UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

_________________________

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2008

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 incorporation or organization)

 

(I.R.S. Employer Identification No.)

13000 North Meridian Street
Carmel, Indiana

 

46032-1404

(Address of principal executive offices)

 

(Zip Code)

Registrant's telephone number, including area code: (317) 706-9200

     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 o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

            Large accelerated filer x

Accelerated filer o

Non-accelerated filer o (Do not check if
       a smaller reporting
       company)

Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o

No x

     38,833,443

Number of shares of Common Stock, $.01 par value, outstanding at June 30, 2008


ITT EDUCATIONAL SERVICES, INC.

Carmel, Indiana

Quarterly Report to Securities and Exchange Commission

June 30, 2008

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

Index

 Condensed Consolidated Balance Sheets as of June 30, 2008 and 2007 (unaudited) and
December 31, 2007

     Condensed Consolidated Statements of Income (unaudited) for the three and six months ended

     June 30, 2008 and 2007

     Condensed Consolidated Statements of Cash Flows (unaudited) for the three and six months ended

     June 30, 2008 and 2007

     Condensed Consolidated Statements of Shareholders’ Equity for the six months ended

     June 30, 2008 and 2007 (unaudited) and the year ended December 31, 2007

     Notes to Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-1-

 


 

ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

 

 

 

As of

 

 

 

June 30, 2008

 

December 31, 2007

 

June 30, 2007

 

(unaudited)

 

 

 

(unaudited)

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

$78,691

 

$7,228

 

$10,079

Short-term investments

170,500

 

303,360

 

290,285

Accounts receivable, net

29,198

 

15,132

 

9,930

Deferred income taxes

11,776

 

7,418

 

9,464

Prepaid expenses and other current assets

10,771

 

16,685

 

25,470

Total current assets

300,936

 

349,823

 

345,228

 

 

 

 

 

 

Property and equipment, net

162,987

 

153,265

 

151,309

Direct marketing costs, net

21,963

 

20,567

 

21,207

Other assets

18,675

 

17,298

 

11,304

Total assets

$504,561

 

$540,953

 

$529,048

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

$--

 

$--

 

$21,429

Accounts payable

54,409

 

45,120

 

60,117

Accrued compensation and benefits

20,823

 

16,137

 

14,129

Accrued income taxes

5,443

 

6,028

 

--

Other accrued liabilities

13,198

 

11,512

 

12,110

Deferred revenue

138,338

 

213,127

 

192,392

Total current liabilities

232,211

 

291,924

 

300,177

       

 

 

Long-term debt

150,000

 

150,000

 

128,571

Deferred income taxes

10,818

 

11,754

 

11,855

Other liabilities

18,486

 

16,717

 

15,116

Total liabilities

411,515

 

470,395

 

455,719

           

Shareholders' equity:

         

Preferred stock, $.01 par value,

         

5,000,000 shares authorized, none issued

--

 

--

 

--

Common stock, $.01 par value, 300,000,000

         

shares authorized, 54,068,904 issued

541

 

541

 

541

Capital surplus

131,389

 

127,017

 

110,082

Retained earnings

620,901

 

531,363

 

479,372

Accumulated other comprehensive (loss)

(3,417)

 

(3,417)

 

(6,364)

Treasury stock, 15,235,461, 14,375,582

 

 

 

 

 

and 13,702,384 shares, at cost

(656,368)

 

(584,946)

 

(510,302)

Total shareholders' equity

93,046

 

70,558

 

73,329

Total liabilities and shareholders' equity

$504,561

 

$540,953

 

$529,048

 

 

 

 

 

 

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

 

-2-


ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)

(unaudited)

 
 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2008

 

2007

 

2008

 

2007

Revenue

$246,411

 

$216,982

 

$481,261

 

$421,152

Costs and expenses:

             

Cost of educational services

95,183

 

90,581

 

187,208

 

181,351

Student services and administrative
     expenses

74,910

 

68,725

 

149,036

 

138,018

Total costs and expenses

170,093

 

159,306

 

336,244

 

319,369

Operating income

76,318

 

57,676

 

145,017

 

101,783

Interest income

1,177

 

2,798

 

3,210

 

5,747

Interest (expense)

(1,057)

 

(2,078)

 

(2,576)

 

(4,183)

Income before provision for income
      taxes

76,438

 

58,396

 

145,651

 

103,347

Provision for income taxes

29,307

 

22,538

 

55,888

 

39,892

Net income

$47,131

 

$35,858

 

$89,763

 

$63,455

 

             

Earnings per share:

             

Basic

$1.21

 

$0.89

 

$2.30

 

$1.56

Diluted

$1.20

 

$0.87

 

$2.28

 

$1.53

               

Weighted average shares
    outstanding:

             

Basic

38,842

 

40,449

 

39,020

 

40,682

Diluted

39,167

 

41,110

 

39,339

 

41,350

 

             

 

             
               
               
               
               
               
               
               
               

 

             

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

 

-3-


ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(unaudited)

               
 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2008

 

2007

 

2008

 

2007

Cash flows from operating activities:

             

Net income

$47,131

 

$35,858

 

$89,763

 

$63,455

Adjustments to reconcile net income to net
          cash flows from operating activities:

             

Depreciation and amortization

5,763

 

6,099

 

11,257

 

12,740

Provision for doubtful accounts

9,685

 

5,349

 

16,618

 

9,990

Deferred income taxes

(3,666)

 

(2,945)

 

(5,303)

 

(6,551)

Excess tax benefit from stock option
                   exercises

(54)

 

(12,224)

 

(87)

 

(23,274)

Stock-based compensation expense

1,928

 

1,196

 

4,103

 

3,171

Changes in operating assets and liabilities:

             

Restricted cash

(159)

 

(7)

 

5,858

 

(13)

Accounts receivable

(23,811)

 

(5,421)

 

(30,684)

 

(10,553)

Direct marketing costs, net

(659)

 

353

 

(1,396)

 

421

Accounts payable

(2,395)

 

3,730

 

9,286

 

12,169

Accrued income taxes

(18,626)

 

(5,259)

 

(485)

 

7,239

Other operating assets and liabilities

2,160

 

1,316

 

6,882

 

14

Deferred revenue

(65,310)

 

(13,378)

 

(74,789)

 

(9,770)

Net cash flows from operating activities

(48,013)

 

14,667

 

31,023

 

59,038

               

Cash flows from investing activities:

             

Facility expenditures and land purchases

(6,896)

 

(3,778)

 

(13,189)

 

(8,696)

Capital expenditures, net

(5,286)

 

(4,423)

 

(7,790)

 

(6,942)

Proceeds from sales and maturities of
          investments

180,430

 

593,489

 

471,805

 

1,184,306

Purchase of investments

(138,845)

 

(542,314)

 

(338,945)

 

(1,279,584)

Net cash flows from investing activities

29,403

 

42,974

 

111,881

 

(110,916)

 

             

Cash flows from financing activities:

             

Excess tax benefit from stock option exercises

54

 

12,224

 

87

 

23,274

Proceeds from exercise of stock options

234

 

7,916

 

275

 

17,541

Repurchase of common stock

--

 

(75,714)

 

