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Itt Educational Services Inc – ‘424B4’ on 1/27/99

As of: Wednesday, 1/27/99 · Accession #: 950131-99-363 · File #: 333-69201

  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 1/27/99  Itt Educational Services Inc      424B4                  1:335K                                   Donnelley R R & S… 03/FA

Prospectus — Rule 424(b)(4)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B4       Final Prospectus                                      91    470K

Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Additional Locations and Programs Administrative Capability Agreements With Selling Stockholder Availability of Lenders and Guarantors Business Capitalization Certain U.S. Federal Tax Considerations for Non-U.S. Holders of Our Common Stock Change in Control Delaware General Corporation Law Description of Capital Stock Dividend Policy Eligibility and Certification Procedures Experts Financial Responsibility Standards Index to Financial Statements Institute Start-Up Costs Institutional Refunds Legal Matters Legal Proceedings Legislative Action Liquidity and Capital Resources Management Management's Discussion and Analysis of Financial Condition and Results of Operations Net income Notes to Financial Statements Notice to Canadian Residents Offering, The Operating income Pension Plan Preferred Stock Price Range of Common Stock Prospectus Summary Provisions of Restated Certificate of Incorporation and By-Laws Affecting Change in Control Regulation of Federal Financial Aid Programs Relationship with Selling Stockholder and Related Transactions Report of Independent Accountants Resale Restrictions Results of Operations Risk Factors Selected Financial and Operating Data Selling Stockholder and ESI Repurchase Shares Eligible for Future Sale State Authorization and Accreditation Stockholder Agreement Stock Repurchase Agreement Student Loan Defaults Tax Agreement The Offering Underwriting Variations in Quarterly Results of Operations Where You Can Find More Information Year 2000 Compliance
1	1st Page - Filing Submission
3	Where You Can Find More Information
4	Prospectus Summary
7	The Offering
10	Risk Factors
"	Legislative Action
11	Student Loan Defaults
"	Financial Responsibility Standards
"	Institutional Refunds
"	Change in Control
12	State Authorization and Accreditation
"	Availability of Lenders and Guarantors
14	Year 2000 Compliance
16	Price Range of Common Stock
"	Dividend Policy
17	Capitalization
18	Selected Financial and Operating Data
20	Management's Discussion and Analysis of Financial Condition and Results of Operations
21	Variations in Quarterly Results of Operations
22	Results of Operations
23	Operating income
"	Net income
25	Liquidity and Capital Resources
32	Business
42	Regulation of Federal Financial Aid Programs
48	Additional Locations and Programs
49	Administrative Capability
50	Eligibility and Certification Procedures
56	Legal Proceedings
60	Management
"	Selling Stockholder and ESI Repurchase
61	Relationship with Selling Stockholder and Related Transactions
"	Pension Plan
62	Agreements With Selling Stockholder
64	Stockholder Agreement
65	Stock Repurchase Agreement
66	Description of Capital Stock
"	Preferred Stock
67	Provisions of Restated Certificate of Incorporation and By-Laws Affecting Change in Control
"	Delaware General Corporation Law
68	Shares Eligible for Future Sale
70	Underwriting
72	Notice to Canadian Residents
"	Resale Restrictions
73	Certain U.S. Federal Tax Considerations for Non-U.S. Holders of Our Common Stock
75	Legal Matters
"	Experts
76	Index to Financial Statements
77	Report of Independent Accountants
81	Notes to Financial Statements
82	Institute Start-Up Costs
84	Tax Agreement

424B4 1st Page of 91 TOC ↑Top Previous Next ↓Bottom Just 1st
FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-69201

7,000,000 Shares

[LOGO APPEARS HERE]

ITT EDUCATIONAL SERVICES, INC.

Common Stock

------------

The shares of common stock in this offering are being sold by the selling
stockholder named under "Selling Stockholder and ESI Repurchase."
We will not receive any of the proceeds from this offering.
Our shares are listed on the New York Stock Exchange
under the symbol "ESI."

We have agreed to repurchase 1,500,000 shares of our
common stock from the selling stockholder
concurrently with the closing of this
offering.

Investing in our common stock involves certain risks. See "Risk Factors"
beginning on page 10.

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or
determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.

[Download Table]

Underwriting Proceeds to
Price to Discounts and Selling
Public Commissions Stockholder
------------ ------------- ------------

Per Share........................ $34.00 $1.28 $32.72
Total (1)........................ $238,000,000 $8,925,000 $229,075,000

(1) The selling stockholder has granted the underwriters an option,
exercisable for 30 days from the date of this prospectus, to purchase a
maximum of 950,000 additional shares to cover over-allotments of shares.

Delivery of the shares of common stock will be made on or about February 1,
1999 against payment in immediately available funds.

Joint Book-Running Managers

Credit Suisse First Boston Salomon Smith Barney

------------

Bear, Stearns & Co. Inc.
BT Alex. Brown
Morgan Stanley Dean Witter
NationsBanc Montgomery Securities LLC

Prospectus dated January 26, 1999

424B4 2nd Page of 91 TOC 1st Previous Next ↓Bottom Just 2nd
Notes to Readers of this Prospectus

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

. References in this document to "we," "us," "our" and "ESI" refer to ITT
Educational Services, Inc. References to "ITT" or the "Selling
Stockholder" refer to ITT Corporation, a Nevada corporation, and its
subsidiaries. References to "Starwood Hotels" refer collectively to
Starwood Hotels & Resorts Worldwide, Inc., a Maryland corporation
formerly known as Starwood Lodging Corporation, and its subsidiaries.

. The terms "ITT Technical Institutes," "technical institutes" or
"institutes" (in singular or plural form) refer to the individual schools
owned and operated by ESI. The terms "institution" or "campus group" (in
singular or plural form) mean a main campus and its additional locations
or branch campuses, if any.

. Unless we tell you otherwise, all information in this prospectus has been
adjusted to reflect a three-for-two stock split of our common stock
occurring on April 15, 1996 and a three-for-two stock split of our common
stock occurring on November 4, 1996.

. This offering is for 7,000,000 shares; however, the underwriters have a
30-day option to purchase up to 950,000 additional shares to cover over-
allotments. Some of the disclosures in this prospectus would be different
if the underwriters exercise the option. Unless we tell you otherwise,
the information in this prospectus assumes that the underwriters will not
exercise the option.

----------------

TABLE OF CONTENTS

[Download Table]

Page
----

WHERE YOU CAN FIND MORE INFORMATION...................................... 3
PROSPECTUS SUMMARY....................................................... 4
RISK FACTORS............................................................. 10
PRICE RANGE OF COMMON STOCK.............................................. 16
DIVIDEND POLICY.......................................................... 16
CAPITALIZATION........................................................... 17
SELECTED FINANCIAL AND OPERATING DATA.................................... 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS........................................................... 20
BUSINESS................................................................. 32
MANAGEMENT............................................................... 60
SELLING STOCKHOLDER AND ESI REPURCHASE................................... 60
RELATIONSHIP WITH SELLING STOCKHOLDER AND RELATED TRANSACTIONS........... 61
DESCRIPTION OF CAPITAL STOCK............................................. 66
SHARES ELIGIBLE FOR FUTURE SALE.......................................... 68
UNDERWRITING............................................................. 70
NOTICE TO CANADIAN RESIDENTS............................................. 72
CERTAIN U.S. FEDERAL TAX CONSIDERATIONS FOR NON-U.S. HOLDERS OF OUR
COMMON STOCK............................................................ 73
LEGAL MATTERS............................................................ 75
EXPERTS.................................................................. 75
INDEX TO FINANCIAL STATEMENTS............................................ F-1

----------------

You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
any different information. This document may only be used where it is legal to
sell these securities. The information in this document may only be accurate as
of the date of this document.

424B4 3rd Page of 91 TOC 1st Previous Next ↓Bottom Just 3rd
WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and special reports, proxy statements and other
information with the SEC under the Exchange Act. The Exchange Act file number
for our SEC filings is 1-13144. You may read and copy any document we file at
the following SEC public reference rooms:

450 Fifth Street, N.W. Seven World Trade Center Room 3190
Judiciary Plaza Suite 1300 Citicorp Center
Room 1024 New York, NY 10048 500 West Madison
Washington, D.C. 20549 Street
Suite 1400
Chicago, IL 60661

You may obtain information on the operation of the public reference room in
Washington, D.C. by calling the SEC at 1-800-SEC-0330.

We file information electronically with the SEC. Our SEC filings also are
available from the SEC's Internet site at http://www.sec.gov, which contains
reports, proxy and information statements, and other information regarding
issuers that file electronically.

You may also inspect and copy our SEC filings and other information at the
offices of the New York Stock Exchange located at 20 Broad Street, New York,
New York 10005.

This prospectus is part of a registration statement we filed with the SEC.
The SEC allows us to "incorporate by reference" certain documents we file with
it, which means that we can disclose important information to you by referring
you to those documents. The information in the documents incorporated by
reference is considered to be part of this prospectus, and information in
documents that we file later with the SEC will automatically update and
supersede this information. We incorporate by reference the documents listed
below and any future filings we will make with the SEC under Section 13(a),
13(c), 14 or 15(d) of the Exchange Act until ITT sells all of its shares of our
common stock being offered or this offering is otherwise terminated:

1. The Annual Report on Form 10-K for our fiscal year ended December 31,
1997;

2. The Quarterly Report on Form 10-Q for our fiscal quarter ended March
31, 1998;

3. The Quarterly Report on Form 10-Q for our fiscal quarter ended June
30, 1998;

4. The Quarterly Report on Form 10-Q for our fiscal quarter ended
September 30, 1998;

5. The Current Report on Form 8-K which we filed on March 10, 1998;

6. The Current Report on Form 8-K which we filed on April 8, 1998;

7. The Current Report on Form 8-K which we filed on April 16, 1998, and
the amendment to that Form 8-K which we filed on April 17, 1998;

8. The Current Report on Form 8-K which we filed on December 21, 1998;

9. The Current Report on Form 8-K which we filed on January 7, 1999;

10. The Current Report on Form 8-K which we filed on January 11, 1999;
and

11. The description of our common stock contained in our Registration
Statement on Form 8-A which we filed on June 16, 1994, and the
amendment to that Form 8-A which we filed on December 20, 1994.

We will provide a copy of the documents we incorporate by reference, at no
cost, to any person who receives this prospectus, including any beneficial
owner of our common stock. To request a copy of any or all of these documents,
you should write or telephone us at the following address and telephone number:

ITT Educational Services, Inc.
Attn: Secretary
5975 Castle Creek Parkway, North Drive
P. O. Box 50466
Indianapolis, Indiana 46250-0466
Telephone: (317) 594-9499

424B4 4th Page of 91 TOC 1st Previous Next ↓Bottom Just 4th
PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus. It may
not contain all of the information that is important to you. To understand this
offering fully, you should read the entire prospectus carefully, including the
risk factors and the financial statements.

The Company

ITT Educational Services, Inc. is a leading provider of technology-oriented
postsecondary degree programs in the United States based on revenues and
student enrollment. We offer associate, bachelor and master degree programs and
non-degree diploma programs. We currently have approximately 25,000 students in
67 institutes located in 27 states. As of December 31, 1998, approximately 99%
of our students were enrolled in a degree program, with approximately 74%
enrolled in electronics engineering technology related programs and
approximately 23% enrolled in computer-aided drafting technology related
programs. We have provided career-oriented education programs for over 30 years
and our institutes have graduated over 125,000 students since 1976. Employers
who have hired our graduates primarily include small, technology companies, but
also include large corporations, such as AT&T, Intel, Microsoft and General
Electric. The mailing address and telephone number of our principal executive
offices are 5975 Castle Creek Parkway N. Drive, P.O. Box 50466, Indianapolis,
Indiana, 46250-0466 and (317) 594-9499.

Of the 67 institutes we currently operate, we established 53 from January 1,
1981 through December 31, 1998. We established 17 of these institutes in our
last five fiscal years. The number of students attending our institutes has
increased 29% from 19,860 on December 31, 1993 to 25,608 on December 31, 1998.
Total revenues increased 72% from $169.0 million in 1993 to $291.4 million in
1998, an 11.5% compound annual growth rate. Operating income increased 141%
from $13.8 million in 1993 to $33.4 million in 1998, a 19.2% compound annual
growth rate. Net income, excluding one-time expenses, increased 179% from $8.3
million in 1993 to $23.2 million in 1998, a 22.7% compound annual growth rate.

We opened three new institutes in each of 1997 and 1998 and two new
institutes in January 1999. In addition, in 1998 we launched our first
information technology program, Computer Network Systems Technology, at three
institutes. We plan to open two additional new institutes in the remainder of
1999. We intend to continue expanding by opening new institutes and offering a
broader range of programs at our existing institutes, including several new
information technology programs.

We expect that the demand for postsecondary education will continue to
increase over the next several years as a result of favorable demographic,
economic and social trends. We believe that we are well positioned to take
advantage of the increasing demand for postsecondary education programs for the
following reasons:

.The Bureau of Labor Statistics projects an incremental 1.1 million new
information technology jobs will be created between 1996 and 2006.

. We offer curricula designed to teach the technical knowledge and skills
desired by many employers for entry-level positions in various fields
involving technology. We design these programs after consultation with
employers.

. Each of our institutes operates year-round and we offer undergraduate
programs on a quarterly basis, which allows our students to complete
their programs of study and enter the work force sooner than students
attending traditional colleges.

. We typically offer classes in most of our programs in four-hour sessions
five days a week, generally in the morning, afternoon and evening, which
allows our students to work while attending our institutes.

424B4 5th Page of 91 TOC 1st Previous Next ↓Bottom Just 5th
. We substantially standardize programs of study throughout our institutes,
which allows students to transfer to the same program offered at another
one of our institutes with less disruption to their education. We believe
this standardization also provides curriculum quality and consistency
throughout our institutes, which increases the marketability of our
graduates to prospective employers.

. We believe that our financial strength enables us to capitalize on
expansion opportunities, while devoting resources to complying with
federal and state regulatory requirements. As of December 31, 1998, after
giving effect to our stock repurchase, we would have had $70.2 million of
cash and marketable debt securities and no debt.

Our Strategy

Our strategy is to pursue multiple opportunities for growth. We are
implementing a business plan designed to increase revenues and operating
efficiencies by increasing the number of program offerings and student
enrollment at existing institutes and by opening new institutes across the
United States. The principal elements of this strategy include the following:

[_] Enhance Results at the Institute Level

Increase Enrollments at Existing Institutes.

In each of the last three fiscal years, we increased our student enrollment
at those institutes open for more than 24 months by an average of approximately
5.1%. We believe that current demographic and employment trends will allow us
to enroll a greater number of recent high school graduates. In addition, we
intend to increase our recruiting efforts aimed at enrolling more working
adults.

Broaden Availability of Current Program Offerings.

We intend to continue expanding the number of program offerings at our
existing institutes. Our objective is to offer at least three programs at each
institute. From January 1, 1994 through December 31, 1998, we increased the
number of institutes which offer three or more programs from 16 to 33. We
believe that introducing new programs at existing institutes will attract more
students. In 1999, we intend to increase the number of program offerings at
approximately 35 additional existing institutes.

Develop or Acquire Additional Degree Programs.

We plan to introduce degree programs in additional fields of study and at
different degree levels. We have introduced five new degree programs at 16
institutes since December 1995. In 1998, we launched our first program in
information technology, an associate degree program in Computer Network Systems
Technology, at three institutes. We intend to introduce this program at 27
additional institutes in 1999, and we plan to begin testing three additional
information technology degree programs in 1999. We believe that introducing new
programs can attract a broader base of students and can motivate current
students to extend their studies.

Extend Total Program Duration.

We have increased the number of institutes that offer bachelor degree
programs to graduates of our associate degree programs. In our last five fiscal
years, the number of our institutes which offer bachelor degree programs
increased from 13 to 28. As a result, the average combined total program time a
student remains enrolled in our programs has increased from 18 months in 1986
to 24 months in 1998. The newly introduced associate degree program in Computer
Network Systems Technology is 24 months in duration. We expect that the average
combined total program time of our students will increase further as additional
bachelor degree programs are added at our institutes.

424B4 6th Page of 91 TOC 1st Previous Next ↓Bottom Just 6th
Improve Student Outcomes.

We strive to improve the graduation and graduate employment rates of our
undergraduate students by providing extensive academic and career services.
From 1993 through 1997, the percentage of graduates of our institutes (other
than graduates who continued in a bachelor degree program at one of our
institutes) who were employed or already working in fields involving their
programs of study increased from 83% to 90%.

[_] Increase the Number of Our Institutes

We plan to add new institutes at sites throughout the United States. Using
our proprietary methodology, we determine locations for new institutes based on
a number of factors, including demographics and population and employment
growth. We opened three new institutes in each of 1997 and 1998 and two new
institutes in January 1999. We plan to open two additional new institutes in
the remainder of 1999. We will continue to consider acquiring schools located
in markets where our institutes are not presently located.

[_] Increase Margins by Leveraging Fixed Costs at Institute and Headquarters
Levels

By optimizing school capacity and class size, we have been able to increase
revenues from increased enrollment without incurring a proportionate increase
in fixed costs at our institutes. In addition, we have realized substantial
operating efficiencies by centralizing management functions and implementing
operational uniformity among our 67 institutes. As a result of these operating
efficiencies, expenses incurred at our headquarters (including the district
offices) declined as a percentage of revenues from 6.6% in 1994 to 5.1% in
1998. We will continue to seek to improve margins by increasing enrollments and
revenues without incurring a proportionate increase in fixed costs at our
institutes.

Recent Developments

In October 1998, the U.S. Congress enacted legislation extending the Higher
Education Act of 1965, the federal law that authorizes the federal student
financial aid programs, for another five-year period. This legislation
reauthorized all of the federal student financial aid programs in which our
institutes participate, in generally the same form and at the same or higher
funding levels. While this legislation revised a number of provisions that
affect our institutes, we believe most of the changes will not have any
material effect on our institutes. Two changes that we believe will have a
material effect are provisions that (1) increase the amount of revenues a for-
profit institution may derive each year from federal student financial aid
programs from 85% to 90%, and (2) limit the amount of federal student financial
aid funds a student who withdraws from an institution may use to pay his or her
education costs.

In September 1998, we agreed to settle eight legal proceedings involving 25
former students and the claims of 15 other former students. Two class
settlements involving former students, which are part of the settlement, are
subject to court approval and to the right of the class members to opt out of
the settlement. We recorded a $12.9 million provision in September 1998
associated with the settlement of these legal proceedings.

In connection with this offering, we have agreed to repurchase 1,500,000
shares of our common stock from ITT Corporation at a price of $49,087,500. We
will fund this repurchase with our cash and cash equivalents and marketable
debt securities. The closing of this offering and the repurchase will be
concurrent and the repurchase will be contingent on the closing of this
offering.

424B4 7th Page of 91 TOC 1st Previous Next ↓Bottom Just 7th
This offering is subject to obtaining all of the necessary approvals from the
applicable regulatory bodies. We have notified all such regulatory bodies of
this offering. On November 20, 1998, the U.S. Department of Education advised
us that this offering will not be a change in control of ESI under its
standards. As a result, this offering will not cause any of our institutions to
become ineligible to participate in federal student financial aid programs,
unless certain state education authorities that consider this offering to be a
change in control fail to reauthorize any of our institutes.

The Offering

[Download Table]

Shares of our common stock offered
by ITT............................ 7,000,000 shares(1)
Shares of our common stock
outstanding at January 20, 1999... 27,016,202 shares(2)
Shares of common stock outstanding
after the offering and the stock
repurchase........................ 25,516,202 shares(2) (3)
Use of proceeds.................... We will not receive any proceeds from the
sale of our common stock in this offering.
Dividend Policy.................... We intend to keep all future earnings to
fund the development and growth of our
business. We do not plan to pay cash
dividends. See "Dividend Policy."
Risk Factors....................... For a discussion of certain risks you
should consider before investing in our
common stock, see "Risk Factors."
NYSE Symbol........................ ESI

--------
(1) Assumes the underwriters' over-allotment option to purchase 950,000 shares
is not exercised. See "Underwriting."
(2) Excludes as of January 20, 1999: (1) 783,750 shares of common stock
issuable upon the exercise of outstanding options (of which options for
401,083 shares were exercisable); (2) 409,500 shares of common stock
issuable upon the exercise of options granted in October 1998 to become
effective on January 26, 1999; and (3) an aggregate of 3,245,500 additional
shares of common stock reserved for issuance under the 1997 ITT Educational
Services, Inc. Incentive Stock Plan and the ITT Educational Services, Inc.
1994 Stock Option Plan.
(3) Concurrently with the closing of this offering, we will repurchase
1,500,000 shares of our common stock from the selling stockholder at a
price of $49,087,500.

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Summary Financial and Operating Data
(In thousands, except per share and operating data)

The following table sets forth certain financial data for ESI. You should
read this information with the Financial Statements and Notes to the Financial
Statements appearing elsewhere or incorporated by reference in this prospectus.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."

[Download Table]

Year Ended December 31,
--------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------

Statement of Income Data:
Total revenue............... $291,375 $261,664 $232,319 $201,831 $186,907
Operating income............ 18,636(a) 26,223 20,576 14,225 11,832
Interest income, net (b).... 5,329(c) 5,565 4,119 4,802 232
Income before income taxes.. 23,965 31,788 24,695 19,027 12,064
Net income.................. 13,941(a)(c) 19,123 14,851 11,391 7,162
Earnings per share (d):
Basic...................... $ 0.52(a)(c) $ 0.71 $ 0.55 $ 0.42 $ 0.32
Diluted.................... 0.51(a)(c) 0.71 0.55 0.42 0.32
Other Operating Data:
EBITDA (e).................. $ 27,918(a) $ 34,162 $ 28,069 $ 21,767 $ 18,687
Operating losses from new
technical institutes before
income taxes (f)........... $ 5,257 $ 3,165 $ 5,721 $ 7,123 $ 7,316
Capital expenditures, net... $ 11,381 $ 11,465 $ 7,868 $ 8,206 $ 7,688
Number of students at end of
period..................... 25,608 24,498 22,633 20,618 20,668
Number of technical
institutes at end of
period..................... 65 62 59 56 54

[Download Table]

At December 31,
--------------------
1998 1997
-------- --------

Balance Sheet Data:
Cash, restricted cash, cash invested with ITT and
marketable debt securities.............................. $119,268(c) $ 98,689
Total current assets..................................... 138,758 112,958
Property and equipment less accumulated depreciation..... 24,985 22,886
Total assets............................................. 175,571 145,914
Total current liabilities................................ 70,241 55,946
Shareholders' equity..................................... 101,856(c) 87,815

--------
(a) Net of one-time expenses of $14,730 ($9,216 after taxes) for legal
settlements, offering expenses associated with the June 1998 offering of
shares of our common stock by ITT, and change in control and other one-time
expenses related to Starwood Hotels' acquisition of ITT. Excluding these
one-time expenses, operating income, net income, EBITDA and earnings per
share for the year ended December 31, 1998, would have been $33,366,
$23,157, $42,648 and $0.85, respectively.
(b) See Note 3 of Notes to Financial Statements for information concerning
intercompany interest between ESI and ITT. Prior to our initial public
offering in December 1994, we did not receive interest on the full amount
of net cash balances we invested with ITT and we were assessed an interest
charge based on an allocation of the consolidated debt of ITT. After our
initial public offering and until February 5, 1998, we received interest
from ITT on the amount of any net cash balances invested with ITT and we
were no longer subject to an interest charge based on such an allocation.
Since February 5, 1998, we have performed our own cash management functions
and no longer have any cash invested with ITT. Lower interest rates on
short-term investments have resulted in lower yields on our cash balances
than the yields on our cash that was invested with ITT. Accordingly,
interest income, net has decreased in 1998.
(c) We will spend $49,088 to repurchase 1,500 shares of our common stock
concurrently with the closing of this offering, which would have reduced
cash and cash equivalents and marketable debt securities and

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shareholders' equity by $49,088 if the repurchase had occurred at December
31, 1998. If the stock repurchase had occurred January 1, 1998, basic and
diluted earnings per share for the year ended December 31, 1998 would have
been reduced by $0.04 and $0.03, respectively, which reflects a reduction in
interest income of $2,700, a reduction of net income of $1,620 and a
reduction in the average number of shares outstanding of 1,500.
(d) Earnings per share data are based on historical net income and the number
of shares of our common stock outstanding during each period after giving
retroactive effect to the three-for-two stock splits in April and November
1996. Earnings per share for all periods have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
(e) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization. We have included information
concerning EBITDA (which is not a measure of financial performance under
generally accepted accounting principles) because we understand that
certain investors use it as one measure of an issuer's financial
performance. EBITDA is not an alternative to operating income (as
determined in accordance with generally accepted accounting principles), an
indicator of our performance or cash flows from operating activities (as
determined in accordance with generally accepted accounting principles) or
a measure of liquidity.
(f) Operating losses from new technical institutes before income taxes
represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first 24 months after
their first class start.

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RISK FACTORS

This section describes some, but not all, of the risks of purchasing our
common stock. The order in which these risks are listed does not necessarily
indicate their relative importance. You should carefully consider these risks
and other information in this prospectus before investing in our common stock.

This prospectus contains forward-looking statements. These statements include
words such as "believe," "expect," "anticipate," "intend," "estimate" or
similar words. These statements are based on our current beliefs, expectations
and assumptions and are subject to a number of risks and uncertainties. Actual
results and events may vary materially from those discussed in the forward-
looking statements. We discuss risks and uncertainties that might cause such a
difference below and in other places in this prospectus.

Extensive Regulation Due to Dependence on Federal Funding

In 1998, we indirectly derived approximately 69% of our revenues from federal
student financial aid programs. To begin and continue participation in federal
student financial aid programs, an institution must receive and maintain
authorization by the appropriate state education authority or authorities,
accreditation by an accrediting commission recognized by the U.S. Department of
Education, and certification by the U.S. Department of Education. As a result,
we are subject to extensive regulation by the U.S. Department of Education,
state education authorities and accrediting commissions.

