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, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-13144
ITT EDUCATIONAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-2061311
(State or other jurisdiction of (I.R.S. Employer Identification 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 [_]
27,011,202
Number of shares of Common Stock, $.01 par value,
outstanding at October 30, 1998
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Quarterly Report to Securities and Exchange Commission
September 30, 1998
PART I
ITEM 1. FINANCIAL STATEMENTS.
INDEX
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Page
----
Statements of Income (unaudited) for the nine months ended September 30,
1998 and 1997 and the three months ended September 30, 1998 and 1997........ 3
Balance Sheets as of September 30, 1998 and 1997 (unaudited) and
December 31, 1997........................................................... 4
Statements of Cash Flows (unaudited) for the nine months ended
September 30, 1998 and 1997 and the three months ended September 30, 1998
and 1997.................................................................... 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 Nine Months Ended
September 30, September 30,
-------------------- --------------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues
Tuition $69,139 $61,849 $185,999 $165,848
Other educational 12,561 11,211 33,065 30,100
------- ------- -------- --------
Total revenues 81,700 73,060 219,064 195,948
------- ------- -------- --------
Costs and Expenses
Cost of educational services 45,778 41,616 132,186 119,407
Student services and administrative expenses 20,986 19,159 60,763 55,151
Legal settlement 12,858 -- 12,858 --
Offering, change in control and other
one-time expenses -- -- 1,872 --
------- ------- -------- --------
Total costs and expenses 79,622 60,775 207,679 174,558
------- ------- -------- --------
Operating income 2,078 12,285 11,385 21,390
Interest income, net 1,417 1,478 3,852 4,051
------- ------- -------- --------
Income before income taxes 3,495 13,763 15,237 25,441
Income taxes 1,398 5,505 6,472 10,176
------- ------- -------- --------
Net income $ 2,097 $ 8,258 $ 8,765 $ 15,265
======= ======= ======== ========
Earnings per common share
(basic and diluted) $ 0.08 $ 0.30 $ 0.32 $ 0.56
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)
September 30, 1998 December 31, 1997 September 30, 1997
(unaudited) (unaudited)
------------------ ----------------- ------------------
Assets
Current assets
Cash and cash equivalents $ 63,265 $ 29 $ 3
Restricted cash 1,161 3,860 911
Cash invested with ITT Corporation -- 94,800 99,630
Marketable debt securities 35,540 -- --
Accounts receivable, net 17,303 9,680 10,881
Deferred income tax 4,494 2,019 1,463
Prepaids and other current assets 4,221 2,570 3,397
------------------ ----------------- ------------------
Total current assets 125,984 112,958 116,285
Property and equipment, net 24,931 22,886 21,857
Direct marketing costs 7,773 6,882 6,687
Other assets 3,182 3,188 2,147
------------------ ----------------- ------------------
Total assets $ 161,870 $ 145,914 $ 146,976
================== ================= ==================
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 20,442 $ 14,974 $ 15,382
Accrued compensation and benefits 6,395 3,245 4,085
Other accrued liabilities 14,711 6,877 6,924
Deferred tuition revenue 21,381 30,850 34,953
------------------ ----------------- ------------------
Total current liabilities 62,929 55,946 61,344
Other liabilities 2,361 2,153 1,675
------------------ ----------------- ------------------
Total liabilities 65,290 58,099 63,019
------------------ ----------------- ------------------
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 issued
and outstanding 270 270 270
Capital surplus 32,513 32,513 32,513
Retained earnings 63,797 55,032 51,174
------------------ ----------------- ------------------
Total shareholders' equity 96,580 87,815 83,957
------------------ ----------------- ------------------
Total liabilities and shareholders'
equity $ 161,870 $ 145,914 $ 146,976
================== ================= ==================
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 Nine Months
Ended September 30, Ended September 30,
------------------------ ---------------------
1998 1997 1998 1997
---- ---- ---- ----
Cash flows from operating activities:
Net income $ 2,097 $ 8,258 $ 8,765 $ 15,265
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,202 1,743 6,763 5,797
Provision for doubtful accounts 1,092 559 2,551 1,416
Deferred taxes (2,517) (20) (2,246) 288
Increase/decrease in operating assets and liabilities:
Marketable debt securities (35,540) -- (35,540) --
Accounts receivable (5,077) (2,348) (10,174) (2,919)
Direct marketing costs (293) (310) (891) (913)
Accounts payable and accrued liabilities 8,625 (1,381) 16,429 4,245
Prepaids and other assets (272) 1,145 (1,645) (1,555)
Deferred tuition revenue 178 642 (9,469) (8,579)
--------- -------- -------- -------
Net cash provided by (used for) operating activities (29,505) 8,288 (25,457) 13,045
--------- -------- -------- -------
Cash flows used for investing activities:
Capital expenditures, net (3,003) (1,628) (8,806) (8,294)
Net decrease in cash invested with ITT Corporation -- (6,570) 94,800 (9,822)
--------- -------- -------- --------
Net cash provided by (used for) investing activities (3,003) (8,198) 85,994 (18,116)
--------- -------- -------- --------
Net increase (decrease) in cash, cash equivalents and restricted cash (32,508) 90 60,537 (5,071)
Cash, cash equivalents and restricted cash at beginning of period 96,934 824 3,889 5,985
--------- -------- -------- -------
Cash, cash equivalents and restricted cash at end of period $ 64,426 $ 914 $ 64,426 $ 914
========= ======== ======== ========
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 NINE MONTHS ENDED SEPTEMBER 30, 1998
(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, 1997.
The American Institute of Certified Public Accountants (the "AICPA") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed
or obtained for internal use and requires costs incurred in the application
development stage (whether internal or external) to be capitalized. Costs
incurred prior to initial application of this SOP, whether or not
capitalized, should not be adjusted to the amounts that would have been
capitalized had this SOP been in effect when those costs were incurred. The
Company adopted this SOP effective July 1, 1998 which increased net income
by $0.3 million ($0.01 per share) in the three and nine months ended
September 30, 1998.
The results of operations for the nine months ended September 30, 1998 are
not necessarily indicative of results for the entire calendar year.
2. From the Company's initial public offering in 1994 until June 9, 1998, 83.3%
of the outstanding Common Stock of the Company was owned by ITT Corporation
("ITT"). On February 23, 1998, Starwood Hotels and Resorts Worldwide, Inc.
