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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-13144
ITT EDUCATIONAL SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
DELAWARE 36-2061311
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
5975 CASTLE CREEK PARKWAY N. DRIVE
P.O. BOX 50466
INDIANAPOLIS, INDIANA 46250-0466
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (317) 594-9499
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE, INC.
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
$115,800,000
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock at February 12, 1998
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
26,999,952
Number of shares of Common Stock, $.01 par value, outstanding at February 9,
1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents have been incorporated by reference
into this Annual Report on Form 10-K:
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<S> <C>
PARTS OF FORM 10-K INTO WHICH
IDENTITY OF DOCUMENT DOCUMENT IS INCORPORATED
Definitive Proxy Statement for the Annual PART III
Meeting of Shareholders
to be held May 12, 1998
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ITT EDUCATIONAL SERVICES, INC.
INDIANAPOLIS, INDIANA
ANNUAL REPORT TO SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 1997
PART I
ITEM 1. 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 Trust, a Maryland real estate
investment trust formerly known as Starwood Lodging Trust ("Starwood Trust"),
and their subsidiaries; 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.
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.
RECENT DEVELOPMENTS
Starwood/ITT Merger. Chess Acquisition Corp. ("Chess"), a wholly owned
subsidiary of Starwood, Inc., is expected to be merged with and into ITT in late
February 1998 (the "Merger") pursuant to an Amended and Restated Agreement and
Plan of Merger dated as of November 12, 1997 among Starwood, Inc., Chess,
Starwood Trust and ITT (the "Merger Agreement"). Pursuant to the Merger
Agreement, Starwood, Inc. will acquire all of the outstanding capital stock of
ITT for a combination of cash and shares of common stock of Starwood, Inc. and
shares of beneficial interest of Starwood Trust. After giving effect to the
Merger, Starwood will be the largest hotel and gaming company in the world in
terms of revenue and own, manage or franchise 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 will trigger a change in control of the Company
and its ITT Technical Institutes. As a result, each ITT Technical Institute
campus group will become ineligible to participate in federal student financial
aid programs until such campus group reestablishes its eligibility, which the
Company believes will be completed by May 29, 1998, although there can be no
assurance thereof. See "-- Change in Control."
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
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associate, bachelor and master degree programs and non-degree diploma programs
to over 24,000 students through 62 ITT Technical Institutes located in 27
states. The education programs are designed, after consultation with employers,
to help graduates prepare for careers in a variety of 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 49 new technical institutes since January 1, 1981. Of the 62
institutes currently operating, 19 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. The Company intends to
continue expanding by opening new technical institutes (including six new
institutes in 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 college 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
prepare for careers in a variety of 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'
employable 1996 graduates 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
2
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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.
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 62 institutes provide significant potential for
the introduction of existing programs to a broader number of ITT Technical
Institutes. In the past five years, the Company has increased the number of
institutes which offer three or more programs from 16 to 28. In 1998, the
Company intends to increase the number of program offerings at
approximately 12 existing ITT Technical Institutes. 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
attracts a broader base of students and motivates current students to
extend their studies. ESI intends to test an associate degree program in
Computer Network Systems Technology ("CNS") at one institute in June 1998
to target the growing need for technically skilled personnel in the
computer systems field. The new CNS program is expected to be tested at
three to four additional institutes by the end of 1998.
Extend Total Program Time. By adding bachelor degree programs in more
institutes, 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 employable graduates of ITT Technical Institutes who were
employed in fields involving their programs of study increased from 80% to
88%. During the same period, average annual graduate salaries rose 24% from
approximately $16,900 to approximately $21,000.
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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 intends to open six new technical institutes in
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 62 institutes. Centralization and
uniformity have resulted in substantial operating efficiencies. Between
1993 and 1997, expenses incurred at headquarters (including the district
offices) have 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.
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.
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>
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(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
4
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programs are designed to help graduates 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 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
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 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.
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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.
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 institution 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
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and also must pass an admissions examination. Students interested in bachelor
degree programs or the MPM program must satisfy additional admissions criteria
which 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 program completion not only affect the student, but also
have a negative regulatory, financial and marketing effect on the institution.
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. 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 A FIELD 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>
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(1) Employable graduates exclude graduates who continue in a bachelor degree
program at an ITT Technical Institute.
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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.
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 offered by the ITT Technical
Institutes who obtained employment or were already employed in a field 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.
