Itt Educational Services 10-Q 2002 Q2 Quarterly report

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2002
	OR
o	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 incorporation or organization)	(I.R.S. Employer Identification No.)
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    ý                     No      o

46,012,640

Number of shares of Common Stock, $.01 par value, outstanding at July 29, 2002

ITT EDUCATIONAL SERVICES, INC.

Indianapolis, Indiana

Quarterly Report to Securities and Exchange Commission

June 30, 2002

PART I

FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS.

INDEX

1

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(unaudited)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2002		2001		2002		2001
Revenues	$	110,830	$	98,464	$	218,372	$	192,240
Costs and Expenses
Cost of educational services	68,013		62,953		133,899		121,922
Student services and administrative expenses	32,698		27,887		64,476		55,596
Total costs and expenses	100,711		90,840		198,375		177,518
Operating income	10,119		7,624		19,997		14,722
Interest income, net	808		568		1,297		1,191
Income before income taxes	10,927		8,192		21,294		15,913
Income taxes	4,174		3,114		8,134		6,047
Net income	$	6,753	$	5,078	$	13,160	$	9,866
Earnings per common share (a):
Basic	$	0.15	$	0.11	$	0.29	$	0.21
Diluted	$	0.14	$	0.10	$	0.28	$	0.20

(a)  Earnings per common share in all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

2

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

	June 30, 2002			December 31, 2001			June 30, 2001
	(unaudited)						(unaudited)
Assets
Current assets
Cash and cash equivalents	$	99,817		$	63,702		$	69,480
Restricted cash	—			5,462			993
Marketable debt securities	25,235			41,068			972
Accounts receivable, net	11,191			12,679			14,303
Deferred and prepaid income tax	4,324			3,989			6,991
Prepaids and other current assets	8,292			7,310			10,631
Total current assets	148,859			134,210			103,370
Property and equipment, net	48,140			49,593			53,013
Direct marketing costs	10,918			10,520			10,620
Other assets	882			1,076			1,315
Total assets	$	208,799		$	195,399		$	168,318
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable	$	26,642		$	16,007		$	20,437
Accrued compensation and benefits	9,219			10,134			4,109
Other accrued liabilities	6,592			5,100			3,989
Deferred revenue	77,384			77,152			51,306
Total current liabilities	119,837			108,393			79,841
Deferred income tax	7,550			7,235			6,044
Other liabilities	1,583			1,583			1,416
Total liabilities	128,970			117,211			87,301
Shareholders’ equity
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued or outstanding	—			—			—
Common stock, $.01 par value, 150,000,000 shares authorized,  54,068,904 issued (a)	540			270			270
Capital surplus	40,065			37,355			36,634
Retained earnings	154,288			148,602			125,829
Accumulated comprehensive income	(1,837		)	(1,837		)	—
Treasury stock, 8,056,264, 7,748,156 and 6,518,238 shares (a), at cost	(113,227		)	(106,202		)	(81,716		)
Total shareholders’ equity	79,829			78,188			81,017
Total liabilities and shareholders’ equity	$	208,799		$	195,399		$	168,318

(a)  The number of shares in all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

3

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2002			2001			2002			2001
Cash flows provided by (used for) operating activities:
Net income	$	6,753		$	5,078		$	13,160		$	9,866
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	5,503			4,770			10,765			9,204
Provision for doubtful accounts	1,457			1,627			3,520			3,883
Deferred taxes	134			694			537			1,569
Increase/decrease in operating assets and liabilities:
Marketable debt securities	(9,725		)	5,951			15,833			7,614
Accounts receivable	(1,089		)	(2,228		)	(2,032		)	(5,772		)
Direct marketing costs	(435		)	(433		)	(398		)	(526		)
Accounts payable and accrued liabilities	298			(1,653		)	11,519			296
Prepaids and other assets	4,414			771			(788		)	(4,156		)
Deferred revenue	(495		)	(516		)	232			(4,345		)
Net cash provided by (used for) operating activities	6,815			14,061			52,348			17,633
Cash flows provided by (used for) investing activities:
Capital expenditures, net	(6,174		)	(6,334		)	(9,312		)	(15,657		)
Net cash provided by (used for) investing activities	(6,174		)	(6,334		)	(9,312		)	(15,657		)
Cash flows provided by (used for) financing activities:
Purchase of treasury stock	—			—			(24,551		)	—
Exercise of stock options	3,869			4,753			12,168			6,465
Net cash provided by (used for) financing activities	3,869			4,753			(12,383		)	6,465
Net increase (decrease) in cash, cash equivalents and restricted cash	4,510			12,480			30,653			8,441
Cash, cash equivalents and restricted cash at beginning of period	95,307			57,993			69,164			62,032
Cash, cash equivalents and restricted cash at end of period	$	99,817		$	70,473		$	99,817		$	70,473

