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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE, INC.
Securities registered pursuant to Section 12(g) of the Act:
NONE
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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
$112,246,998
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock at January 31, 1997
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
26,999,952
Number of shares of Common Stock, $.01 par value, outstanding at
February 28, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents have been incorporated by reference into
this Annual Report on Form 10-K
IDENTITY OF DOCUMENT PARTS OF FORM 10-K INTO WHICH DOCUMENT IS
INCORPORATED
Definitive Proxy Statement for PART III
the Annual Meeting of Shareholders
to be held May 13, 1997
ITT EDUCATIONAL SERVICES, INC.
Indianapolis, Indiana
Annual Report to Securities and Exchange Commission
December 31, 1996
PART I
ITEM 1. BUSINESS.
Unless the context otherwise requires, the term "Company" refers to ITT
Educational Services, Inc., the term "ITT" refers to ITT Corporation, a Nevada
corporation, and its subsidiaries other than the Company, and the terms "ITT
Technical Institutes," "technical institutes" or "institutes" (in singular or
plural form) refer to educational institutions owned and operated by the
Company.
Background
Prior to its initial public offering (the "Offering"), which was
consummated on December 27, 1994, the Company was a wholly owned subsidiary of
ITT Corporation, formerly a Delaware corporation and now known as ITT
Industries, Inc., an Indiana corporation ("Old ITT"). On September 29, 1995, ITT
succeeded to the interests of Old ITT in the beneficial ownership of 83.3% of
the Common Stock of the Company, as part of the division of Old ITT's businesses
among itself and two of its wholly owned subsidiaries (including ITT) and
distribution of all the outstanding common stock of ITT and the other subsidiary
to the shareholders of Old ITT, which occurred on December 19, 1995
("Division"). ITT is a global enterprise engaged, through its subsidiaries, in
the hotel and gaming, sports and entertainment and information services
businesses. A tender offer to obtain control of ITT commenced on January 31,
1997 by Hilton Hotels Corporation ("Hilton") and would, if successful, result in
a change in control of the Company. ITT has stated in the Solicitation/
Recommendation Statement on Schedule 14D-9 filed by ITT with the Securities and
Exchange Commission (the "ITT 14D-9") in response to Hilton's offer that it is
actively exploring opportunities to enhance the value of ITT. As part of this
process, ITT has disclosed in the ITT 14D-9 that it "is taking steps to monetize
or otherwise realize the value of non-core assets." ITT has disclosed that as a
result, it is exploring possible transactions to dispose of some or all of the
Common Stock of the Company held by ITT. There can be no assurance that ITT will
maintain its ownership interest in the Company. Any acquisition of control of
ITT or disposition of Common Stock by ITT that results in a change in control of
the Company may have material adverse consequences for the Company. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
Under agreements with the Company, ITT provides certain administrative,
financial, treasury, accounting, tax and other services to the Company and makes
available certain of its employee benefit plans to the Company's employees. In
addition, ITT and the Company have entered into a number of intercompany
agreements covering matters such as corporate governance, tax sharing
arrangements, the use of the "ITT" name and registration rights. See "Item 12.
Security Ownership of Certain Beneficial Owners and Management" and "Item 13.
Certain Relationships and Related Transactions."
The Company is a Delaware corporation incorporated in 1946. Old ITT
acquired a predecessor of the Company in 1966, and the Company changed its name
to ITT Educational Services, Inc. in 1969. The principal executive offices of
the Company are located at 5975 Castle Creek Parkway, N. Drive, Indianapolis,
Indiana 46250, and its telephone number is (317) 594-9499.
Overview
The Company is a leading proprietary provider of technical postsecondary
degree programs in the United States based on student enrollment. The Company
offers associate, bachelor and master degree programs where authorized and, to a
lesser extent, non-degree diploma programs to over 22,500 students through a
system of 59 ITT Technical Institutes located in 26 states. The undergraduate
programs are designed, after consultation with
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employers, to provide students with the knowledge and skills necessary for
entry-level employment in technical positions in a variety of industries. As of
December 31, 1996, approximately 95% of ITT Technical Institute students were
enrolled in a degree program. Approximately 72% of ITT Technical Institute
students were enrolled in electronics engineering technology ("EET") and related
programs and 24% were enrolled in computer-aided drafting technology ("CAD") and
related programs. Employers of ITT Technical Institute graduates include both
well recognized corporations and small, technology oriented companies.
Old ITT entered the education services business in 1966 through the
acquisition of a predecessor of the Company which owned three technical
institutes. In 1981, the Company began a strategy of significant expansion,
acquiring three and establishing 44 new technical institutes since that date. Of
the 59 institutes currently operating, 18 were established since January 1,
1992. As a result of adding new institutes and increasing enrollment at existing
institutes, the number of students attending ITT Technical Institutes rose 30.9%
from 17,284 students at December 31, 1991 to 22,633 students at December 31,
1996. Revenue from the ITT Technical Institutes has increased 73.1% from $134.2
million (excluding discontinued operations) in 1991 to $232.3 million in 1996.
In fiscal year 1996, the Company obtained state approval to operate one new
technical institute and introduced a new bachelor's degree program in
telecommunications engineering technology. The Company intends to continue
expanding by opening new technical institutes and offering a broader range of
programs at its institutes.
The Company expects the demand for postsecondary education to increase over
the next several years as a result of certain demographic, economic and social
trends. These trends include a projected 24% growth in the number of new high
school graduates from approximately 2.5 million in 1994 to approximately 3.1
million in 2004 (according to government estimates), the fact that only
approximately 27% of adults over age 18 in 1994 possessed a college degree
(according to government statistics), the decline in military service
opportunities and a heightened public recognition of the importance of a
postsecondary education to an individual's career prospects.
The Company believes that it is well positioned relative to other education
providers to take advantage of an expected increase in demand for postsecondary
education for the following reasons:
Employment Oriented Education. The Company expects that an uncertain
employment market for recent high school and college graduates and a
perceived shortage of job applicants who are well-prepared for existing
entry-level positions will lead to an increased emphasis by students on
education that is more directly related to the specific technical knowledge
and skills required by many employers. Unlike many two- and four-year
colleges, the ITT Technical Institutes offer undergraduates curricula that
are focused on providing the technical knowledge and skills desired by many
employers for entry-level positions. Each undergraduate curriculum offered
by ITT Technical Institutes has been designed, after consultation with
employers, for entry-level employment in a variety of careers related to a
graduate's field of study. Curricula are updated periodically to reflect
industry changes. The Company believes that the strength of its programs
and the graduate placement assistance it offers are reflected in its
graduate placement rates. Based on information provided by graduates and
employers, approximately 87% of the ITT Technical Institutes' 1995
placeable graduates had obtained employment related to their field of study
or were already employed in a position related to their field of study as
of April 30, 1996, the most recently completed placement year.
Programs Designed for the Convenience of Students. ITT Technical
Institutes are distinguished by the flexibility they generally permit a
student in scheduling classes. Each institute operates year-round.
Undergraduate programs are offered on a quarterly basis, with four twelve-
week quarters during a year. New students may generally begin an
undergraduate program in March, June, September or December. Classes are
typically offered in four-hour sessions five days a week in the morning,
afternoon and evening. This scheduling flexibility helps students maintain
part-time jobs and enables bachelor degree students to complete their
degree and enter the workforce full-time in as few as three years. Programs
of study are generally standardized among the technical institutes,
permitting students to transfer from one ITT Technical Institute to another
offering the same or similar program.
The master of project management ("MPM") program, currently the
Company's only graduate degree program of study, is offered on a non-term
basis pursuant to which one- to six-week courses are taken sequentially one
at a time. Students may generally begin the MPM program once a sufficient
number of applicants necessary to begin a new class have assembled. Classes
are typically offered in four-hour sessions one night a week, which
generally accommodates students working full-time jobs. Although the MPM
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program is presently offered by only one technical institute in Indiana,
the program is offered by this institute at various sites throughout
Indiana.
Financial Stability. The Company believes that as an established and
financially stable proprietary provider of postsecondary education, it will
be better able to assess and comply with the comprehensive and evolving
federal, state and accreditation standards for the regulation of
educational institutions and student financial aid programs than many other
proprietary providers of postsecondary education.
Strategy
The Company has instituted a business plan for accelerated expansion into
the next decade in response to an expected increase in demand for postsecondary
education. The plan's goals are to increase the number of students at ITT
Technical Institutes and enhance operating efficiencies throughout the ITT
Technical Institute system. Principal elements of this plan include the
following:
Establish New ITT Technical Institutes. The Company plans to add new
technical institutes at sites throughout much of the United States. These
sites are selected primarily on the basis of local demographics with
particular emphasis on the current and projected young adult population and
the concentration of technology oriented employers. Other factors
considered include the level of competition, availability of media
information channels and state regulatory requirements. Once target areas
have been identified, the Company uses specific site selection criteria
based on its experience. The Company opened one new technical institute in
1996, at an anticipated cost of $1.6 million inclusive of capital
expenditures and first year operating losses. Additional institutes are
planned for 1997 and future years. The Company has entered into facility
leases for three of the four new ITT Technical Institutes that the Company
intends to open in 1997. The Company also regularly investigates
opportunities to acquire postsecondary institutions and related businesses,
although no such acquisition is currently planned.
Broaden Availability of Current Program Offerings. The Company seeks
to appeal to a larger population of students by offering multiple programs
of study with the objective of offering a minimum of three separate
programs at each ITT Technical Institute. Currently, most ITT Technical
Institutes offer one or two programs of study while only 28 offer three or
more programs. In 1997, the Company intends to add aproximately 12 current
program offerings at existing ITT Technical Institutes. Additionally, only
25 of the Company's institutes currently offer a bachelor degree program
and only one ITT Technical Institute currently offers a master degree
program. Management believes that the introduction of higher level programs
at other ITT Technical Institutes will attract more students and increase
the number of students continuing their studies beyond the associate degree
level at ITT Technical Institutes.
Develop Additional Degree Programs. The Company also plans to
introduce programs in additional fields of study and at new degree levels.
In 1996, the Company developed a telecommunications engineering technology
program to supplement the Company's current program offerings and broaden
its customer base.
Improve Student Outcomes. To attract new students and enhance student
retention, the Company seeks to improve the graduation and placement rates
of the undergraduate students at the institutes by providing extensive
academic services and dedicating significant administrative resources to
placement assistance. Academic services offered to undergraduate students
by ITT Technical Institutes include academic advising, tutoring, learning
resource centers and individualized assistance when necessary.
Undergraduate students are also instructed in resume preparation,
interviewing skills and job search techniques. Instructors are encouraged
to take a personal interest in the completion by students of their programs
of study.
Control Costs. The Company has centralized many of its administrative
functions, freeing the staff at ITT Technical Institutes to devote its
attention principally to student services. The Company believes that this
centralization has contributed significantly to operating efficiencies and
has positioned the Company to control overhead costs effectively.
Centralized administrative services include: accounting, marketing, public
relations, curricula development, purchasing, human resources, regulatory
and legislative affairs and real estate. Operational uniformity among the
Company's 59 institutes is maintained through the use of documented
policies and procedures for each functional department within each
technical institute. Management assistance and oversight is provided
through the use of district managers who typically manage six to nine
technical institutes and report to the corporate headquarters. In addition,
the Company plans to continue enhancing
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operating efficiencies through the increased use of computers and automated
systems. Measures that have been implemented by the Company include the use
of electronic transfer systems for the timely submission of financial aid
applications and receipt of certain federal student financial aid funds,
the automation of student accounts for tuition, fees and bookstore charges,
and an electronic mail system between the ITT Technical Institutes and the
Company's corporate headquarters. The Company is evaluating enhancements to
its management information systems, a project which will not be implemented
until 1998. The Company intends to continue seeking other means to increase
administrative efficiency and control operating costs.
Programs of Study
The Company offers 15 degree programs and several diploma programs in
various fields of study. All ITT Technical Institutes offer a degree or diploma
program in electronics engineering technology ("EET") and 54 ITT Technical
Institutes offer a degree or diploma program in computer-aided drafting
technology ("CAD"). Together the EET and CAD programs comprise the core of the
ITT Technical Institutes' program offerings. The table below sets forth
information regarding the main programs of study offered by the Company.
Programs of Study Offered at ITT Technical Institutes
Number of Technical Institutes Number of Students Enrolled
Offering at December 31, 1996 at December 31, 1996
---------------------------------------- ----------------------------------------
Master Bachelor Associate Master Bachelor Associate
Program Title Degree Degree Degree Diploma Degree Degree Degree Diploma Total
- ------------- ------ ------- --------- ------- ------ -------- --------- ------- ------
Project Management 1 -- -- -- 123 -- -- -- 123
Electronics Engineering
Technology -- 18 57 2 -- 836 14,640 543 16,019
Computer-Aided Drafting
Technology -- -- 50 4 -- -- 4,490 405 4,895
Automated Manufacturing
Technology (1) -- 5 -- -- -- 345 -- -- 345
Hospitality Management -- 1 1 -- -- 15 141 -- 156
Tool Engineering
Technology (2) -- -- 3 -- -- -- 213 -- 213
Architectural Engineering
Technology (2) -- -- 3 -- -- -- 225 -- 225
Industrial Design (2) -- 3 -- -- -- 111 -- -- 111
Computer Visualization
Technology (2) -- 2 -- -- -- 41 -- -- 41
Chemical Technology -- -- 2 -- -- -- 34 -- 34
Telecommunications
Engineering Technology (1) -- 2 -- -- -- 12 -- -- 12
Other Programs of Study (3) -- -- 168 291 459
--- ----- ------ ----- ------
Total 123 1,360 19,911 1,239 22,633
_______________
(1) EET related program.
(2) CAD related program.
(3) Other programs consist of Business Management Accounting, Automotive Service
Technology, Heating/Air Conditioning/Refrigeration and Legal/Medical
Secretarial.
Students enrolled in EET and CAD related programs represent approximately
72% and 24%, respectively, of the ITT Technical Institute student population as
of December 31, 1996. The Company's EET programs are designed to help graduates
prepare to perform effectively in a variety of entry-level positions by
providing students a practical education with specific electronic circuits and
specialized techniques and, in the case of the bachelor degree programs,
offering a solid foundation in applied mathematics and study and practice in
computer programming. Graduates of the programs have obtained employment in the
fields of radio and television broadcasting, communications, computer
technology, industrial electronics, instrumentation, telecommunications, medical
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electronics, consumer electronics, marine electronics, aviation electronics,
ultrasonics technology and traffic control electronics. The Company's CAD
program is designed to help graduates prepare to work in entry-level positions
in various technical drafting fields through the teaching of computer-aided
drafting techniques as well as conventional drafting methods. Graduates have
obtained entry-level positions in fields such as computer-aided drafting,
electrical and electronics drafting, mechanical drafting, architectural and
construction drafting, civil drafting, interior design and landscape
architecture. The academic schedule of undergraduate programs at the ITT
Technical Institutes is generally organized on the basis of four twelve-week
quarters of instruction with new students beginning at the start of each
academic quarter. Associate degree programs can be completed in eight academic
quarters or less, and bachelor degree programs can typically be completed in 12
academic quarters (including academic quarters completed as part of a related
associate degree program). Classes are typically offered in four-hour sessions
five days a week and, depending on student enrollment, sessions are generally
available in the morning, afternoon and evening. This class schedule generally
affords flexibility to students to pursue part-time employment opportunities.
Based on student surveys, the Company believes that a substantial majority of
ITT Technical Institute students work at least part-time during their programs
of study.
The academic schedule of the MPM program, currently the Company's only
graduate degree program of study, is organized on a non-term basis pursuant to
which one- to six-week courses are taken sequentially one at a time. The MPM
program can be completed in 21 months. Classes are typically offered in four-
hour sessions one night a week, which generally accommodates students working
full-time jobs. Students may generally begin the MPM program once a sufficient
number of applicants necessary to begin a new class have assembled. The MPM
program is presently offered at only one technical institute and has not yet
been in existence for a sufficient period of time to produce its first class of
graduates. As a result, there can be no assurance that the MPM program will be
successful.
ITT Technical Institute programs of study blend traditional academic
content with applied learning concepts and have the objective of better
preparing graduates for a changing economic and technological environment. A
significant portion of a typical student's day in an associate degree program at
an ITT Technical Institute involves practical study in a lab environment.