The purpose of these regulations is to protect students, the public and the
government; it is not to protect stockholders. Among other things, these
regulations require us to satisfy criteria related to:

. our programs of study and educational resources, including faculty,
equipment and facilities;

. our administrative capability; and

. the management and control of our financial operations, including our
ability to meet specified financial ratios and other standards.

Regulatory requirements affect our capital structure, investment practices and
cash management. They also affect our ability to make acquisitions, sell our
common stock or change our corporate structure. These requirements may limit
our operations or expansion plans. Our regulatory agencies periodically change
their regulatory requirements.

If one of our institutes violates any of these regulatory requirements, we
could suffer a financial penalty. Our regulatory agencies could also limit or
terminate our institutes' operations, including our receipt of federal student
financial aid funds, which could have a material adverse effect on our
financial condition, results of operations and cash flows.

We believe that we substantially comply with the requirements of these
regulatory bodies, but we cannot predict with certainty how all of their
requirements will be applied, or if we will be able to comply with all of their
requirements in the future. Some of the most significant regulatory
requirements and risks are described in the following paragraphs. See
"Business--Regulation of Federal Financial Aid Programs."

Legislative Action

The U.S. Congress regularly reviews and revises the laws governing federal
student financial aid programs. The U.S. Congress also must determine the
federal funding level for each of these programs every year. Any action by the
U.S. Congress that significantly reduces funding for federal student financial
aid programs or the ability of our institutes or students to participate in
these programs could have a material adverse effect on our financial condition
or results of operations. Legislative action may also increase our
administrative costs and burden and require us to adjust our practices in order
for our institutes to comply fully with the legislative requirements, which
could have a material adverse effect on our financial condition or results of
operations. See "Business--Regulation of Federal Financial Aid Programs--
Legislative Action."

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Student Loan Defaults

An institution may lose its eligibility to participate in some or all federal
student financial aid programs, if the rates at which the institution's
students default on their federal student loans exceed specified percentages.
In June 1998, our institute in Garland, Texas lost its eligibility to
participate in the major federal student loan programs until at least October
1, 2000 for this reason. As a result, we have decided to stop enrolling new
students at the Garland institute, at least temporarily. The Garland institute
accounted for approximately 1.4% of our revenues in 1998. None of our other
institutes has student default rates that exceed the specified percentages.
High student default rates can also adversely affect an institution's
operations and receipt of federal student financial aid. See "Business--
Regulation of Federal Financial Aid Programs--Student Loan Defaults," "--
Administrative Capability" and "--Eligibility and Certification Procedures."

Financial Responsibility Standards

ESI and each of our institutes must meet financial standards prescribed by
the U.S. Department of Education. The financial standards of the U.S.
Department of Education have recently changed. We have always met the past
financial standards and believe that we will meet the new financial standards,
but we cannot assure you of this. See "Business--Regulation of Federal
Financial Aid Programs--Financial Responsibility Standards."

Institutional Refunds

Federal law and the standards of accrediting commissions and most state
education authorities currently limit how much an institution can charge a
student who withdraws from the institution. The U.S. Congress recently replaced
the federal law limitation with a new limitation that restricts the amount of
federal student financial aid a withdrawing student can use to pay his or her
education costs. The new limitation becomes effective in October 2000. Since
federal student financial aid is generally paid sooner and is more collectible
than tuition payments from other sources, the new limitation could have a
material adverse effect on our financial condition, results of operations and
cash flows beginning with our 2001 fiscal year. See "Business--Regulation of
Federal Financial Aid Programs--Institutional Refunds."

The "85/15" Rule

Federal law provides that a for-profit institution may not derive more than
85% of its revenues in any fiscal year from federal student financial aid
programs and remain eligible to participate in these programs. The U.S.
Congress recently raised this percentage to 90%. In 1998, none of our
institutions received more than 79% of its revenues from federal student
financial aid programs. See "Business--Regulation of Federal Financial Aid
Programs--The "85/15' Rule."

Change in Control

Some types of transactions could cause a change in control of ESI or our
institutes under the standards of state education authorities, accrediting
commissions or the U.S. Department of Education. A transaction that is a change
in control of an institution under the standards of the U.S. Department of
Education would generally result in the suspension of the institution's
participation in federal student financial aid programs until the U.S.
Department of Education reviews and recertifies the institution. A material
adverse effect on our financial condition, results of operations and cash flows
would result if a transaction caused a change in control to occur under state,
accrediting commission or federal standards and a material number of our
institutes failed, in a timely manner, to be reauthorized by their state
education authorities, reaccredited by their accrediting commissions or
recertified by the U.S. Department of Education. See "Business--Regulation of
Federal Financial Aid Programs--Eligibility and Certification Procedures" and
"--Change in Control."

This offering will be a change in control under the standards of some state
education authorities, but the U.S. Department of Education and the accrediting
commission which accredits three of our institutes have advised us that this
offering will not be a change in control under their standards. The accrediting
commission which accredits 61 of our institutes has advised us that it is
unnecessary for it to determine whether this

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offering is a change in control under its standards, and that none of our
institutes' accreditation by this accrediting commission will be affected by
this offering. As a result, this offering will not affect our ability to
participate in federal student financial aid programs, unless certain state
education authorities that consider this offering to be a change in control
fail to reauthorize any of our institutes. Many state education authorities
require that a change in control be approved before it occurs, while others
will only review a change in control after it occurs. We have obtained all of
the approvals of this offering from the state education authorities that
require advance approval. Following this offering, we believe that we will be
able to obtain all of the approvals from the state education authorities that
require approval after this offering occurs, but we cannot assure you that we
will receive them in a timely manner. The California state education authority,
which normally requires advance approval, has advised us that it will not
determine whether this offering is a change in control until after the closing
of this offering. It has also advised us that the provisions of the California
Education Code that provide for termination of its existing authorization of
our California institutes if advance approval is not obtained do not apply to
this offering. Eleven of our institutes are located in California. See
"Business--Change in Control."

Additional Locations

Federal law requires a for-profit institution to operate for two years before
it can qualify to participate in federal student financial aid programs. An
institution that is certified to participate in federal student financial aid
programs can establish additional locations without satisfying the two-year
requirement, so long as each additional location satisfies all other applicable
requirements. Our expansion plans assume that we will continue to be able to
establish new institutes as additional locations of existing main campuses. If
future changes in federal law or other reasons prevented us from taking
advantage of the exception to the two-year requirement, our expansion plans
would be materially adversely affected. See "Business--Regulation of Federal
Financial Aid Programs--Additional Locations and Programs."

State Authorization and Accreditation

Each of our institutes must be authorized by the applicable state education
authority or authorities to operate and grant degrees or diplomas to its
students. State authorization and accreditation by an accrediting commission
recognized by the U.S. Department of Education are also required in order for
an institution to be eligible to participate in federal student financial aid
programs. Loss of state authorization by any of our institutes would force us
to close that institute. See "Business--State Authorization and Accreditation."

Availability of Lenders and Guarantors

In 1998, one lender provided approximately 65% of all federally guaranteed
student loans received by our students and one student loan guaranty agency
guaranteed approximately 94% of all federally guaranteed student loans received
by our students. Federally guaranteed student loans represented approximately
56% of our revenues in 1998. We believe that other lenders and guarantors would
be willing to make and guarantee these loans if they were no longer available
from our primary lender or guarantor, but we cannot assure you of this. See
"Business--Regulation of Federal Financial Aid Programs--Availability of
Lenders and Guarantors."

Material Litigation

We are subject to two pending legal proceedings in California that were
instituted by former students alleging misrepresentations and statutory
violations. One of these legal proceedings involves three former students who
attended the hospitality, electronics engineering technology or computer-aided
drafting technology programs and who allege that ESI, ITT and ten ESI employees
violated state education laws. In May 1998, we agreed to settle all of the
claims of one of the three plaintiffs. In September 1998, we agreed to settle
all of the claims of the two remaining plaintiffs and to seek a class
settlement of the claims of the approximately 19,000 other persons who attended
any program, other than the hospitality program, at any of our institutes in
California from January 1, 1990 through December 31, 1997. The class
settlement, which is subject to court approval, would provide class members
with non-transferable tuition credits to attend a different educational program
at one of our institutes. We have also agreed to stipulate to a permanent
injunction that would enjoin us from certain recruitment practices (none of
which we currently follow) and to pay the plaintiffs' reasonable attorneys'
fees and expenses. If more than 1% of the class members opt out of the class
settlement, we may terminate the class settlement.

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The other legal proceeding involves nine former students who attended the
hospitality program at either our Maitland, Florida or San Diego, California
institute. The suit alleges that ESI and ITT committed common law fraud and/or
concealment, civil conspiracy and violations of a federal racketeering statute
and state education, consumer protection and trade practices laws. In September
1998, we agreed to seek a class settlement of the claims of the nine plaintiffs
in this legal proceeding and of the approximately 1,200 other persons who
attended an associate degree program in hospitality at our institutes in
Maitland, Florida, San Diego, California, Portland, Oregon or Indianapolis,
Indiana. These are the only cities where we offered the hospitality program.
The class settlement, which is subject to court approval, involves our payment
of cash to the class members and the plaintiffs' reasonable attorneys' fees and
expenses. If more than 1% of the class members opt out of the class settlement,
we may terminate the class settlement. In December 1998, the court granted
preliminary approval of the class settlement.

We recorded a $12.9 million provision in September 1998 associated with the
settlement of the pending legal proceedings described above (including the
legal and administrative expenses that we expect to incur in order to
consummate the settlement of these legal proceedings), six other legal
proceedings involving similar claims that we settled in September 1998, and
other similar claims that were not in litigation. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations."

We cannot assure you of the ultimate outcome of any litigation in which we
are involved. A material adverse effect on our financial condition or results
of operations could occur if (1) we fail to obtain court approval of either
class settlement and a significant amount of litigation against us results or
(2) a significant number of class members opt out of either class settlement
and pursue litigation against us. See "Business--Legal Proceedings."

Competition

The postsecondary education market in the United States is highly fragmented
and competitive with no private or public institution enjoying a significant
market share. We compete for students with the following:

. four-year and two-year degree-granting institutions, including:

. non-profit public colleges;

. non-profit private colleges; and

. for-profit institutions.

. alternatives to higher education, including:

. military service; and

. immediate employment.

We believe that competition among educational institutions is based on the
following factors:

. quality of the educational program
. cost of the program

. perceived reputation of the institution
. employability of graduates

Certain public and private colleges may offer programs similar to ours at a
lower tuition cost due in part to governmental subsidies, government and
foundation grants, tax deductible contributions or other financial resources
not available to for-profit institutions. Other for-profit institutions also
offer programs that compete with ours. Some of our competitors in both the non-
profit and for-profit sectors have greater financial and other resources than
we do. We cannot assure you that we will be able to compete successfully in our
markets or that competitive pressures will not have a material adverse affect
on us.

Seasonality in Results of Operations

In reviewing our results of operations, you should not focus on quarter-to-
quarter comparisons. Our results in any quarter may not indicate the results we
may achieve in any subsequent quarter or for the full year. Our quarterly
results of operations tend to fluctuate significantly within a fiscal year
because of differences in the number of weeks of earned tuition revenue in each
fiscal quarter and the timing of student matriculations. Our first and third
fiscal quarters have 13 weeks of earned tuition revenue, while our second and
fourth quarters

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have only 11 weeks of earned tuition revenue because of two-week student
vacation breaks in June and December. In addition, revenues in our third and
fourth fiscal quarters generally are higher because more new students tend to
enter our institutes in June and September following their high school
graduation. The academic schedule generally does not affect our incurrence of
costs, however, and our costs do not fluctuate significantly on a quarterly
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Variations in Quarterly Results of Operations."

Changes in Market Needs and Technology

Prospective employers of graduates of our institutes have increasingly
demanded that their entry-level employees possess appropriate technical skills.
We believe that our management processes and information systems should permit
us to make changes in curricula content and supporting technology in response
to market needs. If we are unable to adequately respond to changes in market
requirements due to financial constraints, unusually rapid technological change
or other factors, our financial condition or results of operations could be
materially adversely affected.

Year 2000 Compliance

The "Year 2000 problem" arose because many information technology systems, as
well as other systems containing embedded technology, such as micro-controllers
and micro-chip processors, use only the last two digits to refer to a year. As
a result, these systems do not properly recognize a year that begins with "20"
instead of "19." If not corrected, this limitation may cause these systems to
experience problems processing information with dates after December 31, 1999.
These problems may cause the systems to fail or create erroneous results. We
are unable at this time to assess the possible impact on our financial
condition, results of operations and cash flows that may result from any
disruptions to our business caused by Year 2000 problems in any systems
controlled by us or any third party with whom we have a material relationship.
We do not believe at the current time, however, that the cost to remedy our
internal Year 2000 problems will have a material adverse effect on our results
of operations or cash flows. We have begun to implement a plan to ensure that
our systems are Year 2000 compliant before January 1, 2000.

Lack of Year 2000 compliance by third parties could pose problems for us.
These third parties primarily include the following:

. U.S. Department of Education;

. state education authorities;

. accrediting commissions;

. guaranty agencies; and

. student loan lenders.

If any of these parties experience a Year 2000 problem that significantly
delays our receipt of federal or state student financial aid in payment of
students' education cost of attending our institutes, it could have a material
adverse effect on our financial condition, results of operations and cash
flows.

Similarly, an interruption in our institutes' operations could occur if, due
to a Year 2000 problem:

. the U.S. Department of Education is unable to grant or renew an
institute's eligibility to participate in federal student financial aid
programs in a timely manner;

. any state education authority is unable to approve an institute to
operate or renew such approval in a timely manner; or

. either accrediting commission is unable to accredit an institute or renew
such accreditation in a timely manner.

A prolonged delay or interruption of operations for a significant number of
institutes could have a material adverse effect on our financial condition,
results of operations and cash flows. We are unable to independently assess the
Year 2000 readiness of any of these third parties at this time. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance."

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Dependence on Key Employees

Our future performance will depend, in part, on the efforts and abilities of
our executive officers and in particular Rene R. Champagne, our Chairman,
President and Chief Executive Officer. The loss of the services of Mr.
Champagne or one or more other executive officers could adversely affect our
business. None of our executive officers has an employment or non-competition
agreement with us. We do not have key man life insurance on any of our
employees.

Potential Adverse Effect of Shares Eligible For Future Sale

If our stockholders sell substantial amounts of our common stock (including
shares issued upon the exercise of outstanding options) in the public market
following this offering, the market price of our common stock could drop. These
sales might make it more difficult for us to sell our equity securities in the
future at a time and price which we deem appropriate.

Immediately after this offering and our stock repurchase, we will have issued
and outstanding approximately 25,500,000 shares of our common stock. The shares
of our common stock sold in this offering will be freely tradeable, except for
shares held by our "affiliates," as that term is defined in Rule 144 under the
Securities Act. The 950,000 outstanding shares of our common stock that will be
held by ITT after this offering and the stock repurchase (no shares if the
over-allotment option is exercised in full) are "restricted" securities, as
that term is defined in Rule 144, and may not be publicly resold unless they
are registered under the Securities Act or exempted from registration by an
exemption under the Securities Act, such as the exemption provided by Rule 144.
We have agreed to file a post-effective amendment to the registration statement
of which this prospectus is a part, converting it into a shelf registration
with respect to any shares of our common stock that ITT continues to own after
this offering and the stock repurchase. See "Relationship with Selling
Stockholder and Related Transactions."

ESI, its executive officers, ITT and Starwood Hotels have agreed, with
certain exceptions, not to sell any shares of our common stock or securities or
other rights convertible into or exchangeable or exercisable for any shares of
our common stock for 90 days after the date of this prospectus, without the
consent of Credit Suisse First Boston Corporation and Salomon Smith Barney Inc.
Such restrictions will not apply to the stock repurchase or the filing of the
post-effective amendment to the registration statement, or affect our ability
to grant stock options for our common stock under our stock option plans or to
issue common stock upon the exercise of stock options currently outstanding or
granted under our stock option plans. See "Shares Eligible for Future Sale" and
"Underwriting."

Anti-Takeover Provisions

Some provisions of our Restated Certificate of Incorporation and By-Laws
could make it more difficult for a third party to acquire control of us without
the approval of our Board of Directors. Among other things, these provisions:

. authorize our Board of Directors to issue preferred stock with terms set
by our Board, without stockholder approval;

. divide our Board of Directors into three classes expiring in rotation;

. require advance notice for stockholder proposals and nominations;

. prohibit stockholders from calling a special meeting; and

. prohibit stockholder action by written consent.

In many cases, stockholders receive a premium for their shares in a change in
control. These provisions may make it difficult for stockholders to take
certain actions and will make it somewhat less likely that a change in control
will occur or that you will receive a premium for your shares if a change in
control does occur. See "Description of Capital Stock--Preferred Stock," "--
Provisions of Restated Certificate of Incorporation and By-Laws Affecting
Change in Control" and "--Delaware General Corporation Law."

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PRICE RANGE OF COMMON STOCK

Our common stock is listed on the New York Stock Exchange under the trading
symbol "ESI." The prices set forth below are the high and low sale prices of
our common stock during the periods indicated, as reported in the NYSE's
consolidated transaction reporting system.

[Download Table]

High Low
------- -------

1997
First Quarter............................................ $27.000 $21.500
Second Quarter........................................... 25.000 19.375
Third Quarter............................................ 26.750 19.000
Fourth Quarter........................................... 26.000 20.750
1998
First Quarter............................................ $28.375 $21.375
Second Quarter........................................... 32.750 24.375
Third Quarter............................................ 33.938 26.000
Fourth Quarter........................................... 36.125 23.688
1999
First Quarter (through January 26, 1999)................. $35.625 $31.625

On January 26, 1999, the last reported sale price of our common stock on the
NYSE was $34.125 per share. There were approximately 200 holders of record of
our common stock on January 26, 1999.

DIVIDEND POLICY

We did not pay a cash dividend in 1997 or 1998. We do not anticipate paying
any cash dividends on our common stock in the foreseeable future and we plan to
retain our earnings to finance future growth. The declaration and payment of
dividends on our common stock are subject to the discretion of our Board of
Directors and compliance with applicable law. Our decision to pay dividends in
the future will depend on general business conditions, the effect of such
payment on our financial condition and other factors our Board of Directors may
in the future consider to be relevant.

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CAPITALIZATION

The following table sets forth the capitalization of ESI at December 31,
1998, and at December 31, 1998 as adjusted for our repurchase of common stock
from the Selling Stockholder. We will not receive any of the proceeds from this
offering. See "Selling Stockholder and ESI Repurchase." You should read this
table with the Financial Statements and the Notes to the Financial Statements
included elsewhere in this prospectus.

[Download Table]

December 31, 1998
--------------------------
Actual Pro Forma(1)
----------- --------------
(Dollars in thousands)

Long-term debt........................................ $ -- $ --
Shareholders' equity:
Preferred Stock, $.01 par value; 5,000,000 shares
authorized; none issued and outstanding............ -- --
Common Stock, $.01 par value; 50,000,000 shares
authorized; 27,011,202 issued and outstanding
actual and 25,511,202 issued and outstanding pro
forma (2).......................................... 270 270
Capital surplus..................................... 32,613 32,613
Retained earnings................................... 68,973 68,973
----------- ----------
101,856 101,856
Less cost of repurchased common stock to be held in
treasury (1,500,000 shares)........................ -- 49,088
----------- ----------
Total stockholders' equity........................ 101,856 52,768
----------- ----------
Total capitalization................................ $101,856 $ 52,768
=========== ==========

--------
(1) Assumes the repurchase as of December 31, 1998 of 1,500,000 shares of our
common stock at a cost of $49,088.
(2) Excludes 4,443,750 shares of our common stock which may be issued pursuant
to the 1997 ITT Educational Services, Inc. Incentive Stock Plan and the ITT
Educational Services, Inc. 1994 Stock Option Plan. Options to purchase an
aggregate of 793,750 shares of our common stock were outstanding under
these plans on December 31, 1998.

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SELECTED FINANCIAL AND OPERATING DATA

The following selected financial data of ESI are qualified by reference to
and should be read with the Financial Statements and the Notes to the Financial
Statements and other financial data included elsewhere or incorporated by
reference in this prospectus. The statement of income data set forth for each
of the three years in the period ended December 31, 1998 and the balance sheet
data as of December 31, 1998 and 1997 have been derived from the Financial
Statements of ESI that have been audited by PricewaterhouseCoopers LLP,
independent accountants, whose report is included elsewhere in this prospectus.
The statement of income data for each of the two years in the period ended
December 31, 1995 and the balance sheet data as of December 31, 1996, 1995 and
1994 have been derived from audited financial statements of ESI not included in
this prospectus. These historical results do not necessarily indicate the
results to be expected in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."

[Download Table]

Year Ended December 31,
--------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(In thousands, except per share and
operating data)

Statement of Income Data:
Revenue:
Tuition.................... $248,399 $222,457 $196,692 $171,936 $159,575
Other educational (a)...... 42,976 39,207 35,627 29,895 27,332
-------- -------- -------- -------- --------
Total revenues........... 291,375 261,664 232,319 201,831 186,907
-------- -------- -------- -------- --------
Cost of educational
services................... 176,487 163,053 145,197 130,338 121,594
Student services and
administrative expenses.... 81,522 72,388 66,546 57,268 53,481
Legal settlement............ 12,858 -- -- -- --
Offering and change in
control expenses........... 1,872 -- -- -- --
-------- -------- -------- -------- --------
Total costs and
expenses................ 272,739 235,441 211,743 187,606 175,075
Operating income............ 18,636 26,223 20,576 14,225 11,832
Interest income, net (b).... 5,329(c) 5,565(c) 4,119 4,802 232
-------- -------- -------- -------- --------
Income before income taxes.. 23,965 31,788 24,695 19,027 12,064
Income taxes................ 10,024 12,665 9,844 7,636 4,902
-------- -------- -------- -------- --------
Net income.................. $ 13,941(c) $ 19,123(c) $ 14,851 $ 11,391 $ 7,162
======== ======== ======== ======== ========
Earnings per share (d):
Basic...................... $ 0.52(c) $ 0.71 $ 0.55 $ 0.42 $ 0.32
Diluted.................... 0.51(c) 0.71 0.55 0.42 0.32
======== ======== ======== ======== ========
Other Operating Data:
EBITDA (e).................. $ 27,918 $ 34,162 $ 28,069 $ 21,767 $ 18,687
Operating losses from new
technical institutes before
income taxes (f)........... $ 5,257 $ 3,165 $ 5,721 $ 7,123 $ 7,316
Capital expenditures, net... $ 11,381 $ 11,465 $ 7,868 $ 8,206 $ 7,688
Number of students at end of
period..................... 25,608 24,498 22,633 20,618 20,668
Number of technical
institutes at end of
period..................... 65 62 59 56 54
Balance Sheet Data:
Cash, restricted cash, cash
invested with ITT and
marketable debt
securities................. $119,268(c) $ 98,689 $ 95,793 $ 77,517 $ 66,810
Total current assets........ 138,758 112,958 108,449 87,567 76,460
Property and equipment less
accumulated depreciation... 24,985 22,886 19,360 18,985 18,321
Total assets................ 175,571 145,914 135,749 114,284 102,899
Total current liabilities... 70,241 55,946 65,405 58,766 57,646
Shareholders' equity........ 101,856(c) 87,815 68,692 53,841 42,450

424B4 19th Page of 91 TOC 1st Previous Next ↓Bottom Just 19th
--------
(a) Other educational revenue is comprised of laboratory and application fees
and textbook sales.
(b) See Note 3 of Notes to Financial Statements for information concerning
intercompany interest between ESI and ITT. Prior to our initial public
offering in December 1994, we did not receive interest on the full amount
of net cash balances we invested with ITT and we were assessed an interest
charge based on an allocation of the consolidated debt of ITT. After our
initial public offering and until February 5, 1998, we received interest
from ITT on the amount of any net cash balances we invested with ITT and we
were no longer subject to an interest charge based on such an allocation.
Since February 5, 1998, we have performed our own cash management functions
and no longer have any cash invested with ITT. Lower interest rates on
short-term investments have resulted in lower yields on our cash balances
than the yields on our cash that was invested with ITT. Accordingly,
interest income, net has decreased in 1998.
(c) We plan to spend $49,088 to repurchase 1,500 shares of our common stock
concurrently with the closing of this offering, which would have reduced
cash and cash equivalents and marketable debt securities and shareholders'
equity by $49,088 if the repurchase had occurred at December 31, 1998. If
the stock repurchase had occurred January 1, 1998, basic and diluted
earnings per share for the year ended December 31, 1998 would have been
reduced by $0.04 and $0.03, respectively, which reflects a reduction in
interest income of $2,700, a reduction in net income of $1,620 and a
reduction in the average number of shares outstanding of 1,500.
(d) Earnings per share data are based on historical net income and the number
of shares of our common stock outstanding during each period after giving
retroactive effect to the three-for-two stock splits in April and November
1996. Earnings per share for all periods have been calculated in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share."
(e) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization. We have included information
concerning EBITDA (which is not a measure of financial performance under
generally accepted accounting principles) because we understand that
certain investors use it as one measure of an issuer's financial
performance. EBITDA is not an alternative to operating income (as
determined in accordance with generally accepted accounting principles), an
indicator of our performance or cash flows from operating activities (as
determined in accordance with generally accepted accounting principles) or
a measure of liquidity.
(f) Operating losses from new technical institutes before income taxes
represents operating losses before income taxes, including amortization of
deferred pre-opening costs, for institutes in the first 24 months after
their first class start.

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read with the Selected Financial and
Operating Data and the Financial Statements and Notes to the Financial
Statements included elsewhere in this prospectus.

General

We operate 67 institutes in 27 states which provide technology-oriented
postsecondary education to approximately 25,000 students. We derive our revenue
almost entirely from tuition, textbook sales, fees and charges paid by, or on
behalf of, our students. Most students at our institutes pay a substantial
portion of their tuition and other education-related expenses with funds
received under various government-sponsored student financial aid programs,
especially the federal student financial aid programs under Title IV ("Title IV
Programs") of the Higher Education Act of 1965, as amended (the "HEA"). In
1998, we indirectly derived approximately 69% of our revenues from Title IV
Programs.

