-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NbNgcHLAAN6S5fP5e5ReUiE8Wb/Q76VTneRiwDnTKJfd8djJXS6gcoWqDNbCutv2 68+np0U9bM2Rv8Cvhjtm3A== 0000950131-97-004869.txt : 19970811 0000950131-97-004869.hdr.sgml : 19970811 ACCESSION NUMBER: 0000950131-97-004869 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970808 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ITT EDUCATIONAL SERVICES INC CENTRAL INDEX KEY: 0000922475 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 362061311 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13144 FILM NUMBER: 97654653 BUSINESS ADDRESS: STREET 1: 5975 CASTLE CREEK PARKWAY N DR STREET 2: PO BOX 50466 CITY: INDIANAPOLIS STATE: IN ZIP: 46250 BUSINESS PHONE: 3175944289 MAIL ADDRESS: STREET 1: 5975 CASTLE CREEK PKWY N DR STREET 2: P O BOX 50466 CITY: INDIANAPOLIS STATE: IN ZIP: 46250-0466 10-Q 1 FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (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, 1997 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) 5975 Castle Creek Parkway N. Drive P.O. Box 50466 Indianapolis, Indiana 46250-0466 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (317) 594-9499 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] 26,999,952 Number of shares of Common Stock, $.01 par value, outstanding at July 31, 1997 ITT EDUCATIONAL SERVICES, INC. Indianapolis, Indiana Quarterly Report to Securities and Exchange Commission June 30, 1997 PART I ITEM 1. FINANCIAL STATEMENTS. INDEX -----
Page ---- Statements of Income (unaudited) for the six months ended June 30, 1997 and 1996 and the three months ended June 30, 1997 and 1996...........................................................................3 Balance Sheets as of June 30, 1997 and 1996 (unaudited) and December 31, 1996.................................................4 Statements of Cash Flows (unaudited) for the six months ended June 30, 1997 and 1996 and the three months ended June 30, 1997 and 1996...........................................................................5 Notes to Financial Statements.................................................................................................6
-2- ITT EDUCATIONAL SERVICES, INC. STATEMENTS OF INCOME (In thousands, except per share data) (unaudited)
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 1997 1996 1997 1996 ---- ---- ---- ---- Revenues Tuition $48,253 $42,376 $103,999 $ 91,644 Other educational 10,159 9,192 18,889 17,027 ------- ------- -------- -------- Total revenues 58,412 51,568 122,888 108,671 ------- ------- -------- -------- Costs and Expenses Cost of educational services 39,807 35,074 77,791 68,561 Student services and administrative expenses 18,456 16,880 35,992 33,385 ------- ------- -------- -------- Total costs and expenses 58,263 51,954 113,783 101,946 ------- ------- -------- -------- Operating income 149 (386) 9,105 6,725 Interest income, net 1,193 909 2,573 1,856 ------- -------- -------- -------- Income before income taxes 1,342 523 11,678 8,581 Income taxes 537 209 4,671 3,432 ------- -------- -------- -------- Net income $ 805 $ 314 $ 7,007 $ 5,149 ======= ======== ======== ======== Earnings per common share $ 0.03 $ 0.01 $ 0.26 $ 0.19 Average equivalent common shares outstanding (in thousands) 27,171 27,159 27,177 27,132
The accompanying notes are an integral part of these financial statements. -3- ITT EDUCATIONAL SERVICES, INC. BALANCE SHEETS (In thousands, except per share data)
June 30, 1997 December 31, 1996 June 30, 1996 (unaudited) (unaudited) ------------- ----------------- ------------- Assets Current assets Cash $ 182 $ 74 $ 46 Restricted cash 642 5,911 910 Cash invested with ITT Corporation 93,060 89,808 75,347 Accounts receivable, net 9,092 9,378 8,932 Deferred income tax 1,302 1,455 509 Prepaids and other current assets 4,529 1,823 3,030 -------- -------- -------- Total current assets 108,807 108,449 88,774 Property and equipment, net 21,972 19,360 17,906 Direct marketing costs 6,377 5,774 5,352 Other assets 2,160 2,166 2,658 -------- -------- -------- Total assets $139,316 $135,749 $114,690 ======== ======== ======== Liabilities and Shareholders' Equity Current liabilities Accounts payable $ 20,594 $ 12,188 $ 16,778 Accrued compensation and benefits 3,141 4,253 2,806 Other accrued liabilities 3,943 5,432 2,953 Deferred tuition revenue 34,311 43,532 31,457 -------- -------- -------- Total current liabilities 61,989 65,405 53,994 Other liabilities 1,628 1,652 1,706 -------- -------- -------- Total liabilities 63,617 67,057 55,700 -------- -------- -------- Shareholders' equity Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued or outstanding Common stock, $.01 par value, 50,000,000 shares authorized, 26,999,952, 26,999,952 and 18,000,000 issued and outstanding 270 270 180 Capital surplus 32,513 32,513 32,603 Retained earnings 42,916 35,909 26,207 -------- -------- -------- Total shareholders' equity 75,699 68,692 58,990 -------- -------- -------- Total liabilities and shareholders' equity $139,316 $135,749 $114,690 ======== ======== ========
The accompanying notes are an integral part of these financial statements. -4- ITT EDUCATIONAL SERVICES, INC. STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Three Months Six Months Ended June 30, Ended June 30, ------------------ ------------------ 1997 1996 1997 1996 ------- ------- ------- ------- Cash flows from operating activities: Net income $ 805 $ 314 $ 7,007 $ 5,149 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,096 2,026 4,054 3,991 Provision for doubtful accounts 404 460 857 849 Deferred taxes 81 199 308 474 Increase/decrease in operating assets and liabilities: Accounts receivable 301 (1,577) (571) (2,189) Direct marketing costs (408) (394) (603) (321) Accounts payable and accrued liabilities 3,386 (2,415) 5,626 3,834 Prepaids and other assets (495) (128) (2,700) (1,483) Deferred tuition revenue 3,511 3,555 (9,221) (8,606) ------- ------- ------- ------- Net cash provided by operating activities 9,681 2,040 4,757 1,698 ------- ------- ------- ------- Cash flows used for investing activities: Capital expenditures, net (2,639) (1,720) (6,666) (2,912) Net decrease (increase) in cash invested with ITT Corporation (7,124) (140) (3,252) (3,462) ------- ------- ------- ------- Net cash used for investing activities (9,763) (1,860) (9,918) (6,374) ------- ------- ------- ------- Net increase (decrease) in cash and restricted cash (82) 180 (5,161) (4,676) Cash and restricted cash at beginning of period (906) 776 5,985 5,632 ------- ------- ------- ------- Cash and restricted cash at end of period $ 824 $ 956 $ 824 $ 956 ======= ======= ======= =======
The accompanying notes are an integral part of these financial statements. -5- ITT EDUCATIONAL SERVICES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 1997 (Dollar amounts in thousands, unless otherwise stated) 1. The accompanying unaudited financial statements have been prepared by ITT Educational Services, Inc. (the "Company") without audit. In the opinion of management, the financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial condition and results of operations of the Company. Certain information and footnote disclosures, including significant accounting policies, normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. The interim financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission for the year ended December 31, 1996. The results of operations for the six months ended June 30, 1997 are not necessarily indicative of results for the entire calendar year. 2. On March 22, 1996, the Company declared a 3 for 2 Common Stock split effected by payment of a stock dividend on April 15, 1996 to all shareholders of record at the close of business on April 1, 1996. On October 8, 1996, the Company declared a 3 for 2 Common Stock split effected by payment of a stock dividend on November 4, 1996 to all shareholders of record at the close of business on October 21, 1996. The earnings per share amounts for all prior periods have been restated to reflect these stock splits. 3. The Company has a number of pending legal and other claims arising out of the normal course of business. Among the legal actions is Eldredge, et al. v. ITT Educational Services, Inc., et al. (the "Eldredge Case"). This action was filed on June 8, 1995 in San Diego, California by seven graduates of the San Diego ITT Technical Institute. In October 1996, the jury in this action rendered a verdict against the Company and awarded the plaintiffs general damages of approximately $0.2 million and exemplary damages of $2.6 million. The judge also awarded the plaintiffs attorney's fees and costs, in the amount of approximately $0.9 million, and interest. The Company is seeking to overturn the awards and has appealed the decision. Management, based on the advice of counsel, believes it is probable that it will prevail in its appeal, thus no provision (other than the Company's legal expenses) for these awards has been made. If the Company's appeal of the judgment in the Eldredge Case is unsuccessful, a charge to earnings would be taken at that time in the amount of the awards, including the general and exemplary damages assessed against the Company, the plaintiffs' attorney's fees and costs and the interest assessed thereon. In late January 1997, six legal actions were filed against the Company in San Diego, California by a total of 21 former students of the San Diego ITT Technical Institute. The plaintiffs in one such action seek to have the action certified as a class action. The claims alleged in these legal actions are similar to the claims alleged in the Eldredge Case and include misrepresentation and violations of certain statutory provisions of the California Education Code and California Business and Professions Code. In the opinion of management, the ultimate outcome of these matters should not have a material adverse effect on the Company's financial position, results of operations or cash flows. -6- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This management's discussion and analysis of financial condition and results of operations should be read in conjunction with the same titled section contained in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission for the year ended December 31, 1996 for discussion of cash receipts from financial aid programs, nature of capital additions, seasonality of revenues, components of income statement captions, interest payments on cash invested with ITT Corporation ("ITT") and other matters. The Company records its revenues as students attend class. Due to the two week vacations in June and December, the first and third quarters include 13 weeks of revenue and the second and fourth quarters include 11 weeks of revenue. The Company's incurrence of costs, however, is generally not affected by the academic schedule and such costs do not fluctuate significantly on a quarterly basis. As a result, net income in the second and fourth quarters is significantly