an
applicable tax treaty) of the non-U.S. corporation's "effectively connected
earnings and profits," subject to certain adjustments.
A Non-U.S. Holder of Common Stock that is eligible for a reduced rate of
United States withholding tax pursuant to a tax treaty may obtain a refund of
any excess amounts withheld by filing a timely claim for refund with the
Internal Revenue Service.
GAIN ON DISPOSITION OF COMMON STOCK
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain recognized on a sale or other taxable disposition of Common
Stock unless (a) the gain is effectively connected with a trade or business of
the Non-U.S. Holder in the United States or, if a tax treaty applies,
attributable to a United States permanent establishment of the Non-U.S. Holder,
(b) in the case of a Non-U.S. Holder who is a nonresident alien individual and
holds the Common Stock as a capital asset, such individual is present in the
United States for 183 or more days in the taxable year of the sale or other
disposition and certain other conditions are met, or (c) the Company is or has
been a "U.S. real property holding corporation" for United States federal income
tax purposes at any time within the shorter of the five-year period preceding
such disposition or the period such Non-U.S. Holder held the Common Stock. A
corporation is a "U.S. real property holding corporation" if the fair market
value of the United States real property interests held by the corporation is
50% or more of the aggregate fair market value of certain assets of the
corporation. The Company believes that it is not, has not been, and does not
anticipate becoming, a "U.S. real property holding corporation." If the Company
were, or were to become, a U.S. real property holding corporation, so long as
the Common Stock is "regularly traded" on an established securities market
within the meaning of the Code, only a Non-U.S. Holder that owns, directly or
pursuant to certain attribution rules, more than 5% of the Common Stock (at any
time during the shorter of the periods described above) will be subject to U.S.
federal income tax on the sale or other disposition of the Common Stock.
If an individual Non-U.S. Holder is described in clause (a) above, he or
she will be taxed on the net gain derived from the sale or other disposition at
regular graduated U.S. federal income tax rates. If an individual Non-U.S.
Holder falls under clause (b) above, he or she will be subject to a flat 30% tax
on the gain derived
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from the sale or other disposition, which may be offset by certain U.S.-source
capital losses (notwithstanding the fact that such individual is not considered
a resident of the United States). If a Non-U.S. Holder that is a corporation
falls under clause (a) above, it will be taxed on its net gain derived from the
sale or other disposition at regular graduated U.S. federal income tax rates and
may be subject to an additional branch profits tax at a rate of 30% (or such
lower rate as may be specified by an applicable tax treaty) on the non-U.S.
corporation's "effectively connected earnings and profits," subject to certain
adjustments.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
Generally, the Company must report annually to the Internal Revenue Service
the amount of dividends paid to a Non-U.S. Holder and the amount, if any, of tax
withheld with respect to, such Non-U.S. Holder. A similar report is sent to the
Non-U.S. Holder. Pursuant to tax treaties or certain other agreements, the
Internal Revenue Service ("IRS") may make its reports available to tax
authorities in the recipient's country of residence.
Currently, United States backup withholding tax (which generally is a
withholding tax imposed at a rate of 31% on certain payments to persons that
fail to furnish the information required under the United States information
reporting requirements) will generally not apply to dividends paid on Common
Stock to a Non-U.S. Holder at an address outside the United States, unless the
payor has actual knowledge that the payee is a U.S. Holder. Backup withholding
tax generally will apply to dividends paid on Common Stock at addresses inside
the United States to Non-U.S. Holders who fail to provide certain identifying
information in the manner required.
In addition, information reporting and backup withholding imposed at a rate
of 31% will apply to the proceeds of a disposition of Common Stock paid to or
through a U.S. office of a broker unless the disposing holder, under penalties
of perjury, certifies as to its non-U.S. status or otherwise establishes an
exemption. Generally, U.S. information reporting and backup withholding will not
currently apply to a payment of disposition proceeds if the payment is made
outside the United States through a non-U.S. office of a non-U.S. broker.
However, U.S. information reporting requirements (but not backup withholding)
will apply to a payment of disposition proceeds outside the United States if the
payment is made through an office outside the United States of a broker that is
(a) a U.S. person, (b) a foreign person that derives 50% or more of its gross
income for certain periods from the conduct of a trade or business in the United
States or (c) a "controlled foreign corporation" for U.S. federal income tax
purposes, unless the broker maintains documentary evidence that the holder is a
Non-U.S. Holder and certain other conditions are met, or the holder otherwise
establishes an exemption.
Under the New Withholding Regulations, which generally are effective for
payments made after December 31, 1999 (but which, in certain circumstances, may
apply to payments made after December 31, 1998), the payment of dividends, and
the payment of proceeds from the disposition of Common Stock through brokers
having certain connections with the United States, may be subject to information
reporting and backup withholding at a rate of 31% unless certain IRS
certification requirements are satisfied or an exemption is otherwise
established. Prospective investors should consult with their own tax advisers
regarding the application of the New Withholding Regulations to their particular
circumstances.
Backup withholding is not an additional tax. Rather, the tax liability of
persons subject to backup withholding will be reduced by a credit for the amount
of tax withheld. If withholding results in an overpayment of taxes, a refund may
be obtained, provided that the required information is furnished to the Internal
Revenue Service.
