FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-13144
ITT EDUCATIONAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-2061311
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5975 CASTLE CREEK PARKWAY N. DRIVE
P.O. BOX 50466
INDIANAPOLIS, INDIANA 46250-0466
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (317) 594-9499
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes /X/ No / /
24,932,952
Number of shares of Common Stock, $.01 par value, outstanding at August 4, 1999
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Quarterly Report to Securities and Exchange Commission
June 30, 1999
PART I
ITEM 1. FINANCIAL STATEMENTS.
INDEX
Page
----
Consolidated Statements of Income (Loss) (unaudited) for the six months ended June 30, 1999 and 1998
and the three months ended June 30, 1999 and 1998 ..................................................... 3
Consolidated Balance Sheets as of June 30, 1999 and 1998 (unaudited) and December 31, 1998 ............... 4
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 1999 and 1998
and the three months ended June 30, 1999 and 1998...................................................... 5
Notes to Consolidated Financial Statements................................................................ 6
-2-
ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(In thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ---------------------
1999 1998 1999 1998
---- ---- ---- ----
REVENUES
Tuition $59,605 $54,273 $129,306 $116,860
Other educational 11,033 10,804 21,304 20,504
------- ------- -------- --------
Total revenues 70,638 65,077 150,610 137,364
------- ------- -------- --------
COSTS AND EXPENSES
Cost of educational services 46,995 44,970 93,463 86,408
Student services and administrative expenses 22,053 20,341 43,571 39,777
Offering, change in control and other one-time
expenses -- 1,429 900 1,872
------- ------- -------- --------
Total costs and expenses 69,048 66,740 137,934 128,057
------- ------- -------- --------
Operating income (loss) 1,590 (1,663) 12,676 9,307
Interest income, net 436 1,191 1,292 2,435
------- ------- -------- --------
Income (loss) before income taxes and
cumulative effect of change in
accounting principle 2,026 (472) 13,968 11,742
Income taxes 775 188 5,375 5,074
------- ------- -------- --------
Income (loss) before cumulative effect of change
in accounting principle 1,251 (660) 8,593 6,668
Cumulative effect of change in accounting
principle for institute start-up costs, net
of tax -- -- (823) --
------- ------- -------- --------
Net income (loss) $ 1,251 $ (660) $ 7,770 $ 6,668
------- ------- -------- --------
------- ------- -------- --------
Earnings (loss) per common share (basic and
diluted):
Income (loss) before cumulative effect of
change in accounting principle $ 0.05 $ (0.02) $ 0.33 $ 0.25
Cumulative effect of change in accounting
principle for institute start-up
costs, net of tax -- -- (0.03) --
------- ------- -------- --------
Net income (loss) $ 0.05 $(0.02) $ 0.30 $ 0.25
------- ------- -------- --------
------- ------- -------- --------
The accompanying notes are an integral part of these financial statements.
-3-
ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
June 30, 1999 December 31, 1998 June 30, 1998
(Unaudited) (Unaudited)
------------- ----------------- -------------
ASSETS
Current assets
Cash and cash equivalents $ 31,847 $ 77,335 $ 95,875
Restricted cash 969 3,617 1,059
Marketable debt securities 19,792 38,316 --
Accounts receivable, net 12,049 10,772 13,318
Deferred and prepaid income tax 9,643 5,969 1,811
Prepaids and other current assets 6,744 2,749 4,011
-------- -------- --------
Total current assets 81,044 138,758 116,074
Property and equipment, net 26,713 24,985 24,128
Direct marketing costs 8,382 7,915 7,480
Other assets 3,288 3,913 3,120
-------- -------- --------
Total assets $119,427 $175,571 $150,802
-------- -------- --------
-------- -------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 27,590 $ 15,992 $ 22,459
Accrued compensation and benefits 6,834 6,488 4,585
Accrued legal settlements -- 7,604 --
Other accrued liabilities 6,538 7,896 5,881
Deferred tuition revenue 22,578 32,261 21,203
-------- -------- --------
Total current liabilities 63,540 70,241 54,128
Other liabilities 3,509 3,474 2,191
-------- -------- --------
Total liabilities 67,049 73,715 56,319
-------- -------- --------
Shareholders' equity
Preferred stock, $.01 par value,
5,000,000 shares authorized, none
issued or outstanding -- -- --
Common stock, $.01 par value, 150,000,000
shares authorized, 27,034,452, 27,011,202
and 26,999,952 issued 270 270 270
Capital surplus 33,912 32,613 32,513
Retained earnings 76,743 68,973 61,700
Treasury stock, 1,893,300 shares (58,547) -- --
-------- -------- --------
Total shareholders' equity 52,378 101,856 94,483
-------- -------- --------
Total liabilities and shareholders' equity $119,427 $175,571 $150,802
-------- -------- --------
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
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ITT EDUCATIONAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 1,251 $ (660) $ 7,770 $ 6,668
