Prepared by MERRILL CORPORATION

 

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, 2001

 

OR

 

 

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

 

¨

 

23,655,613

 

Number of shares of Common Stock, $.01 par value, outstanding at October 26, 2001

 

 


 

ITT EDUCATIONAL SERVICES, INC.

Indianapolis, Indiana

 

Quarterly Report to Securities and Exchange Commission

September 30, 2001

 

PART I

FINANCIAL INFORMATION

 

Item 1.    FINANCIAL STATEMENTS.

 

INDEX

 

 

 

 

 

Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2001 and 2000

 

 

 

Consolidated Balance Sheets as of September 30, 2001 and 2000 (unaudited) and December 31, 2000

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended
September 30, 2001 and 2000

 

 

 

Consolidated Statements of Shareholders’ Equity for the three months ended March 31,
June 30 and September 30, 2001 (unaudited) and the year ended December 31, 2000

 

 

 

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,

 

 

 

2001

 

2000

 

2001

 

2000

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

106,269

 

$

88,479

 

$

298,509

 

$

252,416

 

 

 

 

 

 

 

 

 

 

 

Costs and Expenses

 

 

 

 

 

 

 

 

 

Cost of educational services

 

63,678

 

53,681

 

185,600

 

157,667

 

Student services and administrative expenses

 

28,740

 

23,337

 

84,336

 

71,800

 

Total costs and expenses

 

92,418

 

77,018

 

269,936

 

229,467

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

13,851

 

11,461

 

28,573

 

22,949

 

Interest income, net

 

946

 

593

 

2,137

 

1,748

 

Income before income taxes and cumulative effect of change in accounting principle

 

14,797

 

12,054

 

30,710

 

24,697

 

Income taxes

 

5,618

 

4,581

 

11,665

 

9,385

 

Income before cumulative effect of change in accounting principle

 

9,179

 

7,473

 

19,045

 

15,312

 

Cumulative effect of change in accounting principle, net of tax

 

--

 

--

 

--

 

(2,776

)

Net income

 

$

9,179

 

$

7,473

 

$

19,045

 

$

12,536

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share (basic):

 

 

 

 

 

 

 

 

 

Income before cumulative effect of change in accounting principle

 

$

0.39

 

$

0.31

 

$

0.80

 

$

0.63

 

Cumulative effect of change in accounting principle, net of tax

 

--

 

--

 

--

 

(0.11

)

Net income

 

$

0.39

 

$

0.31

 

$

0.80

 

$

0.52

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share (diluted):

 

 

 

 

 

 

 

 

 

Income before cumulative effect of change in accounting principle

 

$

0.38

 

$

0.31

 

$

0.79

 

$

0.63

 

Cumulative effect of change in accounting principle, net of tax

 

--

 

--

 

--

 

(0.11

)

Net income

 

$

0.38

 

$

0.31

 

$

0.79

 

$

0.52

 

 

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

 


 

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

 

 

September 30, 2001

 

December 31, 2000

 

September 30, 2000

 

 

 

(unaudited)

 

 

 

(unaudited)

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

69,498

 

$

56,366

 

$

43,730

 

Restricted cash

 

32

 

5,666

 

1,542

 

Marketable debt securities

 

38,789

 

8,586

 

8,350

 

Accounts receivable, net

 

16,147

 

12,414

 

15,873

 

Deferred income tax

 

4,782

 

3,420

 

5,476

 

Prepaids and other current assets

 

8,610

 

6,118

 

7,407

 

Total current assets

 

137,858

 

92,570

 

82,378

 

Property and equipment, net

 

52,228

 

46,560

 

45,808

 

Direct marketing costs

 

10,889

 

10,094

 

9,911

 

Other assets

 

1,297

 

1,672

 

1,731

 

Total assets

 

$

202,272

 

$

150,896

 

$

139,828

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

25,854

 

$

16,274

 

$

22,286

 

Accrued compensation and benefits

 

6,033

 

4,454

 

3,169

 

Other accrued liabilities

 

5,221

 

3,547

 

5,291

 

Deferred tuition revenue

 

66,005

 

55,651

 

43,485

 

Total current liabilities

 

103,113

 

79,926

 

74,231

 

Deferred income tax

 

6,778

 

5,056

 

4,809

 

Other liabilities

 

1,406

 

1,228

 

1,134

 

Total liabilities

 

111,297

 

86,210

 

80,174

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

 

Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued or outstanding

 

--

 

--

 

--

 

Common stock, $.01 par value, 150,000,000 shares authorized, 27,034,452 issued

 

270

 

270

 

270

 

Capital surplus

 

37,022

 

33,938

 