(71,803)

 

(140,763)

Net cash flows from financing activities

288

 

(55,574)

 

(71,441)

 

(99,948)

 

             

Net change in cash and cash equivalents

(18,322)

 

2,067

 

71,463

 

(151,826)

 

             

Cash and cash equivalents at beginning of period

97,013

 

8,012

 

7,228

 

161,905

 

             

Cash and cash equivalents at end of period

$78,691

 

$10,079

 

$78,691

 

$10,079

 

   

 

     

 

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

 

-4-


ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(Dollars and shares in thousands)

                   
                 

Accumulated

 

Common Stock

 

Capital

 

Retained

 

Other

Comprehensive

 

Common Stock in Treasury

 
 

Shares

 

Amount

 

Surplus

 

Earnings

 

Income/(Loss)

 

Shares

 

Amount

 

Total

Balance as of December 31, 2006

54,069

 

$541

 

$83,329

 

$471,848

 

($6,533)

 

(13,029)

 

($445,240)

 

$103,945

Effect of adoption of FIN No. 48

           

2,169

             

2,169

Balance as of January 1, 2007

54,069

 

541

 

83,329

 

474,017

 

(6,533)

 

(13,029)

 

(445,240)

 

106,114

For the six months ended June 30,
   2007 (unaudited):

                             

Net income

           

63,455

             

63,455

Other comprehensive income:

                             

Amortization of pension loss, net
   of income tax

               

169

         

169

Comprehensive income

                           

63,624

Exercise of stock options

           

(58,100)

     

856

 

75,641

 

17,541

Tax benefit from exercise of stock
         options

       

23,582

                 

23,582

Stock-based compensation

       

3,171

                 

3,171

Common shares repurchased

                   

(1,530)

 

(140,763)

 

(140,763)

Issuance of shares for Directors’
        compensation

                   

1

 

60

 

60

Balance as of June 30, 2007

54,069

 

541

 

110,082

 

479,372

 

(6,364)

 

(13,702)

 

(510,302)

 

73,329

For the six months ended December 31,
   
2007 (unaudited):

                             

Net income

           

88,137

             

88,137

Other comprehensive income:

                             

Amortization of pension loss, net
    of tax

               

182

         

182

Net actuarial pension gain

               

2,765

         

2,765

Comprehensive income

                           

91,084

Exercise of stock options

       

(77)

 

(36,146)

     

458

 

49,684

 

13,461

Tax benefit from exercise of stock
          options

       

15,006

                 

15,006

Stock-based compensation

       

1,929

                 

1,929

Common shares repurchased

                   

(1,129)

 

(124,231)

 

(124,231)

Restricted stock cancellations and
          shares tendered for taxes

       

77

         

(2)

 

(97)

 

(20)

Balance as of December 31, 2007

54,069

 

541

 

127,017

 

531,363

 

(3,417)

 

(14,375)

 

(584,946)

 

70,558

For the six months ended June 30, 2008
    (unaudited):

                             

Net income

           

89,763

             

89,763

Other comprehensive income

                           

--

Comprehensive income

                           

89,763

Exercise of stock options

           

(200)

     

7

 

475

 

275

Tax benefit from exercise of stock
          options

       

90

                 

90

Stock-based compensation

       

4,103

                 

4,103

Common shares repurchased

                   

(865)

 

(71,803)

 

(71,803)

Issuance of shares for Directors’
         
compensation

           

(25)

     

1

 

85

 

60

Restricted stock cancellations

       

179

         

(3)

 

(179)

 

--

Balance as of June 30, 2008

54,069

 

$541

 

$131,389

 

$620,901

 

($3,417)

 

(15,235)

 

($656,368)

 

$93,046

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

 

 

-5-


ITT EDUCATIONAL SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Dollars in thousands, except per share data and unless otherwise stated)

1.     

The Company and Basis of Presentation


We are a leading provider of technology-oriented postsecondary education in the United States based on revenue and student enrollment. As of June 30, 2008, we were offering master, bachelor and associate degree programs to more than 54,000 students. As of June 30, 2008, we had 102 institutes and nine learning sites located in 35 states. All of our institutes are authorized by the applicable education authorities of the states in which they operate and are accredited by an accrediting commission recognized by the U.S. Department of Education ("ED"). We have provided career-oriented education programs since 1969 under the “ITT Technical Institute” name. Our corporate headquarters are located in Carmel, Indiana.

The accompanying unaudited condensed consolidated financial statements include our wholly-owned subsidiaries' accounts and have been prepared in accordance with generally accepted accounting principles in the United States of America for interim periods and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, including significant accounting policies, normally included in a complete presentation of financial statements prepared in accordance with those principles, rules and regulations have been omitted. The Condensed Consolidated Balance Sheet as of December 31, 2007 was derived from audited financial statements but, as presented in this report, may not include all disclosures required by accounting principles generally accepted in the United States. In the opinion of our management, the financial statements contain all adjustments necessary to fairly state our financial condition and results of operations. The interim financial information should be read in conjunction with the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K as filed with the SEC for the year ended December 31, 2007.

As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, we revised the classification for losses from the sale of treasury stock. Our June 30, 2007 retained earnings balance decreased and capital surplus balance increased by $94,447 from those balances reported in our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2007 to conform to this revised classification. The revised classification did not have an effect on our total shareholders’ equity, results of operations or cash flows.

2.     

Summary of Certain Accounting Policies


Accounts Receivable and Allowance for Doubtful Accounts. We extend unsecured credit to our students for tuition and fees and we record a receivable for the tuition and fees earned in excess of the payment received from or on behalf of a student. The individual student balances of these receivables are insignificant. We record an allowance for doubtful accounts with respect to accounts receivable on an institute-by-institute basis. We review the historical collection experience for each institute, consider other facts and circumstances related to an institute and record an allowance for doubtful accounts based on that review and consideration.

During the second quarter of 2008, we extended larger amounts of unsecured credit to our students due to a decrease in private education loans made to our students by third-party lenders. We categorized these receivables based on the credit profiles of our students and recorded an allowance for doubtful accounts based on our historical collection experience related to amounts owed by students with similar credit profiles.

If our collection trends were to differ significantly from our historical collection experience, we would make a corresponding adjustment to our allowance for doubtful accounts. We write off the accounts receivable due from former students when we conclude that collection is not probable.

Fair Value. In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 was effective for us on January 1, 2008. This pronouncement did not have any effect on our condensed consolidated financial statements, because we did not elect the fair value methodology under SFAS No. 159 for any of our financial instruments or other items that are not currently required to be measured at fair value.

 

- 6 -


Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), for financial assets and financial liabilities measured on a recurring basis. This statement defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures regarding fair value measurements. SFAS No. 157 applies whenever other accounting pronouncements require or permit fair value measurements for assets and liabilities.

In February 2008, the FASB issued FASB Staff Position No. 157-2 (“FSP No. 157-2”), which delays the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. We will apply this provision of SFAS No. 157 beginning on January 1, 2009. We do not expect it to have a material effect on our consolidated financial statements, because we do not have any nonfinancial assets or nonfinancial liabilities recognized or disclosed at fair value.