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,756 2,347 5,292 4,561
Provision for doubtful accounts 1,076 785 1,965 1,459
Deferred taxes 2,720 39 3,252 271
Increase/decrease in operating assets and liabilities:
Marketable debt securities (58) -- 18,524 --
Accounts receivable (505) (1,333) (3,242) (5,097)
Direct marketing costs (374) (426) (467) (598)
Accounts payable and accrued liabilities (6,200) 4,506 (3,248) 7,804
Prepaids and other assets (1,298) 146 (3,370) (1,373)
Deferred tuition revenue (1,003) (1,838) (9,683) (9,647)
----------- ---------- ---------- -----------
Net cash provided by (used for) operating activities (1,635) 3,566 16,793 4,048
----------- ---------- ---------- -----------
Cash flows provided by (used for) investing activities:
Capital expenditures, net (3,391) (3,538) (7,021) (5,803)
Net decrease in cash invested with ITT Corporation -- -- -- 94,800
----------- ---------- ---------- -----------
Net cash provided by (used for) investing activities (3,391) (3,538) (7,021) 88,997
----------- ---------- ---------- -----------
Cash flows provided by (used for) finance activities:
Purchase of treasury stock (9,459) -- (58,547) --
Exercise of stock options 56 -- 639 --
----------- ---------- ---------- -----------
Net cash provided by (used for) finance activities (9,403) -- (57,908) --
----------- ---------- ---------- -----------
Net increase (decrease) in cash, cash
equivalents and restricted cash (14,429) 28 (48,136) 93,045
Cash, cash equivalents and restricted cash at
beginning of period 47,245 96,906 80,952 3,889
----------- ---------- ---------- -----------
Cash, cash equivalents and restricted cash at
end of period $ 32,816 $ 96,934 $32,816 $96,934
----------- ---------- ---------- -----------
----------- ---------- ---------- -----------
The accompanying notes are an integral part of these financial statements.
-5-
ITT EDUCATIONAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(Dollar amounts in thousands, unless otherwise stated)
1. ITT Educational Services, Inc. ("ESI") prepared the accompanying unaudited
financial statements without audit. In the opinion of management, the
financial statements contain all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial condition
and results of operations of ESI. Certain information and footnote
disclosures, including significant accounting policies, normally included
in financial statements prepared in accordance with generally accepted
accounting principles, have been omitted. The interim financial statements
should be read in conjunction with the financial statements and notes
thereto contained in ESI's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission for the year ended December 31, 1998.
The American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities," in
April 1998. SOP 98-5 provides guidance on the financial reporting of
start-up costs and requires the cost of start-up activities to be expensed
as incurred. ESI adopted this standard effective January 1, 1999 and
expensed $1,354 of institute costs, less $531 of deferred tax, as a
cumulative effect of change in accounting principle in the three months
ended March 31, 1999.
2. From ESI's initial public offering in 1994 until June 9, 1998, ITT
Corporation ("ITT") owned 83.3% of the outstanding shares of ESI common
stock.
On February 23, 1998, Starwood Hotels & Resorts Worldwide, Inc. ("Starwood
Hotels") completed the acquisition of ITT (the "Merger") and ITT became a
subsidiary of Starwood Hotels. As a result of the Merger, a change in
control of ESI occurred under regulations of the U.S. Department of
Education ("DOE") and each ITT Technical Institute campus group became
ineligible to participate in federal student financial aid programs.
Effective March 20, 1998, the eligibility of each ITT Technical Institute
campus group to participate in federal student financial aid programs was
reinstated by the DOE with certain conditions imposed by the DOE. ESI
believes that it is in compliance with or satisfies these DOE conditions.
On June 9, 1998, ITT sold 13,050,000 shares of ESI's common stock held by
ITT to the public (48.3% of the outstanding shares) (the "June 1998
Offering"). After the June 1998 Offering, ITT owned 35% of the outstanding
shares of ESI common stock. The June 1998 Offering did not constitute a
change in control of ESI under the DOE's regulations.
On February 1, 1999, ITT sold 7,950,000 shares of ESI common stock held by
ITT to the public (the "February 1999 Offering"). The February 1999
Offering did not constitute a change in control of ESI under the DOE's
regulations. Simultaneous with the close of the February 1999 Offering, ESI
repurchased 1,500,000 shares of ESI common stock from ITT at the February
1999 Offering price to the public, less underwriters' commissions and
discounts, for an aggregate cost of $49,088 (the "February 1999 Stock
Repurchase"). Following the February 1999 Offering and February 1999 Stock
Repurchase, ITT no longer owned any shares of ESI's common stock.
