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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, 1998
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)
DELAWARE 36-2061311
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
5975 CASTLE CREEK PARKWAY N. DRIVE 46250-0466
P.O. BOX 50466 (Zip Code)
INDIANAPOLIS, INDIANA
(Address of principal executive offices)
Registrant's telephone number, including area code (317) 594-9499
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
registered
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE, INC.
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 /X/
$912,756,883
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock at February 11, 1999
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
25,526,452
Number of shares of Common Stock, $.01 par value, outstanding at February
11, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents have been incorporated by reference into
this Annual Report on Form 10-K
IDENTITY OF DOCUMENT PARTS OF FORM 10-K INTO WHICH DOCUMENT
IS INCORPORATED
Definitive Proxy Statement for the PART III
Annual Meeting of Shareholders to be
held May 11, 1999
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ITT EDUCATIONAL SERVICES, INC.
INDIANAPOLIS, INDIANA
ANNUAL REPORT TO SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 1998
PART I
ITEM 1. BUSINESS.
YOU SHOULD KEEP IN MIND THE FOLLOWING POINTS AS YOU READ THIS REPORT:
- REFERENCES IN THIS DOCUMENT TO "WE," "US," "OUR" AND "ESI" REFER TO ITT
EDUCATIONAL SERVICES, INC. AND ITS SUBSIDIARIES. REFERENCES TO "ITT" REFER
TO ITT CORPORATION, A NEVADA CORPORATION, AND ITS SUBSIDIARIES. REFERENCES
TO "STARWOOD HOTELS" REFER COLLECTIVELY TO STARWOOD HOTELS & RESORTS
WORLDWIDE, INC., A MARYLAND CORPORATION FORMERLY KNOWN AS STARWOOD LODGING
CORPORATION, AND ITS SUBSIDIARIES.
- THE TERMS "ITT TECHNICAL INSTITUTES," "TECHNICAL INSTITUTES" OR
"INSTITUTES" (IN SINGULAR OR PLURAL FORM) REFER TO THE INDIVIDUAL SCHOOLS
OWNED AND OPERATED BY ESI. THE TERMS "INSTITUTION" OR "CAMPUS GROUP" (IN
SINGULAR OR PLURAL FORM) MEAN A MAIN CAMPUS AND ITS ADDITIONAL LOCATIONS
OR BRANCH CAMPUSES, IF ANY.
- UNLESS WE TELL YOU OTHERWISE, ALL INFORMATION IN THIS REPORT HAS BEEN
ADJUSTED TO REFLECT A THREE-FOR-TWO STOCK SPLIT OF OUR COMMON STOCK
OCCURRING ON APRIL 15, 1996 AND A THREE-FOR-TWO STOCK SPLIT OF OUR COMMON
STOCK OCCURRING ON NOVEMBER 4, 1996.
BACKGROUND
We are a Delaware corporation incorporated in 1946. Prior to our initial
public offering, which we completed on December 27, 1994, we were a wholly owned
subsidiary of ITT Corporation, formerly a Delaware corporation and now known as
ITT Industries, Inc., an Indiana corporation ("Old ITT"). Old ITT acquired us in
1966, and we changed our name to ITT Educational Services, Inc. in 1969. Our
principal executive offices are located at 5975 Castle Creek Parkway, North
Drive, Indianapolis, Indiana 46250, and our telephone number is (317) 594-9499.
On September 29, 1995, ITT succeeded to the interests of Old ITT in the
beneficial ownership of 83.3% of our common stock, as part of the division of
Old ITT's businesses among itself and two of its wholly owned subsidiaries
(including ITT) and distribution of all the outstanding common stock of ITT and
the other subsidiary to the shareholders of Old ITT, which occurred on December
19, 1995. On February 23, 1998, Starwood Hotels acquired ITT. On June 9, 1998,
ITT sold 13,050,000 shares of our common stock in a public offering, reducing
ITT's beneficial ownership to 35%. On February 1, 1999, ITT sold 7,950,000
shares of our common stock in a public offering (the "February 1999 Offering")
and we repurchased 1,500,000 shares of our common stock from ITT, completely
eliminating ITT's beneficial ownership.
OVERVIEW
We are a leading provider of technology-oriented postsecondary degree
programs in the United States based on revenues and student enrollment. We offer
associate, bachelor and master degree programs and non-degree diploma programs
to approximately 25,000 students. We currently have 67 institutes located in 27
states. We design our education programs, after consultation with employers, to
help graduates begin to prepare for careers in various fields involving
technology. As of December 31, 1998, approximately 99% of our students were
enrolled in a degree program, with approximately 74% enrolled in electronics
engineering technology ("EET") related programs and approximately 23% enrolled
in computer-aided drafting technology ("CAD") related programs. Employers who
have hired
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our graduates primarily include small, technology companies, but also include
large corporations, such as AT&T, Intel, Microsoft and General Electric.
Additionally, many federal and local government agencies, including the Federal
Bureau of Investigation and the Central Intelligence Agency, have hired our
graduates. We have provided career-oriented education programs for over 30 years
and our institutes have graduated over 125,000 students since 1976.
We have grown significantly during the past 18 years. Of the 67 institutes
we currently operate, we established 53 from January 1, 1981 through December
31, 1998. We established 17 of these institutes in our last five fiscal years.
The number of students attending our institutes has increased 29% from 19,860 on
December 31, 1993 to 25,608 on December 31, 1998. Total revenues increased 72%
from $169.0 million in 1993 to $291.4 million in 1998, an 11.5% compound annual
growth rate. Operating income increased 141% from $13.8 million in 1993 to $33.4
million in 1998, a 19.2% compound annual growth rate. Net income, excluding
one-time expenses, increased 179% from $8.3 million in 1993 to $23.2 million in
1998, a 22.7% compound annual growth rate.
We opened three new institutes in each of 1997 and 1998 and two new
institutes in January 1999. In addition, in 1998 we launched our first
information technology program, Computer Network Systems Technology, at three
institutes. We plan to open two additional new institutes in the remainder of
1999. We intend to continue expanding by opening new institutes and offering a
broader range of programs at our existing institutes, including several new
information technology programs.
We expect 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 U.S.
Department of Education ("DOE"), data from the Bureau of Labor Statistics and
data collected in the Current Population Survey conducted by the Bureau of the
Census:
- a 24% projected increase in the number of new high school graduates from
approximately 2.5 million in 1994 to approximately 3.1 million in 2004;
- the relatively small percentage of adults over age 25 who possess a
bachelor degree (approximately 23% in 1995);
- an increasing number of high school graduates attending postsecondary
educational institutions (65% in 1996 versus 53% in 1983);
- a projected increase of 1.1 million in the number of new information
technology jobs between 1996 and 2006; and
- a heightened recognition of the importance of postsecondary education to
an individual's career prospects.
We believe that we are well positioned to take advantage of the increasing
demand for postsecondary education programs for the following reasons:
EMPLOYMENT ORIENTED EDUCATION. Our institutes offer curricula designed to
teach the technical knowledge and skills desired by many employers for
entry-level positions. Unlike the undergraduate curriculum offered by many
two-and four-year colleges, we have designed our undergraduate curriculum, after
consultation with employers, to help graduates begin to prepare for careers in
various fields involving technology. Our headquarters curriculum managers, as
well as advisory committees comprised of representatives of employers, review
our curricula on a regular basis to respond to changes in technology and
industry needs. We believe that our graduate employment rates show the strength
of our programs and career services. Based on information provided by graduates
and employers, approximately 90% of our institutes' 1997 graduates, other than
graduates who continued in a bachelor degree program at one of our institutes,
had obtained employment or were already employed in fields involving their
programs of study as of April 24, 1998, the end of the most recently completed
statistical year.
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PROGRAMS DESIGNED FOR THE CONVENIENCE OF STUDENTS. We design the programs
offered by our institutes to provide students flexibility in scheduling classes.
Each of our institutes operates year-round and offers undergraduate programs 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. We
typically offer classes in most of our programs in four-hour sessions, five days
a week, generally in the morning, afternoon and evening, which allows our
students to work while attending our institutes. Programs of study are
substantially standardized throughout our institutes, providing greater
uniformity and enabling students to transfer, if necessary, to the same program
offered at another institute with less disruption to their education. We believe
this standardization also provides curriculum quality and consistency throughout
our institutes, which increases the marketability of our graduates to employers.
FINANCIAL STRENGTH AND REGULATORY COMPLIANCE. We believe that our financial
strength enables us to capitalize on expansion opportunities, while devoting
resources to complying with federal and state regulatory requirements. As of
December 31, 1998, after giving effect to our stock repurchase, we would have
had $70.2 million in cash and marketable debt securities and no debt.
BUSINESS STRATEGY
Our strategy is to pursue multiple opportunities for growth. We are
implementing a business plan designed to increase revenues and operating
efficiencies by increasing the number of program offerings and student
enrollment at existing institutes and by opening new institutes across the
United States. The principal elements of this strategy include the following:
ENHANCE RESULTS AT THE INSTITUTE LEVEL.
INCREASE ENROLLMENTS AT EXISTING INSTITUTES. In each of the last three
fiscal years, we increased our student enrollment at those institutes open
for more than 24 months by an average of approximately 5.1%. We believe that
current demographic and employment trends will allow us to enroll a greater
number of recent high school graduates. In addition, we intend to increase
recruiting efforts aimed at enrolling more working adults.
BROADEN AVAILABILITY OF CURRENT PROGRAM OFFERINGS. We intend to
continue expanding the number of program offerings at our existing
institutes. Our objective is to offer at least three programs at each
institute. Our 67 institutes provide significant potential for the
introduction of existing programs to a broader number of institutes. From
January 1, 1994 through December 31, 1998, we increased the number of
institutes which offer three or more programs from 16 to 33. We believe that
introducing new programs at existing institutes will attract more students.
In 1998, we increased the number of program offerings at 12 existing
institutes, and in 1999 we intend to increase the number of program
offerings at approximately 35 additional existing institutes.
DEVELOP OR ACQUIRE ADDITIONAL DEGREE PROGRAMS. We plan to introduce
degree programs in additional fields of study and at different degree
levels. We have introduced five new degree programs at 16 institutes since
December 1995, which had approximately 750 students enrolled at December 31,
1998. In 1998, we launched our first program in information technology, an
associate degree program in Computer Network Systems Technology, at three
institutes. We intend to introduce this program at 27 additional institutes
in 1999 and we plan to begin testing three additional information technology
degree programs in 1999. We believe that introducing new programs can
attract a broader base of students and can motivate current students to
extend their studies.
EXTEND TOTAL PROGRAM DURATION. We have increased the number of
institutes that offer bachelor degree programs to graduates of our associate
degree programs. In our last five fiscal
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years, the number of our institutes which offer bachelor degree programs
increased from 13 to 28. As a result, the average combined total program
time a student remains enrolled in our programs has increased from 18 months
in 1986 to 24 months in 1998. The newly introduced associate degree program
in Computer Network Systems Technology is 24 months in duration. We expect
that the average combined total program time of our students will increase
further as additional bachelor degree programs are added at our institutes.
IMPROVE STUDENT OUTCOMES. We strive to improve the graduation and
graduate employment rates of our undergraduate students by providing
extensive academic and career services and dedicating significant
administrative resources to career services. From 1993 through 1997, the
percentage of graduates of our institutes (other than graduates who
continued in a bachelor degree program at one of our institutes) who were
employed or already working in fields involving their programs of study
increased from 83% to 90%.
INCREASE THE NUMBER OF OUR INSTITUTES. We plan to add new institutes at
sites throughout the United States. Using our proprietary methodology, we
determine locations for new institutes based on a number of factors, including
demographics and population and employment growth. We opened three new
institutes in each of 1997 and 1998 and two new institutes in January 1999. We
plan to open two additional new institutes in the remainder of 1999. New
institutes open for less than 24 months had a total of 644 students enrolled at
December 31, 1998. We will continue to consider acquiring schools located in
markets where our institutes are not presently located.
INCREASE MARGINS BY LEVERAGING FIXED COSTS AT INSTITUTE AND HEADQUARTERS
LEVELS. Our efforts to optimize school capacity and class size, have helped us
to increase student enrollment without incurring a proportionate increase in
fixed costs at our institutes. In addition, we have realized substantial
operating efficiencies by centralizing management functions and implementing
operational uniformity among our 67 institutes. Expenses incurred at our
headquarters (including the district offices) declined as a percentage of
revenues from 6.6% in 1994 to 5.1% in 1998 as a result of these operating
efficiencies. We will continue to seek to improve margins by increasing
enrollments and revenues without incurring a proportionate increase in fixed
costs at our institutes.
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PROGRAMS OF STUDY
We offer 15 degree programs and several diploma programs in various fields
of study. All of our institutes offer a degree or diploma program in EET and 59
institutes offer a degree or diploma program in CAD. Together the EET and CAD
programs comprise the core of our institutes' program offerings. The table below
sets forth information regarding the programs of study we offered as of December
31, 1998.
<TABLE>
<CAPTION>
NUMBER OF INSTITUTES OFFERING AT
DECEMBER 31, 1998
---------------------------------------
MASTER BACHELOR ASSOCIATE
PROGRAM OF STUDY DEGREE DEGREE DEGREE DIPLOMA
- ------------------------------------------------------------ ------ -------- --------- -------
<S> <C> <C> <C> <C>
Project Management.......................................... 1 -- -- --
Electronics Engineering Technology.......................... -- 19 63 2
Computer-Aided Drafting Technology.......................... -- -- 59 --
Automated Manufacturing Technology (1)...................... -- 5 -- --
Tool Engineering Technology (2)............................. -- -- 3 --
Architectural Engineering Technology (2).................... -- -- 3 --
Industrial Design (2)....................................... -- 3 -- --
Computer Visualization Technology (2)....................... -- 6 -- --
Chemical Technology......................................... -- -- 3 --
Telecommunications Engineering Technology (1)............... -- 3 -- --
Computer Network Systems Technology......................... -- -- 3 --
Hospitality (3)............................................. -- 1 1 --
Other Programs of Study (4)................................. -- -- 3 2
Total.....................................................
<CAPTION>
NUMBER OF STUDENTS ENROLLED AT
DECEMBER 31, 1998
------------------------------------------------
MASTER BACHELOR ASSOCIATE
PROGRAM OF STUDY DEGREE DEGREE DEGREE DIPLOMA TOTAL
- ------------------------------------------------------------ ------ -------- --------- ------- ------
<S> <C> <C> <C> <C> <C>
Project Management.......................................... 62 -- -- -- 62
Electronics Engineering Technology.......................... -- 932 17,421 91 18,444
Computer-Aided Drafting Technology.......................... -- -- 5,255 -- 5,255
Automated Manufacturing Technology (1)...................... -- 329 -- -- 329
Tool Engineering Technology (2)............................. -- -- 197 -- 197
Architectural Engineering Technology (2).................... -- -- 173 -- 173
Industrial Design (2)....................................... -- 98 -- -- 98
Computer Visualization Technology (2)....................... -- 213 -- -- 213
Chemical Technology......................................... -- -- 153 -- 153
Telecommunications Engineering Technology (1)............... -- 182 -- -- 182
Computer Network Systems Technology......................... -- -- 98 -- 98
Hospitality (3)............................................. -- 6 23 -- 29
Other Programs of Study (4)................................. -- -- 245 130 375
------ -------- --------- ------- ------
Total..................................................... 62 1,760 23,565 221 25,608
------ -------- --------- ------- ------
------ -------- --------- ------- ------
</TABLE>
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(1) EET related program.
(2) CAD related program.
(3) In our normal course of operations, we review the operations and viability
of all of our programs of study (including the marketing, recruitment and
enrollment procedures and materials relating to the programs) and, from time
to time, we make changes with respect to each of our programs. Due to the
continuing lack of profitability of the Hospitality programs, we have ceased
enrolling new students in the associate degree Hospitality program and
intend to cease offering the associate degree Hospitality program once all
students currently enrolled in the program have an opportunity to complete
it. We also intend to cease offering the bachelor degree Hospitality program
once all students currently enrolled in the program have an opportunity to
complete it and all students currently enrolled in the associate degree
Hospitality program have an opportunity to enroll in and complete the
bachelor degree Hospitality program.
(4) Other programs consist of Business Technology and Administration, Business
Management and Accounting, Automotive Service Technology and Heating/Air
Conditioning/Refrigeration.
As of December 31, 1998, approximately 74% of our students were enrolled in
EET related programs and approximately 23% were enrolled in CAD related
programs. We design our EET programs to help graduates begin to prepare for
careers in various fields involving EET by providing students a practical
education with respect to specific electronic circuits and specialized
techniques. Our bachelor degree EET program offers a broader foundation in EET
through the study of subjects such as circuit analysis, computer programming,
computer operating systems and advanced communications systems. Graduates of the
programs have obtained a variety of entry-level positions in various fields
involving EET, such as electronics product design and fabrication,
communications, computer technology, industrial electronics, instrumentation,
telecommunications and consumer electronics. We design our CAD program to help
graduates begin to prepare for careers in various fields involving CAD through
the teaching of computer-aided drafting techniques and conventional drafting
methods. Graduates have obtained a variety of entry-level positions in various
fields involving CAD, such as computer-aided drafting, electrical and
electronics drafting, mechanical drafting, architectural and construction
drafting, civil drafting, interior design and landscape architecture.
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We generally organize the academic schedule of undergraduate programs at our
institutes on the basis of four 12-week quarters of instruction with new
students beginning at the start of each academic quarter. Students can complete
our associate degree programs in eight academic quarters or less, and bachelor
degree programs in 12 academic quarters (including academic quarters completed
as part of a related associate degree program). We typically offer classes in
most programs 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 provides students with the flexibility to
pursue part-time employment opportunities. Based on student surveys, we believe
that a substantial majority of our students work at least part-time during their
programs of study.
We organize the academic schedule of the Master of Project Management
("MPM") program, currently our only graduate degree program of study, on a
non-term basis. Students attending the MPM program take one- to six-week courses
sequentially one at a time. Students can complete the MPM program in 21 months.
We typically offer classes in the MPM program 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. Our Indianapolis institute, which
offers the MPM program at various sites throughout Indiana, is the only
institute that presently offers the MPM program. The limited scope of the DOE's
recognition of the ACCSCT currently prevents us from offering the MPM program at
other institutes. It also prevents our students from participating in Title IV
Programs to pay their education costs. We have arranged for an unaffiliated,
private funding source to provide loans to the students in our MPM program.
Our institutes' 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 one of our
institutes involves practical study in a lab environment.
The content of technical courses in each program of study is substantially
standardized among our institutes to provide greater uniformity and to better
enable students to transfer, if necessary, to the same programs offered at other
institutes with less disruption to their education. We regularly review each
curriculum to respond to changes in technology and industry needs. Each of our
institutes has established an advisory committee for each field of study, which
is comprised of representatives of local employers. These advisory committees
assist our 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 1998 for
three consecutive academic quarters (the equivalent of an academic year at
traditional two- and four-year colleges) is $7,502 for the EET program and
$8,879 for the CAD program. We set a student's tuition cost for a program of
study at the time the student enrolls in the program, provided the student
remains continually enrolled in the program and does not repeat any courses. The
majority of students attending one of our institutes lived in that institute's
metropolitan area prior to enrollment. We do not provide any student housing.
STUDENT RECRUITMENT
We strive to attract students with the motivation and ability to complete
the career-oriented educational programs offered by our institutes. To generate
interest among potential students, we engage in a broad range of activities to
inform potential students and their parents about our institutes and the
programs they offer. These activities include television and other media
advertising, direct mailings and high school visits.
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We centrally coordinate and develop our television advertising. We direct
our television advertising at a combination of both the national market and the
local markets in which our institutes are located. Our television commercials
generally include a toll free telephone number for direct responses and
information about the location of our institutes in the area. We centrally
receive, track and promptly forward direct responses to our television
advertising to the appropriate institute representatives to contact prospective
students and schedule interviews. We target our direct mail campaigns at high
school students and other potential postsecondary students. We centrally
receive, track and forward responses to direct mail campaigns to the appropriate
institute representatives.
We employ a director of recruitment at each of our institutes, who reports
to the director of such institute. We centrally establish, but implement at the
local level, recruiting policies and procedures, as well as standards for hiring
and training representatives. We employ approximately 80 high school
coordinators who make thousands of presentations to students at high schools
annually. These coordinators promote our institutes and obtain information about
high school juniors and seniors who may be interested in attending our
institutes. As of December 31, 1998, we employed approximately 510 other
representatives to assist in local recruiting efforts. As of December 31, 1998,
approximately 255 representatives performed their services solely in student
recruitment offices located at each of our institutes, while approximately 255
representatives worked outside these offices and visited the homes of high
school seniors and other prospective students.
Local representatives of an 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. We have designed these interviews to establish a prospective student's
qualifications, academic background, interests, motivation and goals for the
future. Our interviewers typically show a video providing information about our
institutes and our programs of study to the prospective undergraduate students.
