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 June 30, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-13144
ITT EDUCATIONAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
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 [_]
26,999,952
Number of shares of Common Stock, $.01 par value, outstanding at July 31, 1997
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Quarterly Report to Securities and Exchange Commission
June 30, 1997
PART I
ITEM 1. FINANCIAL STATEMENTS.
INDEX
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Page
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Statements of Income (unaudited) for the six months ended June 30, 1997 and 1996
and the three months ended June 30, 1997 and 1996...........................................................................3
Balance Sheets as of June 30, 1997 and 1996 (unaudited) and December 31, 1996.................................................4
Statements of Cash Flows (unaudited) for the six months ended June 30, 1997 and 1996
and the three months ended June 30, 1997 and 1996...........................................................................5
Notes to Financial Statements.................................................................................................6
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ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1997 1996 1997 1996
---- ---- ---- ----
Revenues
Tuition $48,253 $42,376 $103,999 $ 91,644
Other educational 10,159 9,192 18,889 17,027
------- ------- -------- --------
Total revenues 58,412 51,568 122,888 108,671
------- ------- -------- --------
Costs and Expenses
Cost of educational services 39,807 35,074 77,791 68,561
Student services and administrative expenses 18,456 16,880 35,992 33,385
------- ------- -------- --------
Total costs and expenses 58,263 51,954 113,783 101,946
------- ------- -------- --------
Operating income 149 (386) 9,105 6,725
Interest income, net 1,193 909 2,573 1,856
------- -------- -------- --------
Income before income taxes 1,342 523 11,678 8,581
Income taxes 537 209 4,671 3,432
------- -------- -------- --------
Net income $ 805 $ 314 $ 7,007 $ 5,149
======= ======== ======== ========
Earnings per common share $ 0.03 $ 0.01 $ 0.26 $ 0.19
Average equivalent common shares
outstanding (in thousands) 27,171 27,159 27,177 27,132
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
BALANCE SHEETS
(In thousands, except per share data)
June 30, 1997 December 31, 1996 June 30, 1996
(unaudited) (unaudited)
------------- ----------------- -------------
Assets
Current assets
Cash $ 182 $ 74 $ 46
Restricted cash 642 5,911 910
Cash invested with ITT
Corporation 93,060 89,808 75,347
Accounts receivable, net 9,092 9,378 8,932
Deferred income tax 1,302 1,455 509
Prepaids and other current
assets 4,529 1,823 3,030
-------- -------- --------
Total current assets 108,807 108,449 88,774
Property and equipment, net 21,972 19,360 17,906
Direct marketing costs 6,377 5,774 5,352
Other assets 2,160 2,166 2,658
-------- -------- --------
Total assets $139,316 $135,749 $114,690
======== ======== ========
Liabilities and Shareholders'
Equity
Current liabilities
Accounts payable $ 20,594 $ 12,188 $ 16,778
Accrued compensation and
benefits 3,141 4,253 2,806
Other accrued liabilities 3,943 5,432 2,953
Deferred tuition revenue 34,311 43,532 31,457
-------- -------- --------
Total current liabilities 61,989 65,405 53,994
Other liabilities 1,628 1,652 1,706
-------- -------- --------
Total liabilities 63,617 67,057 55,700
-------- -------- --------
Shareholders' equity
Preferred stock, $.01 par
value, 5,000,000 shares
authorized, none issued or
outstanding
Common stock, $.01 par value,
50,000,000 shares authorized,
26,999,952, 26,999,952 and
18,000,000 issued and
outstanding 270 270 180
Capital surplus 32,513 32,513 32,603
Retained earnings 42,916 35,909 26,207
-------- -------- --------
Total shareholders' equity 75,699 68,692 58,990
-------- -------- --------
Total liabilities and
shareholders' equity $139,316 $135,749 $114,690
======== ======== ========
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
1997 1996 1997 1996
------- ------- ------- -------
Cash flows from operating activities:
Net income $ 805 $ 314 $ 7,007 $ 5,149
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,096 2,026 4,054 3,991
Provision for doubtful accounts 404 460 857 849
Deferred taxes 81 199 308 474
Increase/decrease in operating assets and liabilities:
Accounts receivable 301 (1,577) (571) (2,189)
Direct marketing costs (408) (394) (603) (321)
Accounts payable and accrued liabilities 3,386 (2,415) 5,626 3,834
Prepaids and other assets (495) (128) (2,700) (1,483)
Deferred tuition revenue 3,511 3,555 (9,221) (8,606)
------- ------- ------- -------
Net cash provided by operating activities 9,681 2,040 4,757 1,698
------- ------- ------- -------
Cash flows used for investing activities:
Capital expenditures, net (2,639) (1,720) (6,666) (2,912)
Net decrease (increase) in cash invested with ITT Corporation (7,124) (140) (3,252) (3,462)
------- ------- ------- -------
Net cash used for investing activities (9,763) (1,860) (9,918) (6,374)
------- ------- ------- -------
Net increase (decrease) in cash and restricted cash (82) 180 (5,161) (4,676)
Cash and restricted cash at beginning of period (906) 776 5,985 5,632
------- ------- ------- -------
Cash and restricted cash at end of period $ 824 $ 956 $ 824 $ 956
======= ======= ======= =======
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(Dollar amounts in thousands, unless otherwise stated)
1. The accompanying unaudited financial statements have been prepared by ITT
Educational Services, Inc. (the "Company") 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 the Company. 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 the Company's Annual Report on
Form 10-K as filed with the Securities and Exchange Commission for the year
ended December 31, 1996.