The content of technical courses in each program of study is generally
standardized among the various ITT Technical Institutes to provide uniformity
and to better enable students to transfer among the ITT Technical Institutes
offering similar programs. The curriculum in each field is reviewed periodically
to respond to changes in technology and industry needs. The ITT Technical
Institutes have established advisory committees comprised of representatives of
local employers for each field of study. These advisory committees assist the
ITT Technical Institutes in assessing and updating curricula, equipment and
laboratory design. In addition to courses directly related to a student's
program of study, degree programs may also include general education courses
such as English, economics, history, literature, psychology and public speaking.
Tuition for a student entering an undergraduate program in December 1996
and completing three consecutive academic quarters, the equivalent of an
academic year at traditional two- and four-year colleges, is $6,787 for the EET
program and $8,057 for the CAD program. A student's tuition cost for a program
of study is set at the time of a student's initial enrollment in the program,
provided the student remains continually enrolled in the program and does not
repeat any courses. The majority of students attending an ITT Technical
Institute lived in such technical institute's metropolitan area prior to
enrollment. The Company does not provide any student housing.
Student Recruitment
The Company seeks to attract students with the motivation and ability to
complete the career-oriented educational programs offered by the ITT Technical
Institutes. To generate interest among potential students, the Company engages
in a broad range of activities to inform potential students and their parents
about the ITT Technical Institutes and the programs offered. These activities
include television and other media advertising, direct mailings and high school
visits.
The Company's television advertising is centrally coordinated and
developed. Television advertising is directed primarily, however, at local
markets in which ITT Technical Institutes are located. The Company's television
commercials generally include a toll free telephone number for direct responses
and information about the
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location of ITT Technical Institutes in the area. Direct responses to television
advertising are centrally received, tracked and promptly forwarded to the
appropriate ITT Technical Institute representatives. Responses to direct mail
campaigns, which are targeted at high school students and other potential
postsecondary students, are also centrally received, tracked and forwarded to
the appropriate ITT Technical Institute representatives.
The Company employs a director of recruitment at each technical institute,
who reports to the director of such institute and to a district director of
recruitment. Recruiting policies and procedures, as well as standards for hiring
and training representatives, are established centrally, but are implemented at
the local level. The Company employs approximately 75 high school coordinators
who make approximately 15,000 presentations to students at high schools
annually. These coordinators promote ITT Technical Institutes and obtain
information about high school seniors who may be interested in attending the ITT
Technical Institutes. To assist in local recruiting efforts, the Company employs
approximately 425 other representatives. Approximately 185 recruiting
representatives perform their services solely in student recruitment offices
located at each technical institute, while approximately 240 representatives
work outside these offices and visit the homes of high school seniors and other
prospective students.
Local representatives of an ITT Technical Institute pursue expressions of
interest from potential undergraduate students by contacting prospective
students and arranging for interviews either at such institute or at prospective
students' homes. The interview is designed to establish a prospective student's
qualifications, academic background, interests and goals for the future.
Prospective undergraduate students are generally shown a video providing
information about the ITT Technical Institutes and the programs of study
offered. Expressions of interest from potential graduate students are pursued by
contacting these prospective students and arranging for their attendance at an
informational seminar providing information about the institution and the MPM
program.
The Company monitors the effectiveness of its various marketing efforts and
seeks to determine the extent to which each of its marketing efforts results in
student enrollments. The Company estimates that in 1996 television advertising
produced 37% of student enrollments at ITT Technical Institutes, high school
coordinators accounted for 14%, referrals accounted for 14%, direct mail
campaigns accounted for 14%, associate degree graduates enrolling in a bachelor
degree program accounted for 6% and the remaining 15% were classified as
miscellaneous.
Student recruitment activities are subject to substantial regulation at
both the state and federal level. Most states have bonding and licensing
requirements that apply to many of the Company's representatives. The
implementation of recruitment policies and procedures is overseen by the
district directors of recruitment. In addition, the Company's internal audit
department generally reviews the recruiting practices relating to the execution
and completion of enrollment agreements at each ITT Technical Institute on an
annual basis.
Student Admissions and Retention
The Company seeks to ensure that incoming students have the necessary
academic background to complete their chosen programs of study. All applicants
for admission to any of the ITT Technical Institutes' associate degree or
diploma programs are required to have a high school diploma or a recognized
equivalent and also must pass an admissions examination. Students interested in
bachelor degree programs or the MPM program must satisfy additional admissions
criteria which generally require, among other things, that for: (a) bachelor
degree programs the student first earn an associate degree or complete an
equivalent level program in the same or related subject matter; and (b) the MPM
program the student first earn a bachelor degree and possess at least three
years full-time work experience. ITT Technical Institute students are of varying
ages and backgrounds. At December 31, 1996, 93% of the students were high school
graduates and the remaining 7% possessed the recognized equivalent of a high
school diploma. In addition, 34% of the students had some postsecondary
educational experience prior to entering an ITT Technical Institute for the
first time. Approximately 38% of the students were 19 years of age or younger,
33% were between 20 and 24 years of age, 17% were between 25 and 30 years of age
and 12% were age 31 or over. Male students accounted for 88% of total enrollment
as of December 31, 1996, while total minority enrollment at the ITT Technical
Institutes (based on applicable federal classifications) was 38%.
ITT Technical Institute faculty and staff strive to help students overcome
obstacles to the completion of their programs of study. As is the case in other
postsecondary institutions, however, students often fail to complete their
programs for a variety of personal, financial or academic reasons. Student
withdrawals prior to program completion not only affect the student, but also
have a negative regulatory, financial and marketing effect on the institution.
To minimize student withdrawals, each ITT Technical Institute devotes staff
resources to assist and advise students
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regarding academic and financial matters. Tutoring and one-on-one extra help is
encouraged in the case of undergraduate students experiencing academic
difficulties. Assistance and advice is also offered to undergraduate students
looking for part-time employment and housing. In addition, factors relating to
student retention are considered in the performance evaluation of every
instructor.
The average withdrawal rate of ITT Technical Institutes for the three
academic quarters from April 1996 through December 1996, as calculated under the
current federal regulations, was approximately 17%. Students are most likely to
withdraw before they begin their second academic quarter of study at an ITT
Technical Institute. As a result, new technical institutes generally have higher
withdrawal rates than institutes which have been open for five or more years.
Approximately 70% of all students who continue their education past their first
academic quarter complete their education at an ITT Technical Institute.
Graduate Placement
ITT Technical Institutes have graduated over 115,000 students since 1976.
The Company believes that the successful placement of graduates from
undergraduate programs into occupations related to their field of study is
critical to the ability of the ITT Technical Institutes to continue to recruit
undergraduate students. The Company seeks to obtain data on the number of
undergraduate students employed following graduation and has implemented a
program to monitor these students' career progression. The reliability of such
data is largely dependent on information that students and employers report to
the Company. Based on information from students and employers, the Company
believes that students graduating from ITT Technical Institute undergraduate
programs during the prior five years obtained employment in a field related to
their program of study or were already employed in a position related to their
program of study as of June 30 or earlier of the year following graduation, as
set forth below:
Graduate Employment Statistics
Percent of Placeable Graduates
Who Obtained Employment
Number of Related to Program of Study or
Placeable Were Already Employed in a
Graduating Classes Graduates(1) Related Position
- ------------------ ------------ ------------------------------
1995 8,005 87%
1994 7,459 85%
1993 7,015 83%
1992 6,878 80%
1991 6,607 77%
___________________
(1) Placeable graduates exclude graduates who continue in a bachelor degree
program at an ITT Technical Institute.
Each ITT Technical Institute employs placement personnel to provide
placement assistance services to students and graduates of undergraduate
programs, and to solicit appropriate employment opportunities from employers.
In addition, undergraduate students receive instruction during their program of
study on such job-search skills as the identification of potential employment
opportunities, the use of relevant reference materials, the composition of
resumes and letters of introduction and the appropriate preparation, appearance
and conduct for interviews. No placement assistance is offered to students in
the graduate program of study.
Based on information from students and employers who responded to inquiries
from the Company, the Company estimates that average annual starting salaries
reported for 1995 graduates of certain programs offered by the ITT Technical
Institutes who obtained employment, or who were already employed, in fields
related to their education were as follows:
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Average Starting Salaries
Number of Average Annual
Placeable Starting
Program Graduates Salary
- ------- --------- -------------
Automated Manufacturing Technology (Bachelor Degree) 348 $24,360
Electronics Engineering Technology (Bachelor Degree) 615 $22,704
Computer-Aided Drafting Technology, Tool Engineering Technology and
Architectural Engineering Technology (Associate Degree and Diploma) 1,984 $19,128
Electronics Engineering Technology (Associate Degree and Diploma) 4,123 $19,872
Average annual starting salaries for ITT Technical Institute graduates may
vary significantly among ITT Technical Institutes depending on local employment
conditions. Employers of graduates from ITT Technical Institute undergraduate
programs include both well recognized corporations and small, technology
oriented companies. Small, technology oriented companies are hiring an
increasing proportion of these graduates. Accordingly, placement personnel are
establishing relationships with smaller firms for which greater placement
efforts are generally required.
Regulation of Federal Financial Aid Programs
A substantial majority of the Company's revenue is indirectly derived from
federal financial aid programs under Title IV ("Title IV Programs") of the
Higher Education Act of 1965, as amended ("HEA"), although ITT Technical
Institute students also rely on state financial aid programs, family
contributions, personal savings, employment and other resources. Among the 59
ITT Technical Institutes, 58 currently participate in Title IV Programs. The
remaining ITT Technical Institute, a recently opened school, has begun the
certification process to become eligible to participate in Title IV Programs. In
order to participate in Title IV Programs, an institution must comply with
complex standards set forth in the HEA and the regulations promulgated
thereunder by the U.S. Department of Education. Among other things, the
standards require an institution to obtain certification by the U.S. Department
of Education as an "eligible institution" that has been authorized by the
relevant state agency and accredited by a recognized accrediting commission.
Proprietary providers of postsecondary education have come under increased
scrutiny and regulation by the U.S. Congress and the U.S. Department of
Education as a result of concern about fraud and abuse of federal financial aid
programs by certain proprietary institutions. The HEA and its implementing
regulations are designed to limit institutional dependence on Title IV Program
funds, prevent institutions with unacceptable student loan default rates from
participating in Title IV Programs and, in general, require institutions to
satisfy certain criteria related to educational value, administrative capability
and financial responsibility. The Company believes that its schools are in
substantial compliance with the HEA and its implementing regulations. However,
the Company cannot predict with certainty how all of the HEA provisions and the
implementing regulations will be applied. As described below, the violation of
federal requirements governing Title IV Programs by the Company or any ITT
Technical Institute could have a material adverse effect on the Company. In
addition, it is possible that the HEA and its implementing regulations may be
applied in a way that could hinder the Company's expansion plans. Under the HEA
and its implementing regulations, the Company must comply, primarily on an
institution by institution basis, with applicable standards. For purposes of
these standards, an institution is defined as a main campus and its additional
locations or branch campuses, if any (hereinafter "campus group" in singular or
plural form). Of the 59 ITT Technical Institutes, 31 are considered to be main
campuses and 28 are considered to be additional locations.
Significant factors relating to Title IV Programs that could adversely
affect the Company include the following:
HEA Reauthorization. The next reauthorization of the HEA by the U.S.
Congress is scheduled to begin in 1997. There can be no assurance that
government funding for Title IV Programs will continue to be available or
maintained at current levels or that proprietary providers of postsecondary
education, like the Company's schools, will be able to continue
participating in Title IV Programs at current levels or at all. A reduction
in government funding levels of, or a limitation of the Company's
participation in, Title IV Programs could result in lower enrollments and
require the Company to arrange for alternative sources of financial aid for
its students. Considering the significant percentage of the Company's
revenues that are indirectly
-8-
derived from Title IV Programs, any significant reduction or ability to
participate in Title IV Programs could have a material adverse effect on
the Company.
The "85/15 Rule." This regulation, commonly referred to as the "85/15
Rule," applies only to proprietary institutions such as the ITT Technical
Institutes. Under this rule, a proprietary institution will be ineligible
to participate in Title IV Programs if, under a cash basis of accounting,
more than 85% of the institution's applicable revenue for a fiscal year is
derived from Title IV Programs. Any institution that violates the 85/15
Rule will become ineligible to participate in Title IV Programs on January
1st of the following calendar year and will be unable to apply to regain
its eligibility until the next calendar year. Furthermore, if an ITT
Technical Institute violates the 85/15 Rule and becomes ineligible to
participate in Title IV Programs as of a specific date, but continues to
disburse Title IV Program funds after that date until the determination of
eligibility is made, the U.S. Department of Education will consider all
Title IV Program funds disbursed after the effective date of ineligibility
to be a liability subject to repayment by the institution.
To assist the Company in ensuring that no ITT Technical Institute
loses its eligibility to participate in Title IV Programs under the 85/15
Rule, the Company arranged for an unaffiliated, private funding source
("PFS") to provide loans to the students of certain ITT Technical
Institutes. This alternative source of student financial aid requires the
Company to guarantee repayment of the PFS loans. No PFS loans were made to
students during the Company's 1996 fiscal year, as none of the ITT
Technical Institute campus groups were in jeopardy of violating the 85/15
Rule for that fiscal year. The Company's independent, certified public
accounting firm attested to each ITT Technical Institute campus group's
compliance with the 85/15 Rule for the years ended December 31, 1996 and
December 31, 1995.
The Company believes that as a result of the expansion and increased
availability of certain Title IV Programs resulting from the 1992
reauthorization of the HEA, students have increasingly relied, and probably
will continue to rely, on Title IV Programs to finance their education,
thereby raising the percentage of ITT Technical Institute revenue derived
from Title IV Programs. In an effort to prevent any future loss of Title IV
Program eligibility by any ITT Technical Institute as a result of violating
the 85/15 Rule, the Company has implemented various measures to reduce the
percentage of applicable revenue derived from Title IV Programs. The
Company is also considering whether to continue offering students in
selected ITT Technical Institutes the PFS program on a limited basis as an
alternative source of student financial aid and whether to offer more
scholarships. Both of these alternatives will require the Company to incur
costs not associated with Title IV Programs. There can be no assurance that
the PFS will continue to offer its student loan program, that the Company
will be able to develop other alternative sources of funding for students
in the event the PFS does not continue such funding, or that the additional
costs of obtaining, guaranteeing or offering such funding will not have an
adverse effect on the Company.
Student Loan Defaults. Under the HEA, an educational institution may
lose its eligibility to participate in some or all Title IV Programs if
student defaults on federal student loans exceed certain rates. These rates
are based on the historical cohort default rate of current and former
students on loans provided under certain Title IV Programs, and are
calculated on an institutional basis, defined as a main campus and all of
its additional locations or branch campuses. The cohort default rate of an
institution is calculated on the basis of the number of students who have
defaulted and not the dollar amount of such defaults. Under the Federal
Family Education Loan ("FFEL") programs, an institution whose cohort
default rate on loans made under the Federal Stafford Loan ("Stafford") and
Federal Supplemental Loans for Students ("SLS") programs is 25% or greater
for three consecutive years will no longer be eligible to participate in
any of the FFEL programs (including the Federal PLUS ("PLUS") program) or
the Federal Direct Student Loan ("FDSL") program for the remainder of the
federal fiscal year in which the U.S. Department of Education determines
that the institution has lost its eligibility and for the two subsequent
federal fiscal years, unless it successfully challenges such
disqualification under procedures provided by the HEA and its implementing
regulations. During the pendency of any such appeal, the institution
retains its eligibility to participate in the applicable loan programs. An
institution whose official FFEL cohort default rate for the 1993 federal
fiscal year or any subsequent federal fiscal year exceeds 40% may have its
eligibility to participate in all Title IV Programs limited, suspended or
terminated. In addition, an FFEL cohort default rate of 25% or higher in
any one of the three most recent federal fiscal years, or a cohort default
rate exceeding 15% on loans under the Federal Perkins Loan ("Perkins")
program for any federal award year (i.e., July 1 through June 30), is cause
for the U.S. Department of Education to place an institution on provisional
certification. See "Administrative Capability" and "Eligibility and
Certification Procedures."