less than in the first and third quarters. Results of Operations - --------------------- Revenues increased $6.8 million, or 13.2%, to $58.4 million in the three months ended June 30, 1997 from $51.6 million in the three months ended June 30, 1996. Revenues increased $14.2 million, or 13.1%, to $122.9 million in the six months ended June 30, 1997 from $108.7 million in the six months ended June 30, 1996. These increases were due primarily to a 5% increase in tuition rates in September 1996 and a 9.8% increase in the total student enrollment at January 1, 1997 compared to January 1, 1996. The number of students attending ITT Technical Institutes at January 1, 1997 was 22,633 compared to 20,618 at January 1, 1996. The total number of first-time and re-entering students beginning classes in June 1997 was 6,879 compared to 6,553 for the same period in 1996. First-time students numbered 6,158 in June 1997 compared to 5,918 in June 1996. The total student enrollment on June 30, 1997 was 23,994, compared to 22,100 on June 30, 1996, an increase of 8.6%. Cost of educational services increased $4.7 million, or 13.4%, to $39.8 million in the three months ended June 30, 1997 from $35.1 million in the three months ended June 30, 1996. Cost of educational services increased $9.2 million, or 13.4%, to $77.8 million in the six months ended June 30, 1997 from $68.6 million in the six months ended June 30, 1996. These increases were principally a result of costs required to service the increased enrollment, normal inflationary cost increases for wages, rent and other costs of services, and increased costs at new technical institutes (two opened in March 1996, one in September 1996 and one in June 1997). Cost of educational services as a percentage of revenue increased in the three and six months ended June 30, 1997 compared to the three and six months ended June 30, 1996 as a result of a $0.5 million and $1.0 million provision in the three and six months ended June 30, 1997, respectively (none in the three and six months ended June 30, 1996) for the Company's legal expenses in Eldredge, et al. v. ITT Educational Services, Inc., et al. (the "Eldredge Case"). (See Note 3 of Notes to Financial Statements.) Excluding this provision, cost of educational services in the three months ended June 30, 1997 would have been 67.3% of revenues, a 0.7% improvement from the three months ended June 30, 1996 and 62.5% of revenues for the six months ended June 30, 1997, a 0.6% improvement from the six months ended June 30, 1996. Student services and administrative expenses increased $1.6 million, or 9.5%, to $18.5 million in the three months ended June 30, 1997 from $16.9 million in the three months ended June 30, 1996. Student services and administrative expenses increased $2.6 million, or 7.8%, to $36.0 million in the six months ended June 30, 1997 from $33.4 million in the six months ended June 30, 1996. The Company increased its media advertising expenses in the three and six months ended June 30, 1997 by approximately 16% and 12%, respectively, over the same expenses incurred in the three and six months ended June 30, 1996. This media expense increase was less than the increases experienced during this period in 1996 because of a planned reduction in the percentage increase and an unplanned -7- reduction caused by higher than expected preemptions by the television stations. Student services and administrative expenses decreased to 31.6% of revenues in the three months ended June 30, 1997 compared to 32.7% in the three months ended June 30, 1996, primarily because the greater revenues did not cause an increase in the fixed portion of the marketing and headquarters expenses. The Company incurs operating losses when opening new institutes. Six new institutes were opened in 1994, two in 1995, three in 1996 and one in the first six months of 1997. A new institute typically is open for approximately 24 months before it experiences a profit. The revenues and expenses of these institutes are included in the respective captions in the statements of income. The amount of operating losses (pre-tax) for institutes open less than 24 months during the three and six months ended June 30, 1997 were $1.0 million and $2.0 million, respectively, compared to $2.2 million and $3.6 million for the three and six months ended June 30, 1996, respectively. Operating income increased $0.5 million to $0.1 million in the three months ended June 30, 1997 from a $0.4 million operating loss in the three months ended June 30, 1996. Operating income increased $2.4 million, or 35.8%, to $9.1 million in the six months ended June 30, 1997 from $6.7 million in the six months ended June 30, 1996. These increases were due primarily to the control of costs and the reduction of operating losses of new institutes (i.e., six institutes in the first 24 months of operation in the three months ended June 30, 1997 compared to 10 in the three months ended June 30, 1996). The operating margin increased to 0.3% of revenues in the three months ended June 30, 1997, from a 0.7% operating loss in the three months ended June 30, 1996 despite the $0.5 million provision for legal expenses in the three months ended June 30, 1997. The operating margin for the six months ended June 30, 1997 was 7.4% compared to 6.2% for the six months ended June 30, 1996 despite the $1.0 million provision for legal expenses in 1997. Interest income in the three months ended June 30, 1997 increased $0.3 million from the three months ended June 30, 1996. Interest income increased $0.7 million in the six months ended June 30, 1997 compared to the six months ended June 30, 1996. These increases were primarily due to the increase in the interest rate earned on the cash invested by the Company with ITT (i.e., 6.3% in 1997 compared to 5.5% in 1996) and the $17.9 million increase in cash invested with ITT Corporation during 1996. Financial Condition, Liquidity and Capital Resources - ---------------------------------------------------- Due to the seasonal pattern of enrollments and the receipt of tuition payments, comparisons of financial position and cash generated from operations should be made both to the end of the previous year and to the corresponding period during the previous year. The U.S. Department of Education ("ED") issued final regulations on November 29, 1996 detailing new rules and procedures governing how an institution which participates in federal student financial aid programs under Title IV ("Title IV Programs") of the Higher Education Act of 1965, as amended ("HEA") requests, maintains, disburses and otherwise manages Title IV Program funds. These new funds management regulations are effective July 1, 1997 and require the Company, among other things, to receive its funds in three equal quarterly disbursements rather than the two disbursements currently permitted. The Company estimates that these new regulations will decrease 1997 net cash provided by operating activities (a one-time effect) by approximately $12.0 to $15.0 million, and will decrease interest income in the six months ending December 31, 1997 (an on-going effect) by $0.8 to $1.0 million and annually thereafter by $1.6 to $2.0 million. Net cash provided by operating activities was $4.7 million in the six months ended June 30, 1997 compared to $1.7 million in the six months ended June 30, 1996. This increase in cash provided by operating activities was due primarily to the increased net income and the timing of payments to vendors. Accounts payable and accrued liabilities increased by $5.6 million in the six months ended June 30, 1997 compared to $3.8 million in the six months ended June 30, 1996. -8- An educational institution may lose its eligibility to participate in some or all Title IV Programs if student defaults on federal student loans exceed certain rates. These rates are based on the historical cohort default rate of current and former students on loans provided under certain Title IV Programs, and are calculated on an institutional basis, defined as a main campus and all of its additional locations and branch campuses. The cohort default rate of an institution is calculated on the basis of the number of students who have defaulted and not the dollar amount of such defaults. Under the Federal Family Education Loan ("FFEL") programs, an institution whose cohort default rate on loans made under the Federal Stafford Loan ("Stafford") and Federal Supplemental Loans for Students ("SLS") programs is 25% or greater for three consecutive years will no longer be eligible to participate in any of the FFEL programs (including the Federal PLUS ("PLUS") program) or the Federal Direct Student Loan ("FDSL") program for the remainder of the federal fiscal year in which the ED determines that the institution has lost its eligibility and for the two subsequent federal fiscal years, unless it successfully challenges such disqualification under procedures provided by the HEA and its implementing regulations. During the pendency of any such appeal, the institution retains its eligibility to participate in the applicable loan programs. No ITT Technical Institute campus group has an FFEL cohort default rate equal to or greater than 25% for the 1991 or 1992 federal fiscal years. Three ITT Technical Institute campus groups, consisting of three institutes located in Houston (West), Garland and San Antonio, Texas have an official FFEL cohort default rate of: (a) 27.4%, 27.4% and 25.0%, respectively, for the 1993 federal fiscal year; and (b) 25.8%, 39.1% and 25.6%, respectively, for the 1994 federal fiscal year. For the remaining 28 ITT Technical Institute campus groups, the official 1993 FFEL cohort default rates range from a high of 23.4% to a low of 11.8% and the official 1994 FFEL cohort default rates range from a high of 19.9% to a low of 11.0%. The ITT Technical Institutes in Houston (West), Garland and San Antonio, Texas have a preliminary FFEL cohort default rate of 19.3%, 29.7% and 28.2%, respectively, for the 1995 federal fiscal year (the latest year for which rates are available). For the remaining 28 ITT Technical Institute campus groups, the preliminary 1995 FFEL cohort default rates range from a high of 23.8% to a low of 11.3%. The official 1995 FFEL cohort default rates are scheduled to be released in November 1997. The ITT Technical Institutes in Garland and San Antonio, Texas, which collectively accounted for approximately 4% of the Company's revenues in the Company's 1996 fiscal year, have identified corrections to their official 1993 and 1994, and preliminary 1995, FFEL cohort default rates based on (I) improper loan servicing and/or collection of certain student loans included in the calculation of such rates and/or (II) erroneous data used to calculate such rates. Each of these ITT Technical Institutes has submitted the appropriate appeals and/or requests for adjustment to make these corrections and revise downward the institute's official 1993 and 1994 