FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-13144

ITT EDUCATIONAL SERVICES, INC.

(Exact name of registrant as specified in its charter)


Delaware		36-2061311
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

5975 Castle Creek Parkway N. Drive
P.O. Box 50466
Indianapolis, Indiana		46250-0466
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (317) 594-9499

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

45,447,164

Number of shares of Common Stock, $.01 par value, outstanding at September 30, 2002

ITT EDUCATIONAL SERVICES, INC.

Indianapolis, Indiana

Quarterly Report to Securities and Exchange Commission

September 30, 2002

PART I

FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS.

INDEX


Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2002 and 2001


Consolidated Balance Sheets as of September 30, 2002 and 2001 (unaudited) and December 31, 2001

Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2002 and 2001


Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2002, June 30, 2002 and September 30, 2002 (unaudited) and the year ended December 31, 2001


Notes to Consolidated Financial Statements

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(unaudited)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2002		2001		2002		2001

Revenues	$	120,509	$	106,269	$	338,881	$	298,509

Costs and Expenses
Cost of educational services	67,506		63,678		201,405		185,600
Student services and administrative expenses	34,166		28,740		98,642		84,336
Total costs and expenses	101,672		92,418		300,047		269,936

Operating income	18,837		13,851		38,834		28,573

Interest income, net	755		946		2,052		2,137

Income before income taxes	19,592		14,797		40,886		30,710

Income taxes	7,491		5,618		15,625		11,665

Net income	$	12,101	$	9,179	$	25,261	$	19,045

Earnings per common share (a):
Basic	$	0.26	$	0.19	$	0.55	$	0.40
Diluted	$	0.26	$	0.19	$	0.54	$	0.39

(a) Earnings per common share in all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	September 30, 2002			December 31, 2001			September 30, 2001
	(unaudited)						(unaudited)
Assets
Current assets
Cash and cash equivalents	$	94,496		$	63,702		$	69,498
Restricted cash	—			5,462			32
Marketable debt securities	32,080			41,068			38,789
Accounts receivable, net	12,780			12,679			16,147
Deferred and prepaid income tax	3,621			3,989			4,782
Prepaids and other current assets	5,068			7,310			8,610
Total current assets	148,045			134,210			137,858
Property and equipment, net	66,054			49,593			52,228
Direct marketing costs	10,432			10,520			10,889
Other assets	1,313			1,076			1,297
Total assets	$	225,844		$	195,399		$	202,272

Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable	$	25,893		$	16,007		$	25,854
Accrued compensation and benefits	10,668			10,134			6,033
Other accrued liabilities	8,601			5,100			5,221
Deferred revenue	89,475			77,152			66,005
Total current liabilities	134,637			108,393			103,113
Deferred income tax	7,556			7,235			6,778
Other liabilities	1,476			1,583			1,406
Total liabilities	143,669			117,211			111,297

Shareholders’ equity
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued or outstanding	—			—			—
Common stock, $.01 par value, 150,000,000 shares authorized, 54,068,904 issued (a)	540			270			270
Capital surplus	40,135			37,355			37,022
Retained earnings	166,263			148,602			134,999
Accumulated other comprehensive income	(1,837		)	(1,837		)	—
Treasury stock, 8,621,740, 7,748,156 and 6,467,278 shares (a), at cost	(122,926		)	(106,202		)	(81,316		)
Total shareholders’ equity	82,175			78,188			90,975
Total liabilities and shareholders’ equity	$	225,844		$	195,399		$	202,272

(a) The number of shares in all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2002			2001			2002			2001
Cash flows provided by (used for) operating activities:
Net income	$	12,101		$	9,179		$	25,261		$	19,045
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	4,932			4,395			15,697			13,599
Provision for doubtful accounts	1,884			1,982			5,404			5,865
Deferred taxes	128			1,593			665			3,162
Increase/decrease in operating assets and liabilities:
Marketable debt securities	(6,845		)	(37,817		)	8,988			(30,203		)
Accounts receivable	(3,473		)	(3,826		)	(5,505		)	(9,598		)
Direct marketing costs	486			(269		)	88			(795		)
Accounts payable and accrued liabilities	3,202			9,913			14,721			10,209
Prepaids and other assets	2,793			2,039			2,005			(2,117		)
Deferred revenue	12,091			14,699			12,323			10,354
Net cash provided by (used for) operating activities	27,299			1,888			79,647			19,521