-9-
No ITT Technical Institute campus group has an FFEL cohort default
rate equal to or greater than 25% for the 1991 or 1992 federal fiscal
years. Three ITT Technical Institute campus groups, consisting of three
institutes located in Houston (West), Garland and San Antonio, Texas and
accounting for approximately 7% of the Company's revenues in the Company's
1996 fiscal year, have an official FFEL cohort default rate of: (a) 27.4%,
27.4% and 25.0%, respectively, for the 1993 federal fiscal year; and (b)
25.8%, 39.1% and 25.6%, respectively, for the 1994 federal fiscal year (the
latest year for which official rates are available). All of the other ITT
Technical Institute campus groups have official 1993 and 1994 FFEL cohort
default rates below 25%. The official 1993 FFEL cohort default rates for
the remaining 28 ITT Technical Institute campus groups range from a high of
23.4% to a low of 11.8%. The official 1994 FFEL cohort default rates for
the remaining 28 ITT Technical Institute campus groups range from a high of
19.9% to a low of 11.0%. The ITT Technical Institutes in Houston (West),
Garland and San Antonio, Texas have identified corrections to their
official 1993 and 1994 FFEL cohort default rates based on (I) improper loan
servicing and/or collection of certain student loans included in the
calculation of such rates and (II) erroneous data used to calculate such
rates. Each of these ITT Technical Institutes has submitted the appropriate
appeals and requests for adjustment, respectively, to the U.S. Department
of Education to make these corrections and revise downward the institute's
official 1993 and 1994 FFEL cohort default rates accordingly. The U.S.
Department of Education has since denied each of the Garland, Houston
(West) and San Antonio ITT Technical Institute's appeal of its official
1993 FFEL cohort default rate, and there can be no assurance that any of
these institutes will be successful in any of its remaining appeals or
requests for adjustment to the U.S. Department of Education regarding its
official 1993 and 1994 FFEL cohort default rates, or that even if such
institute is successful in these efforts that its official 1993 or 1994
FFEL cohort default rate will recalculate to less than 25%. If the Company
cannot successfully cause the official 1993 or 1994 FFEL cohort default
rate for each of the Houston (West), Garland and San Antonio, Texas ITT
Technical Institutes to be reduced to less than 25% and any such institute
has an official 1995 FFEL cohort default rate equal to or exceeding 25%,
such institute will be notified by the U.S. Department of Education that it
is ineligible to participate in the FFEL and FDSL programs. The institute
can challenge its loss of eligibility through an administrative review
process within the U.S. Department of Education (as referenced above) and
continue to participate in the FFEL programs during this process. If the
institute's challenge is unsuccessful, the institute will be ineligible to
participate in the FFEL and FDSL programs for the remainder of that federal
fiscal year and for the two subsequent federal fiscal years. Loss of
eligibility to participate in the FFEL and FDSL programs by either the
Houston (West), Garland or San Antonio, Texas ITT Technical Institutes
could have a material adverse effect on the Company's financial condition.
In a further attempt to prevent both the Houston (West) and Garland,
Texas ITT Technical Institutes from losing their eligibility to participate
in the FFEL and FDSL loan programs in the event each of their official
1993, 1994 and 1995 FFEL cohort default rates equals or exceeds 25%, the
Company is in the process of converting both of these institutes from main
campuses to additional locations of other main campuses. Based on the
Company's interpretation of the applicable federal regulations and
discussions with the U.S. Department of Education, the Company believes
that if it can complete the conversion of the Houston (West) and Garland,
Texas ITT Technical Institutes from main campuses to additional locations
of other main campuses before the official 1995 FFEL cohort default rates
are issued by the U.S. Department of Education, neither of these two
institutes will have their own 1995 FFEL cohort default rates. Rather, the
1995 FFEL cohort default rates for the Houston (West) and Garland, Texas
ITT Technical Institutes will be blended into the calculation of the 1995
FFEL cohort default rate of the ITT Technical Institute campus group to
which each of these institutes becomes an additional location. Converting
an ITT Technical Institute that is a main campus into an additional
location of another ITT Technical institute campus group requires approval
of the ITT Technical Institute's accrediting commission and the U.S.
Department of Education. There can be no assurance that the Company can
obtain the requisite accrediting commission and U.S. Department of
Education approvals to convert the Houston (West) and Garland, Texas ITT
Technical Institutes to additional locations of other ITT Technical
Institute campus groups or that the Company can obtain such approvals
before the official 1995 FFEL cohort default rates are issued. If the
Company cannot obtain the requisite approvals for the conversion of these
institutes to additional locations before the official 1995 FFEL cohort
default rates are issued, and either institute has official 1993, 1994 and
1995 FFEL cohort default rates equal to or exceeding 25%, such institute
will be notified by the U.S. Department of Education that it is ineligible
to participate in the FFEL and FDSL programs. As discussed above, the
institute can challenge its loss of eligibility through an administrative
review process within the U.S. Department of Education and continue to
participate in the FFEL programs during this process. If the institute's
challenge is unsuccessful, the institute will be ineligible
-10-
to participate in the FFEL and FDSL programs for the remainder of that
federal fiscal year and for the two subsequent federal fiscal years.
Twenty-eight ITT Technical Institute campus groups (consisting of 55
institutes) had a 1995/1996 federal award year cohort default rate for
Perkins loans that is greater than 15%. The HEA requires institutions with
a Perkins cohort default rate of 15% or greater to establish default
reduction plans. Each ITT Technical Institute has developed a student loan
default management plan. As a result, the Company does not believe that its
financial condition will be materially affected by any required
implementation of a default reduction plan as specified under federal
regulations. Twenty-two ITT Technical Institute campus groups (consisting
of 41 institutes) had a 1995/1996 federal award year cohort default rate
for Perkins loans that is 20% or greater. The HEA subjects institutions
with a Perkins cohort default rate of 20% or greater to a "default
penalty," which reduces the amount of additional funds allocated annually
to the institution for use in the Perkins program by: (a) 10% if the rate
is 20%, but less than 25%; (b) 30% if the rate is 25%, but less than 30%;
or (c) 100% if the rate is 30% or greater. The amount of Perkins loans
disbursed to ITT Technical Institute students has diminished significantly
over the past few years (amounting to less than 1% of the Company's revenue
in 1996) and less than half of the ITT Technical Institutes disburse their
entire annual allocation. As a result, the Company does not believe that
its financial condition will be materially affected by any reduction of
additional funds allocated to the ITT Technical Institute campus groups for
use in the Perkins program.
According to the U.S. Department of Education, a cohort default rate
for loans made under the FDSL program will be calculated for the first time
for schools participating in the FDSL program for the 1995 federal fiscal
year. Three ITT Technical Institutes participated in the FDSL program in
federal fiscal year 1995.
A substantial factor in controlling default rates is the servicing and
collection efforts of student loan lenders and guaranty agencies, which are
independent of the Company. The Company supplements such efforts by
attempting to contact students delinquent in making payments to advise them
of their responsibilities and any deferments or forbearance for which they
may qualify. The Company has also contracted with third party servicers to
provide additional assistance in this area with respect to delinquent
students who attended certain ITT Technical Institutes. In 1996, the
Company utilized a third party servicer to perform the servicing and
collection activities on Perkins loans.
Additional Locations. The HEA requires proprietary educational
institutions, such as the ITT Technical Institutes, to be in full operation
for two years before the institution can qualify to participate in Title IV
Programs. However, the HEA and applicable regulations permit an institution
that is already certified to participate in Title IV Programs to establish
additional locations that may, after review by the U.S. Department of
Education, begin to participate in Title IV Programs without satisfying the
two-year requirement so long as each such additional location satisfies all
other applicable requirements for institutional eligibility. The Company's
expansion plans assume its continued ability to establish new ITT Technical
Institutes as additional locations of existing ITT Technical Institute main
campuses to avoid the two-year delay prior to participation in Title IV
Programs. Applicable accrediting standards generally permit additional
locations if (I) the main campus has not received a show cause order, (II)
the main campus has not been placed on reporting, or, if on reporting, has
been expressly permitted by the accrediting commission to establish an
additional location, (III) the main campus has not applied for
accreditation for an additional location within the past two years and (IV)
more than one year has passed following a change of ownership or control of
the main campus. None of the ITT Technical Institutes is subject to a show
cause order (which obligates an institution to prove to the accrediting
commission that a negative or conditioning action against the institution's
accreditation should not be taken by the accrediting commission), although
23 of the ITT Technical Institutes are currently on reporting with their
accrediting commissions. An accrediting commission may place an institution
on reporting in order to monitor areas such as the institution's financial
condition, timely and proper payment of student refunds, graduation rates
and placement rates. An institution placed on reporting is required to
periodically report the institution's results in such areas to the
accrediting commission. Although accrediting standards may in certain
instances limit the ability of the Company to establish additional
locations, the Company does not believe, based on its current understanding
of how the standards will be applied, that these standards will have a
material adverse effect on the Company or its expansion plans.
Financial Standards and Requirements. The HEA and its implementing
regulations prescribe specific and detailed financial responsibility
standards that an institution must satisfy to participate in Title IV
-11-
Programs. Among the most significant of the financial responsibility
standards is a requirement that proprietary institutions maintain an acid
test ratio (defined as the ratio of cash, cash equivalents and current
accounts receivable to current liabilities) of at least 1 to 1 at the end
of the institution's most recent fiscal year. Another significant standard
of financial responsibility requires institutions to post a letter of
credit in an amount equal to at least 25% of the total dollar amount of
refunds paid by the institution in its most recent fiscal year, if the
institution either does not meet all the other standards of financial
responsibility or has not paid refunds timely for its two most recent
fiscal years. Other significant financial responsibility standards are that
the institution must have had a positive tangible net worth for its latest
fiscal year, and that it did not have operating losses in either or both of
its latest two fiscal years that together resulted in a decrease in its
tangible net worth of more than 10% from the beginning of such two-year
period. If any of these numeric standards are not satisfied, then the
Company could be required to post a surety to establish compliance with the
financial responsibility standards. Historically, the U.S. Department of
Education has evaluated the financial condition of the ITT Technical
Institutes on a consolidated basis. The regulations allow the U.S.
Department of Education to consider both consolidated and individual ITT
Technical Institute campus group financial statements. At December 31,
1996, the Company reported an acid test ratio of 1.61 to 1. In addition,
the Company believes it has met all the other standards of financial
responsibility.
The U.S. Department of Education has issued proposed regulations
detailing new standards of financial responsibility that an institution
must satisfy to participate in Title IV Programs. These new financial
responsibility standards will not become effective before July 1, 1998. It
is also possible that the final regulations may differ substantially from
the proposed regulations. The proposed financial responsibility standards
change the manner by which the U.S. Department of Education evaluates an
institution's financial responsibility. The acid test ratio is replaced
with three different ratios: the viability ratio, the primary reserve ratio
and the net income ratio. The viability ratio measures the institution's
ability to liquidate debt from its expendable resources. The primary
reserve ratio measures the institution's ability to support current
operations from expendable resources. The net income ratio measures the
ability of an institution to operate at a profit. The results of each ratio
are assigned a strength factor on a scale from 1 to 5, with 1 reflecting
poor financial health and 5 reflecting exemplary financial health. An
institution's strength factors are then weighted based on each ratio's
perceived importance. The composite score of all three ratios of an
institution must equal at least 1.75. Another significant financial
responsibility standard that has been proposed by the U.S. Department of
Education affects institutions that undergo a change in ownership that
results in a change in control. Under these circumstances, the new owners
of the institution must submit to the U.S. Department of Education personal
financial guarantees or an irrevocable letter of credit in an amount equal
to at least 50% of the Title IV Program funds that the institution is
expected to receive in the year following the change in ownership. These
financial instruments must remain in place until a financial audit is
completed demonstrating that the institution attains a composite score of
at least 1.75 on its viability, primary reserve and net income ratios. The
Company does not believe, based on its current understanding of how the
proposed financial responsibility standards will be applied, that these
standards will have a material adverse effect on the Company or its
expansion plans. The U.S. Department of Education is also considering
requiring the owners of an institution to post personal financial
guarantees to the U.S. Department of Education when the institution adds an
additional location. Those personal financial guarantees would remain in
place until the institution demonstrated compliance with the proposed
financial responsibility standards. It is uncertain at this time what
effect this requirement, if adopted in any form, would have on the
Company's operations.
Administrative Capability. The HEA directs the U.S. Department of
Education to assess the administrative capability of each institution to
participate in Title IV Programs. The U.S. Department of Education has
issued regulations that require each institution to satisfy a series of
separate standards. Failure by an institution to satisfy any one of the
criteria may lead the U.S. Department of Education to determine that the
institution lacks administrative capability and, therefore, is not eligible
to continue participation in Title IV Programs, or must be placed on
provisional certification as a condition of such continued participation.
One standard that is applicable to certain programs with the stated
objective of preparing students for employment requires that the
institution show a reasonable relationship between the length of the
program and the entry-level requirements of the relevant field of
employment. Other standards provide that an institution lacks
administrative capability if its FFEL cohort default rate equals or exceeds
25% in any of the three most recent federal fiscal years, or if its cohort
default rate for Perkins loans exceeds 15% for any federal award year
(i.e., July 1 through June 30). Three ITT Technical Institute campus groups
(consisting of three institutes) have an official FFEL cohort default rate
equal to or greater than 25% for the 1993 and 1994 federal fiscal years.
Twenty-eight ITT Technical Institute campus groups (consisting of 55 ITT
Technical Institutes) have a cohort
-12-
default rate for Perkins loans in excess of 15% for the 1995/1996 federal
award year. If the U.S. Department of Education determines that an ITT
Technical Institute is not administratively capable solely because it fails
to comply with the cohort default rates specified in this regulation, such
ITT Technical Institute's certification to participate in Title IV Programs
may become provisional. To date, no ITT Technical Institute has been placed
on provisional certification due to its cohort default rates. The Company
does not believe that its financial condition will be materially affected
by any ITT Technical Institutes being provisionally certified to
participate in Title IV Programs.
An additional standard in the HEA prohibits an institution from
providing any commission, bonus or other incentive payment based directly
or indirectly on success in securing enrollments or financial aid to any
person or entity engaged in any student recruitment, admission or financial
aid awarding activity. The U.S. Department of Education has provided only
limited guidance respecting compliance with this requirement. ITT Technical
Institute employees involved in student recruitment, admissions or
financial aid receive only a salary. The Company believes that its method
of compensating these employees complies with the requirements of the HEA.
The regulations do not, however, establish clear standards for compliance,
and there can be no assurance that the U.S. Department of Education will
not find deficiencies in the present or former methods of compensation.
On November 29, 1996, the U.S. Department of Education issued final
regulations adding an administrative capability standard that becomes
effective on July 1, 1997. This new standard requires each institution to
participate in the electronic processes provided by the U.S. Department of
Education in order to be considered administratively capable. Although the
Company will probably have to adjust some of its current practices in order
for its institutes to comply fully with this new requirement, the Company
does not believe, based on its current understanding of how this additional
administrative capability standard will be applied, that its financial
condition will be materially affected by this new standard.
Role of Accrediting Commissions. The HEA specifies a series of
accreditation standards that all recognized accrediting commissions must
utilize in their review of postsecondary institutions. For example,
accrediting commissions must assess the length of each academic program and
the tuition charged by each institution in relation to the subject matters
taught and the objectives of the degrees or diplomas offered. Further,
accrediting commissions must evaluate each institution's success with
respect to student achievement, as measured by rates of program completion,
passing of state licensing examinations and job placement. In 1996, ten ITT
Technical Institutes were each reaccredited by their respective accrediting
commission, and four ITT Technical Institutes obtained their initial
accreditation.
Eligibility and Certification Procedures. Under the HEA and the
regulations promulgated thereunder, each institution is required to
periodically reapply to the U.S. Department of Education for continued
eligibility to participate in Title IV Programs. Each institution deemed to
be in compliance with the HEA and the U.S. Department of Education
requirements is certified for a period not to exceed four years, before
which time it must apply again to reestablish its eligibility. In 1996, six
ITT Technical Institute campus groups (involving 13 ITT Technical
Institutes) were required to reapply for continued eligibility to
participate in Title IV Programs. Each of these campus groups had its
eligibility recertified by the Department for a period of four years.
An institution may be placed on provisional certification for a period
not to exceed three years, if the Department finds that the institution
does not fully satisfy all the eligibility and certification standards. If
an institution successfully participates in the Title IV Programs during
its provisional certification but fails to satisfy the full certification
criteria, the Department may renew the institution's provisional
certification. An institution's provisional certification may be withdrawn
by the U.S. Department of Education without advance notice if the
Department determines that the institution is not fulfilling all applicable
requirements. Further, any institution seeking eligibility to participate
in Title IV Programs after a change of ownership resulting in a change in
control will be certified on a provisional basis for a limited period, at
which time such institution would be required to reapply for continued
eligibility. Currently, no ITT Technical Institute is provisionally
certified by the U.S. Department of Education to participate in Title IV
Programs.