Our revenue varies based on the aggregate student population, which is
influenced by the following factors:

. the number of students attending our institutes at the beginning of a
fiscal period;

. the number of new first-time students entering and former students re-
entering our institutes during a fiscal period;

. student retention rates; and

. general economic conditions.

New students generally enter our institutes at the beginning of an academic
quarter that begins in March, June, September or December. We believe that, in
the absence of countervailing factors, student enrollments and retention rates
tend to increase as opportunities for immediate employment for high school
graduates decline and decrease as such opportunities increase. Our
establishment of new institutes and the introduction of additional program
offerings at our existing institutes have been significant factors in
increasing the aggregate student population in recent years.

A new institute must be authorized by the state in which it will operate,
accredited by an accrediting commission that the U.S. Department of Education
("DOE") recognizes, and certified by the DOE to participate in Title IV
Programs. The approval processes for accreditation and DOE certification cannot
commence until the first students begin classes. Accreditation and DOE
certification for a new location generally take approximately one year from the
first class start date. We defer certain direct costs incurred with respect to
a new institute prior to the first class start ("institute start-up costs") and
amortize them over the first year of operation after the first class start.
From January 1, 1994 through December 31, 1998, we opened 17 new institutes
(six of which started classes in 1996 or 1997 and three of which started
classes in 1998). We opened two additional institutes in January 1999. New
institutes historically incur a loss during the 24-month period after the first
class start date. These losses during a fiscal year by institutes in their
first two years of operation, together with the amortization of institute
start-up costs, are referred to as "operating losses from new technical
institutes." The operating losses from new technical institutes totaled $5.3
million for the year ended December 31, 1998, $3.2 million for the year ended
December 31, 1997, and $5.7 million for the year ended December 31, 1996.

We earn tuition revenue on a weekly basis, pro rata over the length of each
of four, 12-week academic quarters in each fiscal year. Federal and state
regulations and accrediting commission standards generally require us to refund
a portion of the tuition payments received from a student who withdraws from
one of our institutes during an academic quarter. Our statement of income
recognizes immediately the amount of tuition, if any, that we may retain after
payment of any refund. Other educational revenue includes textbook sales and
laboratory fees.

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We incur expenses throughout a fiscal period in connection with the operation
of our institutes. The cost of educational services includes faculty and
administrative salaries, cost of books sold, occupancy costs, depreciation and
amortization of equipment costs and leasehold improvements, and certain other
administrative costs incurred by our institutes.

Student services and administrative expenses include direct marketing costs
(which are marketing expenses directly related to new student recruitment),
indirect marketing expenses, an allowance for doubtful accounts and
administrative expenses incurred at corporate headquarters. Direct marketing
costs include salaries and employee benefits for recruiting representatives and
direct solicitation advertising expenses. We capitalize our direct marketing
costs (excluding advertising expenses) using the successful efforts method and
amortize them on an accelerated basis over the average course length of 24
months commencing on the class start date. We expense as incurred our marketing
costs that do not relate to the direct solicitation of potential students.

Until February 5, 1998, we forwarded all our cash receipts to ITT for
investment on a daily basis after, in the case of some receipts, the lapse of
applicable regulatory restrictions. ITT generally funded our cash disbursements
out of our cash balances that it held and invested for us. Net interest income
represents principally interest paid or received from ITT and miscellaneous
interest paid or received from other parties. Beginning in 1995, ITT paid us
interest on the full amount of any net cash balances that it invested for us at
an interest rate that was set for a six- or twelve-month period and was 30
basis points over the most recently published rate for six- or twelve-month
treasury bills, as appropriate, and no longer assessed us interest charges
except with respect to funds actually advanced to us in excess of cash invested
with ITT. ITT performed a number of other services for us, including the
administration of certain employee benefit plans, for which we paid it
compensation. We have been performing all of these services since June 9, 1998.
We have been performing our own cash management functions since February 5,
1998, and we no longer have any cash invested with ITT. We have included the
invested funds in the captions "cash and cash equivalents" and "marketable debt
securities" in the December 31, 1998 balance sheet. The marketable debt
securities have maturity dates in excess of 90 days at the time of purchase and
we record them at their market value. We include debt securities with maturity
dates less than 90 days at the time of purchase in cash and cash equivalents
and record such securities at cost which approximates market value. We estimate
that the market risk associated with our investments in marketable debt
securities can best be measured by a potential decrease in the fair value of
these securities resulting from a hypothetical 10% increase in interest rates.
If such a hypothetical increase in rates were to occur, the reduction in the
market value of our portfolio of securities would not be material.

Variations in Quarterly Results of Operations

Our quarterly results of operations tend to fluctuate significantly within a
fiscal year because of differences in the number of weeks of earned tuition
revenue in each fiscal quarter and the timing of student matriculations. Our
first and third fiscal quarters have 13 weeks of earned tuition revenue, while
our second and fourth quarters have only 11 weeks of earned tuition revenue
because of two-week student vacation breaks in June and December. In addition,
revenues in our third and fourth fiscal quarters generally benefit from
increased student matriculations. The number of new students entering our
institutes tends to be substantially higher in June (29% of all new students in
1998) and September (37% of all new students in 1998) because of the
significant number of recent high school graduates entering our institutes for
the academic quarters beginning in those two months. The academic schedule
generally does not affect our incurrence of costs, however, and costs do not
fluctuate significantly on a quarterly basis.

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The following table sets forth our revenues in each quarter during the three
prior fiscal years.

Quarterly Revenue
(Dollars in thousands)

[Download Table]

1998 1997 1996
Three-Month ---------------- ---------------- ----------------
Period Ended Amount Percent Amount Percent Amount Percent
------------ -------- ------- -------- ------- -------- -------

March 31..................... $ 72,287 25% $64,476 25% $ 57,103 25%
June 30...................... 65,077 22 58,412 22 51,568 22
September 30................. 81,700 28 73,060 28 65,113 28
December 31.................. 72,311 25 65,716 25 58,535 25
-------- --- -------- --- -------- ---
Total for Year........... $291,375 100% $261,664 100% $232,319 100%
======== === ======== === ======== ===

Results of Operations

The following table sets forth the percentage relationship of certain
statement of income data to tuition and other educational revenues for the
periods indicated.

[Download Table]

Year Ended
December 31,
-------------------
1998 1997 1996
----- ----- -----

Tuition and other educational revenues................... 100.0% 100.0% 100.0%
Cost of educational services............................. 60.6 62.3 62.5
Student services and administrative expenses............. 28.0 27.7 28.6
Legal settlement......................................... 4.4 -- --
June 1998 offering, change in control and other one-time
expenses................................................ 0.6 -- --
----- ----- -----
Operating income......................................... 6.4 10.0 8.9
Interest income, net..................................... 1.8 2.1 1.7
----- ----- -----
Income before income taxes............................... 8.2% 12.1% 10.6%
===== ===== =====

Year Ended December 31, 1998 Compared with Year Ended December 31, 1997

Revenues. Revenues increased $29.7 million, or 11.3%, to $291.4 million for
the year ended December 31, 1998 from $261.7 million for the year ended
December 31, 1997 primarily due to:

.a 5% increase in tuition rates in each of September 1998 and 1997;
. an 8.2% increase in the total student enrollment at January 1, 1998
compared to January 1, 1997 (24,498 at January 1, 1998 compared to 22,633
at January 1, 1997); and
. a 6.1% increase in the number of first-time and re-entering students
beginning classes at our institutes (24,521 in 1998 compared to 23,111 in
1997).

The total student enrollment on December 31, 1998 was 25,608, an increase of
4.5% from the 24,498 total student enrollment on December 31, 1997.

Cost of Educational Services. Cost of educational services increased $13.4
million, or 8.2%, to $176.5 million in 1998 from $163.1 million in 1997. The
principal causes of this increase include:

. the costs required to service the increased enrollment;

. normal inflationary cost increases for wages, rent and other costs of
services; and

. increased costs at new institutes (one opened in June 1997, two in
December 1997, one in March 1998, one in June 1998 and one in October
1998).

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Cost of educational services as a percentage of revenues decreased to 60.6% in
1998 compared to 62.3% in 1997, because the greater revenues did not cause an
increase in the fixed portion of our rent, administrative salaries and other
costs included in cost of educational services. Cost of educational services
includes a $1.2 million provision in 1998 (compared to a $3.2 million provision
in 1997) for legal expenses associated with the legal actions involving the
hospitality program. Excluding this provision, cost of educational services in
1998 would have been 60.2% of revenues, a 0.9% improvement from 1997.

Student Services and Administrative Expenses. Student services and
administrative expenses increased $9.1 million, or 12.6%, to $81.5 million in
1998 from $72.4 million in 1997. Student services and administrative expenses
increased to 28.0% of revenues in 1998 compared to 27.7% in 1997 primarily
because of increased media advertising (up 14.8%) and an increase in the
provision for doubtful accounts. The increase in the provision for doubtful
accounts resulted from a decrease in the amount of Title IV Program funds we
received, which was caused by a change in the DOE regulations that became
effective July 1, 1997. See "--Liquidity and Capital Resources."

One-Time Expenses. We recorded a $7.7 million after tax ($0.28 per share)
provision for the settlement of certain legal proceedings and claims in 1998.
(See Note 10 of Notes to Financial Statements). In June 1998, we incurred total
expenses for the June 1998 offering of $1.0 million after tax ($0.04 per
share). In addition, we incurred expenses of $0.5 million after tax ($0.02 per
share) in 1998 associated with our change in control and establishment of new
employee benefit plans.

Operating Income. The following table sets forth our operating income (in
thousands) for the year ended December 31, 1998 and 1997:

[Download Table]

Year Ended
December 31,
---------------
1998 1997
------- -------

Operating income as reported................................... $18,636 $26,223
Legal settlement............................................... 12,858 --
June 1998 offering expenses.................................... 1,117 --
Change in control and other one-time expenses.................. 755 --
------- -------
Operating income before one-time expenses...................... $33,366 $26,223
======= =======

Interest Income. Interest income decreased $0.2 million in 1998 compared to
1997, which was primarily due to the lower interest rate earned on our cash
investments and marketable debt securities (i.e., 5.5% in 1998 compared to 6.3%
in 1997) partially offset by the earnings on our increased invested balances.

Income Taxes. Our combined effective federal and state income tax rate in
1997 was 39.8%. Our 1998 federal and state income tax rate will be 41.8%,
because $0.9 million of the June 1998 offering expenses are not tax deductible.

Net Income. The following table sets forth our net income (in thousands) for
the year ended December 31, 1998 and 1997:

[Download Table]

Year Ended
December 31,
---------------
1998 1997
------- -------

Net income..................................................... $13,941 $19,123
Legal settlement (after tax)................................... 7,715 --
June 1998 offering expenses (after tax)........................ 1,048 --
Change in control and other one-time expenses (after tax)...... 453 --
------- -------
Net income before one-time expenses............................ $23,157 $19,123
======= =======

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Year Ended December 31, 1997 Compared with Year Ended December 31, 1996

Revenues. Revenues increased $29.4 million, or 12.7%, to $261.7 million for
the year ended December 31, 1997 from $232.3 million for the year ended
December 31, 1996 primarily due to:

. a 9.8% increase in the total student enrollment at January 1, 1997
compared to January 1, 1996 (22,633 at January 1, 1997 compared to 20,618
at January 1, 1996);

. a 5% increase in tuition rates in each of September 1997 and 1996;

. a 2.3% increase in the number of new first-time students who began
attending our institutes (19,911 in 1997 compared to 19,464 in 1996); and

. the opening of new institutes (two in March 1996, one in September 1996,
one in June 1997 and two in December 1997).

Student retention rates did not change materially in the two years. Our three
new institutes beginning classes in 1997 accounted for 140 new students.

Cost of Educational Services. Cost of educational services increased by $17.9
million, or 12.3%, to $163.1 million in 1997 from $145.2 million in 1996
principally as a result of:

. increased costs related to the introduction of additional programs;

. an increase in salaries and occupancy costs at our institutes opened
prior to 1995;

. costs at the two new institutes opened in 1995;

. costs at the three new institutes opened in 1996;

. costs at the three new institutes opened in 1997; and

. to a lesser extent, an increase in the cost of books sold arising from
the increased student population.

Provisions for legal expenses increased by $1.9 million to $3.2 million in 1997
($1.7 million in the fourth quarter) from $1.3 million in 1996 ($1.0 million in
the fourth quarter) as a result of the legal actions associated with the
California and Florida hospitality programs. See "Business -- Legal
Proceedings." Cost of educational services decreased to 62.3% of revenues in
1997 compared to 62.5% in 1996, primarily because the greater revenues did not
cause an increase in the fixed portion of rent, administrative salaries and
other costs included in the cost of educational services. Excluding the
provisions for legal expenses, cost of educational services decreased to 61.1%
of revenues in 1997 compared to 61.9% in 1996.

Student Services and Administrative Expenses. Student services and
administrative expenses increased by $5.9 million, or 8.9%, to $72.4 million in
1997 from $66.5 million in 1996 principally as a result of a $5.0 million
increase in marketing costs. This increase in marketing costs was due to:

. an increase in the marketing costs for the two new institutes opened in
1995 and the three new institutes opened in 1996;

. the commencement of marketing costs for the three new institutes opened
in 1997; and

. the increased marketing costs for our institutes opened prior to 1995.

Our media advertising expenses increased by 10.9% in 1997 from 1996.
Administrative expenses at the corporate headquarters increased by $0.3 million
in 1997 from 1996 levels primarily due to increased headquarters staff. The
provision for doubtful accounts in 1997 was approximately $0.6 million more
than in 1996 principally because of increased revenues and a regulatory change
that delays our receipt of funds under the Title IV Programs. The delay
resulted in a greater number of students who withdrew or whose enrollment was
terminated by the institutes before they could secure federal student financial
aid with which they could pay their obligations to us. See "--Liquidity and
Capital Resources" for a further description of the regulatory changes
affecting when we receive Title IV Program funds after June 30, 1997. Student
services and administrative expenses decreased to 27.7% of revenues in 1997
compared to 28.6% in 1996, primarily because the greater revenues did not cause
an increase in the fixed portion of the marketing and headquarters expenses.

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Interest Income. Interest income increased by $1.4 million in 1997 because of
the increase in the interest rate earned on the cash we invested with ITT
(i.e., 6.3% in 1997 compared to 5.5% in 1996) and the increase in the amount of
cash we invested with ITT.

Net Income. Net income increased $4.2 million, or 28.2%, to $19.1 million for
1997 from $14.9 million for 1996, principally due to the 27.4% increase in
operating income ($3.4 million after tax).

Liquidity and Capital Resources

In 1998, we indirectly derived approximately 69% of our revenues from Title
IV Programs. Federal regulations dictate the timing of disbursements of funds
under Title IV Programs. Students must apply for a new loan for each academic
year, which consists of three academic quarters. Loan funds are generally
provided by lenders in three disbursements for each academic year. The first
disbursement is usually received either 30 days after (in the case of students
commencing a program of study) or ten days before the start of the first
academic quarter of a student's academic year, and the second and third
disbursements are typically received ten days before the start of each
subsequent quarter of a student's academic year. While the timing of loan
disbursements to us is subject to a student's directions to the lender and to
existing regulatory requirements regarding such disbursements, we have
typically received student loan funds upon the lender's disbursement of the
student loan funds.

DOE regulations that became effective July 1, 1997 revised the procedures
governing how an institution participating in Title IV Programs requests,
maintains, disburses and otherwise manages Title IV Program funds. The revised
regulations require us to receive Title IV Program loan funds in three equal
quarterly disbursements rather than the two disbursements previously permitted.
We estimate that this change decreased deferred tuition revenue or increased
accounts receivable by approximately $15 million at December 31, 1997 compared
to December 31, 1996. We also estimate this change (an ongoing effect)
decreased 1997 interest income by $0.2 million and decreased 1998 interest
income by $0.9 million.

Our principal uses of cash are to pay salaries, occupancy and equipment
costs, recruiting and marketing expenses, administrative expenses and taxes,
including institute start-up costs for new institutes. Until February 5, 1998,
we forwarded our cash receipts to ITT on a daily basis after, in the case of
certain receipts, the lapse of applicable regulatory restrictions, and ITT
funded our cash disbursements out of the balance of our cash investments with
ITT. Since February 5, 1998, we have been performing our own cash management
functions and no longer have any cash invested with ITT. Our net cash items
(consisting until February 5, 1998 of cash and cash equivalents, restricted
cash and cash invested with ITT, and since February 5, 1998 of cash and cash
equivalents, restricted cash and marketable debt securities) increased from
$98.7 million at December 31, 1997 to $119.3 million at December 31, 1998.
Marketable debt securities and cash equivalents ranged from a low of $67.3
million in June 1998 to a high of $124.5 million in November 1998.

We have generated positive cash flows from operations for the past five
years. Cash flows from operations, excluding the $38.3 million increase in
marketable debt securities, in 1998 was $31.9 million, an increase of $17.5
million from $14.4 million in 1997. This increase was primarily due to lower
cash flows from operations in 1997 caused by the decrease in deferred tuition
revenue resulting from the July 1, 1997 regulatory change that affects when we
receive federal student loan funds, as discussed above, and the unpaid portion
of the legal settlement. Cash flows from operations in 1997 was $14.4 million,
a decrease of $11.7 million from $26.1 million in 1996. This decrease was
primarily due to the decrease in deferred tuition revenue resulting from the
July 1, 1997 regulatory change that affects when we receive federal student
loan funds, as discussed above.

At December 31, 1998, we had positive working capital of $68.5 million.
Giving effect to the stock repurchase, we would have had positive working
capital of $19.4 million at December 31, 1998. Deferred tuition revenue, which
represents the unrecognized portion of tuition revenue received from students,
was $32.3 million at December 31, 1998.

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An institution may lose its eligibility to participate in some or all Title
IV Programs, if the rates at which the institution's students default on
federal student loans exceed specific percentages. An institution whose cohort
default rate on loans under the Federal Family Education Loan ("FFEL") program
and the William D. Ford Federal Direct Loan ("FDL") program is 25% or greater
for three consecutive federal fiscal years loses eligibility to participate in
those programs for the remainder of the federal fiscal year in which the DOE
determines that the institution has lost its eligibility and for the two
subsequent federal fiscal years. In addition, amendments to the HEA enacted in
connection with the U.S. Congress' reauthorization of the HEA in October 1998
(the "1998 HEA Amendments") provide that if an institution becomes ineligible
to participate in the FFEL and FDL programs following the publication of its
1996 (or any subsequent) federal fiscal year FFEL/FDL cohort default rate, the
institution will also be ineligible to participate in the Federal Pell Grant
("Pell") program for the same period of time.

None of our campus groups (defined as the main campus and its additional
locations or branch campuses) had an FFEL/FDL cohort default rate equal to or
greater than 25% for the 1996 federal fiscal year, the most recent year for
which the DOE has published FFEL/FDL cohort default rates. In June 1998, our
institute in Garland, Texas became ineligible to participate in the FFEL and
FDL programs, because it had FFEL/FDL cohort default rates exceeding 25% for
three consecutive federal fiscal years beginning with the 1993 federal fiscal
year. The Garland institute accounted for approximately 1.4% of our revenues in
1998. The Garland institute can reapply to the DOE to regain its eligibility to
participate in the FFEL and FDL programs on or after October 1, 2000. We have
arranged for an unaffiliated private funding source to provide loans to the
students enrolled in the Garland institute. This alternative financing source
requires us to guarantee repayment of the loans it issues. Based on our
experience with the repayment of Title IV Program loans by students who
attended the Garland institute, we believe that such guaranty should not result
in a material adverse effect on our financial condition, results of operations
or cash flows. We have also decided to stop enrolling new students in the
Garland institute, at least temporarily, while we continue teaching the
students already enrolled. We are considering whether to close the Garland
institute once the students already enrolled have completed their programs of
study or transferred to another school.

Prior to the 1998 HEA Amendments, the HEA limited how much an institution
could charge a student who withdrew from the institution. A student was only
obligated for a pro rata portion of the education costs charged by the
institution, if the student withdrew during the first 60% of the student's
first period of enrollment. For our institutes, a period of enrollment is
generally an academic quarter. A student who withdrew after the first period of
enrollment was also subject to a refund calculation, but it was not a straight
pro rata calculation. The institution had to refund any monies it collected in
excess of the pro rata or other applicable portion to the appropriate lenders
or Title IV Programs in a particular order.

The 1998 HEA Amendments rescinded the limitation on how much an institution
can charge a withdrawing student, but the standards of most state education
authorities that regulate our institutes (the "SEAs") and the two accrediting
commissions that accredit our institutes (the "Accrediting Commissions")
continue to impose such a limitation. The 1998 HEA Amendments imposed a limit
on the amount of Title IV Program funds a withdrawing student can use to pay
his or her education costs. This new limitation permits a student to use only a
pro rata portion of the Title IV Program funds that the student would otherwise
be eligible to use, if the student withdraws during the first 60% of any period
of enrollment. The institution must refund to the appropriate lenders or Title
IV Programs any Title IV Program funds that the institution receives on behalf
of a withdrawing student in excess of the amount the student can use for such
period of enrollment. The new refund requirements contained in the 1998 HEA
Amendments become effective in October 2000, but an institution may elect to
begin complying with these new standards at an earlier date. We do not plan to
elect to comply with these new standards prior to October 2000.

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expect that many withdrawing students will be unable to pay such costs and that
we will be unable to collect a significant portion of such costs. Title IV
Program funds are generally paid sooner and are more collectible than tuition
payments from other sources. As a result, if the new refund requirements remain
unchanged, they could have a material adverse effect on our financial
condition, results of operations and cash flows beginning with our 2001 fiscal
year.

A for-profit institution, such as each of our campus groups, becomes
ineligible to participate in Title IV Programs if, on a cash accounting basis,
the institution derives more than 85% of its applicable revenues for a fiscal
year from Title IV Programs. For each of our 1997 and 1998 fiscal years, none
of our campus groups derived more than 79% of its revenues from Title IV
Programs. For our 1998 fiscal year, the range of our campus groups was from
approximately 58% to approximately 79%. The 1998 HEA Amendments increased the
percentage of applicable revenues that a for-profit institution can derive from
Title IV Programs from 85% to 90%. The DOE has indicated orally that it will
apply this amendment beginning with our 1998 fiscal year. The 5% increase in
the percentage of applicable revenues that we can derive from Title IV Programs
will increase the aggregate amount of Title IV Program funds that students can
use to pay their education costs of attending our institutes. Title IV Program
funds are generally paid sooner and are more collectible than tuition payments
from other sources. As a result, this 5% increase should have a positive impact
on our results of operations and cash flows beginning in our 1999 fiscal year.

The DOE, the Accrediting Commissions and most of the SEAs have laws,
regulations and/or standards (collectively "Regulations") pertaining to the
change in ownership and/or control (collectively "change in control") of
institutions, but these Regulations do not uniformly define what constitutes a
change in control. When a change in control occurs under the DOE's Regulations,
an institution immediately becomes ineligible to participate in Title IV
Programs and can only receive and disburse certain Title IV Program funds that
were previously committed to its students, until it has applied for
certification and is reinstated by the DOE to continue Title IV Program
participation under its new ownership and control. The DOE's Regulations also
require that all of our institutes in a particular campus group have their
state authorizations and accreditations reaffirmed or reestablished before any
institute in that campus group can regain its eligibility from the DOE.

We have notified the DOE, the SEAs and the Accrediting Commissions of this
offering. The DOE and the Accrediting Council for Independent Colleges and
Schools ("ACICS"), which accredits three of our institutes, have advised us
that this offering will not be a change in control under their Regulations, but
this offering will be a change in control under the Regulations of some of the
SEAs. The Accrediting Commission of Career Schools and Colleges of Technology
("ACCSCT"), which accredits 61 of our institutes, has advised us that it is
unnecessary for it to determine whether this offering is a change in control
under its Regulations, and that none of our institutes' accreditation by the
ACCSCT will be affected by this offering. As a result, this offering will not
affect our ability to participate in Title IV Programs, unless any SEA or SEAs
that consider this offering to be a change in control fail to reauthorize any
of our institutes. Many SEA's require that they approve a change in control
before it occurs, while others will only review a change in control after it
occurs. We have obtained all of the approvals of this offering from the SEAs
that require advance approval. Following this offering, we believe that we will
be able to obtain all of the approvals from the SEAs that require approval
after this offering occurs, but we cannot assure you that we will receive them
in a timely manner. A material adverse effect on our financial condition,
results of operations and cash flows could result if we are unable to obtain
these approvals or if we do not obtain these approvals in a timely manner. The
California SEA, which normally requires advance approval, has advised us that
it will not determine whether this offering is a change in control until after
the closing of this offering. It has also advised us that the provisions of the
California Education Code that provide for termination of its existing
authorization of our California institutes if advance approval is not obtained
do not apply to this offering. Eleven of our institutes are located in
California.

424B4 28th Page of 91 TOC 1st Previous Next ↓Bottom Just 28th
financial condition, results of operations and cash flows would result if we
had a change in control and a material number of our institutes failed, in a
timely manner, to be reauthorized by their SEAs, reaccredited by their
Accrediting Commissions or recertified by the DOE to participate in Title IV
Programs. See "Business--Change in Control."

Our capital assets consist primarily of classroom and laboratory equipment
(such as computers, electronic equipment and robotic systems), classroom and
office furniture and leasehold improvements. We lease all our building
facilities. Capital expenditures totaled $11.4 million during 1998 and included
expenditures of $2.2 million for new technical institutes, $2.9 million to
expand curricula offerings at existing institutes, $4.8 million to replace or
add furniture or equipment at existing institutes and $1.5 million on leasehold
improvements. Leasehold improvements represent part of our continuing effort to
maintain our existing facilities in excellent condition. Capital expenditures
decreased by $0.1 million to $11.4 million in 1998 from $11.5 million in 1997,
principally due to the expenditure of approximately $3.0 million for the
acquisition of new computers in 1997 offset by the expenditures for new
institutes opened in 1998. New institutes have large capital additions in the
first two years. To date, cash generated from operations has been sufficient to
meet our capital expenditures.

