form10-q.htm
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 September 30, 2009
 
OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________

Commission file number     1-13144

ITT EDUCATIONAL SERVICES, INC.
(Exact name of registrant as specified in its charter)

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

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      ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes     ¨
No      ¨

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

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


Yes     ¨
No      x

 
36,945,066
 
Number of shares of Common Stock, $.01 par value, outstanding at September 30, 2009
 
 

 
ITT EDUCATIONAL SERVICES, INC.
Carmel, Indiana

Quarterly Report to Securities and Exchange Commission
September 30, 2009

PART I
FINANCIAL INFORMATION



Item 1.
Financial Statements.

Index


Condensed Consolidated Balance Sheets as of September 30, 2009 and 2008 (unaudited) and December 31, 2008
 
Condensed Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2009 and 2008
 
Condensed Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2009 and 2008
 
Condensed Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2009 and 2008 (unaudited) and the year ended December 31, 2008
 
Notes to Condensed Consolidated Financial Statements


 
- 1 -

 

ITT EDUCATIONAL SERVICES, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(Dollars in thousands, except per share data)
 
   
         
As of
       
   
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
   
(unaudited)
         
(unaudited)
 
Assets
                 
Current assets:
                 
Cash and cash equivalents
  $ 130,971     $ 226,255     $ 136,698  
Short-term investments
    144,146       138,709       150,000  
Restricted cash
    5,723       10,405       17  
Accounts receivable, net
    93,819       29,779       33,309  
Deferred income taxes
    16,328       12,104       13,012  
Prepaid expenses and other current assets
    19,106       13,793       12,980  
Total current assets
    410,093       431,045       346,016  
                         
Property and equipment, net
    192,341       166,671       166,140  
Direct marketing costs, net
    27,222       22,973       22,694  
Other assets
    20,705       3,170       19,481  
Total assets
  $ 650,361     $ 623,859     $ 554,331  
                         
Liabilities and Shareholders' Equity
                       
Current liabilities:
                       
Current portion of long-term debt
  $ 150,000     $ --     $ --  
Accounts payable
    67,183       54,815       58,781  
Accrued compensation and benefits
    23,340       21,133       28,574  
Accrued income taxes
    7,917       14,976       1,753  
Other accrued liabilities
    15,884       11,423       12,274  
Deferred revenue
    146,203       162,206       142,044  
Total current liabilities
    410,527       264,553       243,426  
                         
Long-term debt
    --       150,000       150,000  
Deferred income taxes
    4,092       1,504       10,108  
Other liabilities
    22,262       19,951       19,207  
Total liabilities
    436,881       436,008       422,741  
                         
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
    151,653       135,655       133,723  
Retained earnings
    929,907       732,107       670,073  
Accumulated other comprehensive (loss)
    (12,558 )     (13,384 )     (3,417 )
Treasury stock, 17,123,838, 15,352,376
                       
and 15,376,719 shares, at cost
    (856,063 )     (667,068 )     (669,330 )
Total shareholders’ equity
    213,480       187,851       131,590  
Total liabilities and shareholders’ equity
  $ 650,361     $ 623,859     $ 554,331  
                         
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 


 
- 2 -

 
ITT EDUCATIONAL SERVICES, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
(Dollars and shares in thousands, except per share data)
 
(unaudited)
 
   
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Revenue
  $ 339,643     $ 254,273     $ 944,816     $ 735,533  
Costs and expenses:
                               
Cost of educational services
    116,730       95,011       328,609       282,219  
Student services and administrative expenses
    100,187       78,500       276,044       227,535  
Total costs and expenses
    216,917       173,511       604,653       509,754  
Operating income
    122,726       80,762       340,163       225,779  
Interest income
    716       1,565       2,827       4,774  
Interest (expense)
    (191 )     (1,012 )     (593 )     (3,588 )
Income before provision for income taxes
    123,251       81,315       342,397       226,965  
Provision for income taxes
    47,891       31,129       133,185       87,017  
Net income
  $ 75,360     $ 50,186     $ 209,212     $ 139,948  
                                 
Earnings per share:
                               
Basic
  $ 2.02     $ 1.29     $ 5.51     $ 3.59  
Diluted
  $ 2.00     $ 1.28     $ 5.45     $ 3.56  
                                 
Weighted average shares outstanding:
                               
Basic
    37,324       38,777       37,950       38,938  
Diluted
    37,763       39,195       38,412       39,291  
                                 
                                 
                                 
                                 
                                 
                                 
                                 
                                 
                                 
                                 
                                 
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
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Cash flows from operating activities:
                       
Net income
  $ 75,360     $ 50,186     $ 209,212     $ 139,948  
Adjustments to reconcile net income to net cash flows
                               
from operating activities:
                               
Depreciation and amortization
    6,276       5,077       18,204       16,335  
Provision for doubtful accounts
    23,183       12,839       56,012       29,457  
Deferred income taxes
    1,471       (1,948 )     (2,344 )     (7,251 )
Excess tax benefit from stock option exercises
    (1,385 )     (686 )     (5,272 )     (773 )
Stock-based compensation expense
    2,891       1,628       10,247       5,731  
Other
    113       --       (309 )     --  
Changes in operating assets and liabilities, net of
acquisition:
                               