FEDERAL ESTATE TAX
Shares of Common Stock owned or treated as owned by an individual who is
not a citizen or resident of the United States at the time of his or her death
will be includible in the individual's gross estate for United States federal
estate tax purposes, unless an applicable tax treaty provides otherwise, and may
be subject to United States federal estate tax. Estates of non-resident aliens
are generally allowed a statutory credit which
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has the effect of offsetting the United States federal estate tax imposed on the
first $60,000 of the taxable estate.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Baker & Daniels, Indianapolis, Indiana. Certain legal matters
relating to the Offering will be passed upon for the Underwriters by Dewey
Ballantine LLP, New York, New York.
EXPERTS
The financial statements of the Company as of December 31, 1997 and 1996
and for each of the three years in the period ended December 31, 1997 included
in this Prospectus have been so included in reliance on the report of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in accounting and auditing.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants........................... F-2
Statements of Income and Retained Earnings for the years
ended December 31, 1997, December 31, 1996 and December
31, 1995.................................................. F-3
Balance Sheets as of December 31, 1997 and December 31,
1996...................................................... F-4
Statements of Cash Flows for years ended December 31, 1997,
December 31, 1996 and December 31, 1995................... F-5
Notes to Financial Statements............................... F-6
</TABLE>
F-1
<PAGE> 68
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of ITT Educational Services, Inc.
In our opinion, the accompanying balance sheets and the related statements
of income and retained earnings and of cash flows present fairly, in all
material respects, the financial position of ITT Educational Services, Inc. at
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Indianapolis, Indiana
January 10, 1998, except for
Notes 1, 3 and 10 which are
as of April 7, 1998
F-2
<PAGE> 69
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF INCOME AND RETAINED EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES
Tuition.................................................... $222,457 $196,692 $171,936
Other educational.......................................... 39,207 35,627 29,895
-------- -------- --------
Total revenues................................... 261,664 232,319 201,831
COSTS AND EXPENSES
Cost of educational services............................... 163,053 145,197 130,338
Student services and administrative expenses............... 72,388 66,546 57,268
-------- -------- --------
Total costs and expenses......................... 235,441 211,743 187,606
Operating income........................................... 26,223 20,576 14,225
Interest income, net....................................... 5,565 4,119 4,802
-------- -------- --------
Income before income taxes................................. 31,788 24,695 19,027
Income taxes............................................... 12,665 9,844 7,636
-------- -------- --------
Net income................................................. 19,123 14,851 11,391
Retained earnings, beginning of period..................... 35,909 21,058 9,667
-------- -------- --------
Retained earnings, end of period........................... $ 55,032 $ 35,909 $ 21,058
======== ======== ========
Earnings per common share (basic and diluted).............. $ .71 $ .55 $ .42
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 70
ITT EDUCATIONAL SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Current assets
Cash...................................................... $ 29 $ 74
Restricted cash........................................... 3,860 5,911
Cash invested with ITT Corporation........................ 94,800 89,808
Accounts receivable, less allowance for doubtful accounts
of $1,393 and $1,044................................... 9,680 9,378
Deferred income tax....................................... 2,019 1,455
Prepaids and other current assets......................... 2,570 1,823
-------- --------
Total current assets.............................. 112,958 108,449
Property and equipment, net................................. 22,886 19,360
Direct marketing costs...................................... 6,882 5,774
Other assets................................................ 3,188 2,166
-------- --------
Total assets...................................... $145,914 $135,749
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 14,974 $ 12,188
Accrued compensation and benefits......................... 3,245 4,253
Other accrued liabilities................................. 6,877 5,432
Deferred tuition revenue.................................. 30,850 43,532
-------- --------
Total current liabilities......................... 55,946 65,405
Other liabilities........................................... 2,153 1,652
-------- --------
Total liabilities................................. 58,099 67,057
-------- --------
Commitments and contingent liabilities (Note 10)
Shareholders' equity
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued or outstanding................. -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 26,999,952 issued and outstanding.......... 270 270
Capital surplus........................................... 32,513 32,513
Retained earnings......................................... 55,032 35,909
-------- --------
Total shareholders' equity........................ 87,815 68,692
-------- --------
Total liabilities and shareholders' equity........ $145,914 $135,749
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 71
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................. $ 19,123 $ 14,851 $ 11,391
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization......................... 7,939 7,493 7,542
Provision for doubtful accounts....................... 2,354 1,738 1,173
Deferred taxes........................................ 202 (443) (240)
Increase/decrease in operating assets and liabilities:
Accounts receivable................................. (2,656) (3,524) (2,189)
Direct marketing costs.............................. (1,108) (743) 23
Accounts payable and accrued liabilities............ 2,958 3,083 1,438
Prepaids and other assets........................... (1,769) 220 683
Deferred tuition revenue............................ (12,682) 3,469 (908)
-------- -------- --------
Net cash provided by operating activities.................. 14,361 26,144 18,913
-------- -------- --------
Cash flows used for investing activities:
Capital expenditures, net................................ (11,465) (7,868) (8,206)
Net increase in cash invested with ITT Corporation....... (4,992) (17,923) (15,975)
-------- -------- --------
Net cash used for investing activities..................... (16,457) (25,791) (24,181)
-------- -------- --------
Net increase (decrease) in cash and restricted cash........ (2,096) 353 (5,268)
Cash and restricted cash at beginning of period............ 5,985 5,632 10,900
-------- -------- --------
Cash and restricted cash at end of period.................. $ 3,889 $ 5,985 $ 5,632
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes.......................................... $ 12,352 $ 10,051 $ 8,168
Interest.............................................. 291 273 550
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 72
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)
1. OWNERSHIP AND CHANGE IN CONTROL
Since the ITT Educational Services, Inc. (the "Company") initial public
offering in 1994, 83.3% of the outstanding Common Stock of the Company has been
owned by ITT Corporation ("ITT") and 16.7% has been owned by others.