We plan to continue to upgrade and expand current facilities and equipment.
We expect that 1999 capital expenditures will be approximately $17.0 million,
of which approximately $7 million would be capital expenditures for new
curriculum at existing institutes. The capital additions for a new institute
are approximately $0.4 million and the capital expenditures for each new
curriculum at an existing institute are approximately $0.3 million. We
anticipate that our planned capital additions can be funded from cash flows
from operations. Cash flows on a long-term basis are highly dependent upon the
receipt of Title IV Program funds and the amount of funds spent on new
institutes, curricula additions at existing institutes and possible
acquisitions.

We believe that the reduction in cash and cash equivalents and marketable
debt securities that will be used to effect the stock repurchase will not have
a material adverse effect on our expansion plans, planned capital expenditures,
ability to meet any applicable regulatory financial responsibility standards,
or ability to conduct normal operations.

Year 2000 Compliance

The Year 2000 Problem. Many information technology ("IT") hardware and
software systems ("IT Systems") and non-IT Systems containing embedded
technology, such as microcontrollers and microchip processors ("Non-IT
Systems") can only process dates with six digits (e.g., 06/26/98), instead of
eight digits (e.g., 06/26/1998). This limitation may cause IT Systems and Non-
IT Systems to experience problems processing information with dates after
December 31, 1999 (e.g., 01/01/00 could be processed as 01/01/2000 or
01/01/1900) or with other dates, such as September 9, 1999, which was a date
traditionally used as a default date by computer programmers. These problems
may cause IT Systems and Non-IT Systems to suffer miscalculations, malfunctions
or disruptions. These problems are commonly referred to as "Year 2000" or "Y2K"
problems. We are unable at this time to assess the possible impact on our
financial condition, results of operations and cash flows that may result from
any disruptions to our business caused by Y2K problems in any IT Systems and
Non-IT Systems that we control or that any third party with whom we have a
material relationship controls. We do not believe at the current time, however,
that the cost to remedy our internal Y2K problems will have a material adverse
effect on our results of operations or cash flows.

Our State of Readiness. We have begun to implement a plan to ensure that the
IT Systems and material Non-IT Systems that we control are Y2K compliant before
January 1, 2000. In the first phase of the plan, we assessed the potential
exposure of our IT Systems and material Non-IT Systems to Y2K problems. We have
completed this phase. In the second phase, which we have also completed, we
designed a procedure to remediate our exposure to Y2K problems in the IT
Systems and material Non-IT Systems that we control. We are currently in the
third phase, which involves the actual remediation of the IT Systems and
material Non-IT Systems that we control. After we complete the third phase, we
will begin the fourth and final phase of testing the remediation to the IT
Systems and material Non-IT Systems that we control to ensure Y2K compliance.
We plan to complete the testing phase by June 30, 1999.

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We believe that we have identified all IT Systems and material Non-IT Systems
that we control that may require Y2K remediation. We have 12 people (both
employees and outside consultants) dedicated to completing enhancements to our
IT Systems, which include our accounting, human resources, financial services,
admissions, education, recruitment and career services systems. We have been
enhancing our IT Systems on a continuous basis since 1996 and we did not
accelerate these enhancements due to any Y2K problems. These enhancements will
also address the Y2K problems with our IT Systems. We plan to complete these
enhancements by March 31, 1999.

We have dedicated two employees to either remediate or cause the remediation
of material Non-IT Systems that we control and that we have identified as
possessing a Y2K problem. We plan to complete the remediation of these Non-IT
Systems by March 31, 1999. We acquired many of these Non-IT Systems during the
past few years and we believe that a substantial number of these newer systems
do not possess a Y2K problem. In addition, the vendors of many of these Non-IT
Systems have warranted them to be Y2K compliant. We have contacted the third
parties who control our other material Non-IT Systems (including, without
limitation, our communication systems, security systems, electrical systems and
HVAC systems) to assess whether any of these systems possess a Y2K problem that
could adversely affect our operations if a malfunction occurred. We have also
implemented procedures to help ensure that any new Non-IT Systems that we
acquire or utilize are Y2K compliant.

We have identified and begun to contact the third parties whose lack of Y2K
compliance may pose problems for us, such as federal and state regulators,
Accrediting Commissions, guaranty agencies, lenders, computer software and
hardware suppliers and book vendors. The General Accounting Office reported in
September 1998 that the DOE's delay in addressing the Y2K problems in its IT
Systems and the DOE's limited progress in making contingency plans should its
IT Systems fail could result in serious disruptions in the DOE's administration
of, and disbursement of funds under, Title IV Programs. In the DOE's November
1998 report on Y2K compliance submitted to the Office of Management and Budget,
the DOE stated that nine of its 15 mission critical IT Systems are fully Y2K
compliant. According to this report, the DOE's IT System that tracks FFEL
program loans is the only DOE IT System relating to federal student financial
aid that is not Y2K compliant. The DOE reported that this IT System will be Y2K
compliant by March 31, 1999.

The Costs to Address Our Year 2000 Issues. We have expended approximately
$25,000 in direct costs through December 31, 1998 to identify and remediate our
Y2K problems. This amount does not include:

. the salaries of our employees involved in the remediation process;

. the cost of the enhancements to our IT Systems, because we did not
accelerate the enhancements due to Y2K problems; and

. the cost to us of replacing any Non-IT Systems or acquiring any new Non-
IT Systems in the normal course of our operations and not because of any
Y2K problems.

Based on our current assessment of our Y2K problems, we estimate that our
remediation efforts will cost between $50,000 and $100,000 for the IT Systems
and material Non-IT Systems that we control to become Y2K compliant,
representing up to 10% of our IT budget. Approximately 75% of this amount will
be used, if necessary, to replace computer hardware and software and other Non-
IT Systems equipment owned by us at our institutes. This amount does not
include any costs associated with remediating any Y2K problems suffered by any
third parties' IT Systems and Non-IT Systems that may affect our operations.
Our operations will fund our Y2K remediation efforts.

The Risks Associated With Our Year 2000 Issues. The remediation of our Y2K
problems will increasingly cause us to defer some existing and contemplated
projects, particularly those involving our personnel conducting the Y2K
remediation. Although we are unable at this time to quantify our internal
indirect costs resulting from our Y2K problems, we do not believe that the cost
of remediating our internal Y2K problems or the lost opportunity costs arising
from diverting the efforts of our personnel to the remediation will have a

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material adverse effect on our financial condition, results of operations or
cash flows. We do not intend to use any independent verification or validation
processes to assure the reliability of our risk or cost estimates associated
with our Y2K problems.

We have begun to outline several possible worst case scenarios that could
arise from our Y2K problems. At this time, however, we have insufficient
information to assess the likelihood of any worst case scenario. Our most
reasonably likely worst case Y2K scenarios involve:

. significant delays in our receipt of federal and state student financial
aid in payment of students' education costs of attending our institutes;

. significant delays or interruptions in the eligibility to participate in
Title IV Programs, approval to operate or accreditation of our institutes
that are undergoing their initial, or a renewal of, such eligibility,
approval or accreditation; and

. significant delays in obtaining authorization to offer new programs of
study for which our institutes have applied.

In 1998, we derived approximately 69% of our revenues from Title IV Programs
administered by the DOE. In addition, a number of our institutes participate in
various state student financial aid programs administered by SEAs that, in the
aggregate, generate a material portion of our revenues. In 1998, one lender
provided approximately 65% of all FFEL program loans received by our students,
and one student loan guaranty agency guaranteed approximately 94% of all FFEL
program loans received by our students. As a result, we must depend on the
ability of the DOE, the SEAs and our primary student loan lender and guaranty
agency to resolve their Y2K problems. If any of these parties were to
experience a Y2K problem that significantly delays our receipt of federal or
state student financial aid in payment of students' education costs, it could
have a material adverse effect on our financial condition, results of
operations and cash flows. Similarly, an interruption in our institutes'
operations could occur if, due to a Y2K problem:

. the DOE is unable to timely grant or renew an institute's eligibility to
participate in Title IV Programs;

. any SEA is unable to timely approve an institute to operate or renew such
approval; or

. either Accrediting Commission is unable to timely accredit an institute
or renew such accreditation.

A prolonged delay or interruption for a significant number of institutes could
have a material adverse effect on our financial condition, results of
operations and cash flows. We are unable to independently assess the Y2K
readiness of any of these third parties at this time.

Contingency Plan. We have developed a contingency plan for the IT Systems and
material Non-IT Systems that we control. We have dedicated two employees to
remediate an IT System that will become obsolete after we finish the
enhancements to our IT Systems. We plan to complete the remediation of this IT
System by March 31, 1999. If the enhancements to our IT Systems are not
finished before January 1, 2000, we hope to avoid any disruption to our
business by using this other IT System. Our contingency plan with respect to
the material Non-IT Systems that we control includes, among other things,
investigating the availability and replacement cost of such Non-IT Systems that
have Y2K problems, isolating such systems that are not Y2K compliant so that
they do not affect other systems, and adjusting the clocks on such Non-IT
Systems that are not date sensitive. We believe that we could substitute other
student loan lenders and guaranty agencies for our primary lender and guaranty
agency if either of these parties experienced a Y2K problem that could
significantly delay our receipt of federal or state student financial aid in
payment of students' education costs of attending our institutes. Our current
financial resources would also help us weather any such delay. Otherwise, we
have no contingency plan, and do not intend to create a contingency plan, for
the IT Systems and Non-IT Systems that are not controlled by us, including the
third party IT Systems of the DOE, the SEAs and the Accrediting Commissions on
which we rely.

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New Accounting Pronouncements

The American Institute of Certified Public Accountants (the "AICPA") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use and requires us to capitalize costs incurred in the
application development stage (whether internal or external). Costs incurred
prior to initial application of this SOP, whether or not capitalized, should
not be adjusted to the amounts that would have been capitalized had this SOP
been in effect when those costs were incurred. We adopted this SOP in July
1998, effective as of January 1, 1998, which increased net income by $0.5
million ($0.02 per share) in the year ended December 31, 1998.

Additionally, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities," in April 1998. SOP 98-5 provides guidance on the financial
reporting of start-up costs and requires the cost of start-up activities to be
expensed as incurred. This SOP is applicable to all financial statements for
fiscal years beginning after December 15, 1998. Initial application should be
reported as a cumulative effect of a change in accounting principle as
described in Accounting Principles Board Opinion No. 20, "Accounting Changes."
We intend to adopt this standard in the first quarter of 1999. Approximately
$0.8 million, net of tax, will be recorded as a change in accounting principle
in the first quarter of 1999.

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BUSINESS

Background

Prior to our initial public offering, which we completed on December 27,
1994, we were a wholly owned subsidiary of ITT Corporation, formerly a Delaware
corporation and now known as ITT Industries, Inc., an Indiana corporation ("Old
ITT"). On September 29, 1995, ITT succeeded to the interests of Old ITT in the
beneficial ownership of 83.3% of our common stock, as part of the division of
Old ITT's businesses among itself and two of its wholly owned subsidiaries
(including ITT) and distribution of all the outstanding common stock of ITT and
the other subsidiary to the shareholders of Old ITT, which occurred on December
19, 1995. On February 23, 1998, Starwood Hotels acquired ITT. Starwood Hotels
is the largest hotel and gaming company in the world in terms of revenue and
owns, manages or franchises a geographically diversified portfolio of
approximately 650 hotel properties. On June 9, 1998, ITT sold 13,050,000 shares
of our common stock in a public offering, reducing ITT's beneficial ownership
to 35%.

We are a Delaware corporation incorporated in 1946. Old ITT acquired us in
1966, and we changed our name to ITT Educational Services, Inc. in 1969. Our
principal executive offices are located at 5975 Castle Creek Parkway, North
Drive, Indianapolis, Indiana 46250, and our telephone number is (317) 594-9499.

Overview

We are a leading provider of technology-oriented postsecondary degree
programs in the United States based on revenues and student enrollment. We
offer associate, bachelor and master degree programs and non-degree diploma
programs to approximately 25,000 students. We currently have 67 institutes
located in 27 states. We design our education programs, after consultation with
employers, to help graduates begin to prepare for careers in various fields
involving technology. As of December 31, 1998, approximately 99% of our
students were enrolled in a degree program, with approximately 74% enrolled in
electronics engineering technology ("EET") related programs and approximately
23% enrolled in computer-aided drafting technology ("CAD") related programs.
Employers who have hired our graduates primarily include small, technology
companies, but also include large corporations, such as AT&T, Intel, Microsoft
and General Electric. Additionally, many federal and local government agencies,
including the Federal Bureau of Investigation and the Central Intelligence
Agency, have hired our graduates. We have provided career-oriented education
programs for over 30 years and our institutes have graduated over 125,000
students since 1976.

We have grown significantly during the past 18 years. Of the 67 institutes we
currently operate, we established 53 from January 1, 1981 through December 31,
1998. We established 17 of these institutes in our last five fiscal years. The
number of students attending our institutes has increased 29% from 19,860 on
December 31, 1993 to 25,608 on December 31, 1998. Total revenues increased 72%
from $169.0 million in 1993 to $291.4 million in 1998, an 11.5% compound annual
growth rate. Operating income increased 141% from $13.8 million in 1993 to
$33.4 million in 1998, a 19.2% compound annual growth rate. Net income,
excluding one-time expenses, increased 179% from $8.3 million in 1993 to $23.2
million in 1998, a 22.7% compound annual growth rate.

We expect that the demand for postsecondary education will continue to
increase over the next several years as a result of favorable demographic,
economic and social trends. These trends include, based on data from the DOE,
data from the Bureau of Labor Statistics and data collected in the Current
Population Survey conducted by the Bureau of the Census:

. a 24% projected increase in the number of new high school graduates from
approximately 2.5 million in 1994 to approximately 3.1 million in 2004;

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. the relatively small percentage of adults over age 25 who possess a
bachelor degree (approximately 23% in 1995);

. an increasing number of high school graduates attending postsecondary
educational institutions (65% in 1996 versus 53% in 1983);
. a projected increase of 1.1 million in the number of new information
technology jobs between 1996 and 2006; and

. a heightened recognition of the importance of postsecondary education to
an individual's career prospects.

We believe that we are well positioned to take advantage of the increasing
demand for postsecondary education programs for the following reasons:

Employment Oriented Education. Our institutes offer curricula designed to
teach the technical knowledge and skills desired by many employers for
entry-level positions. Unlike the undergraduate curriculum offered by many
two- and four-year colleges, we have designed our undergraduate curriculum,
after consultation with employers, to help graduates begin to prepare for
careers in various fields involving technology. Our headquarters curriculum
managers, as well as advisory committees comprised of representatives of
employers, review our curricula on a regular basis to respond to changes in
technology and industry needs. We believe that our graduate employment
rates show the strength of our programs and career services. Based on
information provided by graduates and employers, approximately 90% of our
institutes' 1997 graduates, other than graduates who continued in a
bachelor degree program at one of our institutes, had obtained employment
or were already employed in fields involving their programs of study as of
April 24, 1998, the end of the most recently completed statistical year.

Programs Designed for the Convenience of Students. We design the programs
offered by our institutes to provide students flexibility in scheduling
classes. Each of our institutes operates year-round and offers
undergraduate programs on a quarterly basis, typically with four 12-week
quarters during a year. This year-round format allows students to complete
their program of study and enter the work force more rapidly than students
attending traditional colleges. We typically offer classes in most of our
programs in four-hour sessions, five days a week, generally in the morning,
afternoon and evening, which allows our students to work while attending
our institutes. Programs of study are substantially standardized throughout
our institutes, providing greater uniformity and enabling students to
transfer, if necessary, to the same program offered at another institute
with less disruption to their education. We believe this standardization
also provides curriculum quality and consistency throughout our institutes,
which increases the marketability of our graduates to employers.

Financial Strength and Regulatory Compliance. We believe that our
financial strength enables us to capitalize on expansion opportunities,
while devoting resources to complying with federal and state regulatory
requirements. As of December 31, 1998, after giving effect to our stock
repurchase, we would have had $70.2 million in cash and marketable debt
securities and no debt.

Business Strategy

Enhance Results at the Institute Level

Increase Enrollments at Existing Institutes. In each of the last three
fiscal years, we increased our student enrollment at those institutes open
for more than 24 months by an average of approximately 5.1%. We believe
that current demographic and employment trends will allow us to enroll a
greater number of recent high school graduates. In addition, we intend to
increase recruiting efforts aimed at enrolling more working adults.

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Broaden Availability of Current Program Offerings. We intend to continue
expanding the number of program offerings at our existing institutes. Our
objective is to offer at least three programs at each institute. Our 67
institutes provide significant potential for the introduction of existing
programs to a broader number of institutes. From January 1, 1994 through
December 31, 1998, we increased the number of institutes which offer three
or more programs from 16 to 33. We believe that introducing new programs at
existing institutes will attract more students. In 1998, we increased the
number of program offerings at 12 existing institutes, and in 1999 we
intend to increase the number of program offerings at approximately 35
additional existing institutes.

Develop or Acquire Additional Degree Programs. We plan to introduce
degree programs in additional fields of study and at different degree
levels. We have introduced five new degree programs at 16 institutes since
December 1995, which had approximately 750 students enrolled at December
31, 1998. In 1998, we launched our first program in information technology,
an associate degree program in Computer Network Systems Technology, at
three institutes. We intend to introduce this program at 27 additional
institutes in 1999 and we plan to begin testing three additional
information technology degree programs in 1999. We believe that introducing
new programs can attract a broader base of students and can motivate
current students to extend their studies.

Extend Total Program Duration. We have increased the number of institutes
that offer bachelor degree programs to graduates of our associate degree
programs. In our last five fiscal years, the number of our institutes which
offer bachelor degree programs increased from 13 to 28. As a result, the
average combined total program time a student remains enrolled in our
programs has increased from 18 months in 1986 to 24 months in 1998. The
newly introduced associate degree program in Computer Network Systems
Technology is 24 months in duration. We expect that the average combined
total program time of our students will increase further as additional
bachelor degree programs are added at our institutes.

Improve Student Outcomes. We strive to improve the graduation and
graduate employment rates of our undergraduate students by providing
extensive academic and career services and dedicating significant
administrative resources to career services. From 1993 through 1997, the
percentage of graduates of our institutes (other than graduates who
continued in a bachelor degree program at one of our institutes) who were
employed or already working in fields involving their programs of study
increased from 83% to 90%.

Increase the Number of Our Institutes

We plan to add new institutes at sites throughout the United States.
Using our proprietary methodology, we determine locations for new
institutes based on a number of factors, including demographics and
population and employment growth. We opened three new institutes in each of
1997 and 1998 and two new institutes in January 1999. We plan to open two
additional new institutes in the remainder of 1999. New institutes open for
less than 24 months had a total of 644 students enrolled at December 31,
1998. We will continue to consider acquiring schools located in markets
where our institutes are not presently located.

Increase Margins By Leveraging Fixed Costs at Institute and Headquarters
Levels

By optimizing school capacity and class size, we have been able to
increase revenues from increased enrollment without incurring a
proportionate increase in fixed costs at our institutes. In addition, we
have realized substantial operating efficiencies by centralizing management
functions and implementing operational uniformity among our 67 institutes.
Expenses incurred at our headquarters (including the district offices)
declined as a percentage of revenues from 6.6% in 1994 to 5.1% in 1998 as a
result of these operating efficiencies. We will continue to seek to improve
margins by increasing enrollments and revenues without incurring a
proportionate increase in fixed costs at our institutes.

Programs of Study

We offer 15 degree programs and several diploma programs in various fields of
study. All of our institutes offer a degree or diploma program in EET and 59
institutes offer a degree or diploma program in CAD. Together the EET and CAD
programs comprise the core of our institutes' program offerings. The table
below sets forth information regarding the programs of study we offered as of
December 31, 1998.

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[Enlarge/Download Table]

Number of Institutes Offering at Number of Students Enrolled at
December 31, 1998 December 31, 1998
--------------------------------- ----------------------------------------
Master Bachelor Associate Master Bachelor Associate
Program of Study Degree Degree Degree Diploma Degree Degree Degree Diploma Total
---------------- ------ -------- --------- ------- ------ -------- --------- ------- ------

Project Management...... 1 -- -- -- 62 -- -- -- 62
Electronics Engineering
Technology............. -- 19 63 2 -- 932 17,421 91 18,444
Computer-Aided Drafting
Technology............. -- -- 59 -- -- -- 5,255 -- 5,255
Automated Manufacturing
Technology (1)......... -- 5 -- -- -- 329 -- -- 329
Tool Engineering
Technology (2)......... -- -- 3 -- -- -- 197 -- 197
Architectural
Engineering Technology
(2).................... -- -- 3 -- -- -- 173 -- 173
Industrial Design (2)... -- 3 -- -- -- 98 -- -- 98
Computer Visualization
Technology (2)......... -- 6 -- -- -- 213 -- -- 213
Chemical Technology..... -- -- 3 -- -- -- 153 -- 153
Telecommunications
Engineering Technology
(1).................... -- 3 -- -- -- 182 -- -- 182
Computer Network Systems
Technology............. -- -- 3 -- -- -- 98 -- 98
Hospitality (3)......... -- 1 1 -- -- 6 23 -- 29
Other Programs of Study
(4).................... -- -- 3 2 -- -- 245 130 375
--- ----- ------ --- ------
Total.................. 62 1,760 23,565 221 25,608
=== ===== ====== === ======

--------
(1) EET related program.
(2) CAD related program.
(3) In our normal course of operations, we review the operations and viability
of all of our programs of study (including the marketing, recruitment and
enrollment procedures and materials relating to the programs) and, from
time to time, we make changes with respect to each of our programs. Due to
the continuing lack of profitability of the Hospitality programs, we have
ceased enrolling new students in the associate degree Hospitality program
and intend to cease offering the associate degree Hospitality program once
all students currently enrolled in the program have an opportunity to
complete it. We also intend to cease offering the bachelor degree
Hospitality program once all students currently enrolled in the program
have an opportunity to complete it and all students currently enrolled in
the associate degree Hospitality program have an opportunity to enroll in
and complete the bachelor degree Hospitality program.
(4) Other programs consist of Business Technology and Administration, Business
Management and Accounting, Automotive Service Technology and Heating/Air
Conditioning/Refrigeration.

As of December 31, 1998, approximately 74% of our students were enrolled in
EET related programs and approximately 23% were enrolled in CAD related
programs. We design our EET programs to help graduates begin to prepare for
careers in various fields involving EET by providing students a practical
education with respect to specific electronic circuits and specialized
techniques. Our bachelor degree EET program offers a broader foundation in EET
through the study of subjects such as circuit analysis, computer programming,
computer operating systems and advanced communications systems. Graduates of
the programs have obtained a variety of entry-level positions in various fields
involving EET, such as electronics product design and fabrication,
communications, computer technology, industrial electronics, instrumentation,
telecommunications and consumer electronics. We design our CAD program to help
graduates begin to prepare for careers in various fields involving CAD through
the teaching of computer-aided drafting techniques and conventional drafting
methods. Graduates have obtained a variety of entry-level positions in various
fields involving CAD, such as computer-aided drafting, electrical and
electronics drafting, mechanical drafting, architectural and construction
drafting, civil drafting, interior design and landscape architecture.

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We generally organize the academic schedule of undergraduate programs at our
institutes on the basis of four 12-week quarters of instruction with new
students beginning at the start of each academic quarter. Students can complete
our associate degree programs in eight academic quarters or less, and bachelor
degree programs in 12 academic quarters (including academic quarters completed
as part of a related associate degree program). We typically offer classes in
most programs in four-hour sessions five days a week and, depending on student
enrollment, sessions are generally available in the morning, afternoon and
evening. This class schedule generally provides students with the flexibility
to pursue part-time employment opportunities. Based on student surveys, we
believe that a substantial majority of our students work at least part-time
during their programs of study.

We organize the academic schedule of the Master of Project Management ("MPM")
program, currently our only graduate degree program of study, on a non-term
basis. Students attending the MPM program take one- to six-week courses
sequentially one at a time. Students can complete the MPM program in 21 months.
We typically offer classes in the MPM program in four-hour sessions one night a
week, which generally accommodates students working full-time jobs. Students
may generally begin the MPM program once the minimum number of applicants
necessary to begin a new class has been assembled. Our Indianapolis institute,
which offers the MPM program at various sites throughout Indiana, is the only
institute that presently offers the MPM program. The limited scope of the DOE's
recognition of the ACCSCT currently prevents us from offering the MPM program
at other institutes. It also prevents our students from participating in Title
IV Programs to pay their education costs. We have arranged for an unaffiliated,
private funding source to provide loans to the students in our MPM program.

Our institutes' programs of study blend traditional academic content with
applied learning concepts and have the objective of helping graduates begin to
prepare for a changing economic and technological environment. A significant
portion of a typical student's day in an associate degree program at one of our
institutes involves practical study in a lab environment.

The content of technical courses in each program of study is substantially
standardized among our institutes to provide greater uniformity and to better
enable students to transfer, if necessary, to the same programs offered at
other institutes with less disruption to their education. We regularly review
each curriculum to respond to changes in technology and industry needs. Each of
our institutes has established an advisory committee for each field of study,
which is comprised of representatives of local employers. These advisory
committees assist our institutes in assessing and updating curricula, equipment
and laboratory design. In addition to courses directly related to a student's
program of study, degree programs may also include general education courses,
such as economics, humanities, oral and written communications, environmental
science and social psychology.

Tuition for a student entering an undergraduate program in December 1998 for
three consecutive academic quarters (the equivalent of an academic year at
traditional two- and four-year colleges) is $7,502 for the EET program and
$8,879 for the CAD program. We set a student's tuition cost for a program of
study at the time the student enrolls in the program, provided the student
remains continually enrolled in the program and does not repeat any courses.
The majority of students attending one of our institutes lived in that
institute's metropolitan area prior to enrollment. We do not provide any
student housing.

Student Recruitment

We strive to attract students with the motivation and ability to complete the
career-oriented educational programs offered by our institutes. To generate
interest among potential students, we engage in a broad range of activities to
inform potential students and their parents about our institutes and the
programs they offer. These activities include television and other media
advertising, direct mailings and high school visits.

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We centrally coordinate and develop our television advertising. We direct our
television advertising at a combination of both the national market and the
local markets in which our institutes are located. Our television commercials
generally include a toll free telephone number for direct responses and
information about the location of our institutes in the area. We centrally
receive, track and promptly forward direct responses to our television
advertising to the appropriate institute representatives to contact prospective
students and schedule interviews. We target our direct mail campaigns at high
school students and other potential postsecondary students. We centrally
receive, track and forward responses to direct mail campaigns to the
appropriate institute representatives.

