<PAGE>
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ENDED MARCH 31, 1999
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 No.)
incorporation or organization)
5975 CASTLE CREEK PARKWAY N. DRIVE
P.O. BOX 50466
INDIANAPOLIS, INDIANA 46250-0466
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (317) 594-9499
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 / /
25,482,152
Number of shares of Common Stock, $.01 par value, outstanding at April 28, 1999
<PAGE>
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Quarterly Report to the Securities and Exchange Commission
March 31, 1999
PART I
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
INDEX
Page
----
<S> <C>
Consolidated Statements of Income (unaudited) for the three months ended March 31, 1999 and 1998.................3
Consolidated Balance Sheets as of March 31, 1999 and 1998 (unaudited) and December 31, 1998......................4
Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 1999 and 1998.............5
Notes to Consolidated Financial Statements.......................................................................6
</TABLE>
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<PAGE>
ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
1999 1998
---- ----
<S> <C> <C>
REVENUES
Tuition $ 69,701 $ 62,587
Other educational 10,271 9,700
-------- -------
Total revenues 79,972 72,287
-------- -------
COSTS AND EXPENSES
Cost of educational services 46,468 41,438
Student services and administrative expenses 21,518 19,436
Offering, change in control and other one-time expenses 900 443
-------- -------
Total costs and expenses 68,886 61,317
-------- -------
Operating income 11,086 10,970
Interest income, net 856 1,244
-------- -------
Income before income taxes and cumulative effect of change in
accounting principle 11,942 12,214
Income taxes 4,600 4,886
-------- -------
Income before cumulative effect of change in accounting principle 7,342 7,328
Cumulative effect of change in accounting principle for institute
start-up costs, net of tax (823) --
-------- -------
Net income $ 6,519 $ 7,328
-------- -------
-------- -------
Earnings per common share (basic and diluted):
Income before cumulative effect of change in accounting principle $0.28 $0.27
Cumulative effect of change in accounting principle for
institute start-up costs, net of tax (0.03) --
-------- -------
Net income $ 0.25 $ 0.27
-------- -------
-------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<TABLE>
<CAPTION>
ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, 1999 DECEMBER 31, 1998 MARCH 31, 1998
(UNAUDITED) (UNAUDITED)
--------------- ----------------- --------------
<S> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 46,316 $ 77,335 $ 90,217
Restricted cash 929 3,617 6,689
Marketable debt securities 19,734 38,316 --
Accounts receivable, net 12,620 10,772 12,770
Deferred income tax 4,653 5,969 1,843
Prepaids and other current assets 5,863 2,749 3,939
--------- --------- ---------
Total current assets 90,115 138,758 115,458
Property and equipment, net 26,078 24,985 22,937
Direct marketing costs 8,008 7,915 7,054
Other assets 2,871 3,913 3,338
--------- --------- ---------
Total assets $ 127,072 $ 175,571 $ 148,787
--------- --------- ---------
--------- --------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 18,050 $ 15,992 $ 11,639
Accrued compensation and benefits 5,922 6,488 5,054
Accrued legal settlements 7,427 7,604 --
Other accrued liabilities 8,196 7,896 11,729
Deferred tuition revenue 23,581 32,261 23,041
--------- --------- ---------
Total current liabilities 63,176 70,241 51,463
Other liabilities 3,366 3,474 2,181
--------- --------- ---------
Total liabilities 66,542 73,715 53,644
--------- --------- ---------
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, 27,032,452, 27,011,202
and 26,999,952 issued 270 270 270
Capital surplus 33,856 32,613 32,513
Retained earnings 75,492 68,973 62,360
Treasury stock, at cost; 1,500,000 shares (49,088) -- --
--------- --------- ---------
Total shareholders' equity 60,530 101,856 95,143
--------- --------- ---------
Total liabilities and shareholders' equity $ 127,072 $ 175,571 $ 148,787
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
---------------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,519 $ 7,328
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,536 2,214
Provision for doubtful accounts 889 674
Deferred taxes 532 232
Increase/decrease in operating assets and liabilities:
Marketable debt securities 18,582 --
Accounts receivable (2,737) (3,764)
Direct marketing costs (93) (172)
Accounts payable and accrued liabilities 2,951 3,298
Prepaids and other assets (2,072) (1,519)
Deferred tuition revenue (8,680) (7,809)
-------- --------
Net cash provided by operating activities 18,427 482
-------- --------