On February 23, 1998, Starwood Hotels & Resorts Worldwide, Inc. ("Starwood,
Inc.") completed the acquisition ("the Merger") of ITT and ITT became a
subsidiary of Starwood, Inc. As a result of the Merger, each ITT Technical
Institute campus group became ineligible to participate in federal financial aid
programs. Effective March 20, 1998, the eligibility of each ITT Technical campus
group to participate in federal student financial aid programs was reinstated by
the U.S. Department of Education ("DOE") with certain conditions imposed by the
DOE. The Company believes that it is in compliance with or satisfies these DOE
conditions.
2. SUMMARY OF ACCOUNTING PRINCIPLES AND POLICIES
Business Activities. The Company is a leading proprietary postsecondary
education system primarily offering career-focused, technical degree programs of
study. At December 31, 1997, the Company operated sixty-two (62) technical
institutes throughout the United States. The Company maintains corporate
headquarters in Indianapolis, Indiana.
Use of Estimates. The preparation of these financial statements, in
conformity with generally accepted accounting principles, includes estimates
that are determined by the Company's management.
Property and Equipment. The Company includes all property and equipment in
the financial statements at cost. Provisions for depreciation of property and
equipment have generally been made using the straight-line method for financial
reporting purposes and accelerated methods for tax purposes. Estimated useful
lives generally range from three to ten years for furniture and equipment and
leasehold improvements. Maintenance, repairs and renewals not of a capital
nature are expensed as incurred. Fully depreciated assets no longer in use are
removed from both the asset and accumulated depreciation accounts in the year of
their retirement. Any gains or losses on dispositions are credited or charged to
income, as appropriate.
Fair Value of Financial Instruments. The carrying amounts reported in the
balance sheets for cash, restricted cash, cash invested with ITT Corporation,
accounts receivable, accounts payable, other accrued liabilities and deferred
tuition revenue approximate fair value because of the immediate or short-term
maturity of these financial instruments.
Recognition of Revenues. Tuition revenue is recorded on a straight-line
basis over the length of the applicable course. If a student discontinues
training, the revenue related to the remainder of that quarter is recorded with
the amount of refund resulting from the application of federal, state or
accreditation requirements recorded as an expense. On an individual student
basis, tuition earned in excess of cash received is recorded as accounts
receivable, and cash received in excess of tuition earned is recorded as
deferred tuition revenue.
Other educational revenue is comprised of laboratory fees and textbook
sales. Laboratory fees are recorded as revenue at the beginning of each quarter.
Textbook sales are recognized when they occur.
Advertising Costs. The Company expenses all advertising costs as incurred.
Direct Marketing Costs. Direct costs incurred relating to the enrollment
of new students are capitalized using the successful efforts method. Direct
marketing costs include recruiting representatives' salaries, employee benefits
and other direct costs less enrollment fees. Direct marketing costs are
amortized on an accelerated basis over the average course length of 24 months
commencing on the start date.
F-6
<PAGE> 73
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Direct marketing costs on the balance sheet totaled $6,882 and $5,774 at
December 31, 1997 and 1996, respectively, net of accumulated amortization of
$5,861 and $5,065 at those dates, respectively.
Institute Start-Up Costs. Deferred institute start-up costs consist of all
direct costs incurred at a new institute (excluding advertising costs) that are
incurred from the date a lease for a technical institute facility is entered
into until the first class start. Such capitalized costs are amortized on a
straight-line basis over a one-year period. At December 31, 1997 and December
31, 1996, deferred start-up costs included in other assets in the balance sheet
totaled $1,316 and $521, respectively, net of accumulated amortization of $174
and $799 at such dates, respectively.
Income Taxes. The Company is included in the consolidated U.S. federal
income tax return of ITT and determines its income tax provision principally on
a separate return basis in conformity with Statement of Financial Accounting
Standards ("SFAS") No. 109. Under a tax sharing policy with ITT, income taxes
are allocated to members of the U.S. consolidated group based principally on
amounts they would pay or receive if they filed a separate income tax return.
Deferred income taxes are provided on the differences in the book and tax basis
of assets and liabilities recorded on the books of the Company (temporary
differences) at the statutory tax rates expected to be in effect when such
differences reverse. Temporary differences related to SFAS No. 106, SFAS No.
