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 September 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 October 30,
1997
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Quarterly Report to Securities and Exchange Commission
September 30, 1997
PART I
ITEM 1. FINANCIAL STATEMENTS.
INDEX
-----
Page
----
Statements of Income (unaudited) for the nine months ended September 30, 1997 and 1996
and the three months ended September 30, 1997 and 1996................................................................ 3
Balance Sheets as of September 30, 1997 and 1996 (unaudited) and December 31, 1996...................................... 4
Statements of Cash Flows (unaudited) for the nine months ended September 30, 1997 and 1996
and the three months ended September 30, 1997 and 1996................................................................ 5
Notes to Financial Statements........................................................................................... 6
-2-
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1997 1996 1997 1996
---- ---- ---- ----
Revenues
Tuition $61,849 $54,653 $165,848 $146,297
Other educational 11,211 10,460 30,100 27,487
------- ------- -------- --------
Total revenues 73,060 65,113 195,948 173,784
------- ------- -------- --------
Costs and Expenses
Cost of educational services 41,616 37,303 119,407 105,864
Student services and administrative
expenses 19,159 17,769 55,151 51,154
------- ------- -------- --------
Total costs and expenses 60,775 55,072 174,558 157,018
------- ------- -------- --------
Operating income 12,285 10,041 21,390 16,766
Interest income, net 1,478 1,076 4,051 2,932
------- ------- -------- --------
Income before income taxes 13,763 11,117 25,441 19,698
Income taxes 5,505 4,447 10,176 7,879
------- ------- -------- --------
Net income $ 8,258 $ 6,670 $ 15,265 $ 11,819
======= ======= ======== ========
Earnings per common share $ 0.30 $ 0.25 $ 0.56 $ 0.44
Average equivalent common shares
outstanding (in thousands) 27,172 27,176 27,175 27,146
The accompanying notes are an integral part of these financial statements.
-3-
ITT EDUCATIONAL SERVICES, INC.
BALANCE SHEETS
(In thousands, except per share data)
September 30, 1997 September 30, 1996
(unaudited) December 31, 1996 (unaudited)
------------------- ----------------- ------------------
Assets
Current assets
Cash $ 3 $ 74 $ 474
Restricted cash 911 5,911 1,197
Cash invested with ITT Corporation 99,630 89,808 88,008
Accounts receivable, net 10,881 9,378 10,910
Deferred income tax 1,463 1,455 945
Prepaids and other current assets 3,397 1,823 2,714
-------- -------- --------
Total current assets 116,285 108,449 104,248
Property and equipment, net 21,857 19,360 18,630
Direct marketing costs 6,687 5,774 5,747
Other assets 2,147 2,166 2,479
-------- -------- --------
Total assets $146,976 $135,749 $131,104
======== ======== ========
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 15,382 $ 12,188 $ 20,321
Accrued compensation and benefits 4,085 4,253 4,430
Other accrued liabilities 6,924 5,432 5,611
Deferred tuition revenue 34,953 43,532 33,069
-------- -------- --------
Total current liabilities 61,344 65,405 63,431
Other liabilities 1,675 1,652 2,013
-------- -------- --------
Total liabilities 63,019 67,057 65,444
-------- -------- --------
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 shares
issued and outstanding 270 270 270
Capital surplus 32,513 32,513 32,513
Retained earnings 51,174 35,909 32,877
-------- -------- --------
Total shareholders' equity 83,957 68,692 65,660
-------- -------- --------
Total liabilities and shareholders' equity $146,976 $135,749 $131,104
======== ======== ========
The accompanying notes are an integral part of these financial statements.