3. On April 21, 1999, ESI's Board of Directors authorized ESI to repurchase up
to 2,000,000 outstanding shares of ESI common stock in the open market or
through privately negotiated transactions in accordance with Rule 10b-18 of
the Securities Exchange Act of 1934, as amended. During the three months
ended June 30, 1999, ESI repurchased 393,300 shares of ESI common stock at
an average cost of $24.05 per share or $9.5 million. ESI is currently
holding all of the repurchased shares of ESI common stock as treasury
shares. ESI may elect to repurchase additional shares of ESI common stock
from time to time in the future, depending on market conditions and other
considerations. The purpose of the stock repurchase program is to help ESI
achieve its long-term goal of enhancing shareholder value.
-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 our Annual Report on Form 10-K as filed with the
Securities and Exchange Commission for the year ended December 31, 1998 for
discussion of, among other matters, the following items:
- Cash receipts from financial aid programs
- Nature of capital additions
- Seasonality of revenues
- Components of income statement captions
- Cash invested with ITT
- Cash transferred from ITT
- Legal settlements
- Marketable debt securities and market risk
- Change in ownership and control of ESI
- Changes in federal regulations regarding:
- Timing of receipt of funds from the federal student
financial aid programs under Title IV of the Higher
Education Act of 1965, as amended (the "Title IV
Programs")
- Refunds
- Percentage of applicable revenues that may be derived
from Title IV Programs
- Default rates
We earn tuition revenue on a weekly basis, pro rata over the length of
each of the four 12-week academic quarters in our fiscal year. Due to the
two-week vacations in June and December at most of our institutes, the first
and third quarters include 13 weeks of revenue and the second and fourth
quarters include 11 weeks of revenue. Our incurrence of costs, however, is
generally not affected by the academic schedule and such costs do not
fluctuate significantly on a quarterly basis. As a result, net income in the
second and fourth quarters is significantly less than in the first and third
quarters.
In 1998, we began offering a new program in information technology,
called Computer Network Systems Technology ("CNST"), at three ITT Technical
Institutes. We began offering the CNST program at an additional 12 ITT
Technical Institutes in the three months ended March 31, 1999 and at an
additional six ITT Technical Institutes in the three months ended June 30,
1999. We intend to begin offering this program at six additional ITT
Technical Institutes in the third quarter of 1999, at seven additional ITT
Technical Institutes in the fourth quarter of 1999, and at 33 additional
schools in 2000. We incur a loss with respect to each CNST program offered
at an ITT Technical Institute until the revenue from the number of enrolled
students is high enough to offset the fixed costs associated with the
program offering, such as salaries, equipment depreciation, rent and
marketing. We incurred estimated losses with respect to the CNST program of
approximately $1.3 million in the three months ended June 30, 1999 and $2.4
million in the six months ended June 30, 1999, compared to none in the three
or six months ended June 30, 1998. We have been developing four separate
information technology programs, each with a different area of
concentration: computer networking, computer programming, web administration
and multimedia. To date, the rollout of our information technology curricula
has primarily focused on the CNST program. One ITT Technical Institute began
offering the computer programming curriculum in the June 1999 term. We
intend to begin offering the computer programming curriculum at other ITT
Technical Institutes prior to the end of 1999 and intend to begin offering
the remaining two information technology programs starting in 2000. The
expenses associated with our accelerated rollout of the information
technology programs will temporarily depress our earnings in the second half
of 1999 and the first half of 2000. The amount of capital required to offer
the CNST program at an ITT Technical Institute is approximately $0.2
million.
-7-
RESULTS OF OPERATIONS
Revenues increased $5.5 million, or 8.4%, to $70.6 million in the three
months ended June 30, 1999 from $65.1 million in the three months ended June 30,
1998. Revenues increased $13.2 million, or 9.6%, to $150.6 million in the six
months ended June 30, 1999 from $137.4 million in the six months ended June 30,
1998. These increases were due primarily to a 5% increase in tuition rates in
September 1998 and a 4.5% increase in the total student enrollment at January 1,
1999 compared to January 1, 1998. The number of students attending ITT Technical
Institutes at January 1, 1999 was 25,608 compared to 24,498 at January 1, 1998.
The total number of new students beginning classes in June 1999 was
7,272, compared to 6,951 in June 1998, an increase of 4.6%. The total student
enrollment on June 30, 1999 was 25,858, compared to 24,909 on June 30, 1998, an
increase of 3.8%.