("Starwood, Inc.") completed the acquisition (the "Merger") of ITT and ITT
became a subsidiary of Starwood, Inc. On June 9, 1998, Starwood, Inc. sold
13,050,000 shares of the Company's Common Stock held by ITT to the public
(48.3% of the outstanding shares) (the "June 1998 Offering"). Starwood, Inc.
presently owns 35% of the outstanding shares of the Company's Common Stock.
The June 1998 Offering did not constitute a change of control under the U.S.
Department of Education regulations.
Until February 5, 1998, the Company's cash receipts were forwarded to ITT on
a daily basis and the Company's cash disbursements were generally funded by
ITT out of the Company's cash balances invested with ITT. On February 5,
1998, ITT transferred the balance to the Company and the Company has since
been performing its own cash management function. The invested funds are
included in cash and cash equivalents or marketable debt securities at
September 30, 1998. The marketable debt securities have maturity dates in
excess of 90 days at the time of purchase and are recorded at their market
value. Debt securities with maturity dates less than 90 days at the time of
purchase are included in cash and cash equivalents and are recorded at cost
which approximates market value.
In June 1998, the Company incurred total expenses for the June 1998 Offering
of $1.1 million. In addition, the Company incurred expenses of $0.8 million
in the nine months ended September 30, 1998 (none in three months ended
September 30, 1998) associated with the Company's change in control and
establishment of new employee benefit plans.
3. The Company has a number of pending legal and other claims arising in the
normal course of business. In September 1998, the Company agreed to settle
eight legal proceedings (including Eldredge, et al. v. ITT Educational
Services, Inc., et al.) involving 25 former students and the claims of 15
other former students that related primarily to the Company's marketing and
recruitment practices and included allegations of
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misrepresentation, fraud and violations of certain federal and state
statutes. As part of the settlement of these legal proceedings and claims,
the Company will seek court approval of a class settlement of the claims of
(a) approximately 1,200 other persons who attended an associate degree
program in hospitality at the ITT Technical Institute in Maitland, San
Diego, Portland or Indianapolis and (b) approximately 19,000 other persons
who attended any technology program at any ITT Technical Institute in
California from January 1, 1990 through December 31, 1997. If the Company
obtains court approval of the class settlements, the members of each class
may still elect to opt out of the settlement and pursue any claims they may
have against the Company. The Company recorded a $12.9 million provision for
legal settlements in the three months ended September 30, 1998 as a result
of the settlement of these legal proceedings and claims.
In the opinion of management, the ultimate outcome of the pending legal and
other claims, excluding the settlement discussed above, should not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
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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, 1997 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, default rates 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 $8.6 million, or 11.8%, to $81.7 million in the three months
ended September 30, 1998 from $73.1 million in the three months ended September
30, 1997. Revenues increased $23.2 million, or 11.8%, to $219.1 million in the
nine months ended September 30, 1998 from $195.9 million in the nine months
ended September 30, 1997. These increases were due primarily to a 5% increase in
tuition rates in September 1997 and an 8.2% increase in the total student
enrollment at January 1, 1998 compared to January 1, 1997. The number of
students attending ITT Technical Institutes at January 1, 1998 was 24,498
compared to 22,633 at January 1, 1997.
The total number of first-time and re-entering students beginning classes in
September 1998 was 8,787 compared to 8,070 for the same period in 1997. First-
time students numbered 7,815 in September 1998 compared to 7,156 in September
1997. The total student enrollment on September 30, 1998 was 27,313, compared to
25,811 on September 30, 1997, an increase of 5.8%.
Cost of educational services increased $4.2 million, or 10.1%, to $45.8 million
in the three months ended September 30, 1998 from $41.6 million in the three
months ended September 30, 1997. Cost of educational services increased $12.8
million, or 10.7%, to $132.2 million in the nine months ended September 30, 1998
from $119.4 million in the nine months ended September 30, 1997. 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 (one opened in June 1997, two in
December 1997, one in March 1998, and one in June 1998). Cost of educational
services as a percentage of revenue decreased in the three and nine months ended
September 30, 1998 compared to the three and nine months ended September 30,
1997 as a result of no provision for legal expenses in the three months ended
September 30, 1998 and a $1.2 million provision in the nine months ended
September 30, 1998 (compared to a $0.5 million and $1.5 million provision for
legal expenses in the three and nine months ended September 30, 1997,
respectively) associated with the legal actions involving the hospitality
program. (See Note 3 of Notes to Financial Statements.) Excluding this
provision, cost of educational services in the three months ended September 30,
1998 would have been 56.0% of revenues, a 0.3% improvement from the three months
ended September 30, 1997, and cost of educational services in the nine months
ended September 30, 1998 would have been 59.8% of revenues, a 0.4% improvement
from the nine months ended September 30, 1997.
Student services and administrative expenses increased $1.8 million, or 9.4%, to
$21.0 million in the three months ended September 30, 1998 from $19.2 million in
the three months ended September 30, 1997. Student services and administrative
expenses increased $5.6 million, or 10.1%, to $60.8 million in the nine months
ended September 30, 1998 from $55.2 million in the nine months ended September
30, 1997. The Company increased its media advertising expenses in the three and
nine months ended September 30, 1998 by approximately 11.5% and 9.6%,
respectively, over the same expenses incurred in the three and nine months ended
September 30, 1997. Student services and administrative expenses decreased to
25.7% of revenues in the three months ended September 30, 1998 compared to
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26.2% in the three months ended September 30, 1997, 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. Three new
institutes were opened in 1996, three in 1997 and two in the first nine months
of 1998. 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, 1998 were $1.3 million and $3.9
million, respectively, compared to $0.6 million and $2.6 million for the three
and nine months ended September 30, 1997, respectively.
The Company recorded a $7.7 million after tax ($0.28 per share) provision for
the settlement of certain legal proceedings and claims in the three months ended
September 30, 1998. (See Note 3 of Notes to Financial Statements). In June
1998, the Company incurred total expenses for the June 1998 Offering of $1.0
million after tax ($0.04 per share). In addition, the Company incurred expenses
of $0.5 million after tax ($0.02 per share) in the nine months ended September
30, 1998 (none in the three months ended September 30, 1998) associated with the
Company's change in control and establishment of new employee benefit plans.