Cash flows provided by (used for) investing activities:
Facility purchases	(19,843		)	—			(19,843		)	—
Capital expenditures, net	(3,003		)	(3,610		)	(12,315		)	(19,267		)
Net cash provided by (used for) investing activities	(22,846		)	(3,610		)	(32,158		)	(19,267		)

Cash flows provided by (used for) financing activities:
Purchase of treasury stock	(10,001		)	—			(34,552		)	—
Exercise of stock options	227			779			12,395			7,244
Net cash flow provided by (used for) financing activities	(9,774		)	779			(22,157		)	7,244

Net increase (decrease) in cash, cash equivalents and restricted cash	(5,321		)	(943		)	25,332			7,498

Cash, cash equivalents and restricted cash at beginning of period	99,817			70,473			69,164			62,032

Cash, cash equivalents and restricted cash at end of period	$	94,496		$	69,530		$	94,496		$	69,530

The accompanying notes are an integral part of these financial statements.

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

														Accumulated
														Other
										Compre-				Compre-
	Common Stock			Capital			Retained			hensive				hensive				Treasury Stock
	Shares(a)	Amount		Surplus			Earnings			Income				Income				Shares(a)		Amount			Total

Balance as of December 31, 2000	54,069	$	270	$	33,938		$	117,115										(7,074	)	$	(86,637	)	$	64,686
Exercise of stock options				3,399			(2,227		)									698		7,431			8,603
Issue treasury stock for employee incentive plan				3														28		272			275
Issue treasury stock for board of directors plan				15														4		21			36
Comprehensive income:
Net income for 2001							33,714			$		33,714											33,714
Other comprehensive income, net of tax:
Minimum pension liability adjustment										(1,837			)	$	(1,837		)						(1,837		)
Other comprehensive income										(1,837			)
Comprehensive income										$	31,877
Purchase of treasury stock																		(1,404	)	(27,289		)	(27,289		)
Balance as of December 31, 2001	54,069	270		37,355			148,602							(1,837			)	(7,748	)	(106,202		)	78,188
For the three months ended March 31, 2002 (unaudited):
Exercise of stock options				2,039			(5,434		)									570		11,694			8,299
Issue treasury stock for employee incentive plan							(123		)									48		968			845
Issue treasury stock for board of directors plan																		2		18			18
Purchase of treasury stock																		(1,150	)	(24,551		)	(24,551		)
Net income							6,408																6,408
Balance as of March 31, 2002	54,069	270		39,394			149,453							(1,837			)	(8,278	)	(118,073		)	69,207
For the three months ended June 30, 2002 (unaudited):
2-for-1 stock split		270		(270		)																	—
Exercise of stock options				941			(1,918		)									222		4,846			3,869
Net income							6,753																6,753
Balance as of June 30, 2002	54,069	540		40,065			154,288							(1,837			)	(8,056	)	(113,227		)	79,829
For the three months ended September 30, 2002 (unaudited):
Purchase of treasury stock																		(584	)	(10,001		)	(10,001		)
Exercise of stock options				70			(126		)									17		283			227
Issue treasury stock for board of directors plan																		1		19			19
Net income							12,101																12,101
Balance as of September 30, 2002	54,069	$	540	$	40,135		$	166,263						$		(1,837	)	(8,622	)	$	(122,926	)	$	82,175

(a) The number of shares for all prior periods have been restated to reflect the two-for-one stock split declared on May 10, 2002 that became effective on June 6, 2002.

The accompanying notes are an integral part of these financial statements.