The results of operations for the six months ended June 30, 1997 are not
necessarily indicative of results for the entire calendar year.
2. On March 22, 1996, the Company declared a 3 for 2 Common Stock split
effected by payment of a stock dividend on April 15, 1996 to all
shareholders of record at the close of business on April 1, 1996. On October
8, 1996, the Company declared a 3 for 2 Common Stock split effected by
payment of a stock dividend on November 4, 1996 to all shareholders of
record at the close of business on October 21, 1996. The earnings per share
amounts for all prior periods have been restated to reflect these stock
splits.
3. The Company has a number of pending legal and other claims arising out of
the normal course of business. Among the legal actions is Eldredge, et al.
v. ITT Educational Services, Inc., et al. (the "Eldredge Case"). This action
was filed on June 8, 1995 in San Diego, California by seven graduates of the
San Diego ITT Technical Institute. In October 1996, the jury in this action
rendered a verdict against the Company and awarded the plaintiffs general
damages of approximately $0.2 million and exemplary damages of $2.6 million.
The judge also awarded the plaintiffs attorney's fees and costs, in the
amount of approximately $0.9 million, and interest. The Company is seeking
to overturn the awards and has appealed the decision. Management, based on
the advice of counsel, believes it is probable that it will prevail in its
appeal, thus no provision (other than the Company's legal expenses) for
these awards has been made. If the Company's appeal of the judgment in the
Eldredge Case is unsuccessful, a charge to earnings would be taken at that
time in the amount of the awards, including the general and exemplary
damages assessed against the Company, the plaintiffs' attorney's fees and
costs and the interest assessed thereon.
In late January 1997, six legal actions were filed against the Company in
San Diego, California by a total of 21 former students of the San Diego ITT
Technical Institute. The plaintiffs in one such action seek to have the
action certified as a class action. The claims alleged in these legal
actions are similar to the claims alleged in the Eldredge Case and include
misrepresentation and violations of certain statutory provisions of the
California Education Code and California Business and Professions Code.
In the opinion of management, the ultimate outcome of these matters should
not have a material adverse effect on the Company's financial position,
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 the Company's Annual Report on Form 10-K as filed with the Securities and
Exchange Commission for the year ended December 31, 1996 for discussion of cash
receipts from financial aid programs, nature of capital additions, seasonality
of revenues, components of income statement captions, interest payments on cash
invested with ITT Corporation ("ITT") and other matters.
The Company records its revenues as students attend class. Due to the two week
vacations in June and December, the first and third quarters include 13 weeks of
revenue and the second and fourth quarters include 11 weeks of revenue. The
Company's incurrence of costs, however, is generally not affected by the
academic schedule and such costs do not fluctuate significantly on a quarterly
basis. As a result, net income in the second and fourth quarters is
significantly less than in the first and third quarters.
Results of Operations
- ---------------------
Revenues increased $6.8 million, or 13.2%, to $58.4 million in the three months
ended June 30, 1997 from $51.6 million in the three months ended June 30, 1996.
Revenues increased $14.2 million, or 13.1%, to $122.9 million in the six months
ended June 30, 1997 from $108.7 million in the six months ended June 30, 1996.
These increases were due primarily to a 5% increase in tuition rates in
September 1996 and a 9.8% increase in the total student enrollment at January 1,
1997 compared to January 1, 1996. The number of students attending ITT
Technical Institutes at January 1, 1997 was 22,633 compared to 20,618 at January
1, 1996.
The total number of first-time and re-entering students beginning classes in
June 1997 was 6,879 compared to 6,553 for the same period in 1996. First-time
students numbered 6,158 in June 1997 compared to 5,918 in June 1996. The total
student enrollment on June 30, 1997 was 23,994, compared to 22,100 on June 30,
1996, an increase of 8.6%.