We pursue expressions of interest from potential graduate students by contacting
them and arranging for their attendance at an informational seminar providing
information about the institute and the MPM program.
We monitor the effectiveness of our various marketing efforts and try to
determine the extent to which each of our marketing efforts results in student
enrollments. We estimate that in 1998 television advertising produced 39% of
student enrollments at our institutes, high school coordinators accounted for
13%, referrals accounted for 14%, direct mail campaigns accounted for 9%,
associate degree graduates enrolling in a bachelor degree program accounted for
7% and the remaining 18% 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 our representatives. Our National Director of Recruitment
and the directors of field recruitment and training oversee the implementation
of recruitment policies and procedures. In addition, our internal audit
department generally reviews the recruiting practices relating to the execution
and completion of enrollment agreements at each of our institutes on an annual
basis.
STUDENT ADMISSIONS AND RETENTION
We strive to ensure that incoming students have the necessary academic
background to complete their chosen programs of study. We require all applicants
for admission to any of our institutes' associate degree or diploma programs to
have a high school diploma or a recognized equivalent and to pass an admissions
examination. Students interested in bachelor degree programs or the MPM program
must satisfy additional admissions criteria that generally require, among other
things: (1) 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
(2) in the case of the MPM program, the student first earn a bachelor degree and
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possess at least three years' full-time work experience. Students of varying
ages and backgrounds attend our institutes. At December 31, 1998, 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 32% of the students had some postsecondary educational experience
prior to entering one of our institutes for the first time. Approximately 34% of
the students were 19 years of age or younger, 35% 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, 1998, while total minority enrollment at our institutes (based on applicable
federal classifications) was approximately 38%.
The faculty and staff at each of our institutes 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, they also
have a negative regulatory, financial and marketing effect on the institute. To
minimize student withdrawals, each of our institutes devotes staff resources to
assist and advise students regarding academic and financial matters. We
encourage academic advising and tutoring in the case of undergraduate students
experiencing academic difficulties. We also offer assistance and advice to
undergraduate students looking for part-time employment and housing. In
addition, we consider factors relating to student retention in the performance
evaluation of all our instructors.
Students are most likely to withdraw before they begin their second academic
quarter of study at our institutes. Approximately 22% of all students who enroll
in our institutes withdraw before their second academic quarter of study and
approximately 23% withdraw at some point after the start of their second
quarter. As a result, new 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 one of our institutes.
GRADUATE EMPLOYMENT
Our institutes have graduated over 125,000 students since 1976. We believe
that the success of graduates from undergraduate programs who begin their
careers in fields involving their programs of study is critical to the ability
of our institutes to continue to recruit undergraduate students. We try to
obtain data on the number of undergraduate students employed following
graduation. The reliability of such data depends largely on information that
students and employers report to us. Based on this information, we believe that
students graduating from our institutes' undergraduate programs during the years
listed below obtained employment or were already employed in fields involving
their programs of study by June 30 or earlier of the year following graduation,
as set forth below:
<TABLE>
<CAPTION>
PERCENT OF EMPLOYABLE
GRADUATES WHO OBTAINED
NUMBER OF EMPLOYMENT OR WERE ALREADY
EMPLOYABLE EMPLOYED IN FIELDS INVOLVING
YEAR OF GRADUATION GRADUATES(1) THEIR PROGRAMS OF STUDY
- ------------------------------------------------------- ------------- -------------------------------
<S> <C> <C>
1997................................................... 8,248 90%
1996................................................... 8,422 88%
1995................................................... 8,005 87%
1994................................................... 7,459 85%
1993................................................... 7,015 83%
</TABLE>
- ------------------------
(1) Employable graduates exclude graduates who continue in a bachelor degree
program at one of our institutes.
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Each of our institutes employs personnel to offer students and graduates of
undergraduate programs career services. These persons assist in job searches and
solicit employment opportunities from employers. In addition, undergraduate
students receive instruction during their programs of study on job search
techniques, the use of relevant reference materials, the composition of resumes
and letters of introduction and the appropriate preparation, appearance and
conduct for interviews. We do not offer career services to students in the
graduate program of study. The increase in employment rates set forth in the
table above may also be due in part to improved conditions in the economy as a
whole.
Based on information from students and employers who responded to our
inquiries, we estimate that average annual starting salaries reported for 1997
graduates of certain programs offered by our institutes who obtained employment
or were already employed in fields involving their programs of study were as
follows:
<TABLE>
<CAPTION>
NUMBER OF
EMPLOYABLE AVERAGE ANNUAL
GRADUATES SALARY UPON
PROGRAM OF STUDY IN 1997(1) GRADUATION
- ------------------------------------------------------------------------------------- ------------- --------------
<S> <C> <C>
Automated Manufacturing Technology (Bachelor Degree)................................. 310 $ 28,440
Electronics Engineering Technology (Bachelor Degree)................................. 786 $ 27,228
Industrial Design (Bachelor Degree).................................................. 57 $ 26,592
Computer-Aided Drafting Technology, Tool Engineering Technology and Architectural
Engineering Technology (Associate Degree and Diploma).............................. 2,429 $ 21,286
Electronics Engineering Technology (Associate Degree and Diploma).................... 4,271 $ 23,172
</TABLE>
- ------------------------
(1) Employable graduates exclude graduates who continue in a bachelor degree
program at one of our institutes.
Average annual salaries upon graduation for our graduates may vary
significantly among our institutes depending on local employment conditions and
each graduate's background. Initial employers of graduates from our institutes'
undergraduate programs include both small, technology-oriented companies and
well recognized corporations.
FACULTY
We hire faculty members in accordance with criteria established by us, the
accrediting commissions that accredit our institutes and the state education
authorities that regulate our institutes. We strive 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
chairs for a program of study, and various categories of instructors. As of
December 31, 1998, our institutes employed 1,101 full-time faculty members and
302 part-time faculty members. The ratio of our total number of students to all
full-time instructors at our institutes is approximately 27 to 1.
ADMINISTRATION AND EMPLOYEES
Each of our institutes is administered by a director who has overall
responsibility for the management of the institute. The administrative staff of
each institute also includes a director of recruitment, a director of career
services, a director of finance and a director of education. We employ
approximately 160 people at our corporate headquarters in Indianapolis, Indiana.
As of December 31, 1998, we had approximately 3,120 full-time and regular
part-time employees. In addition, we employed approximately 445 students as
laboratory assistants and in other part-time positions at that date. None of our
employees are represented by labor unions.
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Our headquarters provides centralized services to all of our institutes in
the following areas:
- accounting
- marketing
- public relations
- curricula development
- purchasing
- human resources
- regulatory and legislative affairs
- real estate
In addition, national directors of each of the following major institute
functions reside at our headquarters and develop policies and procedures to
guide these functions at our institutes:
- recruiting
- finance
- education
- career services
Managers located at our headquarters closely monitor the operating results
of each of our institutes 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. Our institutes compete for students with four-year and two-year
degree-granting institutions, which include nonprofit public and private
colleges and for-profit institutions, as well as with alternatives to higher
education such as military service or immediate employment. We believe
competition among educational institutions is based on the quality of the
educational program, perceived reputation of the institution, cost of the
program and employability of graduates. Certain public and private colleges may
offer programs similar to those offered by our institutes at a lower tuition
cost due in part to government subsidies, foundation grants, tax deductible
contributions or other financial resources not available to for-profit
institutions. Other for-profit institutions offer programs that compete with
those of our institutes. Certain of our competitors in both the public and
private sector have greater financial and other resources than we do.
FEDERAL AND OTHER FINANCIAL AID PROGRAMS
In 1998, we indirectly derived approximately 69% of our revenues from Title
IV Programs. Our institutes' students also rely on state financial aid programs,
family contributions, personal savings, employment and other resources to pay
their educational expenses. Students at our institutes receive grants and loans
to fund the cost of their education under the following Title IV Programs:
- the Federal Family Education Loan ("FFEL") program, which accounted in
aggregate for approximately 56% of our revenues in 1998;
- the Federal Pell Grant ("Pell") Pell program, which accounted in aggregate
for approximately 12% of our revenues in 1998;
- the William D. Ford Federal Direct Loan ("FDL") program, which accounted
in aggregate for approximately 3% of our revenues in 1998;
- the Federal Work-Study ("Work-Study") program, which makes federal funds
available to provide part-time employment to students and under which our
institutes employed approximately 550 students and paid $1,360,000 in
student wages in 1998;
- the Federal Perkins Loan ("Perkins") program, which accounted in aggregate
for less than 1% of our revenues in 1998; and
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- the Federal Supplemental Educational Opportunity Grant ("SEOG") program,
which accounted in aggregate for less than 1% of our revenues in 1998.
The Work-Study, Perkins and SEOG programs each require our institutions to
make a matching contribution in the amount of 25% of the federal funds the
institution receives from the DOE under those programs. In 1998, our 25%
matching contribution amounted to $340,000 for the Work-Study program, $240,000
for the Perkins program and $15,000 for the SEOG program.
In 1998, we indirectly derived approximately 3% of our revenues from state
financial aid programs and our students were awarded $1,181,000 in institutional
scholarships. We also provide tuition discounts to our full-time employees and
their dependents to attend our institutes. For 1998, the cost of these employee
educational discounts was $784,000.
REGULATION OF FEDERAL FINANCIAL AID PROGRAMS
In order to participate in federal student financial aid programs under
Title IV (the "Title IV Programs") of the Higher Education Act of 1965, as
amended (the "HEA"), our institutions must each comply with the standards set
forth in the HEA and the regulations promulgated thereunder by the DOE. The
purpose of these standards is 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. Thirty of our 67 institutes are
main campuses and 37 are 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 or authorities and accredited by an accrediting commission recognized
by the DOE. Sixty-four of our 67 institutes currently participate in Title IV
Programs. This number includes our institute in Garland, Texas which
participates in the Pell, Perkins and Work-Study programs, but is ineligible to
participate in the FFEL and FDL programs until at least October 1, 2000, due to
its high student loan default rates. See "--Student Loan Defaults." The other
three institutes, which we recently opened, have begun the certification process
to participate in Title IV Programs.
The DOE and other regulatory authorities subject for-profit providers of
postsecondary education to increased scrutiny and regulation as a result of
concern about fraud and abuse of Title IV Programs by some for-profit
institutions. We believe that all of our institutes substantially comply with
the HEA and its implementing regulations. We 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
us or any of our institutes could have a material adverse effect on our
financial condition, results of operations or cash flows. In addition, it is
possible that the HEA and its implementing regulations may be applied in a way
that could hinder our operations or expansion plans.
Significant factors relating to Title IV Programs that could adversely
affect us include the following:
LEGISLATIVE ACTION. Political and budgetary concerns significantly affect
Title IV Programs. The U.S. Congress must reauthorize the HEA approximately
every six years. The most recent reauthorization, which occurred in October
1998, reauthorized the HEA through 2003. The U.S. Congress reauthorized all of
the Title IV Programs in which our institutes participate, generally in the same
form and at funding levels no less than for the prior year. Amendments to the
HEA enacted in connection with the U.S. Congress' reauthorization of the HEA in
October 1998 (the "1998 HEA Amendments"), however, revised the following
provisions, among others:
- the effect of cohort default rates on the FFEL, FDL, Perkins and Pell
programs;
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<PAGE>
- the amount of Title IV Program funds an institution may retain for a
student who withdraws from the institution;
- the "85/15" Rule; and
- the change of ownership procedures.
See "--Student Loan Defaults," "--Institutional Refunds," "--The '85/15' Rule"
and "--Change in Control."
In addition, the U.S. Congress reviews and determines federal appropriations
for Title IV Programs on an annual basis. The U.S. Congress can also make
changes in the laws affecting Title IV Programs in those annual appropriations
bills and in other laws it enacts between HEA reauthorizations. Since a
significant percentage of our revenues are indirectly derived from Title IV
Programs, any action by the U.S. Congress that significantly reduces Title IV
Program funding or the ability of our institutes or students to participate in
Title IV Programs could have a material adverse effect on our financial
condition or results of operations.
If one of our institutes lost its eligibility to participate in Title IV
Programs, or if the amount of available Title IV Program funding was
significantly reduced, we would try 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 we believe that one or
more private organizations would be willing to provide loans to students
attending one of our institutes, we cannot assure you 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 private organizations would require
us to guarantee all or part of this assistance and we might incur other
additional costs. If we provided more direct financial assistance to our
students, we would incur additional costs and assume increased credit risks.
Legislative action may also increase our administrative costs and burden and
require us to adjust our practices in order for our institutes to comply fully
with the legislative requirements, which could have a material adverse effect on
our financial condition or results of operations.
STUDENT LOAN DEFAULTS. Under the HEA, an institution may lose its
eligibility to participate in some or all Title IV Programs, if the rates at
which the institution's students default on their federal student loans exceed
specified percentages. The DOE calculates these rates on an institutional basis,
based on the number of students who have defaulted, not the dollar amount of
such defaults. The DOE calculates an institution's cohort default rate 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 the 1994 federal fiscal year, each institution participating
in the FFEL program received an FFEL cohort default rate. Beginning with the
1995 federal fiscal year, the DOE also included loans under the FDL program 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 the programs in which the institution participated.
An institution whose FFEL/FDL cohort default rate is 25% or greater for three
consecutive federal fiscal years loses eligibility to participate in the FFEL
and FDL programs for the remainder of the federal fiscal year in which the DOE
determines that the institution has lost its eligibility and for the two
subsequent federal fiscal years. An institution can appeal this loss of
eligibility. In addition, the 1998 HEA Amendments provide that if an institution
becomes ineligible to participate in the FFEL and FDL programs following the
publication of its 1996 (or any subsequent) federal fiscal year FFEL/FDL cohort
default rate, the institution will also be ineligible to participate in the Pell
program for the same period of time. During the pendency of any appeal of its
FFEL/FDL cohort default rate, the institution remains eligible to participate in
the FFEL, FDL and Pell programs.Beginning with the 1996 federal fiscal year
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<PAGE>
FFEL/FDL cohort default rates, if an institution continues its participation in
the FFEL and/or FDL programs during the pendency of any such appeal and the
appeal is unsuccessful, the institution must pay the DOE the amount of interest,
special allowance, reinsurance and any related payments paid by the DOE (or
which the DOE is obligated to pay) with respect to the FFEL and FDL program
loans made to the institution's students or their parents that would not have
been made if the institution had not continued its participation (the "Direct
Costs"). If a substantial number of our campus groups were subject to losing
their eligibility to participate because of their FFEL/FDL cohort default rates,
the potential amount of the Direct Costs for which we would be liable if our
appeals were unsuccessful would prevent us from continuing some or all of the
affected campus groups' participation in the FFEL and/or FDL programs during the
pendency of those appeals. In addition to the consequences resulting from an
institution having three years of FFEL/FDL cohort default rates of 25% or
greater, the DOE may limit, suspend or terminate the eligibility to participate
in all Title IV Programs of an institution whose FFEL/FDL cohort default rate
for any single federal fiscal year exceeds 40%.
None of our campus groups had an FFEL/FDL cohort default rate equal to or
greater than 25% for the 1996 federal fiscal year, the most recent year for
which the DOE has published FFEL/FDL cohort default rates. One of our campus
groups, consisting only of the institute in Garland, Texas, had FFEL/FDL cohort
default rates exceeding 25% for three consecutive federal fiscal years beginning
with the 1993 federal fiscal year. Consequently, in June 1998, the Garland
institute became ineligible to participate in the FFEL and FDL programs. The
Garland institute accounted for approximately 1.4% of our revenues in 1998. The
Garland institute can reapply to the DOE to regain its eligibility to
participate in the FFEL and FDL programs on or after October 1, 2000. The
Garland institute had an FFEL/FDL cohort default rate of 19.2% for the 1996
federal fiscal year. We have arranged for an unaffiliated, private funding
source to provide loans to the students enrolled in the Garland institute. This
alternative financing source requires us to guarantee repayment of the loans it
issues. Based on our experience with the repayment of Title IV Program loans by
students who attended the Garland institute, we believe that such guaranty
should not result in a material adverse effect on our financial condition,
results of operations or cash flows. We have also decided to stop enrolling new
students in the Garland institute, at least temporarily, while we continue
teaching the students already enrolled. We are considering whether to close the
Garland institute once the students already enrolled have completed their
programs of study or transferred to another school.
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, the DOE
may place that institution on provisional certification status. A federal award
year runs from July 1 through June 30. One of the reasons that the Garland and
San Antonio, Texas institutes were provisionally recertified for participation
in Title IV Programs following Starwood Hotels' acquisition of ITT was because
their FFEL/FDL cohort default rates exceeded 25% for at least one of the three
most recent federal fiscal years. The DOE told each of those institutes that it
would remain provisionally certified until its FFEL/FDL cohort default rates for
three consecutive federal fiscal years are all below 25%. Twenty-seven of our
campus groups (consisting of 59 institutes) had a Perkins cohort default rate in
excess of 15% for students who were scheduled to begin repayment in the
1996/1997 federal award year, the most recent year for which such rates have
been calculated. The DOE could place these institutes on provisional
certification status based on their Perkins cohort default rates. To date, the
DOE has not placed any of our campus groups on provisional certification status
because of their Perkins cohort default rates.
Beginning with the 2000 federal fiscal year, an institution whose Perkins
cohort default rate is 50% or greater for three consecutive federal award years
loses eligibility to participate in the Perkins program 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. An institution
can appeal the loss of eligibility. During the pendency of any such appeal, the
DOE may permit the institution to continue
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participating in the Perkins program. An institution that loses its eligibility
to participate in the Perkins program due to its Perkins cohort default rates
must also return the federal portion of its Perkins loan fund to the DOE. None
of our campus groups had a Perkins cohort default rate equal to or greater than
50% for the 1996/1997 federal award year.
The HEA subjects institutions with a Perkins cohort default rate of 20% or
greater to a "default penalty" that reduces the amount of additional federal
funds allocated annually to the institution for use in the Perkins program. The
"default penalty" for each year through the 1999 federal fiscal year is:
- 10%, if the institution's Perkins cohort default rate is at least 20% but
less than 25%;
- 30%, if the institution's Perkins cohort default rate is at least 25% but
less than 30%; or
- 100%, if the institution's Perkins cohort default rate is 30% or greater.
For the 1996/1997 federal award year, six of our campus groups (consisting of 17
institutes) had a Perkins cohort default rate of at least 20% but less than 25%,
ten of our campus groups (consisting of 20 institutes) had a Perkins cohort
default rate of at least 25% but less than 30%, and nine of our campus groups
(consisting of 19 institutes) had a Perkins cohort default rate of 30% or
greater. Beginning with the 2000 federal fiscal year, there is no "default
penalty" if the institution's Perkins cohort default rate is below 25%, and the
"default penalty" is 100% if the rate is 25% or greater.
The HEA requires an institution with a Perkins cohort default rate of 15% or
greater to establish a default reduction plan. Each of our institutes has
developed such a plan. The Perkins loans disbursed to our students amounted to
less than 1% of our revenues in 1998. Less than half of our institutes disbursed
their entire allocation in 1998. As a result, we do not believe that our
financial condition or results of operations would be materially affected if all
of our campus groups lost their eligibility to participate in the Perkins
program or if there were a reduction in additional federal funds allocated to
our campus groups for use in the Perkins program pursuant to a "default
penalty." See "--Regulation of Federal Financial Aid Programs--Administrative
Capability" and "--Eligibility and Certification Procedures."
The HEA requires an institution that undergoes a change in control to
develop an FFEL/FDL default management plan and to implement the plan for at
least two years following the change in control. All of our campus groups have
implemented a default management plan that we developed in accordance with the
DOE's default reduction measures.
The servicing and collection efforts of student loan lenders and guaranty
agencies help to control our FFEL/FDL cohort default rates. We are not
affiliated with any student loan lenders or guaranty agencies. We supplement
their 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. We have also contracted with third-party
servicers who provide additional assistance in reducing defaults under the FFEL,
FDL and Perkins programs by students who attended some of our 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. As a part
of the DOE's review of the applications of our campus groups to have their
eligibility to participate in Title IV Programs reinstated after Starwood
Hotels' acquisition of ITT, the DOE evaluated the financial responsibility of
all of our campus groups. The DOE determined that each campus group satisfied
the DOE's financial responsibility standards following the acquisition, but the
DOE directed us to address certain issues related to our financial condition and
financial statements. See "--Change in Control."
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The DOE's current standards of financial responsibility, effective as of
July 1, 1998, involve three ratios:
- the equity ratio, which measures the institution's capital resources,
ability to borrow and financial viability;
- the primary reserve ratio, which measures the institution's ability to
support current operations from expendable resources; and
- the net income ratio, which measures the ability of an institution to
operate at a profit.