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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, 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 62 ITT Technical
Institutes, 30 are considered to be main campuses and 32 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 62
ITT Technical Institutes participate in Title IV Programs, and the other two
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 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 financial
condition or results of operations of the Company. 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. 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 derived indirectly 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.
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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, on the number of students who have
defaulted and 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 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 or 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. 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. See "-- Administrative Capability" and
"-- Eligibility and Certification Procedures."
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
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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 to teach the students already enrolled, and
close the institute once the students already enrolled had completed their
programs of study.
Twenty-seven ITT Technical Institute campus groups (consisting of 53
institutes) had Perkins cohort default rates 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 rates have been calculated. 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 Perkins cohort default
rates 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," which 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. To date, no ITT
Technical Institute campus group has been placed on provisional
certification status because of its FFEL/FDL or Perkins cohort default
rates.
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 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 result of the Merger, the DOE will
again evaluate the financial responsibility of the ITT Technical Institute
campus groups and the Company, and may evaluate the
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financial statements of ITT and/or Starwood, Inc. The Company believes that
it will be able to satisfy the applicable financial responsibility
standards.
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
participate 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. The HEA requires proprietary educational
institutions, such as the ITT Technical Institutes, 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
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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 eligible programs that an institution may offer.
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 to
be 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 (three main
campuses and one additional location) 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 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
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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 that the institution 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 rates have been calculated. See "-- Student Loan
Defaults." If the DOE determines that an ITT Technical Institute is not
administratively capable solely because it exceeds the cohort default rate
thresholds specified in this regulation, such institute's certification to
participate in Title IV Programs may become provisional. To date, no ITT
Technical Institute campus group has been placed on provisional
certification status due to its FFEL/FDL or Perkins cohort default rates.
The Company does not believe that its financial condition will be
materially affected if any ITT Technical Institute campus groups are
provisionally certified to participate in Title IV Programs. See
"-- 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.
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
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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 has advised the Company that it
will combine each of these campus groups' applications for recertification
with their applications for reinstatement of participation in Title IV
Programs following the change in control to be caused by the Merger.
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, 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 is currently provisionally certified by the DOE. All of the
ITT Technical Institute campus groups are required to apply for
recertification by the DOE as a result of the change in control to be
caused by the Merger, and the Company expects that because of such change
in control, all of the ITT Technical Institute campus groups will be
recertified on a provisional basis.
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.
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 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 "Item 7. 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
15
<PAGE> 17
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 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.
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<PAGE> 18
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 62 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
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. Two ITT Technical Institutes (both additional locations)
accredited by the ACCSCT are on probation, four ITT Technical Institutes (three
main campuses and one additional location) 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.
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<PAGE> 19
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 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
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<PAGE> 20
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) consider 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
will immediately become ineligible to participate in all of the Title IV
Programs. The Company has obtained all prior approvals of the Merger from the
ACCSCT and the SEAs required before the Merger occurs. The Company will seek the
approvals of the Merger from the ACICS and those SEAs required after a change in
control occurs, and will also seek the DOE's reinstatement of each ITT Technical
Institute campus group's participation in Title IV Programs.
The time required to obtain these approvals can vary substantially and may
take several months. In order to assure that the students attending an ITT
Technical Institute can receive all of the Title IV Program funds necessary to
pay their costs of education for the institute's Spring 1998 quarter (which
starts March 9 and ends May 29), that institute must be recertified by the DOE
to participate in Title IV Programs by May 29, 1998. Otherwise, none of the
students enrolled in that institute could receive Title IV Program grants to pay
their costs of education for such quarter and those students whose loan period
began and ended with such quarter could not receive Title IV Program loans for
such quarter. The Company believes that each ITT Technical Institute campus
group will regain its eligibility to participate in Title IV Programs by May 29,
1998, but there can be no assurance thereof. Failure by a material number of ITT
Technical Institute campus groups to regain their eligibility to participate in
Title IV Programs by May 29, 1998 would have a material adverse effect on the
Company's financial condition, results of operations and cash flows. If no ITT
Technical Institute campus group regains its eligibility to participate in Title
IV Programs by May 29, 1998, the Company estimates that its financial condition,
results of operations and cash flows would be adversely affected by
approximately $8.0 million to $10.0 million (pre-tax). If any subsequent
academic quarter ends before an ITT Technical Institute campus group regains its
eligibility, the students attending any institute in that campus group would not
receive any Title IV Program grants to pay their costs of education for such
quarter, and any such students whose loan period began after the institute
became ineligible and ended before the campus group regained its eligibility
would not receive any Title IV Program loans to pay such costs for such quarter.