Cost of educational services increased $4.7 million, or 13.4%, to $39.8 million
in the three months ended June 30, 1997 from $35.1 million in the three months
ended June 30, 1996. Cost of educational services increased $9.2 million, or
13.4%, to $77.8 million in the six months ended June 30, 1997 from $68.6 million
in the six months ended June 30, 1996. These increases were principally a
result of costs required to service the increased enrollment, normal
inflationary cost increases for wages, rent and other costs of services, and
increased costs at new technical institutes (two opened in March 1996, one in
September 1996 and one in June 1997). Cost of educational services as a
percentage of revenue increased in the three and six months ended June 30, 1997
compared to the three and six months ended June 30, 1996 as a result of a $0.5
million and $1.0 million provision in the three and six months ended June 30,
1997, respectively (none in the three and six months ended June 30, 1996) for
the Company's legal expenses in Eldredge, et al. v. ITT Educational Services,
Inc., et al. (the "Eldredge Case"). (See Note 3 of Notes to Financial
Statements.) Excluding this provision, cost of educational services in the three
months ended June 30, 1997 would have been 67.3% of revenues, a 0.7% improvement
from the three months ended June 30, 1996 and 62.5% of revenues for the six
months ended June 30, 1997, a 0.6% improvement from the six months ended June
30, 1996.
Student services and administrative expenses increased $1.6 million, or 9.5%, to
$18.5 million in the three months ended June 30, 1997 from $16.9 million in the
three months ended June 30, 1996. Student services and administrative expenses
increased $2.6 million, or 7.8%, to $36.0 million in the six months ended June
30, 1997 from $33.4 million in the six months ended June 30, 1996. The Company
increased its media advertising expenses in the three and six months ended June
30, 1997 by approximately 16% and 12%, respectively, over the same expenses
incurred in the three and six months ended June 30, 1996. This media expense
increase was less than the increases experienced during this period in 1996
because of a planned reduction in the percentage increase and an unplanned
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reduction caused by higher than expected preemptions by the television stations.
Student services and administrative expenses decreased to 31.6% of revenues in
the three months ended June 30, 1997 compared to 32.7% in the three months ended
June 30, 1996, primarily because the greater revenues did not cause an increase
in the fixed portion of the marketing and headquarters expenses.
The Company incurs operating losses when opening new institutes. Six new
institutes were opened in 1994, two in 1995, three in 1996 and one in the first
six months of 1997. 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) for institutes open less than 24 months
during the three and six months ended June 30, 1997 were $1.0 million and $2.0
million, respectively, compared to $2.2 million and $3.6 million for the three
and six months ended June 30, 1996, respectively.
Operating income increased $0.5 million to $0.1 million in the three months
ended June 30, 1997 from a $0.4 million operating loss in the three months ended
June 30, 1996. Operating income increased $2.4 million, or 35.8%, to $9.1
million in the six months ended June 30, 1997 from $6.7 million in the six
months ended June 30, 1996. These increases were due primarily to the control
of costs and the reduction of operating losses of new institutes (i.e., six
institutes in the first 24 months of operation in the three months ended June
30, 1997 compared to 10 in the three months ended June 30, 1996). The operating
margin increased to 0.3% of revenues in the three months ended June 30, 1997,
from a 0.7% operating loss in the three months ended June 30, 1996 despite the
$0.5 million provision for legal expenses in the three months ended June 30,
1997. The operating margin for the six months ended June 30, 1997 was 7.4%
compared to 6.2% for the six months ended June 30, 1996 despite the $1.0 million
provision for legal expenses in 1997.
Interest income in the three months ended June 30, 1997 increased $0.3 million
from the three months ended June 30, 1996. Interest income increased $0.7
million in the six months ended June 30, 1997 compared to the six months ended
June 30, 1996. These increases were primarily due to the increase in the
interest rate earned on the cash invested by the Company with ITT (i.e., 6.3% in
1997 compared to 5.5% in 1996) and the $17.9 million increase in cash invested
with ITT Corporation during 1996.
Financial Condition, Liquidity and Capital Resources
- ----------------------------------------------------
Due to the seasonal pattern of enrollments and the 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.
The U.S. Department of Education ("ED") issued final regulations on November 29,
1996 detailing new rules and procedures governing how an institution which
participates in federal student financial aid programs under Title IV ("Title IV
Programs") of the Higher Education Act of 1965, as amended ("HEA") requests,
maintains, disburses and otherwise manages Title IV Program funds. These new
funds management regulations are effective July 1, 1997 and require the
Company, among other things, to receive its funds in three equal quarterly
disbursements rather than the two disbursements currently permitted. The
Company estimates that these new regulations will decrease 1997 net cash
provided by operating activities (a one-time effect) by approximately $12.0 to
$15.0 million, and will decrease interest income in the six months ending
December 31, 1997 (an on-going effect) by $0.8 to $1.0 million and annually
thereafter by $1.6 to $2.0 million.