The U.S. Department of Education normally requires an institution to
file an updated application for institutional eligibility and certification
when it opens an additional location that offers a full educational program
or increases its level of program offering.
-13-
Title IV Program Funds Management. The U.S. Department of Education
issued final regulations on November 29, 1996 detailing new rules and
procedures under which an institution participating in Title IV Programs
requests, maintains, disburses and otherwise manages Title IV Program
funds. These new funds management regulations are effective July 1, 1997.
One significant change in the new regulations is the requirement that all
Title IV Program funds be disbursed by the institution by payment period.
This regulation will increase the number of disbursements institutions on a
quarter system, like the ITT Technical Institutes, must make under the
federal student loan programs and, therefore, delay each institute's
receipt and disbursement of Title IV Program funds. Other significant
changes in the new regulations include enhancing the institution's notice
requirements to Title IV Program fund recipients and reducing the time
period during which an institution must return undisbursed Title IV Program
funds. The Company believes, based on its current understanding of how
these new regulations will be applied, that its cash flow will be
materially affected by these new regulations and that the Company's
administrative burden of complying with the federal regulations will
increase, but that these new regulations will not have a material adverse
effect on the Company's financial condition or results of operations. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources."
Availability of Lenders and Funding. For a variety of reasons,
including the high default rates of students attending certain proprietary
institutions, the Federal Direct Student Loan Program and the potential
assertion of claims against holders of student loans, the number of lenders
willing to make federally guaranteed student loans to students at certain
proprietary institutions has significantly declined. To date, however, the
availability of lenders has not affected the ability of ITT Technical
Institute students to obtain federally guaranteed loans. One lending
institution currently provides approximately 61% of all such loans to ITT
Technical Institute students. The Company anticipates that other lenders
would be willing to make federally guaranteed student loans to its students
if such loans were no longer available from any of its current lenders, but
there can be no assurance in this regard. If an eligible institution is
unable to identify any lenders willing to make Title IV Program loans to
the institution's students, the U.S. Department of Education has required
the establishment of lenders of last resort in every state that will make
most such loans. Using a lender of last resort may delay the Title IV
Program loans received by ITT Technical Institute students and slightly
reduce the total loan access for ITT Technical Institute students, but it
should not have a material adverse effect upon the Company. The lenders of
last resort will not provide PLUS loans, which accounted for 12% of the
Company's revenue in 1996, and are not required to provide any unsubsidized
Stafford loans, which accounted for 25% of the Company's revenue in 1996.
One student loan guaranty agency currently guarantees nearly 94% of all
Stafford and PLUS loans made to ITT Technical Institute students. The
Company believes that other guaranty agencies would be willing to guarantee
loans to ITT Technical Institute students if any of its existing guaranty
agencies ceased guaranteeing such loans or reduced the volume of loans
guaranteed. Most states have a designated guaranty agency that the Company
believes would guarantee most, if not all, Title IV Program loans made to
ITT Technical Institute students in that state. In addition, the U.S.
Department of Education's lender of last resort program provides for the
guarantee of Title IV Program loans made by lenders of last resort. Thus,
any reduction in the guaranty agencies currently guaranteeing Title IV
Program loans made to ITT Technical Institute students should not have a
material adverse effect on the Company. Neither ITT nor any of its
subsidiaries or affiliates (including the Company) makes or guarantees any
Title IV Program loans to any student attending any ITT Technical
Institute.
All government-provided student financial aid programs, including
Title IV Programs, are subject to significant political and budgetary
pressures, and there can be no assurance that government funding for the
financial aid programs in which the Company's students participate will
continue to be available or maintained at current levels. A reduction in
funding levels could result in lower enrollments and require the Company to
arrange for alternative sources of financial aid for its students. If an
ITT Technical Institute lost its eligibility to participate in Title IV
Programs, or if the amount of available federal student financial aid was
reduced, the Company would seek to arrange or provide alternative sources
of financial aid for that institution's students. There are a number of
private organizations that provide loans to students. Although the Company
believes that one or more private organizations, such as the PFS, would be
willing to provide financial assistance to students attending an ITT
Technical Institute, there is no assurance that this would be the case, and
the interest rate and other terms of such student financial aid might not
be as favorable as for Title IV Program funds. The Company would be
required to guarantee all or part of this assistance and might incur other
additional costs in connection with securing alternative sources of
financial aid. If the Company provided more direct financial assistance to
ITT Technical Institute students, it would incur additional costs and
assume increased credit risks.
-14-
Compliance with Regulatory Standards. The Company maintains an
internal audit department that reviews the compliance of ITT Technical
Institutes with Title IV Program requirements. This department has six
full-time auditors and is headed by a former supervising auditor for the
Inspector General of the U.S. Department of Education. An audit plan for
each year is developed and provides for an annual on-site compliance review
of each ITT Technical Institute. The review procedures address significant
compliance areas, including student tuition refunds, student progress,
student admissions, graduate placements, student attendance, student
financial aid applications and implementation of prior audit
recommendations.
The ITT Technical Institutes are subject to audits or program
compliance reviews by various external agencies, including the U.S.
Department of Education, state agencies, guaranty agencies and lenders.
Also, the HEA and its implementing regulations require that institutions'
participation in Title IV Programs be audited annually by an independent
accounting firm. The U.S. Department of Education is currently conducting
program reviews of the ITT Technical Institutes in San Diego, California
and Portland, Oregon, and the Department has made preliminary findings
concerning noncompliance with certain requirements relating to the
administration of Title IV Programs in the San Diego, California program
review. The Company believes that it is in compliance with such
requirements. The Company has challenged the findings of the U.S.
Department of Education in that program review and believes that it will be
successful in its challenge. If the preliminary findings of the U.S.
Department of Education are ultimately sustained, however, the findings
could have a material adverse effect on the Company.
Potential Effect of Regulatory Violations. If the U.S. Department of
Education or other regulatory agency were to determine that one or more ITT
Technical Institutes had improperly disbursed Title IV Program funds, the
affected institutes could be required to repay such funds to the U.S.
Department of Education or the appropriate state agency or lender and could
be assessed an administrative fine. Alternatively, the U.S. Department of
Education could transfer the institutes to the reimbursement system of
receiving Title IV Program funds, under which a school must disburse funds
to students and document the students' eligibility for the funds before the
school receives any funds from the U.S. Department of Education. In
addition, significant violations of regulatory standards governing Title IV
Programs by the Company or any of the ITT Technical Institutes could be the
basis for a proceeding by the U.S. Department of Education to fine, limit,
suspend or terminate the participation of the Company or the particular
institute in these programs. Although there are no such proceedings
pending, and the Company has no reason to believe such a proceeding is
contemplated, if such a proceeding were initiated against the Company or
individual institutes and resulted in a substantial curtailment of the
Company's participation in Title IV Programs, the Company would be
materially adversely affected, even if the Company could arrange or provide
alternative sources of student financial aid. If an institute lost its
eligibility to participate in Title IV Programs and the Company could not
arrange for alternative sources of financial aid for the institute's
students, the Company probably would have to close that institute.
If the U.S. Department of Education terminates the eligibility of an
institution to participate in Title IV Programs, the institution in most
circumstances must wait 18 months before requesting reinstatement to
participate in Title IV Programs. The U.S. Department of Education will
review certain criteria, including corrective actions taken by the
institution, in determining whether the institution's Title IV Program
participation should be reinstated. An institution that loses its
eligibility to participate in Title IV Programs due to high default rates
for three consecutive years normally may not resume participation in those
programs for at least two federal fiscal years. An institution that loses
its eligibility to participate in Title IV Programs due to a violation of
the 85/15 Rule may not participate in Title IV Programs for at least one
year.
Federal and Other Financial Aid Programs
Students at the ITT Technical Institutes receive grants and loans to fund
the cost of their education under the following Title IV Programs: (a) the Pell
program, which accounted in aggregate for approximately 10% of the Company's
revenue in 1996; (b) the Federal Supplemental Educational Opportunity Grant
("SEOG") program, which accounted in aggregate for less than 1% of the Company's
revenue in 1996, and from which the Company has withdrawn most of the ITT
Technical Institutes' participation; (c) the Federal Family Education Loan
program, which accounted in aggregate for approximately 62% of the Company's
revenue in 1996 and includes subsidized and unsubsidized (which replaced SLS
loans in 1994) Stafford loans and PLUS loans; (d) the Perkins program, which
accounted in aggregate for less than 1% of the Company's revenue in 1996; (e)
the Federal Work-Study ("Work-Study") program, under which federal funds are
made available to provide part-time employment to eligible students
-15-
based on financial need and pursuant to which the ITT Technical Institutes
employed approximately 528 students and paid $943,000 in total wages to these
students in 1996; and (f) the William D. Ford Federal Direct Loan Program
("FDLP"), which accounted in aggregate for approximately 4% of the Company's
revenue in 1996, and which includes Federal Direct Stafford/Ford loans, Federal
Direct Unsubsidized Stafford/Ford loans, Federal Direct PLUS loans and Federal
Direct Consolidation loans. The SEOG, Perkins and Work-Study programs each
require the institution to make a matching contribution in the amount of 25% of
all federal funds the institution receives from the U.S. Department of Education
under each program. In 1996, the 25% matching contribution made by the Company
amounted to $36,000 for the SEOG program, $35,000 for the Perkins program and
$282,000 for the Work-Study program.
In 1996, 2% of the Company's revenue was from state financial aid programs.
During 1996, the Company awarded $372,000 in institutional scholarships to
certain students. The Company also has a program whereby it provides educational
discounts of the tuition cost to full-time employees of the Company and their
dependents to attend ITT Technical Institutes. For 1996, the cost of these
employee educational discounts was $674,000.
State Authorization and Accreditation
The Company is dependent on authorizations from state licensing agencies to
operate its institutes and to grant degrees and diplomas to students. The
Company is subject to extensive and varying regulation in each of the 26 states
in which an ITT Technical Institute currently operates. Each ITT Technical
Institute is authorized by the department of education of the state in which it
is located. In most instances this entity also authorizes the awarding of
degrees, but in several states approval from the state's higher education board
is also required in order to award degrees. In addition, certain states require
an institute to be in operation for a period of up to two years before such
institution can be authorized to award degrees.
ITT Technical Institutes that confer bachelor or master degrees must, in
most cases, meet additional regulatory standards. Raising the curricula of
existing ITT Technical Institutes to the bachelor and/or master degree level
requires the approval and oversight of state education authorities and
accrediting commissions. State laws and regulations affect the Company's
operations and may limit the ability of the Company to introduce degree programs
or to obtain authorization to operate in certain states. If any ITT Technical
Institute lost its state authorization, the institute would be unable to offer
postsecondary education and the Company would be forced to close the institute.
Closing an ITT Technical Institute could have a material adverse effect on the
Company.
Accreditation by an accrediting commission recognized by the U.S.
Department of Education is required in order for an institution to become and
remain eligible to participate in Title IV Programs. In addition, some states
require institutions operating therein to be accredited as a condition of state
authorization. Fifty-six ITT Technical Institutes are accredited by the
Accrediting Commission of Career Schools and Colleges of Technology ("ACCSCT"),
and three are accredited by the Accrediting Council for Independent Colleges and
Schools ("ACICS"), both of which are accrediting commissions recognized by the
U.S. Department of Education. The loss of accreditation by an existing ITT
Technical Institute or the failure of a new technical institute to obtain full
accreditation would render the affected institute ineligible to participate in
Title IV Programs and could have a material adverse effect on the Company.
In 1996, both the ACCSCT and the ACICS had their respective recognition by
the U.S. Department of Education as accrediting commissions renewed for a period
of four years. In the event an accrediting commission loses its recognition, the
U.S. Department of Education could continue the eligibility of the affected
institutions to participate in Title IV Programs for a period of time not to
exceed 18 months and affected institutes would be required to obtain
accreditation from another recognized accrediting commission in order to be
eligible to participate in Title IV Programs beyond that period. While there can
be no assurance that any individual technical institute would be able to meet
the accreditation standards of another accrediting commission or that any such
institute would be able to do so on a timely basis, the Company believes that if
either of the ACCSCT or the ACICS loses its recognition by the U.S. Department
of Education, the affected ITT Technical Institutes would apply for and obtain
accreditation from the other accrediting commission on a timely basis. The loss
by both the ACCSCT and the ACICS of their recognition by the U.S. Department of
Education, however, would have a material adverse effect on the Company's
operations because the Company does not expect it could obtain full
accreditation for any ITT Technical Institute from another accrediting
commission within 18 months. In addition, some of the changes in the Company's
operations that would be required to satisfy another accrediting commission's
requirements could have an adverse effect on the Company.
-16-
Faculty
Faculty members are hired in accordance with criteria established by the
Company, accreditation commissions and applicable state regulatory authorities.
Related work experience as well as educational background is considered in
filling faculty positions in most technical areas. Faculty members typically
include education supervisors, who act as department heads for a program of
study, and various categories of instructors. As of December 31, 1996, the ITT
Technical Institutes employed approximately 1,228 full-time and part-time
faculty members. The ratio of the number of all students to all ITT Technical
Institute full-time instructors is approximately 25 to 1.
Administration and Employees
Each ITT Technical Institute is administered by a director who has overall
responsibility for the management of the technical institute. The administrative
staff of each ITT Technical Institute also includes a director of recruitment, a
director of placement, a director of finance and a director of education. The
Company employs approximately 150 people at its corporate headquarters in
Indianapolis, Indiana. As of December 31, 1996, the Company had approximately
2,550 full-time and regular part-time employees. In addition, the Company
employed approximately 500 students as laboratory assistants and in other part-
time positions at that date. None of the Company's employees is represented by
labor unions.
The Company's headquarters provides centralized services to all ITT
Technical Institutes in the following areas: accounting, marketing, public
relations, curriculum development, purchasing, human resources, regulatory and
legislative affairs and real estate. In addition, national directors of each
major technical institute function (i.e., recruiting, finance, education and
placement) reside at headquarters and develop policies and procedures to guide
these functions in the technical institutes. Managers located at headquarters
closely monitor the operating results of each ITT Technical Institute and
frequently conduct on-site reviews.
Competition
The postsecondary education market in the United States is highly
fragmented and competitive with no private or public institution enjoying a
significant market share. ITT Technical Institutes compete for students with
four-year and two-year degree granting institutions, which include nonprofit
public and private colleges and proprietary institutions, as well as with
alternatives to higher education such as military service or immediate
employment. Competition among educational institutions is believed to be based
on the quality of the educational program, perceived reputation of the
institution, cost of the program and employability of graduates. Certain public
and private colleges may offer programs similar to those of ITT Technical
Institutes at a lower tuition cost due in part to government subsidies,
foundation grants, tax deductible contributions or other financial resources not
available to proprietary institutions. Other proprietary institutions offer
programs that compete with those of the ITT Technical Institutes. Certain of the
Company's competitors in both the public and private sector have greater
financial and other resources than the Company.
ITEM 2. PROPERTIES.
All ITT Technical Institute facilities are leased by the Company, except
for a parking lot adjacent to the Houston North ITT Technical Institute that is
owned by the Company. The average lease term is approximately eight years. The
table below sets forth certain information regarding these facilities as of
December 31, 1996.