The following table sets forth the operating income (in thousands) for the three
and nine months ended September 30, 1998 and 1997:
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
1998 1997 1998 1997
------- ------- ------- -------
Operating income as reported $ 2,078 $12,285 $11,385 $21,390
Legal settlement 12,858 12,858
June 1998 Offering expenses 1,117
Change in control and other one-time costs 755
------- ------- ------- -------
Operating income before one-time costs $14,936 $12,285 $26,115 $21,390
======= ======= ======= =======
Interest income in the three months ended September 30, 1998 was equal to the
interest income for the three months ended September 30, 1997. Interest income
decreased $0.2 million in the nine months ended September 30, 1998 compared to
the nine months ended September 30, 1997, which was primarily due to the lower
interest rate earned on the cash invested by the Company (i.e., 5.5% in 1998
compared to 6.3% in 1997) offset by the earnings on increased cash balances.
The Company's combined effective federal and state income tax rate in 1997 and
for the three months ended September 30, 1998 was 40%. The Company's 1998
federal and state tax provision will be greater than 40%, because $0.9 million
of the June 1998 Offering expenses are not tax deductible.
The following table sets forth the net income (in thousands) for the three and
nine months ended September 30, 1998 and 1997:
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
1998 1997 1998 1997
------ ------ ------- -------
Net income $2,097 $8,258 $ 8,765 $15,265
Legal settlement (after tax) 7,715 7,715
June 1998 Offering expenses (after tax) 1,048
Change in control and other
one-time expenses (after tax) 453
------ ------ ------- -------
Net income before one-time expenses $9,812 $8,258 $17,981 $15,265
====== ====== ======= =======
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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.
Until February 5, 1998, the Company's cash receipts were forwarded to ITT on a
daily basis and the Company's cash disbursements were generally funded by ITT
out of the Company's cash balances invested with ITT. The Company's cash
invested with ITT Corporation is separately shown on the balance sheets as of
December 31, 1997 and September 30, 1997. On February 5, 1998, ITT transferred
the balance to the Company. The Company has been performing its own cash
management functions since February 5, 1998 and no longer has any cash invested
with ITT. The invested funds are included in the caption "cash and cash
equivalents" or "marketable debt securities" in the September 30, 1998 balance
sheet. The marketable debt securities have maturity dates in excess of 90 days
at the time of purchase and are recorded at their market value. Debt securities
with maturity dates less than 90 days at the time of purchase are included in
cash and cash equivalents and are recorded at cost which approximates market
value.
Regulations of the U.S. Department of Education ("DOE") that became effective
July 1, 1997 revised the procedures governing how an institution participating
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 regulations
require the Company to receive Title IV Program loan funds in three equal
quarterly disbursements rather than the two disbursements previously permitted.
The Company estimates that this change decreased deferred tuition revenues or
increased accounts receivable at September 30, 1998 by approximately $17.0
million compared to September 30, 1997 and decreased interest income in the
three and nine months ended September 30, 1998 by approximately $0.2 million and
$0.6 million from interest income in the three and nine months ended September
30, 1997, respectively.
Net cash provided by operating activities, excluding the $35.5 million increase
in marketable debt securities, was $10.1 million in the nine months ended
September 30, 1998 compared to $13.0 million in the nine months ended September
30, 1997. This $2.9 million decrease was due primarily to the decrease in
deferred tuition revenues or increase in accounts receivable discussed above and
the decrease in net income as a result of the one-time expenses, offset by an
increase in the amount due ITT under intercompany agreements that the Company
entered into with ITT at the time of the June 1998 Offering. As of September
30, 1998, the Company had not paid ITT $6.5 million for estimated federal income
taxes, pension expenses and medical expenses accrued from January 1, 1998
through the June 1998 Offering date, pending the reconciliation of all accounts
between ITT and the Company pursuant to the terms of such intercompany
agreements. Management does not believe that the Company's settlement of the
intercompany accounts with ITT will have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
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. An institution whose cohort default rate on loans under the
Federal Family Education Loan ("FFEL") program and the William D. Ford Federal
Direct Loan ("FDL") program is 25% or greater for three consecutive federal
fiscal years loses eligibility to participate in those programs for the
remainder of the federal fiscal year in which the DOE determines that the
institution has lost its eligibility and for the two subsequent federal fiscal
years. In addition, amendments to the HEA enacted in connection with the
reauthorization of the HEA in October 1998 (the "1998 HEA Amendments") provide
that if an institution becomes ineligible to participate in the FFEL and FDL
programs as a result of its 1996 (or any subsequent) federal fiscal year
FFEL/FDL cohort default rate, the institution will also be ineligible to
participate in the Federal Pell Grant ("Pell") program for the same period of
time.
In June 1998, the ITT Technical Institute in Garland, Texas, which accounted for
approximately 1.7% of the Company's revenues in 1997, lost its eligibility to
participate in the FFEL and FDL programs until at least October 1, 2000, because
it had FFEL/FDL cohort default rates exceeding 25% for the 1993, 1994 and 1995
federal fiscal years. The Garland institute had an FFEL/FDL cohort default rate
below 25% for the 1996 federal fiscal year, the most
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recent year for which the DOE has published official FFEL/FDL cohort default
rates. The Company has arranged for an unaffiliated private funding source
("PFS") to provide loans to the students enrolled in the Garland institute. This
alternative source of student financial aid requires the Company to guarantee
repayment of the PFS loans. Based on the Company's experience with the repayment
of Title IV Program loans by students who attended the Garland 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 has also decided to stop enrolling new students in the
Garland institute at least temporarily, while it continues teaching the students
already enrolled. The Company is considering whether to close the Garland
institute once the students already enrolled have completed their programs of
study or transferred to another ITT Technical Institute.
No ITT Technical Institute campus group (defined as the main campus and its
additional locations or branch campuses) had FFEL/FDL cohort default rate equal
to or greater than 25% for the 1996 federal fiscal year. The ITT Technical
Institute in San Antonio, Texas, which accounted for approximately 2.4% of the
Company's revenues in 1997, had FFEL/FDL cohort default rates exceeding 25% for
the 1994 and 1995 federal fiscal years, but had FFEL/FDL cohort default rates
below 25% for the 1993 and 1996 federal fiscal years.