33,938

 

Retained earnings

 

134,999

 

117,115

 

104,942

 

Treasury stock, 3,233,639, 3,537,463 and 3,119,563 shares, at cost

 

(81,316

)

(86,637

)

(79,496

)

Total shareholders' equity

 

90,975

 

64,686

 

59,654

 

Total liabilities and shareholders' equity

 

$

202,272

 

$

150,896

 

$

139,828

 

 

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,

 

 

 

2001

 

2000

 

2001

 

2000

 

Cash flows provided by (used for) operating activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

9,179

 

$

7,473

 

$

19,045

 

$

12,536

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

   

 

   

 

   

 

   

Cumulative effect of change in accounting principle

 

--

 

--

 

--

 

2,776

 

Depreciation and amortization

 

4,395

 

3,493

 

13,599

 

10,570

 

Provision for doubtful accounts

 

1,982

 

1,012

 

5,865

 

3,164

 

Deferred taxes

 

1,593

 

198

 

3,162

 

2,512

 

Increase/decrease in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Marketable debt securities

 

(37,817

)

(142

)

(30,203

)

6,747

 

Accounts receivable

 

(3,826

)

(3,447

)

(9,598

)

(7,352

)

Direct marketing costs

 

(269

)

(554

)

(795

)

(1,199

)

Accounts payable and accrued liabilities

 

9,913

 

5,435

 

10,209

 

(530

)

Prepaids and other assets

 

2,039

 

(574

)

(2,117

)

(3,621

)

Deferred tuition revenue

 

14,699

 

9,229

 

10,354

 

2,443

 

Net cash provided by (used for) operating activities

 

1,888

 

22,123

 

19,521

 

28,046

 

 

 

 

 

 

 

 

 

 

 

Cash flows provided by (used for) investing activities:

 

 

 

 

 

 

 

 

 

Capital expenditures, net

 

(3,610

)

(4,365

)

(19,267

)

(24,692

)

Net cash provided by (used for) investing activities

 

(3,610

)

(4,365

)

(19,267

)

(24,692

)

 

 

 

 

 

 

 

 

 

 

Cash flows provided by (used for) financing activities:

 

 

 

 

 

 

 

 

 

Purchase of treasury stock

 

--

 

--

 

--

 

(11,040

)

Exercise of stock options

 

779

 

94

 

7,244

 

94

 

Net cash flow provided by (used for) financing activities

 

779

 

94

 

7,244

 

(10,946

)

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash, cash equivalents and restricted cash

 

(943

)

17,852

 

7,498

 

(7,592

)

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and restricted cash at beginning of period

 

70,473

 

27,420

 

62,032

 

52,864

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and restricted cash at end of period

 

$

69,530

 

$

45,272

 

$

69,530

 

$

45,272

 

 

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


 

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands)

 

 

 

Common Stock

 

Capital

 

Retained

 

Treasury Stock

 

 

 

Shares

 

Amount

 

Surplus

 

Earnings

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 1999

 

27,034

 

$

270

 

$

33,912

 

$

92,501

 

(2,419

)

$

(68,912

)

Exercise of stock options

 

--

 

--

 

26

 

--

 

4

 

68

 

Purchase of treasury stock

 

--

 

--

 

--

 

--

 

(1,144

)

(18,181

)

Issue treasury stock for employee incentive plan

 

--

 

--

 

--

 

(95

)

22

 

388

 

Net income for 2000

 

--

 

--

 

--

 

24,709

 

--

 

--

 

Balance as of December 31, 2000

 

27,034

 

270

 

33,938

 

117,115

 

(3,537

)

(86,637

)

For the three months ended
March 31, 2001 (unaudited):

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

--

 

--

 

386

 

(219

)

65

 

1,252

 

Issue treasury stock for employee incentive plan

 

--

 

--

 

3

 

--

 

14

 

272

 

Issue treasury stock for outside directors plan

 

--

 

--

 

3

 

--

 

1

 

15

 

Net income

 

--

 

--

 

--

 

4,788

 

--

 

--

 

Balance as of March 31, 2001

 

27,034

 

270

 

34,330

 

121,684

 

(3,457

)

(85,098

)

For the three months ended
June 30, 2001 (unaudited):

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

--

 

--

 

2,304

 

(933

)

198

 

3,382

 

Net income

 

--

 

--

 

--

 

5,078

 

--

 

--

 

Balance as of June 30, 2001

 

27,034

 

270

 

36,634

 

125,829

 

(3,259

)

(81,716

)

For the three months ended
September 30, 2001 (unaudited):

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

--

 

--

 

376

 

(9

)

24

 

394

 