 

SFAS No. 157 defines fair value for financial reporting as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants at the measurement date. The fair value measurement of our financial assets utilized assumptions categorized as observable inputs under SFAS No. 157. Observable inputs are assumptions based on independent market data sources.

The following table sets forth information regarding the fair value measurement of our financial assets as of June 30, 2008:

       

Fair Value Measurements at Reporting Date Using

       

(Level 1)

 

(Level 2)

 

(Level 3)

Description

 

As of 6/30/2008

 

Quoted Prices in Active Markets for Identical Assets

 

Significant Other Observable Inputs

 

Significant Unobservable Inputs

Available-for-sale securities

 

$170,500

 

$170,500

 

$--

 

$--

We used quoted prices in active markets to value our available-for-sale securities.

3.     

New Accounting Pronouncements


In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60” (“SFAS No. 163”), which clarifies how FASB Statement No. 60 applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. SFAS No. 163 is effective for fiscal years beginning after December 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

Also in May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. SFAS No. 162 will be effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles” (“AU Section 411”). The SEC has not yet approved the amendments to AU Section 411. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS No. 161”), which expands the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

 

7 -


In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for the noncontrolling interest of a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

Also in December 2007, the FASB revised and replaced SFAS No. 141, “Business Combinations,” with SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for how a company recognizes and measures assets, liabilities and noncontrolling interests acquired or assumed in a business combination. SFAS No. 141(R) will apply to any of our business combinations or acquisitions after December 31, 2008.

In November 2007, FASB’s Emerging Issues Task Force (“EITF”) issued EITF 07-01, “Accounting for Collaborative Arrangements” (“EITF 07-01”), which defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-01 is effective for periods beginning after December 15, 2008 and applies to arrangements in existence as of the effective date. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS No. 158”), which requires a company to measure the funded status of a defined benefit postretirement plan as of the date of the company’s year-end balance sheet. This provision of SFAS No. 158 is effective for fiscal years ending after December 15, 2008 and will be adopted by us no later than December 31, 2008. We have estimated the effect that the transition to a fiscal year-end measurement date will have on our pension amounts based on measurements determined for the prior fiscal year-end reporting. The change will be recorded in retained earnings in the fourth quarter of 2008 and will not have a material impact on our consolidated financial statements.

4.     

Equity Compensation


The stock-based compensation expense and related income tax benefit recognized in our Condensed Consolidated Statements of Income in the periods indicated were as follows:

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2008

 

2007

 

2008

 

2007

Stock-based compensation expense

$1,928

 

$1,196

 

$4,103

 

$3,171

Income tax (benefit)

($742)

 

($460)

 

($1,579)

 

($1,220)

We did not capitalize any stock-based compensation cost in the three or six months ended June 30, 2008 or 2007.

As of June 30, 2008, we estimated that pre-tax compensation expense for unvested stock-based compensation grants in the amount of approximately $13,298, net of estimated forfeitures, will be recognized in future periods. This expense will be recognized over the remaining service period applicable to the grantees which, on a weighted-average basis, is approximately 2.3 years.

 

 

8 -


The stock options granted, forfeited, exercised and expired in the period indicated were as follows:

   

Six Months Ended June 30 , 2008

 

     

Weighted

     

Weighted

   

 

     

Average

 

Aggregate

 

Average

 

Aggregate

 

 

# of

 

Exercise

 

Exercise

 

Remaining

 

Intrinsic

   

Shares

 

Price

 

Price

 

Contractual Term

 

Value (1)

Outstanding at
   beginning of period

 

1,468,993

 

$50.25

 

$73,816

       

Granted

 

177,543

 

$86.83

 

15,416

       

Forfeited

 

(3,334)

 

$61.19

 

(204)

       

Exercised

 

(7,283)

 

$37.76

 

(275)

       

Expired

 

(6,000)

 

$10.83

 

(65)

       

Outstanding at end of
   period

 

1,629,919

 

$54.41

 

$88,688

 

5.1 years

 

$45,992

Exercisable at end of
   period

 

1,271,382

 

$46.24

 

$58,790

 

4.6 years

 

$46,264

_____________________________

(1) The aggregate intrinsic value of the stock options was calculated by multiplying the number of shares subject to the options outstanding or exercisable, as applicable, by the closing market price of our common stock on June 30, 2008, and subtracting the applicable aggregate exercise price.

The following table sets forth information regarding the stock options granted and exercised in the periods indicated:

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2008

 

2007

 

2008

 

2007

Shares subject to stock options
    granted

15,000

 

74,282

 

177,543

 

231,362

Weighted average grant date fair value

$29.71

 

$29.92

 

$36.83

 

$29.11

Shares subject to stock options
    exercised

5,583

 

362,316

 

7,283

 

856,083

Intrinsic value of stock options
    exercised

$171

 

$32,177

 

$257

 

$61,400

Proceeds received from stock options
    exercised

$234

 

$7,916

 

$275

 

$17,541

Tax benefits realized from stock
    options exercised

$57

 

$12,388

 

$90

 

$23,582

The intrinsic value of a stock option is the difference between the fair market value of the stock and the option exercise price.

 

 

 

 

 

9 -


The fair value of each stock option grant was estimated on the date of grant using the following assumptions:

 

Three Months
Ended June 30,

 

Six Months
Ended June 30,

 

2008

 

2007

 

2008

 

2007

Risk-free interest
   rates

2.7%

 

4.5%

 

2.7%

 

4.5% - 4.8%

Expected lives (in
   years)

4.0

 

4.7

 

4.0

 

4.7

Volatility

53%

 

35%

 

53%

 

35%

Dividend yield

None

 

None

 

None

 

None

 

The following table sets forth the number of shares of restricted stock and the restricted stock units ("RSUs") that were granted, forfeited and vested in the period indicated:

 

Six Months Ended June 30, 2008

 

# of Shares of Restricted Stock

 

Weighted Average Grant Date
Fair Value

 

# of RSUs

 

Weighted Average Grant Date
Fair Value

Unvested at beginning of
   period


22,672

 


$61.02

 


58,097

 

$84.40

Granted

--

 

--

 

43,207

 

81.30

Forfeited

(2,865)

 

59.91

 

(5,038)

 

84.59

Vested

--

 

--

 

--

 

--

Unvested at end of
   period


19,807

 

$61.18

 

96,266

 

$83.00

5.     

Stock Repurchases


     As of June 30, 2008, 4,156,800 shares remained available for repurchase under the share repurchase program (the “Repurchase Program”) authorized by our Board of Directors. The terms of the Repurchase Program provide that we may repurchase shares of our common stock, from time to time depending on market conditions and other considerations, in the open market or through privately negotiated transactions in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Unless earlier terminated by our Board of Directors, the Repurchase Program will expire when we repurchase all shares authorized for repurchase thereunder.

The following table sets forth information regarding the shares of our common stock that we repurchased in the periods indicated:

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2008

 

2007

 

2008

 

2007

Number of shares

--

 

720,000

 

865,000

 

1,529,900

Total cost

$--

 

$75,714

 

$71,803

 

$140,763

Average price per share

$--

 

$105.16

 

$83.01

 

$92.01

6.     