Restricted cash
    (5,743 )     181       2,581       6,039  
Accounts receivable
    (47,255 )     (16,950 )     (119,255 )     (47,634 )
Direct marketing costs, net
    (1,234 )     (731 )     (4,249 )     (2,127 )
Accounts payable
    4,763       4,375       10,819       13,661  
Accrued income taxes
    (2,432 )     (2,982 )     (1,308 )     (3,467 )
Other operating assets and liabilities
    (377 )     4,331       1,007       11,214  
Deferred revenue
    19,325       3,706       (17,631 )     (71,083 )
Net cash flows from operating activities
    74,956       59,026       157,714       90,050  
                                 
Cash flows from investing activities:
                               
Facility expenditures and land purchases
    (664 )     (3,944 )     (2,516 )     (17,107 )
Capital expenditures, net
    (3,907 )     (4,286 )     (15,913 )     (12,103 )
Acquisition of college, net of cash acquired
    --       --       (20,792 )     --  
Proceeds from sales and maturities of investments
    57,352       492,760       142,741       964,565  
Purchase of investments
    (56,543 )     (472,260 )     (147,362 )     (811,205 )
Issuance of note receivable, net of repayments
    (71 )     --       (13,991 )     --  
Net cash flows from investing activities
    (3,833 )     12,270       (57,833 )     124,150  
                                 
Cash flows from financing activities:
                               
Excess tax benefit from stock option exercises
    1,385       686       5,272       773  
Proceeds from exercise of stock options
    2,756       1,996       8,750       2,271  
Repurchase of common stock and shares tendered for taxes
    (84,497 )     (15,971 )     (209,187 )     (87,774 )
Net cash flows from financing activities
    (80,356 )     (13,289 )     (195,165 )     (84,730 )
                                 
Net change in cash and cash equivalents
    (9,233 )     58,007       (95,284 )     129,470  
                                 
Cash and cash equivalents at beginning of period
    140,204       78,691       226,255       7,228  
                                 
Cash and cash equivalents at end of period
  $ 130,971     $ 136,698     $ 130,971     $ 136,698  
                                 
 
 
 
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, 2007
    54,069     $ 541     $ 127,017     $ 531,363     $ (3,417 )     (14,375 )   $ (584,946 )   $ 70,558  
For the nine months ended September 30, 2008
    (unaudited):
                                                               
Net income
                            139,948                               139,948  
Other comprehensive income
                                                            --  
Comprehensive income
                                                            139,948  
Exercise of stock options
                            (1,213 )             51       3,484       2,271  
Tax benefit from exercise of stock options
                    796                                       796  
Stock-based compensation
                    5,731                                       5,731  
Common shares repurchased
                                            (1,050 )     (87,774 )     (87,774 )
Issuance of shares for Directors’ compensation
                            (25 )             1       85       60  
Restricted stock cancellations
                    179                       (3 )     (179 )     --  
Balance as of September 30, 2008
    54,069       541       133,723       670,073       (3,417 )     (15,376 )     (669,330 )     131,590  
For the three months ended December 31, 2008
    (unaudited):
                                                               
Net income
                            63,024                               63,024  
Other comprehensive income:
                                                               
Amortization of prior service cost, net of $10 of
    income tax
                                    17                       17  
Net actuarial pension loss, net of $7,237 of
   income tax
                                    (11,212 )                     (11,212 )
Pension settlement loss, net of $599 of income
    tax
                                    928                       928  
Unrealized gain
                                    428                       428  
Comprehensive income
                                                            53,185  
Prior service costs, net of $83 of income tax
                                    (128 )                     (128 )
Adoption of change in pension measurement date, net of $210 of income tax
                            325                               325  
Exercise of stock options
                            (1,315 )             24       2,285       970  
Tax benefit from exercise of stock options
                    405                                       405  
Stock-based compensation
                    1,504                                       1,504  
Common shares repurchased
                                            --       --       --  
Restricted stock  cancellations
                    23                       --       (23 )     --  
Balance as of December 31, 2008
    54,069       541       135,655       732,107       (13,384 )     (15,352 )     (667,068 )     187,851  
For the nine months ended September 30, 2009
    (unaudited):
                                                               
Net income
                            209,212                               209,212  
Other comprehensive income:
                                                               
Amortization of prior service cost, net of $8 of
    income tax
                                    12                       12  
Amortization of net actuarial pension loss, net of
    $696 of income tax
                                    1,078                       1,078  
Unrealized (loss)
                                    (264 )                     (264 )
Comprehensive income
                                                            210,038  
Exercise of stock options
                            (11,414 )             209       20,164       8,750  
Tax benefit from exercise of stock options and
            restricted stock vesting
                    5,751                                       5,751  
Stock-based compensation
                    10,247                                       10,247  
Common shares repurchased
                                            (1,978 )     (208,828 )     (208,828 )
Issuance of shares for Directors’ compensation
                            2               1       28       30  
Restricted stock shares withheld for taxes
                                            (4 )     (359 )     (359 )
Balance as of September 30, 2009
    54,069     $ 541     $ 151,653     $ 929,907     $ (12,558 )     (17,124 )   $ (856,063 )   $ 213,480  

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
 
- 5 -

 
ITT EDUCATIONAL SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2009
(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 September 30, 2009, we were offering master, bachelor and associate degree programs to more than 79,000 students at ITT Technical Institute and Daniel Webster College (“DWC”) locations.  As of September 30, 2009, we had 122 locations (including 113 campuses and nine learning sites) in 38 states.  All of our locations 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 and since June 2009 under the “Daniel Webster College” 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, 2008 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.  Arrangements where we may have a variable interest in another party are evaluated in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”), to determine whether we would be required to include the financial results of the other party in our consolidated financial statements.  As of September 30, 2009, we were not required to include the financial results of any variable interest entity in our condensed consolidated financial statements.