Cash flows provided by (used for) investing activities:
Capital expenditures, net (3,629) (2,265)
Net decrease in cash invested with ITT Corporation -- 94,800
-------- --------
Net cash provided by (used for) investing activities (3,629) 92,535
-------- --------
Cash flow provided by (used for) finance activities:
Purchase of treasury stock (49,088) --
Exercise of stock options 583 --
-------- --------
Net cash flow provided by (used for) finance activities (48,505) --
-------- --------
Net increase (decrease) in cash, cash equivalents and restricted cash (33,707) 93,017
Cash, cash equivalents and restricted cash at beginning of period 80,952 3,889
-------- --------
Cash, cash equivalents and restricted cash at end of period $ 47,245 $ 96,906
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)
1. ITT Educational Services, Inc. ("ESI") prepared the accompanying unaudited
financial statements without audit. In the opinion of management, the
financial statements contain all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial condition
and results of operations of ESI. Certain information and footnote
disclosures, including significant accounting policies, normally included
in financial statements prepared in accordance with generally accepted
accounting principles, have been omitted. The interim financial statements
should be read in conjunction with the financial statements and notes
thereto contained in ESI's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission for the year ended December 31, 1998.
The American Institute of Certified Public Accountants issued Statement of
Position ("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. ESI adopted this standard effective January 1, 1999 and
expensed $1,354 of institute costs, less $531 of deferred tax, as a
cumulative effect of change in accounting principle in the three months
ended March 31, 1999.
2. From ESI's initial public offering in 1994 until June 9, 1998, ITT
Corporation ("ITT") owned 83.3% of the outstanding shares of ESI common
stock.
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 ESI 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. ESI
believes that it is in compliance with or satisfies these DOE conditions.
On June 9, 1998, ITT sold 13,050,000 shares of ESI common stock held by ITT
to the public (48.3% of the outstanding shares) (the "June 1998 Offering").
After the June 1998 Offering, ITT owned 35% of the outstanding shares of
ESI common stock. The June 1998 Offering did not constitute a change in
control of ESI under the DOE's regulations.
On February 1, 1999, ITT sold 7,950,000 shares of ESI common stock held by
ITT to the public (the "February 1999 Offering"). The February 1999
Offering did not constitute a change in control of ESI under the DOE's
regulations. Simultaneous with the close of the February 1999 Offering, ESI
repurchased 1,500,000 shares of ESI common stock from ITT at the February
1999 Offering price to the public, less underwriters' commissions and
discounts, for an aggregate cost of $49,088 (the "February 1999 Stock
Repurchase"). Following the February 1999 Offering and February 1999 Stock
Repurchase, ITT no longer owned any shares of ESI common stock.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This management's discussion and analysis of financial condition and
results of operations should be read in conjunction with the same titled section
contained in our Annual Report on Form 10-K as filed with the Securities and
Exchange Commission for the year ended December 31, 1998 for discussion of,
among other matters, the following items:
- Cash receipts from financial aid programs
- Nature of capital additions
- Seasonality of revenues
- Components of income statement captions
- Cash invested with ITT
- Cash transferred from ITT
- Marketable debt securities and market risk
- Legal settlements
- Change in ownership and control of ESI
- Changes in federal regulations regarding:
- Timing of receipt of funds from the federal student financial
aid programs under Title IV of the Higher Education Act of
1965, as amended (the "Title IV Programs")
- Refunds
- Percentage of applicable revenues that may be derived from
Title IV Programs
- Default rates
We earn tuition revenue on a weekly basis, pro rata over the length of
each of the four 12-week academic quarters in our fiscal year. Due to the
two-week vacations in June and December at most of our institutes, the first and
third quarters include 13 weeks of revenue and the second and fourth quarters
include 11 weeks of revenue. Our incurrence of costs, however, is generally not
affected by the academic schedule and such costs do not fluctuate significantly
on a quarterly basis. As a result, net income in the second and fourth quarters
is significantly less than in the first and third quarters.