4
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- -------------------------------
1997 1996 1997 1996
---- ---- ---- ----
Cash flows from operating activities:
Net income $ 8,258 $ 6,670 $ 15,265 $ 11,819
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 1,743 1,647 5,797 5,638
Provision for doubtful accounts 559 477 1,416 1,326
Deferred taxes (20) (45) 288 429
Increase/decrease in operating
assets and liabilities:
Accounts receivable (2,348) (2,455) (2,919) (4,644)
Direct marketing costs (310) (395) (913) (716)
Accounts payable and accrued
liabilities (1,381) 7,737 4,245 11,571
Prepaids and other assets 1,145 499 (1,555) (984)
Deferred tuition revenue 642 1,612 (8,579) (6,994)
----------- ----------- ----------- ---------
Net cash provided by operating activities 8,288 15,747 13,045 17,445
----------- ----------- ----------- ---------
Cash flows used for investing activities:
Capital expenditures, net (1,628) (2,371) (8,294) (5,283)
Net decrease (increase) in cash invested
with ITT Corporation (6,570) (12,661) (9,822) (16,123)
----------- ----------- ----------- ---------
Net cash used for investing activities (8,198) (15,032) (18,116) (21,406)
----------- ----------- ----------- ---------
Net increase (decrease) in cash and
restricted cash 90 715 (5,071) (3,961)
Cash and restricted cash at beginning
of period 824 956 5,985 5,632
----------- ----------- ----------- ---------
Cash and restricted cash at end of period $ 914 $ 1,671 $ 914 $ 1,671
=========== =========== =========== =========
The accompanying notes are an integral part of these financial statements.
-5-
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 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 nine months ended September 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. In late June 1997, a legal action was filed against the
Company in Orlando, Florida by three former students of the Maitland ITT
Technical Institute. The plaintiffs in one of the California actions and in
the Florida action seek to have each of their actions certified as a class
action. If either of these actions is certified as a class action, the number
of plaintiffs that may be awarded damages would increase significantly. The
claims alleged in all seven legal actions are similar to the claims alleged in
the Eldredge Case, relate primarily to the Company's marketing and recruitment
practices and include misrepresentation and violations of certain state
statutes.
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.
6
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 $8.0 million, or 12.3%, to $73.1 million in the three months
ended September 30, 1997 from $65.1 million in the three months ended September
30, 1996. Revenues increased $22.1 million, or 12.7%, to $195.9 million in the
nine months ended September 30, 1997 from $173.8 million in the nine months
ended September 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
September 1997 was 8,070 compared to 8,151 for the same period in 1996. First-
time students numbered 7,156 in September 1997 compared to 7,271 in September
1996. The total student enrollment on September 30, 1997 was 25,811, compared
to 23,971 on September 30, 1996, an increase of 7.7%.
Cost of educational services increased $4.3 million, or 11.5%, to $41.6 million
in the three months ended September 30, 1997 from $37.3 million in the three
months ended September 30, 1996. Cost of educational services increased $13.5
million, or 12.7%, to $119.4 million in the nine months ended September 30, 1997
from $105.9 million in the nine months ended September 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 decreased in the three months ended
September 30, 1997 and remained the same in the nine months ended September 30,
1997 compared to the three and nine months ended September 30, 1996, despite a
$0.5 million and $1.5 million provision in the three and nine months ended
September 30, 1997, respectively (compared to a $0.3 million provision in the
three and nine months ended September 30, 1996) for the Company's legal expenses
as described in Note 3 of the Notes to Financial Statements. Excluding this
provision, cost of educational services in the three months ended September 30,
1997 would have been 56.3% of revenues, a 1.0% improvement from the three months
ended September 30, 1996, and 60.2% of revenues for the nine months ended
September 30, 1997, a 0.7% improvement from the nine months ended September 30,
1996. The percentage of revenues represented by the cost of educational
services decreased because the greater revenues did not cause an increase in the
fixed portion of rent, administrative salaries and other costs included in the
cost of educational services.