FFEL cohort default rates and preliminary 1995 FFEL cohort default rate accordingly. None of these appeals and/or requests for adjustment that have been considered by the ED have resulted in a recalculation to less than 25% of either institute's official 1993 or 1994, or preliminary 1995, FFEL cohort default rate. There can be no assurance that either of these institutes' remaining appeals and/or requests for adjustment to the ED regarding its official 1993 and 1994, or preliminary 1995, FFEL cohort default rates will result in a recalculation to less than 25% of its official 1993, 1994 or 1995 FFEL cohort default rate. If the Company cannot successfully cause the official 1993 or 1994 FFEL cohort default rate for each of the Garland and San Antonio, Texas ITT Technical Institutes to be reduced to less than 25% and any such institute has an official 1995 FFEL cohort default rate equal to or exceeding 25%, such institute will be notified by the ED that it is ineligible to participate in the FFEL and FDSL programs. The institute can challenge its loss of eligibility through an administrative review process within the ED (as referenced above) and continue to participate in the FFEL programs during this process. If the institute's challenge is unsuccessful, the institute will be ineligible to participate in the FFEL and FDSL programs for the remainder of that federal fiscal year and for the two subsequent federal fiscal years. Loss of eligibility to participate in the FFEL and FDSL programs by either the Garland or San Antonio, Texas ITT Technical Institutes could have a material adverse effect on the Company's results of operations. The Company is in the process of converting the Garland, Texas ITT Technical Institute from a main campus to an additional location of another main campus (the "Conversion"). Based on the Company's interpretation of the -9- applicable federal regulations, the Company believes that if it can complete the Conversion before the official 1995 FFEL cohort default rates are issued by the ED, the 1995 FFEL cohort default rate for the Garland, Texas ITT Technical Institute will be blended into the calculation of the 1995 FFEL cohort default rate of the ITT Technical Institute campus group to which this institute becomes an additional location. Converting an ITT Technical Institute that is a main campus into an additional location of another ITT Technical Institute campus group requires approval of the ITT Technical Institute's accrediting commission and the ED. The Garland, Texas ITT Technical Institute has received the approval of its accrediting commission, but there can be no assurance that the Company can obtain the requisite ED approval of the Conversion, that the Company can obtain such approval before the official 1995 FFEL cohort default rates are issued, or that the official 1995 FFEL cohort default rate for the Garland, Texas ITT Technical Institute, when issued, will be blended into the calculation of the official 1995 FFEL cohort default rate of the ITT Technical Institute campus group to which that institute becomes an additional location. In an effort to reduce the adverse effect on the Company's results of operations that could result from the loss of eligibility to participate in the FFEL and FDSL programs by either the Garland or San Antonio, Texas ITT Technical Institutes, the Company is considering whether to attempt to arrange for an unaffiliated, private funding source ("PFS") to provide loans to the students of these ITT Technical Institutes. This alternative source of student financial aid would most probably require the Company to guarantee repayment of the PFS loans. Based on the Company's experience with student loan repayment on Title IV Program loans for these institutes, such guaranty could result in significant cost to the Company. On January 31, 1997, Hilton Hotels Corporation ("Hilton") commenced a tender offer for approximately 50.1% of the outstanding shares of ITT's common stock (the "Hilton Offer"). Hilton has announced that, if its offer succeeds, it will obtain the entire equity interest in ITT by merging ITT with Hilton or a subsidiary of Hilton (such merger, together with the Hilton Offer, the "Hilton Transaction"). The Hilton Transaction is more fully described in the Tender Offer Statement on Schedule 14D-1 filed by Hilton with the Securities and Exchange Commission (the "Hilton 14D-1"). Hilton has also commenced a solicitation of proxies in support of proposals to be submitted to ITT shareholders at ITT's next annual meeting of shareholders which would have the effect of ensuring the completion of the Hilton Transaction (the "Hilton Proposals"). The Company believes that the Hilton Transaction, if successful, or the Hilton Proposals, if enacted at a meeting of ITT shareholders, would constitute a change in ownership resulting in a change in control of the Company under the regulations of the ED, all or virtually all of the state education authorities that regulate the Company's business (the "States") and the accrediting commissions that accredit each ITT Technical Institute (the "Accrediting Commissions"). Upon a change in control of the Company under ED regulations, each ITT Technical Institute would immediately become ineligible to continue participating in Title IV Programs and its students would be unable to obtain Title IV Program funds to pay their cost of education (except for funds already committed to the students) until such time as the ED recertifies the entire ITT Technical Institute campus group (defined as the main campus and all of its additional locations) to participate in Title IV Programs. The ED will not preapprove a change in control and will only reinstate a campus group's eligibility to participate in Title IV Programs upon review and approval of a complete application following the campus group's change in control. To be complete, among other things, such application must demonstrate that all of the ITT Technical Institutes that comprise a particular campus group are authorized by the appropriate States and accredited by the appropriate Accrediting Commission. Therefore, before any ITT Technical Institute campus group may regain access to Title IV Program funds following a change in control (a) all of its ITT Technical Institutes must be reaccredited (or continue to be accredited) by the appropriate Accrediting Commission and reauthorized (or continue to be authorized) by the appropriate States and (b) the change in control must otherwise be approved by the ED. See "Item 5. Other Information." for a discussion of the procedures involved in regaining such approvals. A material adverse effect on the Company's business, financial condition and results of operations would result if a change in control of the Company occurred as a result of the Hilton Transaction or Hilton Proposals: (a) without the requisite prior approvals of the States; (b) without the continued or reinstated accreditation of the Accrediting Commissions; (c) without the timely and requisite post approvals of the States; or (d) if a material number of ITT Technical Institutes failed to timely regain eligibility to participate in Title IV Programs from the ED. In addition, the time of year at which a change in control of the Company occurs coupled with the length of time required by the ITT Technical Institutes to regain their eligibility to participate in Title IV Programs could have a material adverse -10- effect on the Company's business, financial condition and results of operations and the amount of Title IV Program funds students can obtain to pay the education costs of attending the ITT Technical Institutes. On July 16, 1997, ITT announced a comprehensive plan that includes the pro rata distribution of (a) its shares of the Company's common stock (the "Common Stock") and (b) all of the shares of a new ITT subsidiary, ITT Destinations, Inc. ("Destinations"), that will hold ITT's hotels and gaming business among all ITT shareholders (the "Distribution"). Under the Distribution, each ITT shareholder is expected to receive approximately 0.25 share of the Common Stock held by ITT for each share of ITT common stock held by the ITT shareholder. The Distribution will be made on a date to be determined by ITT's board of directors to ITT's shareholders of record at the close of business on a record date determined by ITT's board of directors. No certificates or scrip representing fractional shares of the Common Stock will be issued as part of the Distribution. ITT's agent will, as soon as practical after the Distribution, combine into whole shares all of the fractional shares of the Common Stock that ITT's shareholders would be entitled to receive and sell them in the open market at then prevailing market prices and distribute the aggregate proceeds (net of brokerage fees) proportionately to any ITT shareholders who are entitled to the fractional shares. The Distribution is subject to certain conditions and may be abandoned by ITT at any time for any reason. The ED, the Accrediting Commissions and most of the States have laws, regulations and/or standards (collectively "Regulations") pertaining to changes of ownership and/or control (collectively "change in control") of the educational institutions they regulate. The ED has determined that the Distribution will constitute a change in control of the Company and all of the ITT Technical Institutes under ED Regulations. The Accrediting Commissions and many of the States have determined that the Distribution will not constitute a change in control of the Company under their Regulations. The Company and ITT plan to seek to obtain any necessary approvals of the Distribution by the ED and the States. Capital expenditures were $6.7 million in the six months ended June 30, 1997 compared to $2.9 million in the six months ended June 30, 1996. This increase was due primarily to the acquisition of approximately $3.0 million of new computers in the first quarter of 1997 (required to accommodate a software upgrade for the Company's computer-aided drafting technology curriculum). The Company expects that the capital additions for the full 1997 year will be approximately $13.0 million or a $5.1 million increase over 1996. The capital additions for a new technical institute are approximately $0.4 million and the capital additions for each new curriculum at an existing institute are approximately $0.2 million. The Company anticipates that its planned capital additions can be funded through cash flows from operations. Cash flows from operations on a long-term basis are highly dependent upon the receipt of funds from Title IV Programs and the amount of funds spent on new technical institutes, curricula additions at existing institutes and possible acquisitions. Management, based on the advice of counsel, believes that it is probable that it will prevail in its appeal in the Eldredge Case, thus no provision for the awards in that case has been made. If