In 1998, we began offering a new program in information technology, called
Computer Network Systems Technology ("CNST"), at three ITT Technical Institutes.
We began offering the CNST program at an additional 12 ITT Technical Institutes
in the three months ended March 31, 1999. We intend to introduce this program at
five additional ITT Technical Institutes in each of the three remaining 1999
calendar quarters. We incur a loss with respect to each CNST program offered at
an ITT Technical Institute until the revenue from the number of enrolled
students is high enough to offset the fixed costs associated with the program
offering, such as salaries, equipment depreciation, rent and marketing. We
incurred estimated losses with respect to the CNST program of approximately $1.1
million in the three months ended March 31, 1999 (none in the three months ended
March 31, 1998). The amount of capital required to offer the CNST program at an
ITT Technical Institute is approximately $0.2 million.
RESULTS OF OPERATIONS
Revenues increased $7.7 million, or 10.7% to $80.0 million in the three
months ended March 31, 1999 from $72.3 million in the three months ended March
31, 1998. This increase was due primarily to a 5% increase in tuition rates in
September 1998 and a 4.5% increase in the total student enrollment at January 1,
1999 compared to January 1, 1998. The number of students attending ITT Technical
Institutes at January 1, 1999 was 25,608 compared to 24,498 at January 1, 1998.
The total number of new students beginning classes in March 1999 was 5,095
compared to 4,730 in March 1998, an increase of 7.7%. The total student
enrollment on March 31, 1999 was 24,588, compared to 23,603 on March 31, 1998,
an increase of 4.2%.
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<PAGE>
Cost of educational services increased $5.1 million, or 12.3%, to $46.5
million in the three months ended March 31, 1999 from $41.4 million in the three
months ended March 31, 1998. The principal causes of this increase are:
- the costs required to service the increased enrollment;
- normal inflationary cost increases for wages, rent and other costs of
services;
- increased costs at new institutes (one opened in March 1998, one in
June 1998, one in October 1998 and two in January 1999); and
- increased costs associated with offering the CNST program at 15
institutes during 1999.
Cost of educational services as a percentage of revenues increased to
58.1% in the three months ended March 31, 1999 compared to 57.3% in the three
months ended March 31, 1998, because of the costs associated with the CNST
program offerings and the new institutes.
Student services and administrative expenses increased $2.1 million, or
10.8%, to $21.5 million in the three months ended March 31, 1999 from $19.4
million in the three months ended March 31, 1998, primarily because of
increased media advertising expenses (up 17%). Student services and
administrative expenses were 26.9% of revenues in the three months ended
March 31, 1999, the same percentage as in the three months ended March 31,
1998.
We incurred net one-time expenses of $0.9 million in the three months
ended March 31, 1999 associated with the costs of the February 1999 Offering
(from which we did not receive any proceeds) and special bonus payments to
employees for extraordinary services, net of amounts reimbursed by ITT.
One-time expenses of $0.4 million in the three months ended March 31, 1998
represent costs associated with our change in control resulting from the
Merger.
We incur operating losses when we open new institutes. We opened three
new institutes in 1996, three in 1997, three in 1998 and two in the three
months ended March 31, 1999. A new institute typically is open for
approximately 24 months before it experiences a profit. The revenues and
expenses of these institutes are included in the respective captions in the
statements of income. The amount of operating losses (pre-tax) during the
three months ended March 31, 1999 for institutes open less than 24 months
were $1.7 million compared to $1.1 million during the three months ended
March 31, 1998.
Our operating income increased $0.1 million, or 0.9%, to $11.1 million
in the three months ended March 31, 1999 from $11.0 million in the three
months ended March 31, 1998 (a 5.0% increase before the offering, change in
control and other one-time expenses). Our operating margin decreased to 13.9%
of revenues in the three months ended March 31, 1999, down from 15.2% in the
three months ended March 31, 1998, primarily because of:
- the costs associated with the offering, change in control and other
one-time expenses;
- the increase in operating losses from opening new institutes; and
- the costs associated with offering the CNST program at 15 institutes
in 1999.