The DOE assigns a strength factor to the results of each of these ratios on a
scale from negative 1.0 to positive 3.0, with negative 1.0 reflecting financial
weakness and 3.0 reflecting financial strength. The DOE then weights an
institution's strength factors based on an assigned weighting percentage for
each ratio and adds the weighted scores for the three ratios 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. We have calculated that the application of these new
regulations to our audited financial statements for our 1998 fiscal year results
in a composite score of 3.0. We believe that we would also meet the DOE's new
standards of financial responsibility for 1998 on a pro forma basis after giving
effect to the stock repurchase.
Historically, the DOE has evaluated the financial condition of our
institutes on a consolidated basis based on our financial statements. The DOE's
regulations, however, permit the DOE to examine our financial statements, the
financial statements of each campus group, and the financial statements of any
related party. If the DOE determines that an institution does not satisfy the
DOE's financial responsibility standards, that institution may establish its
financial responsibility on an alternative basis by, among other things:
- posting a letter of credit in an amount equal to at least 50% of the total
Title IV Program funds received by the institution during the
institution's most recently completed fiscal year;
- posting a letter of credit in an amount equal to at least 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 while being provisionally certified; or
- complying with additional monitoring requirements of the DOE 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 an
institution 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 recently
completed fiscal year, if the institution has made late refunds in its two most
recently completed fiscal years. The DOE considers an institution to have made
late refunds under this standard, if the Title IV Program independent compliance
audit (or any review by the DOE, state or guaranty agency) of the institution
for either such fiscal year: (1) finds that at least 5% of the institution's
refunds were late; or (2) notes a material weakness or reportable condition
related to refunds in the institution's report on internal controls. Our Title
IV Program independent compliance audits for our 1996 and 1997 fiscal years
demonstrate that, in accordance with the DOE's criteria, our campus groups made
timely refunds in each of these fiscal years. No review by the DOE, a state or
guaranty agency has found that any of our institutes was making late refunds
under the DOE's standard. Based on our current understanding of how the DOE will
apply the current financial responsibility standards, we do not believe that
these standards will have a material adverse effect on our financial condition,
results of operations or expansion plans.
INSTITUTIONAL REFUNDS. Prior to the 1998 HEA Amendments, the HEA limited
how much an institution could charge a student who withdrew from the
institution. A student was only obligated for
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a pro rata portion of the education costs charged by the institution, if the
student withdrew during the first 60% of the student's first period of
enrollment. For our institutes, a period of enrollment is generally an academic
quarter. A student who withdrew after the first period of enrollment was also
subject to a refund calculation, but it was not a straight pro rata calculation.
The institution had to refund any monies it collected in excess of the pro rata
or other applicable portion to the appropriate lenders or Title IV Programs in a
particular order.
The 1998 HEA Amendments rescinded the limitation on how much an institution
can charge a withdrawing student, but the standards of most state education
authorities that regulate our institutes (the "SEAs") and the two accrediting
commissions that accredit our institutes (the "Accrediting Commissions")
continue to impose such a limitation. The 1998 HEA Amendments imposed a limit on
the amount of Title IV Program funds a withdrawing student can use to pay his or
her education costs. This new limitation permits a student to use only a pro
rata portion of the Title IV Program funds that the student would otherwise be
eligible to use, if the student withdraws during the first 60% of any period of
enrollment. The institution must refund to the appropriate lenders or Title IV
Programs any Title IV Program funds that the institution receives on behalf of a
withdrawing student in excess of the amount the student can use for such period
of enrollment. The new refund requirements contained in the 1998 HEA Amendments
become effective in October 2000, but an institution may elect to begin
complying with these new standards at an earlier date. We do not plan to elect
to comply with these new standards prior to October 2000.
Depending on the refund policies of the applicable SEAs and Accrediting
Commission, in a variety of instances withdrawing students will still be
obligated to the institution under the new HEA refund requirements for education
costs that the students can no longer pay with Title IV Program funds. In these
instances, we expect that many withdrawing students will be unable to pay such
costs and that we will be unable to collect a significant portion of such costs.
Title IV Program funds are generally paid sooner and are more collectible than
tuition payments from other sources. As a result, if the new refund requirements
remain unchanged, they could have a material adverse effect on our financial
condition, results of operations and cash flows beginning with our 2001 fiscal
year.
THE "85/15" RULE. Under a provision of the HEA commonly referred to as the
"85/15" Rule, a for-profit institution, such as each of our campus groups,
becomes ineligible to participate in Title IV Programs if, on a cash accounting
basis, the institution derives more than 85% of its applicable revenues for a
fiscal year from Title IV Programs. If any of our campus groups violated the
85/15 Rule for any fiscal year, they 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 their eligibility until the next fiscal year. Furthermore, if
one of our campus groups 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 require the institution to repay all Title IV Program funds
disbursed to the institution after the effective date of the loss of
eligibility. For each of our 1997 and 1998 fiscal years, none of our campus
groups derived more than 79% of its revenues from Title IV Programs. For our
1998 fiscal year, the range for our campus groups was from approximately 58% to
approximately 79%. The 1998 HEA Amendments increased the percentage of
applicable revenues that a for-profit institution can derive from Title IV
Programs from 85% to 90%. The DOE has indicated orally that it will apply this
amendment beginning with our 1998 fiscal year. The 5% increase in the percentage
of applicable revenues that we can derive from Title IV Programs will increase
the aggregate amount of Title IV Program funds that students can use to pay
their education costs of attending our institutes. Title IV Program funds are
generally paid sooner and are more collectible than tuition payments from other
sources. As a result, this 5% increase should have a positive impact on our
results of operations and cash flows beginning in our 1999 fiscal year.
Due to the expansion and increased availability of funding under certain
Title IV Programs in recent years, we believe that students have increasingly
relied on Title IV Programs to finance their
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education and will probably continue to do so. Our students' reliance on Title
IV Programs increases the prospect that we will indirectly derive a greater
percentage of our revenues from Title IV Programs. In an effort to prevent any
future loss of Title IV Program eligibility by any of our campus groups as a
result of the current 85/15 Rule and future 90/10 Rule, we have implemented
various measures to limit the percentage of applicable revenues we indirectly
derive from Title IV Programs. Some of these alternatives require us to incur
additional costs.
ADDITIONAL LOCATIONS AND PROGRAMS. Our expansion plans assume we will be
able to continue to obtain the necessary DOE, Accrediting Commission and SEA
approvals to establish new institutes as additional locations of existing main
campuses and to expand the program offerings at our existing institutes. From
1996 through 1998, we established nine new additional locations, eight of which
are participating in Title IV Programs and one of which is in the process of
obtaining certification to participate in Title IV Programs, and added 32
programs at our existing institutes. The HEA requires a for-profit institution
to operate for two years before it can qualify to participate in Title IV
Programs. An institution that is certified to participate in Title IV Programs
can establish additional locations that may, after review by the DOE,
participate in Title IV Programs without satisfying the two-year requirement, so
long as each additional location satisfies all other applicable requirements.
The HEA and applicable regulations permit students to use Title IV Program
funds only to pay the cost associated with enrollment in an eligible program
offered by an institution participating in Title IV Programs. The HEA and
applicable regulations do not restrict the number or delay the introduction of
educational programs that an institution may offer, but each new program must
satisfy all applicable eligibility requirements.
The Accrediting Commission of Career Schools and Colleges of Technology
("ACCSCT") accredits 61 of our institutes, and the Accrediting Council for
Independent Colleges and Schools ("ACICS") accredits three of our institutes.
The ACCSCT standards generally permit an institution's main campus to establish
an additional location, unless the main campus:
- is on probation;
- is subject to a show cause order;
- is subject to outcomes reporting, unless the ACCSCT has expressly
permitted it to establish an additional location;
- has applied for accreditation for an additional location within the past
two years; or
- has undergone a change in control during the past year. This restriction
generally does not apply to an accreditation application for an additional
location submitted prior to the change in control.
The ACICS standards generally permit an institution's main campus to
establish an additional location, unless:
- the main campus is on probation;
- either the main campus or any of its additional locations is subject to a
show cause order;
- either the main campus or any of its additional locations is subject to a
financial or outcomes review, unless the ACICS has expressly permitted it
to establish an additional location; or
- the main campus has 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, unless the institute is
on probation or is 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, unless: (1) the institute is on probation; or (2) either the
main
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campus or any of its additional locations is subject to a financial or outcomes
review, unless the ACICS has expressly permitted it to expand its program
offerings.
None of our institutes accredited by the ACCSCT is on probation or subject
to a show cause order. Eight of our institutes (six main campuses and two
additional locations) accredited by the ACCSCT are subject to outcomes
reporting, which requires them to report on student completion rates for certain
programs of study. None of our institutes accredited by the ACICS is on
probation or subject to a financial or outcomes review. Although the ACCSCT and
the ACICS standards limit our ability to establish additional locations and
expand the programs offered at an institute in certain circumstances, we do not
believe, based on our current understanding of how the accrediting standards
will be applied, that these limitations will have a material adverse effect on
our expansion plans. See "--State Authorization and Accreditation."
State laws and regulations generally treat each of our institutes as a
separate, unaffiliated institution and do not distinguish between main campuses
and additional locations. State laws and regulations generally do not limit the
number of institutes that we can establish within the state or the number of
programs that our institutes can offer, so long as each institute satisfies all
requirements to obtain any required state authorizations. In some states, the
requirements to obtain state authorization limit our ability to establish new
institutes and offer new programs. The process of obtaining any required state
authorizations can also delay the opening of new institutes or the offering of
new programs. Based on our current understanding of how the state laws and
regulations in effect in the states where we are located or anticipate
establishing a new location will be applied, we do not believe that these
limitations will have a material adverse effect on our 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. DOE regulations require each institution to satisfy a series of
separate standards that demonstrate administrative capability. Failure to
satisfy any of the standards may lead the DOE to find the institution ineligible
to participate in Title IV Programs or to place the institution on provisional
certification status as a condition of its participation. One standard that
applies to programs with the stated objective of preparing students for
employment requires the institution to show a reasonable relationship between
the length of the program and the entry-level job requirements of the relevant
field of employment. Other standards provide that an institution lacks
administrative capability if its FFEL/FDL cohort default rate equals or exceeds
25% for any of the three most recent federal fiscal years for which such rates
have been published, or if its Perkins cohort default rate exceeds 15% for any
federal award year.
Our Garland and San Antonio, Texas institutes had FFEL/FDL cohort default
rates exceeding 25% for at least one of the three most recent federal fiscal
years for which the DOE has published such rates. This was one of the reasons
that these two institutes were provisionally recertified for participation in
Title IV Programs following Starwood Hotels' acquisition of ITT. The DOE told
each of these institutes that it would remain provisionally certified until its
FFEL/FDL cohort default rates for three consecutive federal fiscal years are all
below 25%. Twenty-seven of our campus groups (consisting of 59 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. To date, the DOE has not placed
any of our campus groups on provisional certification status because of its
Perkins cohort default rate. See "--Regulation of Federal Financial Aid
Programs--Student Loan Defaults" and "--Eligibility and Certification
Procedures."
An additional standard 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. Our
employees involved in student recruitment, admissions or financial aid receive
only a salary. We believe
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that our method of compensating persons and entities engaged in student
recruitment, admission or financial aid awarding activity complies with the
requirements of the HEA. The regulations do not, however, establish clear
standards for compliance, and we cannot assure you that the DOE will not find
any deficiencies in our present or former methods of compensation.
The DOE's regulations require each institution to use electronic processes
mandated by the DOE. Although we will have to adjust some of our current
practices to comply fully with this requirement, we do not believe, based on our
current understanding of how this requirement will be applied, that our
financial condition will be materially affected by this standard.
ELIGIBILITY AND CERTIFICATION PROCEDURES. The HEA and its implementing
regulations require each institution to periodically reapply to the DOE for
continued certification to participate in Title IV Programs. The DOE recertifies
each institution deemed to be in compliance with the HEA and the DOE's
regulations for a period of six years or less. Before that period ends, the
institution must apply again for recertification. In 1998, the DOE recertified
all 30 of our campus groups following the change in control of our institutes
caused by Starwood Hotels' acquisition of ITT. The DOE normally requires an
institution to submit an updated application for institutional certification
when it opens an additional location that offers at least 50% of a full
educational program or raises its level of program offering.
The DOE may place an institution on provisional certification status for a
period of three years or less, if it finds that the institution does not fully
satisfy all the eligibility and certification standards. If an institution
successfully participates in 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. The DOE may withdraw an
institution's provisional certification without advance notice if the DOE
determines that the institution is not fulfilling all material requirements. The
DOE may also more closely review an institution that is provisionally certified
if it applies for approval to open a new location or make some other significant
change in its eligibility. Provisional certification does not otherwise limit an
institution's access to Title IV Program funds.
Any institution seeking certification to participate in Title IV Programs
after a change in control will be provisionally certified for a limited period,
following which the DOE will require the institution to reapply for continued
certification. None of our institute campus groups were provisionally certified
by the DOE prior to Starwood Hotels' acquisition of ITT. As a result of that
acquisition, the DOE recertified each of our campus groups to participate in
Title IV Programs on a provisional basis for a three-year period. As an
additional condition of each campus group's provisional certification, the DOE
directed us to address certain issues related to our financial condition and
financial statements. The DOE also placed one additional condition on the
provisional certification of four campus groups (consisting of six institutes),
as follows:
- the DOE cited the Garland and San Antonio institutes for having FFEL/FDL
cohort default rates exceeding 25% for at least one of the three most
recent federal fiscal years for which such rates had been published, and
advised each of them that it would stay on provisional certification
status until its rates for three consecutive federal fiscal years are all
below 25%;
- the DOE cited the San Diego, California institute for having a pending DOE
program review, and advised it that it would stay on provisional
certification status until all liabilities identified in the program
review were paid and all deficiencies identified in the program review
were resolved; and
- the DOE cited the Youngstown, Ohio campus group (consisting of three
institutes) because its accrediting commission, the ACICS, had only
temporarily extended the campus group's accreditation following Starwood
Hotels' acquisition of ITT and had not yet formally reaccredited the
campus group.
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In August 1998, the DOE formally closed the pending DOE program review of the
San Diego institute and the ACICS formally reaccredited the Youngstown campus
group. See "--Change in Control."
TITLE IV PROGRAM FUNDS MANAGEMENT. DOE regulations that became effective
July 1, 1997 revised the procedures governing how an institution participating
in Title IV Programs requests, maintains, disburses and otherwise manages Title
IV Program funds. The revised regulations require institutions to disburse all
Title IV Program funds by payment period. For our institutes, the payment period
is an academic quarter. This regulation increases the number of disbursements of
federal student loans that institutions on a quarter system must make, which
delays our receipt and disbursement of federal student loan funds. These
regulations also expand the requirements for institutions to notify Title IV
Program fund recipients of certain information and reduce the time by which an
institution must return undisbursed Title IV Program funds. These regulations
materially affected our cash flows in 1997 and 1998 and increased our
administrative burden, but they have not had a material adverse effect on our
financial condition or results of operations. We do not believe that they will
have a material adverse effect on our financial condition or results of
operations in 1999 or future years. 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 for-profit institutions,
the growth of the FDL program and the potential assertion of claims against
holders of student loans, the number of lenders willing to make federally
guaranteed student loans under the FFEL program to students at some for-profit
institutions has declined. To date, however, the availability of lenders has not
affected the ability of our students to obtain FFEL program loans.
During 1998, one lender made approximately 65% of all FFEL program loans
received by our students. We believe that other lenders would be willing to make
FFEL program loans to our students if such loans were no longer available from
our primary lender, but we cannot assure you of this. 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 FFEL
program loans to its students. Using a lender of last resort may delay the
receipt of FFEL program loans by our students and slightly reduce the total loan
access for our students, but should not have a material adverse effect on us.
Lenders of last resort will not provide loans under the Federal PLUS program (an
FFEL program), which accounted for 11% of our revenues in 1998, and are not
required to provide unsubsidized loans under the Federal Stafford Loan program
(an FFEL program), which accounted for 22% of our revenues in 1998.
During 1998, one student loan guaranty agency guaranteed approximately 94%
of all FFEL program loans received by our students. We believe that other
guaranty agencies would be willing to guarantee FFEL program loans received by
our students if that guaranty agency ceased guaranteeing such loans or reduced
the volume of loans guaranteed, but we cannot assure you of this. Most states
have a designated guaranty agency that we believe would guarantee most, if not
all, FFEL program loans received by our 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 our students guaranteed by the institutes' primary guaranty
agency should not have a material adverse effect on our financial condition,
results of operations or cash flows. We do not make or guarantee any Title IV
Program loans to any student attending any of our institutes.
COMPLIANCE WITH REGULATORY STANDARDS AND EFFECT OF REGULATORY
VIOLATIONS. Our internal audit department reviews our institutes' compliance
with Title IV Program requirements. Our audit plan provides for an annual
on-site compliance review of each of our institutes. The review addresses
numerous compliance areas, including student tuition refunds, student academic
progress, student
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admissions, graduate employment, student attendance, student financial aid
applications and implementation of prior audit recommendations.
Our institutes are subject to audits and 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 determined that one of our institutes improperly disbursed
Title IV Program funds or violated a provision of the HEA or the implementing
regulations, that 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 subject the institute to heightened cash monitoring, or
could 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 us or our institutes to other civil and
criminal penalties.
Significant violations of Title IV Program requirements by us or any of our
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 an institution's participation 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, FDL, Pell or Perkins 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 or the 90/10 Rule may not apply to resume
participation in Title IV Programs for at least one year.
There is no proceeding pending to fine any of our institutes or to limit,
suspend or terminate any of our institutes' participation in Title IV Programs,
and we have no reason to believe that any such proceeding is contemplated. If a
proceeding substantially limited our institutes' participation in Title IV
Programs, we would be materially adversely affected, even if we could arrange or
provide alternative financing sources. If an institute lost its eligibility to
participate in Title IV Programs and we could not arrange for alternative
financing sources for our students, we would probably have to close that
institute.
STATE AUTHORIZATION AND ACCREDITATION
We are subject to extensive and varying regulation in each of the 27 states
in which we currently operate an institute and in four other states in which our
institutes recruit students. Each of our institutes must be authorized by the
applicable SEAs to operate and grant degrees or diplomas to their students. In
addition, some states require an institute to be in operation for a period of up
to two years before such institute can be authorized to grant degrees.
Currently, each of our 67 institutes has received authorization from one or more
SEAs.
Institutes that confer bachelor or master degrees must, in most cases, meet
additional regulatory standards. Raising the curricula of our existing
institutes to the bachelor and/or master degree level requires the approval of
the SEAs and Accrediting Commissions. State education laws and regulations
affect our operations and may limit our ability to introduce degree programs or
to obtain authorization to operate in some states. If any one of our institutes
lost its state authorization, the institute would be unable to offer
postsecondary education and we would be forced to close the institute. Closing
one of our institutes for any reason could have a material adverse effect on our
financial condition or results of operations.
The HEA specifies a series of criteria that each recognized accrediting
commission must use in reviewing institutions. For example, accrediting
commissions must assess the length of each academic
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program offered by an institution in relation to 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 1998, ten of our institutes were reviewed by their respective
Accrediting Commission and all ten institutes were reaccredited. In addition,
three of our institutes obtained their initial accreditation in 1998.
State authorization and accreditation by a recognized accrediting commission
are required for an institution to become and remain eligible to participate in
Title IV Programs. In addition, some states require institutions operating in
their state to be accredited as a condition of state authorization. Sixty-one of
our institutes are accredited by the ACCSCT and three are accredited by the
ACICS, both of which are accrediting commissions recognized by the DOE. The
other three institutes, which were recently opened, have applied for
accreditation. None of our institutes accredited by the ACCSCT is on probation
or subject to a show cause order, but eight of our institutes (six main campuses
and two additional locations) accredited by the ACCSCT are subject to outcomes
reporting. None of our institutes accredited by the ACICS is on probation or
subject to a financial or outcomes review. Under the ACCSCT and the ACICS
standards, an institution's main campus or additional location may be placed on
probation, subjected to outcomes reporting or subjected to a financial or
outcomes review for a variety of reasons. All of our institutes that are subject
to 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 institutes are too low. Under the ACCSCT and the ACICS
standards, an institution's main campus or additional location that is subjected
to outcomes reporting or to a financial or outcomes review is required to
periodically report its results in such areas to the Accrediting Commission. The
loss of accreditation by one of our existing institutes or the failure of a new
technical institute to obtain full accreditation:
- would make only the affected institute ineligible to participate in Title
IV Programs, if the affected institute was an additional location;
- would make the entire campus group ineligible to participate in Title IV
Programs, if the affected institute was a main campus; and
- could have a material adverse effect on our financial condition, results
of operations and cash flows.