-17-
ITT Technical Institute Facilities
Area in Area in
Location (Metropolitan Area] Square Feet Location (Metropolitan Area) Square Feet
- ---------------------------- ----------- ---------------------------- -----------
Birmingham, Alabama 17,447 Arnold, Missouri (St. Louis) 10,350/(1)/
Phoenix, Arizona 25,900 Earth City, Missouri (St. Louis) 29,360
Tucson, Arizona 17,818 Omaha, Nebraska 22,900
Little Rock, Arkansas 23,756 Henderson, Nevada (Las Vegas) 10,650/(1)/
Anaheim, California (Los Angeles) 34,933 Albuquerque, New Mexico 21,588
Carson, California (Los Angeles) 22,695 Getzville, New York (Buffalo) 22,765
Hayward, California (San Francisco) 20,009 Norwood, Ohio (Cincinnati) 21,272
Oxnard, California (Los Angeles) 22,270 Strongsville, Ohio (Cleveland) 21,548
Sacramento, California 21,400 Dayton, Ohio 45,591
San Bernardino, California (Los Angeles) 33,551 Youngstown, Ohio 22,500
San Diego, California 34,132 Portland, Oregon 39,600
Santa Clara, California (San Francisco) 24,390 Mechanicsburg, Pennsylvania (Harrisburg) 21,000
Sylmar, California (Los Angeles) 30,000 Monroeville, Pennsylvania (Pittsburgh) 14,010/(2)/
West Covina, California (Los Angeles) 36,383 Pittsburgh, Pennsylvania 19,232
Aurora, Colorado (Denver) 23,450 Greenville, South Carolina 22,065
Fort Lauderdale, Florida 16,341 Knoxville, Tennessee 30,000
Jacksonville, Florida 25,200 Memphis, Tennessee 21,648
Maitland, Florida (Orlando) 34,192 Nashville, Tennessee 33,631
Miami, Florida 21,347 Arlington, Texas 19,600
Tampa, Florida 35,000 Austin, Texas 25,480
Boise, Idaho 27,978 Garland, Texas 21,138
Burr Ridge, Illinois (Chicago) 10,350/(1)/ Houston (North), Texas 22,695
Hoffman Estates, Illinois (Chicago) 24,000 Houston (South), Texas 22,954
Matteson, Illinois (Chicago) 19,058 Houston (West), Texas 36,413
Newburgh, Indiana (Evansville) 20,000 San Antonio, Texas 20,770
Fort Wayne, Indiana 67,000 Murray, Utah (Salt Lake City) 33,600
Indianapolis, Indiana 58,692 Norfolk, Virginia 25,572
Louisville, Kentucky 20,232 Bothell, Washington (Seattle) 27,800
Framingham, Massachusetts (Boston) 19,938 Seattle, Washington 30,316
Grand Rapids, Michigan 25,000 Spokane, Washington 16,378
Troy, Michigan (Detroit) 32,000 Greenfield, Wisconsin (Milwaukee) 29,650
- ----------------------------------
(1) Facility under lease at which the Company plans to open a new ITT
Technical Institute.
(2) Indicates technical institutes in the first year of operation.
ITT Technical Institutes are generally located in suburban settings near
major population centers. Campus facilities are generally situated in modern,
air conditioned buildings, which include classrooms, laboratories, student break
areas and administrative offices. ITT Technical Institutes have accessible
parking facilities and are generally near a major highway. Approximately 31 ITT
Technical Institutes occupy an entire building. New ITT Technical Institutes
typically lease facilities for a 6 to 11 year term. If desirable or necessary, a
facility may be relocated to a new location reasonably near the existing
facility at the end of the lease term.
The Company leases approximately 41,400 square feet of office space in its
headquarters building in Indianapolis, Indiana. As of December 31, 1996, the
lease requires payments of approximately $4 million over the remaining term of
the lease, which expires in 2003.
-18-
ITEM 3. 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"). As reported in the Company's
Report on Form 10-Q for the quarters ended June 30, 1996 and September
30, 1996, this action was filed on June 8, 1995 in the Superior Court
of San Diego County in San Diego, California by seven graduates of 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 who
were residents of California. 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' misrepresentation 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' CBPA and CCLRA claims and their claims against the
Company employees have been dismissed, and the judge has vacated the
jury verdict against ITT. The Company is seeking to overturn the
awards and has appealed the decision. Although the Company is
optimistic that it may be able to reverse or reduce the verdict, there
can be no assurance thereof. Management, based on the advice of
counsel, believes it is probable that it will prevail in its appeal,
thus no provision (other than the Company's legal expenses) for these
awards has been made. If the Company's appeal of the judgment in the
Eldredge Case is unsuccessful, a charge to earnings would be taken at
that time in the amount of the awards, including the general and
exemplary damages assessed against the Company, the plaintiffs'
attorney's fees and costs and the prejudgment and post-judgment
interest assessed thereon. In addition, a California statute prohibits
the approval of a change in control of any institution that has been
found to have violated Chapter 3 of the CEC ("Chapter 3") in any
judicial or administrative proceeding. Since the jury's verdict in the
Eldredge Case includes violations of Chapter 3, it is highly unlikely
that California would approve a change in control of the San Diego ITT
Technical Institute unless and until: (a) the Company's appeal is
successful; (b) it is determined that the jury's verdict does not
constitute a finding in a judicial proceeding until all of the
Company's appeals are exhausted or otherwise; or (c) the California
statute imposing the restriction is changed or determined to be
unenforceable. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
Other legal proceedings have resulted (such as the actions discussed
below) and may continue to result from other persons alleging similar
claims of misrepresentation and violations of certain statutory
provisions of the CEC and CBPC.
(2) Robb, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 00707460), 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 alleges, among other things,
statutory violations of the CEC and CBPC by the Company and ten
employees of the Company who reside in California. The plaintiffs seek
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, attorney's fees and costs. The plaintiffs also seek to have
the action certified as a class action.
(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); Kellum, et al. v.
ITT Educational Services, Inc., et al. (Civil Action No. 00707709),
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, 17 former students of the San Diego ITT Technical Institute)
alleges, among other things, statutory violations of the CEC and CBPC,
intentional misrepresentation and civil conspiracy by the Company, ITT
Corporation and a Company
-19-
employee who resides in California. The plaintiffs in each action seek
various forms of recovery, including compensatory and exemplary
damages, civil penalties, injunctive relief, disgorgement of ill-
gotten gains, restitution, attorney's fees and costs.
While there can be no assurances as to the ultimate outcome of any
litigation involving the Company, management does not believe any other pending
legal proceeding will result in a judgment or settlement that will have, after
taking into account the Company's existing provisions for such liabilities, a
material adverse effect on the Company's financial position, results of
operations or cash flows. Certain litigation may, however, subject the affected
ITT Technical Institute to additional regulatory scrutiny.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the holders of the Common Stock
during the fourth quarter of 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock is listed on the New York Stock Exchange, Inc.,
under the trading symbol "ESI." The prices set forth below reflect the high and
low sales prices for the Common Stock for the periods indicated, as reported in
the consolidated transaction reporting system of the New York Stock Exchange,
Inc. Such prices have been restated to reflect the following adjustments to the
market price of the Common Stock: (a) on April 16, 1996 to reflect the 3 for 2
Common Stock split declared by the Company on March 22, 1996 and effected by
payment of a stock dividend on April 15, 1996 to all shareholders of record at
the close of business on April 1, 1996; and (b) on November 15, 1996 to reflect
the 3 for 2 Common Stock split declared by the Company on October 8, 1996 and
effected by payment of a stock dividend on November 4, 1996 to all shareholders
of record at the close of business on October 21, 1996.
PRICES
(IN DOLLARS)
1996 1995
---------------- ------------------
THREE MONTHS ENDED High Low High Low
- ------------------ ---- --- ---- ---
March 31 14 7/8 11 3/8 6 1/2 4 1/4
June 30 22 1/4 15 8 5 7/8
September 30 25 3/8 17 1/2 9 1/4 7 1/2
December 31 25 7/8 18 1/2 10 7/8 8 1/2
No cash dividends were declared in 1995 or 1996. The Company anticipates
that it will not pay any cash dividends on the Common Stock for the foreseeable
future and that it will retain its earnings to finance future growth. The
declaration and payment of dividends by the Company are subject to the
discretion of its Board of Directors and to compliance with applicable law. Any
determination as to the payment of dividends in the future will depend on, among
other things, general business conditions, the effect of such payment on the
Company's financial condition and other factors the Company's Board of Directors
may in the future consider to be relevant.
There were approximately 250 holders of record of the Common Stock on
February 28, 1997.
-20-
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
---------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues $232,319 $201,831 $186,907 $168,997 $154,611
Operating income $ 20,576 $ 14,225 $ 11,832 $ 13,839 $ 12,131
Net income/(1)/ $ 14,851 $ 11,391 $ 7,162 $ 8,314 $ 7,228
Operating losses from new institutes,
before income taxes/(2)/ $ 5,721 $ 7,123 $ 7,316 $ 2,914 $ 1,991
Cash, restricted cash and cash invested
with ITT Corporation $ 95,793 $ 77,517 $ 66,810 $ 51,064 $ 35,549
Total assets $135,749 $114,284 $102,899 $ 87,305 $ 69,115
Shareholders' equity $ 68,692 $ 53,841 $ 42,450 $ 35,288 $ 26,974
Capital expenditures, net $ 7,868 $ 8,206 $ 7,688 $ 6,679 $ 6,048
Depreciation $ 7,493 $ 7,542 $ 6,855 $ 6,343 $ 5,871
Number of common shares outstanding
at end of year 27,000 12,000 12,000 10,000 10,000
Earnings per share/(3)/ $ .55 $ .42 $ .32 $ .37 $ .32
Significant ratios
Return on sales 6.4% 5.6% 3.8% 4.9% 4.7%
Operating margin 8.9% 7.0% 6.3% 8.2% 7.8%
Return on average equity 24.2% 23.7% 18.4% 26.7% 29.8%
Book value per share/(3)/ $ 2.54 $ 1.99 $ 1.57 $ 1.57 $ 1.20
_______________________________
(1) Before cumulative effect of accounting change in 1992 ($1,734).
(2) Represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first 24 months after
their first class start.
(3) Restated to reflect the 3 for 2 stock splits effected in April and November
1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion of the Company's results of operations and
financial condition should be read in conjunction with the financial statements
of the Company and the notes thereto appearing elsewhere in this Form 10-K.
General
The Company operates 59 ITT Technical Institutes in 26 states which provide
career-oriented postsecondary education to more than 22,500 students. The
Company derives its revenue almost entirely from tuition, textbook sales, fees
and charges paid by, or on behalf of, its students. Most students at the ITT
Technical Institutes rely on funds received under various government-sponsored
student financial aid programs, especially the federal student financial aid
programs under Title IV of the Higher Education Act of 1965, as amended ("Title
IV Programs"), to pay a substantial portion of their tuition and other
education-related expenses. A substantial majority of the Company's revenue is
indirectly derived from Title IV Programs.
The Company's revenue varies based on the aggregate student population,
which is influenced by the number of students attending ITT Technical Institutes
at the beginning of a fiscal period, by the number of new first-time students
entering and former students re-entering ITT Technical Institutes during such
period and by student retention rates. New students primarily enter ITT
Technical Institutes at the beginning of each academic quarter that commences in
March, June, September and December. The Company believes the size of its
student population is affected to some extent by general economic conditions,
and that, in the absence of countervailing factors, student
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enrollments and retention rates would tend to increase as opportunities for
immediate employment for high school graduates decline and decrease as such
opportunities increase. The establishment of new ITT Technical Institutes and
the introduction of additional program offerings at existing ITT Technical
Institutes have been significant factors in increasing the aggregate student
population in recent years.
A new technical institute must be authorized by the state in which it will
operate, accredited by an accrediting commission that has been recognized by the
U.S. Department of Education, and certified by the U.S. Department of Education
to participate in Title IV Programs. The approval processes for accreditation
and federal certification cannot commence until the first students begin
classes. Such authorization, accreditation and approval processes take
approximately one year from the first class start date. Certain direct costs
incurred with respect to a new technical institute prior to the first class
start ("institute start-up costs") are deferred and amortized over the first
year of operation after the first class start. Since 1992, the Company has
opened 18 new technical institutes (five of which started classes in 1995 or
1996). New technical institutes historically incur a loss during the 24-month
period after the first class start date. These losses during the year by
institutes in their first two years of operation, together with the amortization
of institute start-up costs, are referred to as "operating losses from new
technical institutes." Such operating losses from new technical institutes
totaled $5.7 million, $7.1 million and $7.3 million for the years ended December
31, 1996, 1995 and 1994, respectively.
The Company earns tuition revenue on a weekly basis, pro rata over the
length of each of four, twelve-week academic quarters in each fiscal year. Under
federal and state regulations and accrediting commission standards, the Company
generally is required to refund a portion of the tuition payments received from
a student who withdraws from an ITT Technical Institute during an academic
quarter. The amount of tuition, if any, that may be retained by the Company
after payment of any potential refund is immediately recognized in the Company's
statement of income. Other educational revenue is comprised of textbook sales
and lab and enrollment fees.
The Company incurs expenses throughout a fiscal period in connection with
the operation of the ITT Technical Institutes. The cost of educational services
includes faculty and administrative salaries, cost of books sold, occupancy
costs, depreciation and amortization of equipment costs and leasehold
improvements and certain other administrative costs incurred by the ITT
Technical Institutes.
Student services and administrative expenses during any fiscal period
include direct marketing costs (which are marketing expenses directly related to
new student recruitment), indirect marketing expenses incurred during the
period, an allowance for doubtful accounts and administrative expenses incurred
at corporate headquarters. Direct marketing costs include salaries and employee
benefits for recruiting representatives and direct solicitation advertising
expenses. Direct marketing costs, excluding advertising expenses, are
capitalized and amortized on an accelerated basis over the average course length
of 24 months commencing on the class start date. Marketing costs that do not
relate to the direct solicitation of potential students are expensed as
incurred.
All cash receipts of the Company are forwarded to ITT Corporation ("ITT")
for investment on a daily basis after, in the case of certain receipts, the
lapse of applicable regulatory restrictions. Cash disbursements of the Company
are generally funded by ITT out of the cash balances of the Company held and
invested for the Company by ITT. Net interest income represents principally
interest paid or received from ITT and miscellaneous interest paid or received
from other parties. Commencing in 1995, ITT pays the Company interest on the
full amount of any net cash balances invested for the Company by ITT at an
interest rate that is set for a six- or twelve- month period and is 30 basis
points over the most recently published rate for six- or twelve-month treasury
bills, as appropriate, and no longer assesses interest charges on the Company
except with respect to funds actually advanced to the Company in excess of cash
invested with ITT. ITT performs a number of other services for the Company,
including the administration of certain employee benefit plans, for which it
receives compensation from the Company.
Variations in Quarterly Results of Operations
The Company's quarterly results of operations tend to fluctuate
significantly within a fiscal year because of differences in the number of weeks
of earned tuition revenue in each fiscal quarter and the timing of student
matriculations. The Company's first and third fiscal quarters have 13 weeks of
earned tuition revenue, while the second and fourth quarters have only 11 weeks
of earned tuition revenue because of two-week vacation breaks in June and
December. In addition, revenue in the third and fourth fiscal quarters generally
benefits from increased student matriculations as the number of new students
entering ITT Technical Institutes tends to be substantially higher in June (30%
of all new students in 1996) and September (37% of all new students in 1996)
because of the significant number
-22-
of recent high school graduates entering ITT Technical Institutes for the
academic quarters beginning in those two months. 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.
The following table sets forth the Company's revenue in each quarter during
the three prior fiscal years.
QUARTERLY REVENUE OF ITT TECHNICAL INSTITUTES
(DOLLARS IN THOUSANDS)
1996 1995 1994
THREE MONTH ---- ---- ----
PERIOD ENDED AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
- ------------ ------ ------- ------ ------- ------ -------
March 31 $ 57,103 25% $ 51,169 25% $ 46,658 25%
June 30 51,568 22 44,969 22 41,116 22
September 30 65,113 28 56,017 28 52,683 28
December 31 58,535 25 49,676 25 46,450 25
-------- ---- -------- ---- -------- ----
Total for Year $232,319 100% $201,831 100% $186,907 100%
======== ==== ======== ==== ======== ====
Results of Operations
The following table sets forth the percentage relationship of certain
statement of income data to tuition and other educational revenue for the
periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
Tuition and other educational revenue 100.0% 100.0% 100.0%
Cost of educational services 62.5 64.6 65.1
Student services and administrative expenses 28.6 28.4 28.6
----- ----- -----
Operating income 8.9 7.0 6.3
Interest income, net 1.7 2.4 .1
----- ----- -----
Income before income taxes 10.6% 9.4% 6.4%
===== ===== =====
Year Ended December 31, 1996 Compared with Year Ended December 31, 1995
Revenue. Revenue increased by $30.5 million, or 15.1%, to $232.3 million
for the year ended December 31, 1996 from $201.8 million for the year ended
December 31, 1995 primarily due to a 17.7% increase in the number of new first-
time students commencing their attendance at ITT Technical Institutes (19,464 in
1996 compared to 16,539 in 1995), a 5% increase in tuition rates in September
1995 and 1996, and the opening of new institutes (two in September 1995, two in
March 1996 and one in September 1996). The number of students attending ITT
Technical Institutes at January 1, 1996 was approximately the same as at January
1, 1995. Student retention rates did not change materially in the two years.