112, pension and self-insurance costs are recorded on the books of ITT where the
related assets and liabilities are recorded. ITT pays current federal income
taxes on behalf of the Company, as calculated under the tax sharing policy, and
reflects the funding through the cash invested with ITT Corporation account.
Earnings Per Common Share. Earnings per common share for all years have
been calculated in conformity with SFAS No. 128, "Earnings Per Share." Such data
is based on historical net income and the average number of shares of Common
Stock outstanding during each period. The number of average shares outstanding
utilized for basic earnings per share were 26,999,952 in 1997, 1996 and 1995.
Average shares outstanding utilized for diluted earnings per share were
27,105,000, 27,092,000 and 27,032,000, for 1997, 1996 and 1995, respectively.
The difference in shares utilized in calculating basic and diluted earnings per
share represents the average number of shares issued under the Company's stock
option plan less shares assumed to be purchased with proceeds from the exercise
of the stock options.
3. RELATED PARTY TRANSACTIONS
At December 31, 1997, and during the three-year period then ended, the
relationship between the Company and ITT was governed by various agreements
summarized as follows:
Intercompany Activities. ITT provides the Company with certain centralized
treasury and financing functions. The Company transfers all unrestricted cash
receipts to ITT and receives funds from ITT for all disbursements. The Company
earns interest on the average net cash balance held by ITT, at an interest rate
that is set for a 12-month period and is 30 basis points over the most recently
published rate for 12-month treasury bills. The net of all such cash transfers
as well as charges from ITT for expenses related to the Company's participation
in ITT's plans (such as pensions, medical insurance, federal income taxes, etc.)
resulted in a net balance of cash invested with ITT as of December 31, 1997 and
1996, of $94,800 and $89,808, respectively. On February 5, 1998, ITT transferred
approximately $83,000 to the Company and since that date the Company has been
performing its own cash management function.
ITT also provides certain risk management, tax and pension management
services. The fee (contract service charge) for such services is 0.25% of the
Company's annual revenue. The contract service charges were $654, $578 and $504
for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company's employees participate in certain employee benefit programs
which are sponsored and administered by ITT. Administrative costs relating to
these services and participation in these plans are charged to the Company using
allocation methods management believes are reasonable. The Company pays a
F-7
<PAGE> 74
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
processing fee related to its participation in ITT's consolidated medical plan.
The processing fees were $159, $280 and $464 in 1997, 1996 and 1995,
respectively.
Tax Agreement. ITT and the Company entered into a tax agreement providing,
among other things, that the Company will pay ITT, with respect to federal
income taxes for each period that the Company is included in ITT's consolidated
federal return, that amount that the Company would have been required to pay had
it filed a separate federal income tax return under the tax sharing policy
described in Note 2.
Similarly, with respect to state, corporate, franchise or income taxes for
those states where ITT files a combined or consolidated state return that
includes the Company, the Company will pay as if it filed a separate tax return.
With respect to ITT's consolidated federal and state returns, the Company will
be responsible for any deficiencies assessed with respect to such returns if
such deficiencies relate to the Company. Similarly, the Company will be entitled
to all refunds paid with respect to such returns that relate to the Company. The
Company will be responsible for all taxes, including assessments, if any, for
prior years with respect to all other taxes payable by the Company.
Management believes the statements of income include a reasonable
allocation of costs incurred by ITT which benefit the Company. The
aforementioned agreements could be modified after the Merger described in Note
1.
4. FINANCIAL AID PROGRAMS
The Company participates in various Title IV Programs. Approximately 70% of
the Company's 1997 revenue was derived from funds distributed under these
programs.
The Company participates in the Federal Perkins Loan ("Perkins") program
and administers on behalf of the federal government a pool of Perkins student
loans which aggregated $8,517 and $8,235 at December 31, 1997 and 1996,
respectively. The Company has recorded in its financial statements only its
aggregate mandatory contributions to this program which at December 31, 1997 and
1996 aggregated $1,588 and $1,572, respectively. The Company has provided $971
and $955, respectively, for potential losses related to funds committed by the
Company at December 31, 1997 and 1996.
The Title IV Programs are administered by the Company in separate accounts
as required by government regulation. The Company is required to administer the
funds in accordance with the requirements of the Higher Education Act and DOE
regulations and must use due diligence in approving and disbursing funds and
servicing loans. In the event the Company does not comply with federal
requirements, or if student loan default rates rise to a level considered
excessive by the federal government, the Company could lose its eligibility to
participate in the Title IV Programs or could be required to repay funds
determined to have been improperly disbursed. Management believes that it is in
substantial compliance with the federal requirements. Currently, the Company has
been informed by the DOE that one ITT Technical Institute in Garland, Texas has
default rates that are considered excessive. The Company is in the process of
appealing that decision. Should the appeal be denied by the DOE, the Company
does not believe the loss of Title IV Program funding at this one institute will
have a material adverse effect on the Company's financial position, results of
operations or cash flows.