Net cash provided by operating activities was $4.7 million in the six months
ended June 30, 1997 compared to $1.7 million in the six months ended June 30,
1996. This increase in cash provided by operating activities was due primarily
to the increased net income and the timing of payments to vendors. Accounts
payable and accrued liabilities increased by $5.6 million in the six months
ended June 30, 1997 compared to $3.8 million in the six months ended June 30,
1996.
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An educational institution may lose its eligibility to participate in some or
all Title IV Programs if student defaults on federal student loans exceed
certain rates. These rates are based on the historical cohort default rate of
current and former students on loans provided under certain Title IV Programs,
and are calculated on an institutional basis, defined as a main campus and all
of its additional locations and branch campuses. The cohort default rate of an
institution is calculated on the basis of the number of students who have
defaulted and not the dollar amount of such defaults. Under the Federal Family
Education Loan ("FFEL") programs, an institution whose cohort default rate on
loans made under the Federal Stafford Loan ("Stafford") and Federal Supplemental
Loans for Students ("SLS") programs is 25% or greater for three consecutive
years will no longer be eligible to participate in any of the FFEL programs
(including the Federal PLUS ("PLUS") program) or the Federal Direct Student Loan
("FDSL") program for the remainder of the federal fiscal year in which the ED
determines that the institution has lost its eligibility and for the two
subsequent federal fiscal years, unless it successfully challenges such
disqualification under procedures provided by the HEA and its implementing
regulations. During the pendency of any such appeal, the institution retains
its eligibility to participate in the applicable loan programs.
No ITT Technical Institute campus group has an FFEL cohort default rate equal to
or greater than 25% for the 1991 or 1992 federal fiscal years. Three ITT
Technical Institute campus groups, consisting of three institutes located in
Houston (West), Garland and San Antonio, Texas have an official FFEL cohort
default rate of: (a) 27.4%, 27.4% and 25.0%, respectively, for the 1993 federal
fiscal year; and (b) 25.8%, 39.1% and 25.6%, respectively, for the 1994 federal
fiscal year. For the remaining 28 ITT Technical Institute campus groups, the
official 1993 FFEL cohort default rates range from a high of 23.4% to a low of
11.8% and the official 1994 FFEL cohort default rates range from a high of 19.9%
to a low of 11.0%. The ITT Technical Institutes in Houston (West), Garland and
San Antonio, Texas have a preliminary FFEL cohort default rate of 19.3%, 29.7%
and 28.2%, respectively, for the 1995 federal fiscal year (the latest year for
which rates are available). For the remaining 28 ITT Technical Institute campus
groups, the preliminary 1995 FFEL cohort default rates range from a high of
23.8% to a low of 11.3%. The official 1995 FFEL cohort default rates are
scheduled to be released in November 1997.
The ITT Technical Institutes in Garland and San Antonio, Texas, which
collectively accounted for approximately 4% of the Company's revenues in the
Company's 1996 fiscal year, have identified corrections to their official 1993
and 1994, and preliminary 1995, FFEL cohort default rates based on (I) improper
loan servicing and/or collection of certain student loans included in the
calculation of such rates and/or (II) erroneous data used to calculate such
rates. Each of these ITT Technical Institutes has submitted the appropriate
appeals and/or requests for adjustment to make these corrections and revise
downward the institute's official 1993 and 1994 FFEL cohort default rates and
preliminary 1995 FFEL cohort default rate accordingly. None of these appeals
and/or requests for adjustment that have been considered by the ED have resulted
in a recalculation to less than 25% of either institute's official 1993 or 1994,
or preliminary 1995, FFEL cohort default rate. There can be no assurance that
either of these institutes' remaining appeals and/or requests for adjustment to
the ED regarding its official 1993 and 1994, or preliminary 1995, FFEL cohort
default rates will result in a recalculation to less than 25% of its official
1993, 1994 or 1995 FFEL cohort default rate. If the Company cannot successfully
cause the official 1993 or 1994 FFEL cohort default rate for each of the Garland
and San Antonio, Texas ITT Technical Institutes to be reduced to less than 25%
and any such institute has an official 1995 FFEL cohort default rate equal to or
exceeding 25%, such institute will be notified by the ED that it is ineligible
to participate in the FFEL and FDSL programs. The institute can challenge its
loss of eligibility through an administrative review process within the ED (as
referenced above) and continue to participate in the FFEL programs during this
process. If the institute's challenge is unsuccessful, the institute will be
ineligible to participate in the FFEL and FDSL programs for the remainder of
that federal fiscal year and for the two subsequent federal fiscal years. Loss
of eligibility to participate in the FFEL and FDSL programs by either the
Garland or San Antonio, Texas ITT Technical Institutes could have a material
adverse effect on the Company's results of operations.