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, 2008.

 
2.
Acquisition

On June 10, 2009, we acquired substantially all of the assets and assumed certain liabilities of DWC for approximately $20,800 in cash, net of cash acquired.  Approximately $20,600 of the amount we paid was used to satisfy certain liabilities of DWC that we did not assume in the acquisition.  DWC’s campus is located in Nashua, New Hampshire.  DWC is authorized by the New Hampshire Postsecondary Education Commission and is accredited by the Commission on Institutions of Higher Education of the New England Association of Schools and Colleges.  DWC offers programs of study at the master, bachelor and associate degree levels both in residence and through distance education.

Our condensed consolidated financial statements include the results of operations of DWC from the acquisition date.  The revenue and expenses of DWC included in our Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2009 were not material.  Our revenue, net income and earnings per share would not have been materially affected if the revenue and expenses of DWC were presented for the nine months ended September 30, 2009 and 2008 and the three months ended September 30, 2008 as if the transaction had occurred at the beginning of each of those reporting periods.

The acquisition of DWC has been accounted for in accordance with ASC 805, “Business Combinations” (“ASC 805”), which requires the use of the acquisition method of accounting for all business combinations. The purchase price has been preliminarily allocated to identifiable net assets, with the excess of the estimated fair value of the net assets acquired over the consideration paid recognized as a gain.  The gain was not material and has been recorded in “Student services and administrative expenses” in our Condensed Consolidated Statements of Income for the nine months ended September 30, 2009.

 
- 6 -

 
The following table sets forth the estimated fair values allocated to the major classes of assets acquired and liabilities assumed in the DWC acquisition as of the acquisition date:

   
Assets Acquired
   
Liabilities Assumed
 
Cash and other current assets
  $ 1,215        
Land, buildings, furniture and equipment
    25,445        
Intangibles
    870        
Accounts payable and other liabilities
          $ 5,621  
    $ 27,530     $ 5,621  

These estimated fair values of assets acquired and liabilities assumed in the DWC acquisition are preliminary and are based on information that was available as of the acquisition date and as of September 30, 2009.  The allocation of the purchase price may be revised when we complete the final review of information, but we do not anticipate any material changes.  We expect to finalize the purchase price allocation by December 31, 2009.

 
3.
New Accounting Guidance

In June 2009, the FASB established the FASB Accounting Standards Codification™ (“Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”).  This guidance was included in the Codification under ASC 105, “Generally Accepted Accounting Principles” (“ASC 105”).  All prior accounting standard documents were superseded by the Codification and any accounting literature not included in the Codification is no longer authoritative. Rules and interpretive releases of the SEC issued under the authority of federal securities laws will continue to be sources of authoritative GAAP for SEC registrants.  The Codification became effective for us beginning with our third fiscal quarter of 2009.  Therefore, beginning with our third fiscal quarter of 2009, all references made by us to GAAP in our notes to condensed consolidated financial statements use the new Codification numbering system.  The Codification does not change or alter existing GAAP and, therefore, did not have any impact on our condensed consolidated financial statements.

In May 2009, the FASB established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued.  This guidance was included in the Codification under ASC 855, “Subsequent Events” (“ASC 855”), and became effective for us beginning with our second fiscal quarter of 2009.  We performed an evaluation of subsequent events through October 21, 2009, and we issued our financial statements on October 22, 2009.

See Notes 4 and 8 for a discussion of additional new accounting guidance that became effective for us beginning with our second fiscal quarter of 2009.

The following new accounting guidance became effective for us beginning with our first fiscal quarter of 2009:

 
·
Accounting for financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities, was included in the Codification under ASC 944, “Financial Services – Insurance” (“ASC 944”).  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Expanded disclosure requirements for derivative instruments and hedging activities were included in the Codification under ASC 815, “Derivatives and Hedging” (“ASC 815”). The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Accounting and reporting standards for the noncontrolling interest of a subsidiary and for the deconsolidation of a subsidiary were included in the Codification under ASC 810. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Principles and requirements for how a company recognizes and measures assets, liabilities and noncontrolling interests acquired or assumed in a business combination were included in the Codification under ASC 805. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties and the definition of collaborative arrangements were included in the Codification under ASC 808, “Collaborative Arrangements” (“ASC 808”).  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

See Note 4 for a discussion of additional new accounting guidance that became effective for us beginning with our first fiscal quarter of 2009.

 
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In June 2009, the FASB set forth certain requirements to improve the financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements.  This guidance is effective for our interim and annual reporting periods beginning January 1, 2010.  We have not determined the effect that the adoption of this guidance will have on our condensed consolidated financial statements and disclosures.

Also in June 2009, the FASB provided guidance to improve transparency about transfers of financial assets and a transferor’s continuing involvement, if any, with transferred financial assets.  It also clarified the requirement for isolation and limitations on portions of financial assets that are eligible for sale accounting, eliminated exceptions for qualifying special-purpose entities from the consolidation guidance and eliminated the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the financial assets.  This guidance is effective for our interim and annual reporting periods beginning January 1, 2010.  We have not determined the effect that the adoption of this guidance will have on our condensed consolidated financial statements and disclosures.

In December 2008, the FASB issued guidance which required enhanced disclosures about plan assets in an employer’s defined benefit pension or other postretirement plan.  This guidance was included in the Codification under ASC 715, “Compensation – Retirement Benefits” (“ASC 715”). These disclosures are intended to provide users of financial statements with a greater understanding of how investment allocation decisions are made, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets and significant concentrations of risk within plan assets. This provision of ASC 715 will apply to our plan asset disclosures beginning with our fiscal year ending December 31, 2009.