Cost of educational services increased $2.0 million, or 4.4%, to $47.0
million in the three months ended June 30, 1999 from $45.0 million in the three
months ended June 30, 1998. Cost of educational services increased $7.1 million,
or 8.2%, to $93.5 million in the six months ended June 30, 1999 from $86.4
million in the six months ended June 30, 1998. The principal causes of these
increases include:
- the costs required to service the increased enrollment;
- normal inflationary cost increases for wages, rent and other costs
of services;
- increased costs at new institutes (one opened in March 1998, one in
June 1998, one in October 1998, two in January 1999 and one in
April 1999); and
- increased costs associated with offering the CNST program at 21
institutes.
Cost of educational services included $1.2 million of legal expenses
in the three and six months ended June 30, 1998 (none in 1999). Cost of
educational services as a percentage of revenues decreased to 66.5% in the
three months ended June 30, 1999 compared to 69.1% in the three months ended
June 30, 1998, and decreased to 62.1% in the six months ended June 30, 1999
compared to 62.9% in the six months ended June 30, 1998. The principal causes
of these decreases include the absence of a legal provision in 1999 and a
reduction of book costs, which resulted from lower bookstore sales in 1999.
Student services and administrative expenses increased $1.8 million,
or 8.9%, to $22.1 million in the three months ended June 30, 1999 from $20.3
million in the three months ended June 30, 1998. Student services and
administrative expenses increased $3.8 million, or 9.5%, to $43.6 million in
the six months ended June 30, 1999 from $39.8 million in the six months ended
June 30, 1998. These increases were primarily due to increased media
advertising expenses (up 9% in the three months ended June 30, 1999 and 13%
in the six months ended June 30, 1999). Student services and administrative
expenses were 31.2% of revenues in the three months ended June 30, 1999 and
28.9% of revenues in the six months ended June 30, 1999, which were
approximately the same percentages as in the three and six months ended June
30, 1998.
We incurred net one-time expenses of $0.9 million in the six months
ended June 30, 1999 (none in the three months ended June 30, 1999) associated
with the costs of the February 1999 Offering (from which we did not receive
any proceeds) and special bonus payments to employees for extraordinary
services since 1997, net of amounts reimbursed by ITT. We incurred one-time
expenses of $1.4 million in the three months ended June 30, 1998 and $1.9
million in the six months ended June 30, 1998 associated primarily with our
June 1998 Offering and change in control resulting from the Merger.
We incur operating losses when we open new institutes. We opened
three new institutes in 1996, three in 1997, three in 1998 and three in the
six months ended June 30, 1999. A new institute typically is open for
approximately 24 months before it experiences a profit. The revenues and
expenses of these institutes are included in the respective captions in the
statements of income. The amount of operating losses (pre-tax) for institutes
open less than 24 months were$1.6 million during the three months ended June
30, 1999 and $3.3 million during the six months ended June 30, 1999, compared
to $1.5 million during the three months ended June 30, 1998 and $2.5 million
during the six months ended June 30, 1998.
-8-
Our operating income increased $3.3 million to $1.6 million in the
three months ended June 30, 1999 from an operating loss of $1.7 in the three
months ended June 30, 1998. Our operating income increased $3.4 million to
$12.7 million in the six months ended June 30, 1999 from $9.3 million in the
six months ended June 30, 1998.
The following table sets forth our operating income (in millions) for
the three and six months ended June 30, 1999 and 1998:
Three Months Six Months
Ended June 30, Ended June 30,
----------------------- ------------------------
1999 1998 1999 1998
---- ---- ---- ----
Operating income (loss) as reported................................. $1.6 $(1.7) $12.7 $ 9.3
Offering, change in control and other one-time expenses............. -- 1.4 0.9 1.9
Operating losses from new institutes................................ 1.6 1.5 3.3 2.5
Estimated losses from CNST program.................................. 1.3 -- 2.4 --
Legal provision..................................................... -- 1.2 -- 1.2
------- -------- --------- --------
Adjusted operating income before one-time expenses, losses from
new institutes and CNST program and legal provision............. $4.5 $2.4 $19.3 $14.9
------- -------- --------- --------
------- -------- --------- --------
Percent of revenue.................................................. 6.4% 3.7% 12.8% 10.8%
Interest income decreased $0.8 million in the three months ended
June 30, 1999 from the three months ended June 30, 1998 and $1.1 million in
the six months ended June 30, 1999 from the six months ended June 30, 1998
primarily due to less cash and investments in 1999 as a result of our
repurchase of 1.5 million shares of our common stock from ITT on February 1,
1999 for $49.1 million and our repurchase of an additional 393,300 shares for
$9.5 million in the three months ended June 30, 1999.
Our combined effective federal and state income tax rate for the
three and six months ended June 30, 1999 was 38.5% compared to 40% for the
three and six months ended June 30, 1998 (before non-deductible offering
expenses). This decrease was a result of lower state income taxes.