the Company's appeal of the judgment in the Eldredge Case is unsuccessful, a charge to earnings would be taken at that time in the amount of the awards, including the general and exemplary damages assessed against the Company, the plaintiffs' reasonable attorney's fees and costs, and the prejudgment and post-judgment interest assessed thereon. Factors That May Affect Future Results - -------------------------------------- This report contains certain forward looking statements that involve a number of risks and uncertainties. Among the factors that could cause actual results to differ materially are the following: business conditions and growth in the postsecondary education industry and in the general economy; changes in federal and state governmental regulations with respect to education and accreditation standards, or the interpretation or enforcement thereof, including, but not limited to, the level of government funding for, and the Company's eligibility to participate in, student financial aid programs utilized by the Company's students; the results of the Company's appeal in Eldredge, et al. v. ITT Educational Services, Inc., et al. and the results of any related litigation; effects of any change in ownership of the -11- Company resulting in a change in control of the Company, including, but not limited to, the consequences of such changes on the accreditation and federal and state regulation of the institutes; receptivity of students and employers to the Company's existing program offerings and new curricula; loss of lender access to the Company's students for student loans; and a substantial increase in the shares of Common Stock available for sale in the market if ITT divests some or all of its Common Stock holdings. PART II ITEM 1. LEGAL PROCEEDINGS. The Company is subject to litigation in the ordinary course of its business. Among the legal actions currently pending is DeBattista, et al. v. ITT Educational Services, Inc., et al. (Civil Action No. 97-1366-CA-15-W). This action was filed on June 25, 1997 in the Circuit Court of Seminole County in Orlando, Florida by three students who attended the Hospitality program at the Maitland ITT Technical Institute. The suit alleges, among other things, misrepresentation, fraud, civil conspiracy and statutory violations by the Company, ITT Corporation and eight employees of the Maitland ITT Technical Institute. The plaintiffs seek general damages, exemplary damages, rescission of plaintiffs' enrollment agreements with the Company, attorney's fees, interest and costs. The plaintiffs also seek to have the action certified as a class action. Also pending is Eldredge, et al. v. ITT Educational Services, Inc., et al., and six related legal actions filed in San Diego, California, all of which have been previously reported. While there can be no assurances as to the ultimate outcome of any litigation involving the Company, management does not believe any pending legal proceeding will result in a judgment or settlement that will have, after taking into account the Company's existing provisions for such liabilities, a material adverse effect on the Company's financial position, results of operations or cash flows. Certain litigation may, however, subject the affected ITT Technical Institute to additional regulatory scrutiny. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. During the second quarter of fiscal year 1997, the Company submitted the following matters to a vote of the holders of its Common Stock: The 1997 annual meeting of shareholders of the Company was held on May 13, 1997 to elect directors and adopt the 1997 ITT Educational Services, Inc. Incentive Stock Plan (the "1997 Plan"). At this meeting, the shareholders elected the following persons to serve as directors of the Company in the third class of the Company's Board of Directors, each to hold office for the term of three years and until his or her successor is elected and has qualified: Third Class - Term expiring at 2000 Annual Meeting ----------- 1. Bette B. Anderson 2. Rand V. Araskog 3. Leslie Lenkowsky 4. Margita E. White The final results of the vote taken at such meeting for the director nominees are as follows:
Broker Votes For Votes Withheld Nonvotes Abstentions ---------- -------------- -------- ----------- Bette B. Anderson 25,463,120 59,163 0 0 Rand V. Araskog 25,463,708 58,575 0 0 Leslie Lenkowsky 25,468,320 53,963 0 0 Margita E. White 25,469,245 53,038 0 0
-12- At this meeting, the shareholders also adopted the 1997 Plan. The final results of the vote taken at such meeting to adopt the 1997 Plan are as follows: Broker Votes For Votes Against Non-votes Abstentions ----------- ------------- --------- ----------- 23,606,268 1,497,013 408,371 10,631 ITEM 5. OTHER INFORMATION. At present, ITT holds 22,500,000 shares, or 83.3%, of the Company's outstanding Common Stock and 4,499,952 shares, or 16.79%, of the Company's outstanding Common Stock is publicly traded. On July 16, 1997, ITT announced a comprehensive plan that includes the pro rata distribution of (a) its shares of the Common Stock and (b) all the shares of Destinations among all ITT shareholders (the "Distribution"). Under the Distribution, each ITT shareholder is expected to receive approximately 0.25 share of Common Stock held by ITT for each share of ITT common stock held by the ITT shareholder. The Distribution is subject to certain conditions and may be abandoned by ITT at any time for any reason. The Company intends to enter into the following agreements with ITT, which will give effect to the Distribution, govern the Company's relationship with ITT following the Distribution and provide for the allocation of tax and certain other liabilities and obligations arising from periods prior to the Distribution: (a) a distribution agreement providing for, among other things, certain transactions required to effect the Distribution, the treatment of existing intercompany agreements between the Company and ITT and other arrangements between the Company and ITT after the Distribution; (b) a tax allocation agreement providing for the allocation between the Company, ITT and Destinations of ITT's consolidated tax liability for the years that they were included in ITT's consolidated federal income tax return and for sharing, where appropriate, of state and local taxes attributable to periods prior to the Distribution; and (c) an employee benefits agreement providing for the allocation among the Company, ITT and Destinations of retirement, welfare and other employee benefit and executive compensation plans, programs, policies and arrangements. The Distribution will result in a substantial increase in the shares of Common Stock available for sale in the market. This significant increase in public float is expected to increase the liquidity of the Common Stock and, thereby, raise its market profile in the long term. The market price of the Common Stock may be adversely affected in the short term if a significant number of shares of Common Stock are sold following the Distribution by ITT shareholders who receive such shares in the Distribution. The ownership and operation of educational institutions in the United States are subject to extensive federal and state laws and regulations. In this regard, the Company must obtain certain approvals under the applicable laws, regulations and standards of the ED, the Accrediting Commissions and the States. The ED, the Accrediting Commissions and most of the States have laws, regulations and/or standards (collectively "Regulations") pertaining to changes in ownership and/or control (collectively "change in control") of the educational institutions they regulate. The change in control Regulations do not, however, uniformly define what constitutes a change in control. The ED's change in control Regulations generally subject the Company to the change in control standards of the federal securities laws. Most States and the Accrediting Commissions include the sale of a controlling interest of common stock in the definition of a change in control. Practically all change in control Regulations adopted by the ED, the Accrediting Commissions and the States are subject to varying interpretations as to whether a particular transaction constitutes a change in control. The ED has determined that the Distribution will constitute a change in control of the Company and all of the ITT Technical Institutes under ED Regulations. The Accrediting Commissions and many of the States have determined that the Distribution will not constitute a change in control of the Company under their -13- Regulations. The Company and ITT plan to seek to obtain any necessary approvals of the Distribution by the ED and the States. Upon a change in control of the Company under ED Regulations, each of the Company's ITT Technical Institutes would immediately become ineligible to continue participating in Title IV Programs and their students would be unable to obtain Title IV Program funds to pay their costs of education (except for certain funds already committed to the students) until such time as the ED recertifies the entire ITT Technical Institute campus group (defined as the main campus and all of its additional locations) to participate in Title IV Programs. The ED will not preapprove a change in control and will only reinstate a campus group's eligibility to participate in Title IV Programs upon review and approval of a complete application following the campus group's change in control. To be complete, among other things, such application must demonstrate that all of the ITT Technical Institutes that comprise a particular campus group are authorized by the appropriate States and accredited by the appropriate Accrediting Commission. Therefore, before any ITT Technical Institute campus group may regain its eligibility to participate in Title IV Programs following a change in control (a) all of its ITT Technical Institutes must be reaccredited (or continue to be accredited) by the appropriate Accrediting Commission and reauthorized (or continue to be authorized) by the appropriate States and (b) the change in control must otherwise be approved by the ED. The Company and the ED are discussing the implementation of certain procedures that may help to quicken the recertification of the ITT Technical Institute campus groups to continue participating in Title IV Programs following the Distribution. Most States in which ITT Technical Institutes operate, including California, require that a change in control of an institution be approved before it occurs in order for the institution to maintain its authorization (the "Prior Approval States"). Some States will only review a change in control of an institution after it occurs (the "Post Approval States"). With the possible exception of California (discussed below), management believes that the Company will be able to obtain all necessary approvals from the ED and the States. There can be no assurance, however, that