Issue treasury stock for outside directors plan

 

--

 

--

 

12

 

--

 

1

 

6

 

Net income

 

--

 

--

 

--

 

9,179

 

--

 

--

 

Balance as of September 30, 2001

 

27,034

 

$

270

 

$

37,022

 

$

134,999

 

(3,234

)

$

(81,316

)

 

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


ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2001

(Dollar amounts in thousands, unless otherwise stated)

 

 

1.             Basics of Presentation

 

                ITT Educational Services, Inc. (“ESI”) prepared the accompanying unaudited consolidated financial statements in accordance with generally accepted accounting principles for interim periods. In the opinion of management, the financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial condition and results of operations of ESI.  Certain information and footnote disclosures, including significant accounting policies, normally included in 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 ESI’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2000.

 

2.             Accounting Changes

 

                In December 1999, the SEC issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”).  ESI began following the guidance provided by SAB 101 effective January 1, 2000 and recorded a cumulative effect of change in accounting of $4,477, less $1,701 of deferred taxes.  In conformity with SAB 101, ESI changed the method by which it recognizes the laboratory and application fees charged to a student as revenue.  Previously, the quarterly laboratory fee was recognized as revenue at the beginning of each academic quarter and the application fee was recognized as revenue when ESI received the fee.  As of January 1, 2000, application and laboratory fees are recognized as revenue on a straight-line basis over the average program length of 24 months.  If a student discontinues training, all unrecognized revenue relating to those fees is recognized upon the student’s departure.

 

3.             Earnings Per Share

 

                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 ESI common stock outstanding during each period.

 

 

 

Average Shares Outstanding

 

 

 

(in thousands)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2001

 

2000

 

2001

 

2000

 

Basic

 

23,795

 

23,912

 

23,678

 

24,147

 

Diluted

 

24,331

 

24,146

 

24,176

 

24,305

 

 

                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 ESI’s stock option plans less shares assumed to be purchased with proceeds from the exercise of those stock options.

 

4.             Contingencies

 

                ESI has a number of pending legal and other claims arising out of the ordinary course of its business.  Among the legal actions 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 ESI, one of its employees and its independent auditor in connection with how ESI compensated its sales representatives.  The relators seek various forms of recovery on behalf of themselves and the federal government, including: (i) treble the amount of unspecified damages sustained by the federal government; (ii) a civil penalty of up to $10,000 for each violation of the False Claims Act; and (iii) 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.  ESI believes that it has meritorious defenses to the Qui Tam Action and intends to vigorously defend itself against the claims.

 

                As previously reported, in July 2000, ESI received a subpoena from the U.S. Department of Education’s (“DOE”) Office of Inspector General (“OIG”) requesting information that related primarily to the compensation of our sales representatives (the “OIG Investigation”), which ESI now believes resulted from the Qui Tam Action.

 

                As previously reported, in August 2000, the DOE advised ESI that, during the pendency of the OIG Investigation, it will 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).  The DOE has repeatedly told ESI that the DOE is in the process of approving the additional location applications submitted by three ITT Technical Institutes to participate in the federal student financial aid programs under Title IV (“Title IV Programs”) of the Higher Education Act of 1965, as amended (“HEA”).  ESI has not yet received those approvals, however, and does not know when they will be received.

 

                Another pending 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 alleges, 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 ESI and three of its employees who reside in California.  The claims relate primarily to ESI’s marketing and recruitment practices and the quality of its services.  The plaintiffs seek 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 are 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 ESI provides that all disputes between the parties will be resolved through binding arbitration, instead of litigation.  In May 2001, the court compelled the arbitration of each plaintiff’s claims in this action.  ESI believes that it has meritorious defenses and intends to vigorously defend itself against the plaintiffs’ claims.

 

                In the opinion of management, based on the information currently available to it, the ultimate outcome of the pending legal and other claims should not have a material adverse effect on ESI’s 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 Securities and Exchange Commission (“SEC”) for the year ended December 31, 2000 for discussion of, among other matters, the following items:

 

Ÿ

Cash receipts from financial aid programs

Ÿ

Nature of capital additions

Ÿ

Seasonality of revenues

Ÿ

Components of income statement captions

Ÿ

Marketable debt securities and market risk

Ÿ

Changes in federal regulations regarding:

 

Ÿ

Timing of receipt of funds from Title IV Programs

 

Ÿ

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

 

Ÿ

Return of Title IV Program funds for withdrawn students

Ÿ

Default rates

Ÿ

College Advantage Loan Program (“CALP”)

 

 

                In 1998, we began offering an information technology program of study involving computer network systems (“CNS”) at three ITT Technical Institutes.  We began offering the CNS program at an additional 31 ITT Technical Institutes in 1999, at an additional 32 ITT Technical Institutes in the nine months ended September 30, 2000, at an additional three ITT Technical Institutes in the remainder of 2000 and at an additional one ITT Technical Institute in the three months ended March 31, 2001.  We incur a loss with respect to each CNS program offered at an ITT Technical Institute until the revenue from the number of enrolled students is high enough to offset the fixed costs associated with the program (such as salaries, equipment depreciation, rent and marketing), which typically has not occurred until the program has been offered for three or four quarters.  The initial amount of capital required to offer the CNS program at an ITT Technical Institute is approximately $0.2 million.