The three new ITT Technical Institutes beginning classes in 1996 accounted for
348 new students.
Cost of Educational Services. Cost of educational services increased by
$14.9 million, or 11.4%, to $145.2 million in 1996 from $130.3 million in 1995
principally as a result of increased costs related to the introduction of
additional programs, an increase in salaries and occupancy costs at ITT
Technical Institutes opened prior to 1994, costs at the six new institutes
opened in 1994, costs at the two new institutes opened in 1995, costs at the
three new institutes opened in 1996, and, to a lesser extent, as a result of an
increase in the costs of books sold related to the increased student population.
Provisions for legal expenses increased by $1.2 million in 1996 from 1995
levels. This increase was principally a result of a $1.3 million provision in
1996 ($1.0 million in fourth quarter and $0.3 million in third quarter) for the
legal actions in Eldredge, et al. v. ITT Educational Services, Inc., et al. (the
"Eldredge Case") (See Note 10 of Notes to Financial Statements for a further
description.) Cost of educational services decreased to 62.5% of revenues in
1996, as compared to 64.6% in 1995, primarily because of greater revenues being
spread over the fixed portion of cost of educational services.
-23-
Student Services and Administrative Expenses. Student services and
administrative expenses increased by $9.2 million, or 16.1%, to $66.5 million in
1996 from $57.3 million in 1995 principally as a result of a $7.9 million
increase in marketing costs. This increase is due to (i) an increase in the
marketing costs for the six new technical institutes opened in 1994 and the two
new technical institutes opened in 1995, (ii) the commencement of marketing
costs for the three new technical institutes opened in 1996 and (iii) the
increased marketing costs for ITT Technical Institutes opened prior to 1994.
Administrative expenses at the corporate headquarters increased by $0.7 million
in 1996 from 1995 levels primarily due to increased headquarters staff. The
provision for doubtful accounts in 1996 was approximately $0.6 million more than
in 1995 principally because of increased revenue and a delay in the U.S.
Department of Education's certification of the new institutes opened in 1995 and
1996 to participate in the Title IV Programs (e.g., the delay resulted in a
greater number of students who withdrew or were terminated from the institutes
before they could secure federal student financial aid with which they could pay
their obligations to the Company). Student services and administrative expenses
increased to 28.6% of revenues in 1996 as compared to 28.4% in 1995, because of
increased television advertising.
Interest Income. Interest income decreased by $0.7 million in 1996 because
of the reduction in the interest rate earned on the cash invested by the Company
with ITT (i.e., 5.5% in 1996 compared to 7.5% in 1995).
Net Income. Net income increased $3.5 million, or 30.7%, to $14.9 million
for 1996 from $11.4 million for 1995, principally due to the 44.6% increase in
operating income ($3.8 million after tax).
Year Ended December 31, 1995 Compared with Year Ended December 31, 1994
Revenue. Revenue increased by $14.9 million, or 8.0%, to $201.8 million
for the year ended December 31, 1995 from $186.9 million for the year ended
December 31, 1994 primarily due to an increase in the number of students at ITT
Technical Institutes, a 5% increase in tuition rates in December 1994 and the
opening of new institutes (four in June 1994, two in December 1994 and two in
September 1995). The growth in student population was attributable to a 4.1%
increase in the number of students attending ITT Technical Institutes at January
1, 1995 as compared with January 1, 1994, offset by a 1.5% decrease in the
number of new students entering ITT Technical Institutes in 1995 as compared to
1994. Student retention rates did not change materially in the two years. The
number of new, first-time students at ITT Technical Institutes decreased from
17,053 in 1994 to 16,539 in 1995. The two new ITT Technical Institutes
beginning classes in 1995 accounted for 157 new students.
Cost of Educational Services. Cost of educational services increased by
$8.7 million, or 7.2%, to $130.3 million in 1995 from $121.6 million in 1994
principally as a result of increased costs related to the introduction of
additional programs, an increase in salaries and occupancy costs at ITT
Technical Institutes opened prior to 1993, costs at the five new institutes
opened in 1993, costs at the six new institutes opened in 1994, costs at the two
new institutes opened in 1995, and, to a lesser extent, as a result of an
increase in the costs of books sold related to the increased student population.
Cost of educational services decreased to 64.6% of revenues in 1995, as compared
to 65.1% in 1994, primarily because of the $0.6 million decrease in pension
expenses (the discount rate for computing pension expense increased from 7.5% in
1994 to 8.5% in 1995). Excluding the cost of educational services and revenues
for new institutes (i.e., institutes in their first 24 months of operation after
their first class start), cost of educational services would have been 62.1% of
revenues in 1995 compared to 62.7% in 1994.
Student Services and Administrative Expenses. Student services and
administrative expenses increased by $3.8 million, or 7.1%, to $57.3 million in
1995 from $53.5 million in 1994 principally as a result of a $4.1 million
increase in marketing costs. This increase is due to (i) an increase in the
marketing costs for the five new technical institutes opened in 1993 and the six
new technical institutes opened in 1994, (ii) the commencement of marketing
costs for the two new technical institutes opened in 1995 and (iii) the
increased marketing costs for ITT Technical Institutes opened prior to 1993.
Administrative expenses at the corporate headquarters increased by $0.3 million
in 1995 from 1994 levels primarily due to increased headquarters staff. The
allowance for doubtful accounts in 1995 was approximately $0.6 million less than
in 1994 because of improved student financial aid packaging. Student services
and administrative expenses decreased to 28.4% of revenues in 1995 as compared
to 28.6% in 1994, because of the improvement in bad debt expense. Excluding the
cost of student services and revenues for new institutes, cost of student
services would have been 26.6% in 1995 compared to 26.5% in 1994.
-24-
Interest Income. The Company commenced receiving interest on the cash
invested with ITT in 1995 (previously no interest was paid to the Company by
ITT). This cash earned 7.5% on the daily outstanding balance during 1995.
Net Income. Net income increased $4.2 million, or 58.3%, to $11.4 million
for 1995 from $7.2 million for 1994, due to the 20.2% increase in operating
income ($1.4 million after tax) and the $2.7 million increase in the after tax
interest income.
Liquidity and Capital Resources
A substantial majority of the Company's revenue is derived from Title IV
Programs. Federal regulations dictate the timing of disbursements of funds
under Title IV Programs. Students must apply for a new loan for each academic
year (three academic quarters). Loan funds are generally provided by lenders in
two disbursements for each academic year. The first disbursement is usually
received either 30 days after (in the case of students commencing a program of
study) or 10 days before the start of the first academic quarter of a student's
academic year, and the second disbursement is typically received 10 days before
the start of the second academic quarter of a student's academic year. While
the timing of loan disbursements to the Company is subject to a student's
directions to the lender and to existing regulatory requirements regarding such
disbursements, which last changed effective July 1, 1995, the Company has
typically received student loan funds upon their disbursement by the lender.
The U.S. Department of Education issued final regulations on November 29,
1996 detailing new rules and procedures under which an institution participating
in Title IV Programs requests, maintains, disburses and otherwise manages Title
IV Program funds. These new fund management regulations are effective July 1,
1997 and will require the Company to receive its funds in three equal quarterly
disbursements rather than the two disbursements currently permitted, as
described above. The Company estimates that this change will decrease 1997 net
cash provided by operating activities (a one-time effect) by approximately $12.0
to $15.0 million, and will decrease 1997 interest income (an on-going effect) by
$0.8 to $1.0 million.
The principal uses of cash are to pay salaries, occupancy and equipment
costs, recruiting and marketing expenses, administrative expenses and taxes.
Cash receipts of the Company are forwarded to ITT on a daily basis, and cash
disbursements of the Company are generally funded by ITT out of the cash
balances of the Company invested with ITT. The Company's net cash balances of
the cash invested with ITT increased from $71.9 million at December 31, 1995 to
$89.8 million at December 31, 1996 and ranged from a low of $56.7 million in
May, 1996 to a high of $89.8 million in December, 1996. So long as ITT
continues to own at least 50% of the Company's outstanding Common Stock, the
Company will be able to continue participating in an ITT intercompany cash
management system and will be able to obtain advances from ITT for general
corporate purposes in amounts in excess of any cash invested with ITT up to a
maximum of $10.0 million.
The Company has generated positive cash flows from operations for the past
five years. Cash flows from operations increased by $7.2 million in 1996 to
$26.1 million from $18.9 million in 1995. This increase is primarily due to the
increases in operating income and deferred tuition revenue resulting from the
increased student enrollment. Cash flows from operations in 1995 was $18.9
million, a decrease of $4.5 million from $23.4 million in 1994. This decrease
is primarily due to the one-time increase in receipt of funds in 1994 from the
expansion of electronic receipt of student financial aid.
At December 31, 1996, the Company had positive working capital of $43.0
million. Deferred tuition revenue, which represents the unrecognized portion of
tuition revenue received from students, was $43.5 million at December 31, 1996.
An educational institution may lose its eligibility to participate in some
or all Title IV Programs if student defaults on federal student loans exceed
certain rates. These rates are calculated on an institutional basis, defined as
a main campus and all of its additional locations. Under the Federal Family
Education Loan ("FFEL") programs, any institution whose cohort default rate on
loans made under the Federal Stafford Loan and Federal Supplemental Loans for
Students programs is 25% or greater for three consecutive years will no longer
be eligible to participate in any of the FFEL programs (including the Federal
PLUS program) or the Federal Direct Student Loan ("FDSL") program for the
remainder of the federal fiscal year in which the U.S. Department of Education
determines that the institution has lost its eligibility and for the two
subsequent federal fiscal years, unless the institution successfully challenges
such
-25-
disqualification. During the pendency of any such appeal, the institution
retains its eligibility to participate in the applicable loan programs. No ITT
Technical Institute campus group has an FFEL cohort default rate equal to or
greater than 25% for three consecutive federal fiscal years. Three ITT Technical
Institute campus groups, consisting of three institutes located in Houston
(West), Garland and San Antonio, Texas, have FFEL cohort default rates for the
1993 and 1994 federal fiscal years which exceed 25%. With respect to the 1993
and 1994 FFEL cohort default rates, each of these institutes has submitted the
appropriate appeals and requests for adjustment based on (I) improper loan
servicing and/or collection of certain student loans included in the calculation
of these rates and (II) erroneous data used to calculate such rates. The U.S.
Department of Education has since denied each of the Garland, Houston (West) and
San Antonio ITT Technical Institute's appeal of its official 1993 FFEL cohort
default rate based on improper loan servicing and/or collection. These
institutes have each taken steps to reduce their FFEL cohort default rates for
the 1995 and subsequent federal fiscal years. Loss of eligibility to participate
in the FFEL and FDSL programs by either the Houston (West), Garland or San
Antonio, Texas ITT Technical Institutes could have a material adverse effect on
the Company's financial condition, because they accounted for approximately 7%
of the Company's revenues in the Company's 1996 fiscal year.
On January 31, 1997, Hilton Hotels Corporation ("Hilton") commenced a
tender offer for approximately 50.1% of the outstanding shares of ITT's common
stock (the "Hilton Offer"). Hilton has announced that, if its offer succeeds, it
will obtain the entire equity interest in ITT by merging ITT with Hilton or a
subsidiary of Hilton (such merger, together with the Hilton Offer, the "Hilton
Transaction"). The Hilton Transaction is more fully described in the Tender
Offer Statement on Schedule 14D-1 filed by Hilton with the Securities and
Exchange Commission (the "Hilton 14D-1") Hilton has stated in the Hilton 14D-1
that it "may be required to obtain approvals from or make filings with certain
regulatory bodies governing" the Company in connection with the Hilton
Transaction. The Company believes that the Hilton Transaction would, if
successful, constitute a change in ownership resulting in a change in control of
the Company under the regulations of the U.S. Department of Education, all or
virtually all of the state education authorities that regulate the Company's
business (the "States") and the accrediting commissions that accredit each ITT
Technical Institute (the "Accrediting Commissions"). Upon a change in control of
the Company under U.S. Department of Education regulations, the ITT Technical
Institutes would immediately become ineligible to participate in Title IV
Programs and their students would be unable to obtain Title IV Program funds to
pay their cost of education until such time as the U.S. Department of Education
recertifies the ITT Technical Institutes to participate in Title IV Programs.
The U.S. Department of Education will not preapprove a change in control and
will only reinstate an institution's eligibility to participate in Title IV
Programs upon approval of a proper application following the institution's
change in control. To be proper, among other things, such application must
demonstrate that the relevant ITT Technical Institute is authorized by the
appropriate States and accredited by the appropriate Accrediting commission.
Therefore, before each ITT Technical Institute may regain access to Title IV
Program funds following a change in control (a) it must be reaccredited (or
continue to be accredited) by the appropriate Accrediting Commission and
reauthorized (or continue to be authorized) by the appropriate States and (b)
the change in control must otherwise be approved by the U.S. Department of
Education.
The Accrediting Commissions will not reaccredit an ITT Technical Institute
unless that institute is authorized by the appropriate States. The standards of
the Accrediting Commission which accredits 56 ITT Technical Institutes provide
that, during the 30 days immediately preceding the change in control, the
Accrediting Commission will determine whether to continue the institution's
accreditation for a period of six months after the change in control to allow
the institution to obtain reauthorization (or confirmation of continued
authorization) by the appropriate States and apply for reaccreditation. The
standards of the Accrediting Commission which accredits three ITT Technical
Institutes provide that, within five business days after an institution obtains
reauthorization (or confirmation of continued authorization) by the appropriate
States following a change in control, the Accrediting Commission will determine
whether to temporarily reinstate the institution's accreditation during the
period in which the institution must apply for permanent reinstatement of its
accreditation.
Most States, including California, require that a change in control of an
institution be approved before it occurs in order for the institution to
maintain its authorization (the "Prior Approval States"). Some States will only
review a change in control of an institution after it occurs (the "Post Approval
States"). The Company estimates that it could take up to: (a) six months prior
to a change in control of the ITT Technical Institutes to obtain approval from
all of the Prior Approval States; (b) six months following a change in control
of the ITT Technical Institutes to obtain approval from all of the Post Approval
States; and (c) an additional six months after the institute is reauthorized (or
continues to be authorized) by the appropriate States and reaccredited (or
continues to be accredited) by the appropriate Accrediting Commission for each
ITT Technical Institute to be recertified by the U.S. Department of Education
and, thereby, regain its eligibility to participate in Title IV Programs.
Therefore, the company estimates
-26-
that eligibility to participate in Title IV Programs may not be regained by an
ITT Technical Institute located in: (i) a Prior Approval State for up to six
months following a change in control; and (ii) a Post Approval State for up to
12 months (or, if State reauthorization is not required, for up to six months)
following a change in control. Notwithstanding the foregoing, a California
statute prohibits the approval of a change in control of any institution that
has been found to have violated Chapter 3 of the California Education Code
("Chapter 3") in any judicial or administrative proceeding. In October 1996, the
jury in the Eldredge Case determined that the ITT Technical Institute in San
Diego, California violated Chapter 3. See "--Year Ended December 31, 1996
compared with Year Ended December 31, 1995 --Cost of Educational Services" and
Note 10 of Notes to Financial Statements. The Company has appealed the jury's
verdict in the Eldredge Case, but it is highly unlikely that California would
approve a change in control of the San Diego ITT Technical Institute unless and
until: (A) the Company's appeal is successful; (B) it is determined that the
jury's verdict does not constitute a finding in a judicial proceeding until all
of the Company's appeals are exhausted or otherwise; or (C) the California
statute imposing the restriction is changed or determined to be unenforceable.
In addition to the Eldredge Case, five legal actions are pending against the
Company alleging violations of Chapter 3 by the San Diego ITT Technical
Institute and one legal action is pending against the Company alleging
violations of Chapter 3 by all ten of the ITT Technical Institutes in
California.
A material adverse effect on the Company's business, financial condition
and results of operations would result if a change in control of the Company
occurred: (a) without the prior approvals of the Prior Approval States (and in
particular, California); (b) without the continued or temporarily reinstated
accreditation of the Accrediting Commissions; or (c) after the prior approvals
of the Prior Approval States and the continued or temporarily reinstated
accreditation of the Accrediting Commissions, if a material number of ITT
Technical Institutes failed to timely (i) obtain the requisite reauthorizations
from the Post Approval States or (ii) regain eligibility to participate in Title
IV Programs from the U.S. Department of Education. In addition, the time of year
at which a change in control of the Company occurs coupled with the length of
time required by the ITT Technical Institutes to regain their eligibility to
participate in Title IV Programs could have a material adverse effect on the
Company's business, financial condition and results of operations and the amount
of Title IV Program funds students can obtain to pay the education costs of
attending the ITT Technical Institutes.