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 its shares of Common Stock of the Company, certain corporate
reorganizations and certain changes in the boards of directors of such
corporations.
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 in California 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
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<PAGE> 21
can be no assurance that it will approve any future change in control
application submitted by the Company. See "Item 3. 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 SEA which review a change in control after it occurs;
(c) become accredited (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 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
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<PAGE> 22
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 in 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> 23
ITEM 2. 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 facilities
leased by the Company as of December 31, 1997.
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
Carson, California (Los
Angeles)....................... 22,695
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(2)
West Covina, California
(Los Angeles).................. 36,382
Aurora, Colorado (Denver)........ 23,450(3)
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(4)
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
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
</TABLE>
<TABLE>
<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(4)
Getzville, New York (Buffalo).... 22,765
Liverpool, New York (Syracuse)... 21,000(4)
Dayton, Ohio..................... 45,591
Norwood, Ohio (Cincinnati)....... 21,272
Strongville, 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(4)
San Antonio, Texas............... 20,770
Murray, Utah (Salt Lake City).... 33,600
Norfolk, Virginia................ 25,572
Richmond, Virginia............... 21,000(4)
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.
(2) Facility under lease to which the Company plans to relocate the ITT
Technical Institute from Carson, California.
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<PAGE> 24
(3) 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.
(4) 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 will be deemed a change of 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 is in the process of obtaining such consents and
believes that it will be able to obtain all such consents prior to the Merger.
ITEM 3. 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 who were residents
of California. 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
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
23
<PAGE> 25
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 "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
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 who reside in California. 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 in this action amended their complaint on August 14, 1997
to: (a) delete three and add two named plaintiffs, each of whom was a
student who attended an ITT Technical Institute in California; (b)
allege only violations of the CEC; and (c) seek only statutory damages,
civil penalties, injunctive relief, 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, among other things,
statutory violations of the CEC and CBPC, intentional
misrepresentations and civil conspiracy by the Company, ITT and a
Company employee who resides in California. The plaintiffs in each
action seek various forms of recovery, including compensatory and
exemplary damages, civil penalties, injunctive relief, disgorgement of
ill-gotten gains, restitution, attorney's fees and costs. 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 alleges, among other things, misrepresentation,
fraud, civil conspiracy and statutory violations by the Company, ITT
and seven employees of the Maitland ITT Technical Institute. The
plaintiffs seek general damages, exemplary damages, rescission of
plaintiffs' enrollment agreements with the Company, attorney's fees,
interest and costs. The plaintiffs also seek to have the action
certified as a class action. This action is currently at the discovery
stage.
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, after taking
into account the Company's existing provisions for such liabilities, a material
adverse effect
24
<PAGE> 26
on the Company's financial condition, results of operations or cash flows.
Certain litigation, however, may subject the affected ITT Technical Institute to
additional regulatory scrutiny.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the holders of the Common Stock
during the fourth quarter of 1997.
25
<PAGE> 27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock is listed on the New York Stock Exchange, Inc. ("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
</TABLE>
No cash dividends were declared 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.
There were approximately 200 holders of record, and approximately 1,500
beneficial owners, of the Common Stock on February 9, 1998.
26
<PAGE> 28
ITEM 6. SELECTED FINANCIAL DATA.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues............................ $261,664 $232,319 $201,831 $186,907 $168,997
Operating income.................... $ 26,223 $ 20,576 $ 14,225 $ 11,832 $ 13,839
Net income.......................... $ 19,123 $ 14,851 $ 11,391 $ 7,162 $ 8,314
Cash, restricted cash and cash
invested with ITT Corporation..... $ 98,689 $ 95,793 $ 77,517 $ 66,810 $ 51,064
Total assets........................ $145,914 $135,749 $114,284 $102,899 $ 87,305
Shareholders' equity................ $ 87,815 $ 68,692 $ 53,841 $ 42,450 $ 35,288
Capital expenditures, net........... $ 11,465 $ 7,868 $ 8,206 $ 7,688 $ 6,679
Depreciation........................ $ 7,939 $ 7,493 $ 7,542 $ 6,855 $ 6,343
Number of common shares outstanding
at end of year.................... 27,000 27,000 12,000 12,000 10,000
Earnings per share (basic and
diluted)(1)....................... $ .71 $ .55 $ .42 $ .32 $ .37
Other Operating Data:
Operating losses from new
technical institutes before income
taxes(2).......................... $ 3,165 $ 5,721 $ 7,123 $ 7,316 $ 2,914
Significant ratios
Return on sales................... 7.3% 6.4% 5.6% 3.8% 4.9%
Operating margin.................. 10.0% 8.9% 7.0% 6.3% 8.2%
Return on average equity.......... 24.4% 24.2% 23.7% 18.4% 26.7%
Book value per share(3)........... $ 3.25 $ 2.54 $ 1.99 $ 1.57 $ 1.57
</TABLE>
- ---------------
(1) 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."