The Company is in the process of converting the Garland, Texas ITT Technical
Institute from a main campus to an additional location of another main campus
(the "Conversion"). Based on the Company's interpretation of the
-9-
applicable federal regulations, the Company believes that if it can complete
the Conversion before the official 1995 FFEL cohort default rates are issued by
the ED, the 1995 FFEL cohort default rate for the Garland, Texas ITT Technical
Institute will be blended into the calculation of the 1995 FFEL cohort default
rate of the ITT Technical Institute campus group to which this institute becomes
an additional location. Converting an ITT Technical Institute that is a main
campus into an additional location of another ITT Technical Institute campus
group requires approval of the ITT Technical Institute's accrediting commission
and the ED. The Garland, Texas ITT Technical Institute has received the approval
of its accrediting commission, but there can be no assurance that the Company
can obtain the requisite ED approval of the Conversion, that the Company can
obtain such approval before the official 1995 FFEL cohort default rates are
issued, or that the official 1995 FFEL cohort default rate for the Garland,
Texas ITT Technical Institute, when issued, will be blended into the calculation
of the official 1995 FFEL cohort default rate of the ITT Technical Institute
campus group to which that institute becomes an additional location.
In an effort to reduce the adverse effect on the Company's results of operations
that could result from the loss of eligibility to participate in the FFEL and
FDSL programs by either the Garland or San Antonio, Texas ITT Technical
Institutes, the Company is considering whether to attempt to arrange for an
unaffiliated, private funding source ("PFS") to provide loans to the students of
these ITT Technical Institutes. This alternative source of student financial
aid would most probably require the Company to guarantee repayment of the PFS
loans. Based on the Company's experience with student loan repayment on Title
IV Program loans for these institutes, such guaranty could result in significant
cost to the Company.
On January 31, 1997, Hilton Hotels Corporation ("Hilton") commenced a tender
offer for approximately 50.1% of the outstanding shares of ITT's common stock
(the "Hilton Offer"). Hilton has announced that, if its offer succeeds, it will
obtain the entire equity interest in ITT by merging ITT with Hilton or a
subsidiary of Hilton (such merger, together with the Hilton Offer, the "Hilton
Transaction"). The Hilton Transaction is more fully described in the Tender
Offer Statement on Schedule 14D-1 filed by Hilton with the Securities and
Exchange Commission (the "Hilton 14D-1"). Hilton has also commenced a
solicitation of proxies in support of proposals to be submitted to ITT
shareholders at ITT's next annual meeting of shareholders which would have the
effect of ensuring the completion of the Hilton Transaction (the "Hilton
Proposals"). The Company believes that the Hilton Transaction, if successful,
or the Hilton Proposals, if enacted at a meeting of ITT shareholders, would
constitute a change in ownership resulting in a change in control of the Company
under the regulations of the ED, all or virtually all of the state education
authorities that regulate the Company's business (the "States") and the
accrediting commissions that accredit each ITT Technical Institute (the
"Accrediting Commissions"). Upon a change in control of the Company under ED
regulations, each ITT Technical Institute would immediately become ineligible to
continue participating in Title IV Programs and its students would be unable to
obtain Title IV Program funds to pay their cost of education (except for funds
already committed to the students) until such time as the ED recertifies the
entire ITT Technical Institute campus group (defined as the main campus and all
of its additional locations) to participate in Title IV Programs. The ED will
not preapprove a change in control and will only reinstate a campus group's
eligibility to participate in Title IV Programs upon review and approval of a
complete application following the campus group's change in control. To be
complete, among other things, such application must demonstrate that all of the
ITT Technical Institutes that comprise a particular campus group are authorized
by the appropriate States and accredited by the appropriate Accrediting
Commission. Therefore, before any ITT Technical Institute campus group may
regain access to Title IV Program funds following a change in control (a) all of
its ITT Technical Institutes must be reaccredited (or continue to be accredited)
by the appropriate Accrediting Commission and reauthorized (or continue to be
authorized) by the appropriate States and (b) the change in control must
otherwise be approved by the ED. See "Item 5. Other Information." for a
discussion of the procedures involved in regaining such approvals.