The accompanying notes are an integral part of these financial statements.

4

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

												Accumulated
										Compre-			Compre-
	Common Stock			Capital			Retained			hensive			hensive				Treasury Stock
	Shares(a)	Amount		Surplus			Earnings			Income			Income				Shares(a)		Amount			Total
Balance as of December 31, 2000	54,069	$	270	$	33,938		$	117,115									(7,074	)	$	(86,637	)	$	64,686
Exercise of stock options				3,399			(2,227		)								698		7,431			8,603
Issue treasury stock for employee incentive plan				3													28		272			275
Issue treasury stock for board of directors plan				15													4		21			36
Comprehensive income:
Net income for 2001							33,714			$	33,714											33,714
Other comprehensive income, net of tax:
Minimum pension liability adjustment										(1,837		)	$		(1,837	)						(1,837		)
Other comprehensive income										(1,837		)
Comprehensive income										$	31,877
Purchase of treasury stock																	(1,404	)	(27,289		)	(27,289		)
Balance as of December 31, 2001	54,069	270		37,355			148,602						(1,837			)	(7,748	)	(106,202		)	78,188
For the three months ended March 31, 2002 (unaudited):
Exercise of stock options				2,039			(5,434		)								570		11,694			8,299
Issue treasury stock for employee incentive plan							(123		)								48		968			845
Issue treasury stock for board of directors plan																	2		18			18
Purchase of treasury stock																	(1,150	)	(24,551		)	(24,551		)
Net income							6,408															6,408
Balance as of March 31, 2002	54,069	270		39,394			149,453						(1,837			)	(8,278	)	(118,073		)	69,207
For the three months ended June 30, 2002 (unaudited):
2-for-1 stock split		270		(270		)																—
Exercise of stock options				941			(1,918		)								222		4,846			3,869
Net income							6,753															6,753
Balance as of June 30, 2002	54,069	$	540	$	40,065		$	154,288					$	(1,837		)	(8,056	)	$	(113,227	)	$	79,829

(a)  The number of shares for all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

5

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2002

(Dollar amounts in thousands, unless otherwise stated)

1.             Basis of Presentation

We prepared the accompanying unaudited consolidated financial statements in accordance with generally accepted accounting principles for interim periods.  In the opinion of our management, the financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial condition and results of operations.  Certain information and footnote disclosures, including significant accounting policies, normally included in a complete presentation of financial statements prepared in accordance with generally accepted accounting principles, have been omitted.  The interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2001.

2.             Earnings Per Share

On May 10, 2002, we declared a two-for-one split of our common stock, effected on June 6, 2002 by payment of a stock dividend to all shareholders of record at the close of business on May 28, 2002 of one share on each one share of our common stock issued on May 28, 2002.  Our earnings per share amounts for all prior periods have been restated to reflect this stock split.

Earnings per common share for all periods have been calculated in conformity with Statement of Financial Accounting Standard No. 128, “Earnings Per Share.”  This data is based on historical net income and the average number of shares of our common stock outstanding during each period (as adjusted to reflect the stock split described above).

	Average Shares Outstanding
	(in thousands)
	Three Months Ended June 30,		Six Months Ended June 30,
	2002	2001	2002	2001
Basic	45,925	47,388	46,037	47,240
Diluted	47,155	48,460	47,199	48,198

The difference in the number of shares used to calculate basic and diluted earnings per share represents the average number of shares assumed issued under our stock option plans less shares assumed to be purchased with proceeds from the exercise of those stock options.