 
4.
Fair Value

In February 2008, the FASB delayed the effective date of fair value disclosures 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. This guidance was included in the Codification under ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”). This provision of ASC 820 was effective for us beginning on January 1, 2009.  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements, because we do not have any nonfinancial assets or nonfinancial liabilities recognized or disclosed at fair value.

ASC 820 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 ASC 820.  Observable inputs are assumptions based on independent market data sources.

In April 2009, the FASB provided additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased.  This guidance was included in the Codification under ASC 820. This guidance became effective for us beginning with our disclosures for our second fiscal quarter of 2009.  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements or disclosures.

The following table sets forth information regarding the fair value measurement of our financial assets as of September 30, 2009:


         
Fair Value Measurements at Reporting Date Using
 
         
(Level 1)
   
(Level 2)
   
(Level 3)
 
Description
 
As of
September 30, 2009
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
Cash equivalents
  $ 124,540     $ 124,540     $ --     $ --  
Short-term investments
    144,146       78,291       65,855       --  
    $ 268,686     $ 202,831     $ 65,855     $ --  
 
 
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We used quoted prices in active markets for identical assets as of the measurement date to value our financial assets that were categorized as Level 1.  For assets that were categorized as Level 2, we used:

 
·
quoted prices for similar assets in active markets;
 
·
quoted prices for identical or similar assets in markets that were not active or in which little public information had been released;
 
·
inputs other than quoted prices that were observable for the assets; or
 
·
inputs that were principally derived from or corroborated by observable market data by correlation or other means.

In April 2009, the FASB required disclosures about fair value of financial instruments for interim reporting periods.  This guidance was included in the Codification under ASC 825, “Financial Instruments” (“ASC 825”), and became effective for us beginning with our disclosures for our second fiscal quarter of 2009.

The carrying amounts for cash and cash equivalents, restricted cash, accounts receivable, accounts payable, other accrued liabilities and deferred revenue approximate fair value because of the immediate or short-term maturity of these financial instruments.  Investments classified as available-for-sale are recorded at their market value.

The fair value of a note receivable included in Other assets on our Condensed Consolidated Balance Sheet as of September 30, 2009 is estimated by discounting the future cash flows using current rates for similar arrangements.  As of September 30, 2009, each of the carrying value and the estimated fair value of the note receivable was $13,990.

The fair value of the current portion of our long-term debt is estimated by discounting the future cash flows using current rates for similar loans with similar characteristics and remaining maturities.  As of September 30, 2009, the carrying value of the current portion of our long-term debt was $150,000 and the estimated fair value was approximately $149,400.

 
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5.
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
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Stock-based compensation expense
  $ 2,891     $ 1,628     $ 10,247     $ 5,731  
Income tax (benefit)
  $ (1,113 )   $ (627 )   $ (3,946 )   $ (2,206 )

We did not capitalize any stock-based compensation cost in the three or nine months ended September 30, 2009 or 2008.

As of September 30, 2009, we estimated that pre-tax compensation expense for unvested stock-based compensation grants in the amount of approximately $17,243, 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 2.0 years.

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

   
Nine Months Ended September 30, 2009
         
Weighted
       
Weighted
   
         
Average
   
Aggregate
 
Average
 
Aggregate
   
# of
   
Exercise
   
Exercise
 
Remaining
 
Intrinsic
   
Shares
   
Price
   
Price
 
Contractual Term
 
Value (1)
Outstanding at beginning of period
    1,561,517     $ 54.89     $ 85,710        
Granted
    258,000     $ 121.56       31,362        
Forfeited
    (1,000 )   $ 51.20       (51 )      
Exercised
    (209,044 )   $ 41.86       (8,750 )      
Expired
    --     $ --       --        
Outstanding at end of period
    1,609,473     $ 67.27     $ 108,271  
4.7 years
 
$69,431
Exercisable at end of period
    1,152,025     $ 51.89     $ 59,777  
3.8 years
 
$67,418

     _____________________________
(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 September 30, 2009, 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
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Shares subject to stock options granted
    --       --       258,000       177,543  
Weighted average grant date fair value
  $ --     $ --     $ 54.05     $ 36.83  
Shares subject to stock options exercised
    65,150       43,442       209,044       50,725  
Intrinsic value of stock options exercised
  $ 3,613     $ 1,839     $ 14,582     $ 2,096  
Proceeds received from stock options exercised
  $ 2,756     $ 1,996     $ 8,750     $ 2,271  
Tax benefits realized from stock options exercised
  $ 1,388     $ 706     $ 5,458     $ 796  

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

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

 
Three Months
Ended September 30,
 
Nine Months
Ended September 30,
 
2009
 
2008
 
2009
 
2008
Risk-free interest rates
Not applicable
 
Not applicable
 
1.6%
 
2.7%
Expected lives (in years)
Not applicable
 
Not applicable
 
4.5
 
4.0
Volatility
Not applicable
 
Not applicable
 
54%
 
53%
Dividend yield
Not applicable
 
Not applicable
 
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:

   
Nine Months Ended September 30, 2009
 
   
# of Shares of Restricted Stock
   
Weighted Average Grant Date
Fair Value
   
# of RSUs
   
Weighted Average Grant Date
Fair Value
 
Unvested at beginning of period
    19,440     $ 61.05       95,079     $ 82.95  
Granted
    --       --       36,995     $ 116.43  
Forfeited
    --       --       (5,941 )   $ 93.62  
Vested
    (19,440 )   $ 61.05       --       --  
Unvested at end of period
    --     $ --       126,133     $ 92.27  

The total fair market value of the shares vested during the nine months ended September 30, 2009 was $1,938.