A material adverse effect on the Company's business, financial condition and
results of operations would result if a change in control of the Company
occurred as a result of the Hilton Transaction or Hilton Proposals: (a) without
the requisite prior approvals of the States; (b) without the continued or
reinstated accreditation of the Accrediting Commissions; (c) without the timely
and requisite post approvals of the States; or (d) if a material number of ITT
Technical Institutes failed to timely regain eligibility to participate in Title
IV Programs from the ED. In addition, the time of year at which a change in
control of the Company occurs coupled with the length of time required by the
ITT Technical Institutes to regain their eligibility to participate in Title IV
Programs could have a material adverse
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effect on the Company's business, financial condition and results of operations
and the amount of Title IV Program funds students can obtain to pay the
education costs of attending the ITT Technical Institutes.
On July 16, 1997, ITT announced a comprehensive plan that includes the pro rata
distribution of (a) its shares of the Company's common stock (the "Common
Stock") and (b) all of the shares of a new ITT subsidiary, ITT Destinations,
Inc. ("Destinations"), that will hold ITT's hotels and gaming business among all
ITT shareholders (the "Distribution"). Under the Distribution, each ITT
shareholder is expected to receive approximately 0.25 share of the Common Stock
held by ITT for each share of ITT common stock held by the ITT shareholder. The
Distribution will be made on a date to be determined by ITT's board of directors
to ITT's shareholders of record at the close of business on a record date
determined by ITT's board of directors. No certificates or scrip representing
fractional shares of the Common Stock will be issued as part of the
Distribution. ITT's agent will, as soon as practical after the Distribution,
combine into whole shares all of the fractional shares of the Common Stock that
ITT's shareholders would be entitled to receive and sell them in the open market
at then prevailing market prices and distribute the aggregate proceeds (net of
brokerage fees) proportionately to any ITT shareholders who are entitled to the
fractional shares. The Distribution is subject to certain conditions and may be
abandoned by ITT at any time for any reason. The ED, the Accrediting
Commissions and most of the States have laws, regulations and/or standards
(collectively "Regulations") pertaining to changes of ownership and/or control
(collectively "change in control") of the educational institutions they
regulate. The ED has determined that the Distribution will constitute a change
in control of the Company and all of the ITT Technical Institutes under ED
Regulations. The Accrediting Commissions and many of the States have determined
that the Distribution will not constitute a change in control of the Company
under their Regulations. The Company and ITT plan to seek to obtain any
necessary approvals of the Distribution by the ED and the States.
Capital expenditures were $6.7 million in the six months ended June 30, 1997
compared to $2.9 million in the six months ended June 30, 1996. This increase
was due primarily to the acquisition of approximately $3.0 million of new
computers in the first quarter of 1997 (required to accommodate a software
upgrade for the Company's computer-aided drafting technology curriculum). The
Company expects that the capital additions for the full 1997 year will be
approximately $13.0 million or a $5.1 million increase over 1996.
The capital additions for a new technical institute are approximately $0.4
million and the capital additions for each new curriculum at an existing
institute are approximately $0.2 million. The Company anticipates that its
planned capital additions can be funded through cash flows from operations.
Cash flows from operations on a long-term basis are highly dependent upon the
receipt of funds from Title IV Programs and the amount of funds spent on new
technical institutes, curricula additions at existing institutes and possible
acquisitions.
Management, based on the advice of counsel, believes that it is probable that it
will prevail in its appeal in the Eldredge Case, thus no provision for the
awards in that case has been made. If the Company's appeal of the judgment in
the Eldredge Case is unsuccessful, a charge to earnings would be taken at that
time in the amount of the awards, including the general and exemplary damages
assessed against the Company, the plaintiffs' reasonable attorney's fees and
costs, and the prejudgment and post-judgment interest assessed thereon.
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 the Company's eligibility
to participate in, student financial aid programs utilized by the Company's
students; the results of the Company's appeal in Eldredge, et al. v. ITT
Educational Services, Inc., et al. and the results of any related litigation;
effects of any change in ownership of the
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Company resulting in a change in control of the Company, including, but not
limited to, the consequences of such changes on the accreditation and federal
and state regulation of the institutes; receptivity of students and employers to
the Company's existing program offerings and new curricula; loss of lender
access to the Company's students for student loans; and a substantial increase
in the shares of Common Stock available for sale in the market if ITT divests
some or all of its Common Stock holdings.
PART II
ITEM 1. LEGAL PROCEEDINGS.
The Company is subject to litigation in the ordinary course of its business.