5. RESTRICTED CASH
The Company participates in the Electronic Funds Transfer ("EFT") program
through the DOE. All monies transferred to the Company via the EFT system are
subject to certain holding period restrictions, generally from three to seven
days, before they can be drawn into the Company's cash account. Such amounts are
classified as restricted until they are applied to the students' accounts.
F-8
<PAGE> 75
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. PROPERTY AND EQUIPMENT
Fixed assets include the following:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1997 1996
-------- --------
<S> <C> <C>
Furniture and equipment................................ $ 62,514 $ 52,317
Leasehold improvements................................. 7,848 7,017
Land and land improvements............................. 110 110
Construction in progress............................... 325 1,142
-------- --------
70,797 60,586
Less accumulated depreciation.......................... (47,911) (41,226)
-------- --------
$ 22,886 $ 19,360
======== ========
</TABLE>
7. TAXES
The provision for income taxes includes the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Current
Federal...................................... $10,399 $ 8,673 $6,571
State........................................ 2,064 1,614 1,305
------- ------- ------
12,463 10,287 7,876
Deferred
Federal...................................... 168 (370) (200)
State........................................ 34 (73) (40)
------- ------- ------
202 (443) (240)
------- ------- ------
$12,665 $ 9,844 $7,636
======= ======= ======
</TABLE>
Deferred tax assets (liabilities) include the following:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Direct marketing costs........................ $(2,698) $(2,263) $(1,973)
Institute start-up costs...................... (516) (204) (392)
Depreciation.................................. 759 785 744
Reserves and other............................ 2,399 1,828 1,324
------- ------- -------
Net deferred tax assets (liabilities)......... $ (56) $ 146 $ (297)
======= ======= =======
</TABLE>
Differences between effective income tax rates and the statutory U.S.
federal income tax rates are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Statutory U.S. federal income tax rate................. 35.0% 35.0% 35.0%
State income taxes, net of federal benefit............. 4.1 4.1 4.3
Permanent differences and other........................ .7 .8 .8
---- ---- ----
Effective income tax rate.............................. 39.8% 39.9% 40.1%
==== ==== ====
</TABLE>
F-9
<PAGE> 76
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. RETIREMENT PLANS
Employee Pension Benefits. The Company participates in the Retirement Plan
for Salaried Employees of ITT Corporation, a non-contributory defined benefit,
final average pay pension plan which covers substantially all employees of the
Company. ITT determines the aggregate amount of pension expense on a
consolidated basis based on actuarial calculations and such expense is allocated
to participating units on the basis of compensation covered by the plan. For the
years ended December 31, 1997, 1996 and 1995, pension expense as a percentage of
covered compensation for employees over age 21 who had more than one year of
service was 6.84%, 6.57% and 5.52%, respectively, which resulted in charges to
the Company of $4,458, $3,783 and $2,983, respectively.
Retirement Savings Plan. The Company participates in The ITT 401K
Retirement Savings Plan, a defined contribution plan which covers substantially
all employees of the Company. The Company's non-matching and matching
contributions under this plan are provided for through the issuance of common
shares of ITT. The costs of the non-matching and matching Company contributions
are charged by ITT to the Company. For the years ended December 31, 1997, 1996
and 1995, the costs of providing this benefit (including an allocation of the
administrative costs of the plan) were $2,104, $1,749 and $1,369, respectively.
9. STOCK OPTION AND KEY EMPLOYEE INCENTIVE PLANS
The Company adopted and the stockholders approved the ITT Educational
Services, Inc. 1994 Stock Option Plan ("1994 Plan") and the 1997 ITT Educational
Services, Inc. Incentive Stock Plan ("1997 Plan"). The Company has adopted the
disclosure only provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized in the
financial statements for the 1994 Plan or the 1997 Plan. The Company has
elected, as permitted by the standard, to continue following its intrinsic value
based method of accounting for stock options consistent with APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Under the intrinsic method,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the company's stock at the measurement date over the
exercise price.
Under the 1994 Plan, a maximum of 405,000 shares of Common Stock may be
issued upon exercise of options. Under the 1997 Plan, a maximum of 1.5% of the
outstanding common shares may be issued each year commencing in 1997, with any
unissued shares issuable in later years. Under the 1997 Plan, a maximum of
4,050,000 shares of Common Stock may be issued upon exercise of options. The
option price may not be less than 100% of the fair market value of the Common
Stock on the date of grant and the options will vest and become exercisable in
three equal annual installments commencing with the first anniversary of the
grant. The options outstanding at December 31, 1997, are as follows:
1994 PLAN
<TABLE>
<CAPTION>
NUMBER OF OPTION
DATE OF GRANT SHARES PRICE
------------- --------- ------
<S> <C> <C>
December 27, 1994........................................ 135,000 $ 4.44
October 2, 1995.......................................... 56,250 8.89
February 12, 1996........................................ 67,500 11.94
February 10, 1997........................................ 146,250 24.25
-------
405,000
=======
</TABLE>
1997 PLAN
None
F-10
<PAGE> 77
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
During 1997, 1996 and 1995 no options were exercised, expired or canceled.
At December 31, 1997, 195,000 stock options are exercisable with a weighted
average price of $6.16.