(2) 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.
(3) Restated to reflect the three-for-two stock splits effected in April and
November 1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the Company's results of operations and
financial condition should be read in conjunction with the financial statements
of the Company and the notes thereto appearing elsewhere in this Form 10-K.
GENERAL
The Company operates 62 ITT Technical Institutes in 27 states which provide
technology-oriented postsecondary education to more than 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.
27
<PAGE> 29
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 19 new
technical institutes (six of which started classes in 1996 or 1997). 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.
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
28
<PAGE> 30
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. 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>
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,
29
<PAGE> 31
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 Note 10 of Notes to Financial Statements
for a further description.) 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 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.
30
<PAGE> 32
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).
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 and which 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 such 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)
31
<PAGE> 33
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 "Item 1. 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, 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 consider 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 will immediately become
ineligible to participate in Title IV Programs. In order to assure that the
students attending an ITT Technical Institute can receive all of the Title IV
Program funds necessary to pay their costs of education for the institute's
Spring 1998 quarter (which starts March 9 and ends May 29), that institute must
be recertified by the DOE to participate in Title IV Programs by May 29, 1998.
Otherwise, none of the students enrolled in that institute could receive Title
IV Program grants to pay their costs of education for such quarter and those
students whose loan period began and ended with such quarter could not receive
Title IV Program loans for such quarter. The Company believes that each ITT
Technical Institute campus group will regain its eligibility to participate in
Title IV Programs by May 29, 1998, but there can be no assurance thereof.
Failure by a material number of ITT Technical Institute campus groups to regain
their eligibility to participate in Title IV Programs by May 29, 1998 would have
a material adverse effect on the Company's financial condition, results of
operations and cash flows. If no ITT Technical Institute campus group regains
its eligibility to participate in Title IV Programs by May 29, 1998, the Company
estimates that its financial condition, results of operations
32
<PAGE> 34
and cash flows would be adversely affected by approximately $8.0 million to
$10.0 million (pre-tax). If any subsequent academic quarter ends before an ITT
Technical Institute campus group regains its eligibility, the students attending
any institute in that campus group would not receive any Title IV Program grants
to pay their costs of education for such quarter, and any such students whose
loan period began after the institute became ineligible and ended before the
campus group regained its eligibility would not receive any Title IV Program
loans to pay such costs for such quarter.
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.
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.
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.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains certain forward looking statements that involve a
number of risks and uncertainties. Among the factors that could cause actual
results to differ materially are the following: business conditions and growth
in the postsecondary education industry and in the general economy; changes in
federal and state government regulations with respect to education and
accreditation standards, or the interpretation or enforcement thereof,
including, but not limited to, the level of government funding for, and the
Company's eligibility to participate in, student financial aid programs utilized
by the Company's students; the results of the Company's appeal in Eldredge, et
al. v. ITT Educational Services, Inc., et al. and the results of any related
litigation; effects of any change in ownership of the Company resulting in a
change in control of the Company, including, but not limited to, the
consequences of such changes on the accreditation and federal and state
regulation of the institutes; receptivity of students and employers to the
Company's existing program offerings and new curricula; and loss of lender
access to the Company's students for student loans.