Student services and administrative expenses increased $1.4 million, or 7.9%, to
$19.2 million in the three months ended September 30, 1997 from $17.8 million
in the three months ended September 30, 1996. Student services and
administrative expenses increased $4.0 million, or 7.8%, to $55.2 million in the
nine months ended September 30, 1997 from $51.2 million in the nine months ended
September 30, 1996. The Company increased its media advertising expenses in the
three and nine months ended September 30, 1997 by approximately 7% and 10%,
7
respectively, over the same expenses incurred in the three and nine months ended
September 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 reduction caused by higher than expected
preemptions by the television stations. Student services and administrative
expenses decreased to 26.2% and 28.2% of revenues in the three and nine months
ended September 30, 1997, respectively, compared to 27.3% and 29.5% in the three
and nine months ended September 30, 1996, respectively, 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
nine 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 nine months ended September 30, 1997 were $0.6 million and
$2.6 million, respectively, compared to $1.2 million and $4.9 million for the
three and nine months ended September 30, 1996, respectively.
Operating income increased $2.3 million to $12.3 million in the three months
ended September 30, 1997 from $10.0 million in the three months ended September
30, 1996. Operating income increased $4.6 million, or 27.4%, to $21.4 million
in the nine months ended September 30, 1997 from $16.8 million in the nine
months ended September 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
September 30, 1997 compared to ten in the three months ended September 30,
1996). The operating margin increased to 16.8% of revenues in the three months
ended September 30, 1997 from 15.4% in the three months ended September 30, 1996
despite the increase of $0.2 million in the provision for legal expenses in the
three months ended September 30, 1997. The operating margin for the nine months
ended September 30, 1997 was 10.9% compared to 9.6% for the nine months ended
September 30, 1996 despite the $1.2 million increased provision for legal
expenses in 1997.
Interest income in the three months ended September 30, 1997 increased $0.4
million from the three months ended September 30, 1996. Interest income
increased $1.1 million in the nine months ended September 30, 1997 compared to
the nine months ended September 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 became 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 previously permitted. The
Company estimates that these new regulations (which have the effect of delaying
cash inflow) 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 (an on-going effect) in the six months ending December 31, 1997
by $0.8 to $1.0 million and annually thereafter by $1.6 to $2.0 million.
Net cash provided by operating activities was $13.0 million in the nine months
ended September 30, 1997 compared to $17.4 million in the nine months ended
September 30, 1996. This decrease in cash provided by operating activities was
due primarily to the delay in the Company's receipt of Title IV Program funds
disbursements caused by
8
the ED's new funds management regulations discussed above and the decrease in
accounts payable and accrued liabilities (due to timing of payments to vendors)
offset by the increased net income.
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.
Two ITT Technical Institute campus groups, consisting of two institutes located
in Houston (West) and Garland, Texas have an official FFEL cohort default rate
of 25% or greater for two consecutive federal fiscal years: (a) 27.7% and
27.7%, respectively, for the 1993 federal fiscal year; and (b) 25.7% and 36.8%,
respectively, for the 1994 federal fiscal year. One ITT Technical Institute
campus group, consisting of one institute located in San Antonio, Texas has an
official FFEL cohort default rate of 25.6% for the 1994 federal fiscal year.