Debt


On December 17, 2007, we entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with a single lender to borrow up to $160,000 under two revolving credit facilities: one in the maximum principal amount of $50,000; and the other in the maximum principal amount of $110,000. We can borrow under the credit facilities on either a secured or unsecured basis. The Credit Agreement matures on July 1, 2010.

 

10 -


 

Borrowings under the Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”), plus an applicable margin based on our indebtedness to net worth ratio, adjusted quarterly. We pay a commitment fee of 0.15% per annum of the average daily unused amount of the credit facilities. As of June 30, 2008, the borrowings under the Credit Agreement were $150,000, all of which were secured and bore interest at a rate of 2.63% per annum. Approximately $157,950 of our investments served as collateral for the secured borrowings as of June 30, 2008.

The following table sets forth the interest expense on our borrowings under the Credit Agreement that we recognized in the periods indicated:

Three Months Ended
June 30,

 

Six Months Ended
June 30,

2008

 

2007

 

2008

 

2007

$1,057

 

$2,074

 

$2,524

 

$4,131

7.     

Investments


The following table sets forth how our investments were classified on our Condensed Consolidated Balance Sheets as of the dates indicated:

 

As of:

 

June 30, 2008

 

December 31, 2007

 

June 30, 2007

 

Available-for-Sale

 

Held-to-Maturity

 

Total

 

Available-for-Sale

 

Held-to-Maturity

 

Total

 

Available-for-Sale

 

Held-to-Maturity

 

Total

Short-term
 investments

$170,500

 

$--

 

$170,500

 

$303,360

 

$--

 

$303,360

 

$290,285

 

$--

 

$290,285

Non-current
 investments

--

 

--

 

--

 

--

 

--

 

--

 

- -

 

--

 

--

 

$170,500

 

$--

 

$170,500

 

$303,360

 

$--

 

$303,360

 

$290,285

 

$--

 

$290,285

The following table sets forth the aggregate fair market value of our available-for-sale investments as of the dates indicated:

 

As of:

 

June 30, 2008

 

December 31, 2007

 

June 30, 2007

Available-for-Sale Investments:

 

 

 

 

 

Auction rate debt securities

$--

 

$130,575

 

$74,750

Variable rate demand notes

$170,500

 

$172,785

 

$215,535

 

$170,500

 

$303,360

 

$290,285

We had no material gross unrealized holding or realized gains (losses) from our investments in auction rate securities and variable rate demand notes in the three months or six months ended June 30, 2008 and 2007. All income generated from those investments was recorded as interest income. The interest income recognized from our investments in the periods indicated was as follows:

Three Months Ended
June 30,

 

Six Months Ended
June 30,

2008

 

2007

 

2008

 

2007

$1,174

 

$2,636

 

$3,204

 

$5,579

11 -


The following table sets forth the contractual maturities of our debt securities classified as available-for-sale as of June 30, 2008:

Contractual Maturity

 

Available-for-Sale

Due within five years

 

$ --

Due after five years through ten years

28,150

Due after ten years

 

142,350

 

 

$170,500

8.     

Earnings Per Common Share


Earnings per common share for all periods have been calculated in conformity with SFAS No. 128, “Earnings Per Share.” This data is based on historical net income and the weighted average number of shares of our common stock outstanding during each period as set forth in the following table:

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2008

 

2007

 

2008

 

2007

 

(In thousands)

Shares:

 

     

 

   

Weighted average number of shares of common stock
   outstanding

38,842

 

40,449

 

39,020

 

40,682

Shares assumed issued (less shares assumed purchased for
   treasury) for stock-based compensation

 

325

   

661

   

319

   

668

Outstanding shares for diluted earnings per
   share calculation

 

39,167

   

41,110

   

39,339

   

41,350

A total of 407,395 shares at June 30, 2008 and 74,336 shares at June 30, 2007 were excluded from the calculation of our diluted earnings per common share because the effect was anti-dilutive.

9.     

Employee Pension Benefits


The following table sets forth the components of net periodic pension cost (benefit) of the ESI Pension Plan and ESI Excess Pension Plan for the periods indicated:

   

Three Months

 

Six Months

   

Ended June 30,

 

Ended June 30,

   

2008

 

2007

 

2008

 

2007

Interest cost

 

$738

 

$769

 

$1,538

 

$1,538

Expected return on assets

 

(1,301)

 

(1,202)

 

(2,614)

 

(2,404)

Recognized net actuarial loss

 

--

 

138

 

--

 

276

Net periodic pension (benefit)

 

($563)

 

($295)

 

($1,076)

 

($590)

The benefit accruals under the ESI Pension Plan and ESI Excess Pension Plan were frozen effective March 31, 2006. As a result, no service cost or amortization of prior service cost have been included in the net periodic pension benefit.

We made no contributions to the ESI Pension Plan during the three or six months ended June 30, 2008 and 2007. We do not expect to make any contributions to the ESI Pension Plan in 2008.

- 12 -


10.     

Contingencies


As part of our normal operations, one of our insurers issues surety bonds for us that are required by various education authorities that regulate us. We are obligated to reimburse our insurer for any of those surety bonds that are paid by the insurer. As of June 30, 2008, the total face amount of those surety bonds was approximately $19,226.

We are also subject to various claims and contingencies in the ordinary course of our business, including those related to litigation, business transactions, employee-related matters and taxes, among others. We cannot assure you of the ultimate outcome of any litigation involving us. 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.

Guarantees. In October 2007, we entered into a risk sharing agreement (“RSA”) with an unaffiliated lender for private education loans to be provided to our students by or through that lender to help pay the students’ cost of education that student financial aid from federal, state and other sources do not cover. Under the RSA, if more than a certain percentage of the private education loans, based on dollar volume, are charged off by the lender, we guarantee the repayment of any private education loans that the lender charges off above that percentage. Our obligations under the RSA will remain in effect until all private education loans made under the RSA are paid in full or charged off by the lender. We will have the right to pursue repayment from the borrowers for those charged off private education loans under the RSA that we pay to the lender pursuant to our guarantee obligation. The RSA was terminated effective February 22, 2008, such that no private education loans have been made under the RSA after that date.

The RSA requires that we comply with certain covenants, including that we maintain certain financial ratios which are measured as of December 31 in each year. If we are not in compliance with those ratios at any measurement date, we are obligated to provide the lender with a letter of credit in an amount based on a percentage of the outstanding private education loans under the RSA that have not been paid in full or charged off from time to time.

The maximum potential future payments that we could be required to make pursuant to our guarantee obligation under the RSA are affected by:

·     

the amount of the private education loans made under the RSA;

·     

the fact that those loans consist of a large number of loans of individually immaterial amounts;

·     

the interest and fees associated with those loans;

·     

the repayment performance of those loans; and

·     

when during the life of those loans they are charged off.

As a result, we are not able to estimate the undiscounted maximum potential future payments that we could be required to make under the RSA. Our recorded liability related to the RSA as of June 30, 2008 was not material.