We employ a director of recruitment at each of our institutes, who reports to
the director of such institute. We centrally establish, but implement at the
local level, recruiting policies and procedures, as well as standards for
hiring and training representatives. We employ approximately 80 high school
coordinators who make thousands of presentations to students at high schools
annually. These coordinators promote our institutes and obtain information
about high school juniors and seniors who may be interested in attending our
institutes. As of December 31, 1998, we employed approximately 510 other
representatives to assist in local recruiting efforts. As of December 31, 1998,
approximately 255 representatives performed their services solely in student
recruitment offices located at each of our institutes, while approximately 255
representatives worked outside these offices and visited the homes of high
school seniors and other prospective students.

Local representatives of an institute pursue expressions of interest from
potential undergraduate students by contacting prospective students and
arranging for interviews either at such institute or at prospective students'
homes. We have designed these interviews to establish a prospective student's
qualifications, academic background, interests, motivation and goals for the
future. Our interviewers typically show a video providing information about our
institutes and our programs of study to the prospective undergraduate students.
We pursue expressions of interest from potential graduate students by
contacting them and arranging for their attendance at an informational seminar
providing information about the institute and the MPM program.

We monitor the effectiveness of our various marketing efforts and try to
determine the extent to which each of our marketing efforts results in student
enrollments. We estimate that in 1998 television advertising produced 39% of
student enrollments at our institutes, high school coordinators accounted for
13%, referrals accounted for 14%, direct mail campaigns accounted for 9%,
associate degree graduates enrolling in a bachelor degree program accounted for
7% and the remaining 18% were classified as miscellaneous.

Student recruitment activities are subject to substantial regulation at both
the state and federal level. Most states have bonding and licensing
requirements that apply to many of our representatives. Our National Director
of Recruitment and the directors of field recruitment and training oversee the
implementation of recruitment policies and procedures. In addition, our
internal audit department generally reviews the recruiting practices relating
to the execution and completion of enrollment agreements at each of our
institutes on an annual basis.

Student Admissions and Retention

We strive to ensure that incoming students have the necessary academic
background to complete their chosen programs of study. We require all
applicants for admission to any of our institutes' associate degree or diploma
programs to have a high school diploma or a recognized equivalent and to pass
an admissions examination. Students interested in bachelor degree programs or
the MPM program must satisfy additional admissions criteria that generally
require, among other things: (1) in the case of bachelor degree programs, the
student first earn an associate degree, complete an equivalent level program or
complete an equivalent number of credit hours of coursework in the same or
related subject matter; and (2) in the case of the MPM program, the student
first earn a bachelor degree and possess at least three years' full-time work
experience. Students of varying ages and backgrounds attend our institutes. At
December 31, 1998, approximately 93% of the students were high school graduates
and the remaining students possessed the recognized equivalent of a high school
diploma. In addition, approximately 32% of the students had some postsecondary
educational experience prior

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to entering one of our institutes for the first time. Approximately 34% of the
students were 19 years of age or younger, 35% were between 20 and 24 years of
age, 19% were between 25 and 30 years of age and 12% were age 31 or over. Male
students accounted for approximately 88% of total enrollment as of December 31,
1998, while total minority enrollment at our institutes (based on applicable
federal classifications) was approximately 38%.

The faculty and staff at each of our institutes strive to help students
overcome obstacles to the completion of their programs of study. As is the case
in other postsecondary institutions, however, students often fail to complete
their programs for a variety of personal, financial or academic reasons.
Student withdrawals prior to program completion not only affect the student,
they also have a negative regulatory, financial and marketing effect on the
institute. To minimize student withdrawals, each of our institutes devotes
staff resources to assist and advise students regarding academic and financial
matters. We encourage academic advising and tutoring in the case of
undergraduate students experiencing academic difficulties. We also offer
assistance and advice to undergraduate students looking for part-time
employment and housing. In addition, we consider factors relating to student
retention in the performance evaluation of all our instructors.

Students are most likely to withdraw before they begin their second academic
quarter of study at our institutes. Approximately 22% of all students who
enroll in our institutes withdraw before their second academic quarter of study
and approximately 23% withdraw at some point after the start of their second
quarter. As a result, new institutes generally have higher withdrawal rates
than institutes which have been open for five or more years. Approximately 70%
of all students who continue their education past their first academic quarter
complete their education at one of our institutes.

Graduate Employment

Our institutes have graduated over 125,000 students since 1976. We believe
that the success of graduates from undergraduate programs who begin their
careers in fields involving their programs of study is critical to the ability
of our institutes to continue to recruit undergraduate students. We try to
obtain data on the number of undergraduate students employed following
graduation. The reliability of such data depends largely on information that
students and employers report to us. Based on this information, we believe that
students graduating from our institutes' undergraduate programs during the
years listed below obtained employment or were already employed in fields
involving their programs of study by June 30 or earlier of the year following
graduation, as set forth below:

[Download Table]

Percent of Employable
Graduates Who Obtained
Employment or Were Already
Number of Employed in Fields
Year of Employable Involving Their Programs
Graduation Graduates(1) of Study
---------- ------------ --------------------------

1997.............................. 8,248 90%
1996.............................. 8,422 88%
1995.............................. 8,005 87%
1994.............................. 7,459 85%
1993.............................. 7,015 83%

--------
(1) Employable graduates exclude graduates who continue in a bachelor degree
program at one of our institutes.

Each of our institutes employs personnel to offer students and graduates of
undergraduate programs career services. These persons assist in job searches
and solicit employment opportunities from employers. In addition, undergraduate
students receive instruction during their programs of study on job search
techniques, the use of relevant reference materials, the composition of resumes
and letters of introduction and the

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appropriate preparation, appearance and conduct for interviews. We do not offer
career services to students in the graduate program of study. The increase in
employment rates set forth in the table above may also be due in part to
improved conditions in the economy as a whole.

Based on information from students and employers who responded to our
inquiries, we estimate that average annual starting salaries reported for 1997
graduates of certain programs offered by our institutes who obtained employment
or were already employed in fields involving their programs of study were as
follows:

[Download Table]

Average
Number of Annual
Employable Salary
Graduates Upon
Program of Study in 1997(1) Graduation
---------------- ---------- ----------

Automated Manufacturing Technology (Bachelor Degree).... 310 $28,440
Electronics Engineering Technology (Bachelor Degree).... 786 $27,228
Industrial Design (Bachelor Degree)..................... 57 $26,592
Computer-Aided Drafting Technology, Tool Engineering
Technology and Architectural Engineering Technology
(Associate Degree and Diploma)......................... 2,429 $21,286
Electronics Engineering Technology (Associate Degree and
Diploma)............................................... 4,271 $23,172

--------
(1) Employable graduates exclude graduates who continue in a bachelor degree
program at one of our institutes.

Average annual salaries upon graduation for our graduates may vary
significantly among our institutes depending on local employment conditions and
each graduate's background. Initial employers of graduates from our institutes'
undergraduate programs include both small, technology-oriented companies and
well recognized corporations.

Faculty

We hire faculty members in accordance with criteria established by us, the
Accrediting Commissions and the SEAs. We strive to hire faculty with related
work experience and academic credentials to teach most technical subjects.
Faculty members typically include education supervisors, who act as department
chairs for a program of study, and various categories of instructors. As of
December 31, 1998, our institutes employed 1,101 full-time faculty members and
302 part-time faculty members. The ratio of our total number of students to all
full-time instructors at our institutes is approximately 27 to 1.

Administration and Employees

Each of our institutes is administered by a director who has overall
responsibility for the management of the institute. The administrative staff of
each institute also includes a director of recruitment, a director of career
services, a director of finance and a director of education. We employ
approximately 160 people at our corporate headquarters in Indianapolis,
Indiana. As of December 31, 1998, we had approximately 3,120 full-time and
regular part-time employees. In addition, we employed approximately 445
students as laboratory assistants and in other part-time positions at that
date. None of our employees are represented by labor unions.

Our headquarters provides centralized services to all of our institutes in
the following areas:

. accounting . purchasing

. marketing . human resources

. public relations . regulatory and legislative affairs

. curricula development . real estate

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In addition, national directors of each of the following major institute
functions reside at our headquarters and develop policies and procedures to
guide these functions at our institutes:

. recruiting

. education

. finance . career services

Managers located at our headquarters closely monitor the operating results of
each of our institutes and frequently conduct on-site reviews.

Competition

The postsecondary education market in the United States is highly fragmented
and competitive with no private or public institution enjoying a significant
market share. Our institutes compete for students with four-year and two-year
degree-granting institutions, which include nonprofit public and private
colleges and for-profit institutions, as well as with alternatives to higher
education such as military service or immediate employment. We believe
competition among educational institutions is based on the quality of the
educational program, perceived reputation of the institution, cost of the
program and employability of graduates. Certain public and private colleges may
offer programs similar to those offered by our institutes at a lower tuition
cost due in part to government subsidies, foundation grants, tax deductible
contributions or other financial resources not available to for-profit
institutions. Other for-profit institutions offer programs that compete with
those of our institutes. Certain of our competitors in both the public and
private sector have greater financial and other resources than we do.

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Properties

We lease all of our institute facilities, except for a parking lot we own
adjacent to the Houston (North), Texas institute. The average lease term is
approximately eight years. The table below sets forth some information
regarding our institute facilities that we were leasing as of December 31,
1998.

[Download Table]

Area in
Location (Metropolitan Area) Square Feet
---------------------------- -----------

Birmingham, Alabama......... 23,907
Phoenix, Arizona............ 25,900
Tucson, Arizona............. 17,818
Little Rock, Arkansas....... 22,766
Anaheim, California (Los
Angeles)................... 39,747
Hayward, California (San
Francisco)................. 20,009
Lathrop, California
(Stockton)................. 13,274
Oxnard, California (Los
Angeles)................... 27,098
Rancho Cordova, California
(Sacramento)............... 27,020
San Bernardino, California
(Los Angeles).............. 33,551
San Diego, California....... 34,360
Santa Clara, California (San
Francisco)................. 24,390
Sylmar, California (Los
Angeles)................... 30,000
Torrance, California (Los
Angeles)................... 30,000
West Covina, California (Los
Angeles)................... 36,382
Thornton, Colorado
(Denver)................... 27,076
Fort Lauderdale, Florida.... 29,381
Jacksonville, Florida....... 25,200
Maitland, Florida
(Orlando).................. 32,050
Miami, Florida.............. 21,347
Tampa, Florida.............. 35,000
Boise, Idaho................ 27,978
Burr Ridge, Illinois
(Chicago).................. 21,000(1)
Hoffman Estates, Illinois
(Chicago).................. 24,000
Matteson, Illinois
(Chicago).................. 24,201
Fort Wayne, Indiana......... 67,000
Indianapolis, Indiana....... 58,692
Newburgh, Indiana
(Evansville)............... 20,000
Louisville, Kentucky........ 22,291
St. Rose, Louisiana (New
Orleans)................... 21,000(2)
Framingham, Massachusetts
(Boston)................... 19,938
Woburn, Massachusetts
(Boston)................... 19,999(2)
Grand Rapids, Michigan...... 25,000
Troy, Michigan (Detroit).... 32,000
[Download Table]

Area in
Location (Metropolitan Area) Square Feet
---------------------------- -----------

Arnold, Missouri (St.
Louis)..................... 21,000
Earth City, Missouri (St.
Louis)..................... 29,360
Omaha, Nebraska............. 22,400
Henderson, Nevada (Las
Vegas)..................... 20,972
Albuquerque, New Mexico..... 21,588
Albany, New York............ 21,000(1)
Getzville, New York
(Buffalo).................. 22,765
Liverpool, New York
(Syracuse)................. 21,000(3)
Dayton, Ohio................ 45,591
Norwood, Ohio (Cincinnati).. 28,593
Strongsville, Ohio
(Cleveland)................ 21,548
Youngstown, Ohio............ 22,500
Portland, Oregon............ 39,600
Mechanicsburg, Pennsylvania
(Harrisburg)............... 21,000
Monroeville, Pennsylvania
(Pittsburgh)............... 23,791
Pittsburgh, Pennsylvania.... 23,791
Greenville, South Carolina.. 22,065
Knoxville, Tennessee........ 30,000
Memphis, Tennessee.......... 21,648
Nashville, Tennessee........ 34,690
Arlington, Texas............ 19,600
Austin, Texas............... 25,480
Garland, Texas (Dallas)..... 21,138
Houston (North), Texas...... 22,695
Houston (South), Texas...... 22,954
Houston (West), Texas....... 36,413
Richardson, Texas (Dallas).. 23,500(1)
San Antonio, Texas.......... 25,000
Murray, Utah (Salt Lake
City)...................... 33,600
Norfolk, Virginia........... 25,572
Richmond, Virginia.......... 21,000(3)
Bothell, Washington
(Seattle).................. 27,800
Seattle, Washington......... 30,316
Spokane, Washington......... 16,378
Greenfield, Wisconsin
(Milwaukee)................ 29,650

--------
(1) Institutes in the first year of operation as of December 31, 1998.
(2) Facility under lease where we plan to open a new institute.
(3) Facility under lease on December 31, 1998 and subsequently opened in
January 1999.

We generally locate our institutes in suburban areas near major population
centers. We generally house our campus facilities in modern, air conditioned
buildings, which include classrooms, laboratories, student break areas and
administrative offices. Our institutes have accessible parking facilities and
are generally near a major highway. Approximately 35 of our institutes occupy
an entire building. Our new institutes typically lease facilities for a six to
13 year term. If desirable or necessary, a facility may be relocated to a new
location reasonably near the existing facility at the end of the lease term.

We lease approximately 41,100 square feet of office space in our headquarters
building in Indianapolis, Indiana. As of December 31, 1998, the lease required
payments of approximately $2.8 million over the remaining term of the lease,
which expires in 2003.

This offering may be deemed a change in control under certain of our leases
and, absent the consent of the landlord, would cause such leases to be in
default. We believe that we will obtain all necessary consents in a timely
fashion.

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Federal and Other Financial Aid Programs

In 1998, we indirectly derived approximately 69% of our revenues from Title
IV Programs. Our institutes' students also rely on state financial aid
programs, family contributions, personal savings, employment and other
resources to pay their educational expenses. Students at our institutes receive
grants and loans to fund the cost of their education under the following Title
IV Programs:

. the FFEL program, which accounted in aggregate for approximately 56% of
our revenues in 1998;

. the Pell program, which accounted in aggregate for approximately 12% of
our revenues in 1998;

. the FDL program, which accounted in aggregate for approximately 3% of our
revenues in 1998;

. the Federal Work-Study ("Work-Study") program, which makes federal funds
available to provide part-time employment to students and under which our
institutes employed approximately 550 students and paid $1,360,000 in
student wages in 1998;

. the Federal Perkins Loan ("Perkins") program, which accounted in
aggregate for less than 1% of our revenues in 1998; and

. the Federal Supplemental Educational Opportunity Grant ("SEOG") program,
which accounted in aggregate for less than 1% of our revenues in 1998.

The Work-Study, Perkins and SEOG programs each require our institutions to
make a matching contribution in the amount of 25% of the federal funds the
institution receives from the DOE under those programs. In 1998, our 25%
matching contribution amounted to $340,000 for the Work-Study program, $240,000
for the Perkins program and $15,000 for the SEOG program.

In 1998, we indirectly derived approximately 3% of our revenues from state
financial aid programs and our students were awarded $1,181,000 in
institutional scholarships. We also provide tuition discounts to our full-time
employees and their dependents to attend our institutes. For 1998, the cost of
these employee educational discounts was $784,000.

Regulation of Federal Financial Aid Programs

In order to participate in Title IV Programs, our institutions must each
comply with the standards set forth in the HEA and the regulations promulgated
thereunder by the DOE. The purpose of these standards is to limit institutional
dependence on Title IV Program funds, prevent institutions with unacceptable
student loan default rates from participating in Title IV Programs and, in
general, require institutions to satisfy certain criteria related to
educational value, administrative capability and financial responsibility.
These standards are applied primarily on an institutional basis, with an
institution defined as a main campus and its additional locations or branch
campuses, if any. Thirty of our 67 institutes are main campuses and 37 are
additional locations. The HEA standards require an institution to obtain and
periodically renew its certification by the DOE as an "eligible institution"
that has been authorized by the relevant state education authority or
authorities and accredited by an accrediting commission recognized by the DOE.
Sixty-four of our 67 institutes currently participate in Title IV Programs.
This number includes our institute in Garland, Texas which participates in the
Pell, Perkins and Work-Study programs, but is ineligible to participate in the
FFEL and FDL programs until at least October 1, 2000, due to its high student
loan default rates. See "--Student Loan Defaults." The other four institutes,
which we recently opened, have begun the certification process to participate
in Title IV Programs.

The DOE and other regulatory authorities subject for-profit providers of
postsecondary education to increased scrutiny and regulation as a result of
concern about fraud and abuse of Title IV Programs by some for-profit
institutions. We believe that all of our institutes substantially comply with
the HEA and its implementing regulations. We cannot, however, predict with
certainty how all of the HEA provisions and the implementing regulations will
be applied. As described below, the violation of Title IV Program requirements
by us or any of our institutes could have a material adverse effect on our
financial condition, results of operations or cash flows. In addition, it is
possible that the HEA and its implementing regulations may be applied in a way
that could hinder our operations or expansion plans.

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Significant factors relating to Title IV Programs that could adversely affect
us include the following:

Legislative Action. Political and budgetary concerns significantly affect
Title IV Programs. The U.S. Congress must reauthorize the HEA approximately
every six years. The most recent reauthorization, which occurred in October
1998, reauthorized the HEA through 2003. The U.S. Congress reauthorized all
of the Title IV Programs in which our institutes participate, generally in
the same form and at funding levels no less than for the prior year. The
1998 HEA Amendments, however, revised the following provisions, among
others:

. the effect of cohort default rates on the FFEL, FDL, Perkins and Pell
programs;

. the amount of Title IV Program funds an institution may retain for a
student who withdraws from the institution;

. the "85/15" Rule; and

. the change of ownership procedures.

See "--Student Loan Defaults," "--Institutional Refunds," "--The "85/15'
Rule" and "--Change in Control."

In addition, the U.S. Congress reviews and determines federal
appropriations for Title IV Programs on an annual basis. The U.S. Congress
can also make changes in the laws affecting Title IV Programs in those
annual appropriations bills and in other laws it enacts between HEA
reauthorizations. Since a significant percentage of our revenues are
indirectly derived from Title IV Programs, any action by the U.S. Congress
that significantly reduces Title IV Program funding or the ability of our
institutes or students to participate in Title IV Programs could have a
material adverse effect on our financial condition or results of
operations.

If one of our institutes lost its eligibility to participate in Title IV
Programs, or if the amount of available Title IV Program funding was
significantly reduced, we would try to arrange or provide alternative
sources of financial aid for that institute's students. There are a number
of private organizations that provide loans to students. Although we
believe that one or more private organizations would be willing to provide
loans to students attending one of our institutes, we cannot assure you
that this would occur or that the interest rate and other terms of such
loans would be as favorable as for Title IV Program loans. In addition, the
private organizations would require us to guarantee all or part of this
assistance and we might incur other additional costs. If we provided more
direct financial assistance to our students, we would incur additional
costs and assume increased credit risks.

Legislative action may also increase our administrative costs and burden
and require us to adjust our practices in order for our institutes to
comply fully with the legislative requirements, which could have a material
adverse effect on our financial condition or results of operations.

Student Loan Defaults. Under the HEA, an institution may lose its
eligibility to participate in some or all Title IV Programs, if the rates
at which the institution's students default on their federal student loans
exceed specified percentages. The DOE calculates these rates on an
institutional basis, based on the number of students who have defaulted,
not the dollar amount of such defaults. The DOE calculates an institution's
cohort default rate on an annual basis as the rate at which borrowers
scheduled to begin repayment on their loans in one year default on those
loans by the end of the next year. For each year through the 1994 federal
fiscal year, each institution participating in the FFEL program received an
FFEL cohort default rate. Beginning with the 1995 federal fiscal year, the
DOE also included loans under the FDL program in the calculation of an
institution's cohort default rate, and each institution received an
FFEL/FDL cohort default rate based solely on FFEL program loans, solely on
FDL program loans or on a weighted average of both FFEL and FDL program
loans, depending on the programs in which the institution participated. An
institution whose FFEL/FDL cohort default rate is 25% or greater for three
consecutive federal fiscal years loses eligibility to participate in the
FFEL and FDL programs for the remainder of the federal fiscal year in which
the DOE determines that the institution has lost its eligibility and for
the two subsequent federal fiscal years. An institution can appeal this
loss of eligibility. In

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addition, the 1998 HEA Amendments provide that if an institution becomes
ineligible to participate in the FFEL and FDL programs following the
publication of its 1996 (or any subsequent) federal fiscal year FFEL/FDL
cohort default rate, the institution will also be ineligible to participate
in the Pell program for the same period of time. During the pendency of any
appeal of its FFEL/FDL cohort default rate, the institution remains
eligible to participate in the FFEL, FDL and Pell programs. Beginning with
the 1996 federal fiscal year FFEL/FDL cohort default rates, if an
institution continues its participation in the FFEL and/or FDL programs
during the pendency of any such appeal and the appeal is unsuccessful, the
institution must pay the DOE the amount of interest, special allowance,
reinsurance and any related payments paid by the DOE (or which the DOE is
obligated to pay) with respect to the FFEL and FDL program loans made to
the institution's students or their parents that would not have been made
if the institution had not continued its participation (the "Direct
Costs"). If a substantial number of our campus groups were subject to
losing their eligibility to participate because of their FFEL/FDL cohort
default rates, the potential amount of the Direct Costs for which we would
be liable if our appeals were unsuccessful would prevent us from continuing
some or all of the affected campus groups' participation in the FFEL and/or
FDL programs during the pendency of those appeals. In addition to the
consequences resulting from an institution having three years of FFEL/FDL
cohort default rates of 25% or greater, the DOE may limit, suspend or
terminate the eligibility to participate in all Title IV Programs of an
institution whose FFEL/FDL cohort default rate for any single federal
fiscal year exceeds 40%.

None of our campus groups had an FFEL/FDL cohort default rate equal to or
greater than 25% for the 1996 federal fiscal year, the most recent year for
which the DOE has published FFEL/FDL cohort default rates. One of our
campus groups, consisting only of the institute in Garland, Texas, had
FFEL/FDL cohort default rates exceeding 25% for three consecutive federal
fiscal years beginning with the 1993 federal fiscal year. Consequently, in
June 1998, the Garland institute became ineligible to participate in the
FFEL and FDL programs. The Garland institute accounted for approximately
1.4% of our revenues in 1998. The Garland institute can reapply to the DOE
to regain its eligibility to participate in the FFEL and FDL programs on or
after October 1, 2000. The Garland institute had an FFEL/FDL cohort default
rate of 19.2% for the 1996 federal fiscal year. We have arranged for an
unaffiliated, private funding source to provide loans to the students
enrolled in the Garland institute. This alternative financing source
requires us to guarantee repayment of the loans it issues. Based on our
experience with the repayment of Title IV Program loans by students who
attended the Garland institute, we believe that such guaranty should not
result in a material adverse effect on our financial condition, results of
operations or cash flows. We have also decided to stop enrolling new
students in the Garland institute, at least temporarily, while we continue
teaching the students already enrolled. We are considering whether to close
the Garland institute once the students already enrolled have completed
their programs of study or transferred to another school.

If an institution's FFEL/FDL cohort default rate is 25% or greater in any
of the three most recent federal fiscal years, or if its cohort default
rate for loans under the Perkins program exceeds 15% for any federal award
year, the DOE may place that institution on provisional certification
status. A federal award year runs from July 1 through June 30. One of the
reasons that the Garland and San Antonio, Texas institutes were
provisionally recertified for participation in Title IV Programs following
Starwood Hotels' acquisition of ITT was because their FFEL/FDL cohort
default rates exceeded 25% for at least one of the three most recent
federal fiscal years. The DOE told each of those institutes that it would
remain provisionally certified until its FFEL/FDL cohort default rates for
three consecutive federal fiscal years are all below 25%. Twenty-seven of
our campus groups (consisting of 59 institutes) had a Perkins cohort
default rate in excess of 15% for students who were scheduled to begin
repayment in the 1996/1997 federal award year, the most recent year for
which such rates have been calculated. The DOE could place these institutes
on provisional certification status based on their Perkins cohort default
rates. To date, the DOE has not placed any of our campus groups on
provisional certification status because of their Perkins cohort default
rates.

Beginning with the 2000 federal fiscal year, an institution whose Perkins
cohort default rate is 50% or greater for three consecutive federal award
years loses eligibility to participate in the Perkins program for

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the remainder of the federal fiscal year in which the DOE determines that
the institution has lost its eligibility and for the two subsequent federal
fiscal years. An institution can appeal the loss of eligibility. During the
pendency of any such appeal, the DOE may permit the institution to continue
participating in the Perkins program. An institution that loses its
eligibility to participate in the Perkins program due to its Perkins cohort
default rates must also return the federal portion of its Perkins loan fund
to the DOE. None of our campus groups had a Perkins cohort default rate
equal to or greater than 50% for the 1996/1997 federal award year.

The HEA subjects institutions with a Perkins cohort default rate of 20%
or greater to a "default penalty" that reduces the amount of additional
federal funds allocated annually to the institution for use in the Perkins
program. The "default penalty" for each year through the 1999 federal
fiscal year is:

.10%, if the institution's Perkins cohort default rate is at least 20%
but less than 25%;

.30%, if the institution's Perkins cohort default rate is at least 25%
but less than 30%; or

.100%, if the institution's Perkins cohort default rate is 30% or
greater.

For the 1996/1997 federal award year, six of our campus groups (consisting
of 17 institutes) had a Perkins cohort default rate of at least 20% but
less than 25%, ten of our campus groups (consisting of 20 institutes) had a
Perkins cohort default rate of at least 25% but less than 30%, and nine of
our campus groups (consisting of 19 institutes) had a Perkins cohort
default rate of 30% or greater. Beginning with the 2000 federal fiscal
year, there is no "default penalty" if the institution's Perkins cohort
default rate is below 25%, and the "default penalty" is 100% if the rate is
25% or greater.