33
<PAGE> 35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item appears on pages F-1 through F-14
herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item concerning the Directors, nominees
for Director, executive officers of the Company and disclosure of delinquent
filers is incorporated herein by reference to the Company's definitive Proxy
Statement for its 1998 Annual Meeting of Shareholders, to be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item concerning remuneration of the
Company's officers and Directors and information concerning material
transactions involving such officers and Directors is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A within
120 days after the end of the Company's last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item concerning the stock ownership of
management and five percent beneficial owners is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A within
120 days after the end of the Company's last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Shareholders which
will be filed pursuant to Regulation 14A within 120 days after the end of the
Company's last fiscal year.
34
<PAGE> 36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements:
<TABLE>
<CAPTION>
PAGE NO. IN
THIS FILING
-----------
<S> <C>
Report of Independent Accountants...................... F-1
Statements of Income and Retained Earnings for the
years ended December 31, 1997, December 31, 1996 and
December 31, 1995.................................... F-2
Balance Sheets as of December 31, 1997 and December 31,
1996................................................. F-3
Statements of Cash Flows for the years ended December
31, 1997, December 31, 1996 and December 31, 1995.... F-4
Notes to Financial Statements.......................... F-5
</TABLE>
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts of the Company for
the years ended December 31, 1997, December 31, 1996 and December
31, 1995 appear on page F-13.
3. Quarterly Results for 1997 and 1996 (unaudited) appear on page
F-14.
4. Exhibits:
A list of exhibits required to be filed as part of this report is
set forth in the Index to Exhibits appearing on page S-3, which
immediately precedes such exhibits, and is incorporated herein by
reference.
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended December
31, 1997.
35
<PAGE> 37
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
ITT EDUCATIONAL SERVICES, INC.
In our opinion, the financial statements listed in the index appearing
under item 14(a)(1) and (2) on page 35, 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.
/S/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Indianapolis, Indiana
January 10, 1998
F-1
<PAGE> 38
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-2
<PAGE> 39
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-3
<PAGE> 40
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-4
<PAGE> 41
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.
During 1997, ITT entered into a merger agreement with Starwood Hotels &
Resorts Worldwide, Inc. ("Starwood, Inc.") and Starwood Hotels & Resorts Trust
("Starwood Trust"), pursuant to which ITT would become a wholly owned subsidiary
of Starwood, Inc. The merger, expected to be completed in February 1998, is
subject to certain conditions and the approval of the shareholders of ITT and
Starwood. Following the merger, Starwood (through its ownership of ITT) would
control 83.3% of the Company's outstanding Common Stock.
The U.S. Department of Education ("DOE"), the accrediting commissions that
accredit the Company's ITT Technical Institutes and most states in which the
Company operates have laws, regulations and/or standards pertaining to a change
in ownership and/or control of educational institutions. Most states and
accrediting commissions include the sale of a controlling interest of Common
Stock (such as would occur in the Starwood merger) within the definition of a
change in control that would require the Company to obtain the approval from the
states and reaccreditation of the ITT Technical Institutes from the accrediting
commissions. Upon a change in control of the Company under the DOE's regulations
(such as would occur in the Starwood merger), the ITT Technical Institutes would
become ineligible to participate in the federal student financial aid programs
under Title IV of the Higher Education Act of 1965, as amended ("Title IV
Programs"), until such time as the DOE recertifies the ITT Technical Institutes.
Before any ITT Technical Institute may regain its eligibility to participate in
Title IV Programs following a change in control, (a) the ITT Technical Institute
must be accredited (or continue to be accredited) by the appropriate accrediting
commission and reauthorized (or continue to be authorized) by the appropriate
state education authority and (b) the change in control must otherwise be
approved by the DOE.
During this recertification process, each of the ITT Technical Institutes
would immediately be ineligible to participate in Title IV Programs and may
receive and disburse only those Title IV Program funds that were previously
committed to the students. The time of year during 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, are two important factors that will determine the impact that a change
in control will have on the operating results and cash flows of the Company.
The recertification process is expected to take 30 to 90 days. During this
period, the Company will utilize its existing cash resources to fund operations.
If the recertification is accomplished without delay, those funds should be
replaced by Title IV Program funds that the institutes would have otherwise
received since the date of the change of control. If no ITT Technical Institute
campus group regains its eligibility to participate in Title IV Programs by May
29, 1998 (the end of the Company's Spring 1998 quarter) it may have an adverse
effect on the Company's financial condition, results of operation and cash
flows. The Company believes that each ITT Technical Institute campus group will
regain its eligibility to participate in Title IV Programs by May 29, 1998, but
there can be no assurance thereof.
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.