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2002

(Dollar amounts in thousands, unless otherwise stated)

1. Basis of Presentation

We prepared the accompanying unaudited consolidated financial statements in accordance with generally accepted accounting principles for interim periods. In the opinion of our management, the financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial condition and results of operations. Certain information and footnote disclosures, including significant accounting policies, normally included in a complete presentation of financial statements prepared in accordance with generally accepted accounting principles, have been omitted. The interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2001.

2. Earnings Per Share

On May 10, 2002, we declared a two-for-one split of our common stock, effected on June 6, 2002 by payment of a stock dividend to all shareholders of record at the close of business on May 28, 2002 of one share on each one share of our common stock issued and outstanding or held as treasury stock on May 28, 2002. Our earnings per share amounts for all prior periods have been restated to reflect this stock split.

Earnings per common share for all periods have been calculated in conformity with Statement of Financial Accounting Standard No. 128, “Earnings Per Share.” This data is based on historical net income and the average number of shares of our common stock outstanding during each period (as adjusted to reflect the stock split described above).

	Average Shares Outstanding
	(in thousands)
	Three Months Ended September 30,		Nine Months Ended September 30,
	2002	2001	2002	2001
Basic	45,668	47,590	45,914	47,356
Diluted	46,506	48,662	46,968	48,352

The difference in the number of shares used to calculate basic and diluted earnings per share represents the average number of shares assumed issued under our stock option plans less shares assumed to be purchased with proceeds from the exercise of those stock options.

3. Property and Equipment

During the three months ended September 30, 2002, we purchased six of our facilities, which we previously leased under operating lease agreements, for a total of $19.8 million. The estimated useful lives for the buildings that are part of those facilities range from 27 to 40 years.

4. Contingencies

We are subject to litigation in the ordinary course of our business. Among the legal actions currently pending is United States ex rel. Dan Graves and Susan Newman v. ITT Educational Services, Inc., et al. This action is a qui tam action that was filed on November 5, 1999 in the United States District Court for the Southern District of Texas by two former employees (“relators”) on behalf of themselves and the federal government (the “Qui Tam Action”). The Qui Tam Action alleges, among other things, violations of the False Claims Act, 31 U.S.C. § 3730, by us, one of our employees and our independent auditor in connection with how we compensated our sales representatives. The relators seek various forms of recovery on behalf of themselves and the federal government, including: (a) treble the amount of unspecified damages sustained by the federal government; (b) a civil penalty of up to $10,000 for each violation of the False Claims Act; (c) double back pay for Susan Newman; and (d) attorney’s fees, costs and interest.

A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) on behalf of the federal government for an alleged submission to the federal government of a false claim for payment. A qui tam action is always filed under seal and remains under seal until the U.S. Department of Justice (“DOJ”) decides whether to intervene in the litigation. Whenever a relator files a qui tam action, the DOJ typically initiates an investigation in order to determine whether to intervene in the litigation. If the DOJ intervenes, it has primary control over the litigation. If the DOJ declines to intervene, the relator may pursue the litigation on behalf of the federal government and, if successful, receives a portion of the federal government’s recovery. On May 25, 2001, the DOJ declined to intervene in the Qui Tam Action. On March 31, 2002, the court dismissed all of the claims against all of the defendants for failure to allege facts sufficient to support their claims and gave the relators 20 days to file an amended complaint. The relators filed an amended complaint on April 22, 2002 against all of the defendants. We believe that we have meritorious defenses to the Qui Tam Action and, if the action proceeds, we intend to vigorously defend ourselves against the claims.