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). The official 1995 FFEL cohort default rates are scheduled to be
released in November 1997. No other ITT Technical Institute campus group has an
official or preliminary FFEL cohort default rate equal to or greater than 25%
for any federal fiscal year. The ITT Technical Institutes in Garland and San
Antonio, Texas, which accounted for approximately 1.7% and 2.4%, respectively,
of the Company's revenues in the Company's 1996 fiscal year, have identified
corrections to their preliminary 1995 FFEL cohort default rate based on
erroneous data used to calculate such rate. There can be no assurance that
either of these institutes' request for adjustment to the ED regarding its
preliminary 1995 FFEL cohort default rate will result in a recalculation to less
than 25% for its official 1995 FFEL cohort default rate. If the Company cannot
successfully cause the official 1995 FFEL cohort default rate for the Garland,
Texas ITT Technical Institute to be reduced to less than 25%, such institute
will be notified by the ED that it is ineligible to participate in the FFEL and
FDSL programs. If the Company cannot successfully cause the official 1995 FFEL
cohort default rate for the San Antonio, Texas ITT Technical Institute to be
reduced to less than 25% and this institute has an official 1996 FFEL cohort
default rate equal to or greater than 25%, such institute will be notified by
the ED that it is ineligible to participate in the FFEL and FDSL programs. If
the institute unsuccessfully challenges its disqualification, the institute
would probably become ineligible to participate in the FFEL and FDSL programs
during (a) 1998 for the Garland, Texas ITT Technical Institute or (b) 1999 for
the San Antonio, Texas ITT Technical Institute. Loss of eligibility to
participate in the FFEL and FDSL programs by both the Garland and San Antonio,
Texas ITT Technical Institutes could have a material adverse effect on the
Company's results of operations.
The Company has arranged for an unaffiliated, private funding source ("PFS") to
provide loans to the students of the Garland, Texas ITT Technical Institute in
the event this institute loses its eligibility to participate in the FFEL and
FDSL programs. This alternative source of student financial aid requires the
Company to guarantee repayment of the PFS loans. Based on the Company's
experience with student loan repayment on Title IV Program loans for the
Garland, Texas ITT Technical Institute, the Company believes that such guaranty
should not result in a material adverse effect on the Company's financial
condition, results of operations or cash flows.
The Company is also 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 official 1995 FFEL cohort
default rate of the ITT Technical Institute campus group to which this institute
becomes an additional location. 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.
The ED, the accrediting commissions that accredit each ITT Technical Institute
(the "Accrediting Commissions") and most of the state education authorities that
regulate the Company's business (the "States") have laws, regulations and/or
standards (collectively "Regulations") pertaining to changes of ownership and/or
control (collectively "change in control") of educational institutions. Upon a
change in control of the Company under the ED's 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.
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 annual meeting of shareholders, to be held on November 12,
1997, 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 control of the Company under the
Regulations of the ED, the vast majority of the States and the Accrediting
Commissions. The Company believes that Hilton has not yet filed any application
for approval of a change in control of the Company with the ED, the States or
the Accrediting Commissions.
On July 16, 1997, ITT announced a comprehensive plan that included the pro rata
distribution among all ITT shareholders 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., that would hold ITT's hotels and gaming
business (the "Comprehensive Plan"). On October 20, 1997, ITT announced that it
had abandoned the Comprehensive Plan.
ITT also announced on October 20, 1997 that it has entered into a definitive
merger agreement providing for Starwood Lodging Trust and Starwood Lodging
Corporation (collectively "Starwood") to acquire the entire equity interest in
ITT for a combination of cash and Starwood stock ("Merger"). Under the Merger,
ITT will become a wholly owned subsidiary of Starwood. The Merger is expected
to be completed in late January or early February, 1998 and is subject to
certain conditions and the approval of the shareholders of both ITT and
Starwood. Following
10
the Merger, ITT would continue to hold 22,500,000 shares, or 83.3%, of the
Company's outstanding Common Stock, and 4,499,952 shares, or 16.7%, of the
Company's outstanding Common Stock would continue to be publicly traded. The
Company is in the process of notifying the ED, the States and the Accrediting
Commissions of the Merger. The Company believes that the ED, most of the States
and the Accrediting Commissions may consider the Merger to constitute a change
in control of the Company. The Company will pursue all approvals from the ED,
the States and the Accrediting Commissions necessitated by the Merger. Starwood
has not made clear its intentions with respect to ITT's ownership interest in
the Company following the Merger. Starwood may, however, seek to monetize or
otherwise realize the value of certain assets acquired in the Merger. There can
be no assurance that Starwood will maintain ITT's ownership interest in the
Company following the Merger. The Company believes that, if ITT were to dispose
of its ownership interest in the Company before or following the Merger, a
change in control of the Company might occur under the Regulations of the ED,
most of the States and the Accrediting Commissions.