Prior to the 1998 HEA Amendments, the HEA limited how much an institution could
charge a student who withdrew from the institution before the end of the
student's first period of enrollment (i.e., quarter, semester, trimester, etc.)
at the institution. A student was only obligated for a pro rata portion of the
education costs charged by the institution, if the student withdrew during the
first 60% of the student's first period of enrollment. Any monies collected by
the institution in excess of the pro rata portion had to be refunded to lenders
or certain Title IV Programs in a particular order. The 1998 HEA Amendments
deleted the limitation on how much an institution can charge a withdrawing
student (although the laws and/or regulations of most state education
authorities that regulate the ITT Technical Institutes (the "SEAs") and the
standards of the accrediting commissions that accredit the ITT Technical
Institutes (the "Accrediting Commissions") continue to impose such a limitation)
and, instead, impose a limit on the amount of Title IV Program funds a
withdrawing student can use to pay his or her education costs of attending the
institution. This new limitation is applicable to any period of enrollment in
which the student withdraws, not just the first period of enrollment. The 1998
HEA Amendments permit a student to use only a pro rata portion of the Title IV
Program funds for which the student would otherwise be eligible to use, if the
student withdraws during the first 60% of the period of enrollment. Any Title
IV Program funds that the institution receives by or on behalf of a withdrawing
student in excess of the amount the student can use for such period of
enrollment must be refunded by the institution to lenders or certain Title IV
Programs in a particular order. Institutions have until October 1, 2000 to
begin complying with these new refund requirements.
Depending on the refund policies of the applicable state education authorities
and accrediting commission that limit how much an institution can charge a
student who withdraws during any period of enrollment, in a variety of instances
withdrawing students will still be obligated to the institution under the new
HEA refund requirements for education costs that the students can no longer pay
with Title IV Program funds. In these instances, the Company expects that many
withdrawing students will be unable to pay such costs and that the Company will
be unable to collect a significant portion of such costs. If the new refund
requirements remain unchanged, they could have a material adverse effect on the
Company's financial condition, results of operations or cash flows beginning
with the Company's 2001 fiscal year, because payments of Title IV Program funds
are generally paid sooner and are more collectible than certain other
receivables.
A proprietary institution, such as each ITT Technical Institute campus group,
becomes ineligible to participate in Title IV Programs if, on a cash accounting
basis, the institution derives more than 85% of its applicable revenues for a
fiscal year from Title IV Programs. For each of its 1996 and 1997 fiscal years,
the Company has calculated that no ITT Technical Institute campus group derived
more than 81% of its revenues from Title IV Programs, and for its 1997 fiscal
year, the range of the campus groups was from approximately 61% to approximately
80%. The 1998 HEA Amendments increased from 85% to 90% the percentage of
applicable fiscal year revenues that a proprietary institution can derive from
Title IV Programs and still remain eligible to participate in Title IV Programs.
The DOE has not yet issued regulations or guidance regarding the institution's
fiscal year to which this amendment first applies. The 5% increase in the
percentage of applicable fiscal year revenues that the Company can derive from
Title IV
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Programs and still remain eligible to participate therein will increase the
aggregate amount of Title IV Program funds that students can use to pay their
education costs of attending the ITT Technical Institutes. This change should
have a positive impact on the Company's results of operations and cash flows
beginning in the Company's 1999 fiscal year, because payments of Title IV
Program funds are generally paid sooner and are more collectible than certain
other receivables.
The DOE, the Accrediting Commissions and most of the SEAs have laws, regulations
and/or standards (collectively "Regulations") pertaining to the change in
ownership and/or control (collectively "change in control") of educational
institutions, but these Regulations do not uniformly define what constitutes a
change in control. Upon the occurrence of a change in control under the DOE's
Regulations, an institution immediately becomes ineligible to participate in
Title IV Programs and can only receive and disburse certain Title IV Program
funds that were previously committed to its students, until it has applied for
certification and is reinstated by the DOE to continue Title IV Program
participation under such institution's new ownership and control. The time
required for the DOE to act on such an application can vary substantially and
may take several months. The DOE's Regulations also require that all of the ITT
Technical Institutes in a particular campus group have their state
authorizations and accreditations reaffirmed or reestablished before any
institute in that campus group can regain its eligibility from the DOE to
continue participation in Title IV Programs. The 1998 HEA Amendments provide
that the DOE may provisionally certify an institution undergoing a change in
control. This provisional certification would allow the institution temporarily
to maintain its eligibility to participate in Title IV Programs following a
change in control while the DOE considers the institution's application for
reinstatement. The DOE has not yet issued regulations or guidance regarding how
it will interpret or apply this amendment to the HEA.
At present, 9.45 million shares, or 35%, of the Company's outstanding common
stock ("Common Stock") are owned by ITT and 17.55 million shares, or 65%, of the
Common Stock are publicly traded. On October 14, 1998, Starwood Hotels &
Resorts Worldwide, Inc. ("Starwood") announced that it intends to have ITT (a
wholly owned subsidiary of Starwood) divest its 9.45 million shares of the
Common Stock (the "Divestiture"). Depending on market conditions, the
Divestiture is expected to occur in January or February 1999 after the Company
obtains all of the necessary approvals from the applicable regulatory bodies.
The Company has notified the DOE, the SEAs and the Accrediting Commissions of
the Divestiture. The Company believes that it is probable that the DOE and some
of the SEAs (but not the Accrediting Commissions) may consider the Divestiture
to constitute a change in control of the Company and/or the ITT Technical
Institutes. The Company will pursue all approvals from the DOE, the SEAs and
the Accrediting Commissions necessitated by the Divestiture. If the Divestiture
constitutes a change in control under the Regulations of the DOE, effective upon
the Divestiture, each ITT Technical Institute campus group will become
immediately ineligible to participate in all of the Title IV Programs, unless
the DOE provisionally certifies each ITT Technical Institute campus group to
temporarily continue participating in Title IV Programs while the DOE considers
the campus group's application for reinstatement. The Company will obtain all
approvals of the Divestiture from the SEAs and any temporary continuance of
accreditation from the Accrediting Commissions required before the Divestiture
occurs. Following the Divestiture, the Company will seek the approvals of the
Divestiture from the SEAs and any temporary reinstatement of accreditation from
the Accrediting Commissions required after the Divestiture occurs, and will also
seek the DOE's reinstatement of each ITT Technical Institute campus group's
continued participation in Title IV Programs if it is lost as a result of a
change in control caused by the Divestiture. The Company believes that it will
be able to obtain all of the necessary SEA approvals (with the possible
exception of the California SEA), Accrediting Commission reaccreditation and DOE
reinstatement of each ITT Technical Institute campus group required as a result
of the Divestiture. There can be no assurance, however, that all such approvals,
reaccreditations and reinstatements can be obtained in a timely manner. In
particular, obtaining any such approval required by the California SEA could be
adversely affected by a state statute that prohibits the California SEA from
approving a change in control application by any applicant that has been found
in any judicial or administrative proceeding to have violated certain provisions
of the California Education Code ("CEC"). In October 1996, a state court jury
determined that the Company, through its ITT Technical Institute in San Diego,
California violated those provisions of the CEC. The Company appealed the jury's
verdict in that case and has recently settled the case. The Company and the
plaintiffs in that case have filed a joint application and stipulation with the
appellate court to reverse the judgment against the Company and remand the case
back to the trial court with instructions to dismiss the case with prejudice. If
the appellate court reverses the judgment against the Company in that case, the
Company believes
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that it will not have been found in any judicial or administrative proceeding to
have violated the CEC and the California SEA will no longer be prohibited from
approving any subsequent application for a change in control submitted by the
Company for any of the 11 ITT Technical Institutes in California. See "Part II,
Item 1. Legal Proceedings."