3.             Contingencies

We are subject to litigation in the ordinary course of our business.  Among the legal actions currently pending is United States ex rel. Dan Graves and Susan Newman v. ITT Educational Services, Inc., et al.  This action is a qui tam action that was filed on November 5, 1999 in the United States District Court for the Southern District of Texas by two former employees (“relators”) on behalf of themselves and the federal government (the “Qui Tam Action”).  The Qui Tam Action alleges, among other things, violations of the False Claims Act, 31 U.S.C. § 3730, by us, one of our employees and our independent auditor in connection with how we compensated our sales representatives. The relators seek various forms of recovery on behalf of themselves and the federal government, including: (i) treble the amount of unspecified damages sustained by the federal government; (ii) a civil penalty of up to $10,000 for each violation of the False Claims Act; (iii) double back pay for Susan Newman; and (iv) attorney’s fees, costs and interest.

6

A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) on behalf of the federal government for an alleged submission to the federal government of a false claim for payment.  A qui tam action is always filed under seal and remains under seal until the U.S. Department of Justice (“DOJ”) decides whether to intervene in the litigation.  Whenever a relator files a qui tam action, the DOJ typically initiates an investigation in order to determine whether to intervene in the litigation.  If the DOJ intervenes, it has primary control over the litigation.  If the DOJ declines to intervene, the relator may pursue the litigation on behalf of the federal government and, if successful, receives a portion of the federal government’s recovery. On May 25, 2001, the DOJ declined to intervene in the Qui Tam Action.  On March 31, 2002, the court dismissed all of the claims against all of the defendants for failure to allege facts sufficient to support their claims and gave the relators 20 days to file an amended complaint.  The relators filed an amended complaint on April 22, 2002 against all of the defendants.  We believe that we have meritorious defenses to the Qui Tam Action and, if the action proceeds, we intend to vigorously defend ourselves against the claims.

The DOE is currently investigating our method of compensation for employees involved in student recruitment.  In August 2000, the DOE advised us that, during the pendency of its investigation, it would not approve any application submitted by any ITT Technical Institute with respect to any change of ownership, additional location, certification of initial or continuing eligibility, or extension of course or program offerings (such as raising the level of programs offered at an institution).  During December 2001 and January 2002, however, the DOE recertified all of our ITT Technical Institute campus groups to participate in Title IV Programs.  In addition, as part of the recertification, the DOE approved (a) five ITT Technical Institutes as new additional locations of existing main campuses and (b) an increase in the level of program offerings from associate degree to bachelor degree at one of our campus groups.  In July 2002, the DOE also approved another ITT Technical Institute as a new additional location of an existing main campus.  Nevertheless, we cannot assure you that the DOE will, during the pendency of its investigation, approve any further applications submitted by any ITT Technical Institute with respect to any change of ownership, additional location, certification of initial or continuing eligibility or extension of course or program offerings.  A material adverse effect on our expansion plans, financial condition, results of operations and cash flows would result if the DOE’s restrictions are not lifted prior to 2005.  We cannot assure you that the DOE will lift its restrictions prior to 2005 or that the DOE will not place additional or other more severe restrictions on our ITT Technical Institutes’ ability to participate in Title IV Programs.

Another pending legal action is Contreras, et al. v. ITT Educational Services, Inc., et al., which was filed on March 3, 2000 (served on January 19, 2001) in the Superior Court of Santa Clara County in Santa Clara, California by five former students of the ITT Technical Institute in Santa Clara, California.  The suit alleges, among other things, fraud, negligence, negligent misrepresentation, breach of oral contract, and statutory violations of the California Business and Professions Code and California Education Code by us and three of our employees who reside in California.  The claims relate primarily to our marketing and recruitment practices and the quality of our services.  The plaintiffs seek compensatory damages, punitive damages, exemplary damages, civil penalties, restitution on behalf of the plaintiffs and all other persons similarly situated, injunctive relief, attorney’s fees and costs.  On February 6, 2001, the plaintiffs filed an amended complaint in this action adding 57 plaintiffs, who are current and former students of the ITT Technical Institute in either Santa Clara, California or Hayward, California.  The written enrollment agreement between each of the plaintiffs and us provides that all disputes between the parties will be resolved through binding arbitration, instead of litigation.  In May 2001, the court compelled the arbitration of each plaintiff’s claims in this action.  In July 2002, we agreed to settle the claims of 58 of the plaintiffs for an amount that is not material.  We believe that we have meritorious defenses to the claims of the remaining four plaintiffs should they choose to arbitrate their claims, and that the results of any such arbitration would not have a material adverse effect on our financial condition, results of operations or cash flows.