such approvals can be obtained in a timely manner that would not unreasonably delay the availability of Title IV Program funds. Based on the Company's interpretation of California's change in control Regulations and the advice of counsel, the Company does not believe that the Distribution will constitute a change in control of the Company, or any of its ten ITT Technical Institutes currently operating in California, under such Regulations. If, however, the California regulators should determine otherwise, obtaining approval from California would be complicated by a California statute that prohibits the approval of a change in control of any institution that has been found to have violated Chapter 7 (formerly Chapter 3) of the California Education Code ("Chapter 7") in any judicial or administrative proceeding. In October 1996, the jury in Eldredge, et al. v. ITT Educational Services, Inc., et al. (the "Eldredge Case") determined that the Company, through its ITT Technical Institute in San Diego, California, violated Chapter 7. The Company has appealed the jury's verdict in the Eldredge Case. A material adverse effect on the Company's business, financial condition and results of operations: (a) would result if the Distribution occurs and a material number of ITT Technical Institutes fail to timely (i) obtain the requisite reauthorizations from the Post Approval States whose Regulations regard the Distribution as a change in control of the Company or (ii) regain eligibility to participate in Title IV Programs from the ED; or (b) could result if the Distribution occurs at a time shortly before significant amounts of Title IV funds were anticipated to be released to the ITT Technical Institutes and their students and the Company experiences any delay by the ED in recertifying the ITT Technical Institutes to continue their participation in Title IV Programs. -14- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. A list of exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated herein by reference. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended June 30, 1997. -15- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ITT Educational Services, Inc. Date: August 8, 1997 By: /s/ Gene A. Baugh -------------------------------- Gene A. Baugh Senior Vice President and Chief Financial Officer (Principal Financial Officer) S-1 INDEX TO EXHIBITS Exhibit No. Description - ----------------------------------------------------------------------------- 10.8 1997 ITT Educational Services, Inc. Incentive Stock Plan......... 11 Statement re Computation of Per Share Earnings................... 27 Financial Data Schedule.......................................... S-2 EX-10.8 2 INCENTIVE STOCK PLAN Exhibit 10.8 1997 ITT EDUCATIONAL SERVICES, INC. INCENTIVE STOCK PLAN The following is the text of the 1997 ITT Educational Services, Inc. Incentive Stock Plan: 1. Purpose The purpose of the 1997 ITT Educational Services, Inc. Incentive Stock Plan is to motivate and reward superior performance on the part of employees of ITT Educational Services, Inc. and its subsidiaries and to thereby attract and retain employees of superior ability. In addition, the Plan is intended to further opportunities for stock ownership by such employees in order to increase their proprietary interest in ITT Educational Services, Inc. and, as a result, their interest in the success of the Company. Awards will be made, in the discretion of the Committee, to Key Employees (including officers and directors who are also employees) whose responsibilities and decisions directly affect the performance of any Participating Company and its subsidiaries. Such incentive awards may consist of stock options, stock appreciation rights payable in stock or cash, performance shares, restricted stock or any combination of the foregoing, as the Committee may determine. 2. Definitions When used herein, the following terms shall have the following meanings: "Acceleration Event" means the occurrence of an event defined in Section 9 of the Plan. "Act" means the Securities Exchange Act of 1934. "Annual Limit" means the maximum number of shares of Stock for which Awards may be granted under the Plan in each Plan Year as provided in Section 3 of the Plan. "Award" means an award granted to any Key Employee in accordance with the provisions of the Plan in the form of Options, Rights, Performance Shares or Restricted Stock, or any combination of the foregoing. "Award Agreement" means the written agreement evidencing each Award granted to a Key Employee under the Plan. "Beneficiary" means the beneficiary or beneficiaries designated pursuant to Section 10 to receive the amount, if any, payable under the Plan upon the death of a Key Employee. "Board" means the Board of Directors of the Company. "Code" means the Internal Revenue Code of 1986, as now in effect or as hereafter amended. (All citations to sections of the Code are to such sections as they may from time to time be amended or renumbered.) E-1 "Committee" means the Compensation Committee of the Board or such other committee as may be designated by the Board to administer the Plan. "Company" means ITT Educational Services, Inc. and its successors and assigns. "Fair Market Value", unless otherwise indicated in the provisions of this Plan, means, as of any date, the composite closing price for one share of Stock on the New York Stock Exchange or, of no sales of Stock have taken place on such date, the composite closing price on the most recent date on which selling prices were quoted, the determination to be made in the discretion of the Committee. "Incentive Stock Option" means a stock option qualified under Section 422 of the Code. "Key Employee" means an employee (including any officer or director who is also an employee) of any Participating Company whose responsibilities and decisions, in the judgment of the Committee, directly affect the performance of the Company and its subsidiaries. "Limited Stock Appreciation Right" means a stock appreciation right which shall become exercisable automatically upon the occurrence of an Acceleration Event as described in Section 9 of the Plan. "Option" means an option awarded under Section 5 of the Plan to purchase Stock of the Company, which may be an Incentive Stock Option or a non-qualified stock option. "Participating Company" means the Company or any subsidiary or other affiliate of the Company; provided, however, for Incentive Stock Options only, "Participating Company" means the Company or any corporation which at the time such Option is granted qualifies as a "subsidiary" of the Company under Section 425(f) of the Code. "Performance Share" means a performance share awarded under Section 6 of the Plan. "Plan" means the 1997 ITT Educational Services, Inc. Incentive Stock Plan, as the same may be amended, administered or interpreted from time to time. "Plan Year" means the calendar year. "Retirement" means eligibility to receive immediate retirement benefits under a Participating Company pension plan. "Restricted Stock" means Stock awarded under Section 7 of the Plan subject to such restrictions as the Committee deems appropriate or desirable. "Right" means a stock appreciation right awarded in connection with an Option under Section 5 of the Plan. "Stock" means the common stock ($0.01 par value) of the Company. E-2 "Total Disability" means the complete and permanent inability of a Key Employee to perform all of his or her duties under the terms of his or her employment with any Participating Company, as determined by the Committee upon the basis of such evidence, including independent medical reports and data, as the Committee deems appropriate or necessary. 3. Shares Subject to the Plan The aggregate number of shares of Stock which may be awarded under the Plan in any Plan Year shall be subject to an annual limit. The maximum number of shares of Stock for which Awards may be granted under the Plan in each Plan Year shall be 1.5 percent (1.5%) of the total of the issued and outstanding shares of Stock as reported in the Annual Report on Form 10-K of the Company for the fiscal year ending immediately prior to any Plan Year. Any unused portion of the Annual Limit for any Plan Year shall be carried forward and be made available for awards in succeeding Plan Years. In addition to the foregoing: (i) in no event shall more than four million fifty thousand (4,050,000) shares of Stock be cumulatively available for Awards of incentive stock options under the Plan; (ii) no more than twenty percent (20%) of the total number of shares on a cumulative basis shall be available for restricted stock and performance share Awards; (iii) for any Plan Year, no individual employee may receive an Award of stock options for more than sixty- seven thousand five hundred (67,500) shares; and (iv) until such time as ITT Corporation, in a transaction or series of transactions approved by the ITT Corporation Board of Directors, ceases to own at least 80.1% of the issued and outstanding Stock, in no event shall the number of shares of Stock available for Awards under the Plan be equal to or greater than a number which could cause ITT Corporation to own less than 80.1% of the issued and outstanding Stock. Subject to the above limitations, shares of Stock to be issued under the Plan may be made available from the authorized but unissued shares or shares held by the Company in treasury or from shares purchased in the open market. For the purpose of computing the total number of shares of Stock available for Awards under the Plan, there shall be counted against the foregoing limitations the number of shares of Stock which equal the value of performance share Awards, in each case determined as of the dates on which such Awards are granted. If any Awards under the Plan are forfeited, terminated, expire unexercised, are settled in cash in lieu of Stock or are exchanged for other Awards, the shares of Stock which were theretofore subject to such Awards shall again be available for Awards under the Plan to the extent of such forfeiture or expiration of such Awards. Further, any shares that are exchanged (either actually or constructively) by optionees as full or partial payment to the Company of the purchase price of shares being acquired through the exercise of a stock option granted under the Plan may be available for subsequent Awards; provided, however, that such shares may be awarded only to those participants who are not directors or executive officers (as that term is defined in the rules and regulations under Section 16 of the Act). 4. Grant of Awards and Award Agreements (a) Subject to the provisions of the Plan, the Committee shall: (i) determine and designate from time to time those Key Employees or groups of Key Employees to whom Awards are to be granted; (ii) determine the form or forms of Award to be granted to any Key Employee; (iii) determine the amount or number of shares of Stock subject to each Award; and (iv) determine the terms and conditions of each Award. E-3 (b) Each Award granted under the Plan shall be evidenced by a written Award Agreement. Such agreement shall be subject to and incorporate the express terms and conditions of each Award. 