We have begun the process of changing the accreditation of our 61 institutes
accredited by the ACCSCT to the ACICS. We believe that ACICS accreditation is
more appropriate for our institutes for a number of reasons, including the
following:
- the ACICS's scope of accreditation, as recognized by the DOE, includes
master degree programs, unlike the ACCSCT's scope of accreditation;
- the ACICS's accrediting standards are more applicable to degree-granting
institutions than are the ACCSCT's accrediting standards; and
- the laws and/or regulations of many SEAs may, in the future, require
institutions to be accredited by an accrediting commission recognized by
the Council for Higher Education Accreditation ("CHEA"). The ACICS, but
not the ACCSCT, is recognized by the CHEA.
Changing our institutes' accreditation from the ACCSCT to the ACICS will require
us to incur additional expense and adjust some of our current practices. In
addition, we will have to demonstrate to the DOE that reasonable cause exists
for changing the accreditation of our institutes from the ACCSCT to the ACICS.
We do not believe that changing the accreditation of our institutes from the
ACCSCT to the ACICS will have a material adverse effect on our financial
condition, results of operations or cash flows.
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CHANGE IN CONTROL
The DOE, the Accrediting Commissions and most of the SEAs have laws,
regulations and/or standards (collectively "Regulations") pertaining to the
change in ownership and/or control (collectively "change in control") of
institutions, but these Regulations do not uniformly define what constitutes a
change in control. The DOE's Regulations describe some transactions that are 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 ESI, occurs when there is an event that obligates the
corporation to file a Current Report on Form 8-K with the SEC 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.
When a change in control occurs 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. The February 1999 Offering was not a change in control under the
Regulations of the DOE or the ACICS, but the February 1999 Offering was a change
in control under the Regulations of some of the SEAs. The ACCSCT advised us that
it was unnecessary for it to determine whether the February 1999 Offering would
be a change in control under its Regulations, and that none of our institutes'
accreditation by the ACCSCT would be affected by the February 1999 Offering. As
a result, the February 1999 Offering will not affect our ability to participate
in Title IV Programs, unless any SEA or SEAs that considered the February 1999
Offering to be a change in control fail to reauthorize any of our institutes.
Many SEAs require that they approve a change in control before it occurs, while
others will only review a change in control after it occurs. We obtained all of
the approvals of the February 1999 Offering from the SEAs that require advance
approval. We are pursuing and believe that we will be able to obtain all of the
approvals from the SEAs that require approval after the February 1999 Offering
occurred, but we cannot assure you that we will receive all of these approvals
in a timely manner. A material adverse effect on our financial condition,
results of operations and cash flows could result if we are unable to obtain
these approvals or if we do not obtain these approvals in a timely manner. The
California SEA, which normally requires advance approval, advised us that it
would not determine whether the February 1999 Offering was a change in control
until after the consummation of the February 1999 Offering. It also advised us
that the provisions of the California Education Code that provide for
termination of its existing authorization of our California institutes if
advance approval is not obtained would not apply to the February 1999 Offering.
Eleven of our institutes are located in California. We are pursuing a
determination from the California SEA whether the February 1999 Offering was a
change in control under its standards.
A change in control could occur as a result of future transactions in which
we, our institutes or a parent company as defined in DOE regulations are
involved. Some corporate reorganizations and some changes in the boards of
directors of such corporations are two examples of such transactions. If a
future transaction results in a change in control of ESI, our institutes or a
parent company, we believe that we will be able to obtain all necessary
approvals from the DOE, the SEAs and the Accrediting Commissions. We cannot
assure you, however, that all such approvals can be obtained in a timely manner
that would not delay the availability of Title IV Program funds or prevent some
students from receiving Title IV Program funds.
A material adverse effect on our financial condition, results of operations
and cash flows would result if we had a change in control and a material number
of our institutes failed to timely:
- obtain the approvals of the SEAs required prior to a change in control;
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- obtain the required reauthorizations from the SEAs which review a change
in control after it occurs;
- regain accreditation by the Accrediting Commissions or have their
accreditation temporarily continued or reinstated by the Accrediting
Commissions; or
- regain eligibility to participate in Title IV Programs from the DOE or
receive provisional certification to temporarily continue to participate
in Title IV Programs from the DOE.
In addition, the time of year at which a change in control occurs, coupled with
the length of time that our institutes are ineligible 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 our institutes
and, accordingly, on our business, financial condition, results of operations
and cash flows.
After a change in control, an institution must file an application with the
DOE in order to have its eligibility to participate in Title IV Programs
reinstated. The DOE's reinstatement of an institution's certification to
participate in Title IV Programs depends on its determination that the
institution, under its new ownership and control, complies with specified DOE
requirements for institutional eligibility. The time required for the DOE to act
on an application can vary substantially and may take several months. Among
other things, the 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 education
authority or authorities and accredited by an accrediting commission recognized
by the DOE. The 1998 HEA Amendments provide that the DOE may provisionally
certify an institution undergoing a change in control based on the DOE's
preliminary review of the institution's materially complete application for
reinstatement received by the DOE within 10 business days of the change in
control. This provisional certification would allow the institution temporarily
to maintain its eligibility to participate in Title IV Programs following a
change in control while the DOE considers the institution's application for
reinstatement. The DOE has not yet issued regulations or guidance regarding how
it will interpret or apply this amendment to the HEA.
The Accrediting Commissions will not reaccredit an institution following a
change in control until the institution submits an application for
reaccreditation, which requires documentation that the institution has been
reauthorized, or continues to be authorized, by the appropriate SEA or SEAs. The
standards of the ACCSCT 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 provide that, generally within five business days after an institution
documents that it has been reauthorized, or continues to be authorized, by the
appropriate SEA or SEAs following a change in control, the ACICS will determine
whether to temporarily reinstate the institution's accreditation for an
undefined period to allow for the completion and review of the application. The
ACCSCT currently accredits 61 of our institutes and the ACICS currently
accredits three of our institutes.
Many of the SEAs 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 considered
Starwood Hotels' acquisition of ITT to be a change in control of ESI and our
institutes. As a result, effective upon that acquisition, each of our campus
groups immediately became ineligible to participate in Title IV Programs. We
obtained all approvals of the acquisition from the Accrediting Commissions and
the SEAs. In March 1998, four weeks after Starwood Hotels acquired ITT, the DOE
approved the reinstatement of each campus group's participation in Title IV
Programs. The DOE's approval was on a provisional basis, which is the DOE's
practice for all institutions following a change in control.
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As an additional condition of each institute's provisional certification,
the DOE directed us to maintain a sufficient, but undefined, level of cash or
cash equivalents, and to revise our current accounting treatment of direct
marketing costs, revenue recognition and amortization of direct marketing costs
or provide evidence that our treatment of these items conforms with Generally
Accepted Accounting Principles ("GAAP"). We believe that our treatment of these
items is in accordance with GAAP and that we maintain cash and cash equivalents
in sufficient amounts to satisfy the DOE, but we cannot assure you of this. If
the DOE requires us to change our accounting treatment for any of the above
items, we do not believe that such change would have a material adverse effect
on our financial condition or results of operations before the cumulative effect
of any change in accounting. Four of our campus groups (consisting of six
institutes) each had one additional condition placed on its provisional
certification. See "--Regulation of Federal Financial Aid Programs--Eligibility
and Certification Procedures."
The secondary offering of 13,050,000 shares of our common stock owned by ITT
completed on June 9, 1998 was a change in control under the Regulations of
certain SEAs, but not under the Regulations of the DOE or of either Accrediting
Commission. We obtained all approvals required in connection with the June 1998
offering from the SEAs.
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, as amended by the IRS Restructuring and
Reform Act of 1998 ("TRA"). The TRA:
- provides 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.
- provides 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. The Lifetime Learning tax
credit is not available in any tax year in which the taxpayer is claiming
the Hope Scholarship tax credit.
- provides 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 or
loans incurred solely to pay qualified higher education expenses.
- provides 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.
- 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 before the student
reaches the age of 30 years.
The tax benefits provided by the TRA may reduce the effective cost of
postsecondary education to the student and his or her family, which may increase
enrollments at our institutes, decrease student dependence on Title IV Program
funds and decrease 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. These
IRS reporting requirements will increase our administrative burden, but such
compliance will not have a material adverse effect on our financial condition,
results of operations or cash flows.
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ITEM 2. PROPERTIES.
We lease all of our institute facilities, except for a parking lot we own
adjacent to the Houston (North), Texas institute. The average lease term is
approximately eight years. The table below sets forth some information regarding
our institute facilities that we were leasing as of December 31, 1998.
<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)........ 39,747
Hayward, California (San Francisco)...... 20,009
Lathrop, California (Stockton)........... 13,274
Oxnard, California (Los Angeles)......... 27,098
Rancho Cordova, California
(Sacramento)........................... 27,020
San Bernardino, California
(Los Angeles).......................... 33,551
San Diego, California.................... 34,360
Santa Clara, California
(San Francisco)........................ 24,390
Sylmar, California (Los Angeles)......... 30,000
Torrance, California (Los Angeles)....... 30,000
West Covina, California
(Los Angeles).......................... 36,382
Thornton, Colorado (Denver).............. 27,076
Fort Lauderdale, Florida................. 29,381
Jacksonville, Florida.................... 25,200
Maitland, Florida (Orlando).............. 32,050
Miami, Florida........................... 21,347
Tampa, Florida........................... 35,000
Boise, Idaho............................. 27,978
Burr Ridge, Illinois (Chicago)........... 21,000(1)
Hoffman Estates, Illinois (Chicago)...... 24,000
Matteson, Illinois (Chicago)............. 24,201
Fort Wayne, Indiana...................... 67,000
Indianapolis, Indiana.................... 58,692
Newburgh, Indiana (Evansville)........... 20,000
Louisville, Kentucky..................... 22,291
St. Rose, Louisiana (New Orleans)........ 21,000(2)
Framingham, Massachusetts
(Boston)............................... 19,938
Woburn, Massachusetts (Boston)........... 19,999(2)
Grand Rapids, Michigan................... 25,000
<CAPTION>
AREA IN
LOCATION (METROPOLITAN AREA) SQUARE FEET
- ----------------------------------------- -----------
<S> <C>
Troy, Michigan (Detroit)................. 32,000
Arnold, Missouri (St. Louis)............. 21,000
Earth City, Missouri (St. Louis)......... 29,360
Omaha, Nebraska.......................... 22,400
Henderson, Nevada (Las Vegas)............ 20,972
Albuquerque, New Mexico.................. 21,588
Albany, New York......................... 21,000(1)
Getzville, New York (Buffalo)............ 22,765
Liverpool, New York (Syracuse)........... 21,000(3)
Dayton, Ohio............................. 45,591
Norwood, Ohio (Cincinnati)............... 28,593
Strongsville, Ohio (Cleveland)........... 21,548
Youngstown, Ohio......................... 22,500
Portland, Oregon......................... 39,600
Mechanicsburg, Pennsylvania
(Harrisburg)........................... 21,000
Monroeville, Pennsylvania
(Pittsburgh)........................... 23,791
Pittsburgh, Pennsylvania................. 20,907
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(1)
San Antonio, Texas....................... 25,000
Murray, Utah (Salt Lake City)............ 33,600
Norfolk, Virginia........................ 25,572
Richmond, Virginia....................... 21,000(3)
Bothell, Washington (Seattle)............ 27,800
Seattle, Washington...................... 30,316
Spokane, Washington...................... 16,378
Greenfield, Wisconsin (Milwaukee)........ 29,650
</TABLE>
- ------------------------
(1) Institutes in the first year of operation as of December 31, 1998.
(2) Facility under lease where we plan to open a new institute.
(3) Facility under lease on December 31, 1998 and subsequently opened in January
1999.
26
<PAGE>
We generally locate our institutes in suburban areas near major population
centers. We generally house our campus facilities in modern, air conditioned
buildings, which include classrooms, laboratories, student break areas and
administrative offices. Our institutes have accessible parking facilities and
are generally near a major highway. Approximately 35 of our institutes occupy an
entire building. Our new institutes typically lease facilities for a six to 13
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.
We lease approximately 41,100 square feet of office space in our
headquarters building in Indianapolis, Indiana. As of December 31, 1998, the
lease required payments of approximately $2.8 million over the remaining term of
the lease, which expires in 2003.
ITEM 3. LEGAL PROCEEDINGS.
We are subject to litigation in the ordinary course of our business. Among
the legal actions currently pending and recently concluded are the following
cases. We have agreed to settle all of the plaintiffs' claims in these cases.
The settlements that are class settlements are subject to court approval and to
the right of the class members to opt out of the settlement.
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 offered at our San Diego institute. The suit alleged,
among other things, misrepresentation, civil conspiracy and statutory
violations of the California Education Code (including the Maxine Waters
School Reform and Student Protection Act of 1989) ("CEC"), California
Business and Professions Code ("CBPC") and California Consumer Legal
Remedies Act ("CCLRA") by us, ITT and three of our employees. The plaintiffs
claimed that the defendants (1) made misrepresentations and engaged in
deceptive acts in the recruitment of the plaintiffs for, and/or in the
promotion of, the program, (2) provided inadequate instruction to the
plaintiffs, (3) used inadequate facilities and equipment in the program and
inappropriate forms of contracts with the plaintiffs, (4) failed to provide
the plaintiffs with all required information and disclosures and (5)
misrepresented the plaintiffs' prospects for employment upon graduation, the
employment of the program's graduates and the plaintiffs' ability to
transfer program credits. The jury rendered a verdict against us and ITT in
this action in October 1996. General damages of approximately $0.2 million
were assessed against us and ITT, jointly, on the plaintiffs'
misrepresentation and CEC claims. Exemplary damages in the amount of $2.6
million were assessed against us and exemplary damages in the amount of $4.0
million were assessed against ITT. 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 our employees were dismissed,
and the judge granted a judgment notwithstanding the verdict, setting aside
the verdict against ITT. We appealed the awards rendered against us, and the
plaintiffs appealed the judgment against plaintiffs on their claims against
ITT.
In September 1998, we settled all of the plaintiffs' claims in the Eldredge
Case in conjunction with the settlement of other related legal proceedings
and claims discussed below. We recorded a $12.9 million provision in
September 1998 associated with all of these settlements, including the legal
and administrative expenses we expect to incur in order to consummate these
settlements. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations." All of the
parties in the Eldredge Case have dismissed their respective appeals. In
November 1998, based on the joint application and stipulation filed by us
and the plaintiffs in the Eldredge Case, the appellate court reversed the
judgment against us and remanded the case back to the trial court, which
vacated and set aside the judgment and dismissed the case with prejudice in
December 1998. A California statute prohibits the California SEA from
27
<PAGE>
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"). We believe that since the judgment in the Eldredge
Case was reversed, vacated and set aside, the California SEA is no longer
prohibited from approving any subsequent application for a change in control
submitted by us or any of our 11 institutes in California.
Other related legal proceedings and claims (as 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) (the "Robb Case") was filed on January 24, 1997, in the Superior
Court of San Diego County in San Diego, California by four graduates of our
San Diego institute. The suit, as originally filed, alleged, among other
things, statutory violations of the CEC and CBPC by us and ten of our
employees. 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 who attended any of our
institutes in California, attorney's fees and costs, and also sought to have
the action certified as a class action. The plaintiffs amended their
complaint on August 14, 1997. The amended complaint deleted three and added
two named plaintiffs. Each of the three plaintiffs was a student who
attended one of three different programs (i.e., hospitality, EET and CAD) at
a California institute. The plaintiffs in the amended complaint alleged only
violations of the CEC, based on the plaintiffs' claims that the defendants
(1) made misrepresentations and engaged in deceptive acts in the recruitment
of students for, and/or in the promotion of, the programs offered in
California, (2) failed to provide students with all required information and
disclosures and (3) misrepresented students' prospects for employment upon
graduation and the employment of the programs' graduates. The plaintiffs
sought (1) a refund of an unspecified amount representing all consideration
paid to us by the plaintiffs and all other persons similarly situated who
attended any of the programs in California at any time from January 1, 1991
through December 31, 1996, (2) a state statutory penalty equal to two times
the refund amount, (3) injunctive relief and (4) an unspecified amount of
attorney's fees and costs.
In May 1998, we settled all of the claims of one of the three plaintiffs in
this legal proceeding. In September 1998, we agreed to settle all of the
claims of the two remaining plaintiffs in this legal proceeding and to seek
a class settlement of the claims of the approximately 19,000 other persons
who attended any program (other than the hospitality program) at any of our
institutes in California from January 1, 1990 through December 31, 1997. The
class settlement, which is subject to court approval, would provide class
members with nontransferable tuition credits to attend a different
educational program at any of our institutes in the amount of: (1) $250 per
quarter off the then prevailing quarterly tuition for class members who
completed at least 50% of an associate degree program at one of our
institutes in California; (2) $125 per quarter off the then prevailing
quarterly tuition for class members who completed (a) less than 50% of an
associate degree program at one of our institutes in California or (b) at
least 50% of a bachelor degree program at one of our institutes in
California; and (3) $62.50 per quarter off the then prevailing quarterly
tuition for class members who completed less than 50% of a bachelor degree
program at one of our institutes in California. The class member can use the
tuition credit toward the cost of attending any of our institutes' programs
that the class member had not previously attended. In addition to the
issuance of tuition credits, we have also agreed to stipulate to a permanent
injunction that would enjoin us from certain recruitment practices (none of
which we currently follow) and to pay the plaintiffs' reasonable attorneys'
fees and expenses. If more than 1% of the class members opt out of the class
settlement, we may, in our sole discretion, terminate the class settlement.
On February 11, 1999, the court granted preliminary approval of the class
settlement.
28
<PAGE>
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) (the "Barrent Case"); and KELLUM, ET AL. V. ITT
EDUCATIONAL SERVICES, INC., ET AL. (Civil Action No. 00707709) (the "Kellum
Case") 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, 16 former students who attended the hospitality program at our San
Diego institute) alleged statutory violations of the CEC, the CBPC and the
California Consumer Contract Awareness Act of 1990, intentional
misrepresentation and/or concealment, and civil conspiracy by us, ITT and
one of our employees. The plaintiffs claimed that the defendants (1) made
misrepresentations and engaged in deceptive acts in the recruitment of the
plaintiffs for, and/or in the promotion of, the program, (2) used inadequate
facilities and equipment in the program and inappropriate forms of contracts
with the plaintiffs, (3) failed to provide the plaintiffs with all required
information and disclosures and a fully executed copy of their contracts
with us and (4) misrepresented the plaintiffs' prospects for employment upon
graduation, the employment of the program's graduates and the externship
portion of the program. The plaintiffs in each action sought various forms
of recovery, including (1) an unspecified amount for compensatory damages,
disgorgement of ill-gotten gains, restitution, attorney's fees and costs,
(2) state statutory penalties equal to two times actual damages, (3)
injunctive relief and (4) $10 million in exemplary damages.
In May 1998, we settled all of the claims of four of the five plaintiffs in
the Kellum Case and five of the six plaintiffs in the Barrent Case. In
September 1998, we settled all of the claims of the remaining seven
plaintiffs in these five legal proceedings. In October 1998, the court
dismissed all five of these legal proceedings with prejudice.
4. COLLINS, ET AL. V. ITT EDUCATIONAL SERVICES, INC., ET AL. (Civil Action No.
98 cv 0659 BTM) (the "Collins Case") was filed on April 6, 1998, in the U.S.
District Court for the Southern District of California in San Diego,
California by nine former students who attended the hospitality program at
either our Maitland or San Diego institutes. The suit alleged violations of
the federal Racketeer Influenced and Corrupt Organizations Act, the CEC, the
CBPC, the CCLRA, the Florida Deceptive and Unfair Trade Practices Act, the
Florida Civil Remedies for Criminal Practices Act and Florida statutes
prohibiting misleading advertising, common law fraud and/or concealment and
civil conspiracy by us and ITT. The plaintiffs claimed that the defendants
(1) made misrepresentations and engaged in deceptive acts in the recruitment
of students for, and/or in the promotion of, the program, (2) failed to
provide students with all required information and disclosures and (3)
misrepresented students' prospects for employment upon graduation, the
employment of the program's graduates and the students' externship portion
of the program. The plaintiffs sought various forms of recovery on behalf of
the plaintiffs and all other persons similarly situated who attended the
program at our Indianapolis, Maitland, Portland or San Diego institutes at
any time from January 1, 1990 through December 31, 1996, including (1) an
unspecified amount for compensatory damages, exemplary damages, rescission
and the return of all tuition and fees paid to us by or on behalf of
students who attended the program, the disgorgement of ill-gotten gains,
restitution, attorney's fees and costs, (2) state statutory penalties of two
and three times actual damages, (3) a federal statutory penalty of $45
million and (4) injunctive relief.
In September 1998, we agreed to seek a class settlement of the claims of the
nine plaintiffs in this legal proceeding and of the approximately 1,200
other persons who attended an associate degree program in hospitality at our
institutes in Maitland, San Diego, Portland or Indianapolis (the only
institutes where the hospitality program was offered). The class settlement,
which is subject to court approval, involves our payment of cash to the
class members and the plaintiffs' reasonable attorneys' fees and expenses.