The following table sets forth the net income (in thousands, except per
share data) for the three and six months ended June 30, 1999 and 1998:
Three Months Six Months
Ended June 30, Ended June 30,
------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
Net income (loss) as reported......................................... $1,251 $(660) $7,770 $6,668
Cumulative effect of change in accounting principle for
institute start-up costs, net of tax............................. -- -- 823 --
Offering, change in control and other one time expenses (after tax) -- 1,235 554 1,501
----------- ---------- ----------- ----------
Net income before one-time expenses................................... 1,251 575 9,147 8,169
Operating losses from new institutes (after tax)...................... 1,007 885 2,041 1,521
Estimated losses from new CNST program offerings (after tax).......... 801 -- 1,491 --
Legal provision (after tax) .......................................... -- 720 -- 720
----------- ---------- ----------- ----------
Adjusted net income before one-time expenses, losses from new
institutes and CNST program and legal provision....................... $3,059 $2,180 $12,679 $10,410
----------- ---------- ----------- ----------
----------- ---------- ----------- ----------
Diluted average number of outstanding common shares................... 25,430 27,183 25,863 27,163
Diluted earnings per share............................................ $0.12 $0.08 $0.49 $0.38
-9-
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Due to the seasonal pattern of enrollments and our receipt of
tuition payments, comparisons of financial position and cash generated from
operations should be made both to the end of the previous year and to the
corresponding period during the previous year.
Our net cash used for operating activities, excluding the $18.5
million decrease in marketable debt securities, was $1.7 million in the six
months ended June 30, 1999 compared to $4.0 million of net cash provided by
operating activities in the six months ended June 30, 1998. This $5.7 million
decrease was due primarily to our June 1999 payment of the legal settlement
amount in the student litigation related to our hospitality program that was
previously reported.
Our capital expenditures were $3.4 million in the three months ended
June 30, 1999 compared to $3.5 million in the three months ended June 30,
1998. Our capital expenditures were $7.0 million in the six months ended June
30, 1999 compared to $5.8 million in the six months ended June 30, 1998.
These increases were due primarily to increased capital expenditures in 1999
for offering of the CNST program at 18 additional ITT Technical Institutes.
We expect that our capital expenditures for the full 1999 year will be
approximately $17.0 million, which will represent a $5.6 million increase
over 1998 that is primarily due to our plans to offer the CNST program at a
minimum of 31 additional ITT Technical Institutes in all of 1999.
Capital expenditures for a new institute are approximately $0.4
million and capital expenditures for each new curriculum offered at an
existing institute are approximately $0.3 million ($0.2 million for the CNST
program). We expect to be able to fund our planned capital expenditures in
1999 from cash flows from operations.
On April 21, 1999, our Board of Directors authorized ESI to
repurchase up to 2,000,000 outstanding shares of ESI common stock in the open
market or through privately negotiated transactions in accordance with Rule
10b-18 of the Securities Exchange Act of 1934, as amended. During the three
months ended June 30, 1999, we repurchased 393,300 shares of ESI common stock
at an average cost of $24.05 per share or $9.5 million. We are currently
holding all of the repurchased shares of ESI common stock as treasury shares.
We may elect to repurchase additional shares of ESI common stock from time to
time in the future, depending on market conditions and other considerations.
The purpose of the stock repurchase program is to help ESI achieve its
long-term goal of enhancing shareholder value.
Cash flows on a long-term basis are highly dependent upon the
receipt of Title IV Programs funds and the amount of funds spent on new
institutes, curricula additions at existing institutes and possible
acquisitions.
YEAR 2000 COMPLIANCE
THE YEAR 2000 PROBLEM. Many information technology ("IT") hardware
and software systems ("IT Systems") and non-IT Systems containing embedded
technology, such as microcontrollers and microchip processors ("Non-IT
Systems") can only process dates with six digits (e.g., 06/26/98), instead of
eight digits (e.g., 06/26/1998). This limitation may cause IT Systems and
Non-IT Systems to experience problems processing information with dates after
December 31, 1999 (e.g., 01/01/00 could be processed as 01/01/2000 or
01/01/1900) or with other dates, such as September 9, 1999, which was a date
traditionally used as a default date by computer programmers. These problems
may cause IT Systems and Non-IT Systems to suffer miscalculations,
malfunctions or disruptions. These problems are commonly referred to as "Year
2000" or "Y2K" problems. We are unable at this time to assess the possible
impact on our financial condition, results of operations and cash flows that
may result from any disruptions to our business caused by Y2K problems in any
IT Systems and Non-IT Systems that we control or that any third party with
whom we have a material relationship controls. We do not believe at the
current time, however, that the cost to remedy our internal Y2K problems will
have a material adverse effect on our results of operations or cash flows.