The DOE is currently investigating our method of compensation for employees involved in student recruitment. In August 2000, the DOE advised us that, during the pendency of its investigation, it would not approve any application submitted by any ITT Technical Institute with respect to any change of ownership, additional location, certification of initial or continuing eligibility, or extension of course or program offerings (such as raising the level of programs offered at an institution). During December 2001 and January 2002, however, the DOE recertified all of our ITT Technical Institute campus groups to participate in Title IV Programs. In addition, as part of the recertification, the DOE approved (a) five ITT Technical Institutes as new additional locations of existing main campuses and (b) an increase in the level of program offerings from associate degree to bachelor degree at one of our campus groups. In the third quarter of 2002, the DOE also approved (i) two ITT Technical Institutes as new additional locations of existing main campuses and (ii) an increase in the level of program offerings from associate degree to bachelor degree at two of our campus groups. Nevertheless, we cannot assure you that the DOE will, during the pendency of its investigation, approve any further applications submitted by any ITT Technical Institute with respect to any change of ownership, additional location, certification of initial or continuing eligibility or extension of course or program offerings. A material adverse effect on our expansion plans, financial condition, results of operations and cash flows would result if the DOE’s restrictions are not lifted prior to 2005. We cannot assure you that the DOE will lift its restrictions prior to 2005 or that the DOE will not place additional or other more severe restrictions on our ITT Technical Institutes’ ability to participate in Title IV Programs.

Another legal action is Contreras, et al. v. ITT Educational Services, Inc., et al., which was filed on March 3, 2000 (served on January 19, 2001) in the Superior Court of Santa Clara County in Santa Clara, California by five former students of the ITT Technical Institute in Santa Clara, California. The suit alleged, among other things, fraud, negligence, negligent misrepresentation, breach of oral contract, and statutory violations of the California Business and Professions Code and California Education Code by us and three of our employees who reside in California. The claims related primarily to our marketing and recruitment practices and the quality of our services. The plaintiffs sought compensatory damages, punitive damages, exemplary damages, civil penalties, restitution on behalf of the plaintiffs and all other persons similarly situated, injunctive relief, attorney’s fees and costs. On February 6, 2001, the plaintiffs filed an amended complaint in this action adding 57 plaintiffs, who were current and former students of the ITT Technical Institute in either Santa Clara, California or Hayward, California. The written enrollment agreement between each of the plaintiffs and us provided that all disputes between the parties would be resolved through binding arbitration, instead of litigation. In May 2001, the court compelled the arbitration of each plaintiff’s claims in this action. In July 2002, we agreed to settle the claims of 58 of the plaintiffs for an amount that was not material. In September 2002, the court dismissed the claims of the remaining four plaintiffs without prejudice.

In the opinion of our management, based on the information currently available to them, the ultimate outcome of the pending legal and other claims should not have a material adverse effect on our financial condition, results of operations or cash flows.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the same titled section contained in our Annual Report on Form 10-K as filed with the SEC for the year ended December 31, 2001 for discussion of, among other matters, the following items:

• Cash receipts from financial aid programs

• Nature of capital additions

• Seasonality of revenues

• Components of income statement captions

• Marketable debt securities and market risk

• Federal regulations regarding:

• Timing of receipt of funds from the federal student financial aid programs under Title IV of the Higher Education Act of 1965, as amended (the “Title IV Programs”)

• Percentage of applicable revenues that may be derived from Title IV Programs

• Return of Title IV Program funds for withdrawn students

• Default rates

• College Advantage Loan Program (“CALP”)

• Our programs in information technology (“IT”), computer and electronics engineering technology (“CEET”) and computer drafting and design (“CDD”)

Critical Accounting Policies and Estimates

This management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and contingent assets and liabilities. Actual results may differ from those estimates and judgments under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. These policies should be read in conjunction with Note 2 of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K as filed with the SEC for the year ended December 31, 2001.

Property and Equipment. We include 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. The estimated useful lives for our furniture and equipment and leasehold improvements generally range from three to ten years. The estimated useful lives for the buildings that are part of our facilities generally range from 27 to 40 years. We apply the American Institute of Certified Public Accountants (the “AICPA”) Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” The estimated useful lives for our capitalized software generally range from three to eight years. 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. Changes in circumstances, such as changes in our curricula and technological advances, may result in the actual useful lives of our property, equipment and capitalized software differing from our estimates. We regularly review and evaluate the estimated useful lives of our property and equipment and capitalized software. Although we believe our assumptions and estimates are reasonable, deviations from our assumptions and estimates could produce a materially different result.