In the opinion of our management, based on the information currently available to them, the ultimate outcome of the pending legal and other claims should not have a material adverse effect on our financial condition, results of operations or cash flows.

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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 SEC for the year ended December 31, 2001 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

•Marketable debt securities and market risk

•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”)

•Percentage of applicable revenues that may be derived from Title IV Programs

•Return of Title IV Program funds for withdrawn students

•Default rates

•College Advantage Loan Program (“CALP”)

•Our programs in information technology (“IT”), computer and electronics engineering technology (“CEET”) and computer drafting and design (“CDD”)

Critical Accounting Policies and Estimates

        This management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and contingent assets and liabilities.  Actual results may differ from those estimates and judgments under different assumptions or conditions.

        We believe the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements.  These policies should be read in conjunction with Note 2 of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K as filed with the SEC for the year ended December 31, 2001.

Property and Equipment. We include 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.  We apply the American Institute of Certified Public Accountants (the “AICPA”) Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.”  Estimated useful lives generally range from three to eight years for capitalized software.  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.  Changes in circumstances, such as changes in our curricula and technological advances, may result in the actual useful lives of our property, equipment and capitalized software differing from our estimates.  We regularly review and evaluate the estimated useful lives of our property and equipment and capitalized software.  Although we believe our assumptions and estimates are reasonable, deviations from our assumptions and estimates could produce a materially different result.

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 tuition 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 or our refund policy 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 revenue.  Textbook sales and the related cost of the textbooks are recognized at the beginning of each academic quarter with respect to students who are attending courses in which textbooks are charged separately from tuition.  For those students who are attending courses in which the cost of textbooks is included in the tuition, the cost of the textbooks is amortized on a straight-line basis over the applicable course length and the deferral of book costs is recorded in prepaids and other current assets.  Academic fees (which are charged only one time to students on their first day of class attendance), application fees and laboratory fees are recognized as revenue on a straight-line basis over the average course length of 24 months.  If a student discontinues training, all unrecognized revenue relating to his or her fees is recognized upon the student’s departure.  More than 95% of our revenues represent tuition charges and less than 5% of our revenues represent bookstore sales and student fees.  The amount of tuition earned depends on the cost per credit hour of the courses in the program, the number of courses in the program, how long a student remains enrolled in the program, how many program courses a student takes during each period of enrollment in the program, and the total number of students enrolled in each program.  Each of these factors is known at the time our tuition revenues are calculated and is not subject to estimation.

8

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 application fees. Successful efforts is the ratio of students enrolled to prospective students interviewed. Direct marketing costs are amortized on an accelerated basis over the average course length of 24 months commencing on the start date.  The higher the rate of interviewed students who enroll, the greater the percentage of our direct marketing costs that are capitalized.  The direct costs subject to capitalization are readily quantifiable and are not subject to estimation.  The amortization method is based on historical trends of student enrollment activity and is not subject to significant assumptions.  We regularly evaluate the future recoverability of these deferred costs.

Results of Operations

Three Months Ended June 30, 2002 Compared with Three Months Ended June 30, 2001

        Revenues increased $12.3 million, or 12.5%, to $110.8 million in the three months ended June 30, 2002 from $98.5 million in the three months ended June 30, 2001.  This increase was due primarily to a 5% increase in tuition rates in September 2001 and a 9.8% increase in the total student enrollment at April 1, 2002 compared to April 1, 2001.  The number of students attending ITT Technical Institutes at April 1, 2002 was 30,986 compared to 28,229 at April 1, 2001.