OUR STATE OF READINESS. We have implemented a plan to ensure that
the IT Systems and material Non-IT Systems that we control are Y2K compliant
before January 1, 2000. In the first phase of the plan, which has been
completed, we assessed the potential exposure of our IT Systems and material
Non-IT Systems to Y2K problems.
-10-
In the second phase, which has also been completed, we designed a procedure
to remediate our exposure to Y2K problems in the IT Systems and material
Non-IT Systems that we control. We are currently in the third phase, which
involves the actual remediation of the IT Systems and material Non-IT Systems
that we control. After we complete the third phase, we will begin the fourth
and final phase of testing the remediation to the IT Systems and material
Non-IT Systems that we control to ensure Y2K compliance. We plan to complete
the testing phase by September 30, 1999.
We believe that we have identified all IT Systems and material
Non-IT Systems that we control that may require Y2K remediation. We have 12
people (both employees and outside consultants) dedicated to completing
enhancements to our IT Systems, which include our accounting, human
resources, financial services, admissions, education, recruitment and career
services systems. We have been enhancing our IT Systems on a continuous basis
since 1996 and we did not accelerate these enhancements due to any Y2K
problems. These enhancements will also address the Y2K problems with our IT
Systems. We plan to complete these enhancements by September 30, 1999.
We have dedicated two employees to either remediate or cause the
remediation of material Non-IT Systems that we control and that we have
identified as possessing a Y2K problem. We plan to complete the remediation
of these Non-IT Systems by September 30, 1999. We acquired many of these
Non-IT Systems during the past few years and we believe that a substantial
number of these newer systems do not possess a Y2K problem. In addition, the
vendors of many of these Non-IT Systems have warranted them to be Y2K
compliant. We have contacted the third parties who control our other material
Non-IT Systems (including, without limitation, our communication systems,
security systems, electrical systems and HVAC systems) to assess whether any
of these systems possess a Y2K problem that could adversely affect our
operations if a malfunction occurred. We have also implemented procedures to
help ensure that any new Non-IT Systems that we acquire or utilize are Y2K
compliant.
We have identified and contacted the third parties whose lack of Y2K
compliance may pose problems for us, such as the U.S. Department of Education
("DOE"), the state education authorities that regulate our institutes
("SEAs"), the accrediting commission that accredits our institutes
("Accrediting Commission"), student loan guaranty agencies, student loan
lenders, computer software and hardware suppliers and book vendors. In the
DOE's March 8, 1999 status report on the Y2K compliance of its
mission-critical IT Systems, the DOE stated that all of its 14
mission-critical IT Systems are Y2K compliant.
THE COSTS TO ADDRESS OUR YEAR 2000 ISSUES. We have expended
approximately $125,000 in direct costs through June 30, 1999 to identify and
remediate our Y2K problems. This amount does not include:
- the salaries of our employees involved in the remediation process;
- the cost of the enhancements to our IT Systems, because we did not
accelerate the enhancements due to Y2K problems; and
- the cost of replacing any Non-IT Systems or acquiring any new Non-IT
Systems in the normal course of our operations and not because of any
Y2K problems.
Based on our current assessment of our Y2K problems, we estimate
that our remediation efforts will cost between $150,000 and $200,000 for the
IT Systems and material Non-IT Systems that we control to become Y2K
compliant, representing up to 10% of our IT budget. Approximately 75% of this
amount will be used, if necessary, to replace computer hardware and software
and other Non-IT Systems equipment owned by us at our institutes. This amount
does not include any costs associated with remediating any Y2K problems
suffered by any third parties' IT Systems and Non-IT Systems that may affect
our operations. Our operations will fund our Y2K remediation efforts.
THE RISKS ASSOCIATED WITH OUR YEAR 2000 ISSUES. The remediation of
our Y2K problems will increasingly cause us to defer some existing and
contemplated projects, particularly those involving our personnel conducting
the Y2K remediation. Although we are unable at this time to quantify our
internal indirect costs resulting from our Y2K problems, we do not believe
that the cost of remediating our internal Y2K problems or the lost
opportunity costs arising from diverting the efforts of our personnel to the
remediation will have a material adverse effect on our financial
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condition, results of operations or cash flows. We do not intend to use any
independent verification or validation processes to assure the reliability of
our risk or cost estimates associated with our Y2K problems.
We have outlined several possible worst case scenarios that could
arise from our Y2K problems. At this time, however, we have insufficient
information to assess the likelihood of any worst case scenario. Our most
reasonably likely worst case Y2K scenarios involve:
- significant delays in our receipt of federal and state student
financial aid in payment of students' education costs of attending our
institutes;
- significant delays or interruptions in the eligibility to participate
in Title IV Programs, approval to operate or accreditation of our
institutes that are undergoing their initial, or a renewal of, such
eligibility, approval or accreditation; and
- significant delays in obtaining authorization to offer new programs of
study for which our institutes have applied.