 
6.
Stock Repurchases

As of September 30, 2009, 1,994,225 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
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Number of shares
    827,842       184,700       1,977,875       1,049,700  
Total cost
  $ 84,492     $ 15,971     $ 208,828     $ 87,774  
Average cost per share
  $ 102.06     $ 86.47     $ 105.58     $ 83.62  

 
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7.
Debt

We are a party to an Amended and Restated Credit Agreement dated as of December 17, 2007 and amended as of March 19, 2009 (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.  Both revolving credit facilities under the Credit Agreement mature on July 1, 2010.

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 September 30, 2009, the borrowings under the Credit Agreement were $150,000, all of which were secured and bore interest at a rate of 0.40% per annum.  Approximately $157,950 of our investments and cash equivalents served as collateral for the secured borrowings as of September 30, 2009.

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
September 30,
   
Nine Months Ended
September 30,
 
2009
   
2008
   
2009
   
2008
 
$ 189     $ 1,012     $ 584     $ 3,536  

 
8.
Investments

In April 2009, the FASB amended the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.  This guidance was included in the Codification under ASC 320, “Investments – Debt and Equity Securities” (“ASC 320”), and became effective for us beginning with our disclosures for our second fiscal quarter of 2009.  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements or disclosures because we did not hold any investments at September 30, 2009 that were impaired.

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

   
As of:
 
   
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Available-for-Sale
   
Held-to-Maturity
   
Total
   
Available-for-Sale
   
Held-to-Maturity
   
Total
   
Available-for-Sale
   
Held-to-Maturity
   
Total
 
Short-term investments
  $ 139,050     $ --     $ 139,050     $ 138,709     $ --     $ 138,709     $ 150,000     $ --     $ 150,000  

The following table sets forth the aggregate fair value and the net unrealized gains included in accumulated other comprehensive income (loss) of our available-for-sale investments as of the dates indicated:
 
 
- 12 -

 
   
As of:
 
   
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Aggregate Fair Value
   
Net Unrealized Gains
   
Aggregate Fair Value
   
Net Unrealized Gains
   
Aggregate Fair Value
   
Net Unrealized Gains
 
Available-for-Sale Investments:
                                   
Variable rate demand notes
  $ --     $ --     $ 30,500     $ --     $ 150,000     $ --  
Government obligations
    78,291       60       53,056       146       --       --  
Government agency obligations
    27,863       20       29,641       165       --       --  
Corporate obligations
    32,896       84       25,512       117       --       --  
    $ 139,050     $ 164     $ 138,709     $ 428     $ 150,000     $ --  

We also held a certificate of deposit with a total principal value of $5,096 as of September 30, 2009.  This investment is included in short-term investments on our Condensed Consolidated Balance Sheet.

The following table sets forth the components of investment income included in interest income in our Condensed Consolidated Statements of Income in the periods indicated:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Interest income
  $ 655     $ 1,563     $ 2,766     $ 4,767  
Net realized gain on sale of investments
    61       --       61       --  
    $ 716     $ 1,563     $ 2,827     $ 4,767  

The following table sets forth the contractual maturities of our debt securities classified as available-for-sale as of September 30, 2009:

Contractual Maturity
 
Available-for-Sale
 
Due within five years
  $ 139,050  
Due after five years through ten years
    --  
Due after ten years
    --  
    $ 139,050  

 
9.
Note Receivable

In the second and third fiscal quarters of 2009, we made advances to an unaffiliated third party, whose purpose is to purchase private education loans and sell participation interests in those loans.  The third party used the advances from us to provide partial funding for private education loans made to our students.  As of September 30, 2009, we had advanced $13,990 to this entity.  The advances bear interest at a rate based on the Prime Rate plus an applicable margin.  Substantially all of the assets of the third party serve as collateral for the advances.  The advances are subject to customary terms and conditions and may be repaid at any time without penalty prior to their maturity date of August 21, 2024.

As a result of those advances, we held a variable interest in this third party, but we are not considered the primary beneficiary for purposes of including the financial results of this third party in our consolidated financial statements.  If we had been required to include the financial results of this third party in our condensed consolidated financial statements for the three and nine month periods ended September 30, 2009, it would not have had a material effect.

 
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10.
Earnings Per Common Share

Earnings per common share for all periods have been calculated in conformity with ASC 260, “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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In thousands)
Shares:
             
Weighted average number of shares of common stock outstanding
37,324
 
38,777
 
37,950
 
38,938
Shares assumed issued (less shares assumed purchased for treasury)
             
for stock-based compensation
439
 
418
 
462
 
353
Outstanding shares for diluted
             
earnings per share calculation
37,763
 
39,195
 
38,412
 
39,291

A total of 272,400 shares at September 30, 2009 and 265,825 shares at September 30, 2008 were excluded from the calculation of our diluted earnings per common share because the effect was anti-dilutive.

 
11.
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
   
Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Interest cost
  $ 779     $ 769     $ 2,327     $ 2,307  
Expected return on assets
    (956 )     (1,307 )     (2,864 )     (3,921 )
Recognized net actuarial loss
    641       --       1,773       --  
Amortization of prior service cost
    7       --       21       --  
Net periodic pension cost (benefit)
  $ 471     $ (538 )   $ 1,257     $ (1,614 )

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 has been included in the net periodic pension cost or benefit.