Recognition of Revenues. Tuition revenues are recorded on a straight-line basis over the length of the applicable course. If a student discontinues training, the tuition revenue related to the remainder of that academic quarter is recorded with the amount of refund resulting from the application of federal, state or accreditation requirements or our refund policy 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 revenue. Textbook sales and the related cost of the textbooks are recognized at the beginning of each academic quarter with respect to students who are attending courses in which textbooks are charged separately from tuition. For those students who are attending courses in which the cost of textbooks is included in the tuition, the cost of the textbooks is amortized on a straight-line basis over the applicable course length and the deferral of textbook costs is recorded in

prepaids and other current assets. Academic fees (which are charged only one time to students on their first day of class attendance), application fees and laboratory fees are recognized as revenue on a straight-line basis over the average course length of 24 months. If a student discontinues training, all unrecognized revenue relating to his or her fees is recognized upon the student’s departure. More than 95% of our revenues represent tuition charges and less than 5% of our revenues represent bookstore sales and student fees. The amount of tuition earned depends on the cost per credit hour of the courses in the program, the number of courses in the program, how long a student remains enrolled in the program, how many program courses a student takes during each period of enrollment in the program, and the total number of students enrolled in each program. Each of these factors is known at the time our tuition revenues are calculated and is not subject to estimation.

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 application fees. Successful efforts is the ratio of students enrolled to prospective students interviewed. Direct marketing costs are amortized on an accelerated basis over the average course length of 24 months commencing on the start date. The higher the rate of interviewed students who enroll, the greater the percentage of our direct marketing costs that are capitalized. The direct costs subject to capitalization are readily quantifiable and are not subject to estimation. The amortization method is based on historical trends of student enrollment activity and is not subject to significant assumptions. We regularly evaluate the future recoverability of these deferred costs.

Results of Operations

Three Months Ended September 30, 2002 Compared with Three Months Ended September 30, 2001

Revenues increased $14.2 million, or 13.4%, to $120.5 million in the three months ended September 30, 2002 from $106.3 million in the three months ended September 30, 2001. This increase was due primarily to a 7% increase in tuition rates in March 2002 and a 6.9% increase in the total student enrollment at July 1, 2002 compared to July 1, 2001. The number of students attending ITT Technical Institutes at July 1, 2002 was 31,557 compared to 29,522 at July 1, 2001.

The total number of new students beginning classes in the three months ended September 30, 2002 was 10,660, compared to 10,046 in the three months ended September 30, 2001. The total student enrollment on September 30, 2002 was 33,799, compared to 31,815 on September 30, 2001, an increase of 6.2%.

Cost of educational services increased $3.8 million, or 6.0%, to $67.5 million in the three months ended September 30, 2002 from $63.7 million in the three months ended September 30, 2001. The principal causes of this increase include:

• the costs required to service the increased enrollment;

• normal inflationary cost increases for wages, rent and other costs of services; and

• increased costs due to opening new institutes (one opened in March 2001, one opened in June 2002 and three opened in September 2002).

Cost of educational services as a percentage of revenues decreased to 56.0% in the three months ended September 30, 2002 from 59.9% in the three months ended September 30, 2001. This decrease was primarily due to:

• the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs;

• certain fixed costs at our institutes did not increase proportionately with increases in our revenues resulting from a larger number of students; and

• a reduction of rent expense that resulted from our purchase of six facilities that we had previously leased in the three months ended September 30, 2002.

Student services and administrative expenses increased $5.5 million, or 19.2%, to $34.2 million in the three months ended September 30, 2002 from $28.7 million in the three months ended September 30, 2001, primarily due to increased media advertising expenses (up 28.2%). Student services and administrative expenses increased to 28.4% of revenues in the three months ended September 30, 2002 from 27.1% in the three months ended September 30, 2001, primarily due to the increased media advertising expenses offset by a reduction in bad debt expense from 1.9% of revenues in the three months ended September 30, 2001 to 1.6% of revenues in the three months ended September 30, 2002.