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 safe harbor provision of the Private Securities Litigation Reform Act of 1995 and as defined in Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Exchange Act. Forward-looking statements are made based on our management’s current expectations and beliefs concerning future developments and their potential effects on us. You can identify those statements by the use of words such as “could,” “should,” “would,” “may,” “will,” “project,” “believe,” “anticipate,” “expect,” “plan,” “estimate,” “forecast,” “potential,” “intend,” “continue” and “contemplate,” as well as similar words and expressions. Forward-looking statements involve risks and uncertainties and do not guarantee future performance. We cannot assure you that future developments affecting us will be those anticipated by our management. Among the factors that could cause actual results to differ materially from those expressed in our forward-looking statements are the following:

 

 

13 -


 

·     

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 of those regulations, 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;

·     

our failure to comply with the extensive education laws and regulations and accreditation standards that we are subject to;

·     

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 our institutes;

·     

our ability to implement our growth strategies;

·     

our failure to maintain or renew required regulatory authorizations or accreditation of our institutes;

·     

receptivity of students and employers to our existing program offerings and new curricula;

·     

loss of access by our students to lenders for student loans;

·     

our ability to collect internally funded financing from our students; and

·     

our ability to successfully defend litigation and other claims brought against us.

     Readers are also directed to other risks and uncertainties discussed in other documents we file with the SEC, including, without limitation, those discussed in Item 1A. “Risk Factors.” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 filed with the SEC and those discussed in Part II, Item 1A. “Risk Factors.” of this Quarterly Report on Form 10-Q We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.

Overview

     You should keep in mind the following points as you read this report:

·     

References in this document to “we,” “us,” “our” and “ITT/ESI” refer to ITT Educational Services, Inc. and its subsidiaries.

·     

The terms “ITT Technical Institute” or “institute” (in singular or plural form) refer to an individual school owned and operated by ITT/ESI, including its learning sites, if any. The terms “institution” or “campus group” (in singular or plural form) mean a main campus and its additional locations, branch campuses and/or learning sites, if any.

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 for the fiscal year ended December 31, 2007 filed with the SEC for discussion of, among other matters, the following items:

·     

cash receipts from financial aid programs;

·     

nature of capital additions;

·     

seasonality of revenue;

·     

components of income statement captions;

·     

federal regulations regarding:

·     

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

·     

percentage of applicable revenue that may be derived from the Title IV Programs;

·     

return of Title IV Program funds for withdrawn students; and

 

14 -


·     

default rates;

·     

private loan programs;

·     

investments; and

·     

repurchase of shares of our common stock.

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

Background

We are a leading provider of technology-oriented postsecondary education programs in the United States based on revenue and student enrollment. As of June 30, 2008, we were offering master, bachelor and associate degree programs to more than 54,000 students. As of June 30, 2008, we had 102 institutes and nine learning sites of those institutes located in 35 states. All of our institutes are authorized by the applicable education authorities of the states in which they operate, and are accredited by an accrediting commission recognized by the ED. We design our education programs, after consultation with employers, to help graduates prepare for careers in various fields involving their areas of study. We have provided career-oriented education programs since 1969 under the “ITT Technical Institute” name.

In the second quarter of 2008, we began operations at two new institutes. We plan to begin operations at one to three additional locations in 2008. Our overall expansion plans include:

·     

operating new institutes;

·     

adding learning sites to existing institutes;

·     

offering a broader range of both residence and online programs at our existing institutes; and

·     

increasing the number of our institutes that offer bachelor degree programs.

Critical Accounting Policies and Estimates

The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue, expenses, and contingent assets and liabilities. Actual results may differ from those estimates and judgments under different assumptions or conditions. We have discussed the critical accounting policies that we believe affect our more significant estimates and judgments used in the preparation of our consolidated financial statements in the "Management's Discussion and Analysis of Financial Condition and Results of the Operations – Critical Accounting Policies and Estimates" section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 filed with the SEC. There have been no material changes to those critical accounting policies or the underlying accounting estimates or judgments, except as discussed below.

Accounts Receivable and Allowance for Doubtful Accounts. We extend unsecured credit to our students for tuition and fees and we record a receivable for the tuition and fees earned in excess of the payment received from or on behalf of a student. The individual student balances of these receivables are insignificant. We record an allowance for doubtful accounts with respect to accounts receivable on an institute-by-institute basis. We review the historical collection experience for each institute, consider other facts and circumstances related to an institute and record an allowance for doubtful accounts based on that review and consideration.

During the second quarter of 2008, we extended larger amounts of unsecured credit to our students due to a decrease in private education loans made to our students by third-party lenders. We categorized these receivables based on the credit profiles of our students and recorded an allowance for doubtful accounts based on our historical collection experience related to amounts owed by students with similar credit profiles.

15 -


If our collection trends were to differ significantly from our historical collection experience, we would make a corresponding adjustment to our allowance for doubtful accounts. We write off the accounts receivable due from former students when we conclude that collection is not probable.

Fair Value. Effective January 1, 2008, we adopted SFAS No. 157 for financial assets and financial liabilities measured on a recurring basis. This statement defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures regarding fair value measurements. SFAS No. 157 applies whenever other accounting pronouncements require or permit fair value measurements for assets and liabilities.

In February 2008, the FASB issued FSP No. 157-2, which delays the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. We will apply this provision of SFAS No. 157 beginning on January 1, 2009. We do not expect it to have a material effect on our consolidated financial statements, because we do not have any nonfinancial assets or nonfinancial liabilities recognized or disclosed at fair value.

SFAS No. 157 defines fair value for financial reporting as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants at the measurement date. The fair value measurement of our financial assets utilized assumptions categorized as observable inputs under SFAS No. 157. Observable inputs are assumptions based on independent market data sources.

The following table sets forth information regarding the fair value measurement of our financial assets as of June 30, 2008:

       

Fair Value Measurements at Reporting Date Using

       

(Level 1)

 

(Level 2)

 

(Level 3)

Description

 

As of 6/30/2008

 

Quoted Prices in Active Markets for Identical Assets

 

Significant Other Observable Inputs

 

Significant Unobservable Inputs

       

(In thousands)

   

Available-for-sale securities

 

$170,500

 

$170,500

 

$--

 

$--

We used quoted prices in active markets to value our available-for-sale securities.

New Accounting Pronouncements

In May 2008, the FASB issued SFAS No. 163, which clarifies how FASB Statement No. 60 applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. SFAS No. 163 is effective for fiscal years beginning after December 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

Also in May 2008, the FASB issued SFAS No. 162, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. SFAS No. 162 will be effective 60 days following the SEC’s approval of the PCAOB amendments to AU Section 411. The SEC has not yet approved the amendments to AU Section 411. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 was effective for us on January 1, 2008. This pronouncement did not have any effect on our condensed consolidated financial statements,

- 16 -


because we did not elect the fair value methodology under SFAS No. 159 for any of our financial instruments or other items that are not currently required to be measured at fair value.

In March 2008, the FASB issued SFAS No. 161, which expands the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, which establishes accounting and reporting standards for the noncontrolling interest of a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. We do not believe that the adoption of this pronouncement will have a material impact on our consolidated financial statements.