We made no contributions to the ESI Pension Plan during the three or nine months ended September 30, 2009 and 2008.  We do not expect to make any contributions to the ESI Pension Plan in 2009.  We made no contributions to the ESI Excess Pension Plan in the three months ended September 30, 2009 and we contributed $528 in the nine months ended September 30, 2009.  We contributed $1,251 to the ESI Excess Pension Plan in the three and nine months ended September 30, 2008.

 
12.
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 September 30, 2009, the total face amount of those surety bonds was approximately $19,986.

 
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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 campuses to additional regulatory scrutiny.

Guarantees. In February 2009, we entered into an agreement with an unaffiliated third party whereby private education loans are provided to our students to help pay the students’ cost of education that student financial aid from federal, state and other sources do not cover (the “Private Student Loan Program”).  In connection with the Private Student Loan Program, we entered into a risk sharing agreement (“2009 RSA”) under which we have guaranteed the repayment of any private education loans that are charged off above a certain percentage of the private education loans made under the Private Student Loan Program, based on the annual dollar volume.  As of September 30, 2009, approximately $52,000 of private education loans had been made under the Private Student Loan Program.  Our obligations under the 2009 RSA will remain in effect until all private education loans made under the Private Student Loan Program are paid in full or charged off.  The standard repayment term for a private education loan made under the Private Student Loan Program is ten years, with repayment generally beginning six months after a student graduates or three months after a student withdraws or is terminated from his or her program of study.  We did not record a liability for our guarantee obligations under the 2009 RSA as of September 30, 2009, because we do not anticipate that the private education loans charged off will exceed the percentage that would require us to make a payment under our guarantee.

Pursuant to the 2009 RSA, we are required to maintain collateral to secure our guarantee obligation in an amount equal to a percentage of the total private education loans disbursed to our students under the Private Student Loan Program.  As of September 30, 2009, the total collateral maintained in a restricted bank account was not material.  This amount is included in Other assets on our Condensed Consolidated Balance Sheet as of September 30, 2009.  The 2009 RSA also requires that we comply with certain covenants, including that we maintain certain financial ratios which are measured on a quarterly basis.  We were in compliance with these covenants as of September 30, 2009.

We also are a party to a separate risk sharing agreement (the “2007 RSA”) with a different lender for certain private education loans that were made to our students in 2007 and early 2008.  We guaranteed the repayment of any private education loans that the lender charges off above a certain percentage of the total dollar volume of private education loans made under this agreement.  We will have the right to pursue repayment from the borrowers for those charged off private education loans under the 2007 RSA that we pay to the lender pursuant to our guarantee obligation.  The 2007 RSA was terminated effective February 22, 2008, such that no private education loans have been or will be made under the 2007 RSA after that date.  Our obligations under the 2007 RSA will remain in effect until all private education loans under the agreement are paid in full or charged off by the lender.

The maximum future payments that we could be required to make pursuant to our guarantee obligation under the 2007 RSA are affected by:
 
·
the amount of the private educations loans made under the 2007 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 the 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 2007 RSA.  Our recorded liability related to the 2007 RSA as of September 30, 2009 was not material.
 
 
13.
Subsequent Event

In the fourth quarter of 2009, we decided to change our accounting method for direct costs that relate to the enrollment of new students (“Direct Marketing Costs”).  Under the accounting method for Direct Marketing Costs that we used through the third quarter of 2009, we capitalized and amortized those costs over the period during which the revenue streams from the associated contracts were recognized.  Under our new accounting method for Direct Marketing Costs, we will expense those costs in the period incurred.  We evaluated both methods of accounting and determined that expensing Direct Marketing Costs in the period incurred is a preferable accounting method under GAAP, primarily because it will improve the comparability of our financial statements to those of other publicly traded companies in our industry which generally expense such costs as incurred.

If we had expensed Direct Marketing Costs in the three and nine months ended September 30, 2009:

 
·
our net income would have decreased by approximately:
 
·
$752 in the three months ended September 30, 2009; and
 
·
$2,590 in the nine months ended September 30, 2009; and
 
·
our total cash flows from operating activities, investing activities or financing activities would not have changed in either period.
 
 
- 15 -

 
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:

 
·
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 campuses;
 
·
our ability to implement our growth strategies;
 
·
our failure to maintain or renew required regulatory authorizations or accreditation of our campuses;
 
·
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;
 
·
our exposure under our guarantees related to private student loan programs; 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, 2008 filed with the SEC and those discussed in Part II, Item 1A. “Risk Factors.” of our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2009 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.

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 “Daniel Webster College” (in singular or plural form) refer to an individual campus 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, 2008 filed with the SEC for discussion of, among other matters, the following items:

 
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·
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 of the Higher Education Act of 1965, as amended (the “Title IV Programs”);
 
·
percentage of applicable revenue that may be derived from the Title IV Programs;
 
·
return of Title IV Program funds for withdrawn students; and
 
·
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.

In this management’s discussion and analysis of financial condition and results of operations, when we discuss factors that contributed to a change in our financial condition or results of operations, we disclose the primary factors that materially contributed to that change.

Background

We are a leading provider of technology-oriented postsecondary education programs in the United States based on revenue and student enrollment.  As of September 30, 2009, we were offering master, bachelor and associate degree programs to more than 79,000 students.  As of September 30, 2009, we had 122 locations (including 113 campuses and nine learning sites) in 38 states.  All of our locations 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 and since June 2009 under the “Daniel Webster College” name.