Operating income increased $4.9 million, or 35.3%, to $18.8 million in the three months ended September 30, 2002 from $13.9 million in the three months ended September 30, 2001. The operating margin increased to 15.6% of revenues in the three months ended September 30, 2002 from 13.0% in the three months ended September 30, 2001, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs.

Our combined effective federal and state income tax rate for the three months ended September 30, 2002 was 38.2% compared to 38.0% for the three months ended September 30, 2001.

Nine Months Ended September 30, 2002 Compared with Nine Months Ended September 30, 2001

Revenues increased $40.4 million, or 13.5%, to $338.9 million in the nine months ended September 30, 2002 from $298.5 million in the nine months ended September 30, 2001. This increase was due primarily to a 7% increase in tuition rates in March 2002, an 11.4% increase in the total student enrollment at January 1, 2002 compared to January 1, 2001 and a 6.9% increase in total student enrollment at July 1, 2002 compared to July 1, 2001. The number of students attending ITT Technical Institutes at January 1, 2002 was 30,778 compared to 27,640 at January 1, 2001.

The total number of new students beginning classes in the nine months ended September 30, 2002 was 25,051, compared to 24,327 in the nine months ended September 30, 2001. The total student enrollment on September 30, 2002 was 33,799, compared to 31,815 on September 30, 2001, an increase of 6.2%.

Cost of educational services increased $15.8 million, or 8.5%, to $201.4 million in the nine months ended September 30, 2002 from $185.6 million in the nine months ended September 30, 2001. The principal causes of this increase include:

• the costs required to service the increased enrollment;

• normal inflationary cost increases for wages, rent and other costs of services; and

• increased costs due to opening new institutes (one opened in March 2001, one opened in June 2002 and three opened in September 2002).

Cost of educational services as a percentage of revenues decreased to 59.4% in the nine months ended September 30, 2002 from 62.2% in the nine months ended September 30, 2001. This decrease was primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs, and because certain fixed costs at our institutes did not increase proportionately with increases in our revenues resulting from a larger number of students.

Student services and administrative expenses increased $14.3 million, or 17.0%, to $98.6 million in the nine months ended September 30, 2002 from $84.3 million in the nine months ended September 30, 2001, primarily due to increased media advertising expenses (up 27.9%). Student services and administrative expenses increased to 29.1% of revenues in the nine months ended September 30, 2002 from 28.2% in the nine months ended September 30, 2001, primarily due to the increased media advertising expenses offset by a reduction in bad debt expense from 2.0% of revenues in the nine months ended September 30, 2001 to 1.6% of revenues in the nine months ended September 30, 2002.

Operating income increased $10.2 million, or 35.7%, to $38.8 million in the nine months ended September 30, 2002 from $28.6 million in the nine months ended September 30, 2001. The operating margin increased to 11.5% of revenues in the nine months ended September 30, 2002 from 9.6% in the nine months ended September 30, 2001, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the IT, CEET and CDD programs.

Our combined effective federal and state income tax rate for the nine months ended September 30, 2002 was 38.2% compared to 38.0% for the nine months ended September 30, 2001.

Financial Condition, Liquidity and Capital Resources

Due to the seasonal pattern of enrollments and our receipt of tuition payments, comparisons of financial position and cash generated from operations should be made both to the end of the previous year and to the corresponding period during the previous year.

Net cash provided by operating activities (excluding the $9.0 million decrease in marketable debt securities) was $70.7 million in the nine months ended September 30, 2002, compared to $49.7 million of net cash provided from operating activities

(excluding the $30.2 million increase in marketable debt securities) in the nine months ended September 30, 2001. This $21.0 million increase was primarily due to higher cash flows from operations resulting from the increase in income and accelerated cash collections from students associated with their use of the CALP.

In the three months ended December 31, 2001, we recorded a $3.0 million minimum liability adjustment with respect to our obligations under the ESI Pension Plan. This $3.0 million adjustment resulted in a $3.0 million increase in accrued compensation and benefits and a corresponding $1.8 million reduction in shareholders’ equity, which is net of a $1.2 million deferred tax asset, as of September 30, 2002 and December 31, 2001.

