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ESI > SEC Filings for ESI > Form 10-Q on 26-Jul-2013All Recent SEC Filings

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Form 10-Q for ITT EDUCATIONAL SERVICES INC


26-Jul-2013

Quarterly Report


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:

changes in federal and state governmental laws and regulations with respect to education and accreditation standards, or the interpretation or enforcement of those laws and 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;

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

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 federal or state authorizations or accreditations of our campuses or programs of study;

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

loss of access by our students to lenders for education 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, 2012 filed with the SEC, in Part II, Item 1A. "Risk Factors" of our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013 and in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.

Overview

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

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

The terms "ITT Technical Institute" or "Daniel Webster College" (in singular or plural form) refer to an individual school or campus owned and operated by ITT/ESI, including its learning sites, if any. The term "institution" (in singular or plural form) means 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, 2012 filed with the SEC for discussion of, among other matters, the following items:

cash receipts from financial aid programs;

nature of capital additions;

seasonality of revenue;

components of income statement captions;

federal regulations regarding:

timing of receipt of funds from the 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 in the order of significance.

Background

We are a leading proprietary provider of postsecondary degree programs in the United States based on revenue and student enrollment. As of June 30, 2013, we were offering master, bachelor and associate degree programs to approximately 59,000 students. As of June 30, 2013, we had 149 college locations (including 147 campuses and two learning sites) in 39 states. In addition, we offered one or more of our online programs to students who are located in 48 states. All of our college locations are authorized by the applicable education authorities of the states in which they operate, and are accredited by an accrediting

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commission recognized by the ED. We design our education programs, after consultation with employers and other constituents, 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.

Our strategy is to pursue multiple opportunities for growth. We are implementing a growth strategy designed to:

improve the academic outcomes of our students;

increase the value proposition of our education programs for our students; and

increase access to high-quality, career-based education.

We intend to pursue this strategy by:

increasing student enrollment in existing programs at existing campuses;

increasing the number and types of program and other educational offerings that are delivered in residence and/or online;

increasing our students' engagement in their programs of study;

enhancing the relevancy of our educational offerings;

assessing student achievement and learning;

improving the flexibility and convenience of how our institutions deliver their educational offerings;

increasing our students' access to financial aid;

helping our graduates obtain entry-level employment involving their fields of study at higher starting annual salaries;

operating new campuses across the United States and new institutions in international markets;

adding learning sites to existing campuses; and

investing in other education-related opportunities.

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, 2012 filed with the SEC. There have been no material changes to those critical accounting policies or the underlying accounting estimates or judgments.

New Accounting Guidance

In February 2013, the FASB issued ASU No. 2013-02, which is included in the Codification under ASC 220. This update requires an entity to report the effect, by component, of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income. This guidance is effective for interim and annual reporting periods beginning January 1, 2013. The adoption of this guidance requires that we provide additional disclosures regarding the amounts reclassified out of accumulated other comprehensive income during the reporting period. We have included these disclosures in the footnotes to our condensed consolidated financial statements.

In October 2012, the FASB issued ASU No. 2012-04, which makes technical corrections, clarifications and limited-scope improvements to various topics throughout the Codification. The amendments in this ASU that do not have transition guidance are effective upon issuance and the amendments that are subject to transition guidance are effective for our interim and annual reporting periods beginning January 1, 2013. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

In July 2012, the FASB issued ASU No. 2012-02, which is included in the Codification under ASC 350. This update allows an entity to first assess qualitative factors to determine whether it must perform a quantitative impairment test. An entity would be required to calculate the fair value of an indefinite-lived intangible asset, if the entity determines, based on a qualitative assessment, that it is more likely than not that the indefinite-lived asset is impaired. This guidance is effective for impairment tests performed for our interim and annual reporting periods beginning January 1, 2013. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

In December 2011, the FASB issued ASU No. 2011-11, which is included in the Codification under ASC 210. This update provides for enhanced disclosures to help users of financial statements evaluate the effect or potential effect of netting arrangements on an entity's financial position. In January 2013, the FASB issued ASU No. 2013-01, which clarifies the scope of the disclosures required under ASU No. 2011-11. Both of these updates are effective for interim and annual reporting periods beginning January 1, 2013. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

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Results of Operations

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



                                                  Three Months Ended            Six Months Ended
                                                       June 30,                     June 30,
                                                  2013           2012          2013          2012
Revenue                                            100.0%        100.0%        100.0%        100.0%
Cost of educational services                        47.6%         42.7%         45.5%         41.1%
Student services and administrative expenses        38.8%         33.8%         37.8%         32.4%
Loss related to private student loan programs        0.0%          0.0%          0.6%          0.0%

Operating income                                    13.5%         23.5%         16.1%         26.5%
Interest (expense), net                             (0.4% )       (0.3% )       (0.4% )       (0.1% )

Income before provision for income taxes            13.2%         23.2%         15.7%         26.4%