ITT has stated in the Solicitation/Recommendation Statement on
Schedule 14D-9 filed by ITT with the Securities and Exchange Commission (the
"ITT 14D-9") in response to the Hilton Offer that it is actively exploring
opportunities to enhance the value of ITT. As part of this process, ITT has
disclosed in the ITT 14D-9 that it "is taking steps to monetize or otherwise
realize the value of non-core assets." ITT has disclosed that as a result, it is
exploring possible transactions to dispose of some or all of the Common Stock of
the Company held by ITT. There can be no assurance that ITT will maintain its
ownership interest in the Company. The Company believes that, if ITT were to
decide to dispose of its ownership interest in the Company, certain types of
transactions by which ITT could dispose of such ownership interest might not
result in a change in control of the Company under U.S. Department of Education
regulations; however, if the means of disposition chosen by ITT result in such a
change in control, such change in control could have the material adverse
consequences for the Company described above.
The Company's capital assets consist primarily of classroom and laboratory
equipment (such as computers, electronic equipment and robotic systems),
classroom and office furniture and leasehold improvements. All building
facilities are leased. Capital expenditures totaled $7.9 million during 1996 and
included expenditures of $1.1 million for new technical institutes, $1.6 million
to expand curricula offerings at existing institutes, $4.4 million to replace or
add furniture or equipment at existing institutes, and $0.8 million on leasehold
improvements. Leasehold improvements represent part of a continuing effort by
the Company to maintain its existing facilities in excellent condition. Capital
expenditures decreased by $0.3 million to $7.9 million in 1996 from $8.2 million
in 1995, principally due to the decreased number of new institutes in 1995 and
1996 (5 institutes) compared to 1994 and 1995 (8 institutes). New institutes
have large capital additions in the first two years. Capital expenditures for
1995 of $8.2 million were $0.5 million more than the $7.7 million of capital
expenditures in 1994, principally due to the increased expansion of curricula
offerings at existing institutes. To date, cash generated from operations has
been sufficient to meet capital expenditures.
The Company plans to continue to upgrade and expand current facilities and
equipment. The Company has purchased new software for its computer-aided
drafting technology program which will require the expenditure of approximately
$3.0 million to acquire new computers in the first quarter of 1997. The Company
expects that the 1997 capital expenditures, including these computers, will be
approximately $13.0 million. The capital additions for a new institute are
approximately $0.4 million and the capital expenditures for new curricula at an
existing institute are approximately $0.2 million. The Company anticipates that
its planned capital additions can be funded from cash
-27-
flows from operations. Cash flows from operations on a long-term basis is highly
dependent upon the receipt of funds from federal financial aid program and the
amount of funds spent on new institutes, curricula additions at existing
institutes and possible acquistions.
Factors That May Affect Future Results
This report contains certain forward looking statements that involve a
number of risks and uncertainties. Among the factors that could cause actual
results to differ materially are the following: business conditions and growth
in the postsecondary education industry and in the general economy; changes in
federal and state governmental regulations with respect to education and
accreditation standards, or the interpretation or enforcement thereof,
including, but not limited to, the level of government funding for, and the
Company's eligibility to participate in, student financial aid programs utilized
by the Company's students; the results of the Company's appeal in Eldredge, et
al. v. ITT Educational Services, Inc., et al. and the results of any related
litigation; effects of any change in ownership of the Company resulting in a
change in control of the Company, including, but not limited to, the
consequences of such changes on the accreditation and federal and state
regulation of the institutes; receptivity of students and employers to the
Company's existing program offerings and new curricula; loss of lender access to
the Company's students for student loans; and a substantial increase in the
shares of Common Stock available for sale in the market if ITT divests some or
all of its Common Stock holdings.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item appears on pages F-1 through F-11
herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
-28-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item concerning the Directors, nominees
for Director, executive officers of the Company and disclosure of delinquent
filers is incorporated herein by reference to the Company's definitive Proxy
Statement for its 1997 Annual Meeting of Shareholders, to be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item concerning remuneration of the
Company's officers and Directors and information concerning material
transactions involving such officers and Directors is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1997 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A within
120 days after the end of the Company's last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item concerning the stock ownership of
management and five percent beneficial owners is incorporated herein by
reference to the Company's definitive Proxy Statement for its 1997 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A within
120 days after the end of the Company's last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to the Company's
definitive Proxy Statement for its 1997 Annual Meeting of Shareholders which
will be filed pursuant to Regulation 14A within 120 days after the end of the
Company's last fiscal year.
-29-
Report of Independent Accountants
To the Board of Directors and Shareholders of
ITT Educational Services, Inc.
In our opinion, the financial statements listed in the index appearing under
item 14 (a) (1) and (2) on page 30, present fairly, in all material respects,
the financial position of ITT Educational Services, Inc. at December 31, 1996
and 1995, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
PRICE WATERHOUSE LLP
January 8, 1997, except for Note 10
which is as of February 12, 1997
F - 1
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF INCOME AND RETAINED EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
Revenues
Tuition $196,692 $171,936 $159,575
Other educational 35,627 29,895 27,332
-------- -------- --------
Total revenue 232,319 201,831 186,907
Costs and Expenses
Cost of educational services 145,197 130,338 121,594
Student services and administrative
expenses 66,546 57,268 53,481
-------- -------- --------
211,743 187,606 175,075
Operating income 20,576 14,225 11,832
Interest income, net 4,119 4,802 232
-------- -------- --------
Income before income taxes 24,695 19,027 12,064
Income taxes 9,844 7,636 4,902
-------- -------- --------
Net income 14,851 11,391 7,162
Retained earnings, beginning of period 21,058 9,667 19,567
Special dividend 0 0 (17,062)
-------- -------- --------
Retained earnings, end of period $ 35,909 $ 21,058 $ 9,667
======== ======== ========
Earnings per common share $ .55 $ .42 $ .32
======== ======== ========
The accompanying notes are an integral part of these financial statements.
F - 2
ITT EDUCATIONAL SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31,
------------------
1996 1995
-------- --------
ASSETS
Currents assets
Cash $ 74 $ 595
Restricted cash 5,911 5,037
Cash invested with ITT Corporation 89,808 71,885
Accounts receivable, less allowance for doubtful
accounts of $1,044 and $963 9,378 7,592
Deferred income tax 1,455 950
Prepaids and other current assets 1,823 1,508
-------- --------
Total current assets 108,449 87,567
Property and equipment, net 19,360 18,985
Direct marketing costs 5,774 5,031
Other assets 2,166 2,701
-------- --------
Total assets $135,749 $114,284
======== ========
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 12,188 $ 8,336
Accrued compensation and benefits 4,253 4,195
Other accrued liabilities 5,432 6,172
Deferred tuition revenue 43,532 40,063
-------- --------
Total current liabilities 65,405 58,766
Other liabilities 1,652 1,677
-------- --------
Total liabilities 67,057 60,443
-------- --------
Commitments and contingent liabilities (Note 10)
Shareholders' equity
Preferred stock, $.01 par value, 5,000,000
shares authorized, none issued or outstanding
Common stock, $.01 par value, 50,000,000 and 25,000,000
shares authorized, 26,999,952 and 12,000,000
issued and outstanding 270 120
Capital surplus 32,513 32,663
Retained earnings 35,909 21,058
-------- --------
Total shareholders' equity 68,692 53,841
-------- --------
Total liabilities and shareholders' equity $135,749 $114,284
======== ========
The accompanying notes are an integral part of these financial statements.
F - 3
ITT EDUCATIONAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
-------- -------- --------
Cash flows from operating activities:
Net income $ 14,851 $ 11,391 $ 7,162
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 7,493 7,542 6,855
Provision for doubtful accounts 1,738 1,173 1,803
Deferred taxes (443) (240) 633
Increase/decrease in operating assets
and liabilities:
Accounts receivable (3,524) (2,189) (2,923)
Direct marketing costs (743) 23 178
Accounts payable and accrued liabilities 3,083 1,438 1,051
Prepaids and other assets 220 683 2,327
Deferred tuition revenue 3,469 (908) 6,348
-------- -------- --------
Net cash provided by operating
activities 26,144 18,913 23,434
-------- -------- --------
Cash flows used for investing activities:
Capital expenditures, net (7,868) (8,206) (7,688)
Net increase in cash invested with ITT
Corporation (17,923) (15,975) ( 8,902)
-------- -------- --------
Net cash used for investing activities (25,791) (24,181) (16,590)
-------- -------- --------
Cash flows from financing activities:
Proceeds from sale of common stock, 17,062
net of expenses
Special dividend paid (17,062)
-------- -------- --------
Net cash from financing activities 0 0 0
-------- -------- --------
Net increase (decrease) in cash and
restricted cash 353 (5,268) 6,844
Cash and restricted cash at beginning
of period 5,632 10,900 4,056
-------- -------- --------
Cash and restricted cash at end of period $ 5,985 $ 5,632 $ 10,900
======== ======== ========
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Income taxes $ 10,051 $ 8,168 $ 4,322
Interest 273 550 127
The accompanying notes are an integral part of these financial statements.
F - 4
ITT EDUCATIONAL SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)
1. Initial Public Offering and Stock Ownership
On October 11, 1994, the Board of Directors of the Company approved an
initial public offering (the "Offering") of 2,000,000 shares of the Company's
Common Stock and declared a special dividend in the amount of the net proceeds
of the "Offering." The net proceeds and dividend of $17,062 were received and
paid on December 27, 1994. After the "Offering," 83.3% of the Common Stock is
owned by ITT Corporation ("ITT") and 16.7% is owned by others.
On March 22, 1996, the Company declared a 3 for 2 Common Stock split,
effected by payment of a stock dividend on April 15, 1996, to all shareholders
of record at the close of business on April 1, 1996. On May 14, 1996, the
shareholders approved an increase in the number of authorized common shares of
Common Stock from 25,000,000 to 50,000,000. On October 8, 1996, the Company
declared a 3 for 2 Common Stock split, effected by payment of a stock dividend
on November 4, 1996, to all shareholders of record at the close of business on
October 21, 1996. The earnings per share amounts for all prior periods have been
restated to reflect these stock splits.
The change in Common Stock and capital surplus can be summarized as
follows:
Common Common Capital
Stock Shares Stock Surplus
------------ ------ -------
Balance December 31, 1994 and 1995 12,000,000 $120 $32,663
Common Stock Splits 14,999,952 150 (150)
---------- ---- ------
Balance December 31, 1996 26,999,952 $270 $32,513
========== ==== =======
2. Summary of Accounting Principles and Policies
Business Activities. The Company is a leading college system providing
career-focused, technical degree programs of study. At December 31, 1996,
the Company operated fifty-nine (59) technical institutes throughout the
United States. The Company maintains corporate headquarters in
Indianapolis, Indiana.
Use of Estimates. The preparation of these financial statements, in
conformity with generally accepted accounting principles, includes
estimates that are determined by the Company's management.
Property and Equipment. The Company includes all property and
equipment in the financial statements at cost. Provisions for depreciation
of property and equipment have generally been made using the straight-line
method for financial reporting purposes and accelerated methods for tax
purposes. Estimated useful lives generally range from three to ten years
for furniture and equipment and leasehold improvements. Maintenance,
repairs and renewals not of a capital nature are expensed as incurred.
Fully depreciated assets no longer in use are removed from both the asset
and accumulated depreciation accounts in the year of their retirement. Any
gains or losses on dispositions are credited or charged to income, as
appropriate.
Fair Value of Financial Instruments. The carrying amounts reported in
the balance sheets for cash, restricted cash, cash invested with ITT
Corporation, accounts receivable, accounts payable, other accrued
liabilities and deferred tuition revenue approximate fair value because of
the immediate or short-term maturity of these financial instruments.
Recognition of Revenues. Tuition revenue is recorded on a straight-
line basis over the length of the applicable course. If a student
discontinues training, the revenue related to the remainder of that quarter
is recorded with the amount of refund resulting from the application of
federal, state or accreditation requirements recorded as an expense. On an
individual student basis, tuition earned in excess of cash received is
recorded as accounts receivable, and cash received in excess of tuition
earned is recorded as deferred tuition revenue.
F - 5
Other educational revenue is comprised of lab fees and textbook sales.
Lab fees are recorded as revenue at the beginning of each quarter. Textbook
sales are recognized when they occur.
Advertising Costs. The Company expenses all advertising costs as
incurred.
Direct Marketing Costs. Direct costs incurred relating to the
enrollment of new students are capitalized using the successful efforts
method. Direct marketing costs include recruiting representatives'
salaries, employee benefits and other direct costs less enrollment fees.
Direct marketing costs are amortized on an accelerated basis over the
average course length of 24 months commencing on the start date.
Direct marketing costs on the balance sheet totaled $5,774 and $5,031
at December 31, 1996 and 1995, respectively, net of accumulated
amortization of $5,065 and $5,099 at those dates, respectively.
Institute Start-Up Costs. Deferred institute start-up costs consist of
all direct costs incurred at a new institute (excluding advertising costs)
that are incurred from the date a lease for a technical institute facility
is entered into until the first class start. Such capitalized costs are
amortized on a straight-line basis over a one year period. At December 31,
1996 and December 31, 1995, deferred start-up costs included in other
assets in the balance sheet totaled $521 and $1,000, respectively, net of
accumulated amortization of $799 and $166 at such dates, respectively.
Income Taxes. The Company is included in the consolidated U.S. federal
income tax return of ITT and determines its income tax provision
principally on a separate return basis in conformity with Statement of
Financial Accounting Standards ("SFAS") No. 109. Under a tax sharing policy
with ITT, income taxes are allocated to members of the U.S. consolidated
group based principally on amounts they would pay or receive if they filed
a separate income tax return. Deferred income taxes are provided on the
differences in the book and tax basis of assets and liabilities recorded on
the books of the Company (temporary differences) at the statutory tax rates
expected to be in effect when such differences reverse. Temporary
differences related to SFAS No. 106, SFAS No. 112, pension and self-
insurance costs are recorded on the books of ITT where the related assets
and liabilities are recorded. ITT pays current federal income taxes on
behalf of the Company, as calculated under the tax sharing policy, and
reflects the funding through the cash invested with ITT Corporation
account.
Earnings Per Common Share. Earnings per common share data are based on
historical net income and the average number of shares of Common Stock
outstanding during each period. After restatement for stock splits
described in Note 1, the number of average shares outstanding in 1996, 1995
and 1994 was 27,153,000, 27,052,000 and 22,561,000, respectively.
3. Related Party Transactions
At the time of the Offering, the Company and ITT entered into various
agreements, which remain in effect, as follows:
Intercompany Activities. ITT provides the Company with certain
centralized treasury and financing functions. The Company transfers all
unrestricted cash receipts to ITT and receives funds from ITT for all
disbursements. Prior to the Offering in 1994, neither the remittances to,
nor advances from, ITT were interest bearing. After the Offering, the
Company receives interest on the average net cash balance held by ITT, at
an interest rate that is set for a 12-month period and is 30 basis points
over the most recently published rate for twelve month treasury bills. The
net of all such cash transfers as well as charges from ITT for expenses
related to the Company's participation in ITT's plans such as pensions,
medical insurance, federal income taxes, etc. resulted in a net balance of
cash invested with ITT as of December 31, 1996 and 1995 of $89,808 and
$71,885, respectively.
ITT also provides certain risk management, tax and pension management
services. The fee (contract service charge) for such services is 0.25% of
the Company's annual revenue. The contract service charges were $578, $504
and $454 for the years ended December 31, 1996, 1995 and 1994,
respectively.
F - 6
The Company's employees participate in certain employee benefit
programs which are sponsored and administered by ITT. Administrative costs
relating to these services and participation in these plans are charged to
the Company using allocation methods management believes are reasonable.
The Company pays a processing fee related to its participation in ITT's
consolidated medical plan. The processing fees were $280, $464 and $336 in
1996, 1995 and 1994, respectively.