If more than 1% of the class members opt out of the class
29
<PAGE>
settlement, we may, in our sole discretion, terminate the class settlement.
In December 1998, the court granted preliminary approval of the class
settlement.
On September 22, 1997, we received an inquiry from the staff of the U.S.
Federal Trade Commission (the "FTC") requesting information relating to our
offering and promotion of vocational or career training. We responded to this
inquiry in November 1997. On February 11, 1999, the FTC notified us orally that
it was closing this inquiry and would not take any further action.
We cannot assure you of the ultimate outcome of any litigation involving us.
We do not believe any pending legal proceeding will result in a judgment or
settlement that will have, after taking into account our existing insurance and
provisions for such liabilities, a material adverse effect on our financial
condition, results of operations or cash flows, unless (1) we fail to obtain
court approval of the class settlement in the Robb Case or the Collins Case and
a significant amount of litigation against us results from such failure or (2) a
significant number of class members opt out of either class settlement and
pursue litigation against us. Any litigation alleging violations of education or
consumer protection laws and/or regulations, misrepresentation, fraud or
deceptive practices may also subject our affected institutes 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 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock is listed on the New York Stock Exchange under the trading
symbol "ESI." The prices set forth below are the high and low sale prices of our
common stock during the periods indicated, as reported in the NYSE's
consolidated transaction reporting system.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1997
First Quarter........................................................... $ 27.000 $ 21.500
Second Quarter.......................................................... 25.000 19.375
Third Quarter........................................................... 26.750 19.000
Fourth Quarter.......................................................... 26.000 20.750
1998
First Quarter........................................................... $ 28.375 $ 21.375
Second Quarter.......................................................... 32.750 24.375
Third Quarter........................................................... 33.938 26.000
Fourth Quarter.......................................................... 36.125 23.688
</TABLE>
There were approximately 200 holders of record of our common stock on
February 11, 1999.
We did not pay a cash dividend in 1997 or 1998. We do not anticipate paying
any cash dividends on our common stock in the foreseeable future and we plan to
retain our earnings to finance future growth. The declaration and payment of
dividends on our common stock are subject to the discretion of our Board of
Directors and compliance with applicable law. Our decision to pay dividends in
the future will depend on general business conditions, the effect of such
payment on our financial condition and other factors our Board of Directors may
in the future consider to be relevant.
30
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data of ESI are qualified by reference to
and should be read with the Financial Statements and the Notes to the Financial
Statements and other financial data included elsewhere in this report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996 1995 1994
------------ -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Tuition................................................... $ 248,399 $222,457 $196,692 $171,936 $159,575
Other educational (a)..................................... 42,976 39,207 35,627 29,895 27,332
------------ -------- -------- -------- --------
Total revenues.......................................... 291,375 261,664 232,319 201,831 186,907
------------ -------- -------- -------- --------
Cost of educational services................................ 176,487 163,053 145,197 130,338 121,594
Student services and administrative expenses................ 81,522 72,388 66,546 57,268 53,481
Legal settlement............................................ 12,858 -- -- -- --
Offering and change in control expenses..................... 1,872 -- -- -- --
------------ -------- -------- -------- --------
Total costs and expenses................................ 272,739 235,441 211,743 187,606 175,075
Operating income............................................ 18,636 26,223 20,576 14,225 11,832
Interest income, net (b).................................... 5,329(c) 5,565 4,119 4,802 232
------------ -------- -------- -------- --------
Income before income taxes.................................. 23,965 31,788 24,695 19,027 12,064
Income taxes................................................ 10,024 12,665 9,844 7,636 4,902
------------ -------- -------- -------- --------
Net income.................................................. $ 13,941(c) $ 19,123 $ 14,851 $ 11,391 $ 7,162
------------ -------- -------- -------- --------
------------ -------- -------- -------- --------
Earnings per share (d):
Basic..................................................... $ 0.52(c) $ 0.71 $ 0.55 $ 0.42 $ 0.32
Diluted................................................... 0.51(c) 0.71 0.55 0.42 0.32
------------ -------- -------- -------- --------
------------ -------- -------- -------- --------
OTHER OPERATING DATA:
EBITDA (e).................................................. $ 27,918 $ 34,162 $ 28,069 $ 21,767 $ 18,687
Operating losses from new technical institutes before income
taxes (f)................................................. $ 5,257 $ 3,165 $ 5,721 $ 7,123 $ 7,316
Capital expenditures, net................................... $ 11,381 $ 11,465 $ 7,868 $ 8,206 $ 7,688
Number of students at end of period......................... 25,608 24,498 22,633 20,618 20,668
Number of technical institutes at end of period............. 65 62 59 56 54
BALANCE SHEET DATA:
Cash, restricted cash, cash invested with ITT and marketable
debt securities........................................... $ 119,268(c) $ 98,689 $ 95,793 $ 77,517 $ 66,810
Total current assets........................................ 138,758 112,958 108,449 87,567 76,460
Property and equipment less accumulated depreciation........ 24,985 22,886 19,360 18,985 18,321
Total assets................................................ 175,571 145,914 135,749 114,284 102,899
Total current liabilities................................... 70,241 55,946 65,405 58,766 57,646
Shareholders' equity........................................ 101,856(c) 87,815 68,692 53,841 42,450
</TABLE>
- ------------------------
(a) Other educational revenue is comprised of laboratory fees and textbook
sales.
(b) See Note 3 of Notes to Financial Statements for information concerning
intercompany interest between ESI and ITT. Prior to our initial public
offering in December 1994, we did not receive interest on the full amount of
net cash balances we invested with ITT and we were assessed an
31
<PAGE>
interest charge based on an allocation of the consolidated debt of ITT.
After our initial public offering and until February 5, 1998, we received
interest from ITT on the amount of any net cash balances we invested with
ITT and we were no longer subject to an interest charge based on such an
allocation. Since February 5, 1998, we have performed our own cash
management functions and no longer have any cash invested with ITT. Lower
interest rates on short-term investments have resulted in lower yields on
our cash balances than the yields on our cash that was invested with ITT.
Accordingly, interest income, net has decreased in 1998.
(c) We spent $49,088 to repurchase 1,500 shares of our common stock concurrently
with the closing of the February 1999 Offering, which would have reduced
cash and cash equivalents and marketable debt securities and shareholders'
equity by $49,088 if the repurchase had occurred at December 31, 1998. If
the stock repurchase had occurred January 1, 1998, basic and diluted
earnings per share for the year ended December 31, 1998 would have been
reduced by $0.04 and $0.03, respectively, which reflects a reduction in
interest income of $2,700, a reduction in net income of $1,620 and a
reduction in the average number of shares outstanding of 1,500.
(d) Earnings per share data are based on historical net income and the number of
shares of our 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 periods have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
(e) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization. We have included information
concerning EBITDA (which is not a measure of financial performance under
generally accepted accounting principles) because we understand that certain
investors use it as one measure of an issuer's financial performance. EBITDA
is not an alternative to operating income (as determined in accordance with
generally accepted accounting principles), an indicator of our performance
or cash flows from operating activities (as determined in accordance with
generally accepted accounting principles) or a measure of liquidity.
(f) 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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ WITH THE SELECTED FINANCIAL DATA AND
THE FINANCIAL STATEMENTS AND NOTES TO THE FINANCIAL STATEMENTS INCLUDED
ELSEWHERE IN THIS REPORT.
GENERAL
We operate 67 institutes in 27 states which provide technology-oriented
postsecondary education to approximately 25,000 students. We derive our revenue
almost entirely from tuition, textbook sales, fees and charges paid by, or on
behalf of, our students. Most students at our institutes pay a substantial
portion of their tuition and other education-related expenses with funds
received under various government-sponsored student financial aid programs,
especially the Title IV Programs. In 1998, we indirectly derived approximately
69% of our revenues from Title IV Programs.
Our revenue varies based on the aggregate student population, which is
influenced by the following factors:
- the number of students attending our institutes at the beginning of a
fiscal period;
- the number of new first-time students entering and former students
re-entering our institutes during a fiscal period;
32
<PAGE>
- student retention rates; and
- general economic conditions.
New students generally enter our institutes at the beginning of an academic
quarter that begins in March, June, September or December. We believe 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. Our establishment
of new institutes and the introduction of additional program offerings at our
existing institutes have been significant factors in increasing the aggregate
student population in recent years.
A new institute must be authorized by the state in which it will operate,
accredited by an accrediting commission that the DOE recognizes, 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. Accreditation and DOE certification for a new location generally
take approximately one year from the first class start date. We defer certain
direct costs incurred with respect to a new institute prior to the first class
start ("institute start-up costs") and amortize them over the first year of
operation after the first class start. From January 1, 1994 through December 31,
1998, we opened 17 new institutes (six of which started classes in 1996 or 1997
and three of which started classes in 1998). We opened two additional institutes
in January 1999. New institutes historically incur a loss during the 24-month
period after the first class start date. These losses during a fiscal 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." The operating losses from new technical institutes
totaled $5.3 million for the year ended December 31, 1998, $3.2 million for the
year ended December 31, 1997, and $5.7 million for the year ended December 31,
1996.
We earn tuition revenue on a weekly basis, pro rata over the length of each
of four, 12-week academic quarters in each fiscal year. Federal and state
regulations and accrediting commission standards generally require us to refund
a portion of the tuition payments received from a student who withdraws from one
of our institutes during an academic quarter. Our statement of income recognizes
immediately the amount of tuition, if any, that we may retain after payment of
any refund. Other educational revenue includes textbook sales and laboratory
fees.
We incur expenses throughout a fiscal period in connection with the
operation of our 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 our 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. We capitalize our direct marketing
costs (excluding advertising expenses) using the successful efforts method and
amortize them on an accelerated basis over the average course length of 24
months commencing on the class start date. We expense as incurred our marketing
costs that do not relate to the direct solicitation of potential students.
Until February 5, 1998, we forwarded all our cash receipts to ITT for
investment on a daily basis after, in the case of some receipts, the lapse of
applicable regulatory restrictions. ITT generally funded our cash disbursements
out of our cash balances that it held and invested for us. Net interest income
represents principally interest paid or received from ITT and miscellaneous
interest paid or received from other parties. Beginning in 1995, ITT paid us
interest on the full amount of any net cash balances that it invested for us 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
33
<PAGE>
no longer assessed us interest charges except with respect to funds actually
advanced to us in excess of cash invested with ITT. ITT performed a number of
other services for us, including the administration of certain employee benefit
plans, for which we paid it compensation. We have been performing all of these
services since June 9, 1998. We have been performing our own cash management
functions since February 5, 1998, and we no longer have any cash invested with
ITT. We have included the invested funds in the captions "cash and cash
equivalents" and "marketable debt securities" in the December 31, 1998 balance
sheet. The marketable debt securities have maturity dates in excess of 90 days
at the time of purchase and we record them at their market value. We include
debt securities with maturity dates less than 90 days at the time of purchase in
cash and cash equivalents and record such securities at cost which approximates
market value. We estimate that the market risk associated with our investments
in cash equivalents and marketable debt securities can best be measured by a
potential decrease in the fair value of these securities resulting from a
hypothetical 10% increase in interest rates. If such a hypothetical increase in
rates were to occur, the reduction in the market value of our portfolio of
securities would not be material.
VARIATIONS IN QUARTERLY RESULTS OF OPERATIONS
Our 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. Our
first and third fiscal quarters have 13 weeks of earned tuition revenue, while
our second and fourth quarters have only 11 weeks of earned tuition revenue
because of two-week student vacation breaks in June and December. In addition,
revenues in our third and fourth fiscal quarters generally benefit from
increased student matriculations. The number of new students entering our
institutes tends to be substantially higher in June (29% of all new students in
1998) and September (37% of all new students in 1998) because of the significant
number of recent high school graduates entering our institutes for the academic
quarters beginning in those two months. The academic schedule generally does not
affect our incurrence of costs, however, and costs do not fluctuate
significantly on a quarterly basis.
The following table sets forth our revenues in each quarter during the three
prior fiscal years.
QUARTERLY REVENUE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
THREE-MONTH ----------------------- ----------------------- -----------------------
PERIOD ENDED AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------- ---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
March 31......................................... $ 72,287 25% $ 64,476 25% $ 57,103 25%
June 30.......................................... 65,077 22 58,412 22 51,568 22
September 30..................................... 81,700 28 73,060 28 65,113 28
December 31...................................... 72,311 25 65,716 25 58,535 25
---------- ----- ---------- ----- ---------- -----
Total for Year................................. $ 291,375 100% $ 261,664 100% $ 232,319 100%
---------- ----- ---------- ----- ---------- -----
---------- ----- ---------- ----- ---------- -----
</TABLE>
34
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain
statement of income data to tuition and other educational revenues for the
periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Tuition and other educational revenues........... 100.0% 100.0% 100.0%
Cost of educational services..................... 60.6 62.3 62.5
Student services and administrative expenses..... 28.0 27.7 28.6
Legal settlement................................. 4.4 -- --
June 1998 offering, change in control and other
one-time expenses.............................. 0.6 -- --
--------- --------- ---------
Operating income................................. 6.4 10.0 8.9
Interest income, net............................. 1.8 2.1 1.7
--------- --------- ---------
Income before income taxes....................... 8.2% 12.1% 10.6%
--------- --------- ---------
--------- --------- ---------
</TABLE>
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
REVENUES. Revenues increased $29.7 million, or 11.3%, to $291.4 million for
the year ended December 31, 1998 from $261.7 million for the year ended December
31, 1997 primarily due to:
- a 5% increase in tuition rates in each of September 1998 and 1997;
- an 8.2% increase in the total student enrollment at January 1, 1998
compared to January 1, 1997 (24,498 at January 1, 1998 compared to 22,633
at January 1, 1997); and
- a 6.1% increase in the number of first-time and re-entering students
beginning classes at our institutes (24,521 in 1998 compared to 23,111 in
1997).
The total student enrollment on December 31, 1998 was 25,608, an increase of
4.5% from the 24,498 total student enrollment on December 31, 1997.
COST OF EDUCATIONAL SERVICES. Cost of educational services increased $13.4
million, or 8.2%, to $176.5 million in 1998 from $163.1 million in 1997. The
principal causes of this increase include:
- the costs required to service the increased enrollment;
- normal inflationary cost increases for wages, rent and other costs of
services; and
- increased costs at new institutes (one opened in June 1997, two in
December 1997, one in March 1998, one in June 1998 and one in October
1998).
Cost of educational services as a percentage of revenues decreased to 60.6% in
1998 compared to 62.3% in 1997, because the greater revenues did not cause an
increase in the fixed portion of our rent, administrative salaries and other
costs included in cost of educational services. Cost of educational services
includes a $1.2 million provision in 1998 (compared to a $3.2 million provision
in 1997) for legal expenses associated with the legal actions involving the
hospitality program. Excluding this provision, cost of educational services in
1998 would have been 60.2% of revenues, a 0.9% improvement from 1997.
STUDENT SERVICES AND ADMINISTRATIVE EXPENSES. Student services and
administrative expenses increased $9.1 million, or 12.6%, to $81.5 million in
1998 from $72.4 million in 1997. Student services and administrative expenses
increased to 28.0% of revenues in 1998 compared to 27.7% in 1997 primarily
because of increased media advertising (up 14.8%) and an increase in the
provision for doubtful accounts. The increase in the provision for doubtful
accounts resulted from a decrease in the amount of Title IV Program funds we
received, which was caused by a change in the DOE regulations that became
effective July 1, 1997. See "--Liquidity and Capital Resources."
35
<PAGE>
ONE-TIME EXPENSES. We recorded a $7.7 million after tax ($0.28 per share)
provision for the settlement of certain legal proceedings and claims in 1998.
(See Note 10 of Notes to Financial Statements). In June 1998, we incurred total
expenses for the June 1998 offering of $1.0 million after tax ($0.04 per share).
In addition, we incurred expenses of $0.5 million after tax ($0.02 per share) in
1998 associated with our change in control and establishment of new employee
benefit plans.
OPERATING INCOME. The following table sets forth our operating income (in
thousands) for the year ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Operating income as reported.............................. $ 18,636 $ 26,223
Legal settlement.......................................... 12,858 --
June 1998 offering expenses............................... 1,117 --
Change in control and other one-time expenses............. 755 --
--------- ---------
Operating income before one-time expenses................. $ 33,366 $ 26,223
--------- ---------
--------- ---------
</TABLE>
INTEREST INCOME. Interest income decreased $0.2 million in 1998 compared to
1997, which was primarily due to the lower interest rate earned on our cash
investments and marketable debt securities (i.e., 5.5% in 1998 compared to 6.3%
in 1997) partially offset by the earnings on our increased invested balances.
INCOME TAXES. Our combined effective federal and state income tax rate in
1997 was 39.8%. Our 1998 federal and state income tax rate will be 41.8%,
because $0.9 million of the June 1998 offering expenses are not tax deductible.
NET INCOME. The following table sets forth our net income (in thousands)
for the year ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Net income................................................ $ 13,941 $ 19,123
Legal settlement (after tax).............................. 7,715 --
June 1998 offering expenses (after tax)................... 1,048 --
Change in control and other one-time expenses (after
tax).................................................... 453 --
--------- ---------
Net income before one-time expenses....................... $ 23,157 $ 19,123
--------- ---------
--------- ---------
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues increased $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:
- a 9.8% increase in the total student enrollment at January 1, 1997
compared to January 1, 1996 (22,633 at January 1, 1997 compared to 20,618
at January 1, 1996);
- a 5% increase in tuition rates in each of September 1997 and 1996;
- a 2.3% increase in the number of new first-time students who began
attending our institutes (19,911 in 1997 compared to 19,464 in 1996); and
- the opening of new institutes (two in March 1996, one in September 1996,
one in June 1997 and two in December 1997).
36
<PAGE>
Student retention rates did not change materially in the two years. Our three
new 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 our 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, an increase in the cost of books sold arising from the
increased student population.
Provisions for legal expenses increased by $1.9 million to $3.2 million in 1997
($1.7 million in the fourth quarter) from $1.3 million in 1996 ($1.0 million in
the fourth quarter) as a result of the legal actions associated with the
California and Florida hospitality programs. See "Item 3. Legal Proceedings."
Cost of educational services decreased to 62.3% of revenues in 1997 compared to
62.5% in 1996, primarily because the greater revenues did not cause an increase
in the fixed portion of rent, administrative salaries and other costs included
in the cost of educational services. Excluding the provisions for 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 in marketing costs was due to:
- an increase in the marketing costs for the two new institutes opened in
1995 and the three new institutes opened in 1996;
- the commencement of marketing costs for the three new institutes opened in
1997; and
- the increased marketing costs for our institutes opened prior to 1995.
Our 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 revenues and a regulatory change that
delays our receipt of funds under the Title IV Programs. The delay resulted in a
greater number of students who withdrew or whose enrollment was terminated by
the institutes before they could secure federal student financial aid with which
they could pay their obligations to us. See "--Liquidity and Capital Resources"
for a further description of the regulatory changes affecting when we receive
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 we invested with ITT
(i.e., 6.3% in 1997 compared to 5.5% in 1996) and the increase in the amount of
cash we 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).
37
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
In 1998, we indirectly derived approximately 69% of our 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, which consists of 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 ten days before the start of the first
academic quarter of a student's academic year, and the second and third
disbursements are typically received ten days before the start of each
subsequent quarter of a student's academic year. While the timing of loan
disbursements to us is subject to a student's directions to the lender and to
existing regulatory requirements regarding such disbursements, we have typically
received student loan funds upon the lender's disbursement of the student loan
funds.
DOE regulations that became effective July 1, 1997 revised the procedures
governing how an institution participating in Title IV Programs requests,
maintains, disburses and otherwise manages Title IV Program funds. The revised
regulations require us to receive Title IV Program loan funds in three equal
quarterly disbursements rather than the two disbursements previously permitted.
We estimate that this change decreased deferred tuition revenue or increased
accounts receivable by approximately $15 million at December 31, 1997 compared
to December 31, 1996. We also estimate this change (an ongoing effect) decreased
1997 interest income by $0.2 million and decreased 1998 interest income by $0.9
million.
Our principal uses of cash are to pay salaries, occupancy and equipment
costs, recruiting and marketing expenses, administrative expenses and taxes,
including institute start-up costs for new institutes. Until February 5, 1998,
we forwarded our cash receipts to ITT on a daily basis after, in the case of
certain receipts, the lapse of applicable regulatory restrictions, and ITT
funded our cash disbursements out of the balance of our cash investments with
ITT. Since February 5, 1998, we have been performing our own cash management
functions and no longer have any cash invested with ITT. Our net cash items
(consisting until February 5, 1998 of cash and cash equivalents, restricted cash
and cash invested with ITT, and since February 5, 1998 of cash and cash
equivalents, restricted cash and marketable debt securities) increased from
$98.7 million at December 31, 1997 to $119.3 million at December 31, 1998.