Among the legal actions currently pending is DeBattista, et al. v. ITT
Educational Services, Inc., et al. (Civil Action No. 97-1366-CA-15-W). This
action was filed on June 25, 1997 in the Circuit Court of Seminole County in
Orlando, Florida by three students who attended the Hospitality program at the
Maitland ITT Technical Institute. The suit alleges, among other things,
misrepresentation, fraud, civil conspiracy and statutory violations by the
Company, ITT Corporation and eight employees of the Maitland ITT Technical
Institute. The plaintiffs seek general damages, exemplary damages, rescission
of plaintiffs' enrollment agreements with the Company, attorney's fees, interest
and costs. The plaintiffs also seek to have the action certified as a class
action. Also pending is Eldredge, et al. v. ITT Educational Services, Inc., et
al., and six related legal actions filed in San Diego, California, all of which
have been previously reported.
While there can be no assurances as to the ultimate outcome of any litigation
involving the Company, management does not believe any pending legal proceeding
will result in a judgment or settlement that will have, after taking into
account the Company's existing provisions for such liabilities, a material
adverse effect on the Company's financial position, results of operations or
cash flows. Certain litigation may, however, subject the affected ITT Technical
Institute to additional regulatory scrutiny.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the second quarter of fiscal year 1997, the Company submitted the
following matters to a vote of the holders of its Common Stock:
The 1997 annual meeting of shareholders of the Company was held on May 13, 1997
to elect directors and adopt the 1997 ITT Educational Services, Inc. Incentive
Stock Plan (the "1997 Plan"). At this meeting, the shareholders elected the
following persons to serve as directors of the Company in the third class of the
Company's Board of Directors, each to hold office for the term of three years
and until his or her successor is elected and has qualified:
Third Class - Term expiring at 2000 Annual Meeting
-----------
1. Bette B. Anderson
2. Rand V. Araskog
3. Leslie Lenkowsky
4. Margita E. White
The final results of the vote taken at such meeting for the director nominees
are as follows:
Broker
Votes For Votes Withheld Nonvotes Abstentions
---------- -------------- -------- -----------
Bette B. Anderson 25,463,120 59,163 0 0
Rand V. Araskog 25,463,708 58,575 0 0
Leslie Lenkowsky 25,468,320 53,963 0 0
Margita E. White 25,469,245 53,038 0 0
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At this meeting, the shareholders also adopted the 1997 Plan. The final results
of the vote taken at such meeting to adopt the 1997 Plan are as follows:
Broker
Votes For Votes Against Non-votes Abstentions
----------- ------------- --------- -----------
23,606,268 1,497,013 408,371 10,631
ITEM 5. OTHER INFORMATION.
At present, ITT holds 22,500,000 shares, or 83.3%, of the Company's outstanding
Common Stock and 4,499,952 shares, or 16.79%, of the Company's outstanding
Common Stock is publicly traded. On July 16, 1997, ITT announced a comprehensive
plan that includes the pro rata distribution of (a) its shares of the Common
Stock and (b) all the shares of Destinations among all ITT shareholders (the
"Distribution"). Under the Distribution, each ITT shareholder is expected to
receive approximately 0.25 share of Common Stock held by ITT for each share of
ITT common stock held by the ITT shareholder. The Distribution is subject to
certain conditions and may be abandoned by ITT at any time for any reason.
The Company intends to enter into the following agreements with ITT, which will
give effect to the Distribution, govern the Company's relationship with ITT
following the Distribution and provide for the allocation of tax and certain
other liabilities and obligations arising from periods prior to the
Distribution: (a) a distribution agreement providing for, among other things,
certain transactions required to effect the Distribution, the treatment of
existing intercompany agreements between the Company and ITT and other
arrangements between the Company and ITT after the Distribution; (b) a tax
allocation agreement providing for the allocation between the Company, ITT and
Destinations of ITT's consolidated tax liability for the years that they were
included in ITT's consolidated federal income tax return and for sharing, where
appropriate, of state and local taxes attributable to periods prior to the
Distribution; and (c) an employee benefits agreement providing for the
allocation among the Company, ITT and Destinations of retirement, welfare and
other employee benefit and executive compensation plans, programs, policies and
arrangements.
The Distribution will result in a substantial increase in the shares of Common
Stock available for sale in the market. This significant increase in public
float is expected to increase the liquidity of the Common Stock and, thereby,
raise its market profile in the long term. The market price of the Common Stock
may be adversely affected in the short term if a significant number of shares of
Common Stock are sold following the Distribution by ITT shareholders who receive
such shares in the Distribution.
The ownership and operation of educational institutions in the United States are
subject to extensive federal and state laws and regulations. In this regard, the
Company must obtain certain approvals under the applicable laws, regulations and
standards of the ED, the Accrediting Commissions and the States.