Compensation costs for the 1994 Plan, calculated in accordance with SFAS
No. 123, are not significant for the years ending December 31, 1996 and 1995.
Had compensation costs been determined based upon the fair value of the stock
options at grant date consistent with SFAS No. 123, the Company's net income and
earnings per share for the year ended December 31, 1997 would have been reduced
to the pro forma amounts of $18,519 and $.69 (basic earnings per share) and $.68
(diluted earnings per share), respectively, from the as reported amounts of
$19,123 and $.71.
The fair value of each option grant was estimated on the date of grant
using the Black-Sholes option-pricing model with the following assumptions for
1997, 1996 and 1995, respectively: risk-free interest rates of 6.6%, 5.7% and
6.4%; expected lives of 10 years; volatility of 46% and no dividend yield.
In January 1998, an additional 405,000 stock options, at an option price of
$21.69 each, were granted by the Board of Directors.
10. COMMITMENTS AND CONTINGENT LIABILITIES
Lease Commitments. The Company leases substantially all of its facilities
under operating lease agreements. A majority of the operating leases contain
renewal options that can be exercised after the initial lease term. Renewal
options are generally for periods of one to five years. All operating leases
will expire over the next fourteen years and management expects that leases will
be renewed or replaced by other leases in the normal course of business. There
are no material restrictions imposed by the lease agreements and the Company has
not entered into any significant guarantees related to the leases. The Company
is required to make additional payments under the operating lease terms for
taxes, insurance and other operating expenses incurred during the operating
lease period.
Rent expense was composed of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Minimum rentals............................... $18,961 $17,131 $15,842
Contingent rentals............................ 272 249 223
------- ------- -------
$19,233 $17,380 $16,065
======= ======= =======
</TABLE>
Future minimum rental payments required under operating leases that have
initial or remaining non-cancelable lease terms in excess of one year as of
December 31, 1997, are as follows:
<TABLE>
<S> <C>
1998.................................................... $ 20,855
1999.................................................... 19,681
2000.................................................... 19,818
2001.................................................... 15,982
2002.................................................... 13,547
Later Years............................................. 43,885
--------
$133,768
========
</TABLE>
Operating leases related to four institutes that are still in the
developmental phase at December 31, 1997 include special clauses that allow the
Company to terminate the lease within one year of signing the lease if the new
school is not accredited. If this were to occur, the Company would be liable, at
the date of termination, for an agreed upon termination cost based on the
lessor's tenant improvement costs. The future
F-11
<PAGE> 78
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
minimum rental payments schedule above includes such termination costs for the
four institutes. If the institutes are accredited as expected, aggregate
additional minimum rental payments of $4,290 will be required over the lease
term.
Rent expense and future minimum rental payments related to equipment leases
are not material.
Contingent Liabilities. In December 1994, the Company entered into an
agreement with an unaffiliated, private funding source to provide loans to
students of certain technical institutes. The agreement requires the Company to
guarantee repayment of the loans. Outstanding loans at December 31, 1997
aggregated $1,457. Additionally, the Company is required to maintain on deposit
with the lender 15% of the aggregate principal balance of outstanding loans.
This interest bearing deposit is included in other assets in the balance sheet.
The Company has a number of pending legal and other claims arising out of
the normal course of business. Among the legal actions is Eldredge, et al. v.
ITT Educational Services, Inc., et al. (the "Eldredge Case"). This action was
filed on June 8, 1995 in San Diego, California, by seven graduates of the San
Diego ITT Technical Institute. In October 1996, the jury in this action rendered
a verdict against the Company and awarded the plaintiffs general damages of
approximately $0.2 million and exemplary damages of $2.6 million. The judge also
awarded the plaintiffs attorney's fees and costs, in the amount of approximately
$0.9 million, and interest. The Company is seeking to overturn the awards and
has appealed the decision. Management, based on the advice of counsel, believes
it is probable that it will prevail in its appeal, thus no provision (other than
the Company's legal expenses) for these awards has been made. If the Company's
appeal of the judgment in the Eldredge Case is unsuccessful, a charge to
earnings would be taken at that time in the amount of the awards, including the
general and exemplary damages assessed against the Company, the plaintiffs'
attorney's fees and costs and the interest assessed thereon.
In January 1997, six legal actions were filed against the Company in San
Diego, California by a total of 21 former students of the San Diego ITT
Technical Institute. In June 1997, a legal action was filed against the Company
in Orlando, Florida by three former students of the Maitland ITT Technical
Institute. The plaintiffs in one of the California actions and in the Florida
action seek to have each of their actions certified as a class action. Recently,
the court denied the plaintiffs' request to have the California action certified
as a class action. In April 1998, the legal action in Florida was dismissed
without prejudice by the plaintiffs. If a class action is certified, the number
of plaintiffs that may be awarded damages would increase significantly. The
claims alleged in all seven legal actions are similar to the claims alleged in
the Eldredge Case, relate primarily to the Company's marketing and recruitment
practices and include misrepresentation and violations of certain state
statutes. The Company believes that it has meritorious defenses and intends to
vigorously defend itself against these claims.