Marketable debt securities and cash equivalents ranged from a low of $67.3
million in June 1998 to a high of $124.5 million in November 1998.
We have generated positive cash flows from operations for the past five
years. Cash flows from operations, excluding the $38.3 million increase in
marketable debt securities, in 1998 was $31.9 million, an increase of $17.5
million from $14.4 million in 1997. This increase was primarily due to lower
cash flows from operations in 1997 caused by the decrease in deferred tuition
revenue resulting from the July 1, 1997 regulatory change that affects when we
receive federal student loan funds, as discussed above, and the unpaid portion
of the legal settlement. Cash flows from operations in 1997 was $14.4 million, a
decrease of $11.7 million from $26.1 million in 1996. This decrease was
primarily due to the decrease in deferred tuition revenue resulting from the
July 1, 1997 regulatory change that affects when we receive federal student loan
funds, as discussed above.
At December 31, 1998, we had positive working capital of $68.5 million.
Giving effect to the stock repurchase, we would have had positive working
capital of $19.4 million at December 31, 1998. Deferred tuition revenue, which
represents the unrecognized portion of tuition revenue received from students,
was $32.3 million at December 31, 1998.
An institution may lose its eligibility to participate in some or all Title
IV Programs, if the rates at which the institution's students default on federal
student loans exceed specific percentages. An institution whose cohort default
rate on loans under the FFEL program and the FDL program is 25% or greater for
three consecutive federal fiscal years loses eligibility to participate in those
programs for the remainder of the federal fiscal year in which the DOE
determines that the institution has lost its
38
<PAGE>
eligibility and for the two subsequent federal fiscal years. In addition, the
1998 HEA Amendments provide that if an institution becomes ineligible to
participate in the FFEL and FDL programs following the publication of its 1996
(or any subsequent) federal fiscal year FFEL/FDL cohort default rate, the
institution will also be ineligible to participate in the Pell program for the
same period of time.
None of our campus groups (defined as the main campus and its additional
locations or branch campuses) had an FFEL/FDL cohort default rate equal to or
greater than 25% for the 1996 federal fiscal year, the most recent year for
which the DOE has published FFEL/FDL cohort default rates. In June 1998, our
institute in Garland, Texas became ineligible to participate in the FFEL and FDL
programs, because it had FFEL/FDL cohort default rates exceeding 25% for three
consecutive federal fiscal years beginning with the 1993 federal fiscal year.
The Garland institute accounted for approximately 1.4% of our revenues in 1998.
The Garland institute can reapply to the DOE to regain its eligibility to
participate in the FFEL and FDL programs on or after October 1, 2000. We have
arranged for an unaffiliated private funding source to provide loans to the
students enrolled in the Garland institute. This alternative financing source
requires us to guarantee repayment of the loans it issues. Based on our
experience with the repayment of Title IV Program loans by students who attended
the Garland institute, we believe that such guaranty should not result in a
material adverse effect on our financial condition, results of operations or
cash flows. We have also decided to stop enrolling new students in the Garland
institute, at least temporarily, while we continue teaching the students already
enrolled. We are considering whether to close the Garland institute once the
students already enrolled have completed their programs of study or transferred
to another school.
Prior to the 1998 HEA Amendments, the HEA limited how much an institution
could charge a student who withdrew from the institution. A student was only
obligated for a pro rata portion of the education costs charged by the
institution, if the student withdrew during the first 60% of the student's first
period of enrollment. For our institutes, a period of enrollment is generally an
academic quarter. A student who withdrew after the first period of enrollment
was also subject to a refund calculation, but it was not a straight pro rata
calculation. The institution had to refund any monies it collected in excess of
the pro rata or other applicable portion to the appropriate lenders or Title IV
Programs in a particular order.
The 1998 HEA Amendments rescinded the limitation on how much an institution
can charge a withdrawing student, but the standards of most SEAs and the
Accrediting Commissions continue to impose such a limitation. The 1998 HEA
Amendments imposed a limit on the amount of Title IV Program funds a withdrawing
student can use to pay his or her education costs. This new limitation permits a
student to use only a pro rata portion of the Title IV Program funds that the
student would otherwise be eligible to use, if the student withdraws during the
first 60% of any period of enrollment. The institution must refund to the
appropriate lenders or Title IV Programs any Title IV Program funds that the
institution receives on behalf of a withdrawing student in excess of the amount
the student can use for such period of enrollment. The new refund requirements
contained in the 1998 HEA Amendments become effective in October 2000, but an
institution may elect to begin complying with these new standards at an earlier
date. We do not plan to elect to comply with these new standards prior to
October 2000.
Depending on the refund policies of the applicable SEAs and Accrediting
Commission, in a variety of instances withdrawing students will still be
obligated to the institution under the new HEA refund requirements for education
costs that the students can no longer pay with Title IV Program funds. In these
instances, we expect that many withdrawing students will be unable to pay such
costs and that we will be unable to collect a significant portion of such costs.
Title IV Program funds are generally paid sooner and are more collectible than
tuition payments from other sources. As a result, if the new refund requirements
remain unchanged, they could have a material adverse effect on our financial
condition, results of operations and cash flows beginning with our 2001 fiscal
year.
39
<PAGE>
A for-profit institution, such as each of our campus groups, becomes
ineligible to participate in Title IV Programs if, on a cash accounting basis,
the institution derives more than 85% of its applicable revenues for a fiscal
year from Title IV Programs. For each of our 1997 and 1998 fiscal years, none of
our campus groups derived more than 79% of its revenues from Title IV Programs.
For our 1998 fiscal year, the range of our campus groups was from approximately
58% to approximately 79%. The 1998 HEA Amendments increased the percentage of
applicable revenues that a for-profit institution can derive from Title IV
Programs from 85% to 90%. The DOE has indicated orally that it will apply this
amendment beginning with our 1998 fiscal year. The 5% increase in the percentage
of applicable revenues that we can derive from Title IV Programs will increase
the aggregate amount of Title IV Program funds that students can use to pay
their education costs of attending our institutes. Title IV Program funds are
generally paid sooner and are more collectible than tuition payments from other
sources. As a result, this 5% increase should have a positive impact on our
results of operations and cash flows beginning in our 1999 fiscal year.
The DOE, the Accrediting Commissions and most of the SEAs have Regulations
pertaining to the change in control of institutions, but these Regulations do
not uniformly define what constitutes a change in control. When a change in
control occurs under the DOE's Regulations, an institution immediately becomes
ineligible to participate in Title IV Programs and can only receive and disburse
certain Title IV Program funds that were previously committed to its students,
until it has applied for certification and is reinstated by the DOE to continue
Title IV Program participation under its new ownership and control. The DOE's
Regulations also require that all of our institutes in a particular campus group
have their state authorizations and accreditations reaffirmed or reestablished
before any institute in that campus group can regain its eligibility from the
DOE.
The February 1999 Offering was not a change in control under the Regulations
of the DOE or the ACICS, which accredits three of our institutes, but the
February 1999 Offering was a change in control under the Regulations of some of
the SEAs. The ACCSCT, which accredits 61 of our institutes, advised us that it
was unnecessary for it to determine whether the February 1999 Offering would be
a change in control under its Regulations, and that none of our institutes'
accreditation by the ACCSCT would be affected by the February 1999 Offering. As
a result, the February 1999 Offering will not affect our ability to participate
in Title IV Programs, unless any SEA or SEAs that considered the February 1999
Offering to be a change in control fail to reauthorize any of our institutes.
Many SEA's require that they approve a change in control before it occurs, while
others will only review a change in control after it occurs. We obtained all of
the approvals of the February 1999 Offering from the SEAs that require advance
approval. We are pursuing and believe that we will be able to obtain all of the
approvals from the SEAs that require approval after the February 1999 Offering
occurred, but we cannot assure you that we will receive all of these approvals
in a timely manner. A material adverse effect on our financial condition,
results of operations and cash flows could result if we are unable to obtain
these approvals or if we do not obtain these approvals in a timely manner. The
California SEA, which normally requires advance approval, advised us that it
would not determine whether the February 1999 Offering was a change in control
until after the consummation of the February 1999 Offering. It also advised us
that the provisions of the California Education Code that provide for
termination of its existing authorization of our California institutes if
advance approval is not obtained would not apply to the February 1999 Offering.
Eleven of our institutes are located in California. We are pursuing a
determination from the California SEA whether the February 1999 Offering was a
change in control under its standards.
A change in control could occur as a result of future transactions in which
we, our institutes or a parent company as defined in DOE regulations are
involved. Some corporate reorganizations and some changes in the boards of
directors of such corporations are two examples of such transactions. A material
adverse effect on our financial condition, results of operations and cash flows
would result if we had a change in control and a material number of our
institutes failed, in a timely manner, to be
40
<PAGE>
reauthorized by their SEAs, reaccredited by their Accrediting Commissions or
recertified by the DOE to participate in Title IV Programs. See "Item 1.
Business--Change in Control."
Our capital assets consist primarily of classroom and laboratory equipment
(such as computers, electronic equipment and robotic systems), classroom and
office furniture and leasehold improvements. We lease all our building
facilities. Capital expenditures totaled $11.4 million during 1998 and included
expenditures of $2.2 million for new technical institutes, $2.9 million to
expand curricula offerings at existing institutes, $4.8 million to replace or
add furniture or equipment at existing institutes and $1.5 million on leasehold
improvements. Leasehold improvements represent part of our continuing effort to
maintain our existing facilities in excellent condition. Capital expenditures
decreased by $0.1 million to $11.4 million in 1998 from $11.5 million in 1997,
principally due to the expenditure of approximately $3.0 million for the
acquisition of new computers in 1997 offset by the expenditures for new
institutes opened in 1998. New institutes have large capital additions in the
first two years. To date, cash generated from operations has been sufficient to
meet our capital expenditures.
We plan to continue to upgrade and expand current facilities and equipment.
We expect that 1999 capital expenditures will be approximately $17.0 million, of
which approximately $7 million would be capital expenditures for new curriculum
at existing institutes. 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 $0.3 million. We anticipate that our
planned capital additions can be funded from cash flows from operations. Cash
flows on a long-term basis are highly dependent upon the receipt of Title IV
Program funds and the amount of funds spent on new institutes, curricula
additions at existing institutes and possible acquisitions.
We believe that the reduction in cash and cash equivalents and marketable
debt securities that were used to effect the stock repurchase will not have a
material adverse effect on our expansion plans, planned capital expenditures,
ability to meet any applicable regulatory financial responsibility standards, or
ability to conduct normal operations.
YEAR 2000 COMPLIANCE
THE YEAR 2000 PROBLEM. Many information technology ("IT") hardware and
software systems ("IT Systems") and non-IT Systems containing embedded
technology, such as microcontrollers and microchip processors ("Non-IT Systems")
can only process dates with six digits (e.g., 06/26/98), instead of eight digits
(e.g., 06/26/1998). This limitation may cause IT Systems and Non-IT Systems to
experience problems processing information with dates after December 31, 1999
(e.g., 01/01/00 could be processed as 01/01/2000 or 01/01/1900) or with other
dates, such as September 9, 1999, which was a date traditionally used as a
default date by computer programmers. These problems may cause IT Systems and
Non-IT Systems to suffer miscalculations, malfunctions or disruptions. These
problems are commonly referred to as "Year 2000" or "Y2K" problems. We are
unable at this time to assess the possible impact on our financial condition,
results of operations and cash flows that may result from any disruptions to our
business caused by Y2K problems in any IT Systems and Non-IT Systems that we
control or that any third party with whom we have a material relationship
controls. We do not believe at the current time, however, that the cost to
remedy our internal Y2K problems will have a material adverse effect on our
results of operations or cash flows.
OUR STATE OF READINESS. We have begun to implement a plan to ensure that
the IT Systems and material Non-IT Systems that we control are Y2K compliant
before January 1, 2000. In the first phase of the plan, we assessed the
potential exposure of our IT Systems and material Non-IT Systems to Y2K
problems. We have completed this phase. In the second phase, which we have also
completed, we designed a procedure to remediate our exposure to Y2K problems in
the IT Systems and material Non-IT Systems that we control. We are currently in
the third phase, which involves the actual remediation of the IT Systems and
material Non-IT Systems that we control. After we complete the
41
<PAGE>
third phase, we will begin the fourth and final phase of testing the remediation
to the IT Systems and material Non-IT Systems that we control to ensure Y2K
compliance. We plan to complete the testing phase by June 30, 1999.
We believe that we have identified all IT Systems and material Non-IT
Systems that we control that may require Y2K remediation. We have 12 people
(both employees and outside consultants) dedicated to completing enhancements to
our IT Systems, which include our accounting, human resources, financial
services, admissions, education, recruitment and career services systems. We
have been enhancing our IT Systems on a continuous basis since 1996 and we did
not accelerate these enhancements due to any Y2K problems. These enhancements
will also address the Y2K problems with our IT Systems. We plan to complete
these enhancements by April 30, 1999.
We have dedicated two employees to either remediate or cause the remediation
of material Non-IT Systems that we control and that we have identified as
possessing a Y2K problem. We plan to complete the remediation of these Non-IT
Systems by April 30, 1999. We acquired many of these Non-IT Systems during the
past few years and we believe that a substantial number of these newer systems
do not possess a Y2K problem. In addition, the vendors of many of these Non-IT
Systems have warranted them to be Y2K compliant. We have contacted the third
parties who control our other material Non-IT Systems (including, without
limitation, our communication systems, security systems, electrical systems and
HVAC systems) to assess whether any of these systems possess a Y2K problem that
could adversely affect our operations if a malfunction occurred. We have also
implemented procedures to help ensure that any new Non-IT Systems that we
acquire or utilize are Y2K compliant.
We have identified and begun to contact the third parties whose lack of Y2K
compliance may pose problems for us, such as federal and state regulators,
Accrediting Commissions, guaranty agencies, lenders, computer software and
hardware suppliers and book vendors. The General Accounting Office reported in
September 1998 that the DOE's delay in addressing the Y2K problems in its IT
Systems and the DOE's limited progress in making contingency plans should its IT
Systems fail could result in serious disruptions in the DOE's administration of,
and disbursement of funds under, Title IV Programs. In the DOE's January 15,
1999 status report on the Y2K compliance of its mission-critical IT systems, the
DOE stated that 12 of its 14 mission-critical IT Systems are Y2K compliant.
According to this report, the DOE's IT System that tracks FFEL program loans is
the only DOE IT System relating to federal student financial aid that is not Y2K
compliant. The DOE reported that this IT System will be Y2K compliant by March
31, 1999.
THE COSTS TO ADDRESS OUR YEAR 2000 ISSUES. We have expended approximately
$25,000 in direct costs through December 31, 1998 to identify and remediate our
Y2K problems. This amount does not include:
- the salaries of our employees involved in the remediation process;
- the cost of the enhancements to our IT Systems, because we did not
accelerate the enhancements due to Y2K problems; and
- the cost to us of replacing any Non-IT Systems or acquiring any new Non-IT
Systems in the normal course of our operations and not because of any Y2K
problems.
Based on our current assessment of our Y2K problems, we estimate that our
remediation efforts will cost between $50,000 and $100,000 for the IT Systems
and material Non-IT Systems that we control to become Y2K compliant,
representing up to 10% of our IT budget. Approximately 75% of this amount will
be used, if necessary, to replace computer hardware and software and other
Non-IT Systems equipment owned by us at our institutes. This amount does not
include any costs associated with remediating any Y2K problems suffered by any
third parties' IT Systems and Non-IT Systems that may affect our operations. Our
operations will fund our Y2K remediation efforts.
42
<PAGE>
THE RISKS ASSOCIATED WITH OUR YEAR 2000 ISSUES. The remediation of our Y2K
problems will increasingly cause us to defer some existing and contemplated
projects, particularly those involving our personnel conducting the Y2K
remediation. Although we are unable at this time to quantify our internal
indirect costs resulting from our Y2K problems, we do not believe that the cost
of remediating our internal Y2K problems or the lost opportunity costs arising
from diverting the efforts of our personnel to the remediation will have a
material adverse effect on our financial condition, results of operations or
cash flows. We do not intend to use any independent verification or validation
processes to assure the reliability of our risk or cost estimates associated
with our Y2K problems.
We have begun to outline several possible worst case scenarios that could
arise from our Y2K problems. At this time, however, we have insufficient
information to assess the likelihood of any worst case scenario. Our most
reasonably likely worst case Y2K scenarios involve:
- significant delays in our receipt of federal and state student financial
aid in payment of students' education costs of attending our institutes;
- significant delays or interruptions in the eligibility to participate in
Title IV Programs, approval to operate or accreditation of our institutes
that are undergoing their initial, or a renewal of, such eligibility,
approval or accreditation; and
- significant delays in obtaining authorization to offer new programs of
study for which our institutes have applied.
In 1998, we derived approximately 69% of our revenues from Title IV Programs
administered by the DOE. In addition, a number of our institutes participate in
various state student financial aid programs administered by SEAs that, in the
aggregate, generate a material portion of our revenues. In 1998, one lender
provided approximately 65% of all FFEL program loans received by our students,
and one student loan guaranty agency guaranteed approximately 94% of all FFEL
program loans received by our students. As a result, we must depend on the
ability of the DOE, the SEAs and our primary student loan lender and guaranty
agency to resolve their Y2K problems. If any of these parties were to experience
a Y2K problem that significantly delays our receipt of federal or state student
financial aid in payment of students' education costs, it could have a material
adverse effect on our financial condition, results of operations and cash flows.
Similarly, an interruption in our institutes' operations could occur if, due to
a Y2K problem:
- the DOE is unable to timely grant or renew an institute's eligibility to
participate in Title IV Programs;
- any SEA is unable to timely approve an institute to operate or renew such
approval; or
- either Accrediting Commission is unable to timely accredit an institute or
renew such accreditation.
A prolonged delay or interruption for a significant number of institutes could
have a material adverse effect on our financial condition, results of operations
and cash flows. We are unable to independently assess the Y2K readiness of any
of these third parties at this time.
CONTINGENCY PLAN. We have developed a contingency plan for the IT Systems
and material Non-IT Systems that we control. We have dedicated two employees to
remediate an IT System that will become obsolete after we finish the
enhancements to our IT Systems. We plan to complete the remediation of this IT
System by March 31, 1999. If the enhancements to our IT Systems are not finished
before January 1, 2000, we hope to avoid any disruption to our business by using
this other IT System. Our contingency plan with respect to the material Non-IT
Systems that we control includes, among other things, investigating the
availability and replacement cost of such Non-IT Systems that have Y2K problems,
isolating such systems that are not Y2K compliant so that they do not affect
other systems, and adjusting the clocks on such Non-IT Systems that are not date
sensitive. We believe that we could
43
<PAGE>
substitute other student loan lenders and guaranty agencies for our primary
lender and guaranty agency if either of these parties experienced a Y2K problem
that could significantly delay our receipt of federal or state student financial
aid in payment of students' education costs of attending our institutes. Our
current financial resources would also help us weather any such delay.
Otherwise, we have no contingency plan, and do not intend to create a
contingency plan, for the IT Systems and Non-IT Systems that are not controlled
by us, including the third party IT Systems of the DOE, the SEAs and the
Accrediting Commissions on which we rely.
NEW ACCOUNTING PRONOUNCEMENTS
The American Institute of Certified Public Accountants (the "AICPA") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use and requires us to capitalize costs incurred in the
application development stage (whether internal or external). Costs incurred
prior to initial application of this SOP, whether or not capitalized, should not
be adjusted to the amounts that would have been capitalized had this SOP been in
effect when those costs were incurred. We adopted this SOP in July 1998,
effective as of January 1, 1998, which increased net income by $0.5 million
($0.02 per share) in the year ended December 31, 1998.
Additionally, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities," in April 1998. SOP 98-5 provides guidance on the financial
reporting of start-up costs and requires the cost of start-up activities to be
expensed as incurred. This SOP is applicable to all financial statements for
fiscal years beginning after December 15, 1998. Initial application should be
reported as a cumulative effect of a change in accounting principle as described
in Accounting Principles Board Opinion No. 20, "Accounting Changes." We intend
to adopt this standard in the first quarter of 1999. Approximately $0.8 million,
net of tax, will be recorded as a change in accounting principle in the first
quarter of 1999.
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 governmental 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 ESI's
eligibility to participate in, student financial aid programs utilized by our
students; the consummation of the proposed settlements of student litigation and
claims related to our technology programs in California and our hospitality
programs; effects of any change in ownership of ESI resulting in a change in
control of ESI, 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 our existing program offerings and new
curricula; and loss of lender access to our students for student loans.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this Item appears in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--General."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item appears on pages F-1 through F-16
herein.