Also in December 2007, the FASB revised and replaced SFAS No. 141 with SFAS No. 141(R), which establishes principles and requirements for how a company recognizes and measures assets, liabilities and noncontrolling interests acquired or assumed in a business combination. SFAS No. 141(R) will apply to any of our business combinations or acquisitions after December 31, 2008.

In November 2007, FASB’s EITF issued EITF 07-01, which defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-01 is effective for periods beginning after December 15, 2008 and applies to arrangements in existence as of the effective date. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, which requires a company to measure the funded status of a defined benefit postretirement plan as of the date of the company’s year-end balance sheet. This provision of SFAS No. 158 is effective for fiscal years ending after December 15, 2008 and will be adopted by us no later than December 31, 2008. We have estimated the effect that the transition to a fiscal year-end measurement date will have on our pension amounts based on measurements determined for the prior fiscal year-end reporting. The change will be recorded in retained earnings in the fourth quarter of 2008 and will not have a material impact on our consolidated financial statements.

Results of Operations

The following table sets forth the percentage relationship of certain statement of income data to revenue for the periods indicated:

 

Three Months Ended

 

Six Months Ended

June 30,

 

June 30,

 

2008

 

2007

 

2008

 

2007

Revenue

100.0%

 

100.0%

 

100.0%

 

100.0%

Cost of educational services

38.6%

 

41.7%

 

38.9%

 

43.0%

Student services and administrative
   expenses

30.4%

 

31.7%

 

31.0%

 

32.8%

Operating income

31.0%

 

26.6%

 

30.1%

 

24.2%

Interest income, net

0.0%

 

0.3%

 

0.1%

 

0.3%

Income before provision for income
   taxes

31.0%

 

26.9%

 

30.2%

 

24.5%

The following table sets forth our total student enrollment as of the dates indicated:

 

 

2008

 

2007

 

 

Total

Student

Enrollment

 

Increase

Over

Prior Year

 

Total

Student

Enrollment

 

Increase

Over

Prior Year

Total Student

 

 

 

 

Enrollment as of:

 

 

 

 

March 31

 

54,194

 

9.9%

 

49,295

 

12.4%

June 30

 

54,793

 

12.1%

 

48,873

 

11.0%

September 30

 

Not applicable

 

Not applicable

 

53,675

 

11.5%

December 31

 

Not applicable

 

Not applicable

 

53,027

 

13.1%

Total student enrollment includes all new and continuing students. A continuing student is any student who, in the academic quarter being measured, is enrolled in a program of study at an ITT Technical Institute and was enrolled in the same program at any ITT Technical Institute at the end of the immediately preceding academic quarter. A new student is any student who, in the academic quarter being measured, enrolls in and begins attending any program of study at an ITT Technical Institute:

·     

for the first time at that institute;

·     

after graduating in a prior academic quarter from a different program of study at that institute; or

·     

after having withdrawn or been terminated from a program of study at that institute.

- 17 -


The following table sets forth our new student enrollment in the periods indicated:

 

 

2008

 

2007

New Student Enrollment

 

New

 

Increase

 

New

 

Increase

in the Three

 

Student

 

Over

 

Student

 

Over

Months Ended:

 

Enrollment

 

Prior Year

 

Enrollment

 

Prior Year

March 31

 

13,844

 

8.7%

 

12,738

 

13.1%

June 30

 

14,751

 

22.5%

 

12,043

 

3.2%

September 30

 

Not applicable

 

Not applicable

 

18,270

 

8.8%

December 31

 

Not applicable

 

Not applicable

 

11,542

 

13.1%

   Total for the year

 

Not applicable

 

Not applicable

 

54,593

 

9.3%

We generally organize the academic schedule for programs of study offered at our institutes on the basis of four 12-week academic quarters in a calendar year that typically begin in early March, mid-June, early September and late November or early December. To measure the persistence of our students, the number of continuing students in any academic quarter is divided by the total student enrollment in the immediately preceding academic quarter.

The following table sets forth the rates of our students’ persistence for the periods indicated:

 

 

Student Persistence for the Three Months Ended:

Year

 

March 31

 

June 30

 

September 30

 

December 31

2006

 

75.8%

 

73.7%

 

71.2%

 

 

76.2%

2007

 

78.0%

 

74.7%

 

72.4%

 

 

77.3%

2008

 

76.1%

 

73.9%

 

Not applicable

 

 

Not applicable

Changes that we made to how we deliver certain program courses, primarily those courses taught either entirely or partially online over the Internet, have impacted our students’ persistence over the past several years.  Student retention is typically lower in the courses that we teach online over the Internet compared to the courses that we teach in residence on campus.  Our students’ persistence decreased as a result of teaching certain courses online over the Internet.  In the second quarter of 2006, we began modifying the academic qualifications for students to take online courses, which led to year-over-year improvements in persistence in each quarter of 2007 as compared to 2006.  The decrease in the student persistence rate in the first quarter of 2008 compared to the same period in 2007 was primarily due to a change in our 2008 academic calendar, which eliminated a break in classes in the first quarter of 2008 compared to the first quarter of 2007.  We believe that this change in the academic calendar resulted in approximately 500 additional student withdrawals occurring in the first quarter of 2008 than would have occurred if we had not changed the academic calendar. The decrease in the student persistence rate in the three months ended June 30, 2008 compared to the same period in 2007 was primarily due to a higher number of students who graduated at the end of the March 2008 academic quarter compared to the end of the March 2007 academic quarter.

Three Months Ended June 30, 2008 Compared with Three Months Ended June 30, 2007. Revenue increased $29.4 million, or 13.6%, to $246.4 million in the three months ended June 30, 2008 compared to $217.0 million in the three months ended June 30, 2007, primarily due to:

·     

a 9.9% increase in total student enrollment at March 31, 2008 compared to March 31, 2007; and

·     

a 5.0% increase in tuition rates in March 2008.

The increase in revenue was partially offset by a 80 basis point reduction in our students’ persistence to 73.9% for the three months ended June 30, 2008 compared to 74.7% for the three months ended June 30, 2007.

The increase in student enrollment was primarily due to:

·     

student enrollment growth in programs of study and at locations that were in existence prior to 2007;

·     

new programs of study offered by our institutes; and

·     

operating new institutes.

Cost of educational services increased $4.6 million, or 5.1%, to $95.2 million in the three months ended June 30, 2008 compared to $90.6 million in the three months ended June 30, 2007, primarily due to:

·     

increased costs associated with operating new institutes and learning sites; and

·     

the costs required to service the increased total student enrollment.

The increase in cost of educational services was partially offset by:

·     

greater efficiencies in the operation of our institutes; and

·     

decreased costs associated with decreased sales of laptop computers.

Cost of educational services as a percentage of revenue decreased 310 basis points to 38.6% in the three months ended June 30, 2008 compared to 41.7% in the three months ended June 30, 2007, primarily due to greater efficiencies in the operation of our

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institutes. The decrease in cost of educational services as a percentage of revenue was partially offset by the costs associated with operating new institutes and learning sites.

Student services and administrative expenses increased $6.2 million, or 9.0%, to $74.9 million in the three months ended June 30, 2008 compared to $68.7 million in the three months ended June 30, 2007. The principal causes of this increase included:

·     

an increase in bad debt expense associated with increases in internally funded student financing; and

·     

an increase in compensation and benefit costs associated with a greater number of employees.