5. Stock Options and Rights (a) With respect to Options and Rights, the Committee shall: (i) authorize the granting of Incentive Stock Options, non-qualified stock options or a combination of Incentive Stock Options and non-qualified stock options; (ii) authorize the granting of Rights which may be granted in connection with all or part of any Option granted under this Plan, either concurrently with the grant of the Option or at any time thereafter during the term of the Option; (iii) determine the number of shares of Stock subject to each Option or the number of shares of Stock that shall be used to determine the value of a Right; and (iv) determine the time or times when and the manner in which each Option or Right shall be exercisable and the duration of the exercise period. (b) Any option issued hereunder which is intended to qualify as an Incentive Stock Option shall be subject to such limitations or requirements as may be necessary for the purposes of Section 422 of the Code or any regulations and rulings thereunder to the extent and in such form as determined by the Committee in its discretion. (c) Rights may be granted only to Key Employees who may be considered directors or officers of the Company for purposes of Section 16 of the Act. (d) The exercise period for a non-qualified stock option and any related Right shall not exceed ten years and two days from the date of grant, and the exercise period for an Incentive Stock Option and any related Right shall not exceed ten years from the date of grant. (e) The exercise price per share shall be determined by the Committee at the time any Option is granted and shall be not less than the Fair Market Value of one share of Stock on the date the Option is granted. (f) No part of any Option or Right may be exercised until the Key Employee who has been granted the Award shall have remained in the employ of a Participating Company for such period after the date of grant as the Committee may specify, if any, and the Committee may further require exercisability in installments; provided, however, the period during which a Right is exercisable shall commence no earlier than six months following the date the Option or Right is granted. (g) The exercise price of the shares as to which an Option shall be exercised shall be paid to the Company at the time of exercise either in cash or Stock already owned by the optionee having a total Fair Market Value equal to the purchase price, or a combination of cash and Stock having a total fair market value, as so determined, equal to the purchase price. The Committee shall determine acceptable methods for tendering Stock as payment upon exercise of an Option and may impose such limitations and prohibitions on the use of Stock to exercise an Option as it deems appropriate. (h) Unless Section 9 shall provide otherwise, Rights granted to a director or officer shall terminate when such person ceases to be considered a director or officer of the Company subject to Section 16 of the Act. E-4 (i) In case of termination of employment, the following provisions shall apply: (A) If a Key Employee who has been granted an Option shall die before such Option has expired, his or her Option may be exercised in full by the person or persons to whom the Key Employee's rights under the Option pass by will, or if no such person has such right, by his or her executors or administrators, at any time, or from time to time, within five years after the date of the Key Employee's death or within such other period, and subject to such terms and conditions as the Committee may specify, but not later than the expiration date specified in Section 5(d) above. (B) If the Key Employee's employment by any Participating Company terminates because of his or her Retirement or Total Disability, he or she may exercise his or her Options in full at any time, or from time to time, within five years after the date of the termination of his or her employment or within such other period, and subject to such terms and conditions as the Committee may specify, but not later than the expiration date specified in Section 5(d) above. Any such Options not fully exercisable immediately prior to such optionee's retirement shall become fully exercisable upon such retirement unless the Committee, in its sole discretion, shall otherwise determine. (C) Except as provided in Section 9, if the Key Employee shall voluntarily resign before eligibility for Retirement or he or she is terminated for cause as determined by the Committee, the Options or Rights shall be canceled coincident with the effective date of the termination of employment. (D) If the Key Employee's employment terminates for any other reason, he or she may exercise his or her Options, to the extent that he or she shall have been entitled to do so at the date of the termination of his or her employment, at any time, or from time to time, within three months after the date of the termination of his or her employment or within such other period, and subject to such terms and conditions as the Committee may specify, but not later than the expiration date specified in Section 5(d) above. (j) No Option or Right granted under the Plan shall be transferable other than by will or by the laws of descent and distribution. During the lifetime of the optionee, an Option or Right shall be exercisable only by the Key Employee to whom the Option or Right is granted (or his or her estate or designated beneficiary). (k) With respect to an Incentive Stock Option, the Committee shall specify such terms and provisions as the Committee may determine to be necessary or desirable in order to qualify such Option as an "incentive stock option" within the meaning of Section 422 of the Code. No Incentive Stock Option shall be granted which would permit a Key Employee to acquire, through the exercise of Incentive Stock Options in any calendar year, shares of any capital stock of the Company or any Participating Company having an aggregate Fair Market Value (determined as of the time any Incentive Stock Option is granted) in excess of $100,000. The foregoing limitation shall be determined by assuming that the Key Employee will exercise each Incentive Stock Option on the date that such Option first becomes exercisable. Notwithstanding the foregoing, in the case of any Key Employee who, at the date of grant, owns stock possessing more than 10% of the total combined voting power of all classes of capital stock of the Company or any Participating Company, the exercise price of any Incentive Stock Option shall not be less than 110% of the Fair Market Value per share on the date such E-5 Incentive Stock Option is granted and such Incentive Stock Option shall not be exercisable more than five years from the date such Incentive Stock Option is granted. (l) With respect to the exercisability and settlement of Rights: (i) Upon exercise of a Right, the Key Employee shall be entitled, subject to such terms and conditions the Committee may specify, to receive upon exercise thereof all or a portion of the excess of (A) the Fair Market Value of a specified number of shares of Stock at the time of exercise, as determined by the Committee, over (B) a specified amount which shall not, subject to Section 5(e), be less than the Fair Market Value of such specified number of shares of Stock at the time the Right is granted. Upon exercise of a Right, payment of such excess shall be made as the Committee shall specify in cash, the issuance or transfer to the Key Employee of whole shares of Stock with a Fair Market Value at such time equal to any excess, or a combination of cash and shares of Stock with a combined Fair Market Value at such time equal to any such excess, all as determined by the Committee. The Company will not issue a fractional share of Stock and, if a fractional share would otherwise be issuable, the Company shall pay cash equal to the Fair Market Value of the fractional share of Stock at such time. (ii) For the purposes of Subsection (i) of this Section 5(l), in the case of any such Right or portion thereof, other than a Right related to an Incentive Stock Option, exercised for cash during a "window period" specified by Rule 16b-3 under the Act, the Fair Market Value of the Stock at the time of such exercise shall be the highest composite daily closing price of the Stock during such window period. (iii) In the event of the exercise of such Right, the Company's obligation in respect of any related Option or such portion thereof will be discharged by payment of the Right so exercised. 6. Performance Shares (a) Subject to the provisions of the Plan, the Committee shall: (i) determine and designate from time to time those Key Employees or groups of Key Employees to whom Awards of Performance Shares are to be made; (ii) determine the performance period (the "Performance Period") and performance objectives (the "Performance Objectives") applicable to such Awards; (iii) determine the form of settlement of a Performance Share; and (iv) generally determine the terms and conditions of each such Award. At any date, each Performance Share shall have a value equal to the Fair Market Value of a share of Stock at such date; provided that the Committee may limit the aggregate amount payable upon the settlement of any Award. The maximum award for any individual employee in any given year shall be one hundred thousand (100,000) Performance Shares. (b) The Committee shall determine a Performance Period of not less than two nor more than five years. Performance Periods may overlap and Key Employees may participate simultaneously with respect to Performance Shares for which different Performance Periods are prescribed. (c) The Committee shall determine the Performance Objectives of Awards of Performance Shares. Performance Objectives may vary from Key Employee to Key Employee and between groups of Key E-6 Employees and shall be based upon one or more of the following objective criteria, as the Committee deems appropriate: earnings per share, return on equity, cash flow or total shareholder return of the Company. If, during the course of a Performance Period, there shall occur significant events which the Committee expects to have a substantial effect on the applicable Performance Objectives during such period, the Committee may revise such Performance Objectives. (d) At the beginning of a Performance Period, the Committee shall determine for each Key Employee or group of Key Employees the number of Performance Shares or the percentage of Performance Shares which shall be paid to the Key Employee or member of the group of Key Employees if the applicable Performance Objectives are met in whole or in part. (e) If a Key Employee terminates service with all Participating Companies during a Performance Period because of death, Total Disability, Retirement or under other circumstances where the Committee in its sole discretion finds that a waiver would be in the best interests of the Company, that Key Employee may, as determined by the Committee, be entitled to payment in settlement of such Performance Shares at the end of the Performance Period based upon the extent to which the Performance Objectives were satisfied at the end of such period and prorated for the portion of the Performance Period during which the Key Employee was employed by any Participating Company; provided, however, the Committee may provide for an earlier payment in settlement of such Performance Shares in such amount and under such terms and conditions as the Committee deems appropriate or desirable. If a Key Employee terminates service with all Participating Companies during a Performance Period for any other reason, then such Key Employee shall not be entitled to any Award with respect to that Performance Period unless the Committee shall otherwise determine. (f) Each Award of a Performance Share shall be paid in whole shares of Stock, or cash, or a combination of Stock and cash either as a lump sum payment or in annual installments, all as the Committee shall determine, with payment to commence as soon as practicable after the end of the relevant Performance Period. 