The HEA requires an institution with a Perkins cohort default rate of 15%
or greater to establish a default reduction plan. Each of our institutes
has developed such a plan. The Perkins loans disbursed to our students
amounted to less than 1% of our revenues in 1998. Less than half of our
institutes disbursed their entire allocation in 1998. As a result, we do
not believe that our financial condition or results of operations would be
materially affected if all of our campus groups lost their eligibility to
participate in the Perkins program or if there were a reduction in
additional federal funds allocated to our campus groups for use in the
Perkins program pursuant to a "default penalty." See "--Regulation of
Federal Financial Aid Programs--Administrative Capability" and "--
Eligibility and Certification Procedures."

The HEA requires an institution that undergoes a change in control to
develop an FFEL/FDL default management plan and to implement the plan for
at least two years following the change in control. All of our campus
groups have implemented a default management plan that we developed in
accordance with the DOE's default reduction measures.

The servicing and collection efforts of student loan lenders and guaranty
agencies help to control our FFEL/FDL cohort default rates. We are not
affiliated with any student loan lenders or guaranty agencies. We
supplement their efforts by attempting to contact students who are
delinquent in making payments to advise them of their responsibilities and
any deferment or forbearance for which they may qualify. We have also
contracted with third-party servicers who provide additional assistance in
reducing defaults under the FFEL, FDL and Perkins programs by students who
attended some of our institutes.

Financial Responsibility Standards. The HEA and its implementing
regulations prescribe specific and detailed financial responsibility
standards that an institution must satisfy to participate in Title IV
Programs. As a part of the DOE's review of the applications of our campus
groups to have their eligibility to participate in Title IV Programs
reinstated after Starwood Hotels' acquisition of ITT, the DOE evaluated the
financial responsibility of all of our campus groups. The DOE determined
that each campus group satisfied the DOE's financial responsibility
standards following the acquisition, but the DOE directed us to address
certain issues related to our financial condition and financial statements.
See "--Change in Control."

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The DOE's current standards of financial responsibility, effective as of
July 1, 1998, involve three ratios:

. the equity ratio, which measures the institution's capital resources,
ability to borrow and financial viability;

. the primary reserve ratio, which measures the institution's ability
to support current operations from expendable resources; and

. the net income ratio, which measures the ability of an institution to
operate at a profit.

The DOE assigns a strength factor to the results of each of these ratios on
a scale from negative 1.0 to positive 3.0, with negative 1.0 reflecting
financial weakness and 3.0 reflecting financial strength. The DOE then
weights an institution's strength factors based on an assigned weighting
percentage for each ratio and adds the weighted scores for the three ratios
together to produce a composite score for the institution. The composite
score must be at least 1.5 for the institution to be deemed financially
responsible by the DOE without the need for further oversight. We have
calculated that the application of these new regulations to our audited
financial statements for our 1998 fiscal year results in a composite score
of 3.0. We believe that we would also meet the DOE's new standards of
financial responsibility for 1998 on a pro forma basis after giving effect
to the stock repurchase.

Historically, the DOE has evaluated the financial condition of our
institutes on a consolidated basis based on our financial statements. The
DOE's regulations, however, permit the DOE to examine our financial
statements, the financial statements of each campus group, and the
financial statements of any related party. If the DOE determines that an
institution does not satisfy the DOE's financial responsibility standards,
that institution may establish its financial responsibility on an
alternative basis by, among other things:

. posting a letter of credit in an amount equal to at least 50% of the
total Title IV Program funds received by the institution during the
institution's most recently completed fiscal year;

. posting a letter of credit in an amount equal to at least 10% of such
prior year's Title IV Program funds and agreeing to receive Title IV
Program funds under an arrangement other than the DOE's standard
advance funding arrangement while being provisionally certified; or

. complying with additional monitoring requirements of the DOE and
agreeing to receive Title IV Program funds under an arrangement other
than the DOE's standard advance funding arrangement.

Another significant financial responsibility standard requires an
institution to post a letter of credit with the DOE in an amount equal to
25% of the total dollar amount of refunds paid by the institution in its
most recently completed fiscal year, if the institution has made late
refunds in its two most recently completed fiscal years. The DOE considers
an institution to have made late refunds under this standard, if the Title
IV Program independent compliance audit (or any review by the DOE, state or
guaranty agency) of the institution for either such fiscal year: (1) finds
that at least 5% of the institution's refunds were late; or (2) notes a
material weakness or reportable condition related to refunds in the
institution's report on internal controls. Our Title IV Program independent
compliance audits for our 1996 and 1997 fiscal years demonstrate that, in
accordance with the DOE's criteria, our campus groups made timely refunds
in each of these fiscal years. No review by the DOE, a state or guaranty
agency has found that any of our institutes was making late refunds under
the DOE's standard. Based on our current understanding of how the DOE will
apply the current financial responsibility standards, we do not believe
that these standards will have a material adverse effect on our financial
condition, results of operations or expansion plans.

Institutional Refunds. Prior to the 1998 HEA Amendments, the HEA limited
how much an institution could charge a student who withdrew from the
institution. A student was only obligated for a pro rata portion of the
education costs charged by the institution, if the student withdrew during
the first 60% of the student's first period of enrollment. For our
institutes, a period of enrollment is generally an academic quarter. A
student who withdrew after the first period of enrollment was also subject
to a refund

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calculation, but it was not a straight pro rata calculation. The
institution had to refund any monies it collected in excess of the pro rata
or other applicable portion to the appropriate lenders or Title IV Programs
in a particular order.

The 1998 HEA Amendments rescinded the limitation on how much an
institution can charge a withdrawing student, but the standards of most
SEAs and the two Accrediting Commissions continue to impose such a
limitation. The 1998 HEA Amendments imposed a limit on the amount of Title
IV Program funds a withdrawing student can use to pay his or her education
costs. This new limitation permits a student to use only a pro rata portion
of the Title IV Program funds that the student would otherwise be eligible
to use, if the student withdraws during the first 60% of any period of
enrollment. The institution must refund to the appropriate lenders or Title
IV Programs any Title IV Program funds that the institution receives on
behalf of a withdrawing student in excess of the amount the student can use
for such period of enrollment. The new refund requirements contained in the
1998 HEA Amendments become effective in October 2000, but an institution
may elect to begin complying with these new standards at an earlier date.
We do not plan to elect to comply with these new standards prior to October
2000.

Depending on the refund policies of the applicable SEAs and Accrediting
Commission, in a variety of instances withdrawing students will still be
obligated to the institution under the new HEA refund requirements for
education costs that the students can no longer pay with Title IV Program
funds. In these instances, we expect that many withdrawing students will be
unable to pay such costs and that we will be unable to collect a
significant portion of such costs. Title IV Program funds are generally
paid sooner and are more collectible than tuition payments from other
sources. As a result, if the new refund requirements remain unchanged, they
could have a material adverse effect on our financial condition, results of
operations and cash flows beginning with our 2001 fiscal year.

The "85/15" Rule. Under a provision of the HEA commonly referred to as
the "85/15" Rule, a for-profit institution, such as each of our campus
groups, becomes ineligible to participate in Title IV Programs if, on a
cash accounting basis, the institution derives more than 85% of its
applicable revenues for a fiscal year from Title IV Programs. If any of our
campus groups violated the 85/15 Rule for any fiscal year, they would be
ineligible to participate in Title IV Programs as of the first day of the
following fiscal year and would be unable to apply to regain their
eligibility until the next fiscal year. Furthermore, if one of our campus
groups violated the 85/15 Rule and became ineligible to participate in
Title IV Programs but continued to disburse Title IV Program funds, the DOE
would require the institution to repay all Title IV Program funds disbursed
to the institution after the effective date of the loss of eligibility. For
each of our 1997 and 1998 fiscal years, none of our campus groups derived
more than 79% of its revenues from Title IV Programs. For our 1998 fiscal
year, the range for our campus groups was from approximately 58% to
approximately 79%. The 1998 HEA Amendments increased the percentage of
applicable revenues that a for-profit institution can derive from Title IV
Programs from 85% to 90%. The DOE has indicated orally that it will apply
this amendment beginning with our 1998 fiscal year. The 5% increase in the
percentage of applicable revenues that we can derive from Title IV Programs
will increase the aggregate amount of Title IV Program funds that students
can use to pay their education costs of attending our institutes. Title IV
Program funds are generally paid sooner and are more collectible than
tuition payments from other sources. As a result, this 5% increase should
have a positive impact on our results of operations and cash flows
beginning in our 1999 fiscal year.

Due to the expansion and increased availability of funding under certain
Title IV Programs in recent years, we believe that students have
increasingly relied on Title IV Programs to finance their education and
will probably continue to do so. Our students' reliance on Title IV
Programs increases the prospect that we will indirectly derive a greater
percentage of our revenues from Title IV Programs. In an effort to prevent
any future loss of Title IV Program eligibility by any of our campus groups
as a result of the

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current 85/15 Rule and future 90/10 Rule, we have implemented various
measures to limit the percentage of applicable revenues we indirectly
derive from Title IV Programs. Some of these alternatives require us to
incur additional costs.

Additional Locations and Programs. Our expansion plans assume we will be
able to continue to obtain the necessary DOE, Accrediting Commission and
SEA approvals to establish new institutes as additional locations of
existing main campuses and to expand the program offerings at our existing
institutes. From 1996 through 1998, we established nine new additional
locations, eight of which are participating in Title IV Programs and one of
which is in the process of obtaining certification to participate in Title
IV Programs, and added 32 programs at our existing institutes. The HEA
requires a for-profit institution to operate for two years before it can
qualify to participate in Title IV Programs. An institution that is
certified to participate in Title IV Programs can establish additional
locations that may, after review by the DOE, participate in Title IV
Programs without satisfying the two-year requirement, so long as each
additional location satisfies all other applicable requirements.

The HEA and applicable regulations permit students to use Title IV
Program funds only to pay the cost associated with enrollment in an
eligible program offered by an institution participating in Title IV
Programs. The HEA and applicable regulations do not restrict the number or
delay the introduction of educational programs that an institution may
offer, but each new program must satisfy all applicable eligibility
requirements.

The ACCSCT accredits 61 of our institutes, and the ACICS accredits three
of our institutes. The ACCSCT standards generally permit an institution's
main campus to establish an additional location, unless the main campus:

. is on probation;

. is subject to a show cause order;

. is subject to outcomes reporting, unless the ACCSCT has expressly
permitted it to establish an additional location;

. has applied for accreditation for an additional location within the
past two years; or

. has undergone a change in control during the past year. This
restriction generally does not apply to an accreditation application
for an additional location submitted prior to the change in control.

Prior to the change in control caused by Starwood Hotels' acquisition of
ITT, we submitted applications for accreditation to the ACCSCT for all
additional locations that we anticipated opening in 1998 and for most of
the additional locations that we anticipate opening in 1999.

The ACICS standards generally permit an institution's main campus to
establish an additional location, unless:

. the main campus is on probation;

. either the main campus or any of its additional locations is subject
to a show cause order;

. either the main campus or any of its additional locations is subject
to a financial or outcomes review, unless the ACICS has expressly
permitted it to establish an additional location; or

. the main campus has any additional location awaiting final
accreditation.

The ACCSCT standards generally permit an institution's main campus and
its additional locations to expand their program offerings, unless the
institute is on probation or is subject to a show cause order. The ACICS
standards generally permit an institution's main campus and its additional
locations to expand their program offerings, unless: (1) the institute is
on probation; or (2) either the main campus or any of its additional
locations is subject to a financial or outcomes review, unless the ACICS
has expressly permitted it to expand its program offerings.

None of our institutes accredited by the ACCSCT is on probation or
subject to a show cause order. Nine of our institutes (seven main campuses
and two additional locations) accredited by the ACCSCT are

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subject to outcomes reporting, which requires them to report on student
completion rates for certain programs of study. None of our institutes
accredited by the ACICS is on probation or subject to a financial or
outcomes review. Although the ACCSCT and the ACICS standards limit our
ability to establish additional locations and expand the programs offered
at an institute in certain circumstances, we do not believe, based on our
current understanding of how the accrediting standards will be applied,
that these limitations will have a material adverse effect on our expansion
plans. See "--State Authorization and Accreditation."

State laws and regulations generally treat each of our institutes as a
separate, unaffiliated institution and do not distinguish between main
campuses and additional locations. State laws and regulations generally do
not limit the number of institutes that we can establish within the state
or the number of programs that our institutes can offer, so long as each
institute satisfies all requirements to obtain any required state
authorizations. In some states, the requirements to obtain state
authorization limit our ability to establish new institutes and offer new
programs. The process of obtaining any required state authorizations can
also delay the opening of new institutes or the offering of new programs.
Based on our current understanding of how the state laws and regulations in
effect in the states where we are located or anticipate establishing a new
location will be applied, we do not believe that these limitations will
have a material adverse effect on our expansion plans. See "--State
Authorization and Accreditation."

Administrative Capability. The HEA directs the DOE to assess the
administrative capability of each institution to participate in Title IV
Programs. DOE regulations require each institution to satisfy a series of
separate standards that demonstrate administrative capability. Failure to
satisfy any of the standards may lead the DOE to find the institution
ineligible to participate in Title IV Programs or to place the institution
on provisional certification status as a condition of its participation.
One standard that applies to programs with the stated objective of
preparing students for employment requires the institution to show a
reasonable relationship between the length of the program and the entry-
level job requirements of the relevant field of employment. Other standards
provide that an institution lacks administrative capability if its FFEL/FDL
cohort default rate equals or exceeds 25% for any of the three most recent
federal fiscal years for which such rates have been published, or if its
Perkins cohort default rate exceeds 15% for any federal award year.

Our Garland and San Antonio, Texas institutes had FFEL/FDL cohort default
rates exceeding 25% for at least one of the three most recent federal
fiscal years for which the DOE has published such rates. This was one of
the reasons that these two institutes were provisionally recertified for
participation in Title IV Programs following Starwood Hotels' acquisition
of ITT. The DOE told each of these institutes that it would remain
provisionally certified until its FFEL/FDL cohort default rates for three
consecutive federal fiscal years are all below 25%. Twenty-seven of our
campus groups (consisting of 59 institutes) had a Perkins cohort default
rate in excess of 15% for the most recent federal award year for which such
rates have been calculated. To date, the DOE has not placed any of our
campus groups on provisional certification status because of its Perkins
cohort default rate. See "--Regulation of Federal Financial Aid Programs--
Student Loan Defaults" and "--Eligibility and Certification Procedures."

An additional standard prohibits an institution from providing any
commission, bonus or other incentive payment based directly or indirectly
on success in securing enrollments or financial aid to any person or entity
engaged in any student recruitment, admission or financial aid awarding
activity. Our employees involved in student recruitment, admissions or
financial aid receive only a salary. We believe that our method of
compensating persons and entities engaged in student recruitment, admission
or financial aid awarding activity complies with the requirements of the
HEA. The regulations do not, however, establish clear standards for
compliance, and we cannot assure you that the DOE will not find any
deficiencies in our present or former methods of compensation.

The DOE's regulations require each institution to use electronic
processes mandated by the DOE. Although we will have to adjust some of our
current practices to comply fully with this requirement, we

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do not believe, based on our current understanding of how this requirement
will be applied, that our financial condition will be materially affected
by this standard.

Eligibility and Certification Procedures. The HEA and its implementing
regulations require each institution to periodically reapply to the DOE for
continued certification to participate in Title IV Programs. The DOE
recertifies each institution deemed to be in compliance with the HEA and
the DOE's regulations for a period of six years or less. Before that period
ends, the institution must apply again for recertification. In 1998, the
DOE recertified all 30 of our campus groups following the change in control
of our institutes caused by Starwood Hotels' acquisition of ITT. The DOE
normally requires an institution to submit an updated application for
institutional certification when it opens an additional location that
offers at least 50% of a full educational program or raises its level of
program offering.

The DOE may place an institution on provisional certification status for
a period of three years or less, if it finds that the institution does not
fully satisfy all the eligibility and certification standards. If an
institution successfully participates in Title IV Programs during its
period of provisional certification but fails to satisfy the full
certification criteria, the DOE may renew the institution's provisional
certification. The DOE may withdraw an institution's provisional
certification without advance notice if the DOE determines that the
institution is not fulfilling all material requirements. The DOE may also
more closely review an institution that is provisionally certified if it
applies for approval to open a new location or make some other significant
change in its eligibility. Provisional certification does not otherwise
limit an institution's access to Title IV Program funds.

Any institution seeking certification to participate in Title IV Programs
after a change in control will be provisionally certified for a limited
period, following which the DOE will require the institution to reapply for
continued certification. None of our institute campus groups were
provisionally certified by the DOE prior to Starwood Hotels' acquisition of
ITT. As a result of that acquisition, the DOE recertified each of our
campus groups to participate in Title IV Programs on a provisional basis
for a three-year period. As an additional condition of each campus group's
provisional certification, the DOE directed us to address certain issues
related to our financial condition and financial statements. The DOE also
placed one additional condition on the provisional certification of four
campus groups (consisting of six institutes), as follows:

. the DOE cited the Garland and San Antonio institutes for having
FFEL/FDL cohort default rates exceeding 25% for at least one of the
three most recent federal fiscal years for which such rates had been
published, and advised each of them that it would stay on provisional
certification status until its rates for three consecutive federal
fiscal years are all below 25%;

. the DOE cited the San Diego, California institute for having a
pending DOE program review, and advised it that it would stay on
provisional certification status until all liabilities identified in
the program review were paid and all deficiencies identified in the
program review were resolved; and

. the DOE cited the Youngstown, Ohio campus group (consisting of three
institutes) because its accrediting commission, the ACICS, had only
temporarily extended the campus group's accreditation following
Starwood Hotels' acquisition of ITT and had not yet formally
reaccredited the campus group.

In August 1998, the DOE formally closed the pending DOE program review of
the San Diego institute and the ACICS formally reaccredited the Youngstown
campus group. See "--Change in Control."

Title IV Program Funds Management. DOE regulations that became effective
July 1, 1997 revised the procedures governing how an institution
participating in Title IV Programs requests, maintains, disburses and
otherwise manages Title IV Program funds. The revised regulations require
institutions to disburse all Title IV Program funds by payment period. For
our institutes, the payment period is an academic quarter. This regulation
increases the number of disbursements of federal student loans that

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institutions on a quarter system must make, which delays our receipt and
disbursement of federal student loan funds. These regulations also expand
the requirements for institutions to notify Title IV Program fund
recipients of certain information and reduce the time by which an
institution must return undisbursed Title IV Program funds. These
regulations materially affected our cash flows in 1997 and 1998 and
increased our administrative burden, but they have not had a material
adverse effect on our financial condition or results of operations. We do
not believe that they will have a material adverse effect on our financial
condition or results of operations in 1999 or future years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

Availability of Lenders and Guarantors. For a variety of reasons,
including the high default rates of students attending certain for-profit
institutions, the growth of the FDL program and the potential assertion of
claims against holders of student loans, the number of lenders willing to
make federally guaranteed student loans under the FFEL program to students
at some for-profit institutions has declined. To date, however, the
availability of lenders has not affected the ability of our students to
obtain FFEL program loans.

During 1998, one lender made approximately 65% of all FFEL program loans
received by our students. We believe that other lenders would be willing to
make FFEL program loans to our students if such loans were no longer
available from our primary lender, but we cannot assure you of this. The
HEA requires the establishment of lenders of last resort in every state to
make loans to students at any school that cannot otherwise identify lenders
willing to make FFEL program loans to its students. Using a lender of last
resort may delay the receipt of FFEL program loans by our students and
slightly reduce the total loan access for our students, but should not have
a material adverse effect on us. Lenders of last resort will not provide
loans under the Federal PLUS program (an FFEL program), which accounted for
11% of our revenues in 1998, and are not required to provide unsubsidized
loans under the Federal Stafford Loan program (an FFEL program), which
accounted for 22% of our revenues in 1998.

During 1998, one student loan guaranty agency guaranteed approximately
94% of all FFEL program loans received by our students. We believe that
other guaranty agencies would be willing to guarantee FFEL program loans
received by our students if that guaranty agency ceased guaranteeing such
loans or reduced the volume of loans guaranteed, but we cannot assure you
of this. Most states have a designated guaranty agency that we believe
would guarantee most, if not all, FFEL program loans received by our
students in that state. In addition, the HEA's lender of last resort
program provides for the guarantee of FFEL program loans made by lenders of
last resort. Thus, any reduction in the volume of FFEL program loans for
our students guaranteed by the institutes' primary guaranty agency should
not have a material adverse effect on our financial condition, results of
operations or cash flows. Neither we, nor ITT, Starwood Hotels or any of
their subsidiaries or affiliates make or guarantee any Title IV Program
loans to any student attending any of our institutes.

Compliance with Regulatory Standards and Effect of Regulatory Violations.
Our internal audit department reviews our institutes' compliance with Title
IV Program requirements. Our audit plan provides for an annual on-site
compliance review of each of our institutes. The review addresses numerous
compliance areas, including student tuition refunds, student academic
progress, student admissions, graduate employment, student attendance,
student financial aid applications and implementation of prior audit
recommendations.

Our institutes are subject to audits and program compliance reviews by
various external agencies, including the DOE, state agencies, guaranty
agencies and accrediting commissions. The HEA and its implementing
regulations also require that an institution's administration of Title IV
Program funds be audited annually by an independent accounting firm. If the
DOE or another regulatory agency determined that one of our institutes
improperly disbursed Title IV Program funds or violated a provision of the
HEA or the implementing regulations, that institute could be required to
repay such funds to the DOE or the appropriate state agency or lender and
could be assessed an administrative fine. The DOE could also

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subject the institute to heightened cash monitoring, or could transfer the
institute from the advance system of receiving Title IV Program funds to
the reimbursement system, under which a school must disburse its own funds
to students and document the students' eligibility for Title IV Program
funds before receiving such funds from the DOE. Violations of Title IV
Program requirements could also subject us or our institutes to other civil
and criminal penalties.

Significant violations of Title IV Program requirements by us or any of
our institutes could be the basis for a proceeding by the DOE to limit,
suspend or terminate the participation of the affected institutes in Title
IV Programs. If the DOE terminates an institution's participation in Title
IV Programs, the institution in most circumstances must wait 18 months
before requesting a reinstatement of its participation. An institution that
loses its eligibility to participate in the FFEL, FDL, Pell or Perkins
programs due to high cohort default rates for three consecutive years
normally may not apply to resume participation in those programs for at
least two federal fiscal years. An institution that loses its eligibility
to participate in Title IV Programs due to a violation of the 85/15 Rule or
the 90/10 Rule may not apply to resume participation in Title IV Programs
for at least one year.

There is no proceeding pending to fine any of our institutes or to limit,
suspend or terminate any of our institutes' participation in Title IV
Programs, and we have no reason to believe that any such proceeding is
contemplated. If a proceeding substantially limited our institutes'
participation in Title IV Programs, we would be materially adversely
affected, even if we could arrange or provide alternative financing
sources. If an institute lost its eligibility to participate in Title IV
Programs and we could not arrange for alternative financing sources for our
students, we would probably have to close that institute.

State Authorization and Accreditation

We are subject to extensive and varying regulation in each of the 27 states
in which we currently operate an institute and in four other states in which
our institutes recruit students. Each of our institutes must be authorized by
the applicable state education authority or authorities to operate and grant
degrees or diplomas to their students. In addition, some states require an
institute to be in operation for a period of up to two years before such
institute can be authorized to grant degrees. Currently, each of our 67
institutes has received authorization from one or more state education
authorities.

Institutes that confer bachelor or master degrees must, in most cases, meet
additional regulatory standards. Raising the curricula of our existing
institutes to the bachelor and/or master degree level requires the approval of
state education authorities and accrediting commissions. State education laws
and regulations affect our operations and may limit our ability to introduce
degree programs or to obtain authorization to operate in some states. If any
one of our institutes lost its state authorization, the institute would be
unable to offer postsecondary education and we would be forced to close the
institute. Closing one of our institutes for any reason could have a material
adverse effect on our financial condition or results of operations.

The HEA specifies a series of criteria that each recognized accrediting
commission must use in reviewing institutions. For example, accrediting
commissions must assess the length of each academic program offered by an
institution in relation to the objectives of the degrees or diplomas offered.
Further, accrediting commissions must evaluate each institution's success with
respect to student achievement, as measured by rates of program completion,
passing of state licensing examinations and job placement. In 1998, ten of our
institutes were reviewed by their respective accrediting commission and all ten
institutes were reaccredited. In addition, three of our institutes obtained
their initial accreditation in 1998.

State authorization and accreditation by a recognized accrediting commission
are required for an institution to become and remain eligible to participate in
Title IV Programs. In addition, some states require institutions operating in
their state to be accredited as a condition of state authorization. Sixty-one
of our institutes are accredited by the ACCSCT and three are accredited by the
ACICS, both of which are accrediting commissions recognized by the DOE. The
other three institutes, which were recently opened, have applied for

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accreditation. None of our institutes accredited by the ACCSCT is on probation
or subject to a show cause order, but nine of our institutes (seven main
campuses and two additional locations) accredited by the ACCSCT are subject to
outcomes reporting. None of our institutes accredited by the ACICS is on
probation or subject to a financial or outcomes review. Under the ACCSCT and
the ACICS standards, an institution's main campus or additional location may be
placed on probation, subjected to outcomes reporting or subjected to a
financial or outcomes review for a variety of reasons. All of our institutes
that are subject to outcomes reporting by the ACCSCT received such status
because the ACCSCT determined that the student completion rates for certain
programs of study offered by these institutes are too low. Under the ACCSCT and
the ACICS standards, an institution's main campus or additional location that
is subjected to outcomes reporting or to a financial or outcomes review is
required to periodically report its results in such areas to the accrediting
commission. The loss of accreditation by one of our existing institutes or the
failure of a new technical institute to obtain full accreditation:

. would make only the affected institute ineligible to participate in Title
IV Programs, if the affected institute was an additional location;

. would make the entire campus group ineligible to participate in Title IV
Programs, if the affected institute was a main campus; and

. could have a material adverse effect on our financial condition, results
of operations and cash flows.