Deferred revenue, which represents the unrecognized portion of revenue received from students, increased $23.5 million to $89.5 million at September 30, 2002 from $66.0 million at September 30, 2001. This increase was primarily due to the students’ use of the CALP and increased tuition revenue resulting from higher tuition rates and a larger number of students.

Capital expenditures (excluding facility purchases) were $12.3 million in the nine months ended September 30, 2002 compared to $19.3 million in the nine months ended September 30, 2001. This decrease was primarily due to $7.0 million of capital expenditures in the nine months ended September 30, 2001 to replace computer equipment used in the computer-aided drafting technology program with computer equipment that can also be used in the CDD and IT programs. We expect that capital expenditures (excluding facility purchases) for the full 2002 year will be approximately $15 to $18 million.

During the three months ended September 30, 2002, we purchased six of our facilities for a total of $19.8 million. Previously, we leased these facilities under operating lease agreements. We do not plan to purchase any additional facilities in 2002.

Capital expenditures for each new institute are approximately $0.4 million, and the capital expenditures for each new curriculum at an existing institute are approximately $0.3 million. We expect to be able to fund our planned capital expenditures for the remainder of 2002 from cash flows from operations.

Cash flows on a long-term basis are highly dependent upon the receipt of Title IV Program funds and the amount of funds spent on new institutes, curricula additions at existing institutes and possible acquisitions.

We currently lease most of our 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 14 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 we have not entered into any significant guarantees related to the leases. We are required to make additional payments under the operating lease terms for taxes, insurance and other operating expenses incurred during the operating lease period.

Future minimum rental payments (in thousands) that were required under operating leases that had initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2001 are as follows and include the rental payments required under the operating leases related to the six facilities that we purchased in the three months ended September 30, 2002:

2002	$	27,679
2003	28,108
2004	26,414
2005	17,102
2006	13,080
Later Years	33,051
	$	145,434

We do not have any off-balance sheet arrangements or any other significant long-term obligations, lines of credit, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments. There are no commitments or guarantees that provide for the potential issuance of shares of our common stock.

On May 10, 2002, we declared a two-for-one split of our common stock, effected on June 6, 2002 by payment of a stock dividend to all shareholders of record at the close of business on May 28, 2002 of one share on each one share of our common stock issued and outstanding or held as treasury stock on May 28, 2002 (“Stock Split”). Our earnings per share amounts for all prior periods have been restated to reflect the Stock Split.

During 1999 and 2000, our Board of Directors authorized us to repurchase in aggregate up to 4.0 million shares of our common stock (as adjusted by our Board of Directors to give effect to the Stock Split). On October 15, 2002 our Board of Directors authorized us to repurchase an additional 5.0 million shares of our common stock. In the three months ended September 30, 2002, we repurchased 584,300 shares of our common stock at an average cost of $17.12 per share, or $10.0 million in total. In the nine months ended September 30, 2002, we repurchased 1,734,300 shares of our common stock at an average cost of $19.92 per share after giving effect to the Stock Split, or $34.6 million in total. As of October 15, 2002, 5,734,300 shares remain under the existing repurchase authorizations. We may repurchase the shares of our common stock in the open market or through privately negotiated transactions in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended. We may elect to repurchase additional shares of our common stock from time to time in the future, depending on market conditions and other considerations. The purpose of the stock repurchase is to help us achieve our long-term goal of enhancing shareholder value.

As previously reported, in July 2000, we received a subpoena from the DOE requesting information that related to the compensation of our sales representatives, which we now believe resulted from the Qui Tam Action. See Note 4 of the Notes to Consolidated Financial Statements for a discussion of this investigation and its potential effect on our expansion plans, financial condition, results of operations and cash flows.

Forward-Looking Statements

All statements, trend analyses and other information contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements are made based upon our management’s current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those anticipated by our management.