7. Restricted Stock (a) Restricted Stock shall be subject to a restriction period (after which restrictions will lapse) which shall mean a period commencing on the date the Award is granted and ending on such date as the Committee shall determine (the "Restriction Period"). The Committee may provide for the lapse of restrictions in installments where deemed appropriate and it may also require the achievement of predetermined performance objectives in order for such shares to vest. (b) Except when the Committee determines otherwise pursuant to Section 7(d), if a Key Employee terminates employment with all Participating Companies for any reason before the expiration of the Restriction Period, all shares of Restricted Stock still subject to restriction shall be forfeited by the Key Employee and shall be reacquired by the Company. (c) Except as otherwise provided in this Section 7, no shares of Restricted Stock received by a Key Employee shall be sold, exchanged, transferred, pledged, hypothecated or otherwise disposed of during the Restriction Period. (d) In cases of death, Total Disability or Retirement or in cases of special circumstances, the E-7 Committee may, in its sole discretion when it finds that a waiver would be in the best interests of the Company, elect to waive any or all remaining restrictions with respect to such Key Employee's Restricted Stock. (e) The Committee may require, under such terms and conditions as it deems appropriate or desirable, that the certificates for Stock delivered under the Plan may be held in custody by a bank or other institution, or that the Company may itself hold such shares in custody until the Restriction Period expires or until restrictions thereon otherwise lapse, and may require, as a condition of any Award of Restricted Stock that the Key Employee shall have delivered a stock power endorsed in blank relating to the Restricted Stock. (f) Nothing in this Section 7 shall preclude a Key Employee from exchanging any shares of Restricted Stock subject to the restrictions contained herein for any other shares of Stock that are similarly restricted. (g) Subject to Section 7(e) and Section 8, each Key Employee entitled to receive Restricted Stock under the Plan shall be issued a certificate for the shares of Stock. Such certificate shall be registered in the name of the Key Employee, bear an appropriate legend reciting the terms, conditions and restrictions, if any, applicable to such Award and be subject to appropriate stop-transfer orders. 8. Certificates for Awards of Stock (a) The Company shall not be required to issue or deliver any certificates for shares of Stock prior to: (i) the listing of such shares on any stock exchange on which the Stock may then be listed; and (ii) the completion of any registration or qualification of such shares under any federal or state law, or any ruling or regulation of any government body which the Company shall, in its sole discretion, determine to be necessary or advisable. (b) All certificates for shares of Stock delivered under the Plan shall also be subject to such stop-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Stock is then listed and any applicable federal or state securities laws, and the Committee may cause a legend or legends to be placed on any such certificates to make appropriate reference to such restrictions. In making such determination, the Committee may rely upon an opinion of counsel for the Company. (c) Except for the restrictions on Restricted Stock under Section 7, each Key Employee who receives Stock in settlement of an Award of Stock, shall have all of the rights of a shareholder with respect to such shares, including the right to vote the shares and receive dividends and other distributions. No Key Employee awarded an Option, a Right or Performance Share shall have any right as a shareholder with respect to any shares covered by his or her Option, Right or Performance Share prior to the date of issuance to him or her of a certificate or certificates for such shares. 9. Acceleration Events (a) For the purposes of this Plan, an Acceleration Event shall occur if: (i) a report on Schedule E-8 13D shall be filed with the Securities and Exchange Commission pursuant to Section 13(d) of the Act disclosing that any person (within the meaning of Section 13(d) of the Act), other than the Company, ITT Corporation or a subsidiary of the Company, or any employee benefit plan sponsored by the Company, ITT Corporation or a subsidiary of the Company, is the beneficial owner directly or indirectly of 20 percent or more of the outstanding Stock of the Company; (ii) any person (within the meaning of Section 13(d) of the Act), other than the Company, ITT Corporation or a subsidiary of the Company, or any employee benefit plan sponsored by the Company, ITT Corporation or a subsidiary of the Company, shall purchase shares pursuant to a tender offer or exchange offer to acquire any Stock of the Company (or securities convertible into Stock) for cash, securities or any other consideration, provided that after consummation of the offer, the person in question is the beneficial owner (as such term is defined in Rule 13d-3 under the Act), directly or indirectly, of 15 percent or more of the outstanding Stock of the Company (calculated as provided in paragraph (d) of Rule 13d-3 under the Act in the case of rights to acquire Stock); (iii) the stockholders of the Company shall approve (A) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of Stock of the Company would be converted into cash, securities or other property, other than a merger of the Company in which holders of Stock of the Company immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger as immediately before, or (B) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all the assets of the Company; or (iv) there shall have been a change in a majority of the members of the Board within a 12-month period, unless the election or nomination for election by the Company's stockholders of each new director during such 12-month period was approved by the vote of two-thirds of the directors then still in office who were directors at the beginning of such 12-month period. (b) Notwithstanding any provisions in this Plan to the contrary: (i) Each outstanding Option granted under the Plan shall become immediately exercisable in full for the aggregate number of shares covered thereby and all related Rights shall also become exercisable upon the occurrence of an Acceleration Event described in this Section 9 and shall continue to be exercisable in full for cash for a period of 60 calendar days beginning on the date that such Acceleration Event occurs and ending on the 60th calendar day following that date; provided, however, that (A) no Right shall become exercisable earlier than six months following the date the Right is granted, and (B) no Option or Right shall be exercisable beyond the expiration date of its original term. (ii) Options and Rights shall not terminate and shall continue to be fully exercisable for a period of seven months following the occurrence of an Acceleration Event in the case of an employee who is terminated other than for just cause or who voluntarily terminates his or her employment because he or she in good faith believes that as a result of such Acceleration Event he or she is unable effectively to discharge his or her present duties or the duties of the position he or she occupied just prior to the occurrence of such Acceleration Event. For purposes of Section 9 only, termination shall be for "just cause" only if such termination is based on fraud, misappropriation or embezzlement on the part of the employee which results in a final conviction of a felony. Under no circumstances, however, shall any Option or Right be exercised beyond the expiration date of its original term. (iii) Any Right or portion thereof may be exercised for cash within the 60-calendar-day E-9 period following the occurrence of an Acceleration Event with settlement, except in the case of a Right related to an Incentive Stock Option, based on the "Formula Price" which shall be the highest of (A) the highest composite daily closing price of the Stock during the period beginning on the 60th calendar day prior to the date on which the Right is exercised and ending on the date such Right is exercised, (B) the highest gross price paid for the Stock during the same period of time, as reported in a report on Schedule 13D filed with the Securities and Exchange Commission or (C) the highest gross price paid or to be paid for a share of Stock (whether by way of exchange, conversion, distribution upon merger, liquidation or otherwise) in any of the transactions set forth in this Section 9 as constituting an Acceleration Event. (iv) Upon the occurrence of an Acceleration Event, Limited Stock Appreciation Rights shall automatically be granted as to any Option with respect to which Rights are not then outstanding; provided, however, that Limited Stock Appreciation Rights shall be provided at the time of grant of any Incentive Stock Option subject to exercisability upon the occurrence of an Acceleration Event. Limited Stock Appreciation Rights shall entitle the holder thereof, upon exercise of such rights and surrender of the related Option or any portion thereof, to receive, without payment to the Company (except for applicable withholding taxes), an amount in cash equal to the excess, if any, of the Formula Price as that term is defined in Section 9 over the option price of the Stock as provided in such Option; provided that in the case