 

                In 2000, we began offering a computer and electronics engineering technology (“CEET”) program at 34 ITT Technical Institutes and a computer drafting and design (“CDD”) program at 20 ITT Technical Institutes.  In the first quarter of 2001, we began offering the CEET program at an additional 33 ITT Technical Institutes and the CDD program at an additional 28 ITT Technical Institutes.  Following the first quarter of 2001, we began offering these programs as needed at new and additional existing ITT Technical Institutes.

 

Results of Operations

 

Three Months Ended September 30, 2001 Compared with Three Months Ended September 30, 2000

 

                Revenues increased $17.8 million, or 20.1%, to $106.3 million in the three months ended September 30, 2001 from $88.5 million in the three months ended September 30, 2000.  This increase was due primarily to a 5% increase in tuition rates in June 2000 (10% for information technology programs), a 5% increase in tuition rates in September 2001 and a 9.3% increase in the total student enrollment at July 1, 2001 compared to July 1, 2000.  The number of students attending ITT Technical Institutes at July 1, 2001 was 29,522 compared to 27,014 at July 1, 2000.

 

                The total number of new students beginning classes in September 2001 was 10,046 compared to 9,394 in September 2000, an increase of 6.9%.  The total student enrollment on September 30, 2001 was 31,815 compared to 28,639 on September 30, 2000, an increase of 11.1%.

 

                Cost of educational services increased $10.0 million, or 18.6%, to $63.7 million in the three months ended September 30, 2001 from $53.7 million in the three months ended September 30, 2000.  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;

          increased costs at new institutes (one opened in each of March 2000, December 2000 and March 2001); and

          increased costs associated with offering the CNS program at 70 institutes.

 

                Cost of educational services as a percentage of revenues decreased to 59.9% in the three months ended September 30, 2001 from 60.7% in the three months ended September 30, 2000, primarily due to increased revenue without a corresponding proportionate increase in fixed costs at our institutes.

 

                Student services and administrative expenses increased $5.4 million, or 23.2%, to $28.7 million in the three months ended September 30, 2001 from $23.3 million in the three months ended September 30, 2000, primarily due to increased media advertising expenses (up 23.5%) and an increase in bad debt expense.  The increase in bad debt expense primarily resulted from a change in the HEA that reduces the amount of Title IV Program funds that we can retain on behalf of a withdrawing student depending on when the student withdraws during an academic quarter.  Student services and administrative expenses were 27.1% of revenues in the three months ended September 30, 2001 compared to 26.4% in the three months ended September 30, 2000, primarily due to the increase in bad debt expense, increased media advertising expenses, the initial costs to implement our distance education program and costs associated with legal matters.

 

                Operating income increased $2.4 million, or 20.9%, to $13.9 million in the three months ended September 30, 2001 from $11.5 million in the three months ended September 30, 2000.  The operating margin increased to 13.0% of revenues in the three months ended September 30, 2001 from 12.9% in the three months ended September 30, 2000, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the CNS program which has been offered for more than one year (i.e., 66 ITT Technical Institutes began offering the CNS program prior to September 30, 2000).

 

Nine Months Ended September 30, 2001 Compared with Nine Months Ended September 30, 2000

 

                Revenues increased $46.1 million, or 18.3%, to $298.5 million in the nine months ended September 30, 2001 from $252.4 million in the nine months ended September 30, 2000.  This increase was due primarily to a 5% increase in tuition rates in June 2000 (10% for information technology programs), a 5% increase in tuition rates in September 2001, a 4.6% increase in the total student enrollment at January 1, 2001 compared to January 1, 2000, a 9.6% increase in the total enrollment at April 1, 2001 compared to April 1, 2000 and a 9.3% increase in the total student enrollment at July 1, 2001 compared to July 1, 2000.  The number of students attending ITT Technical Institutes at January 1, 2001 was 27,640 compared to 26,428 at January 1, 2000.