These forward-looking statements involve a number of risks and uncertainties. Among the factors that could cause actual results to differ materially are the following:

• business conditions and growth in the postsecondary education industry and in the general economy;

• changes in federal and state governmental regulations with respect to education and accreditation standards, or the interpretation or enforcement thereof, including, but not limited to, the level of government funding for, and our eligibility to participate in, student financial aid programs utilized by our students;

• the results of the investigation being conducted by the DOE which, if adversely determined, could cause the DOE to subject us to monetary fines or penalties or other sanctions (including a limitation, suspension or termination of our ability to participate in federal student financial aid programs) that could adversely affect our ability to enroll students, expand the number of our institutes and increase the number of the programs of study offered at our institutes;

• the results of the Qui Tam Action which, if adversely determined, could result in a demand for repayment of Title IV Program funds, trebled under the False Claims Act and penalties;

• our ability to hire and retain qualified faculty;

• effects of any change in our ownership resulting in a change in control, including, but not limited to, the consequences of such changes on the accreditation and federal and state regulation of the institutes;

• our ability to implement our growth strategies;

• receptivity of students and employers to our existing technology-oriented program offerings and new curricula; and

• loss of lender access to our students for student loans.

Readers are also directed to other risks and uncertainties discussed in other documents we file with the SEC. We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

Item 4. CONTROLS AND PROCEDURES.

We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. Based on that evaluation, our Chairman and Chief Executive Officer and Senior Vice President and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

There have been no significant changes in our internal controls or other factors that could significantly affect those controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II

OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

The information set forth in Note 4 of the Notes to Consolidated Financial Statements set forth elsewhere in this report is incorporated herein by reference.

We cannot assure you of the ultimate outcome of any litigation involving us. Based on the information currently available to us, we do not believe any pending legal proceeding will result in a judgment or settlement that will have, after taking into account our existing insurance and provisions for such liabilities, a material adverse effect on our financial condition, results of operations or cash flows. Any litigation alleging violations of education or consumer protection laws and/or regulations, misrepresentation, fraud or deceptive practices may also subject our affected institutes to additional regulatory scrutiny.

Item 5. OTHER INFORMATION.

The Audit Committee of our Board of Directors has approved the following audit and non-audit services to be performed for us by our independent accountants, PricewaterhouseCoopers, LLP:

(a) accounting and audit related services, including auditing our financial statements included in our annual report on Form 10-K which is filed with the SEC, reviewing our financial statements included in our quarterly reports on Form 10-Q which are filed with the SEC, supplying us with technical accounting guidance and conducting special audit projects;

(b) compliance audits relating to our participation in federal and state student financial aid programs;

(d) federal, state and international tax planning services; and

(e) audits of our employee benefit plans.

Item 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits.

A list of exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which immediately precedes the exhibits, and is incorporated herein by reference.

(b) Reports on Form 8-K.

No reports on Form 8-K were filed during the quarter ended September 30, 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ITT Educational Services, Inc.

Date: October 18, 2002

	By:	/s/ Gene A. Baugh
	Gene A. Baugh
	Senior Vice President and Chief Financial Officer
	(Duly Authorized Officer and Principal Financial Officer)

CERTIFICATIONS

I, Rene R. Champagne, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ITT Educational Services, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

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the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 18, 2002

	/s/ Rene R. Champagne
	Chairman and Chief Executive Officer

I, Gene A. Baugh, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ITT Educational Services, Inc.;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 18, 2002

	/s/ Gene A. Baugh
	Senior Vice President and Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit
No.		Description
3.2		Restated By-laws, as Amended to Date

10.32		* Second Amendment to ESI Excess Savings Plan

11		Statement re Computation of Per Share Earnings

99.1		Chief Executive Officer’s Certification Pursuant to 18 U.S.C. Section 1350

99.2		Chief Financial Officer’s Certification Pursuant to 18 U.S.C. Section 1350

* The indicated exhibit is a management contract, compensatory plan or arrangement

required to be filed by Item 601 of Regulation S-K.

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