44
<PAGE>
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 our Directors, nominees for
Director, executive officers and disclosure of delinquent filers is incorporated
herein by reference to ESI's definitive Proxy Statement for our 1999 Annual
Meeting of Shareholders, to be filed with the SEC pursuant to Regulation 14A
within 120 days after the end of our last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item concerning remuneration of our
officers and Directors and information concerning material transactions
involving such officers and Directors is incorporated herein by reference to
ESI's definitive Proxy Statement for our 1999 Annual Meeting of Shareholders
which will be filed with the SEC pursuant to Regulation 14A within 120 days
after the end of our 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 ESI's definitive Proxy Statement for our 1999 Annual Meeting of
Shareholders which will be filed with the SEC pursuant to Regulation 14A within
120 days after the end of our 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 ESI's definitive
Proxy Statement for our 1999 Annual Meeting of Shareholders which will be filed
with the SEC pursuant to Regulation 14A within 120 days after the end of our
last fiscal year.
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, 1998,
December 31, 1997 and December 31, 1996........................................ F-2
Balance Sheets as of December 31, 1998 and December 31, 1997..................... F-3
Statements of Cash Flows for the years ended December 31, 1998, December 31, 1997
and December 31, 1996.......................................................... F-4
Notes to Financial Statements.................................................... F-5
</TABLE>
45
<PAGE>
2. Financial Statement Schedules:
Schedule II--Valuation and Qualifying Accounts of the Company for the
years ended December 31, 1998, December 31, 1997 and December 31, 1996
appear on page F-15.
3. Quarterly Results for 1998 and 1997 (unaudited) appear on page F-16.
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-2, which immediately
precedes such exhibits, and is incorporated herein by reference.
(b) Reports on Form 8-K
On December 21, 1998, we filed a Current Report on Form 8-K dated December
21, 1998 to report, under Item 5 of Form 8-K: (a) our filing of a registration
statement on Form S-3 on December 18, 1998 with the SEC; and (b) our execution
of a Stock Repurchase Agreement with ITT.
46
<PAGE>
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 45 present fairly, in all material respects, the
financial position of ITT Educational Services, Inc. at December 31, 1998 and
1997, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998, 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/ PricewaterhouseCoopers LLP
- ---------------------------------
PRICEWATERHOUSECOOPERS LLP
Indianapolis, Indiana
January 9, 1999
F-1
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF INCOME AND RETAINED EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES
Tuition...................................................................... $ 248,399 $ 222,457 $ 196,692
Other educational............................................................ 42,976 39,207 35,627
---------- ---------- ----------
Total revenues............................................................. 291,375 261,664 232,319
COSTS AND EXPENSES
Cost of educational services................................................. 176,487 163,053 145,197
Student services and administrative expenses................................. 81,522 72,388 66,546
Legal settlement............................................................. 12,858 -- --
Offering, change in control and other one-time expenses...................... 1,872 -- --
---------- ---------- ----------
Total costs and expenses................................................... 272,739 235,441 211,743
Operating income............................................................. 18,636 26,223 20,576
Interest income, net......................................................... 5,329 5,565 4,119
---------- ---------- ----------
Income before income taxes................................................... 23,965 31,788 24,695
Income taxes................................................................. 10,024 12,665 9,844
---------- ---------- ----------
Net income................................................................... 13,941 19,123 14,851
Retained earnings, beginning of period....................................... 55,032 35,909 21,058
---------- ---------- ----------
Retained earnings, end of period............................................. $ 68,973 $ 55,032 $ 35,909
---------- ---------- ----------
---------- ---------- ----------
Earnings per common share:
Basic...................................................................... $ 0.52 $ 0.71 $ 0.55
Diluted.................................................................... $ 0.51 $ 0.71 $ 0.55
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents............................................................... $ 77,335 $ 29
Restricted cash......................................................................... 3,617 3,860
Cash invested with ITT Corporation...................................................... -- 94,800
Marketable debt securities.............................................................. 38,316 --
Accounts receivable, less allowance for doubtful accounts of $2,531
and $1,393............................................................................ 10,772 9,680
Deferred income tax..................................................................... 5,969 2,019
Prepaids and other current assets....................................................... 2,749 2,570
---------- ----------
Total current assets.................................................................. 138,758 112,958
Property and equipment, net............................................................... 24,985 22,886
Direct marketing costs.................................................................... 7,915 6,882
Other assets.............................................................................. 3,913 3,188
---------- ----------
Total assets.......................................................................... $ 175,571 $ 145,914
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable........................................................................ $ 15,992 $ 14,974
Accrued compensation and benefits....................................................... 6,488 3,245
Accrued legal settlements............................................................... 7,604 --
Other accrued liabilities............................................................... 7,896 6,877
Deferred tuition revenue................................................................ 32,261 30,850
---------- ----------
Total current liabilities............................................................. 70,241 55,946
Other liabilities......................................................................... 3,474 2,153
---------- ----------
Total liabilities..................................................................... 73,715 58,099
---------- ----------
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, 27,011,202 and 26,999,952
issued and outstanding................................................................ 270 270
Capital surplus......................................................................... 32,613 32,513
Retained earnings....................................................................... 68,973 55,032
---------- ----------
Total shareholders' equity............................................................ 101,856 87,815
---------- ----------
Total liabilities and shareholders' equity............................................ $ 175,571 $ 145,914
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income..................................................... $ 13,941 $ 19,123 $ 14,851
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................ 9,282 7,939 7,493
Provision for doubtful accounts.............................. 4,326 2,354 1,738
Deferred taxes............................................... (3,219) 202 (443)
Increase/decrease in operating assets and liabilities:
Marketable debt securities................................. (38,316) -- --
Accounts receivable........................................ (5,418) (2,656) (3,524)
Direct marketing costs..................................... (1,033) (1,108) (743)
Accounts payable and accrued liabilities................... 13,474 2,958 3,083
Prepaids and other assets.................................. (904) (1,769) 220
Deferred tuition revenue................................... 1,411 (12,682) 3,469
--------- --------- ---------
Net cash provided by (used for) operating activities............. (6,456) 14,361 26,144
--------- --------- ---------
Cash flows used for investing activities:
Capital expenditures, net...................................... (11,381) (11,465) (7,868)
Net decrease (increase) in cash invested with ITT
Corporation.................................................. 94,800 (4,992) (17,923)
--------- --------- ---------
Net cash provided by (used for) investing activities............. 83,419 (16,457) (25,791)
--------- --------- ---------
Cash flow provided by finance activities:
Exercise of stock options...................................... 100 -- --
--------- --------- ---------
Net increase (decrease) in cash, cash equivalents and restricted
cash........................................................... 77,063 (2,096) 353
Cash, cash equivalents and restricted cash at beginning of
period......................................................... 3,889 5,985 5,632
--------- --------- ---------
Cash, cash equivalents and restricted cash at end of period...... $ 80,952 $ 3,889 $ 5,985
--------- --------- ---------
--------- --------- ---------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes................................................. $ 12,757 $ 12,352 $ 10,051
Interest..................................................... 238 291 273
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)
1. OWNERSHIP AND CHANGE IN CONTROL
From ITT Educational Services, Inc.'s (the "Company") initial public
offering in 1994 until June 9, 1998, ITT Corporation ("ITT") owned 83.3% of the
outstanding common stock of the Company.
On February 23, 1998, Starwood Hotels & Resorts Worldwide, Inc. ("Starwood
Hotels") completed the acquisition of ITT (the "Merger") and ITT became a
subsidiary of Starwood Hotels. As a result of the Merger, a change in control of
the Company occurred under regulations of the U.S. Department of Education
("DOE") and each ITT Technical Institute campus group became ineligible to
participate in federal student financial aid programs. Effective March 20, 1998,
the eligibility of each ITT Technical Institute campus group to participate in
federal student financial aid programs was reinstated by the DOE with certain
conditions imposed by the DOE. The Company believes that it is in compliance
with or satisfies these DOE conditions.
On June 9, 1998, ITT sold 13,050,000 shares of the Company's common stock
held by ITT to the public (48.3% of the outstanding shares) (the "June 1998
Offering"). ITT presently owns 35% of the outstanding shares of the Company's
common stock. The June 1998 Offering did not constitute a change in control
under the DOE's regulations. In December 1998, the Company filed a registration
statement with the Securities and Exchange Commission, which was not effective
as of December 31, 1998, relating to the offering of shares of the Company's
common stock to the public (the "February 1999 Offering"). The February 1999
Offering contemplates the sale of 7,000,000 shares, together with an
underwriters' over-allotment option to purchase up to 950,000 additional shares,
of the Company's common stock held by ITT. The February 1999 Offering does not
constitute a change in control under the DOE's regulations. Simultaneous with
the close of the February 1999 Offering, the Company intends to repurchase
1,500,000 shares of its common stock from ITT at an aggregate cost not to exceed
$49,260.
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, 1998, the Company operated 65 technical institutes
throughout the United States. The Company maintains its corporate headquarters
in Indianapolis, Indiana.
USE OF ESTIMATES. The preparation of these financial statements, in
conformity with generally accepted accounting principles, includes estimates
that are determined by the Company's management.
CASH EQUIVALENTS AND MARKETABLE DEBT SECURITIES. Marketable debt securities
are classified as trading securities and have maturity dates in excess of 90
days at the time of purchase and are recorded at their market value. Debt
securities with maturity dates less than 90 days at the time of purchase are
included in cash and cash equivalents and are recorded at cost, which
approximates market value. The cost of securities sold is based on the first-in,
first-out method.
Investment income for the year ended December 31, 1998 consists of:
<TABLE>
<S> <C>
Net realized gains on the sale of trading securities................ $ 11
Interest and dividend income, net................................... 4,926
Change in net unrealized holding gain............................... 85
---------
$ 5,022
---------
---------
</TABLE>
F-5
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
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 and cash equivalents, 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. Marketable debt
securities are recorded at their market value.
RECOGNITION OF REVENUES. Tuition revenues are 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 academic 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 revenues are comprised of laboratory fees and textbook
sales. Laboratory fees are recorded as revenue at the beginning of each academic
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 $7,915 and $6,882 at December 31, 1998 and December 31, 1997,
respectively, net of accumulated amortization of $6,895 and $5,861 at those
dates, respectively.
INSTITUTE START-UP COSTS. Deferred institute start-up costs consist of all
direct costs (excluding advertising costs) incurred at a new institute 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, 1998 and December 31, 1997, deferred start-up
costs included in other assets in the balance sheet totaled $1,353 and $1,316,
respectively, net of accumulated amortization of $511 and $174 at such dates,
respectively. In conformity with Statement of Position ("SOP") 98-5, "Reporting
on the Costs of Start-Up Activities," the Company intends to expense the $1,353
of institute start-up costs, less $531 of deferred taxes, as a cumulative effect
of a change in accounting principle in the first quarter of 1999.
OFFERING, CHANGE IN CONTROL AND OTHER ONE-TIME EXPENSES. The Company
incurred total expenses for the June 1998 Offering of $1,117. In addition, the
Company incurred expenses of $755 associated with its change in control and
establishment of new employee benefit plans.
F-6
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. The
American Institute of Certified Public Accountants (the "AICPA") issued SOP
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," in March 1998. SOP 98-1 provides guidance on accounting for costs
of computer software developed or obtained for internal use and requires costs
incurred in the application development stage (whether internal or external) to
be capitalized. Costs incurred prior to initial application of this SOP, whether
or not capitalized, should not be adjusted to the amounts that would have been
capitalized had this SOP been in effect when those costs were incurred. The
Company adopted this SOP effective July 1, 1998, which increased net income by
$508 ($0.02 per share) in the year ended December 31, 1998.
INCOME TAXES. The Company was included in the consolidated U.S. federal
income tax return of ITT prior to June 9, 1998 and determined 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 were allocated to members of the U.S. consolidated group based
principally on the amounts they would pay or receive if they filed a separate
income tax return. Deferred income taxes were 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 reversed. Temporary differences related to SFAS No.
106, SFAS No. 112, pension and self-insurance costs were recorded on the books
of ITT where the related assets and liabilities were recorded. ITT paid current
federal income taxes on behalf of the Company, as calculated under the tax
sharing policy, and reflected the funding through the cash invested with ITT
Corporation account.
Beginning June 9, 1998, the Company started filing its own federal income
tax returns, paying its own federal income taxes and recording all deferred
income taxes on its books.
EARNINGS PER COMMON SHARE. Earnings per common share for all periods 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 the
Company's common stock outstanding during each period. The number of average
shares outstanding utilized for basic earnings per share were 27,001,542 in 1998
and
26,999,952 in 1997 and 1996. Average shares outstanding utilized for diluted
earnings per share were approximately 27,185,000, 27,105,000 and 27,092,000 for
1998, 1997 and 1996, 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, 1998, 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 provided the Company with certain centralized
treasury and financing functions. The Company transferred all unrestricted cash
receipts to ITT and received funds from ITT for all disbursements. The Company
earned interest on the average net cash balance held by ITT, at an interest rate
that was set for a 12-month period and was 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 of
$94,800 at
F-7
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
December 31, 1997. On February 5, 1998, ITT transferred approximately $83,000 to
the Company and, since that date, the Company has been performing its own cash
management function.
ITT also provided certain risk management and pension management services to
the Company until June 9, 1998. The fee (contract service charge) for such
services was 0.25% of the Company's annual revenue. The contract service charges
were $15, $654 and $578 for the years ended December 31, 1998, 1997 and 1996,
respectively.
The Company's employees participated in certain employee benefit programs
which were sponsored and administered by ITT until June 9, 1998. Administrative
costs relating to these services and participation in these plans were charged
to the Company using allocation methods management believes were reasonable. The
Company paid a processing fee related to its participation in ITT's consolidated
medical plan. The processing fees were $159 and $280 in 1997 and 1996,
respectively.
TAX AGREEMENT. ITT and the Company participated in a tax agreement that
provided, among other things, that the Company would pay ITT, with respect to
federal income taxes for each period that the Company was included in ITT's
consolidated federal return, the 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 filed a combined or consolidated state return that
included the Company, the Company paid ITT an amount 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 benefited the Company. The aforementioned
agreements were modified in connection with the June 1998 Offering.
4. FINANCIAL AID PROGRAMS
The Company participates in various Title IV Programs. Approximately 69% of
the Company's 1998 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 $8,565 and $8,517 at December 31, 1998 and 1997, respectively.
The Company has recorded in its financial statements only its aggregate
mandatory contributions to this program which at December 31, 1998 and 1997
aggregated $1,581 and $1,588, respectively. The Company has provided $972 and
$971, respectively, for potential losses related to funds committed by the
Company at December 31, 1998 and 1997.
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 of 1965,
as amended, 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
F-8
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
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.
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 cash until they are applied to the students' accounts.
6. PROPERTY AND EQUIPMENT
Fixed assets include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Furniture and equipment................................. $ 70,581 $ 62,514
Leasehold improvements.................................. 8,699 7,848
Land and land improvements.............................. 110 110
Construction in progress................................ 583 325
--------- ---------
79,973 70,797
Less accumulated depreciation........................... (54,988) (47,911)
--------- ---------
$ 24,985 $ 22,886
--------- ---------
--------- ---------
</TABLE>
7. TAXES
The provision for income taxes includes the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Current
Federal......................................... $ 11,052 $ 10,399 $ 8,673
State........................................... 2,191 2,064 1,614
--------- --------- ---------
13,243 12,463 10,287
Deferred
Federal......................................... (2,686) 168 (370)
State........................................... (533) 34 (73)
--------- --------- ---------
(3,219) 202 (443)
--------- --------- ---------
$ 10,024 $ 12,665 $ 9,844
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-9
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
Deferred tax assets (liabilities) include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Direct marketing costs............................ $ (3,105) $ (2,698) $ (2,263)
Legal settlements................................. 2,983 -- --
Institute start-up costs.......................... (531) (516) (204)
Depreciation...................................... 607 759 785
Reserves and other................................ 3,209 2,399 1,828
--------- --------- ---------
Net deferred tax assets (liabilities)............. $ 3,163 $ (56) $ 146
--------- --------- ---------
--------- --------- ---------
</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,
-------------------------------
1998 1997 1996
--------- --------- ---------
<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% 4.1%
Non-deductible June 1998 Offering expenses............ 1.5% -- --
Permanent differences and other....................... 1.2% 0.7% 0.8%
--- --- ---
Effective income tax rate............................. 41.8% 39.8% 39.9%
--- --- ---
--- --- ---
</TABLE>
8. RETIREMENT PLANS
EMPLOYEE PENSION BENEFITS. Prior to June 9, 1998, the Company participated
in the Retirement Plan for Salaried Employees of ITT Corporation which covered
substantially all employees of the Company. ITT determined the aggregate amount
of pension expense on a consolidated basis based on actuarial calculations and
such expense was allocated to participating units on the basis of compensation
covered by the plan. Effective June 9, 1998, the Company adopted its own
non-contributory defined benefit pension plan. This plan, commonly referred to
as a cash balance plan, provides benefits based upon annual employee earnings
times established percentages of pay based on age and years of service. Charges
to the Company by ITT for pension expense for the years ended December 31, 1998,
1997 and 1996 were $1,858, $4,458 and $3,783, respectively. The net periodic
benefit cost for the Company's plan for the year ended December 31, 1998 was
comprised of service cost of $2,217.
The following is information on the Company's plan for 1998:
Change in benefit obligation:
<TABLE>
<S> <C>
Projected benefit obligation at beginning of period................ $ --
Service cost....................................................... 2,217
Actuarial loss..................................................... 527
---------
Projected benefit obligation at end of period...................... $ 2,744
---------
Funded status...................................................... $ (2,744)
Unrecognized net actuarial loss.................................... 527
---------
Accrued benefit cost............................................... $ (2,217)
---------
---------
</TABLE>
F-10
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
The accumulated benefit obligation at September 30, 1998 is $1,551. The plan
does not have any assets as of December 31, 1998, and the Company intends to
make its first funding contribution to the plan in 1999.
Weighted-average assumptions as of September 30, 1998:
<TABLE>
<S> <C>
Discount rate.......................................................... 6.5%
Expected return on plan assets......................................... 9.0%
Rate of compensation increase.......................................... 4.5%
</TABLE>
RETIREMENT SAVINGS PLAN. Prior to May 16, 1998, the Company participated in
The ITT 401K Retirement Savings Plan, a defined contribution plan which covered
substantially all employees of the Company. The Company's non-matching and
matching contributions under this plan were provided for through the issuance of
common shares of ITT until February 23, 1998 and paired shares of Starwood
Hotels and Starwood Hotels & Resorts, a Maryland real estate investment trust,
until May 16, 1998. The costs of the non-matching and matching Company
contributions were charged by ITT to the Company. Effective May 16, 1998, the
Company adopted its own 401(k) plan, a defined contribution plan which covers
substantially all employees of the Company and operates similar to The ITT 401K
Retirement Savings Plan. The Company's non-matching and matching contributions
under its 401(k) plan are made in the form of shares of the Company's common
stock. For the years ended December 31, 1998, 1997 and 1996, the costs of
providing this benefit (including an allocation of the administrative costs of
the plan) were $2,109, $2,104 and 1,749, 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 common stock at the measurement date over
the exercise price.
Under the 1994 Plan, a maximum of 405,000 shares of the Company's 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 the Company's 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 Company's 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
F-11
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
outstanding, granted, exercised and forfeited for the three years ended December
31, 1998 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
# OF OPTION # OF OPTION # OF OPTION
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year............................ 405,000 $ 13.46 258,750 $ 7.37 191,250 $ 5.75
Granted..................................................... 405,000 21.69 146,250 24.25 67,500 11.94
Exercised................................................... (11,250) 8.89
Forfeited................................................... (5,000) 21.69
--------- --------- --------- --------- --------- ---------
Outstanding at end of year.................................. 793,750 $ 17.67 405,000 $ 13.46 258,750 $ 7.37
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
EXERCISE PRICE RANGE
-------------------------------------------------
$4.44 $8.89-$11.94 $21.69-$24.25 TOTAL
---------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
Options outstanding at year end.............................. 135,000 112,500 546,250 793,750
Weighted average exercise price.............................. $ 4.44 $ 10.72 $ 22.38 $ 17.67
Remaining contractual life................................... 6 years 7 years 8.8 years 8.1 years
Options exercisable at year end.............................. 135,000 90,000 48,750 273,750
Weighted average exercise price.............................. $ 4.44 $ 10.42 $ 24.25 $ 9.93
</TABLE>
During 1998, the Company issued 11,250 shares of common stock for proceeds
of $100 in conjunction with the exercise of stock options.
Compensation costs for the 1994 Plan, calculated in accordance with SFAS No.
123, are not significant for the year ended December 31, 1996. If compensation
costs had been determined based on 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 years ended December 31, 1998 and 1997 would have been reduced to
the proforma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Proforma
Net income............................................................ $ 12,554 $ 18,519
Basic earnings per share.............................................. 0.46 0.69
Diluted earnings per share............................................ 0.46 0.68
As reported
Net income............................................................ $ 13,941 $ 19,123
Basic earnings per share.............................................. 0.52 0.71
Diluted earnings per share............................................ 0.51 0.71
</TABLE>
F-12
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for the
three years ended December 31, 1998:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rates............................................ 5.3% 6.6% 5.7%
Expected lives (in years)........................................... 5 10 10
Volatility.......................................................... 41% 46% 46%
Dividend yield...................................................... None None None
</TABLE>
In October 1998, the Compensation Committee of the Board of Directors
awarded additional stock options for 409,500 shares of the Company's common
stock. The effective date of this award will be the date of the February 1999
Offering and the exercise price will be equal to the offering price of the
shares of the Company's common stock sold in the February 1999 Offering.