In the opinion of management, the ultimate outcome of these matters will
not have a material adverse effect on the Company's financial position, results
of operations or cash flows.
F-12
<PAGE> 79
- ------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDER OR ANY
UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY
JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER IN SUCH
JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Documents Incorporated by Reference... 3
Available Information................. 3
Prospectus Summary.................... 4
Risk Factors.......................... 9
Price Range of Common Stock........... 18
Dividend Policy....................... 18
Capitalization........................ 19
Selected Financial and Operating
Data................................ 20
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 21
Business.............................. 28
Management............................ 53
Principal and Selling Stockholder..... 53
Relationship With Selling Stockholder
and Related Transactions............ 54
Description of Capital Stock.......... 56
Shares Eligible for Future Sale....... 58
Underwriting.......................... 60
Notice to Canadian Residents.......... 61
Certain U.S. Federal Tax
Considerations for Non-U.S. Holders
of Common Stock..................... 62
Legal Matters......................... 65
Experts............................... 65
Index to Financial Statements......... F-1
</TABLE>
======================================================
ITT EDUCATIONAL SERVICES, INC. LOGO
11,000,000 Shares
Common Stock
($.01 par value)
PROSPECTUS
CREDIT SUISSE FIRST BOSTON
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER
- ------------------------------------------------------
<PAGE> 80
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses incurred in connection with the
sale and distribution of the securities being registered which will be paid by
the Company. All the amounts shown are estimates, except the Commission
registration fee and the NASD filing fee.
<TABLE>
<S> <C>
Commission registration fee................................. $ 94,460
NASD filing fee............................................. 30,500
Blue sky fees and expenses.................................. 5,000
Accounting fees and expenses................................ 150,000
Legal fees and expenses..................................... 300,000
Printing and engraving expenses............................. 300,000
Miscellaneous expenses...................................... 120,040
----------
Total.................................................. $1,000,000
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the State of Delaware
provides that under certain circumstances a corporation may indemnify any person
who was or is a party or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that he or she is or was
a director, officer, employee or agent of the corporation or is or was serving
at its request in such capacity in another corporation or business association,
against expenses (including attorney's fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by him or her in connection with
such action, suit or proceeding if he or she acted in good faith and in a manner
he or she reasonably believed to be in or not opposed to the best interests of
the corporation and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his or her conduct was unlawful.
The Restated Certificate of Incorporation and By-Laws of the registrant
provide that (a) the registrant shall indemnify to the full extent permitted by
law any person made, or threatened to be made, a party to any action, suit or
proceeding (whether civil, criminal, administrative or investigative) by reason
of the fact that he or she is or was a director or officer of the registrant or
is or was serving or has agreed to serve at the request of the registrant as a
director or officer of another corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise (including the heirs, executor,
administrators or estate of such person) and (b) the registrant shall pay the
expenses, including attorney's fees, incurred by a director or officer in
defending or investigating a threatened or pending action, suit or proceeding,
in advance of the final disposition of such action, suit or proceeding upon
receipt of an undertaking by or on behalf of such director or officer to repay
such amount if it is ultimately determined that the director or officer is not
entitled to be indemnified with respect to such amount by the registrant. The
Restated Certificate of Incorporation also provides that, to the extent
permitted by law, the directors of the registrant shall have no liability to the
registrant or its stockholders for monetary damages for breach of fiduciary duty
as a director.
The Company's directors and officers are insured under directors and
officers insurance policies maintained by the Company (and, until the Offering,
by Starwood, Inc.), within the limits and subject to the limitations of the
policies, against certain expenses in connection with the defense of actions,
suits or proceedings, and certain liabilities which might be imposed as a result
of such actions, suits or proceedings, to which they are parties by reason of
being or having been such directors or officers.
S-1
<PAGE> 81
The form of Underwriting Agreement filed as Exhibit 1 provides for the
indemnification of the registrant, its controlling persons, its directors and
certain of its officers by the Underwriters against certain liabilities under
the Securities Act.
ITEM 16. EXHIBITS
The list of exhibits is incorporated herein by reference to the Index to
Exhibits on page E-1.
ITEM 17. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
Registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
(b) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of Prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in
a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
Prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(c) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
S-2
<PAGE> 82
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment to
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Indianapolis, State of Indiana, on the 8th day
of April, 1998.
ITT EDUCATIONAL SERVICES, INC.