In order to assure that the students attending an ITT Technical Institute can
receive all of the Title IV Program funds necessary to pay their costs of
education for any academic quarter following the academic quarter in which the
Divestiture occurs, that institute must be either: (a) provisionally certified
by the DOE to temporarily continue participating in Title IV Programs while the
DOE considers the institute's application for reinstatement; or (b) reinstated
by the DOE to participate in Title IV Programs before the end of such subsequent
academic quarter. Otherwise, none of the students enrolled in that institute
could receive any Title IV Program grants to pay their costs of education for
such subsequent academic quarter, and any such students whose loan period began
after the institute became ineligible and ended before the campus group regained
its eligibility would not receive any Title IV Program loans to pay such costs
for such subsequent academic quarter(s). Failure by a material number of ITT
Technical Institute campus groups to either (a) obtain provisional certification
by the DOE to temporarily continue participating in Title IV Programs while the
DOE considers the campus groups' applications for reinstatement or (b) have
their eligibility to participate in Title IV Programs reinstated before the end
of the first such subsequent academic quarter would have a material adverse
effect on the Company's financial condition, results of operations and cash
flows.
A change in control of the Company and the ITT Technical Institutes could occur
in the future as a result of certain transactions involving the ITT Technical
Institutes, the Company or a principal stockholder, including, but not limited
to, certain corporate reorganizations and certain changes in the boards of
directors of such corporations. A material adverse effect on the Company's
financial condition, results of operations and cash flows would result if a
change in control of the Company occurred and a material number of ITT Technical
Institutes failed, in a timely manner, to be reauthorized by their SEAs,
reaccredited by their Accrediting Commissions or recertified by the DOE to
participate in Title IV Programs.
Capital expenditures were $8.8 million in the nine months ended September 30,
1998 compared to $8.3 million in the nine months ended September 30, 1997. This
increase was due primarily to increased capital expenditures in 1998 for new
institutes and curricula additions at existing institutes offset by a decrease
of approximately $3.0 million used to purchase 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 expenditures for the full 1998 year will be approximately $11.5 million,
the same as in 1997.
Capital expenditures for a new technical institute are approximately $0.4
million and capital expenditures for each new curriculum at an existing
institute are approximately $0.3 million. The Company anticipates that its
planned capital expenditures 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.
The American Institute of Certified Public Accountants (the "AICPA") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use and requires costs incurred in the application
development stage (whether internal or external) to be capitalized. Costs
incurred prior to initial application of this SOP, whether or not capitalized,
should not be adjusted to the amounts that would have been capitalized had this
SOP been in effect when those costs were incurred. The Company adopted this SOP
effective July 1, 1998 which increased net income by $0.3 million ($0.01 per
share) in the three and nine months ended September 30, 1998.
Additionally, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities," in April 1998. SOP 98-5 provides guidance on the financial
reporting of start-up costs and requires the cost of start-up activities to be
expensed
-13-
as incurred. This SOP is applicable to all financial statements for fiscal years
beginning after December 15, 1998. Initial application should be reported as a
cumulative effect of a change in accounting principle as described in Accounting
Principles Board (APB) Opinion No. 20, "Accounting Changes." The Company intends
to adopt this standard in the first quarter of 1999. The cumulative effect of
the change in accounting is not expected to have a material effect on the 1999
annual operating results of the Company.
Year 2000 Compliance
The Year 2000 Problem. Many information technology ("IT") hardware and software
systems ("IT Systems") and non-IT systems containing embedded technology, such
as microcontrollers and microchip processors ("Non-IT Systems") can only process
dates with six digits (e.g., 06/26/98), instead of eight digits (e.g.,
06/26/1998). This limitation may cause IT Systems and Non-IT Systems to
experience problems processing information with dates after December 31, 1999
(e.g., 01/01/00 could be processed as 01/01/2000 or 01/01/1900) or with other
dates, such as September 9, 1999, which was a date traditionally used as a
default date by computer programmers. These problems may cause IT Systems and
Non-IT Systems to suffer miscalculations, malfunctions or disruptions. These
problems are commonly referred to as "Year 2000" or "Y2K" problems. The Company
is unable at this time to assess the possible impact on its financial condition,
results of operations and cash flows that may result from any disruptions to its
business caused by Y2K problems in any IT Systems and Non-IT Systems that the
Company, or any third party with which the Company has a material relationship,
uses. Management does not believe at the current time, however, that the cost
to remedy the Company's internal Y2K problems will have a material adverse
effect on the Company's results of operations or cash flows.
The Company's State of Readiness. The Company has begun to implement a plan to
ensure that its IT Systems and material Non-IT Systems controlled by the Company
are Y2K compliant before January 1, 2000. The first phase of the plan was to
assess the potential exposure of the Company's IT Systems and material Non-IT
Systems to Y2K problems. This phase has been completed. In the second phase,
which has also been completed, the Company designed a procedure to remediate the
Company's exposure to Y2K problems in its IT Systems and material Non-IT Systems
that it controls. The Company is currently in the third phase, which involves
the actual remediation of the Company's IT Systems and material Non-IT Systems
that it controls. After the third phase is completed, the Company will begin
the fourth and final phase of testing the remediation to the Company's IT
Systems and material Non-IT Systems that it controls to ensure Y2K compliance.