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 12 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,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Minimum rentals.............................................. $ 21,408 $ 18,961 $ 17,131
Contingent rentals........................................... 246 272 249
--------- --------- ---------
$ 21,654 $ 19,233 $ 17,380
--------- --------- ---------
--------- --------- ---------
</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, 1998 are as follows:
<TABLE>
<S> <C>
1999.............................................................. $ 21,564
2000.............................................................. 22,798
2001.............................................................. 19,270
2002.............................................................. 17,328
2003.............................................................. 16,300
Later Years....................................................... 36,378
---------
$ 133,638
---------
---------
</TABLE>
F-13
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
Operating leases related to two institutes that are still in the
developmental phase at December 31, 1998 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 two institutes. If the institutes
are accredited as expected, aggregate additional minimum rental payments of
$3,010 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, 1998
aggregated $1,768. Additionally, the Company is required to maintain on deposit
with the lender 15% of the aggregate principal balance of the 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 in the
normal course of business. In September 1998, the Company agreed to settle eight
legal proceedings (including ELDREDGE, ET AL. V. ITT EDUCATIONAL SERVICES, INC.,
ET AL.) involving 25 former students and the claims of 15 other former students
that related primarily to the Company's marketing and recruitment practices and
included allegations of misrepresentation, fraud and violations of certain
federal and state statutes. As part of the settlement of these legal proceedings
and claims, the Company is seeking court approval of a class settlement of the
claims of (a) approximately 1,200 other persons who attended an associate degree
program in hospitality at the ITT Technical Institute in Maitland, San Diego,
Portland or Indianapolis and (b) approximately 19,000 other persons who attended
any technology program at any ITT Technical Institute in California from January
1, 1990 through December 31, 1997. If the Company obtains court approval of the
class settlements, the members of each class may still elect to opt out of the
settlement and pursue any claims they may have against the Company. The Company
recorded a $12.9 million provision for legal settlements in the year ended
December 31, 1998 as a result of the settlement of these legal proceedings and
claims.
In the opinion of management, the ultimate outcome of the pending legal and
other claims, excluding the settlement discussed above, should not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
F-14
<PAGE>
SCHEDULE II
ITT EDUCATIONAL SERVICES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THREE YEARS ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT
BEGINNING CHARGED TO BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES WRITE-OFFS OF PERIOD
- ------------------------------------------------------------- ----------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year Ended December 31, 1998............................... $ 1,393 $ 4,326 $ (3,188) $ 2,531
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
FFEL Reserve (1):
Year Ended December 31, 1998............................... $ 971 $ 1 $ -- $ 972
Year Ended December 31, 1997............................... $ 955 $ 16 $ -- $ 971
Year Ended December 31, 1996............................... $ 955 $ -- $ -- $ 955
</TABLE>
- ------------------------
(1) Represents Federal Family Education Loan/Perkins Loan programs.
F-15
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
QUARTERLY RESULTS
FOR 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31 YEAR
----------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
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 & Diluted............................. $ 0.23 $ 0.03 $ 0.30 $ 0.14 $ 0.71
1998
Revenues...................................... $ 72,287 $ 65,077 $ 81,700 $ 72,311 $ 291,375
Cost and expenses............................. $ 61,317 $ 66,740 $ 79,622 $ 65,060 $ 272,739
Operating income (1).......................... $ 10,970 $ (1,663) $ 2,078 $ 7,251 $ 18,636
Interest income, net.......................... $ 1,244 $ 1,191 $ 1,417 $ 1,477 $ 5,329
Net income (loss) (1)......................... $ 7,328 $ (660) $ 2,097 $ 5,176 $ 13,941
Earnings per share (1)
Basic....................................... $ 0.27 $ (0.02) $ 0.08 $ 0.19 $ 0.52
Diluted..................................... $ 0.27 $ (0.02) $ 0.08 $ 0.19 $ 0.51
Other operating data:
Operating losses from new institutes before
income taxes (2)
1997...................................... $ 964 $ 1,035 $ 592 $ 574 $ 3,165
1998...................................... $ 1,060 $ 1,475 $ 1,338 $ 1,384 $ 5,257
</TABLE>
- ------------------------
(1) Includes one-time expenses of $14,730 ($9,216 after taxes) for legal
settlements, offering expenses associated with the June 1998 Offering, and
change in control and other one-time expenses related to Starwood, Inc.'s
acquisition of ITT. Excluding these one-time expenses, operating income, net
income and earnings per share for the year ended December 31, 1998 would
have been $33,366, $23,157 and $0.85, respectively.
(2) Operating losses from new 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-16
<PAGE>
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.
<TABLE>
<S> <C> <C>
ITT EDUCATIONAL SERVICES, INC.
By: /s/ RENE R. CHAMPAGNE
-----------------------------------------
Rene R. Champagne
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE
OFFICER
</TABLE>
Dated: February 19, 1999
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
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
Chairman, President, Chief
/s/ RENE R. CHAMPAGNE Executive Officer and
- ------------------------------ Director (Principal February 19, 1999
Rene R. Champagne Executive Officer)
Senior Vice President and
/s/ GENE A. BAUGH Chief Financial Officer
- ------------------------------ (Principal Financial February 19, 1999
Gene A. Baugh Officer and Principal
Accounting Officer)
- ------------------------------ Director , 1999
Rand V. Araskog
/s/ JOHN E. DEAN
- ------------------------------ Director February 19, 1999
John E. Dean
/s/ JAMES D. FOWLER, JR.
- ------------------------------ Director February 19, 1999
James D. Fowler, Jr.
/s/ LESLIE LENKOWSKY
- ------------------------------ Director February 19, 1999
Leslie Lenkowsky
/s/ VIN WEBER
- ------------------------------ Director February 19, 1999
Vin Weber
</TABLE>
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
PAGE NO.
EXHIBIT IN THIS
NO. DESCRIPTION FILING
- ------------ ----------------------------------------------------------------------------------------- -------------
<C> <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 ESI and ITT....................................
10.2 (3) Tax Sharing Agreement between ESI and ITT............................................
10.3 (3) Intercompany Agreement between ESI and ITT...........................................
10.4 (3) Trade Name and Service Mark License Agreement between ESI and ITT....................
10.5 (3) Employee Benefits and Administrative Services Agreement between ESI and ITT..........
10.6 (3) Treasury Services and Credit Facilities Agreement between ESI and ITT................
10.7 *(4) ITT Educational Services, Inc. 1994 Stock Option Plan...............................
10.8 *(5) 1997 ITT Educational Services, Inc. Incentive Stock Plan............................
10.9 (6) Employee Benefits Agreement between ESI and ITT......................................
10.10 (6) Income Tax Sharing Agreement between ESI, ITT and Starwood Hotels & Resorts
Worldwide, Inc...........................................................................
10.11 (6) Trade Name and Service Mark License Agreement between ESI and ITT Sheraton
Corporation..............................................................................
10.12 (7) Amended and Restated Registration Rights Agreement between ESI and ITT...............
10.13 (8) Stockholder Agreement between ESI and ITT............................................
10.14 *(9) ESI 401(k) Plan.....................................................................
10.15 *(6) ESI Excess Savings Plan.............................................................
10.16 *(10) ESI Pension Plan...................................................................
10.17 (11) Stock Repurchase Agreement between ESI and ITT......................................
10.18 First Amendment to Trade Name and Service Mark License Agreement between ESI and ITT
Sheraton Corporation.....................................................................
11 Statement re Computation of Per Share Earnings...........................................
23 Consent of PricewaterhouseCoopers 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 ESI'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 ESI'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 ESI's 1994
Annual Report on Form 10-K is incorporated herein by reference.
S-2
<PAGE>
(4) The copy of this exhibit filed as the same exhibit number to ESI'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 ESI's 1997
second fiscal quarter report on Form 10-Q is incorporated herein by
reference.
(6) The copy of this exhibit filed as the same exhibit number to ESI's 1998
second fiscal quarter report on Form 10-Q is incorporated herein by
reference.
(7) The copy of this exhibit filed as Exhibit 99.2 to Starwood Hotels & Resorts
Worldwide, Inc.'s and ITT's Amendment No. 1 to Schedule 13D dated June 29,
1998 is incorporated herein by reference.
(8) The copy of this exhibit filed as Exhibit 99.1 to Starwood Hotels & Resorts
Worldwide, Inc.'s and ITT's Amendment No. 1 to Schedule 13D dated June 29,
1998 is incorporated herein by reference.
(9) The copy of this exhibit filed as Exhibit 4.3 to ESI's Registration
Statement on Form S-8 (Registration No. 333-55903) is incorporated herein
by reference.
(10) The copy of this exhibit filed as the same exhibit number to ESI's 1998
third fiscal quarter report on Form 10-Q is incorporated herein by
reference.
(11) The copy of this exhibit filed as Exhibit 99.1 to ESI's current report on
Form 8-K dated December 21, 1998 is incorporated herein by reference.
S-3
<PAGE>
EXHIBIT 10.18
FIRST AMENDMENT TO TRADE NAME
AND SERVICE MARK LICENSE AGREEMENT
This First Amendment to Trade Name and Service Mark License Agreement
(this "Amendment") is entered into as of February 1, 1999, by and between ITT
Sheraton Corporation, a Delaware corporation ("Licensor"), and ITT
Educational Services, Inc., a Delaware corporation ("Licensee") (individually
a "Party" and collectively, "Parties").
WHEREAS Licensor and Licensee are parties to a Trade Name and Service
Mark License Agreement dated June 3, 1998 (the "License");
WHEREAS ITT Corporation, a Nevada corporation ("Parent") owns all of the
outstanding shares of Licensor; and
WHEREAS Parent and Licensee entered into a Stock Repurchase Agreement,
dated as of December 18, 1998 (the "Repurchase Agreement"), pursuant to which,
among other things, Parent agreed to cause Licensor to amend the License as set
forth below.
NOW, THEREFORE, in consideration of the mutual covenants contained herein
and other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, the Parties agree as follows:
I. DEFINITIONS
A. GENERALLY. Except as otherwise specified in this Amendment, all
capitalized terms in this Amendment shall have the meanings provided
in the License.
B. AMENDMENT EFFECTIVE DATE. "Amendment Effective Date" means the
date of the closing of the Repurchase and the Public Offering (as
those terms are defined in the Repurchase Agreement).
C. CHANGE OF CONTROL. As of the Amendment Effective Date, Section
I.F(iii) of the License is amended and restated to read in its
entirety as follows:
"(iii) the stockholders of Licensee shall approve (a) any
consolidation or merger of Licensee in which Licensee is not
the continuing or surviving corporation or pursuant to which
all shares of Common Stock would be converted into cash,
securities or other property, other than a merger of
Licensee in which holders of Common Stock immediately prior
to the merger have the same proportionate ownership of
common stock of the surviving corporation immediately after
the merger as immediately before, or (b) any sale, lease,
exchange or other transfer (in one transaction or a series
of related transactions) of all or substantially all of the
assets of
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<PAGE>
Licensee to any person or entity other than a wholly-owned
subsidiary of Licensee."
II. SCOPE OF LICENSE
A. As of the Amendment Effective Date, Section II.A of the License shall
be amended and restated to read in its entirety as follows:
"A. GRANT. Subject to the terms and conditions of this
Agreement, Licensor hereby grants to Licensee, during the
term of this Agreement, a nonexclusive, non-transferable,
worldwide, royalty-free license to use the Licensed Mark in
accordance with the applicable Permitted Manner of Use
solely in connection with the operation of the Business of
the Licensee and solely in the following manner:
"(1) in its corporate name, in its popular name and in the
name of its schools in and only in the manner specified
on Exhibit B attached hereto, as such Exhibit may be
supplemented from time to time pursuant to Section II.E
hereof; and
"(2) as a trademark and service mark for the purpose of
conducting the Business of Licensee."
B. As of the Amendment Effective Date, Section II.B of the
License shall be amended and restated to read in its
entirety as follows:
"B. SUBLICENSING, ASSIGNING AND TRANSFERRING. Licensee
shall not sublicense, sell, assign, share or otherwise
transfer any of its rights under this Agreement to any
other person or entity, and any attempted sublicense,
sale, assignment, or other transfer in violation of
this Agreement shall be null and void and shall
immediately terminate this Agreement and the license
granted herein. Notwithstanding the foregoing, Licensee
may sublicense its rights hereunder to any of its
current or future Subsidiaries and may assign or
transfer this Agreement to and among Licensee and any
of its current or future wholly-owned subsidiaries,
conditioned in each case upon and so long as: (i) any
and all sublicensees, assignees or transferees execute
a written agreement agreeing to be bound by the terms
of this Agreement; (ii) Licensee guarantees that the
performance of any and all such sublicensees, assignees
or transferees shall be in compliance with the terms of
this Agreement, and (iii) such sublicensee continues to
be a Subsidiary of Licensee or such assignee or
transferee continues to be a wholly-owned subsidiary of
Licensee."
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<PAGE>
C. As of the Amendment Effective Date, Section II.E shall be added
to the License, as follows:
"E. ADDITIONAL USES.
"1. If Licensee desires to add names to Exhibit B
attached hereto for use solely in connection with
acquisitions within the Business of Licensee by
Licensee after January 1, 1999, Licensee may so
notify Licensor in writing, which notice shall
state: "By this notice, ITT Educational Services,
Inc. proposes to amend the Trade Name and Service
Mark License Agreement dated June 3, 1998, by and
between ITT Educational Services, Inc. and ITT
Sheraton Corporation, as amended, solely by adding
the following names to Exhibit B of such license
for use under such license agreement solely in
connection with acquisitions by ITT Educational
Services, Inc. after January 1, 1999 within its
business (as conducted as of June, 1998, and
generally described in its Annual Report on Form
10-K for the year ending December 31, 1997): [list
additional proposed names]."
"2. If Licensor does not respond to such notice by
either accepting or rejecting the additional names
proposed within thirty (30) days after it receives
such notice, Licensee may give a second notice
regarding such names not less than thirty (30)
days nor more than sixty (60) days after giving
the initial notice, which second notice shall be
identical to the initial notice except for its
date and except that it shall prominently state:
"THIS IS YOUR SECOND NOTICE. YOUR FAILURE TO
ACCEPT OR REJECT IN WRITING THE PROPOSAL TO ADD
THE NAMES SPECIFIED HEREIN TO EXHIBIT B OF THE
LICENSE AGREEMENT REFERENCED HEREIN WITHIN TEN
(10) DAYS AFTER RECEIPT OF THIS SECOND NOTICE MAY
BE DEEMED TO CONSTITUTE ACCEPTANCE OF SUCH
PROPOSAL. "
"3. Licensor may elect in the exercise of its sole and
absolute discretion whether to accept or reject
any proposal to add names to Exhibit B; provided
that Licensor shall be deemed to accept any such
proposal if (i) Licensee sends an initial notice
conforming in all respects to this Section II.E
making such proposal, (ii) not less than thirty
(30) nor more than sixty (60) days thereafter it
sends a second notice conforming in all respects
to this Section II.E repeating such proposal, and
(iii) Licensor nevertheless fails to accept or
reject such proposal in writing within ten (10)
days after it receives such second notice."
-3-
<PAGE>
"4. Copies of all notices to Licensor under this
Section II.E shall be given or delivered in a
manner specified in Section XII.B hereof
concurrently with the giving of such notice to
Licensor at the following address:
c/o Starwood Hotels and Resorts Worldwide, Inc.
777 Westchester Avenue
White Plains, New York 10604
Attention: General Counsel
with a copy (which shall not constitute notice) to:
Sidley & Austin
555 West Fifth Street, 40th Floor
Los Angeles, California 90013
Attention: Sherwin L. Samuels
Facsimile: (213) 896-6600
or to such other or additional addresses as
Licensor shall specify in writing. Notice to
Licensor under this Section II.E shall be of no
force or effect unless it and all required copies
(i) are given or delivered in conformity with
Section XII.B hereof, (ii) comply with all
requirements of this Section II.E, and (iii) are
actually received by Starwood Hotels and Resorts
Worldwide, Inc., or its successor. Notice to
Licensee under this Section II.E shall be
effective if it is provided in accordance with
Section XII.B hereof or if it is actually received
by Licensee."
D. EXHIBIT B
As of the Amendment Effective Date, Exhibit B shall be added to the License in
the form attached hereto.
III. TERM OF LICENSE
As of the Amendment Effective Date, Section III.A of the License shall be
amended and restated to read in its entirety as follows:
"A. TERM. This Agreement shall continue in full force and effect in
perpetuity unless it is terminated as provided herein."
IV. TERMINATION
Either party may terminate this Amendment upon written notice to the
other party if the Amendment Effective Date does not occur on or
before March 31, 1999. This Amendment shall be of no force or effect
whatsoever if it terminates before the Amendment Effective Date;
provided that Section V of this Amendment shall be fully
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<PAGE>
effective whether or not the Amendment Effective Date occurs and shall
survive any termination of this Amendment and remain fully effective
thereafter in perpetuity.
V. NO OTHER AMENDMENT
This Amendment sets forth the Parties' entire understanding and
agreement regarding amendments to the License and supersedes all prior
or contemporaneous communications regarding such amendments, all of
which are merged herein. Without limiting the generality of the
foregoing, Licensee agrees for the benefit of both Licensor and Parent
that Licensee has no right to demand or require amendment of the
License under the Repurchase Agreement except as specifically and
expressly provided herein. Subject to this Amendment, the License
remains in full force and effect.
VI. COUNTERPARTS
This Amendment may be executed in counterparts, each of which shall be
deemed an original and all of which together shall constitute one and
the same instrument.
IN WITNESS WHEREOF, the Parties have executed this Amendment as of the date
first above written.
ITT SHERATON CORPORATION ITT EDUCATIONAL SERVICES, INC.
By: /S/ JAMES D. LATHAM By: /s/ Clark D. Elwood
---------------------------- --------------------------------
Print Name: James D. Latham Print Name: Clark D. Elwood
------------------- -----------------
Title: Senior Vice President Title: Senior Vice President
------------------------ ----------------------------
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<PAGE>
EXHIBIT B
ITT Educational Services, Inc.
ITT Educational Services
ITT Technical Institute
ITT Technical Institutes
ITT Tech
ITT Technical College
ITT College of Technology
ITT College
ITT Technical University
ITT University
ITT Adult Learning Corp.
ITT Distance Education Corp.
ITT Distance Learning Corp.
ITT Educational Services Foundation
ITT Graduate Division
ITT Graduate School
ITT Technical Institute Alumni Association
ITT Tech Alumni Association
ITT Scholarship Program
ITT Student Finance Corporation
ITT ESI PAC
ITT Tech PAC
ITT Technical Institute Foundation
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<PAGE>
EXHIBIT 11
ITT EDUCATIONAL SERVICES, INC.
COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1998 1997 1996
------- ------- --------
<S> <C> <C> <C>
Net income ........................................... $13,941 $19,123 $14,851
------- ------- -------
------- ------- -------
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...................... 186 105 92
------- ------- -------
Outstanding shares for diluted
earnings per share calculation...................... 27,186 27,105 27,092
------- ------- -------
------- ------- -------
Earnings per common share:
Basic........................................... $ 0.52 $ 0.71 $ 0.55
Diluted......................................... $ 0.51 $ 0.71 $ 0.55
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Registration
Statements on Form S-8 (No.'s 33-80435, 333-38883 and 333-55903) of ITT
Educational Services, Inc. of our report dated January 9, 1999, appearing on
page F-1 of this Form 10-K.
/s/ PricewaterhouseCoopers
- ------------------------------
PRICE WATERHOUSECOOPERS LLP
Indianapolis, Indiana
February 18, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 80,952
<SECURITIES> 38,316
<RECEIVABLES> 13,303
<ALLOWANCES> (2,531)
<INVENTORY> 0
<CURRENT-ASSETS> 138,758
<PP&E> 79,972
<DEPRECIATION> (54,987)
<TOTAL-ASSETS> 175,571
<CURRENT-LIABILITIES> 70,241
<BONDS> 0
0
0
<COMMON> 270
<OTHER-SE> 101,586
<TOTAL-LIABILITY-AND-EQUITY> 175,571
<SALES> 0
<TOTAL-REVENUES> 291,375
<CGS> 0
<TOTAL-COSTS> 272,739
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,326
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 23,965
<INCOME-TAX> 10,024
<INCOME-CONTINUING> 13,941
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,941
<EPS-PRIMARY> .52
<EPS-DILUTED> .51
</TABLE>