In 1998, we derived approximately 69% of our revenues from Title IV
Programs administered by the DOE. In addition, a number of our institutes
participate in various state student financial aid programs administered by
SEAs that, in the aggregate, generate a material portion of our revenues. In
1998, one lender provided approximately 65% of all Title IV Program loans
under the Federal Family Education Loan ("FFEL") program that were received
by our students, and one student loan guaranty agency guaranteed
approximately 94% of all FFEL program loans that were received by our
students. As a result, we must depend on the ability of the DOE, the SEAs and
our primary student loan lender and guaranty agency to resolve their Y2K
problems. If any of these parties were to experience a Y2K problem that
significantly delays our receipt of federal or state student financial aid in
payment of students' education costs, it could have a material adverse effect
on our financial condition, results of operations and cash flows. Similarly,
an interruption in our institutes' operations could occur if, due to a Y2K
problem:
- the DOE is unable to timely grant or renew an institute's eligibility
to participate in Title IV Programs;
- any SEA is unable to timely approve an institute to operate or renew
such approval; or
- the Accrediting Commission is unable to timely accredit an institute
or renew such accreditation.
A prolonged delay or interruption for a significant number of
institutes could have a material adverse effect on our financial condition,
results of operations and cash flows. We are unable to independently assess the
Y2K readiness of any of these third parties at this time.
CONTINGENCY PLAN. We have developed a contingency plan for the IT
Systems and material Non-IT Systems that we control. We have dedicated two
employees to remediate an IT System that will become obsolete after we finish
the enhancements to our IT Systems. We plan to complete the remediation of
this IT System by September 30, 1999. If the enhancements to our IT Systems
are not finished before January 1, 2000, we hope to avoid any disruption to
our business by using this other IT System. Our contingency plan with respect
to the material Non-IT Systems that we control includes, among other things,
investigating the availability and replacement cost of such Non-IT Systems
that have Y2K problems, isolating such systems that are not Y2K compliant so
that they do not affect other systems, and adjusting the clocks on such
Non-IT Systems that are not date sensitive. We believe that we could
substitute other student loan lenders and guaranty agencies for our primary
lender and guaranty agency if either of these parties experienced a Y2K
problem that could significantly delay our receipt of federal or state
student financial aid in payment of students' education costs of attending
our institutes. Our current financial resources would also help us weather
any such delay. Otherwise, we have no contingency plan, and do not intend to
create a contingency plan, for the IT Systems and Non-IT Systems that are not
controlled by us, including the third party IT Systems of the DOE, the SEAs
and the Accrediting Commission on which we rely.
-12-
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains certain forward looking statements that involve
a number of risks and uncertainties. Among the factors that could cause
actual results to differ materially are the following: business conditions
and growth in the postsecondary education industry and in the general
economy; changes in federal and state governmental regulations with respect
to education and accreditation standards, or the interpretation or
enforcement thereof, including, but not limited to, the level of government
funding for, and our eligibility to participate in, student financial aid
programs utilized by our students; the consummation of the proposed
settlement of student litigation related to our technology programs in
California; effects of any change in ownership of ESI resulting in a change
in control of ESI, including, but not limited to, the consequences of such
changes on the accreditation and federal and state regulation of the
institutes; our ability to implement our growth strategies, including our new
information technology programs; receptivity of students and employers to our
existing program offerings and new curricula; and loss of lender access to
our students for student loans.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
-13-
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are subject to litigation in the ordinary course of our
business. Among the legal actions currently pending and recently concluded is
the following case. We have agreed to settle all of the plaintiff's claims in
this case. The settlement is a class settlement which has been subject to
court approval and to the right of the class members to opt out of the
settlement.
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 our San Diego institute. The suit, as originally filed, alleged, among
other things, statutory violations of the California Educational Code (the
"CEC") and the California Business and Professions Code (the "CBPC") by us
and ten of our employees. 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
any of our institutes 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 a
California institute. The plaintiffs in the amended complaint alleged only
violations of the CEC, based on the plaintiffs' claims that the defendants
(1) made misrepresentations and engaged in deceptive acts in the recruitment
of students for, and/or in the promotion of, the programs offered in
California, (2) failed to provide students with all required information and
disclosures and (3) misrepresented students' prospects for employment upon
graduation and the employment of the programs' graduates. The plaintiffs
sought (1) a refund of an unspecified amount representing all consideration
paid to us 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, (2) a state statutory penalty equal to two times
the refund amount, (3) injunctive relief and (4) an unspecified amount of
attorney's fees and costs.