of the exercise of any such Limited Stock Appreciation Right or portion thereof related to an Incentive Stock Option, the Fair Market Value of the Stock at the time of such exercise shall be substituted for the Formula Price. Each such Limited Stock Appreciation Right shall be exercisable only during the period beginning on the first business day following the occurrence of such Acceleration Event and ending on the 60th day following such date and only to the same extent the related Option is exercisable. In the case of persons who are considered directors or officers of the Company for purposes of Section 16 of the Act, Limited Stock Appreciation Rights shall not be so exercisable until they have been outstanding for at least six months. Upon exercise of a Limited Stock Appreciation Right and surrender of the related Option, or portion thereof, such Option, to the extent surrendered, shall not thereafter be exercisable. (v) The restrictions applicable to Awards of Restricted Stock issued pursuant to Section 7 shall lapse upon the occurrence of an Acceleration Event and the Company shall issue stock certificates without a restrictive legend. Key Employees holding Restricted Stock on the date of an Acceleration Event may tender such Restricted Stock to the Company which shall pay the Formula Price as that term is defined in Section 9; provided, such Restricted Stock must be tendered to the Company within 60 calendar days of the Acceleration Event. (vi) If an Acceleration Event occurs during the course of a Performance Period applicable to an Award of Performance Shares pursuant to Section 6, then the Key Employee shall be deemed to have satisfied the Performance Objectives and settlement of such Performance Shares shall be based on the Formula Price, as defined in this Section 9. 10. Beneficiary (a) Each Key Employee shall file with the Company a written designation of one or more persons as the Beneficiary who shall be entitled to receive the Award, if any, payable under the Plan upon his or her death. A Key Employee may from time to time revoke or change his or her Beneficiary E-10 designation without the consent of any prior Beneficiary by filing a new designation with the Company. The last such designation received by the Company shall be controlling; provided, however, that no designation, or change or revocation thereof, shall be effective unless received by the Company prior to the Key Employee's death, and in no event shall it be effective as of a date prior to such receipt. (b) If no such Beneficiary designation is in effect at the time of a Key Employee's death, or if no designated Beneficiary survives the Key Employee or if such designation conflicts with law, the Key Employee's estate shall be entitled to receive the Award, if any, payable under the Plan upon his or her death. If the Committee is in doubt as to the right of any person to receive such Award, the Company may retain such Award, without liability for any interest thereon, until the Committee determines the rights thereto, or the Company may pay such Award into any court of appropriate jurisdiction and such payment shall be a complete discharge of the liability of the Company therefor. 11. Administration of the Plan (a) Each member of the Committee shall be both a member of the Board and a "disinterested person" within the meaning of Rule 16b-3 under the Act or successor rule or regulation. No member of the Committee shall be, or shall have been, eligible to receive an Award under the Plan or any other plan maintained by any Participating Company to acquire stock, stock options, stock appreciation rights, performance shares or restricted stock of a Participating Company at any time within the one year immediately preceding the member's appointment to the Committee. (b) All decisions, determinations or actions of the Committee made or taken pursuant to grants of authority under the Plan shall be made or taken in the sole discretion of the Committee and shall be final, conclusive and binding on all persons for all purposes. (c) The Committee shall have full power, discretion and authority to interpret, construe and administer the Plan and any part thereof, and its interpretations and constructions thereof and actions taken thereunder shall be, except as otherwise determined by the Board, final, conclusive and binding on all persons for all purposes. (d) The Committee's decisions and determinations under the Plan need not be uniform and may be made selectively among Key Employees, whether or not such Key Employees are similarly situated. (e) The Committee may, in its sole discretion, delegate such of its powers as it deems appropriate to the chief executive officer or other members of senior management, except that Awards to Key Employees who are executive officers or directors shall be made solely by the Committee and subject to compliance with Rule 16b-3 of the Act. (f) If an Acceleration Event has not occurred and if the Committee determines that a Key Employee has taken action inimical to the best interests of any Participating Company, the Committee may, in its sole discretion, terminate in whole or in part such portion of any Option (including any related Right) as has not yet become exercisable at the time of termination, terminate any Performance Share Award for which the Performance Period has not been completed or terminate any Award of Restricted Stock for which the Restriction Period has not lapsed. 12. Amendment, Extension or Termination E-11 The Board may, at any time, amend or terminate the Plan and, specifically, may make such modifications to the Plan as it deems necessary to avoid the application of Section 162(m) of the Code and the Treasury regulations issued thereunder. However, no amendment shall, without approval by a majority of the Company's stockholders: (a) alter the group of persons eligible to participate in the Plan; (b) except as provided in Section 13, increase the maximum number of shares of Stock which are available for Awards under the Plan; (c) materially increase the benefits accruing to participants under the Plan; or (d) extend the period during which awards may be granted beyond ten years and two days from the effective date of this Plan, as provided below in Section 15. If an Acceleration Event has occurred, no amendment or termination shall impair the rights of any person with respect to a prior Award. 13. Adjustments in Event of Change in Common Stock In the event of any reorganization, merger, recapitalization, consolidation, liquidation, stock dividend, stock split, reclassification, combination of shares, rights offering, split-up or extraordinary dividend (including a spin-off) or divestiture, or any other change in the corporate structure or shares, the Committee may make such adjustment in the Stock subject to Awards, including Stock subject to purchase by an Option, or the terms, conditions or restrictions on Stock or Awards, including the price payable upon the exercise of such Option and the number of shares subject to restricted stock awards, as the Committee deems equitable. 14. Miscellaneous (a) Except as provided in Section 9, nothing in this Plan or any Award granted hereunder shall confer upon any employee any right to continue in the employ of any Participating Company or interfere in any way with the right of any Participating Company to terminate his or her employment at any time. No Award payable under the Plan shall be deemed salary or compensation for the purpose of computing benefits under any employee benefit plan or other arrangement of any Participating Company for the benefit of its employees, unless the Company shall determine otherwise. No Key Employee shall have any claim to an Award until it is actually granted under the Plan. To the extent that any person acquires a right to receive payments from the Company under this Plan, such right shall be no greater than the right of an unsecured general creditor of the Company. All payments to be made hereunder shall be paid from the general funds of the Company and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts except as provided in Section 7(e) with respect to Restricted Stock. (b) The Committee may cause to be made, as a condition precedent to the payment of any Award, or otherwise, appropriate arrangements with the Key Employee or his or her Beneficiary, for the withholding of any federal, state, local or foreign taxes. (c) The Plan and the grant of Awards shall be subject to all applicable federal and state laws, rules and regulations, and to such approvals by any government or regulatory agency as may be required. (d) The terms of the Plan shall be binding on the Company and its successors and assigns. E-12 (e) Captions preceding the sections hereof are inserted solely as a matter of convenience and in no way define or limit the scope or intent of any provision hereof. (f) Insofar as Key Employees who are directors or officers subject to Section 16 of the Act are concerned (i) the Plan is intended to comply with all applicable conditions of Rule 16b-3 and its successors; (ii) all transactions involving Key Employees who are directors or officers are subject to such conditions, regardless of whether such conditions are expressly set forth in the Plan; and (iii) any provision of the Plan that is contrary to a condition of Rule 16b-3 shall not apply to Key Employees who are directors or officers. 15. Effective Date and Term of Plan The Plan shall become effective upon its adoption by the Board of Directors and shareholders of the Company. No Award shall be granted under this Plan after the Plan's termination date. The Plan's termination date shall be ten years and two days from the effective date, unless sooner terminated under Section 12 hereof. The Plan will continue in effect for existing Awards as long as any such Award is outstanding. E-13 EX-11 3 COMPUTATION OF EARNINGS Exhibit 11 ITT EDUCATIONAL SERVICES, INC. COMPUTATION OF PRIMARY AND FULLY DILUTED EARNINGS PER SHARE (In thousands, except per share data)
Three Months Ended June 30, Six Months Ended June 30, ---------------------------- -------------------------- 1997 1996 1997 1996 ---- ---- ---- ---- Net income $ 805 $ 314 $ 7,007 $ 5,149 ======= ======= ======= ======= Shares: Weighted average number of shares of common stock outstanding 27,000 27,000 27,000 27,000 Shares assumed issued (less shares assumed purchased for treasury) on stock options 171 159 177 132 ------- ------- ------- ------- Outstanding shares for primary earnings per share calculation 27,171 27,159 27,177 27,132 ======= ======= ====== ====== Earnings per common share: $ 0.03 $ 0.01 $ 0.26 $ 0.19 ======= ======= ======= =======
EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1997 JUN-30-1997 93,884 0 9,533 (441) 0 108,807 66,415 (44,443) 139,316 61,989 0 0 0 270 75,429 139,316 0 122,888 0 113,783 0 857 0 11,678 4,671 7,007 0 0 0 7,007 0.26 0.26
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