Service Agreements. The Company and ITT entered into service
agreements relating to the provision of certain services by ITT to the
Company. All services historically provided to the Company by ITT continue
to be provided by ITT at comparable cost. Management believes the
statements of income include a reasonable allocation of costs incurred by
ITT which benefit the Company. The Company will be able to obtain advances
from ITT for general corporate purposes in amounts in excess of any cash
invested with ITT up to a maximum of $10,000.
Interest on any loans made to the Company by ITT will accrue at
prevailing market rates (reflecting a spread over a selected interbank
lending rate) which will be determined at the time of any such loan. Any
loans to the Company by ITT will be subject to a condition precedent that
ITT directly or indirectly owns at least 50% of the outstanding common
stock of the Company.
Tax Agreement. ITT and the Company entered into a tax agreement
providing, among other things, that the Company will pay ITT, with respect
to federal income taxes for each period that the Company is included in
ITT's consolidated federal return, that amount that the Company would have
been required to pay had it filed a separate federal income tax return
under the tax sharing policy described in Note 2.
Similarly, with respect to state, corporate, franchise or income taxes
for those states where ITT files a combined or consolidated state return
that includes the Company, the Company will pay as if they filed a separate
tax return. With respect to ITT's consolidated federal and state returns,
the Company will be responsible for any deficiencies assessed with respect
to such returns if such deficiencies relate to the Company. Similarly, the
Company will be entitled to all refunds paid with respect to such returns
that relate to the Company. The Company will be responsible for all taxes,
including assessments, if any, for prior years with respect to all other
taxes payable by the Company.
4. Financial Aid Programs
The Company participates in various federal student financial aid programs
under Title IV of the Higher Education Act of 1965, as amended ("Title IV
Programs"). Approximately 74% of the Company's 1996 revenue was derived from
funds distributed under these programs.
The Company participates in the Federal Perkins Loan ("Perkins") program
and administers on behalf of the federal government a pool of Perkins student
loans which aggregated $8,235 and $8,671 at December 31, 1996 and 1995,
respectively. The Company has recorded in its financial statements only its
aggregate mandatory contributions to this program which at December 31, 1996 and
1995 aggregated $1,572 and $1,606, respectively. The Company has provided $955
for potential losses related to funds committed by the Company at December 31,
1996 and 1995.
The Title IV Programs are administered by the Company in separate accounts
as required by government regulation. The Company is required to administer the
funds in accordance with the requirements of the Higher Education Act and U.S.
Department of Education regulations and must use due diligence in approving and
disbursing funds and servicing loans. In the event the Company does not comply
with federal requirements, or if student loan default rates are at a level
considered excessive by the federal government, the Company could lose its
eligibility to participate in the Title IV Programs or could be required to
repay funds determined to have been improperly disbursed. Management believes
that it is in substantial compliance with the federal requirements.
5. Restricted Cash
The Company participates in the Electronic Funds Transfer ("EFT") program
through the U.S. Department of Education. All monies transferred to the Company
via the EFT system are subject to certain holding period
F - 7
restrictions, generally from 3 to 7 days, before they can be drawn into the
Company's cash account. Such amounts are classified as restricted until they
are applied to the students accounts.
6. Property and Equipment
Fixed assets include the following:
DECEMBER 31,
-------------------
1996 1995
-------- --------
Furniture and equipment $ 52,317 $ 51,045
Leasehold improvements 7,017 6,620
Land and land improvements 110 110
Construction in progress 1,142 414
-------- --------
60,586 58,189
Less accumulated depreciation (41,226) (39,204)
-------- --------
$ 19,360 $ 18,985
======== ========
7. Taxes
The provision for income taxes includes the following:
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
-------- -------- -------
Current
Federal $ 8,673 $ 6,571 $ 3,648
State 1,614 1,305 621
-------- -------- -------
10,287 7,876 4,269
-------- -------- -------
Deferred
Federal (370) (200) 543
State (73) (40) 90
-------- -------- -------
(443) (240) 633
-------- -------- -------
$ 9,844 $ 7,636 $ 4,902
======== ======== =======
Deferred tax assets (liabilities) include the following:
DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
Direct marketing costs $(2,263) $(1,973) $(1,982)
Institute start-up costs (204) (392) (495)
Depreciation 785 744 102
Reserves and other 1,828 1,324 1,838
------- ------- -------
Net deferred tax assets(liabilities) $ 146 $ (297) $ (537)
======= ======= =======
Differences between effective income tax rates and the statutory U.S.
federal income tax rates are as follows:
YEAR ENDED DECEMBER 31,
------------------------
1996 1995 1994
----- ----- -----
Statutory U.S. federal income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 4.1% 4.3% 3.8%
Permanent differences and other .8% .8% 1.8%
---- ---- ----
Effective income tax rates 39.9% 40.1% 40.6%
==== ==== ====
F - 8
8. Retirement Plans
Employee Pension Benefits. The Company participates in the Retirement
Plan for Salaried Employees of ITT Corporation, a noncontributory defined
benefit, final average pay pension plan which covers substantially all
employees of the Company. ITT determines the aggregate amount of pension
expense on a consolidated basis based on actuarial calculations and such
expense is allocated to participating units on the basis of compensation
covered by the plan. For the years ended December 31, 1996, 1995 and 1994,
pension expense as a percentage of covered compensation for employees over
age 21 who had more than one year of service was 6.57%, 5.52% and 7.30%,
respectively, which resulted in charges to the Company of $3,783, $2,983
and $3,642, respectively. The amount recorded as annual pension expense is
paid to ITT through the cash invested with ITT Corporation account on a
monthly basis.
Retirement Savings Plan. The Company participates in The ITT 401K
Retirement Savings Plan (formerly known as the ITT Investment and Savings
Plan for Salaried Employees), a defined contribution pension plan which
covers substantially all employees of the Company. The Company's non-
matching and matching contributions under this plan are provided for
through the issuance of common shares of ITT. The costs of the non-matching
and matching Company contributions are charged by ITT to the Company. For
the years ended December 31, 1996, 1995 and 1994, the costs of providing
this benefit (including an allocation of the administrative costs of the
plan) were $1,749, $1,369 and $1,259, respectively.
9. Stock Option and Key Employee Incentive Plans
The Company adopted, effective at the date of the Offering, the ITT
Educational Services, Inc. 1994 Stock Option Plan (the "1994 Plan"). The Company
has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been recognized
in the financial statements for the 1994 Plan. Compensation costs for the 1994
Plan calculated using the Black-Scholes method in accordance with SFAS No. 123
are not significant.
Under the 1994 Plan, a maximum of 405,000 shares of Common Stock may be
issued upon exercise of options. The option price may not be less than 100% of
the fair market value of the Common Stock on the date of grant and the options
will vest and become exercisable in three equal annual installments commencing
with the first anniversary of the grant. A special grant of 135,000 stock
options (at an option price of $4.44) was made to certain executive officers of
the Company at the time of the Offering, and an additional 56,250 stock options
(at an option price of $8.89) were granted in 1995. In 1996, 67,500 stock
options were granted at an option price of $11.94. All amounts reflect the April
15, 1996 and October 21, 1996 3 for 2 Common stock splits as mentioned in Note
1.
During 1996, 1995 and 1994, no options were exercised, expired or canceled.
At December 31, 1996, 108,750 stock options are exercisable.
10. Commitments and Contingent Liabilities
Lease Commitments. The Company leases substantially all of its
facilities under operating lease agreements. A majority of the operating
leases contain renewal options that can be exercised after the initial
lease term. Renewal options are generally for periods of one to five years.
All operating leases will expire over the next fourteen years and
management expects that leases will be renewed or replaced by other leases
in the normal course of business. There are no material restrictions
imposed by the lease agreements and the Company has not entered into any
significant guarantees related to the leases. The Company is required to
make additional payments under the operating lease terms for taxes,
insurance and other operating expenses incurred during the operating lease
period.
F - 9
Rent expense was composed of the following:
YEAR ENDED DECEMBER 31,
-------------------------
1996 1995 1994
------- ------- -------
Minimum rentals
Contingent rentals $17,131 $15,842 $14,304
249 223 219
------- ------- -------
$17,380 $16,065 $14,523
======= ======= =======
Future minimum rental payments required under operating leases that have initial
or remaining noncancelable lease terms in excess of one year as of December 31,
1996 are as follows:
1997 $ 17,003
1998 18,568
1999 16,534
2000 15,460
2001 10,350
Later Years 33,913
--------
$111,828
========
Operating leases related to four institutes that are still in the
developmental phase at December 31, 1996 include special clauses that allow the
Company to terminate the lease within one year of signing the lease if the new
school is not accredited. If this were to occur, the Company would be liable, at
the date of termination, for an agreed upon termination cost based on the
lessor's tenant improvement costs. The future minimum rental payments schedule
above includes such termination costs for the four institutes. If the institutes
are accredited as expected, aggregate additional minimum rental payments of
$3,742 will be required over the lease term.
Rent expense and future minimum rental payments related to equipment leases
are not material.
Contingent Liabilities. In December, 1994, the Company entered into an
agreement with an unaffiliated, private funding source to provide loans to
students of certain technical institutes. The agreement requires the Company to
guarantee repayment of the loans. Outstanding loans at December 31, 1996
aggregated $1,853. Additionally, the Company is required to maintain on deposit
with the lender 15% of the aggregate principal balance of outstanding loans.
This deposit is included in other assets in the balance sheet.
The Company has a number of pending legal and other claims arising out of
the normal course of business. Among the legal actions currently pending is
Eldredge, et al. v. ITT Educational Services, Inc., et al. (the "Eldredge
Case"). This action was filed on June 8, 1995 in San Diego, California by seven
graduates of the San Diego ITT Technical Institute. In October 1996, the jury in
this action rendered a verdict against the Company and awarded the plaintiffs
general damages of approximately $0.2 million and exemplary damages of $2.6
million. The judge also awarded the plaintiffs attorney's fees and costs, in the
amount of approximately $0.9 million, and interest. The Company is seeking to
overturn the awards and has appealed the decision. Management, based on the
advice of counsel, believes it is probable that it will prevail in its appeal,
thus no provision (other than the Company's legal expenses) for these awards has
been made. If the Company's appeal of the judgment in the Eldredge Case is
unsuccessful, a charge to earnings would be taken at that time in the amount of
the awards, including the general and exemplary damages assessed against the
Company, the plaintiffs' attorney's fees and costs and the interest assessed
thereon.
In late January 1997, six legal actions were filed against the Company in
San Diego, California by a total of 21 former students of the San Diego ITT
Technical Institute. The plaintiffs in one such action seek to have the action
certified as a class action. The claims alleged in these legal actions are
similar to the claims alleged in the Eldredge Case and include misrepresentation
and violations of certain statutory provisions of the California Education Code
and California Business and Professions Code.
In the opinion of management, the ultimate outcome of these matters should
not have a material adverse effect on the Company's financial position, results
of operations or cash flows.
F - 10
ITT EDUCATIONAL SERVICES, INC.
QUARTERLY RESULTS
FOR 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
------------------------------------------
1995 MAR. 31 JUNE 30 SEPT. 30 DEC. 31 YEAR
------- ------- -------- ------- --------
Revenues $51,169 $44,969 $56,017 $49,676 $201,831
Cost and expenses $45,682 $46,143 $48,466 $47,315 $187,606
Operating income $ 5,487 $(1,174) $ 7,551 $ 2,361 $ 14,225
Interest income, net $ 1,212 $ 801 $ 1,438 $ 1,351 $ 4,802
Net income $ 4,026 $ (224) $ 5,402 $ 2,187 $ 11,391
Earnings per share** $ 0.15 $ (0.01) $ 0.20 $ 0.08 $ 0.42
1996
Revenues $57,103 $51,568 $65,113 $58,535 $232,319
Cost and expenses $49,992 $51,954 $55,072 $54,725 $211,743
Operating income $ 7,111 $ (386) $10,041 $ 3,810 $ 20,576
Interest income, net $ 947 $ 909 $ 1,076 $ 1,187 $ 4,119
Net income $ 4,835 $ 314 $ 6,670 $ 3,032 $ 14,851
Earnings per share** $ 0.18 $ 0.01 $ 0.25 $ 0.11 $ 0.55
Supplemental data:
Operating losses at
new institutes,
before income taxes*
1995 $ 2,091 $ 2,307 $ 1,523 $ 1,202 $ 7,123
1996 $ 1,405 $ 2,230 $ 1,227 $ 859 $ 5,721
*Represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first twenty-four months
after their first class start.
**Restated to reflect stock splits in April 1996 and November 1996.
F-11
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
BY: /s/Rene R. Champagne
---------------------------------------
Dated: March 12, 1997 Rene R. Champagne
Chairman, President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/Rene R. Champagne Chairman, President, Chief March 12, 1997
- --------------------------- Executive Officer and Director
Rene R. Champagne (Principal Executive Officer)
/s/Gene A. Baugh Senior Vice President and Chief March 12, 1997
- --------------------------- Financial Officer (Principal
Gene A. Baugh Financial Officer and Principal
Accounting Officer)
/s/Bette B. Anderson Director March 12, 1997
- ---------------------------
Bette B. Anderson
/s/Rand V. Araskog Director March 12, 1997
- ---------------------------
Rand V. Araskog
/s/Robert A. Bowman Director March 12, 1997
- ---------------------------
Robert A. Bowman
/s/John E. Dean Director March 12, 1997
- ---------------------------
John E. Dean
/s/James D. Fowler, Jr. Director March 12, 1997
- ---------------------------
James D. Fowler, Jr.
/s/Leslie Lenkowsky Director March 12, 1997
- ---------------------------
Leslie Lenkowsky
/s/Richard S. Ward Director March 12, 1997
- ---------------------------
Richard S. Ward
/s/Vin Weber Director March 12, 1997
- ---------------------------
Vin Weber
/s/Margita E. White Director March 12, 1997
- ---------------------------
Margita E. White
S-1
SCHEDULE II
ITT EDUCATIONAL SERVICES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THREE YEARS ENDED DECEMBER 31, 1996
(IN THOUSANDS)
BALANCE AT
BEGINNING CHARGED TO BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES WRITE-OFFS OF PERIOD
- -------------------- ---------- ---------- ---------- --------------
Allowance for Doubtful
Accounts:
Year Ended December 31,
1996 ................ $ 963 $ 1,738 ($ 1,657) $ 1,044
-------- ------- ------- -------
Year Ended December 31,
1995 ................ $ 1,171 $ 1,173 ($ 1,381) $ 963
-------- ------- ------- -------
Year Ended December 31,
1994 ................ $ 1,146 $ 1,803 ($ 1,778) $ 1,171
-------- ------- ------- -------
FFEL Reserve/(1)/:
Year Ended December 31,
1996 ................ $ 955 $ 0 $ 0 $ 955
-------- ------- ------- -------
Year Ended December 31,
1995 ................ $ 893 $ 62 $ 0 $ 955
-------- ------- ------- -------
Year Ended December 31,
1994 ................ $ 834 $ 59 $ 0 $ 893
-------- ------- ------- -------
- ----------------------
(1) Represents Federal Family Education Loan/Perkins Loan programs.
S-2
INDEX TO EXHIBITS
Page
No.
Exhibit In This
No. Description Filing
- ------- ------------------------------------------------------------------------------ -------
3.1 (1) Restated Certificate of Incorporation, as Amended to Date...................
3.2 (2) Amended By-laws.............................................................
10.1 (2) Registration Rights Agreement between the Company and ITT...................
10.2 (2) Tax Sharing Agreement between the Company and ITT...........................
10.3 (2) Intercompany Agreement between the Company and ITT..........................
10.4 (2) Trade Name and Service Mark License Agreement between the Company
and ITT.....................................................................
10.5 (2) Employee Benefits and Administrative Services Agreement between the
Company and ITT.............................................................
10.6 (2) Treasury Services and Credit Facilities Agreement between the Company
and ITT....................................................................
10.7 *(3) ITT Educational Services, Inc. 1994 Stock Option Plan......................
11 Statement re Computation of Per Share Earnings.................................
23 Consent of Price Waterhouse LLP................................................
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.
(1) The copy of this exhibit filed as the same exhibit number to the Company's
1996 second fiscal quarter report on Form 10-Q is incorporated herein by
reference.
(2) The copy of this exhibit filed as the same exhibit number to the Company's
1994 Annual Report on Form 10-K is incorporated herein by reference.
(3) The copy of this exhibit filed as the same exhibit number to the Company's
Registration Statement on Form S-1 (Registration No. 33-78272) is
incorporated herein by reference.
S-3