In the third quarter of 2009, we began operations at five new ITT Technical Institute campuses.  We plan to begin operations at three additional locations during the remainder of 2009.  Our overall expansion plans include:

 
·
operating new campuses;
 
·
adding learning sites to existing campuses;
 
·
offering a broader range of both residence and online programs at our existing campuses; and
 
·
increasing the number of our campuses that offer bachelor degree programs.

On June 10, 2009, we acquired substantially all of the assets and assumed certain liabilities of DWC for approximately $20.8 million in cash, net of cash acquired.  DWC’s campus is located in Nashua, New Hampshire.  DWC is authorized by the New Hampshire Postsecondary Education Commission and is accredited by the Commission on Institutions of Higher Education of the New England Association of Schools and Colleges.  DWC offers programs of study at the master, bachelor and associate degree levels both in residence and through distance education.

 
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Our condensed consolidated financial statements include the results of operations of DWC from the acquisition date.  The revenue and expenses of DWC that were included in our Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2009 were not material.

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, 2008 filed with the SEC.  There have been no material changes to those critical accounting policies or the underlying accounting estimates or judgments.

As described in Note 1 of the Notes to Consolidated Financial Statements in our Form 10-K for the fiscal year ended December 31, 2008, we capitalized and amortized Direct Marketing Costs over the period during which the revenue streams from the associated contracts were recognized.  This is an acceptable accounting method under, and in accordance with, GAAP.  Other publicly traded companies in our industry expense Direct Marketing Costs in the period incurred, which is an alternative accounting method that is also acceptable under, and in accordance with, GAAP.  In connection with a review by the SEC of our Form 10-K for the fiscal year ended December 31, 2008, we re-evaluated our accounting method for Direct Marketing Costs.  We determined that expensing our Direct Marketing Costs in the period incurred is a preferable GAAP accounting method, primarily because it will improve the comparability of our financial statements with those of other publicly traded companies in our industry.  As a result, in the fourth quarter of 2009, we will change our accounting method for Direct Marketing Costs and begin expensing those costs in the period incurred.

As required by the accounting guidance for changes in accounting methods, the presentations of our financial statements for prior periods that we include in future press releases and SEC filings will be adjusted to reflect the accounting for Direct Marketing Costs under our new accounting method.  The following table sets forth the effect that this change in accounting method would have had on our net income and diluted earnings per share in the periods indicated:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(In thousands, except earnings per share data)
 
Net Income as reported
  $ 75,360     $ 50,186     $ 209,212     $ 139,948  
   Estimated effect of planned accounting change
    (752 )     (446 )     (2,590 )     (1,298 )
Net income as adjusted
  $ 74,608     $ 49,740     $ 206,622     $ 138,650  
                                 
Earnings per share:
                               
   Diluted - as reported
  $ 2.00     $ 1.28     $ 5.45     $ 3.56  
      Estimated effect of planned accounting change
    (0.02 )     (0.01 )     (0.07 )     (0.03 )
   Diluted - as adjusted
  $ 1.98     $ 1.27     $ 5.38     $ 3.53  

We believe that our diluted earnings per share in the fiscal year ending December 31, 2009 will decrease approximately $0.08 as a result of our change in accounting method for Direct Marketing Costs.  If we had used our new accounting method for Direct Marketing Costs in prior periods:

 
- 18 -

 
 
·
our shareholders’ equity as of:
 
·
September 30, 2009 would have decreased by approximately $16.6 million; and
 
·
December 31, 2008 would have decreased by approximately $14.0 million; and
 
·
our total cash flows from operating activities, investing activities or financing activities would not have changed in any period presented.
 
New Accounting Guidance

In June 2009, the FASB established the Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with GAAP.  This guidance was included in the Codification under ASC 105.  All prior accounting standard documents were superseded by the Codification and any accounting literature not included in the Codification is no longer authoritative. Rules and interpretive releases of the SEC issued under the authority of federal securities laws will continue to be sources of authoritative GAAP for SEC registrants.  The Codification became effective for us beginning with our third fiscal quarter of 2009.  Therefore, beginning with our third fiscal quarter of 2009, all references made by us to GAAP use the new Codification numbering system.  The Codification does not change or alter existing GAAP and, therefore, it did not have any impact on our condensed consolidated financial statements.

The following new accounting guidance became effective for us beginning with our second fiscal quarter of 2009:

 
·
General standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued were included in the Codification under ASC 855.  We performed an evaluation of subsequent events through October 21, 2009, and we issued our financial statements on October 22, 2009.
 
·
Disclosures about fair value of financial instruments for interim reporting periods were included in the Codification under ASC 825. See Note 4 of the Notes to Condensed Consolidated Financial Statements for the required disclosures.
 
·
Additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased was included in the Codification under ASC 820. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements or disclosures.
 
·
Other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements was included in the Codification under ASC 320. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements or disclosures.

The following new accounting guidance became effective for us beginning with our first fiscal quarter of 2009:

 
·
Accounting for financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities, was included in the Codification under ASC 944. The adoption of this pronouncement did not have a material impact on our condensed consolidated financial statements.
 
·
Expanded disclosure requirements for derivative instruments and hedging activities were included in the Codification under ASC 815. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Accounting and reporting standards for the noncontrolling interest of a subsidiary and for the deconsolidation of a subsidiary were included in the Codification under ASC 810. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Principles and requirements for how a company recognizes and measures assets, liabilities and noncontrolling interests acquired or assumed in a business combination were included in the Codification under ASC 805. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
Reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties and the definition of collaborative arrangements were included in the Codification under ASC 808. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
 
·
The delay of the effective date of the fair value standards 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, was included in the Codification under ASC 820. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.