The following table sets forth our operating income (in millions) for the
three months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------
<S> <C> <C>
1999 1998
--------- ---------
Operating income as reported.......................................... $11.1 $11.0
Offering, change in control and other one-time expenses............... 0.9 0.4
Operating losses from new institutes.................................. 1.7 1.1
Estimated losses from CNST program.................................... 1.1 --
--------- ---------
Operating income before one-time expenses and losses at new
institutes and CNST program....................................... $14.8 $12.5
--------- ---------
--------- ---------
Percent of revenue.................................................... 18.5% 17.3%
</TABLE>
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<PAGE>
Interest income decreased $0.4 million in the three months ended March
31, 1999 from the three months ended March 31, 1998 primarily due to less
cash and investments in 1999 as a result of our repurchase of 1.5 million
shares of our common stock from ITT on February 1, 1999 for $49.1 million.
Our combined effective federal and state income tax rate for the three
months ended March 31, 1999 was 38.5% compared to 40% for the three months
ended March 31, 1998. This decrease was a result of lower state income taxes.
The following table sets forth the net income (in thousands, except per
share data) for the three months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
------------------------
1999 1998
---- ----
<S> <C> <C>
Net income as reported................................................ $6,519 $7,328
Cumulative effect of change in accounting principle for
institute start-up costs, net of tax............................. 823 --
Offering, change in control and other one time expenses (after tax)... 554 266
------ ------
Net income before one-time expenses................................... 7,896 7,594
Operating losses from new institutes (after tax)...................... 1,034 636
Estimated losses from CNST program offerings (after tax).............. 690 --
------ ------
Adjusted net income before one-time expenses and losses at new
institutes and CNST program...................................... $9,620 $8,230
------ ------
------ ------
Diluted average number of outstanding common shares................... 26,297 27,144
Adjusted diluted earnings per share................................... $0.37 $0.30
</TABLE>
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Due to the seasonal pattern of enrollments and our receipt of tuition
payments, comparisons of financial position and cash generated from
operations should be made both to the end of the previous year and to the
corresponding period during the previous year.
Our net cash used for operating activities, excluding the $18.6 million
decrease in marketable debt securities, was $0.2 million in the three months
ended March 31, 1999 compared to $0.5 million of net cash provided by
operating activities in the three months ended March 31, 1998. This $0.7
million decrease was due primarily to the decrease in net income caused by
the $0.8 million cumulative effect of the change in accounting principle as
discussed above.
Our capital expenditures were $3.6 million in the three months ended
March 31, 1999 compared to $2.3 million in the three months ended March 31,
1998. This increase was due primarily to increased capital expenditures in
1999 for offering of the CNST program at 12 additional ITT Technical
Institutes. We expect that our capital expenditures for the full 1999 year
will be approximately $17.0 million, which will represent a $5.6 million
increase over 1998 that is primarily due to our plans to offer the CNST
program at a minimum of 27 additional ITT Technical Institutes in all of 1999.
Capital expenditures for a new institute are approximately $0.4 million
and capital expenditures for each new curriculum offered at an existing
institute are approximately $0.3 million ($0.2 million for the CNST program).
We expect to be able to fund our planned capital expenditures in 1999 from
cash flows from operations.
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<PAGE>
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.
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, which has been
completed, we assessed the potential exposure of our IT Systems and material
Non-IT Systems to Y2K problems. 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
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 June 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 June 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 the DOE, the state education
authorities that regulate our institutes ("SEAs"), the accrediting
commissions that accredit our institutes ("Accrediting Commissions"), student
loan guaranty agencies, student loan lenders, computer software and hardware
suppliers and book vendors. In the DOE's March 8, 1999 status report on the
Y2K compliance of its mission-critical IT Systems, the DOE stated that all of
its 14 mission-critical IT Systems are Y2K compliant.
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<PAGE>
THE COSTS TO ADDRESS OUR YEAR 2000 ISSUES. We have expended
approximately $125,000 in direct costs through March 31, 1999 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 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 in total will cost between $150,000 and $200,000 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.
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 Title IV Program loans
under the Federal Family Education Loan ("FFEL") program that were received
by our students, and one student loan guaranty agency guaranteed
approximately 94% of all FFEL program loans that were 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;
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<PAGE>
- 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 June 30, 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
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.