F-5
<PAGE> 42
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-6
<PAGE> 43
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
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 proposed Starwood merger
described in Note 1 is completed.
F-7
<PAGE> 44
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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>
F-8
<PAGE> 45
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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>
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
F-9
<PAGE> 46
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
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.
F-10
<PAGE> 47
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 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
F-11
<PAGE> 48
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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. 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> 49
SCHEDULE II
ITT EDUCATIONAL SERVICES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THREE YEARS ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT
BEGINNING CHARGED TO BALANCE AT
DESCRIPTION OF PERIOD EXPENSES WRITE-OFFS END OF PERIOD
----------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year Ended December 31, 1997.................. $1,044 $2,354 $(2,005) $1,393
Year Ended December 31, 1996.................. $ 963 $1,738 $(1,657) $1,044
Year Ended December 31, 1995.................. $1,171 $1,173 $(1,381) $ 963
FFEL Reserve(1)
Year Ended December 31, 1997.................. $ 955 $ 16 $ 0 $ 971
Year Ended December 31, 1996.................. $ 955 $ 0 $ 0 $ 955
Year Ended December 31, 1995.................. $ 893 $ 62 $ 0 $ 955
</TABLE>
- ---------------
(1) Represents Federal Family Education Loan/Perkins Loan programs.
F-13
<PAGE> 50
ITT EDUCATIONAL SERVICES, INC.
QUARTERLY RESULTS
FOR 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 YEAR
------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
1996
Revenues................................ $57,103 $51,568 $65,113 $58,535 $232,319
Cost and expenses....................... $49,992 $51,954 $55,072 $54,725 $211,743
Operating income........................ $ 7,111 $ (386) $10,041 $ 3,810 $ 20,576
Interest income, net.................... $ 947 $ 909 $ 1,076 $ 1,187 $ 4,119
Net income.............................. $ 4,835 $ 314 $ 6,670 $ 3,032 $ 14,851
Earnings per share (basic and
diluted)*............................. $ 0.18 $ 0.01 $ 0.25 $ 0.11 $ 0.55
1997
Revenues................................ $64,476 $58,412 $73,060 $65,716 $261,664
Cost and expenses....................... $55,520 $58,263 $60,775 $60,883 $235,441
Operating income........................ $ 8,956 $ 149 $12,285 $ 4,833 $ 26,223
Interest income, net.................... $ 1,380 $ 1,193 $ 1,478 $ 1,514 $ 5,565
Net income.............................. $ 6,202 $ 805 $ 8,258 $ 3,858 $ 19,123
Earnings per share (basic and
diluted).............................. $ 0.23 $ 0.03 $ 0.30 $ 0.14 $ 0.71
Other Operating Data:
Operating losses from new technical
institutes before income taxes**
1996............................... $ 1,405 $ 2,230 $ 1,227 $ 859 $ 5,721
1997............................... $ 964 $ 1,035 $ 592 $ 574 $ 3,165
</TABLE>
- ---------------
* 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 quarters have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
** Operating losses from new technical institutes before income taxes represents
operating losses before income taxes, including amortization of deferred
pre-operating costs, for institutes in the first 24 months after their first
class start.
F-14
<PAGE> 51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ITT Educational Services, Inc.
By: /s/ RENE R. CHAMPAGNE
------------------------------------
Rene R. Champagne
Chairman, President and Chief
Dated: February 12, 1998 Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ RENE R. CHAMPAGNE Chairman, President, Chief February 12, 1998
- --------------------------------------------------- Executive Officer and
Rene R. Champagne Director (Principal Executive
Officer)
/s/ GENE A. BAUGH Senior Vice President and Chief February 12, 1998
- --------------------------------------------------- Financial Officer (Principal
Gene A. Baugh Financial Officer and
Principal Accounting Officer)
/s/ BETTE B. ANDERSON Director February 12, 1998
- ---------------------------------------------------
Bette B. Anderson
/s/ RAND V. ARASKOG Director February 12, 1998
- ---------------------------------------------------
Rand V. Araskog
/s/ ROBERT A. BOWMAN Director February 12, 1998
- ---------------------------------------------------
Robert A. Bowman
/s/ JOHN E. DEAN Director February 12, 1998
- ---------------------------------------------------
John E. Dean
/s/ JAMES D. FOWLER, JR. Director February 12, 1998
- ---------------------------------------------------
James D. Fowler, Jr.