By: /s/ RENE R. CHAMPAGNE
--------------------------------------
Rene R. Champagne
Chairman, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to Registration Statement has been signed by the following persons in their
respective capacities and on the respective dates set forth opposite their
names. Each person whose signature appears below hereby authorizes each of Rene
R. Champagne and Gene A. Baugh, each with full power of substitution, to execute
in the name and on behalf of such person any amendment or any post-effective
amendment to this Registration Statement and any subsequent registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933 and to
file the same, with exhibits thereto, and other documents in connection
therewith, making such changes in this Registration Statement and any such
subsequent registration statement as the Registrant deems appropriate, and
appoints each of Rene R. Champagne and Gene A. Baugh, each with full power of
substitution, attorney-in-fact to sign any amendment and any post-effective
amendment to this Registration Statement and any such subsequent registration
statement and to file same, with exhibits thereto, and other documents in
connection therewith.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<C> <S> <C>
/s/ RENE R. CHAMPAGNE Chairman, President, Chief Executive April 8, 1998
- --------------------------------------------------- Officer and Director (Principal
Rene R. Champagne Executive Officer)
/s/ GENE A. BAUGH Senior Vice President and Chief April 8, 1998
- --------------------------------------------------- Financial Officer (Principal
Gene A. Baugh Financial Officer and Principal
Accounting Officer)
/s/ RAND V. ARASKOG Director April 8, 1998
- ---------------------------------------------------
Rand V. Araskog
/s/ TONY COELHO Director April 8, 1998
- ---------------------------------------------------
Tony Coelho
/s/ *JOHN E. DEAN Director April 8, 1998
- ---------------------------------------------------
John E. Dean
/s/ JAMES D. FOWLER, JR. Director April 8, 1998
- ---------------------------------------------------
James D. Fowler, Jr.
/s/ ROBIN JOSEPHS Director April 8, 1998
- ---------------------------------------------------
Robin Josephs
/s/ MERRICK R. KLEEMAN Director April 8, 1998
- ---------------------------------------------------
Merrick R. Kleeman
</TABLE>
S-3
<PAGE> 83
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<C> <S> <C>
/s/ LESLIE LENKOWSKY Director April 8, 1998
- ---------------------------------------------------
Leslie Lenkowsky
/s/ BARRY S. STERNLICHT Director April 8, 1998
- ---------------------------------------------------
Barry S. Sternlicht
/s/ VIN WEBER Director April 8, 1998
- ---------------------------------------------------
Vin Weber
*By /s/ GENE A. BAUGH
----------------------------------------------
Gene A. Baugh
Attorney-in-Fact
</TABLE>
S-4
<PAGE> 84
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
1** Form of Underwriting Agreement.
4.1 Restated Certificate of Incorporation of the Registrant, as
amended to date. (The copy of this Exhibit filed as Exhibit
3.1 to the Registrant's 1996 second fiscal quarter report on
Form 10-Q is incorporated herein by reference.)
4.2 By-Laws of the Registrant, as amended to date. (The copy of
this Exhibit filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form S-8 (Registration 333-38883)
is incorporated herein by reference.)
5* Opinion of Baker & Daniels.
23.1* Consent of Price Waterhouse LLP.
23.2 Consent of Baker & Daniels. (Included in the Baker & Daniels
Opinion filed as Exhibit 5.)
24* Power of Attorney (Included on the Signature Page of the
Registration Statement.)
</TABLE>
- ---------------
* Filed with this amendment.
** To be filed by amendment.
E-1
<PAGE> 1
EXHIBIT 5
BAKER & DANIELS
300 NORTH MERIDIAN STREET, SUITE 2700 INDIANAPOLIS, INDIANA 46204-1782
(317) 237-0300 FAX (317) 237-1000
April 8, 1998
ITT Educational Services, Inc.
5975 Castle Creek Parkway North Drive
Indianapolis, Indiana 46250-0466
Gentlemen:
We have examined the corporate records and proceedings of ITT
Educational Services, Inc., a Delaware corporation (the "Company"), with respect
to the legal sufficiency of all corporate proceedings of the Company taken in
connection with the authorization, issuance, form, validity and
non-assessability of all of the presently issued and outstanding shares of
common stock, $0.01 par value, of the Company (the "Common Stock") to be offered
for sale by ITT Corporation, a Nevada corporation (the "Selling Stockholder")
(including the shares to cover an over-allotment option) under the Company's
Registration Statement on Form S-3 (Registration No. 333-46267), as amended (the
"Registration Statement"), in connection with which this opinion is given.
Based on such examination, we are of the opinion that all of
the shares of Common Stock being offered by the Selling Stockholder (including
the shares to cover an over-allotment option) are validly authorized, legally
issued, and fully paid and non-assessable.
We hereby consent to the filing of this opinion as Exhibit 5
to the Registration Statement and to the references to us in the Prospectus
which is a part of the Registration Statement. In giving this consent, we do not
admit that we come within the category of persons whose consent is required
under Section 7 of the Securities Act of 1933, as amended, or rules and
regulations of the Securities and Exchange Commission promulgated thereunder.
Yours very truly,
BAKER & DANIELS
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-3 of our report dated January 10, 1998, except
as to Notes 1, 3 and 10 which are as of April 7, 1998 relating to the financial
statements of ITT Educational Services, Inc. which appear in such Prospectus. We
also consent to the incorporation by reference in the Prospectus constituting
part of this Registration Statement on Form S-3 of our report dated January 10,
1998 appearing on page F-1 of ITT Educational Services, Inc. Annual Report on
Form 10-K for the year ended December 31, 1997. We also consent to the
references to us under the headings "Experts" and "Selected Financial Data" in
such Prospectus. However, it should be noted that Price Waterhouse LLP has not
prepared or certified such "Selected Financial Data."
PRICE WATERHOUSE LLP
Indianapolis, Indiana
April 9, 1998