        The total number of new students beginning classes in the three months ended June 30, 2002 was 7,573, compared to 7,575 in the three months ended June 30, 2001.  The total student enrollment on June 30, 2002 was 31,557, compared to 29,522 on June 30, 2001, an increase of 6.9%.

        Cost of educational services increased $5.0 million, or 7.9%, to $68.0 million in the three months ended June 30, 2002 from $63.0 million in the three months ended June 30, 2001.  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 March 2001 and one opened in June 2002).

        Cost of educational services as a percentage of revenues decreased to 61.4% in the three months ended June 30, 2002 from 63.9% in the three months ended June 30, 2001.  This decrease was primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs, and because certain fixed costs at our institutes did not increase proportionately with increases in our revenues resulting from a larger number of students.

        Student services and administrative expenses increased $4.8 million, or 17.2%, to $32.7 million in the three months ended June 30, 2002 from $27.9 million in the three months ended June 30, 2001, primarily due to increased media advertising expenses (up 30.7%).  Student services and administrative expenses increased to 29.5% of revenues in the three months ended June 30, 2002 from 28.4% in the three months ended June 30, 2001, primarily due to the increased media advertising expenses offset by a reduction in bad debt expense from 1.7% of revenues in the three months ended June 30, 2001 to 1.3% of revenues in the three months ended June 30, 2002.

        Operating income increased $2.5 million, or 32.9%, to $10.1 million in the three months ended June 30, 2002 from $7.6 million in the three months ended June 30, 2001.  The operating margin increased to 9.1% of revenues in the three months ended June 30, 2002 from 7.7% in the three months ended June 30, 2001, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs.

Our combined effective federal and state income tax rate for the three months ended June 30, 2002 was 38.2% compared to 38.0% for the three months ended June 30, 2001.

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Six Months Ended June 30, 2002 Compared with Six Months Ended June 30, 2001

        Revenues increased $26.2 million, or 13.6%, to $218.4 million in the six months ended June 30, 2002 from $192.2 million in the six months ended June 30, 2001.  This increase was due primarily to a 5% increase in tuition rates in September 2001, an 11.4% increase in the total student enrollment at January 1, 2002 compared to January 1, 2001 and a 9.8% increase in total student enrollment at April 1, 2002 compared to April 1, 2001.  The number of students attending ITT Technical Institutes at January 1, 2002 was 30,778 compared to 27,640 at January 1, 2001.

        The total number of new students beginning classes in the six months ended June 30, 2002 was 14,391, compared to 14,281 in the six months ended June 30, 2001.  The total student enrollment on June 30, 2002 was 31,557, compared to 29,522 on June 30, 2001, an increase of 6.9%.

        Cost of educational services increased $12.0 million, or 9.8%, to $133.9 million in the six months ended June 30, 2002 from $121.9 million in the six months ended June 30, 2001.  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 March 2001 and one opened in June 2002).

        Cost of educational services as a percentage of revenues decreased to 61.3% in the six months ended June 30, 2002 from 63.4% in the six months ended June 30, 2001.  This decrease was primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs, and because certain fixed costs at our institutes did not increase proportionately with increases in our revenues resulting from a larger number of students.

        Student services and administrative expenses increased $8.9 million, or 16.0%, to $64.5 million in the six months ended June 30, 2002 from $55.6 million in the six months ended June 30, 2001, primarily due to increased media advertising expenses (up 27.8%).  Student services and administrative expenses increased to 29.5% of revenues in the six months ended June 30, 2002 from 28.9% in the six months ended June 30, 2001, primarily due to the increased media advertising expenses offset by a reduction in bad debt expense from 2.0% of revenues in the six months ended June 30, 2001 to 1.6% of revenues in the six months ended June 30, 2002.

        Operating income increased $5.3 million, or 36.1%, to $20.0 million in the six months ended June 30, 2002 from $14.7 million in the six months ended June 30, 2001.  The operating margin increased to 9.2% of revenues in the six months ended June 30, 2002 from 7.7% in the six months ended June 30, 2001, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs.

Our combined effective federal and state income tax rate for the six months ended June 30, 2002 was 38.2% compared to 38.0% for the six months ended June 30, 2001.

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.