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

                                    2013                                    2012
                         Total              (Decrease)             Total          (Decrease)
Total Student           Student                 To                Student             To
Enrollment as of:      Enrollment           Prior Year           Enrollment       Prior Year
March 31                      61,039                (14.2 %)          71,123            (15.4 %)
June 30                       58,617                (11.7 %)          66,397            (15.7 %)
September 30          Not applicable       Not applicable             65,662            (17.1 %)
December 31           Not applicable       Not applicable             61,059            (16.6 %)

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:

                                            2013                                      2012
New Student Enrollment         New             Increase (Decrease)           New           (Decrease)
in the Three                 Student                   To                  Student             To
Months Ended:               Enrollment             Prior Year             Enrollment       Prior  Year
March 31                           17,412                     (3.6% )          18,067            (17.0% )
June 30                            16,883                      7.5%            15,698             (9.5% )
September 30               Not applicable            Not applicable            19,298            (15.8% )
December 31                Not applicable            Not applicable            13,398            (11.4% )

Total for the year         Not applicable            Not applicable            66,461            (13.9% )

We believe that the 7.5% increase in new student enrollment in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 was primarily due to:

an increase in the number of prospective students who inquired about our programs of study;

an increase in the rate at which prospective students who applied for enrollment actually began attending classes in their programs of study; and

increased availability to and use by our students of institutional scholarships and awards, which have the effect of reducing the students' cost of our programs of study.

We believe that the 3.6% decrease in new student enrollment in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 was primarily due to:

changes that we made to program offerings at select campuses which resulted in a more significant decline in new student enrollment in the criminal justice programs of study compared to our other curricula; and

a decrease in new student enrollment in our bachelor degree programs.

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We believe that the decrease in new student enrollment in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 was also due to our prospective students':

greater sensitivity to the cost of postsecondary education; and

uncertainty about the value of a postsecondary education due to the prolonged economic and labor market disruptions.

A continued decline in total student enrollment, and further declines in new student enrollment similar to those that we experienced prior to the three months ended June 30, 2013, could have a material adverse effect on our business, financial condition, revenue and other results of operations and cash flows. We have taken a number of steps in an attempt to reverse the declines in total and new student enrollment, including, without limitation:

introducing an institutional scholarship program, called the Opportunity Scholarship, which is intended to help reduce the cost of an ITT Technical Institute education and increase student access to our programs of study; and

refining our marketing, advertising and communications to focus more on the student value proposition and outcomes of an ITT Technical Institute education.

At the vast majority of our campuses, we generally organize the academic schedule for programs of study offered on the basis of four 12-week academic quarters in a calendar year. The academic quarters typically begin in early March, mid-June, early September and late November or early December. To measure the persistence of our students, the number of continuing students in any academic 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:
        Year    March 31        June 30         September 30          December 31
        2011         73.5 %         73.1 %                71.5 %                73.4 %
        2012         72.4 %         71.3 %                69.8 %                72.6 %
        2013         71.5 %         68.4 %      Not applicable        Not applicable

We believe that the decrease in student persistence as of June 30, 2013 compared to June 30, 2012 was primarily due to:

an increase in the number of graduates at the end of the academic quarter that began in March 2013 compared to the end of the same academic quarter in the prior year; and

a slight decrease in student retention in the three months ended June 30, 2013 compared to the same prior year period, primarily attributed to lower student retention in a few courses that are delivered in the early portions of certain associate degree programs of study.

The increase in the number of graduates at the end of the academic quarter that began in March 2013 was primarily due to two, instead of one, graduating classes of students comprised of:

the first graduation class of the associate degree programs of study that we introduced in 2011, which reduce from eight to seven the number of academic quarters required for a full-time student to graduate; and

the last graduation class of full-time students of the associate degree programs of study that required eight academic quarters for a full-time student to graduate.

We believe that the decrease in student persistence as of March 31, 2013 compared to March 31, 2012 was primarily due to the number of graduates in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 decreasing at a lesser rate than the decline in total student enrollment as of December 31, 2012 compared to December 31, 2011.

Three Months Ended June 30, 2013 Compared with Three Months Ended June 30, 2012. Revenue decreased $69.9 million, or 21.2%, to $259.9 million in the three months ended June 30, 2013 compared to $329.8 million in the three months ended June 30, 2012. The primary factors that contributed to this decrease included:

a 14.2% decrease in total student enrollment as of March 31, 2013 compared to March 31, 2012;

an 11.7% decrease in total student enrollment as of June 30, 2013 compared to June 30, 2012; and

a $30.1 million increase in institutional scholarships and awards provided to our students in the three months ended June 30, 2013 compared to the same prior year period.

The increase in institutional scholarships and awards was primarily due to the introduction of the Opportunity Scholarship at the vast majority of the ITT Technical Institute campuses in the academic quarter that began in March 2013.