Student services and administrative expenses decreased to 30.4% of revenue in the three months ended June 30, 2008 compared to 31.7% of revenue in the three months ended June 30, 2007, primarily due to media advertising costs increasing at a lower rate than the increase in revenue. The decrease in student services and administrative expenses as a percentage of revenue was partially offset by an increase in bad debt expense. Bad debt expense as a percentage of revenue increased to 3.9% in the three months ended June 30, 2008, compared to 2.5% in the three months ended June 30, 2007. We believe that our bad debt expense as a percentage of revenue could increase further during the remainder of 2008, primarily due to increases in internally funded student financing.

Operating income increased $18.6 million, or 32.3%, to $76.3 million in the three months ended June 30, 2008 compared to $57.7 million in the three months ended June 30, 2007. The operating margin increased to 31.0% in the three months ended June 30, 2008 compared to 26.6% in the three months ended June 30, 2007.

Interest income decreased $1.6 million, or 57.9%, to $1.2 million in the three months ended June 30, 2008 compared to $2.8 million in the three months ended June 30, 2007, primarily due to a decrease in investment returns in the overall market and a more conservative investment strategy. Interest expense decreased $1.0 million, or 49.1%, to $1.1 million in the three months ended June 30, 2008 compared to $2.1 million in the three months ended June 30, 2007, primarily due to a decrease in the effective interest rate on our revolving credit facilities.

Our combined federal and state effective income tax rate was 38.3% in the three months ended June 30, 2008 compared to 38.6% in the three months ended June 30, 2007.

Six Months Ended June 30, 2008 Compared with Six Months Ended June 30, 2007. Revenue increased $60.1 million, or 14.3%, to $481.3 million in the six months ended June 30, 2008 compared to $421.2 million in the six months ended June 30, 2007, primarily due to:

·     

a 9.9% increase in total student enrollment at March 31, 2008 compared to March 31, 2007;

·     

a 5.0% increase in tuition rates in March 2008 and March 2007; and

·     

a 13.1% increase in total student enrollment at December 31, 2007 compared to December 31, 2006 .

The increase in student enrollment was primarily due to:

·     

student enrollment growth in programs of study and at locations that were in existence prior to 2007;

·     

new programs of study offered by our institutes; and

·     

operating new institutes.

Cost of educational services increased $5.9 million, or 3.2%, to $187.2 million in the six months ended June 30, 2008 compared to $181.4 million in the six months ended June 30, 2007, primarily due to:

·     

increased costs associated with operating new institutes; and

·     

the costs required to service the increased total student enrollment.

The increase in cost of educational services was partially offset by:

 

·     

greater efficiencies in the operation of our institutes;

·     

lower amortization expense due to certain assets being fully amortized in 2007; and

·     

decreased costs associated with decreased sales of laptop computers.

Cost of educational services as a percentage of revenue decreased 410 basis points to 38.9% in the six months ended June 30, 2008 from 43.0% in the six months ended June 30, 2007, primarily due to greater efficiencies in the operation of our institutes and decreased costs associated with decreased sales of laptop computers. The decrease in cost of educational services as a percentage of revenue was partially offset by the costs associated with operating new institutes and learning sites.

Student services and administrative expenses increased $11.0 million, or 8.0%, to $149.0 million in the six months ended June 30, 2008 compared to $138.0 million in the six months ended June 30, 2007. The principal causes of this increase included:

·     

an increase in bad debt expense associated with increases in internally funded student financing;

·     

an increase in compensation and benefit costs associated with a greater number of employees; and

·     

an increase in media advertising expenditures.

Student services and administrative expenses decreased to 31.0% of revenue in the six months ended June 30, 2008 compared to 32.8% of revenue in the six months ended June 30, 2007, primarily due to media advertising costs increasing at a lower rate than

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the increase in revenue. The decrease in student services and administrative expenses as a percentage of revenue was partially offset by an increase in bad debt expense. Bad debt expense as a percentage of revenue increased to 3.5% in the six months ended June 30, 2008, compared to 2.4% in the six months ended June 30, 2007.

Operating income increased $43.2 million, or 42.5%, to $145.0 million in the six months ended June 30, 2008 compared to $101.8 million in the six months ended June 30, 2007. The operating margin increased to 30.1% of revenue in the six months ended June 30, 2008 compared to 24.2% in the six months ended June 30, 2007.

Interest income decreased $2.5 million, or 44.1%, to $3.2 million in the six months ended June 30, 2008 compared to $5.7 million in the six months ended June 30, 2007, primarily due to a decrease in investment returns in the overall market and a more conservative investment strategy. Interest expense decreased $1.6 million, or 38.4%, to $2.6 million in the six months ended June 30, 2008 compared to $4.2 million in the six months ended June 30, 2007, primarily due to a decrease in the effective interest rate on our revolving credit facilities.

Our combined federal and state effective income tax rate was 38.4% in the six months ended June 30, 2008 compared to 38.6% in the six months ended June 30, 2007.

Financial Condition, Liquidity and Capital Resources

Cash and cash equivalents were $78.7 million as of June 30, 2008 compared to $7.2 million as of December 31, 2007 and $10.1 million as of June 30, 2007. We also had short-term investments of $170.5 million as of June 30, 2008 compared to $303.4 million as of December 31, 2007 and $290.3 million as of June 30, 2007. The increase in our cash and cash equivalents and the decrease in our short-term investments as of June 30, 2008 compared to December 31, 2007 and June 30, 2007, were primarily due to the execution of a revised investment strategy focused on liquidity in response to uncertainty in the capital markets. In total, our cash and cash equivalents and short-term investments were $249.2 million as of June 30, 2008 compared to $310.6 million as of December 31, 2007 and $300.4 million as of June 30, 2007. The decrease in the total amount of cash and cash equivalents and short-term investments as of June 30, 2008 was primarily due to a decrease in funds received from private education loans made to our students by third-party lenders and delays in the receipt of certain Title IV Program loan funds from new lenders related to the configuration of information systems.

We are required to recognize the funded status of our defined benefit postretirement plans on our balance sheet. As of June 30, 2008, the balance recognized for the ESI Pension Plan, a non-contributory defined benefit pension plan commonly referred to as a cash balance plan, was an asset of $15.9 million and the balance recognized for the ESI Excess Pension Plan, a nonqualified, unfunded retirement plan, was a liability of $1.9 million.

We do not expect to make any contribution to the ESI Pension Plan in 2008.

Operations.Cash used in operating activities was $48.0 million in the three months ended June 30, 2008 compared to cash generated from operating activities of $14.7 million in the three months ended June 30, 2007. The $62.7 million decrease in operating cash flow was primarily due to:

·     

a decrease in funds received from private education loans made to our students by third-party lenders;

·     

delays in the receipt of certain Title IV Program loan funds from new lenders related to the configuration of information systems; and

·     

higher income tax payments primarily resulting from lower tax benefits from the exercise of stock options.

The decrease in operating cash flow was partially offset by an increase in operating income.