We have begun the process of changing the accreditation of our 61 institutes
accredited by the ACCSCT to the ACICS. We believe that ACICS accreditation is
more appropriate for our institutes for a number of reasons, including the
following:

. the ACICS's scope of accreditation, as recognized by the DOE, includes
master degree programs, unlike the ACCSCT's scope of accreditation;

. the ACICS's accrediting standards are more applicable to degree-granting
institutions than are the ACCSCT's accrediting standards; and

. the laws and/or regulations of many SEAs may, in the future, require
institutions to be accredited by an accrediting commission recognized by
the Council for Higher Education Accreditation ("CHEA"). The ACICS, but
not the ACCSCT, is recognized by the CHEA.

Changing our institutes' accreditation from the ACCSCT to the ACICS will
require us to incur additional expense and adjust some of our current
practices. In addition, we will have to demonstrate to the DOE that reasonable
cause exists for changing the accreditation of our institutes from the ACCSCT
to the ACICS. We do not believe that changing the accreditation of our
institutes from the ACCSCT to the ACICS will have a material adverse effect on
our financial condition, results of operations or cash flows.

Change in Control

The DOE, the Accrediting Commissions and most of the SEAs have Regulations
pertaining to the change in control of institutions, but these Regulations do
not uniformly define what constitutes a change in control. The DOE's
Regulations describe some transactions that are a change in control, including
the transfer of a controlling interest in the voting stock of an institution or
such institution's parent corporation. The DOE's standards also specify that a
change in control of a publicly traded corporation, such as ESI, occurs when
there is an event that obligates the corporation to file a Current Report on
Form 8-K with the SEC disclosing a change in control. Most of the SEAs and the
Accrediting Commissions include the sale of a controlling interest of common
stock in the definition of a change in control. The change in control
Regulations adopted by the DOE, the Accrediting Commissions and the SEAs are
subject to varying interpretations as to whether a particular transaction
constitutes a change in control.

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When a change in control occurs under the DOE's Regulations, an institution
immediately becomes ineligible to participate in Title IV Programs, cannot
commit additional Title IV Program funds to its students, and can only receive
and disburse certain Title IV Program funds that were previously committed to
its students. The DOE and the ACICS have advised us that this offering will not
be a change in control under their Regulations, but this offering will be a
change in control under the Regulations of some of the SEAs. The ACCSCT has
advised us that it is unnecessary for it to determine whether this offering is
a change in control under its Regulations, and that none of our institutes'
accreditation by the ACCSCT will be affected by this offering. As a result,
this offering will not affect our ability to participate in Title IV Programs,
unless any SEA or SEAs that consider this offering to be a change in control
fail to reauthorize any of our institutes. Many SEAs require that they approve
a change in control before it occurs, while others will only review a change in
control after it occurs. We have obtained all of the approvals of this offering
from the SEAs that require advance approval. Following this offering, we
believe that we will be able to obtain all of the approvals from the SEAs that
require approval after this offering occurs, but we cannot assure you that we
will receive them in a timely manner. A material adverse effect on our
financial condition, results of operations and cash flows could result if we
are unable to obtain these approvals or if we do not obtain these approvals in
a timely manner. The California SEA, which normally requires advance approval,
has advised us that it will not determine whether this offering is a change in
control until after the closing of this offering. It has also advised us that
the provisions of the California Education Code that provide for termination of
its existing authorization of our California institutes if advance approval is
not obtained do not apply to this offering. Eleven of our institutes are
located in California.

A change in control could occur as a result of future transactions in which
we, our institutes or a parent company as defined in DOE regulations are
involved. Some corporate reorganizations and some changes in the boards of
directors of such corporations are two examples of such transactions. If a
future transaction results in a change in control of ESI, our institutes or a
parent company, we believe that we will be able to obtain all necessary
approvals from the DOE, the SEAs and the Accrediting Commissions. We cannot
assure you, however, that all such approvals can be obtained in a timely manner
that would not delay the availability of Title IV Program funds or prevent some
students from receiving Title IV Program funds.

A material adverse effect on our financial condition, results of operations
and cash flows would result if we had a change in control and a material number
of our institutes failed to timely:

. obtain the approvals of the SEAs required prior to a change in control;

. obtain the required reauthorizations from the SEAs which review a change
in control after it occurs;

. regain accreditation by the Accrediting Commissions or have their
accreditation temporarily continued or reinstated by the Accrediting
Commissions; or

. regain eligibility to participate in Title IV Programs from the DOE or
receive provisional certification to temporarily continue to participate
in Title IV Programs from the DOE.

In addition, the time of year at which a change in control occurs, coupled with
the length of time that our institutes are ineligible to participate in Title
IV Programs, could have a material adverse effect on the amount of Title IV
Program funds students can obtain to pay the education costs of attending our
institutes and, accordingly, on our business, financial condition, results of
operations and cash flows.

After a change in control, an institution must file an application with the
DOE in order to have its eligibility to participate in Title IV Programs
reinstated. The DOE's reinstatement of an institution's certification to
participate in Title IV Programs depends on its determination that the
institution, under its new ownership and control, complies with specified DOE
requirements for institutional eligibility. The time required for the DOE to
act on an application can vary substantially and may take several months. Among
other things, the application must demonstrate that, following the change in
control, the main campus and all of the

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additional locations and branch campuses that comprise the institution are
authorized by the appropriate state education authority or authorities and
accredited by an accrediting commission recognized by the DOE. The 1998 HEA
Amendments provide that the DOE may provisionally certify an institution
undergoing a change in control based on the DOE's preliminary review of the
institution's materially complete application for reinstatement received by the
DOE within 10 business days of the change in control. This provisional
certification would allow the institution temporarily to maintain its
eligibility to participate in Title IV Programs following a change in control
while the DOE considers the institution's application for reinstatement. The
DOE has not yet issued regulations or guidance regarding how it will interpret
or apply this amendment to the HEA.

The Accrediting Commissions will not reaccredit an institution following a
change in control until the institution submits an application for
reaccreditation, which requires documentation that the institution has been
reauthorized, or continues to be authorized, by the appropriate SEA or SEAs.
The standards of the ACCSCT provide that, during the 30 days immediately
preceding the change in control, the ACCSCT will determine whether to
temporarily continue the institution's accreditation for a period of six months
after the change to allow time for the completion and review of the
application. The standards of the ACICS provide that, generally within five
business days after an institution documents that it has been reauthorized, or
continues to be authorized, by the appropriate SEA or SEAs following a change
in control, the ACICS will determine whether to temporarily reinstate the
institution's accreditation for an undefined period to allow for the completion
and review of the application. The ACCSCT currently accredits 61 of our
institutes and the ACICS currently accredits three of our institutes.

Many of the SEAs require that a change in control of an institution be
approved before it occurs in order for the institution to maintain its SEA
authorization. Other SEAs will only review a change in control of an
institution after it occurs.

The DOE, the Accrediting Commissions and most of the SEAs considered Starwood
Hotels' acquisition of ITT to be a change in control of ESI and our institutes.
As a result, effective upon that acquisition, each of our campus groups
immediately became ineligible to participate in Title IV Programs. We obtained
all approvals of the acquisition from the Accrediting Commissions and the SEAs.
In March 1998, four weeks after Starwood Hotels acquired ITT, the DOE approved
the reinstatement of each campus group's participation in Title IV Programs.
The DOE's approval was on a provisional basis, which is the DOE's practice for
all institutions following a change in control.

As an additional condition of each institute's provisional certification, the
DOE directed us to maintain a sufficient, but undefined, level of cash or cash
equivalents, and to revise our current accounting treatment of direct marketing
costs, revenue recognition and amortization of direct marketing costs or
provide evidence that our treatment of these items conforms with Generally
Accepted Accounting Principles ("GAAP"). We believe that our treatment of these
items is in accordance with GAAP and that we maintain cash and cash equivalents
in sufficient amounts to satisfy the DOE, but we cannot assure you of this. If
the DOE requires us to change our accounting treatment for any of the above
items, we do not believe that such change would have a material adverse effect
on our financial condition or results of operations before the cumulative
effect of any change in accounting. Four of our campus groups (consisting of
six institutes) each had one additional condition placed on its provisional
certification. See "--Regulation of Federal Financial Aid Programs--Eligibility
and Certification Procedures."

The secondary offering of 13,050,000 shares of our common stock owned by ITT
completed on June 9, 1998 was a change in control under the Regulations of
certain SEAs, but not under the Regulations of the DOE or of either Accrediting
Commission. We obtained all approvals required in connection with the June 1998
offering from the SEAs.

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Federal Income Tax Relief

Federal income tax relief in the form of tax credits, tax deductions and
income exclusions is available to students and their families beginning in 1998
under the Taxpayer Relief Act of 1997, as amended by the IRS Restructuring and
Reform Act of 1998 ("TRA"). The TRA :

. provides an annual Hope Scholarship tax credit of up to $1,500 for
tuition and related expenses incurred on or after January 1, 1998, for
each of a student's first two years of postsecondary education.

. provides an annual Lifetime Learning tax credit of up to $1,000 in 1998
through 2002 and up to $2,000 in subsequent years for tuition and related
expenses incurred on or after July 1, 1998. The Lifetime Learning tax
credit is not available in any tax year in which the taxpayer is claiming
the Hope Scholarship tax credit.

. provides an annual tax deduction, ranging from up to $1,000 in 1998 to up
to $2,500 in 2001 and thereafter, for interest paid during the first 60
months in which interest payments are required on any student loan or
loans incurred solely to pay qualified higher education expenses.

. provides an annual income exclusion of up to $5,250 for undergraduate
educational expenses incurred on or after January 1, 1998, and before
June 1, 2000, that are paid by the student's employer.

. allows taxpayers to establish Education IRAs, for taxable years beginning
on or after January 1, 1998, that can be funded with non-deductible
contributions of up to $500 annually for any child up to the age of 18
years, and the earnings on those accounts are tax-free if the funds are
used to pay for qualified higher education expenses before the student
reaches the age of 30 years.

The tax benefits provided by the TRA may reduce the effective cost of
postsecondary education to the student and his or her family, which may
increase enrollments at our institutes, decrease student dependence on Title IV
Program funds and decrease Title IV Program loan defaults. Educational
institutions are required to submit certain information about the student and
the student's family to the Internal Revenue Service ("IRS") in order for the
student and the student's family to qualify for some of the tax benefits under
the TRA. These IRS reporting requirements will increase our administrative
burden, but such compliance will not have a material adverse effect on our
financial condition, results of operations or cash flows.

Legal Proceedings

We are subject to litigation in the ordinary course of our business. Among
the legal actions currently pending and recently concluded are the following
cases. We have agreed to settle all of the plaintiffs' claims in these cases.
The settlements that are class settlements are subject to court approval and to
the right of the class members to opt out of the settlement.

1. Eldredge, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 689376) (the "Eldredge Case") was filed on June 8, 1995, in the
Superior Court of San Diego County in San Diego, California by seven
graduates of the hospitality program offered at our San Diego institute.
The suit alleged, among other things, misrepresentation, civil
conspiracy and statutory violations of the California Education Code
(including the Maxine Waters School Reform and Student Protection Act of
1989) ("CEC"), California Business and Professions Code ("CBPC") and
California Consumer Legal Remedies Act ("CCLRA") by us, ITT and three of
our employees. The plaintiffs claimed that the defendants (1) made
misrepresentations and engaged in deceptive acts in the recruitment of
the plaintiffs for, and/or in the promotion of, the program, (2)
provided inadequate instruction to the plaintiffs, (3) used inadequate
facilities and equipment in the program and inappropriate forms of
contracts with the plaintiffs, (4) failed to provide the plaintiffs with
all required information and disclosures and (5) misrepresented the
plaintiffs' prospects for employment upon graduation, the employment of
the program's graduates and the plaintiffs' ability to transfer program
credits. The jury rendered a verdict against us and ITT in this action
in October 1996. General damages of approximately $0.2 million were
assessed against us and ITT, jointly, on the plaintiffs'

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misrepresentation and CEC claims. Exemplary damages in the amount of
$2.6 million were assessed against us and exemplary damages in the
amount of $4.0 million were assessed against ITT. The judge also awarded
the plaintiffs attorney's fees and costs in the amount of approximately
$0.9 million. Prejudgment interest was assessed on the general damages
award and post-judgment interest was assessed on the entire award. The
plaintiffs' CBPC and CCLRA claims and their claims against our employees
were dismissed, and the judge granted a judgment notwithstanding the
verdict, setting aside the verdict against ITT. We appealed the awards
rendered against us, and the plaintiffs appealed the judgment against
plaintiffs on their claims against ITT.

In September 1998, we settled all of the plaintiffs' claims in the
Eldredge Case in conjunction with the settlement of other related legal
proceedings and claims discussed below. We recorded a $12.9 million
provision in September 1998 associated with all of these settlements,
including the legal and administrative expenses we expect to incur in
order to consummate these settlements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Results of
Operations." All of the parties in the Eldredge Case have dismissed
their respective appeals. In November 1998, based on the joint
application and stipulation filed by us and the plaintiffs in the
Eldredge Case, the appellate court reversed the judgment against us and
remanded the case back to the trial court, which vacated and set aside
the judgment and dismissed the case with prejudice in December 1998. A
California statute prohibits the California SEA from approving an
application for a change in control of any institution submitted by an
applicant that has been found in any judicial or administrative
proceeding to have violated Chapter 7 (formerly Chapter 3) of the CEC
("Chapter 7"). We believe that since the judgment in the Eldredge Case
was reversed, vacated and set aside, the California SEA is no longer
prohibited from approving any subsequent application for a change in
control submitted by us or any of our 11 institutes in California.

Other related legal proceedings and claims (as discussed below) have
resulted and may continue to result from other persons alleging similar
claims of misrepresentation and violations of certain statutory
provisions.

2. Robb, et al. v. ITT Educational Services, Inc., et al. (Civil Action No.
00707460) (the "Robb Case") was filed on January 24, 1997, in the
Superior Court of San Diego County in San Diego, California by four
graduates of our San Diego institute. The suit, as originally filed,
alleged, among other things, statutory violations of the CEC and CBPC by
us and ten of our employees. The plaintiffs in the original complaint
sought compensatory damages, civil penalties, injunctive relief,
disgorgement of ill-gotten gains, restitution (including return of
educational costs) on behalf of plaintiffs and all other persons
similarly situated who attended any of our institutes in California,
attorney's fees and costs, and also sought to have the action certified
as a class action. The plaintiffs amended their complaint on August 14,
1997. The amended complaint deleted three and added two named
plaintiffs. Each of the three plaintiffs was a student who attended one
of three different programs (i.e., hospitality, EET and CAD) at a
California institute. The plaintiffs in the amended complaint alleged
only violations of the CEC, based on the plaintiffs' claims that the
defendants (1) made misrepresentations and engaged in deceptive acts in
the recruitment of students for, and/or in the promotion of, the
programs offered in California, (2) failed to provide students with all
required information and disclosures and (3) misrepresented students'
prospects for employment upon graduation and the employment of the
programs' graduates. The plaintiffs sought (1) a refund of an
unspecified amount representing all consideration paid to us by the
plaintiffs and all other persons similarly situated who attended any of
the programs in California at any time from January 1, 1991 through
December 31, 1996, (2) a state statutory penalty equal to two times the
refund amount, (3) injunctive relief and (4) an unspecified amount of
attorney's fees and costs.

In May 1998, we settled all of the claims of one of the three plaintiffs
in this legal proceeding. In September 1998, we agreed to settle all of
the claims of the two remaining plaintiffs in this legal proceeding and
to seek a class settlement of the claims of the approximately 19,000
other persons who attended any program (other than the hospitality
program) at any of our institutes in California

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from January 1, 1990 through December 31, 1997. The class settlement,
which is subject to court approval, would provide class members with
nontransferable tuition credits to attend a different educational
program at any of our institutes in the amount of: (1) $250 per quarter
off the then prevailing quarterly tuition for class members who
completed at least 50% of an associate degree program at one of our
institutes in California; (2) $125 per quarter off the then prevailing
quarterly tuition for class members who completed (a) less than 50% of
an associate degree program at one of our institutes in California or
(b) at least 50% of a bachelor degree program at one of our institutes
in California; and (3) $62.50 per quarter off the then prevailing
quarterly tuition for class members who completed less than 50% of a
bachelor degree program at one of our institutes in California. The
class member can use the tuition credit toward the cost of attending
any of our institutes' programs that the class member had not
previously attended. In addition to the issuance of tuition credits, we
have also agreed to stipulate to a permanent injunction that would
enjoin us from certain recruitment practices (none of which we
currently follow) and to pay the plaintiffs' reasonable attorneys' fees
and expenses. If more than 1% of the class members opt out of the class
settlement, we may, in our sole discretion, terminate the class
settlement.

3. Iverson, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 00707705); Ohrt v. ITT Educational Services, Inc., et al. (Civil
Action No. 00707706); Sayers v. ITT Educational Services, Inc., et al.
(Civil Action No. 00707707); Barrent, et al. v. ITT Educational
Services, Inc., et al. (Civil Action No. 00707708) (the "Barrent Case");
and Kellum, et al. v. ITT Educational Services, Inc., et al. (Civil
Action No. 00707709) (the "Kellum Case") were each filed on January 31,
1997, in the Superior Court of San Diego County in San Diego,
California. Each of the five actions (involving, in total, 16 former
students who attended the hospitality program at our San Diego
institute) alleged statutory violations of the CEC, the CBPC and the
California Consumer Contract Awareness Act of 1990, intentional
misrepresentation and/or concealment, and civil conspiracy by us, ITT
and one of our employees. The plaintiffs claimed that the defendants (1)
made misrepresentations and engaged in deceptive acts in the recruitment
of the plaintiffs for, and/or in the promotion of, the program, (2) used
inadequate facilities and equipment in the program and inappropriate
forms of contracts with the plaintiffs, (3) failed to provide the
plaintiffs with all required information and disclosures and a fully
executed copy of their contracts with us and (4) misrepresented the
plaintiffs' prospects for employment upon graduation, the employment of
the program's graduates and the externship portion of the program. The
plaintiffs in each action sought various forms of recovery, including
(1) an unspecified amount for compensatory damages, disgorgement of ill-
gotten gains, restitution, attorney's fees and costs, (2) state
statutory penalties equal to two times actual damages, (3) injunctive
relief and (4) $10 million in exemplary damages.

In May 1998, we settled all of the claims of four of the five
plaintiffs in the Kellum Case and five of the six plaintiffs in the
Barrent Case. In September 1998, we settled all of the claims of the
remaining seven plaintiffs in these five legal proceedings. In October
1998, the court dismissed all five of these legal proceedings with
prejudice.

4. Collins, et al. v. ITT Educational Services, Inc., et al. (Civil Action
No. 98 cv 0659 BTM) (the "Collins Case") was filed on April 6, 1998, in
the U.S. District Court for the Southern District of California in San
Diego, California by nine former students who attended the hospitality
program at either our Maitland or San Diego institutes. The suit alleged
violations of the federal Racketeer Influenced and Corrupt Organizations
Act, the CEC, the CBPC, the CCLRA, the Florida Deceptive and Unfair
Trade Practices Act, the Florida Civil Remedies for Criminal Practices
Act and Florida statutes prohibiting misleading advertising, common law
fraud and/or concealment and civil conspiracy by us and ITT. The
plaintiffs claimed that the defendants (1) made misrepresentations and
engaged in deceptive acts in the recruitment of students for, and/or in
the promotion of, the program, (2) failed to provide students with all
required information and disclosures and (3) misrepresented students'
prospects for employment upon graduation, the employment of the
program's graduates and the students' externship portion of the program.
The plaintiffs sought various forms of recovery on

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behalf of the plaintiffs and all other persons similarly situated who
attended the program at our Indianapolis, Maitland, Portland or San
Diego institutes at any time from January 1, 1990 through December 31,
1996, including (1) an unspecified amount for compensatory damages,
exemplary damages, rescission and the return of all tuition and fees
paid to us by or on behalf of students who attended the program, the
disgorgement of ill-gotten gains, restitution, attorney's fees and
costs, (2) state statutory penalties of two and three times actual
damages, (3) a federal statutory penalty of $45 million and (4)
injunctive relief.

In September 1998, we agreed to seek a class settlement of the claims
of the nine plaintiffs in this legal proceeding and of the
approximately 1,200 other persons who attended an associate degree
program in hospitality at our institutes in Maitland, San Diego,
Portland or Indianapolis (the only institutes where the hospitality
program was offered). The class settlement, which is subject to court
approval, involves our payment of cash to the class members and the
plaintiffs' reasonable attorneys' fees and expenses. If more than 1% of
the class members opt out of the class settlement, we may, in our sole
discretion, terminate the class settlement. In December 1998, the court
granted preliminary approval of the class settlement.

5. In August 1998, 15 former students who attended the hospitality program
at our institutes in San Diego or Maitland threatened to commence legal
proceedings against us and others. The claimants alleged, among other
things, statutory violations, misrepresentation, fraud and concealment
by us and others arising out of their recruitment to attend, and their
education at, our institutes. In September 1998, we settled all of the
claims of the 15 claimants.

On September 22, 1997, we received an inquiry from the staff of the U.S.
Federal Trade Commission requesting information relating to our offering and
promotion of vocational or career training. We responded to this inquiry in
November 1997 and have received no further requests.

We cannot assure you of the ultimate outcome of any litigation involving us.
We do not believe any pending legal proceeding will result in a judgment or
settlement that will have, after taking into account our existing insurance and
provisions for such liabilities, a material adverse effect on our financial
condition, results of operations or cash flows, unless (1) we fail to obtain
court approval of the class settlement in the Robb Case or the Collins Case and
a significant amount of litigation against us results from such failure or (2)
a significant number of class members opt out of either class settlement and
pursue litigation against us. Any litigation alleging violations of education
or consumer protection laws and/or regulations, misrepresentation, fraud or
deceptive practices may also subject our affected institutes to additional
regulatory scrutiny.

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MANAGEMENT

Executive Officers

The following table sets forth information about our current executive
officers.

[Download Table]

Name Age Position
---- --- --------

Rene R. Champagne....... 57 Chairman, President and Chief Executive Officer
Gene A. Baugh........... 56 Senior Vice President and Chief Financial Officer
Clark D. Elwood......... 38 Senior Vice President, General Counsel and Secretary
Edward G. Hartigan...... 59 Senior Vice President
Thomas W. Lauer......... 52 Senior Vice President

Rene R. Champagne has served as Chairman since October 1994, President and
Chief Executive Officer since September 1985 and has served as a Director since
October 1985.

Gene A. Baugh has served as Chief Financial Officer since December 1996 and
Senior Vice President since January 1993. From 1981 through November 1996 he
served as Treasurer and Controller.

Clark D. Elwood has served as Senior Vice President since December 1996,
Secretary since October 1992 and General Counsel since May 1991. From January
1993 through November 1996, he served as Vice President.

Edward G. Hartigan has served as Senior Vice President since January 1993.

Thomas W. Lauer has served as Senior Vice President since January 1993.

SELLING STOCKHOLDER AND ESI REPURCHASE

Starwood Hotels, through its subsidiary ITT, is selling 7,000,000 shares of
our common stock in this offering and has granted the underwriters an over-
allotment option for an additional 950,000 shares of our common stock. In
addition, we have entered into a Stock Repurchase Agreement, pursuant to which
we have agreed to repurchase from the Selling Stockholder 1,500,000 shares of
our common stock at a price equal to the lesser of (1) the public offering
price per share, less underwriting discounts and commissions and (2) $32.84 per
share. We currently plan to fund this repurchase from cash and cash equivalents
and marketable debt securities. Following this offering and the stock
repurchase, the Selling Stockholder will own 950,000 shares of our common
stock. If the underwriters exercise the over-allotment option in full, the
Selling Stockholder will no longer own any shares of our common stock.

The consummation of this offering and the stock repurchase will be concurrent
and the stock repurchase will be contingent on the closing of this offering. We
and the Selling Stockholder have the right to terminate the stock repurchase
under certain circumstances, including if the anticipated public offering price
in this offering is unacceptable to the Selling Stockholder or if the closing
of this offering has not occurred by March 31, 1999. Pursuant to an Amended and
Restated Registration Rights Agreement, we have agreed to pay the expenses of
this offering incurred by ESI (other than underwriting discounts and
commissions and the Selling Stockholder's legal, accounting and advisors'
expenses in connection with this offering). Pursuant to the Stock Repurchase
Agreement, however, the Selling Stockholder has agreed to reimburse us upon the
consummation of this offering $500,000 for administrative expenses and an
additional $500,000 for administrative expenses if certain conditions related
to this offering are satisfied. We have also agreed with the Selling
Stockholder to indemnify each other against certain liabilities which may arise
in connection with this offering, the stock repurchase or the related
transactions.

In the Stock Repurchase Agreement, the Selling Stockholder has agreed to use
its best efforts to obtain the resignations of the four Directors who were
nominated by the Selling Stockholder, effective upon the consummation of this
offering and the stock repurchase. Also in connection with this offering and
the stock repurchase, we are amending certain of our arrangements with the
Selling Stockholder and its affiliates. See "Relationship with Selling
Stockholder and Related Transactions."