The testing phase is scheduled to be completed by June 30, 1999. The Company
believes that it has identified all IT Systems and material Non-IT Systems
controlled by the Company that may require Y2K remediation. The Company has 12
people (both employees and outside consultants) dedicated to completing
enhancements to its IT Systems, which include its accounting, human resources,
financial services, admissions, education, recruitment and career services
systems. These enhancements, which have been ongoing since 1996 and were not
accelerated due to any Y2K problems, will also address the Y2K problems with the
Company's IT Systems. The enhancements are scheduled to be completed by March
31, 1999. The Company has dedicated two employees to either remediate or cause
the remediation of material Non-IT Systems controlled by the Company that have
been identified as possessing a Y2K problem. The remediation of the Company's
material Non-IT Systems controlled by the Company is scheduled to be completed
by March 31, 1999. The Company acquired many of these Non-IT Systems during the
past few years and does not believe that a substantial number of these newer
systems possess a Y2K problem and many have been warranted by the vendor to be
Y2K compliant. The Company has contacted the third parties who control the
Company's other material Non-IT Systems (including, without limitation, the
Company's communication systems, security systems, electrical systems and HVAC
systems) to assess whether any of these systems possess a Y2K problem that could
adversely affect the Company's operations if a malfunction occurred. The
Company has also implemented procedures to help ensure that any new Non-IT
Systems acquired or utilized by the Company are Y2K compliant. In addition, the
Company has identified and begun to contact the third parties whose lack of Y2K
compliance may pose problems for the Company, such as federal and state
regulators, Accrediting Commissions, guaranty agencies, lenders, computer
software and hardware suppliers and book vendors. The General Accounting Office
("GAO") reported in September 1998 that the DOE's delay in addressing the Y2K
problems in its IT Systems and the DOE's limited progress in making contingency
plans should its IT Systems fail could result in serious disruptions in the
DOE's administration of, and disbursement of funds under, the Title IV Programs.
This report followed a negative assessment of the DOE's Y2K preparedness by the
House Government
-14-
Reform and Oversight Committee. The DOE responded to the GAO report that it is
optimistic that it will resolve its material Y2K problems before January 1,
2000.
The Costs to Address the Company's Year 2000 Issues. The Company has expended
approximately $25,000 in direct costs through September 30, 1998 to identify and
remediate its Y2K problems. This amount does not include: (a) the salaries of
the Company's employees involved in the remediation process; (b) the cost of the
enhancements to the Company's IT Systems, because the enhancements have not been
accelerated due to Y2K problems; and (c) the cost to the Company of replacing
any Non-IT Systems or acquiring any new Non-IT Systems in the normal course of
the Company's operations and not because of any Y2K problems. Based on its
current assessment of the Company's Y2K problems, the Company estimates that its
remediation efforts will cost between $50,000 and $100,000 for the Company's IT
Systems and material Non-IT Systems controlled by the Company to become Y2K
compliant, representing up to 10% of the Company's IT budget. Approximately 75%
of this amount will be used, if necessary, to replace computer hardware and
software and other Non-IT Systems equipment owned by the Company at the ITT
Technical Institutes. This amount does not include any costs associated with
remediating any Y2K problems suffered by any third parties' IT Systems and Non-
IT Systems that may affect the Company's operations. The source of the funds
for the Company's Y2K remediation efforts will be the Company's operations.
The Risks of the Company's Year 2000 Issues. The remediation of the Company's
Y2K problems will increasingly result in the deferral of some existing and
contemplated projects, particularly those involving the Company personnel
conducting the Y2K remediation. Although the Company is unable at this time to
quantify its internal indirect costs resulting from its Y2K problems, management
does not believe that the cost of remediating the Company's internal Y2K
problems or the lost opportunity costs arising from diverting the efforts of
Company personnel to the remediation will have a material adverse effect on its
financial condition, results of operations or cash flows. The Company does not
intend to use any independent verification or validation processes to assure the
reliability of the Company's risk or cost estimates associated with its Y2K
problems. The Company has begun to outline several possible worst case scenarios
that could arise from its Y2K problems. At this time, however, the Company has
insufficient information to assess the likelihood of any worst case scenario.
The Company's most reasonably likely worst case Y2K scenarios involve
significant (a) delays in the Company's receipt of federal and state student
financial aid in payment of students' education costs of attending the ITT
Technical Institutes, (b) delays or interruptions in the eligibility to
participate in Title IV Programs, approval to operate or accreditation of the
ITT Technical Institutes that are undergoing their initial, or a renewal of,
such eligibility, approval or accreditation and (c) delays in obtaining
authorization to offer new programs of study for which the ITT Technical
Institutes have applied. In 1997, the Company derived approximately 70% of its
revenues from Title IV Programs administered by the DOE. In addition, a number
of the Company's ITT Technical Institutes participate in various state student
financial aid programs administered by the SEAs that, in total, generate a
material portion of the Company's revenues. In the Company's 1997 fiscal year,
one lending institution provided approximately 62% of all federally guaranteed
student loans to ITT Technical Institute students, and one student loan guaranty
agency guaranteed approximately 94% of all FFEL program loans made to ITT
Technical Institute students. As a result, the Company is dependent on the
ability of the DOE, the SEAs and its primary student loan lender and guaranty
agency to resolve their Y2K problems. If any of these parties experienced a Y2K
problem that significantly delayed the Company's receipt of federal or state
student financial aid in payment of students' education costs of attending the
ITT Technical Institutes, such a Y2K problem could have a material adverse
effect on the Company's financial condition, results of operations and cash
flows. Similarly, an interruption in the ITT Technical Institutes' operations
could occur if the DOE, any SEA or either Accrediting Commission is unable to
timely grant or renew an ITT Technical Institute's eligibility to participate in
Title IV Programs, approval to operate or accreditation, respectively, due to a
Y2K problem. A prolonged delay or interruption for a significant number of
institutes could have a material adverse effect on the Company's financial
condition, results of operations and cash flows. The Company is unable to
independently assess the Y2K readiness of any of these third parties at this
time.
Contingency Plan. The Company has developed a contingency plan for the
Company's IT Systems and material Non-IT Systems controlled by the Company. The
Company has dedicated two employees to remediate a Company IT System that will
become obsolete after the enhancements to the Company's IT Systems are finished.