        Net cash provided by operating activities (excluding the $15.8 million decrease in marketable debt securities) was $36.5 million in the six months ended June 30, 2002, compared to $10.0 million of net cash provided from operating activities (excluding the $7.6 million decrease in marketable debt securities) in the six months ended June 30, 2001.  This $26.5 million increase was primarily due to higher cash flows from operations resulting from the increase in income and accelerated cash collections from students associated with their use of the CALP.

        In the three months ended December 31, 2001, we recorded a $3.0 million minimum liability adjustment with respect to our obligations under the ESI Pension Plan.  This $3.0 million adjustment resulted in a $3.0 million increase in accrued compensation and benefits and a corresponding $1.8 million reduction in shareholders’ equity, which is net of a $1.2 million deferred tax asset, as of June 30, 2002 and December 31, 2001.

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        Deferred revenue, which represents the unrecognized portion of revenue received from students, increased $26.1 million to $77.4 million at June 30, 2002 from $51.3 million at June 30, 2001.  This increase was primarily due to the students’ use of the CALP and increased tuition revenue resulting from higher tuition rates and a larger number of students.

        Capital expenditures were $9.3 million in the six months ended June 30, 2002 compared to $15.7 million in the six months ended June 30, 2001.  This decrease was primarily due to $7.0 million of capital expenditures in the six months ended June 30, 2001 to replace computer equipment used in the computer-aided drafting technology program with computer equipment that can also be used in the CDD and IT programs.  We expect that capital expenditures, other than for facility acquisitions, for the full 2002 year will be approximately $18 to $20 million.  In addition, we plan to purchase six of our facilities in the last six months of 2002 at a total estimated cost of $19.0 million.

        Capital expenditures for each 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 expect to be able to fund our planned capital expenditures in 2002 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 currently lease substantially all of our 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 14 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 we have not entered into any significant guarantees related to the leases.  We are required to make additional payments under the operating lease terms for taxes, insurance and other operating expenses incurred during the operating lease period.

        Future minimum rental payments (in thousands) required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2001 are as follows:

2002	$	27,679
2003	28,108
2004	26,414
2005	17,102
2006	13,080
Later Years	33,051
	$	145,434

        We do not have any off-balance sheet arrangements or any other significant long-term obligations, lines of credit, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments.  There are no commitments or guarantees that provide for the potential issuance of shares of our common stock.

        On May 10, 2002, we declared a two share for one split of our common stock, effected on June 6, 2002 by payment of a stock dividend to all shareholders of record at the close of business on May 28, 2002 of one share on each one share of our common stock issued on May 28, 2002 (“Stock Split”).  Our earnings per share amounts for all prior periods have been restated to reflect the Stock Split.

        During 1999 and 2000, our Board of Directors authorized us to repurchase in aggregate up to 4.0 million shares of our common stock.  In the six months ended June 30, 2002, we repurchased 575,000 shares of our common stock prior to the Stock Split at an average cost of $42.70 per share, or $24.6 million in total.  As of June 30, 2002, 1,318,600 shares (as adjusted by our Board of Directors to give effect to the Stock Split) remain under the existing repurchase authorization.  We may repurchase the shares of our common stock in the open market or through privately negotiated transactions in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended.  We may elect to repurchase additional shares of our common stock from time to time in the future, depending on market conditions and other considerations. The purpose of the stock repurchase is to help us achieve our long-term goal of enhancing shareholder value.

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As previously reported, in July 2000, we received a subpoena from the DOE requesting information that related to the compensation of our sales representatives, which we now believe resulted from the Qui Tam Action.  See note 3 of the Notes to Consolidated Financial Statements for a discussion of this investigation and its potential effect on our expansion plans, financial condition, results of operations and cash flows.

Forward-Looking Statements

        All statements, trend analyses and other information contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act.  Forward-looking statements are made based upon our management’s current expectations and beliefs concerning future developments and their potential effects on us.  There can be no assurance that future developments affecting us will be those anticipated by our management.