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 our eligibility to participate in, student financial aid programs
utilized by our students; the consummation of the proposed settlements of
student litigation 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; our ability to implement our growth strategies, including our new
information technology programs; receptivity of students and employers to our
existing program offerings and new curricula; and loss of lender access to
our students for student loans.
PART II
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 4. LEGAL PROCEEDINGS.
We are subject to litigation in the ordinary course of our business.
Among the legal actions currently pending and recently concluded is the
following case. We have agreed to settle all of the plaintiffs' claims in
this case. The settlement is a class settlement which has been subject to
court approval and to the right of the class members to opt out of the
settlement.
-12-
<PAGE>
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 California Education Code (including the Maxine
Waters School Reform and Student Protection Act of 1989), the
California Business and Professions Code, the California Consumer Legal
Remedies Act, 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 was 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 had opted out of the class settlement, we could have, in our sole
discretion, terminated the class settlement. In December 1998, the court
granted preliminary approval of the class settlement. On April 28, 1999,
the court granted final approval of the class settlement and dismissed the
Collins case with prejudice. None of the class members opted out of
the class settlement.
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 ROBB, ET AL. V. ITT
EDUCATIONAL SERVICES, INC., ET. AL (Civil Action No. 00707460) and a
significant amount of litigation against us results from such failure or (2)
a significant number of class members opt out of this 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits, which immediately precedes such exhibits, and
is incorporated herein by reference.
(b) Reports on Form 8-K.
On January 7, 1999, we filed a Current Report on Form 8-K dated January
7, 1999 to report, under Item 5 of Form 8-K, a press release issued by us
reporting student enrollment data and certain expansion plans.
On January 11, 1999, we filed a Current Report on Form 8-K dated
January 11, 1999 to report, under Item 5 of Form 8-K, a press release issued
by us reporting our financial results for the year ended December 31, 1998.
-13-
<PAGE>
On February 3, 1999, we filed a Current Report on Form 8-K dated February
1, 1999 to report, under Item 2 of Form 8-K: (a) our repurchase of 1,500,000
shares of our common stock on February 1, 1999 from ITT for an aggregate
purchase price of $49,087,500; and (b) the resignation of four of the ten
members of our Board of Directors.
-14-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ITT EDUCATIONAL SERVICES, INC.
Date: May 3, 1999
By: /s/ Gene A. Baugh
-------------------------
GENE A. BAUGH
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
No. Description
------- ----------------------------------------------
<S> <C>
11 Statement re Computation of Per Share Earnings...............
27 Financial Data Schedule......................................
</TABLE>
S-2
<PAGE>
Exhibit 11
ITT EDUCATIONAL SERVICES, INC.
COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
---- ----
<S> <C> <C>
Net income $ 6,519 $ 7,328
------- -------
------- -------
Shares:
Weighted average number of shares
of common stock outstanding 26,057 27,000
Shares assumed issued
(less shares assumed purchased)
on stock options 240 144
------- -------
Outstanding shares for diluted
earnings per share calculation 26,297 27,144
------- -------
------- -------
Earnings per common share:
Basic $ 0.25 $ 0.27
Diluted $ 0.25 $ 0.27
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 47,245
<SECURITIES> 19,734
<RECEIVABLES> 14,110
<ALLOWANCES> (1,490)
<INVENTORY> 0
<CURRENT-ASSETS> 90,115
<PP&E> 83,244
<DEPRECIATION> (57,166)
<TOTAL-ASSETS> 127,072
<CURRENT-LIABILITIES> 63,176
<BONDS> 0
0
0
<COMMON> 270
<OTHER-SE> 60,260
<TOTAL-LIABILITY-AND-EQUITY> 127,072
<SALES> 0
<TOTAL-REVENUES> 79,972
<CGS> 0
<TOTAL-COSTS> 68,886
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 889
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 11,942
<INCOME-TAX> 4,600
<INCOME-CONTINUING> 7,342
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (823)
<NET-INCOME> 6,519
<EPS-PRIMARY> 0.25
<EPS-DILUTED> 0.25
</TABLE>