The remediation of this IT System is scheduled to be completed by March 31,
1999. If the enhancements to the Company's IT Systems
-15-
are not finished before January 1, 2000, the Company hopes to avoid any
disruption to its business by using this other IT System. The Company's
contingency plan with respect to the material Non-IT Systems that it controls
includes, among other things, investigating the availability and replacement
cost of such Non-IT Systems that have Y2K problems, isolating such systems that
are not Y2K compliant so that they do not affect other systems, and adjusting
the clocks on such Non-IT Systems that are not date sensitive. The Company
believes that it could substitute other student loan lenders and guaranty
agencies for its primary lender and guaranty agency if either of these parties
experienced a Y2K problem that could significantly delay the Company's receipt
of federal or state student financial aid in payment of students' education
costs of attending the ITT Technical Institutes. The Company's current financial
resources would also help the Company weather any such delay. Otherwise, the
Company has no contingency plan, and does not intend to create a contingency
plan, for the IT systems and Non-IT Systems that are not controlled by the
Company, including the third party IT Systems of the DOE, the SEAs and the
Accrediting Commissions on which the Company relies.
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 consummation of the proposed settlements of student litigation and
claims related to the Company's technology programs in California and the
Company's hospitality programs; effects of any change in ownership of the
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 the Company's common stock available for sale in the market
upon ITT Corporation's divestment of its holdings of the Company's common stock.
-16-
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 are:
1. Eldredge, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 689376) (the "Eldredge Case"), was filed on June 8, 1995 in
the Superior Court of San Diego County in San Diego, California by
seven graduates of the hospitality program at the San Diego ITT
Technical Institute. The suit alleged, among other things,
misrepresentation, civil conspiracy and statutory violations of the
California Education Code ("CEC"), California Business and Professions
Code ("CBPC") and California Consumer Legal Remedies Act ("CCLRA") by
the Company, ITT and three employees of the Company. The plaintiffs
claimed that the defendants (a) made misrepresentations and engaged in
deceptive acts in the recruitment of the plaintiffs for, and/or in the
promotion of, the program, (b) provided inadequate instruction to the
plaintiffs, (c) used inadequate facilities and equipment in the
program and inappropriate forms of contracts with the plaintiffs, (d)
failed to provide the plaintiffs with all required information and
disclosures and (e) misrepresented the plaintiffs' prospects for
employment upon graduation, the employment of the program's graduates
and the plaintiffs' ability to transfer program credits. The jury
rendered a verdict against the Company and ITT in this action in
October 1996. General damages of approximately $0.2 million were
assessed against the Company and ITT, jointly, on the plaintiffs'
misrepresentations and CEC claims. Exemplary damages of $2.6 million
and $4.0 million were assessed against the Company and ITT,
respectively. The judge also awarded the plaintiffs attorney's fees
and costs in the amount of approximately $0.9 million. Prejudgment
interest was assessed on the general damages award and post-judgment
interest was assessed on the entire award. The plaintiffs' CBPC and
CCLRA claims and their claims against the Company employees were
dismissed, and the judge vacated the jury verdict against ITT. The
Company appealed the awards rendered against it, and the plaintiffs
appealed the vacated verdict against ITT.
In September 1998, the Company agreed to settle all of the plaintiffs'
claims in the Eldredge case in conjunction with the settlement of
other related legal proceedings and claims discussed below. The
Company recorded a $12.9 million provision for legal settlements in
September 1998 associated with such settlements, including the legal
and administrative expenses the Company expects to incur to consummate
the settlements. See "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations Results of Operations."
All of the parties in the Eldredge case have dismissed their
respective appeals and have filed a joint application and stipulation
with the appellate court to reverse the judgment against the Company
and remand the case back to the trial court with instructions to
dismiss the case with prejudice. A California statute prohibits the
California SEA from approving an application for a change in control
of any institution submitted by an applicant that has been found in
any judicial or administrative proceeding to have violated Chapter 7
(formerly Chapter 3) of the CEC ("Chapter 7"). If the appellate court
reverses the judgment against the Company in the Eldredge case, the
Company believes that it will not have been found in any judicial or
administrative proceeding to have violated Chapter 7 and the
California SEA will no longer be prohibited from approving any
subsequent application for a change in control submitted by the
Company for any of the 11 ITT Technical Institutes in California.
Other related legal proceedings and claims (as discussed below) have
resulted and may continue to result from other persons alleging
similar claims of misrepresentation and violations of certain
statutory provisions.
-17-
2. Robb, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 00707460) (the "Robb Case"), was filed on January 24, 1997 in the
Superior Court of San Diego County in San Diego, California by four
graduates of the San Diego ITT Technical Institute. The suit, as
originally filed, alleged, among other things, statutory violations of
the CEC and CBPC by the Company and ten employees of the Company. The
plaintiffs in the original complaint sought compensatory damages,
civil penalties, injunctive relief, disgorgement of ill-gotten gains,
restitution (including return of educational costs) on behalf of
plaintiffs and all other persons similarly situated who attended an
ITT Technical Institute in California, attorney's fees and costs, and
also sought to have the action certified as a class action. The
plaintiffs amended their complaint on August 14, 1997. The amended
complaint deleted three and added two named plaintiffs. Each of the
three plaintiffs was a student who attended one of three different
programs (i.e., hospitality, electronics engineering technology and
computer-aided drafting technology) at an ITT Technical Institute in
California. The plaintiffs in the amended complaint alleged only
violations of the CEC, based on the plaintiffs' claims that the
defendants (a) made misrepresentations and engaged in deceptive acts
in the recruitment of students for, and/or in the promotion of, the
programs offered in California, (b) failed to provide students with
all required information and disclosures and (c) misrepresented
students' prospects for employment upon graduation and the employment
of the programs' graduates. The plaintiffs sought (a) a refund of an
unspecified amount representing all consideration paid to the Company
by the plaintiffs and all other persons similarly situated who
attended any of the programs in California at any time from January 1,
1991 through December 31, 1996, (b) a state statutory penalty equal to
two times the refund amount, (c) injunctive relief and (d) an
unspecified amount of attorney's fees and costs.
In May 1998, the Company agreed to settle all of the claims of one of
the three plaintiffs in this legal proceeding. In September 1998, the
Company agreed to settle all of the claims of the two remaining
plaintiffs in this legal proceeding and to seek a class settlement of
the claims of the approximately 19,000 other persons who attended any
technology program at any ITT Technical Institute in California from
January 1, 1990 through December 31, 1997. The class settlement, which
is subject to court approval, would provide class members with
nontransferable tuition credits to attend a different educational
program at an ITT Technical Institute in the amount of: (a) $250.00
per quarter off the then prevailing quarterly tuition for class
members who completed at least 50% of an associate degree program at
an ITT Technical Institute in California; (b) $125.00 per quarter off
the then prevailing quarterly tuition for class members who completed
(i) less than 50% of an associate degree program at an ITT Technical
Institute in California or (ii) at least 50% of a bachelor degree
program at an ITT Technical Institute in California; and (c) $62.50
per quarter off the then prevailing quarterly tuition for class
members who completed less than 50% of a bachelor degree program at an
ITT Technical Institute in California. The class member could use the
tuition credit toward the cost of attending any ITT Technical
Institute program that the class member had not previously attended.