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: (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 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.
Capital expenditures were $8.3 million in the nine months ended September 30,
1997 compared to $5.3 million in the nine months ended September 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
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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 some or all of
ITT's Common Stock holdings are divested.
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 and previously reported is Robb, et
al. v. ITT Educational Services, Inc., et al. (Civil Action No. 707460) which
was filed on January 21, 1997 in the Superior Court of San Diego County in San
Diego, California. The plaintiffs in this action amended their complaint on
August 14, 1997 to (a) delete three and add two named plaintiffs, each of whom
was a student who attended an ITT Technical Institute in California, (b) allege
only violations of the California Education Code and (c) seek only statutory
damages, civil penalties, injunctive relief, attorney's fees and costs. The
plaintiffs still seek to have this action certified as a class action.
On September 22, 1997, the Company received an inquiry from the staff of the
Federal Trade Commission requesting information relating to the Company's
offering and promotion of vocational or career training. The Company intends to
provide the requested information.
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 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 16.7%, of the Company's outstanding Common
Stock is publicly traded. On October 20, 1997, ITT announced that it has
entered into a definitive merger agreement providing for Starwood to acquire the
entire equity interest in ITT for a combination of cash and Starwood stock
("Merger"). Under the Merger, ITT will become a wholly owned subsidiary of
Starwood. The Merger is expected to be completed in late January or early
February, 1998 and is subject to certain conditions and the approval of the
shareholders of both ITT and Starwood. Following the Merger, ITT would continue
to hold 22,500,000 shares, or 83.3%, of the Company's outstanding Common Stock.
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 educational
institutions. 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 Company is in the process of notifying the ED, the States and the
Accrediting Commissions of the Merger. The Company believes that it is probable
that the ED, most of the States and
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the Accrediting Commissions will consider the Merger to constitute a change in
control of the Company. The Company will pursue all approvals from the ED, the
States and the Accrediting Commissions necessitated by the Merger.
Upon a change in control of the Company under the ED's 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 Accrediting Commissions will not reaccredit an ITT Technical Institute
unless that institute is authorized by the appropriate States. The standards of
the Accrediting Commission which accredits 57 ITT Technical Institutes provide
that, during the 30 days immediately preceding the change in control, the
Accrediting Commission will determine whether to continue the institution's
accreditation for a period of six months after the change in control to allow
the institution to obtain reauthorization (or confirmation of continued
authorization) by the appropriate States and apply for reaccreditation. The
standards of the Accrediting Commission which accredits three ITT Technical
Institutes provide that, within five business days after an institution obtains
reauthorization (or confirmation of continued authorization) by the appropriate
States following a change in control, the Accrediting Commission will determine
whether to temporarily reinstate the institution's accreditation during the
period in which the institution must apply for permanent reinstatement of its
accreditation.
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, the Accrediting Commissions and
the States in the event of a change in control of the ITT Technical Institutes.
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. Obtaining approval from the Company's California regulator could
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 would result if a change in control of the Company
occurred: (a) without the prior approvals of the Prior Approval States (and in
particular, California); (b) without the continued or temporarily reinstated
accreditation of the Accrediting Commissions; or (c) after the prior approvals
of the Prior Approval States and the continued or temporarily reinstated
accreditation of the Accrediting Commissions, if a material number of ITT
Technical Institutes failed to timely (i) obtain the requisite reauthorizations
from the Post Approval States or (ii) 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
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participate in Title IV Programs could have a material adverse 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.
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 September 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: October 30, 1997
By: /s/ Gene A. Baugh
------------------------------------------------
Gene A. Baugh
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
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INDEX TO EXHIBITS
Exhibit
No. Description
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11 Statement re Computation of Per Share Earnings.....................
27 Financial Data Schedule............................................