Cost of educational services decreased $17.1 million, or 12.1%, to $123.8 million in the three months ended June 30, 2013 compared to $140.9 million in the three months ended June 30, 2012. The primary factors that contributed to this decrease included:

a decrease in compensation and benefit costs, resulting from fewer employees; and

a decrease in course supply expenses, due to lower student enrollments.

Cost of educational services as a percentage of revenue increased 490 basis points to 47.6% in the three months ended June 30, 2013 compared to 42.7% in the three months ended June 30, 2012. The primary factor that contributed to this increase was a decline in revenue, which was partially offset by decreases in compensation and benefit costs and course supply expenses.

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Student services and administrative expenses decreased $10.6 million, or 9.5%, to $100.9 million in the three months ended June 30, 2013 compared to $111.5 million in the three months ended June 30, 2012. The principal causes of this decrease were decreases in compensation and benefit costs and media advertising expenses.

Student services and administrative expenses increased to 38.8% of revenue in the three months ended June 30, 2013 compared to 33.8% of revenue in the three months ended June 30, 2012. The principal cause of this increase was a decline in revenue, which was partially offset by decreases in compensation and benefit costs and media advertising expenses. Bad debt expense as a percentage of revenue increased to 7.3% in the three months ended June 30, 2013 compared to 5.8% in the three months ended June 30, 2012, primarily as a result of an increase in student account balances that were determined to be uncollectible.

Operating income decreased $42.2 million, or 54.5%, to $35.2 million in the three months ended June 30, 2013 compared to $77.4 million in the three months ended June 30, 2012, primarily as a result of the impact of the factors discussed above in connection with revenue, cost of educational services, and student services and administrative expenses. Our operating margin decreased to 13.5% in the three months ended June 30, 2013 compared to 23.5% in the three months ended June 30, 2012, primarily as a result of the impact of the factors discussed above.

Interest income decreased $0.3 million, or 65.7%, to $0.2 million in the three months ended June 30, 2013 compared to $0.5 million in the three months ended June 30, 2012, primarily due to discontinuing the amortization of the discount on the Subordinated Note that we issued in connection with the PEAKS Program. See Note 8 of the Notes to Condensed Consolidated Financial Statements for a discussion of the Subordinated Note. Interest expense decreased $0.1 million, or 11.2%, to $1.1 million in the three months ended June 30, 2013 compared to $1.3 million in the three months ended June 30, 2012, primarily due to a decrease in our weighted average outstanding borrowings under the Credit Agreement, which was partially offset by an increase in the effective interest rate on the Revolver.

Our combined federal and state effective income tax rate was 39.1% in the three months ended June 30, 2013 compared to 40.0% in the three months ended June 30, 2012. The effective income tax rate was higher in the three months ended June 30, 2012 primarily due to the settlement of certain income tax audits during that time period.

Six Months Ended June 30, 2013 Compared with Six Months Ended June 30, 2012. Revenue decreased $124.0 million, or 18.5%, to $547.6 million in the six months ended June 30, 2013 compared to $671.6 million in the six months ended June 30, 2012. The primary factors that contributed to this decrease included:

a 14.2% decrease in total student enrollment as of March 31, 2013 compared to March 31, 2012;

a 16.6% decrease in total student enrollment as of December 31, 2012 compared to December 31, 2011;

an 11.7% decrease in total student enrollment as of June 30, 2013 compared to June 30, 2012; and

a $30.9 million increase in institutional scholarships and awards provided to our students in the six months ended June 30, 2013 compared to the same prior year period.

The increase in institutional scholarships and awards was primarily due to the introduction of the Opportunity Scholarship at the vast majority of the ITT Technical Institute campuses in the academic quarter that began in March 2013.

Cost of educational services decreased $26.8 million, or 9.7%, to $249.0 million in the six months ended June 30, 2013 compared to $275.9 million in the six months ended June 30, 2012. The primary factors that contributed to this decrease included:

a decrease in compensation and benefit costs, resulting from fewer employees; and

a decrease in course supply expenses, due to lower student enrollments.

Cost of educational services as a percentage of revenue increased 440 basis points to 45.5% in the six months ended June 30, 2013 compared to 41.1% in the six months ended June 30, 2012. The primary factor that contributed to this increase was a decline in revenue, which was partially offset by decreases in compensation and benefit costs and course supply expenses.

Student services and administrative expenses decreased $10.5 million, or 4.8%, to $207.2 million in the six months ended June 30, 2013 compared to $217.7 million in the six months ended June 30, 2012. The principal causes of this decrease were decreases in compensation and benefit costs and expenses related to student scholarships, which were partially offset by an increase in bad debt expense.

Student services and administrative expenses increased to 37.8% of revenue in the six months ended June 30, 2013 compared to 32.4% of revenue in the six months ended June 30, 2012. The principal causes of this increase were a decline in revenue and an increase in bad debt expense, which were partially offset by decreases in compensation and benefit costs and expenses related to student scholarships. Bad debt expense as a percentage of revenue increased to 7.1% in the six months ended June 30, 2013 compared to 5.2% in the six months ended . . .

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