 
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In June 2009, the FASB set forth certain requirements to improve the financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements.  This guidance is effective for our interim and annual reporting periods beginning January 1, 2010.  We have not determined the effect that the adoption of this guidance will have on our condensed consolidated financial statements and disclosures.

Also in June 2009, the FASB issued guidance to improve transparency about transfers of financial assets and a transferor’s continuing involvement, if any, with transferred financial assets. It also clarified the requirement for isolation and limitations on portions of financial assets that are eligible for sale accounting, eliminated exceptions for qualifying special-purpose entities from the consolidation guidance and eliminated the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the financial assets.  This guidance is effective for our interim and annual reporting periods beginning January 1, 2010.  We have not determined the effect that the adoption of this guidance will have on our condensed consolidated financial statements and disclosures.

In December 2008, the FASB issued guidance to enhance disclosures about plan assets in an employer’s defined benefit pension or other postretirement plan. This guidance was included in the Codification under ASC 715. These disclosures are intended to provide users of financial statements with a greater understanding of how investment allocation decisions are made, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets and significant concentrations of risk within plan assets. This provision of ASC 715 will apply to our plan asset disclosures beginning with our fiscal year ending December 31, 2009.

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
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2009
 
2008
 
2009
 
2008
Revenue
100.0%
 
100.0%
 
100.0%
 
100.0%
Cost of educational services
34.4%
 
37.4%
 
34.8%
 
38.4%
Student services and administrative expenses
29.5%
 
30.8%
 
29.2%
 
30.9%
Operating income
36.1%
 
31.8%
 
36.0%
 
30.7%
Interest income, net
0.2%
 
0.2%
 
0.2%
 
0.2%
Income before provision for income taxes
36.3%
 
32.0%
 
36.2%
 
30.9%

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

   
2009
 
2008
   
Total
 
Increase
 
Total
 
Increase
Total Student
 
Student
 
Over
 
Student
 
Over
Enrollment as of:
 
Enrollment (1)
 
Prior Year (1)
 
Enrollment
 
Prior Year
March 31
 
65,620
 
21.1%
 
54,194
 
9.9%
June 30
 
69,889
 
27.6%
 
54,793
 
12.1%
September 30
 
79,208
 
28.7%
 
61,556
 
14.7%
December 31
 
Not applicable
 
Not applicable
 
61,983
 
16.9%
        _____________________________
 
(1)
Students enrolled at Daniel Webster College have been included beginning with the June 30, 2009 period.

 
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Total student enrollment includes all new and continuing students.  A continuing student is any student who, in the academic term being measured, is enrolled in a program of study at one of our campuses and was enrolled in the same program at any of our campuses at the end of the immediately preceding academic term.  A new student is any student who, in the academic term being measured, enrolls in and begins attending any program of study at one of our campuses:

 
·
for the first time at that campus;
 
·
after graduating in a prior academic term from a different program of study at that campus; or
 
·
after having withdrawn or been terminated from a program of study at that campus.

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

   
2009
 
2008
New Student Enrollment
 
New
 
Increase
 
New
 
Increase
in the Three
 
Student
 
Over
 
Student
 
Over
Months Ended:
 
Enrollment (1)
 
Prior Year (1)
 
Enrollment
 
Prior Year
March 31
 
18,935
 
36.8%
 
13,844
 
8.7%
June 30
 
19,692
 
33.5%
 
14,751
 
22.5%
September 30
 
27,738
 
27.2%
 
21,807
 
19.4%
December 31
 
Not applicable
 
Not applicable
 
14,911
 
29.2%
Total for the year
 
Not applicable
 
Not applicable
 
65,313
 
19.6%
        _____________________________
 
(1)
New students enrolled at Daniel Webster College have been included beginning with the September 30, 2009 period.

We believe that economic downturns in the United States, in particular those that result in higher unemployment rates among unskilled workers, have historically been associated with increased student enrollment at postsecondary educational institutions.  Based on this, we believe that the current economic recession in the United States which has given rise to higher unemployment among unskilled workers has contributed to the year-over-year increases in our new and total student enrollment in each of the past few fiscal quarters.  These increases have had a material favorable effect on our results of operations, cash flows and financial condition.  There are a number of other factors, however, that affect student enrollment, and we cannot assure you that this trend will continue or we will continue to experience similar financial and operating results.  In addition, tighter credit markets in the United States have contributed to reduced availability of private education loans from third-party lenders to our students and, as a result, have led to an increase in the amount of internal student financing that we have provided to our students.  See “—Financial Condition, Liquidity and Capital ResourcesStudent Financing Update” below.

We generally organize the academic schedule for programs of study offered at our campuses on the basis of four 12-week academic quarters or two 14-week academic semesters in a calendar year.  The academic quarters typically begin in early March, mid-June, early September and late November or early December, and the academic semesters typically begin in early September and mid-January.  To measure the persistence of our students, the number of continuing students in any academic term is divided by the total student enrollment in the immediately preceding academic term.

The following table sets forth the rates of our students’ persistence as of the dates indicated:
 
   
Student Persistence as of (1):
Year
 
March 31
 
June 30
 
September 30
 
December 31
2007
 
78.0%
 
74.7%
 
72.4%
 
77.3%
2008