The ED, the Accrediting Commissions and most of the States have laws,
regulations and/or standards (collectively "Regulations") pertaining to changes
in ownership and/or control (collectively "change in control") of the
educational institutions they regulate. The change in control Regulations do
not, however, uniformly define what constitutes a change in control. The ED's
change in control Regulations generally subject the Company to the change in
control standards of the federal securities laws. Most States and the
Accrediting Commissions include the sale of a controlling interest of common
stock in the definition of a change in control. Practically all change in
control Regulations adopted by the ED, the Accrediting Commissions and the
States are subject to varying interpretations as to whether a particular
transaction constitutes a change in control. The ED has determined that the
Distribution will constitute a change in control of the Company and all of the
ITT Technical Institutes under ED Regulations. The Accrediting Commissions and
many of the States have determined that the Distribution will not constitute a
change in control of the Company under their
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Regulations. The Company and ITT plan to seek to obtain any necessary approvals
of the Distribution by the ED and the States.
Upon a change in control of the Company under ED Regulations, each of the
Company's ITT Technical Institutes would immediately become ineligible to
continue participating in Title IV Programs and their students would be unable
to obtain Title IV Program funds to pay their costs of education (except for
certain funds already committed to the students) until such time as the ED
recertifies the entire ITT Technical Institute campus group (defined as the main
campus and all of its additional locations) to participate in Title IV Programs.
The ED will not preapprove a change in control and will only reinstate a campus
group's eligibility to participate in Title IV Programs upon review and approval
of a complete application following the campus group's change in control. To be
complete, among other things, such application must demonstrate that all of the
ITT Technical Institutes that comprise a particular campus group are authorized
by the appropriate States and accredited by the appropriate Accrediting
Commission. Therefore, before any ITT Technical Institute campus group may
regain its eligibility to participate in Title IV Programs following a change in
control (a) all of its ITT Technical Institutes must be reaccredited (or
continue to be accredited) by the appropriate Accrediting Commission and
reauthorized (or continue to be authorized) by the appropriate States and (b)
the change in control must otherwise be approved by the ED. The Company and the
ED are discussing the implementation of certain procedures that may help to
quicken the recertification of the ITT Technical Institute campus groups to
continue participating in Title IV Programs following the Distribution.
Most States in which ITT Technical Institutes operate, including California,
require that a change in control of an institution be approved before it occurs
in order for the institution to maintain its authorization (the "Prior Approval
States"). Some States will only review a change in control of an institution
after it occurs (the "Post Approval States"). With the possible exception of
California (discussed below), management believes that the Company will be able
to obtain all necessary approvals from the ED and the States. There can be no
assurance, however, that such approvals can be obtained in a timely manner that
would not unreasonably delay the availability of Title IV Program funds. Based
on the Company's interpretation of California's change in control Regulations
and the advice of counsel, the Company does not believe that the Distribution
will constitute a change in control of the Company, or any of its ten ITT
Technical Institutes currently operating in California, under such Regulations.
If, however, the California regulators should determine otherwise, obtaining
approval from California would be complicated by a California statute that
prohibits the approval of a change in control of any institution that has been
found to have violated Chapter 7 (formerly Chapter 3) of the California
Education Code ("Chapter 7") in any judicial or administrative proceeding. In
October 1996, the jury in Eldredge, et al. v. ITT Educational Services, Inc., et
al. (the "Eldredge Case") determined that the Company, through its ITT Technical
Institute in San Diego, California, violated Chapter 7. The Company has appealed
the jury's verdict in the Eldredge Case.
A material adverse effect on the Company's business, financial condition and
results of operations: (a) would result if the Distribution occurs and a
material number of ITT Technical Institutes fail to timely (i) obtain the
requisite reauthorizations from the Post Approval States whose Regulations
regard the Distribution as a change in control of the Company or (ii) regain
eligibility to participate in Title IV Programs from the ED; or (b) could result
if the Distribution occurs at a time shortly before significant amounts of Title
IV funds were anticipated to be released to the ITT Technical Institutes and
their students and the Company experiences any delay by the ED in recertifying
the ITT Technical Institutes to continue their participation in Title IV
Programs.
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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 such exhibits, and is
incorporated herein by reference.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended June 30, 1997.
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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, 1997
By: /s/ Gene A. Baugh
--------------------------------
Gene A. Baugh
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
S-1
INDEX TO EXHIBITS
Exhibit
No. Description
- -----------------------------------------------------------------------------
10.8 1997 ITT Educational Services, Inc. Incentive Stock Plan.........
11 Statement re Computation of Per Share Earnings...................
27 Financial Data Schedule..........................................
S-2