In May 1998, we settled all of the claims of one of the three
plaintiffs in this legal proceeding. In September 1998, we 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 program (other than the hospitality program)
at any of our institutes in California from January 1, 1990 through December
31, 1997. The class settlement, which was subject to court approval, provides
class members with nontransferable tuition credits to attend a different
educational program at any of our institutes in the amount of: (1) $250 per
quarter off the then prevailing quarterly tuition for class members who
completed at least 50% of an associate degree program at one of our
institutes in California; (2) $125 per quarter off the then prevailing
quarterly tuition for class members who completed (a) less than 50% of an
associate degree program at one of our institutes in California or (b) at
least 50% of a bachelor degree program at one of our institutes in
California; and (3) $62.50 per quarter off the then prevailing quarterly
tuition for class members who completed less than 50% of a bachelor degree
program at one of our institutes in California. The class member can use the
tuition credit toward the cost of attending any of our institutes' programs
that the class member had not previously attended. In addition to the
issuance of tuition credits, we stipulated to a permanent injunction that
enjoins us from certain recruitment practices (none of which we currently
follow) and agreed to pay the plaintiffs' reasonable attorneys' fees and
expenses. If more than 1% of the class members had opted out of the class
settlement, we could have, in our sole discretion, terminated the class
settlement. On July 2, 1999, the court granted final approval of the class
settlement and dismissed the Robb case with prejudice. Twenty-four of the
class members opted out of the class settlement.
We cannot assure you of the ultimate outcome of any litigation
involving us. We do not believe any pending legal proceeding will result in a
judgment or settlement that will have, after taking into account our existing
insurance and provisions for such liabilities, a material adverse effect on
our financial condition, results of operations or cash flows. Any litigation
alleging violations of education or consumer protection laws and/or
regulations, misrepresentation, fraud or deceptive practices may also subject
our affected institutes to additional regulatory scrutiny.
-14-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the second quarter of fiscal year 1999, we held the ESI 1999
annual meeting of shareholders on May 11, 1999 to elect directors and to
approve an amendment to our Restated Certificate of Incorporation. Our Board
of Directors currently consists of eight directors divided into three
classes. The first and third classes contain three directors each and the
second class contains two directors. The term of one class expires each year.
Generally, each director serves until the annual meeting of shareholders held
in the year that is three years after that director's election and thereafter
until that director's successor is elected and has qualified. At the ESI 1999
annual meeting of shareholders, our shareholders elected the following
persons to serve as directors of ESI in the second class of our Board of
Directors, each to hold office for the term of three years and until his
successor is elected and has qualified:
Second Class - Term expiring at 2002 Annual Meeting
------------
1. John E. Dean
2. Vin Weber
The final results of the vote taken at such meeting for the director
nominees are as follows:
Broker
Votes For Votes Withheld Nonvotes Abstentions
---------- -------------- -------- -----------
John E. Dean 21,300,851 21,078 0 0
Vin Weber 21,301,276 20,653 0 0
The ESI directors who continued in office after the meeting are as
follows:
First Class - Term expiring at 2001 Annual Meeting
-----------
1. Rene R. Champagne
2. James D. Fowler, Jr.
Third Class - Term expiring at 2000 Annual Meeting
-----------
1. Rand V. Araskog
2. Leslie Lenkowsky
3. Daniel P. Weadock
In addition, at its meeting on July 13, 1999, our Board of Directors elected
Harris N. Miller to serve as an ESI Director, as a member of the First Class.
At the ESI 1999 annual meeting of shareholders, our shareholders
also approved an amendment to our Restated Certificate of Incorporation to
increase the number of authorized shares of ESI's Common Stock, $0.01 par
value per share, from 50,000,000 to 150,000,000. The final results of the
vote taken at that meeting to approve the amendment to our Restated
Certificate of Incorporation are as follows:
Percentage of Shares Broker
Votes For Outstanding Voting For Votes Against Nonvotes Abstentions
------------ ---------------------- ------------- -------- -----------
18,472,296 72.3% 2,839,226 0 10,407
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
A list of exhibits required to be filed as part of this report is
set forth in the Index to Exhibits, which immediately precedes the exhibits, and
is incorporated herein by reference.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended June 30,
1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ITT EDUCATIONAL SERVICES, INC.
Date: August 6, 1999
By: /s/ Gene A. Baugh
-------------------------------
GENE A. BAUGH
SENIOR VICE PRESIDENT AND CHIEF
FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
S-1
INDEX TO EXHIBITS
Exhibit
No. Description
- -----------------------------------------------------------------------------------------
3.1 Restated Certificate of Incorporation, as Amended to Date............
10.19 *ESI Excess Pension Plan ............................................
11 Statement re Computation of Per Share Earnings.......................
27 Financial Data Schedule..............................................
- ----------
* The indicated exhibit is a management contract, compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.
S-2