In addition to the issuance of tuition credits, the Company has also
agreed to stipulate to a permanent injunction that would enjoin the
Company from certain recruitment practices (none of which the Company
currently follows) and to pay the plaintiffs' reasonable attorneys'
fees and expenses. If more than 1% of the class members opt out of the
class settlement, the Company may, in its sole discretion, terminate
the class settlement.
3. Iverson, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 00707705); Ohrt v. ITT Educational Services, Inc., et al.
(Civil Action No. 00707706); Sayers v. ITT Educational Services, Inc.,
et al. (Civil Action No. 00707707); Barrent, et al. v. ITT Educational
Services, Inc., et al. (Civil Action No. 00707708) (the "Barrent
Case"); and Kellum, et al. v. ITT Educational Services, Inc., et al.
(Civil Action No. 00707709) (the "Kellum Case"), were each filed on
January 31, 1997 in the Superior Court of San Diego County in San
Diego, California. Each of the five actions (involving, in total, 16
former students who attended the hospitality program at the San Diego
ITT Technical Institute) alleged statutory violations of the CEC, the
CBPC and the California Consumer Contract Awareness Act of 1990,
intentional misrepresentation and/or concealment, and civil
-18-
conspiracy by the Company, ITT and a Company employee. The plaintiffs
claimed that the defendants (a) made misrepresentations and engaged in
deceptive acts in the recruitment of the plaintiffs for, and/or in the
promotion of, the program, (b) used inadequate facilities and
equipment in the program and inappropriate forms of contracts with the
plaintiffs, (c) failed to provide the plaintiffs with all required
information and disclosures and a fully executed copy of their
contracts with the Company and (d) misrepresented the plaintiffs'
prospects for employment upon graduation, the employment of the
program's graduates and the plaintiffs' externship portion of the
program. The plaintiffs in each action sought various forms of
recovery, including (a) an unspecified amount for compensatory
damages, disgorgement of ill-gotten gains, restitution, attorney's
fees and costs, (b) state statutory penalties equal to two times
actual damages, (c) injunctive relief and (d) $10 million in exemplary
damages.
In May 1998, the Company agreed to settle all of the claims of four of
the five plaintiffs in the Kellum Case and five of the six plaintiffs
in the Barrent Case. In September 1998, the Company agreed to settle
all of the claims of the remaining seven plaintiffs in these five
legal proceedings.
4. Collins, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 98 cv 0659 BTM) (the "Collins Case"), was filed on April 6,
1998 in the U.S. District Court for the Southern District of
California in San Diego, California by nine former students who
attended the hospitality program at either the Maitland or San Diego
ITT Technical Institute. The suit alleged violations of the federal
Racketeer Influenced and Corrupt Organizations Act, the CEC, the CBPC,
the CCLRA, the Florida Deceptive and Unfair Trade Practices Act, the
Florida Civil Remedies for Criminal Practices Act and Florida statutes
prohibiting misleading advertising, common law fraud and/or
concealment and civil conspiracy by the Company and ITT. The
plaintiffs claimed that the defendants (a) made misrepresentations and
engaged in deceptive acts in the recruitment of students for, and/or
in the promotion of, the program, (b) failed to provide students with
all required information and disclosures and (c) misrepresented
students' prospects for employment upon graduation, the employment of
the program's graduates and the students' externship portion of the
program. The plaintiffs sought various forms of recovery on behalf of
the plaintiffs and all other persons similarly situated who attended
the program at the Indianapolis, Maitland, Portland or San Diego ITT
Technical Institute at any time from January 1, 1990 through December
31, 1996, including (a) an unspecified amount for compensatory
damages, exemplary damages, rescission and the return of all tuition
and fees paid to the Company by or on behalf of students who attended
the program, the disgorgement of ill-gotten gains, restitution,
attorney's fees and costs, (b) state statutory penalties of two and
three times actual damages, (c) a federal statutory penalty of $45
million and (d) injunctive relief.
In September 1998, the Company agreed to seek a class settlement of
the claims of the nine plaintiffs in this legal proceeding and of the
approximately 1,200 other persons who attended an associate degree
program in hospitality at the ITT Technical Institute in Maitland,
Florida, San Diego, California, Portland, Oregon or Indianapolis,
Indiana. The class settlement, which is subject to court approval,
involves the Company's payment of cash to the class members and the
plaintiffs' reasonable attorneys' fees and expenses. If more than 1%
of the class members opt out of the class settlement, the Company may,
in its sole discretion, terminate the class settlement.
5. In August 1998, 15 former students who attended the hospitality
program at the ITT Technical Institute in San Diego or Maitland
threatened to commence legal proceedings against the Company and
others. The claimants alleged, among other things, statutory
violations, misrepresentation, fraud and concealment by the Company
and others arising out of their recruitment to attend, and their
education at, the ITT Technical Institute. In September 1998, the
Company agreed to settle all of the claims of the 15 claimants.
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There can be no assurance as to the ultimate outcome of any litigation involving
the Company. Nevertheless, 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 (including the $12.9 million
provision in September 1998 described above) for such liabilities, a material
adverse effect on the Company's financial condition, results of operations or
cash flows, unless (a) the Company fails to obtain court approval of the class
settlement in the Robb Case or the Collins Case and a significant amount of
litigation against the Company results from such failure or (b) a significant
number of class members opt out of either class settlement and pursue litigation
against the Company. Any litigation alleging violations of education or consumer
protection laws and/or regulations, misrepresentation, fraud or deceptive
practices may also subject the affected ITT Technical Institute to additional
regulatory scrutiny.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
A list of exhibits required to be filed as part of this report is set forth in
the Index to Exhibits, which immediately precedes such exhibits, and is
incorporated herein by reference.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended September 30, 1998.
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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: November 2, 1998
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
- -------------------------------------------------------------------------------
10.16 *ESI Pension Plan....................................................
11 Statement re Computation of Per Share Earnings......................
27 Financial Data Schedule.............................................
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* The indicated exhibit is a management contract, compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.
S-2