These forward-looking statements 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 results of the investigation being conducted by the DOE which, if adversely determined, could cause the DOE to subject us to monetary fines or penalties or other sanctions (including a limitation, suspension or termination of our ability to participate in federal student financial aid programs) that could adversely affect our ability to enroll students, expand the number of our institutes and increase the number of the programs of study offered at our institutes;

•the results of the Qui Tam Action which, if adversely determined, could result in a demand for repayment of Title IV Program funds, trebled under the False Claims Act and penalties;

•our ability to hire and retain qualified faculty;

•effects of any change in our ownership resulting in a change in control, 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;

•receptivity of students and employers to our existing program offerings and new curricula; and

•loss of lender access to our students for student loans.

Readers are also directed to other risks and uncertainties discussed in other documents we file with the SEC.  We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.

Item 3.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

                      Not applicable.

PART II

OTHER INFORMATION

Item 1.    LEGAL PROCEEDINGS.

    The information set forth in Note 3 of the Notes to Consolidated Financial Statements set forth elsewhere in this report is incorporated herein by reference.

            We cannot assure you of the ultimate outcome of any litigation involving us.  Based on the information currently available to 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.  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.

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Item 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.

            The following information is furnished as to our securities sold that were not registered under the Securities Act of 1933, as amended (the “Securities Act”):

(a)

On July 1, 2002, we issued 412 treasury shares of ESI Common Stock to two non-employee directors under the ESI Non-Employee Director Deferred Compensation Plan (“ENDDCP”) as the stock portion of the semi-annual installment payment of their annual retainer.

(b)

On July 1, 2002, we credited 412 treasury shares of ESI Common Stock to the deferred share accounts of two other non-employee directors under the ENDDCP as the stock portion of the semi-annual installment payment of their annual retainer.  These shares of ESI Common Stock will be issued upon the termination of the non-employee director’s service as a non-employee director for any reason, including retirement or death.

            The transactions described in paragraphs (a) and (b) above are exempt from the registration requirements of

the Securities Act pursuant to Section 4(2) thereof.

Item 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

            During the second quarter of fiscal year 2002, we held the ESI 2002 annual meeting of shareholders on May 10, 2002 to elect directors.  Our Board of Directors currently consists of nine directors divided into three classes.  Each class contains three directors.  The term of one class expires each year.  Generally, each director serves until the annual meeting of shareholders held in the year that is three years after that director’s election and thereafter until that director’s successor is elected and has qualified.  At the ESI 2002 annual meeting of shareholders, our shareholders elected the following persons to serve as directors of ESI in the second class of our Board of Directors, each to hold office for the term of three years and until his successor is elected and has qualified:

	Second Class -	Term expiring at 2005 Annual Meeting
1.		John E. Dean
2.		Omer E. Waddles
3.		Vin Weber

              The final results of the vote taken at the ESI 2002 annual meeting of shareholders for the director nominees are as follows:

	Votes For	Votes Withheld	Abstentions
John E. Dean	21,610,048	174,671	0
Omer E. Waddles	21,505,735	278,984	0
Vin Weber	21,609,582	175,137	0

 The ESI directors who continued in office after the ESI 2002 annual meeting of shareholders are as follows:

	First Class -	Term expiring at 2004 Annual Meeting
1.		Rene R. Champagne
2.		James D. Fowler, Jr.
3.		Harris N. Miller

	Third Class -	Term expiring at 2003 Annual Meeting
1.		Rand V. Araskog
2.		Daniel P. Weadock
3.		Vacant

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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 the exhibits, and is incorporated herein by reference.

(b)     Reports on Form 8-K.

               No reports on Form 8-K were filed during the quarter ended June 30, 2002.

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                                                                                              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: August 8, 2002
		/s/ Gene A. Baugh
	By:	Gene A. Baugh
		Senior Vice President and Chief Financial Officer
	(Duly Authorized Officer and Principal Financial Officer)

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INDEX TO EXHIBITS

Exhibit No.
	Description
10.31	* First Amendment of ESI 401(k) Plan
11	Statement re Computation of Per Share Earnings
99.1	Chief Executive Officer’s Certification Pursuant to 18 U.S.C. Section 1350
99.2	Chief Financial Officer’s Certification Pursuant to 18 U.S.C. Section 1350

* The indicated exhibit is a management contract, compensatory plan or arrangement required to be filed by Item 601 of Regulation S-K.

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