/s/ LESLIE LENKOWSKY Director February 12, 1998
- ---------------------------------------------------
Leslie Lenkowsky
/s/ RICHARD S. WARD Director February 12, 1998
- ---------------------------------------------------
Richard S. Ward
</TABLE>
S-1
<PAGE> 52
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
<-> Director February 12, 1998
/s/ VIN WEBER
- ---------------------------------------------------
Vin Weber
/s/ MARGITA E. WHITE Director February 12, 1998
- ---------------------------------------------------
Margita E. White
</TABLE>
S-2
<PAGE> 53
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
PAGE NO.
EXHIBIT IN THIS
NO. DESCRIPTION FILING
- ------- ----------- --------
<S> <C>
3.1 (1) Restated Certificate of Incorporation, as Amended to
Date...................................................
3.2 (2) Restated By-laws, as Amended to Date....................
10.1 (3) Registration Rights Agreement between the Company and
ITT....................................................
10.2 (3) Tax Sharing Agreement between the Company and ITT.......
10.3 (3) Intercompany Agreement between the Company and ITT......
10.4 (3) Trade Name and Service Mark License Agreement between
the Company
and ITT................................................
10.5 (3) Employee Benefits and Administrative Services Agreement
between the Company and ITT............................
10.6 (3) Treasury Services and Credit Facilities Agreement
between the Company and ITT............................
10.7 *(4) ITT Educational Services, Inc. 1994 Stock Option
Plan...................................................
10.8 *(5) 1997 ITT Educational Services, Inc. Incentive Stock
Plan...................................................
11 Statement re Computation of Per Share Earnings..............
23 Consent of Price Waterhouse LLP.............................
27 Financial Data Schedule.....................................
</TABLE>
- ---------------
* The indicated exhibit is a management contract, compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.
(1) The copy of this exhibit filed as the same exhibit number to the Company's
1996 second fiscal quarter report on Form 10-Q is incorporated herein by
reference.
(2) The copy of this exhibit filed as the same exhibit number to the Company's
Registration Statement on Form S-8 (Registration No. 33-38883) is
incorporated herein by reference.
(3) The copy of this exhibit filed as the same exhibit number to the Company's
1994 Annual Report on Form 10-K is incorporated herein by reference.
(4) The copy of this exhibit filed as the same exhibit number to the Company's
Registration Statement on Form S-1 (Registration No. 33-78272) is
incorporated herein by reference.
(5) The copy of this exhibit filed as the same exhibit number to the Company's
1997 second fiscal quarter report on Form 10-Q is incorporated herein by
reference.
S-3
<PAGE> 1
EXHIBIT 11
ITT EDUCATIONAL SERVICES, INC.
COMPUTATION OF PRIMARY AND FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net income.................................................. $19,123 $14,851 $11,391
======= ======= =======
Shares:
Weighted average number of shares of common stock
outstanding............................................ 27,000 27,000 27,000
Shares assumed issued (less shares assumed purchased for
treasury) on stock options................................ 105 92 32
------- ------- -------
Outstanding shares for primary earnings per share
calculation............................................... 27,105 27,092 27,032
======= ======= =======
Earnings per common share................................... $ .71 $ .55 $ .42
======= ======= =======
(Restated for FASB 128)
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Forms S-8 (Nos. 33-80435 and 333-38883) of ITT Educational
Services, Inc. of our report dated January 10, 1998, appearing on page F-1 of
this Form 10-K.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Indianapolis, Indiana
February 13, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 98,689
<SECURITIES> 0
<RECEIVABLES> 11,073
<ALLOWANCES> (1,393)
<INVENTORY> 0
<CURRENT-ASSETS> 112,958
<PP&E> 70,797
<DEPRECIATION> (47,911)
<TOTAL-ASSETS> 145,914
<CURRENT-LIABILITIES> 55,946
<BONDS> 0
0
0
<COMMON> 270
<OTHER-SE> 87,545
<TOTAL-LIABILITY-AND-EQUITY> 145,914
<SALES> 0
<TOTAL-REVENUES> 261,654
<CGS> 0
<TOTAL-COSTS> 235,441
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,354
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 31,788
<INCOME-TAX> 12,665
<INCOME-CONTINUING> 19,123
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,123
<EPS-PRIMARY> 0.71
<EPS-DILUTED> 0.71
</TABLE>