 

                The total number of new students beginning classes in the nine months ended September 30, 2001 was 24,327 compared to 22,337 in the nine months ended September 30, 2000, an increase of 8.9%.  The total student enrollment on September 30, 2001 was 31,815 compared to 28,639 on September 30, 2000, an increase of 11.1%.

 

                Cost of educational services increased $27.9 million, or 17.7%, to $185.6 million in the nine months ended September 30, 2001 from $157.7 million in the nine months ended September 30, 2000.  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;

          increased costs at new institutes (one opened in each of March 2000, December 2000 and March 2001); and

          increased costs associated with offering the CNS program at 70 institutes.

 

                Cost of educational services as a percentage of revenues decreased to 62.2% in the nine months ended September 30, 2001 from 62.5% in the nine months ended September 30, 2000, primarily due to increased revenue without a corresponding proportionate increase in fixed costs at our institutes.


                Student services and administrative expenses increased $12.5 million, or 17.4%, to $84.3 million in the nine months ended September 30, 2001 from $71.8 million in the nine months ended September 30, 2000, primarily due to increased media advertising expenses (up 21.1%), an increase in bad debt expense and costs associated with responding to an investigation being conducted by the OIG.  Student services and administrative expenses were 28.2% of revenues in the nine months ended September 30, 2001 compared to 28.4% in the nine months ended September 30, 2000, primarily due to increased revenue without a corresponding proportionate increase in fixed costs at our institutes.

 

                Operating income increased $5.7 million, or 24.9%, to $28.6 million in the nine months ended September 30, 2001 from $22.9 million in the nine months ended September 30, 2000.  The operating margin increased to 9.6% of revenues in the nine months ended September 30, 2001 from 9.1% in the nine months ended September 30, 2000, primarily due to the greater facility and faculty utilization efficiencies associated with the three-day per week class schedule of the CNS program which has been offered for more than one year (i.e., 66 ITT Technical Institutes began offering the CNS program prior to September 30, 2000).

 

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 $30.2 million increase in marketable debt securities) was $49.7 million in the nine months ended September 30, 2001 compared to $21.3 million of net cash provided by operating activities (excluding the $6.7 million decrease in marketable debt securities) in the nine months ended September 30, 2000.  This $28.4 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.

 

                Deferred revenue, which represents the unrecognized portion of revenue received from students, increased to $66.0 million at September 30, 2001 from $43.5 million at September 30, 2000.  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 were $3.6 million in the three months ended September 30, 2001 compared to $4.4 million in the three months ended September 30, 2000.  Capital expenditures decreased to $19.3 million in the nine months ended September 30, 2001 compared to $24.7 million in the nine months ended September 30, 2000, primarily due to capital expenditures incurred in the first half of 2000 for the changes made in our electronics engineering technology curriculum.  We expect that capital expenditures for the full 2001year will be approximately $25 million, which will be approximately $4 million less than 2000.

 

                Capital expenditures for each new institute are approximately $0.4 million.  We expect to be able to fund our planned capital expenditures in 2001 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.

 

                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 of September 30, 2001, 1.9 million shares remain under the existing repurchase authorization.  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 OIG requesting information that related primarily 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.


                As previously reported, in August 2000, the DOE advised us that, during the pendency of the OIG Investigation, it will 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).  The DOE has repeatedly told us that the DOE is in the process of approving the additional location applications submitted by three ITT Technical Institutes to participate in Title IV Programs.  We have not yet received those approvals, however, and do not know when they will be received.

 

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 on 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 OIG Investigation 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, 31 U.S.C. § 3730,  and penalties; our ability to hire and retain qualified faculty; effects of any change in ownership of us resulting in a change in control of us, including, but not limited to, the consequences of such changes on the accreditation and federal and state regulation of our institutes; our ability to implement our growth strategies; receptivity of students and employers to our existing 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 filed 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.

 

 

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 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, 2001.


 

 

SIGNATURES

 

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

 

 

 

ITT Educational Services, Inc.

 

 

 

Date: November 1, 2001

 

 

 

 

 

 

By:

/s/ Gene A. Baugh

 

 

Gene A. Baugh

 

 

Senior Vice President and Chief Financial Officer

 

 

(Duly Authorized Officer and Principal Financial Officer)


 

 

INDEX TO EXHIBITS

 

Exhibit
No.

 


Description

 

10.27

 

*ESI Senior Executive Severance Pay Plan

 

 

 

10.28

 

*ESI Special Senior Executive Severance Pay Plan

 

 

 

11    

 

Statement re Computation of Per Share Earnings

 


*

 

The indicated exhibit is a management contract, compensatory plan or arrangement required to be filed by Item 601 of Regulation S-K.