Cash from operating activities decreased $28.0 million to $31.0 million in the six months ended June 30, 2008 compared to $59.0 million in the six months ended June 30, 2007, primarily due to:

·     

a decrease in funds received from private education loans made to our students by third-party lenders;

·     

delays in the receipt of certain Title IV Program loan funds from new lenders related to the configuration of information systems; and

·     

higher income tax payments primarily resulting from lower tax benefits from the exercise of stock options.

The decrease in cash from operating activities was partially offset by an increase in operating income and the timing of payroll payments. See “—Student Financing Update” below for a discussion of the impact on our liquidity and cash flows from operations as a result of increases in internally funded student financing.

Accounts receivable less allowance for doubtful accounts was $29.2 million as of June 30, 2008 compared to $9.9 million as of June 30, 2007. Days sales outstanding was 10.8 days at June 30, 2008 and 4.2 days at June 30, 2007. Both increases were primarily due to increases in internally funded student financing and delays in the receipt of certain Title IV Program loan funds from new lenders related to the configuration of information systems. We believe that our days sales outstanding could increase further during the remainder of 2008, primarily due to increases in internally funded student financing.

In May 2008, the U.S. Congress enacted the Ensuring Continued Access to Student Loans Act of 2008 (the “Continued Access Act”) which, among other things, increased the annual and total amount of certain loans that students can receive under the Title IV Programs. We believe that the increase in certain Title IV Program loan funds under the Continued Access Act will result in a reduction in individual balances of the accounts receivable owed to us by our students in the remainder of 2008.

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Investing.In the three months ended June 30, 2008, we spent $3.0 million to purchase a facility we had been leasing and $3.9 million to renovate, expand or construct buildings at 10 of our locations, compared to $3.8 million for similar expenditures at six facilities in the three months ended June 30, 2007. In the six months ended June 30, 2008, we spent $1.5 million to purchase a parcel of land on which we are building a facility and $11.7 million to purchase, renovate, expand or construct buildings at 15 of our locations compared to $8.7 million for similar expenditures at nine facilities in the six months ended June 30, 2007. We do not currently intend to purchase any additional properties or facilities during the remainder of 2008.

Capital expenditures, excluding facility and land purchases and facility construction, totaled:

·     

$5.3 million in the three months ended June 30 , 2008 compared to $4.4 million in the three months ended June 30, 2007; and

·     

$7.8 million in the six months ended June 30, 2008 compared to $6.9 million in the six months ended June 30, 2007.

These expenditures consisted primarily of classroom and laboratory equipment (such as computers and electronic equipment), classroom and office furniture, software and leasehold improvements. We plan to continue to upgrade and expand current facilities and equipment throughout the remainder of 2008. Cash generated from operations is expected to be sufficient to fund our capital expenditure requirements.

Financing.On December 17, 2007, we entered into the Credit Agreement to borrow up to $160.0 million under two revolving credit facilities: one in the maximum principal amount of $50.0 million; and the other in the maximum principal amount of $110.0 million. The borrowings under the Credit Agreement were used to allow us to continue repurchasing shares of our common stock while maintaining compliance with certain financial ratios required by the ED, the state education authorities that regulate our institutes and the accrediting agency that accredits our institutes.

Both lines of credit under the Credit Agreement mature on July 1, 2010. The borrowings under each line of credit may be secured or unsecured at our election, provided that we have not defaulted under the Credit Agreement, in which case, any borrowings made on a secured basis must remain secured. Investments held in a pledged account serve as the collateral for any secured borrowings under the Credit Agreement.

Borrowings under the Credit Agreement bear interest at LIBOR plus an applicable margin based on our indebtedness to net worth ratio, adjusted quarterly. We pay a commitment fee of 0.15% per annum of the average daily unused amount of the credit facilities. As of June 30, 2008, the borrowings under the Credit Agreement were $150.0 million, all of which were secured, and bore interest at a rate of 2.63% per annum. Approximately $158.0 million of our investments served as collateral for the secured borrowings as of June 30, 2008.

The availability of borrowings under the Credit Agreement is subject to our ability at the time of borrowing to satisfy certain specified conditions. These conditions include the absence of default by us, as defined in the Credit Agreement, and that certain representations and warranties contained in the Credit Agreement continue to be true and accurate. We are also required to maintain a certain maximum leverage ratio and a minimum ratio of cash and investments to outstanding indebtedness at the end of each of our fiscal quarters. We were in compliance with those ratio requirements as of June 30, 2008.

Our Board of Directors has authorized us to repurchase shares of our common stock in the open market or through privately negotiated transactions in accordance with Rule 10b-18 of the Exchange Act under the Repurchase Program. The following table sets forth information regarding our share repurchase activity in the periods indicated:

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

2008

 

2007

 

2008

 

2007

 

(Dollars in thousands, except per share data)

Number of shares

--

 

720,000

 

865,000

 

1,529,900

Total cost

$--

 

$75,714

 

$71,803

 

$140,763

Average price per share

$--

 

$105.16

 

$83.01

 

$92.01

The shares that remained available for repurchase under the Repurchase Program were 4,156,800 as of June 30, 2008. We may repurchase additional shares of our common stock under the Repurchase Program, from time to time, in the future depending on market conditions and other considerations.

We believe that cash generated from operations and our investments will be adequate to satisfy our working capital and capital expenditure requirements for the foreseeable future. We also believe that any reduction in cash and cash equivalents or investments that may result from their use to provide student financing, purchase facilities, construct facilities or repurchase shares of our common stock will not have a material adverse effect on our expansion plans, planned capital expenditures, ability to meet any applicable regulatory financial responsibility standards or ability to conduct normal operations.

Student Financing Update. We continue to work with new lenders for them to provide private education loans to our students. The tighter credit markets, along with the time required to integrate third-party lenders, has resulted in us providing increased internally funded financing to our students. We intend to maintain our current admission standards and to continue providing internally funded financing to our students who fail to qualify for private education loans made by third-party lenders.

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We may also enter into additional risk sharing or other guarantee arrangements with third-party lenders in order to help our students qualify for private education loans from those third-party lenders.

We indirectly derived approximately 29% of our revenue in 2007, and approximately 34% of our revenue in 2006, from private education loan programs.  Primarily as a result of the Continued Access Act and its increases in the level of certain Title IV Program loans, we anticipate a decline in the percentage of our revenue that we indirectly derive from private education loans made to our students, including internally funded student financing, in 2008. Although we cannot quantify with certainty the effect that the increases in those Title IV Program loans will have on the amount of our revenue that is derived from private education loans made to our students, we believe that the percentage of our revenue that we indirectly derive from private education loans, including internally funded student financing, in 2008 could be in the range of 12% to 13%. We are still in the early stages of data collection and experience with new third-party lenders of private education loans to our students and, therefore, we are not yet able to predict with certainty the portion of our revenue in 2008 that will be derived from private education loans made by third-party lenders or the portion that will be internally funded by us.

The increased internally funded financing that we are providing to our students could further negatively impact our liquidity and exposes us to new and greater credit risk. Internally funded financing provides for payments to us by our students over an extended term, which could have a material adverse effect on our cash flows from operations in 2008. In addition, we have the risk of collection with respect to our internally funded financing, which could