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RELATIONSHIP WITH SELLING STOCKHOLDER AND RELATED TRANSACTIONS

General

Prior to this offering, ITT holds 35% of the outstanding shares of our common
stock. In connection with Starwood Hotels' acquisition of ITT on February 23,
1998, four of our directors who were also officers or directors of ITT
resigned. On February 25, 1998, the remaining members of our Board of Directors
elected four individuals recommended by ITT (Tony Coelho, Robin Josephs,
Merrick R. Kleeman and Barry S. Sternlicht) to fill the vacancies caused by
these resignations. Mr. Coelho, Ms. Josephs, Mr. Kleeman and Mr. Sternlicht
were elected for the terms expiring at the Annual Meeting of Shareholders as
follows: Mr. Coelho, 2000; Ms. Josephs, 1999; Mr. Kleeman, 2000; and Mr.
Sternlicht, 1998. Mr. Sternlicht was re-elected as a Director at the 1998
Annual Meeting of Shareholders for a term expiring at the 2001 Annual Meeting
of Shareholders. Mr. Sternlicht serves as chairman and chief executive officer
and a director of Starwood Hotels & Resorts Worldwide, Inc. Mr. Sternlicht is
also the general manager of Starwood Capital Group, L.L.C., which, together
with its affiliates and Mr. Sternlicht, beneficially owns approximately 5.9% of
the outstanding units of Starwood Hotels & Resorts Worldwide, Inc. common stock
and Starwood Hotels & Resorts Class B shares of beneficial interest. Mr.
Kleeman is also a managing director of Starwood Capital Group, L.L.C. Mr.
Coelho and Ms. Josephs are not affiliated with ITT, Starwood Hotels, Starwood
Hotels & Resorts or Starwood Capital Group, L.L.C. ITT has agreed to use its
best efforts to obtain the resignations of Mr. Coelho, Ms. Josephs, Mr. Kleeman
and Mr. Sternlicht from our Board of Directors upon the consummation of this
offering and the stock repurchase. See "Selling Stockholder and ESI
Repurchase."

Services

Set forth below are descriptions of some services ITT provided to us from the
date of our initial public offering in 1994 until the secondary offering of our
common stock owned by ITT in June 1998 (the "June 1998 Offering"). As described
below and in "--Agreements With Selling Stockholder," there have been changes
in such arrangements in connection with Starwood Hotels' acquisition of ITT,
the June 1998 Offering and this offering.

Treasury and Financing Services. Until February 5, 1998, ITT provided us with
centralized treasury and financing services. As part of these functions, we
remitted our surplus cash receipts to ITT, and ITT advanced cash, as necessary,
to us. From January 1, 1998 through February 5, 1998, the net amount of cash
transferred from ITT to us, exclusive of payments for the services described
below, was $94,284,000 and aggregate payments for the services described below
were $8,607,000. ITT paid interest to us on the average of our net cash
balances held by ITT. For the period January 1, 1998 through February 5, 1998,
we received net interest income from ITT in the amount of $549,000. We have
been managing and investing our own cash since February 5, 1998. We have not
been able to obtain the same yields on our cash balances that ITT paid.
Accordingly, interest income, net decreased in 1998.

General and Administrative Services. Under agreements in place prior to the
June 1998 Offering, ITT periodically provided advice and assistance to us with
regard to certain risk management, accounting, tax and other management
services. We ceased using substantially all of these services and incurring the
related fee at the time of Starwood Hotels' acquisition of ITT. The fee for
these services was $15,000 for the period in 1998 that we used these services.

Pension Plan. From December 19, 1995 until the June 1998 Offering, we
participated in the Retirement Plan for Salaried Employees of ITT Corporation
(the "Pension Plan"), a non-contributory defined benefit pension plan which
covered substantially all of our employees. ITT determined the aggregate amount
of pension expense on a consolidated basis based on actuarial calculations, and
such expense was allocated to participating units on the basis of compensation
covered by the plan. Prior to December 19, 1995, we participated in the
Retirement Plan for Salaried Employees of Old ITT (the "Old Pension Plan"),
which was substantially identical to the terms of the Pension Plan. For the
period January 1, 1998 through June 9, 1998, our pension expense was
$1,858,000. Federal legislation limits the amount of benefits that can be paid
and compensation that may be recognized under a tax-qualified retirement plan.
ITT adopted a non-qualified

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unfunded retirement plan (the "Excess Pension Plan") for payment of those
benefits at retirement that could not be paid from the qualified Pension Plan.
The practical effect of the Excess Pension Plan was to continue calculation of
retirement benefits to all employees on a uniform basis. We paid directly the
benefits for our employees under the Excess Pension Plan. Any "excess" benefit
accrued to any such employee was immediately payable in the form of a single
discounted lump sum payment upon the occurrence of a change in corporate
control. The approval by ITT's shareholders of Starwood Hotels' acquisition of
ITT constituted a change in corporate control as defined in the Excess Pension
Plan, which resulted in a distribution of all of the accrued benefits under the
Excess Pension Plan to the participants. After the June 1998 Offering, we
implemented our own pension and excess pension plans.

Retirement Savings Plan. Prior to May 16, 1998, we participated in The ITT
401k Retirement Savings Plan (the "Savings Plan"), a defined contribution
pension plan which covered substantially all of our employees. Employees could
contribute (subject to certain IRS limitations) amounts ranging from 2% to 16%
of their base pay. We contributed 1% of the employee's covered pay and matched
the employee's contributions at the rate of 50% up to a maximum of 5% of
covered pay, amounting to a maximum matching contribution of 2.5% of the
employee's covered pay. Our non-matching and matching contributions were, prior
to Starwood Hotels' acquisition of ITT, in the form of common shares of ITT.
After Starwood Hotels' acquisition of ITT and before May 16, 1998, our non-
matching and matching contributions were in the form of paired shares of
Starwood Hotels & Resorts Worldwide, Inc. common stock and Starwood Hotels &
Resorts beneficial interest. ITT charged us the costs of our non-matching and
matching contributions. For the period January 1, 1998 through May 15, 1998,
our costs of providing this benefit (including an allocation of the
administrative costs of the plan) were $774,000. Federal legislation limited
the annual contributions which an employee could make to the Savings Plan, a
tax-qualified retirement plan. Accordingly, ITT adopted, and we participated
in, prior to Starwood Hotels' acquisition of ITT, an ITT Excess Savings Plan
(the "Excess Savings Plan"), a non-qualified retirement plan, which enabled
employees who were precluded by these limitations from contributing 5% of their
salary to the tax-qualified plan to make up the shortfall through salary
deferrals and, thereby, receive the 1% non-matching company contribution and
the 2.5% matching company contribution otherwise allowable under the tax-
qualified plan. Salary deferrals, company contributions and imputed earnings
were entered into a book reserve account maintained by ITT for each
participant. The account balance maintained on behalf of a participant was
immediately payable in a single lump sum payment upon the occurrence of a
change in control. The approval by ITT's shareholders of Starwood Hotels'
acquisition of ITT constituted a change in control as defined in the Excess
Savings Plan, which resulted in a distribution of all the account balances
maintained under the Excess Savings Plan to participants. We adopted our own
401(k) and excess savings plans that became effective on May 16, 1998.

Group Medical Benefits. In 1998, we began providing all of our own medical
insurance benefits to our employees, but we continued to utilize ITT's services
in the administration of our indemnity medical plan. We were responsible for
all claims incurred under our indemnity plan, but in 1998 our liability for
such claims was subject to stop loss coverage for individual medical claims
greater than $50,000. We paid an allocated share of all indemnity plan claims
in excess of $50,000 for all companies affiliated with ITT that participated in
this stop loss arrangement. We also paid our share of the administrative and
stop loss pooling expenses incurred by ITT with respect to these services. For
1998, we made payments to ITT for these services totaling $1,615,000.

Federal Income Taxes. Prior to the June 1998 Offering, we had been included
in the consolidated U.S. federal income tax return of ITT. Under an agreement
with ITT, income taxes were allocated among affiliates of ITT based upon the
amounts they would pay or receive if they filed a separate income tax return.
For the period January 1, 1998 through June 9, 1998, our allocated federal
income taxes were $4,345,000.

Agreements With Selling Stockholder

Set forth below are descriptions of some agreements between us and ITT and/or
its affiliates that we entered into in connection with the June 1998 Offering.
Pursuant to the Stock Repurchase Agreement, certain provisions of these
agreements are being amended in connection with this offering. See "--Stock
Repurchase Agreement."

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Amended and Restated Registration Rights Agreement. An Amended and Restated
Registration Rights Agreement (the "Registration Rights Agreement"), among
other things, provides that, upon request of ITT, we will register under the
Securities Act any of the shares of our common stock held by ITT for sale in
accordance with ITT's intended method of disposition, and we will take any
action necessary to permit the sale of such shares in other jurisdictions. ITT
has the right to request two such registrations. We will pay all registration
expenses (other than underwriting discounts and commissions and ITT's legal,
accounting and advisors' expenses) in connection with such registrations. ITT
also has the right, which it may exercise at any time and from time to time
during the term of the agreement, to include the shares of our common stock
held by it in other registrations of shares of our common stock initiated by us
on our own behalf or on behalf of any other person. We will pay all
registration expenses (other than underwriting discounts and commissions
related to the shares of our common stock sold by ITT, ITT's legal, accounting
and advisors' expenses, and the filing fees payable under the Securities Act
for the shares of our common stock sold by ITT) in connection with each such
registration. The rights of ITT under the Registration Rights Agreement are
transferable by ITT. The Registration Rights Agreement terminates on June 9,
2003. In 1998, we incurred $1,117,000 in costs associated with the June 1998
Offering under the predecessor to the Registration Rights Agreement and
approximately $103,000 in costs associated with this offering under the
Registration Rights Agreement. We will be paying the remaining costs of this
offering in 1999 pursuant to the Registration Rights Agreement.

The Registration Rights Agreement prohibits the holder of any shares of our
common stock that we register pursuant to such agreement from disposing of any
such shares if the disposition would cause a change in control of ESI or any of
our institutes, until we receive all of the required prior approvals of the
DOE, Accrediting Commissions and SEAs.

Trade Name and Service Mark License Agreement. A Trade Name and Service Mark
License Agreement (the "License Agreement"), among other things, provides that
ITT Sheraton Corporation ("Sheraton"), an ITT affiliate, grants to us for a
period of seven years from June 1998 a non-exclusive, non-transferable,
worldwide, royalty-free license to use the "ITT" corporate and trade name,
service mark and trademark "ITT" (the "Licensed Mark") solely in connection
with the operation of our business and in a manner specifically identified in
the License Agreement. This period may be extended for an additional five years
if we request an extension and we can reach an agreement with Sheraton on the
amount of royalties, if any, that we would pay during such extension. The
License Agreement further provides that (1) our use of the Licensed Mark shall
be consistent with Sheraton guidelines and standards, (2) certain of our
materials bearing the Licensed Mark must contain a prescribed notice and (3)
certain changes in control of ESI, as defined in the License Agreement, will
terminate the License Agreement. Pursuant to the Stock Repurchase Agreement, we
have agreed to enter into an amendment to the License Agreement that will
become effective upon the closing of this offering and the stock repurchase.
See "--Stock Repurchase Agreement."

Amended and Restated Income Tax Sharing Agreement. Prior to the June 1998
Offering, we had been included in the consolidated United States federal income
tax return of ITT. We also had been included in certain state and local tax
returns of ITT or its subsidiaries. An Amended and Restated Income Tax Sharing
Agreement (the "Tax Agreement") which became effective at the time of the June
1998 Offering, provides, among other things, for the allocation of liability
for federal, state and local taxes between us and ITT. Under the Tax Agreement,
we are responsible for all federal, state and local taxes related to our
operations before and after the June 1998 Offering, and Starwood Hotels is
responsible for all such taxes related to all other operations of Starwood
Hotels and its subsidiaries before and after the June 1998 Offering.

The Tax Agreement also sets forth procedures for filing returns, paying
estimated taxes, amending returns, allocating refunds, tax audits and contests
and certain tax elections. In particular, all tax refunds attributable to our
operations will be paid to us and we will pay all tax assessments, interest and
penalties attributable to our operations. Starwood Hotels is responsible for
preparing and filing all tax returns, and any amendments to these returns,
involving our operations prior to the June 1998 Offering, and we are
responsible for preparing and filing all tax returns, and any amendments to
these returns, involving our operations following the June 1998 Offering.

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Stockholder Agreement. A Stockholder Agreement (the "Stockholder Agreement"),
among other things, provides that:

. the authorized number of directors on our Board of Directors (the
"Board") shall not exceed 10;

. the authorized number of classes of directors of the Board shall not
exceed three;

. in connection with each annual meeting of our shareholders, the Board
shall nominate and recommend such number of persons (rounded up to the
next whole number but not to exceed four) designated by ITT to be elected
to the Board so that the total number of ITT designees on the Board is in
relative proportion to the percentage of the outstanding shares of our
common stock held by ITT and its affiliates (collectively, the "ITT
Group"); and

. the membership of our standing Nominating Committee of the Board shall be
limited to four members, two of whom must be directors who are ITT
designees until the number of ITT designees on the Board is two, in which
event only one ITT designated director must be on the Nominating
Committee, and if there is one ITT designee on the Board, such designee
is not required to be on the Nominating Committee (collectively, the
"Board Rights").

The Stockholder Agreement also provides that the Board Rights shall terminate
when the ITT Group holds less than 7.5% of the outstanding shares of our common
stock. The ITT Group may assign the Board Rights in whole, but not in part, to
any one transferee from the ITT Group of 10% or more of the outstanding shares
of our common stock (the "Rights Transferee"). The ITT designees currently on
the Board are Tony Coelho, Robin Josephs, Merrick R. Kleeman and Barry S.
Sternlicht. Upon completion of this offering and the stock repurchase, whether
or not the underwriters exercise the over-allotment option, the ITT Group will
hold less than 7.5% of our outstanding common stock, terminating the Board
Rights.

The Stockholder Agreement prevents us, as a result of any statutory anti-
takeover or other anti-takeover provisions adopted by us, from (1)
significantly limiting or restricting the ability of the ITT Group or any
transferee from the ITT Group of 10% or more of the outstanding shares of our
common stock to transfer or vote our common stock held by it or (2)
significantly adversely affecting the value of the shares of our common stock
currently owned by the ITT Group or any transferee from the ITT Group of 10% or
more of the outstanding shares of our common stock. The Stockholder Agreement
also prevents us from taking any action that would subject any such shares to
any restriction, limitation or provision of law to which other holders of our
common stock are not subject. These restrictions will end when the ITT Group
holds less than 10% of the outstanding shares of our common stock. Upon the
closing of this offering and the stock repurchase, the ITT Group will hold less
than 10% of our outstanding common stock.

The Stockholder Agreement prohibits the ITT Group or the Rights Transferee
from transferring any of the shares of our common stock if such transfer would
cause a change in control of ESI or any of our institutes, until we receive all
of the required prior approvals of the DOE, Accrediting Commissions and SEAs.

The Stockholder Agreement also includes reciprocal indemnifications of ITT
and ESI by the other against all losses, claims and expenses arising after June
9, 1998 from (1) any misstatements or omissions by the indemnifying party in
the Registration Statement and Prospectus for the June 1998 Offering or (2) any
current or future litigation involving the indemnifying party's operations or
business. Pursuant to these provisions, we will indemnify ITT against all
expenses and any liabilities incurred by ITT in connection with the Eldredge
case and similar lawsuits described under "Business--Legal Proceedings."

The Stockholder Agreement preserves our access to certain insurance policies
covering us when we were a subsidiary of ITT.

Employee Benefits Agreement. An Employee Benefits Agreement (the "Benefits
Agreement"), among other things, provides for the allocation and assignment of
the respective rights and obligations of ESI and ITT before and after the June
1998 Offering with respect to benefits and compensation matters pertaining to
our

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current and former employees. Under the terms of the Benefits Agreement, after
the June 1998 Offering we ceased participation in all ITT employee benefit
plans and programs, the services provided to us under our former Employee
Benefits and Administrative Services Agreement with ITT ceased and we became
responsible for establishing and maintaining our own employee benefit plans and
programs.

In particular, the Benefits Agreement ended participation of our employees in
the Pension Plan, the Excess Pension Plan, the Savings Plan and the Excess
Savings Plan. The Pension Plan retained all assets and all liabilities for the
benefits accrued under it by our participating employees. We assumed the
liability for all benefits accrued under the Excess Pension Plan by each of our
participating employees since the date of Starwood Hotels' acquisition of ITT
and prior to the June 1998 Offering. The Savings Plan transferred a significant
portion of the assets in such plan for the accounts of our employees to a
qualified 401(k) plan established by us, and we assumed all obligations with
respect to such transferred assets. We assumed the liability for all benefits
accrued under the Excess Savings Plan by each of our participating employees
since the date of Starwood Hotels' acquisition of ITT and prior to the June
1998 Offering.

The Benefits Agreement also provides that, during 1998, we could utilize
ITT's services in the administration of our indemnity medical plan. We were
responsible for all claims incurred under our indemnity plan, but in 1998 our
liability for such claims was subject to stop loss coverage for individual
medical claims greater than $50,000. We paid an allocated share of all
indemnity plan claims in excess of $50,000 for all companies affiliated with
ITT that participated in this stop loss arrangement. We also paid our share of
the administrative and stop loss pooling expenses incurred by ITT with respect
to these services.

In accordance with the Benefits Agreement, ITT transferred assets relating
to, and we assumed all obligations for, (1) all future post-retirement medical
plan obligations attributable to one of our employees and (2) medical and life
insurance coverage of our current and former disabled employees entitled to
such coverage. ITT retained all assets relating to, and all obligations to
provide, (1) retiree life insurance coverage to our former employees entitled
to such coverage as of December 31, 1997 and (2) disability payments to our
current and former employees who were disabled as of December 31, 1997 and are
receiving disability payments under ITT's long-term disability plan.

In addition to the other employee benefit plans and programs offered by us,
we offer our own 401(k) plan, excess savings plan, pension plan and excess
pension plan for the benefit of our employees, at a cost similar to what we
paid to participate in comparable plans offered by ITT.

Stock Repurchase Agreement. In connection with this offering, we have entered
into a Stock Repurchase Agreement, pursuant to which we and the Selling
Stockholder have agreed, among other things, to the following:

. we will repurchase from the Selling Stockholder 1,500,000 shares of our
common stock at a per share price equal to the lesser of (1) the public
offering price, less underwriting discounts and commissions and (2)
$32.84;
. upon completion of this offering and the stock repurchase, the Selling
Stockholder will reimburse us $500,000 for administrative expenses and an
additional $500,000 for administrative expenses if certain conditions
related to this offering are satisfied;

. the License Agreement will be amended, effective upon the consummation of
this offering and the stock repurchase, and would:

. provide us with a perpetual royalty-free license to use the Licensed
Mark;

. expand the manner in which we can use the Licensed Mark; and

. allow us to assign our license to use the Licensed Mark to any of our
wholly-owned subsidiaries;

. the Selling Stockholder will use its best efforts to cause Tony Coelho,
Robin Josephs, Merrick R. Kleeman and Barry S. Sternlicht to resign from
the Board upon the consummation of this offering and the stock
repurchase;

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. if the underwriters' over-allotment option is not exercised in full, we
will file a post-effective amendment to the registration statement of
which this prospectus is a part converting it into a shelf registration
statement covering all remaining shares of our common stock held by ITT.
In addition, ITT has agreed that this shelf registration will constitute
ITT's last remaining demand registration under the Registration Rights
Agreement; and

. we and the Selling Stockholder will indemnify each other against certain
liabilities that may arise in connection with this offering, the stock
repurchase or the related transactions.

DESCRIPTION OF CAPITAL STOCK

Our authorized capital stock consists of 50,000,000 shares of common stock
and 5,000,000 shares of preferred stock, $.01 par value. As of January 20,
1999, 27,016,202 shares of our common stock (including the shares of our common
stock being offered by ITT) were outstanding and, after giving effect to this
offering and the stock repurchase, 25,516,202 shares of our common stock would
have been outstanding. We have not issued any shares of our preferred stock.

Common Stock

All outstanding shares of our common stock are validly issued, fully paid and
non-assessable. Each outstanding share of our common stock is entitled to such
dividends as may be declared from time to time by the Board consistent with the
provisions of our Restated Certificate of Incorporation, By-Laws and applicable
law. See "Dividend Policy." Each outstanding share is entitled to one vote on
all matters submitted to a vote of stockholders. There are no cumulative voting
rights and, therefore, the holders of a majority of the shares voting for the
election of the classified Board can elect all of the Directors in any class up
for election, if they so choose. In the event of our liquidation, dissolution
or winding up, holders of our common stock are entitled to receive on a pro
rata basis any assets remaining after provision for payment of creditors and
after payment of any liquidation preferences to holders of our preferred stock.
Holders of our common stock have no conversion rights or preemptive rights to
purchase or subscribe for additional shares of our common stock or any of our
other securities. The rights, preferences and privileges of holders of shares
of our common stock are subject to, and may be adversely affected by, the
rights of the holders of shares of any series of our preferred stock that we
designate and issue in the future.

Preferred Stock

Our authorized preferred stock is available for issuance from time to time at
the discretion of the Board without stockholder approval. The Board has the
authority to prescribe for each series of preferred stock it establishes: (1)
the number of shares in that series, (2) the consideration (not less than its
par value) for such shares in that series and (3) the designations, powers,
preferences and relative, participating, optional or other special rights, and
the qualifications, limitations or restrictions of such series. Depending on
the rights of such preferred stock, the issuance of our preferred stock could
have an adverse effect on holders of our common stock by delaying or preventing
a change in control of ESI, making removal of our present management more
difficult or resulting in restrctions upon the payment of dividends and other
distributions to the holders of our common stock. We currently have no
intentions to issue any shares of any class or series of our preferred stock.

Certain Effects of Authorized but Unissued Stock

Immediately after this offering and the stock repurchase, there will be
approximately 24,500,000 shares of
our common stock and 5,000,000 shares of our preferred stock available for
future issuance. Delaware law does not require stockholder approval for any
issuance of authorized shares. The listing requirements of the NYSE, which
would apply so long as our common stock remained listed on the NYSE, however,
require stockholder

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approval of certain issuances equal to or exceeding 20% of the then-outstanding
voting power of ESI. These additional shares may be used for a variety of
corporate purposes, including future public offerings to raise additional
capital or to facilitate corporate acquisitions. We currently do not have any
plans to issue additional shares of common stock or preferred stock.

One of the effects of the existence of unissued and unreserved shares of our
common stock and preferred stock may be to enable the Board to issue shares to
persons friendly to current management, which issuance could render more
difficult or discourage an attempt to obtain control of ESI by means of a
merger, tender offer, proxy contest or otherwise and, thereby, protect the
continuity of our managment and possibly deprive our stockholders of
opportunities to sell their shares of our common stock at prices higher than
prevailing market prices. Such additional shares also could be used to dilute
the stock ownership of persons seeking to obtain control of ESI pursuant to the
operation of a stockholders' rights plan or otherwise.

Provisions of Restated Certificate of Incorporation and By-Laws Affecting
Change in Control

Our Restated Certificate of Incorporation and By-Laws provide that the Board
will be divided into three classes of Directors, each class to be as nearly
equal in number as possible. The term of office of one class of Directors
expires each year in rotation so that one class is elected at each annual
meeting of stockholders for a full three-year term. Under Delaware law, members
of a classified board of directors can be removed by stockholders only for
"cause" unless a corporation's certificate of incorporation provides otherwise.
Our Restated Certificate of Incorporation does not provide for removal without
cause. Our Restated Certificate of Incorporation provides that the Board shall
consist of not less than three nor more than 20 members. The number of
Directors will be fixed from time to time by resolution of the Board. The
affirmative vote of the holders of a majority of the outstanding shares of our
capital stock entitled to vote is required to amend, alter, change or repeal
the classified board of directors provisions in our Restated Certificate of
Incorporation or to remove a Director with cause prior to the expiration of his
or her term. Under the classified board of directors provisions described
above, it would take at least two elections of Directors for any individual or
group to gain control of the Board. Accordingly, these provisions would tend to
discourage unfriendly takeovers.

Our By-Laws also contain provisions that may limit or restrict the ability of
our stockholders to effect changes in control. Under our By-Laws, our
stockholders do not have the right to call special meetings of stockholders. In
addition, our stockholders must comply with the advance notice provisions in
our By-Laws to make nominations for members of the Board and to submit matters
for a vote at meetings of stockholders.

Delaware General Corporation Law

We are subject to Section 203 of the Delaware General Corporation Law
("Section 203"). In general, Section 203 provides that a corporation may not
engage in a "business combination" with an "interested stockholder" for a
period of three years from the date that such person became an interested
stockholder, unless (1) the transaction that results in the person becoming an
interested stockholder or the business combination is approved by the board of
directors of the corporation before the person becomes an interested
stockholder, (2) upon consummation of the transaction which results in the
stockholder becoming an interested stockholder, the interested stockholder owns
85% or more of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding shares owned by persons who are directors and
officers, and shares owned by employee stock plans or (3) on or after the date
the person becomes an interested stockholder, the business combination is
approved by the corporation's board of directors and by holders of at least
two-thirds of the corporation's outstanding voting stock, excluding shares
owned by the interested stockholder, at a meeting of stockholders. Under
Section 203, an "interested stockholder" is defined as any person, other than
the corporation and any direct or indirect majority-owned subsidiaries, that is
(1) the owner of 15% or more of the outstanding voting stock of the corporation
or (2) an affiliate or associate of the corporation and the owner of 15% or
more of the outstanding voting stock of the corporation at any time within the
three-year period immediately prior to the date on which it is sought to be
determined whether such person is an interested

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stockholder or (3) an affiliate or associate of such person. Section 203
defines a "business combination" to include, without limitation, mergers,
consolidations, stock sales and asset based transactions and other transactions
resulting in a financial benefit to the interested stockholder.

Under certain circumstances, Section 203 makes it more difficult for a person
who would be an "interested stockholder" to effect various business
combinations with a corporation for a three-year period, although the
stockholders may elect to exclude a corporation from the restrictions imposed
under Section 203. Our Restated Certificate of Incorporation does not exclude
us from the restrictions imposed under Section 203. The provisions of Section
203 may encourage companies interested in acquiring us to negotiate in advance
with the Board, because the stockholder approval requirement would be avoided
if a majority of the Directors then in office approve either the business
combination or the transaction which results in the stockholder becoming an
interested stockholder. Such provisions also may have the effect of preventing
changes in our management. It is possible that such provisions could make it
more difficult to accomplish transactions which stockholders may otherwise deem
to be in their best interests.

Section 203 excludes from the definition of "interested stockholder" any of
our stockholders that owned over 15% of our outstanding voting stock on
December 23, 1987, so long as such holder continues to own over 15% of our
outstanding voting stock. Accordingly, ITT is not subject to the restrictions
of Section 203.

Transfer Agent and Registrar

The Bank of New York is the transfer agent and registrar of our common stock.

SHARES ELIGIBLE FOR FUTURE SALE

We cannot make any predictions as to the effect, if any, that future sales of
shares of our common stock, or the availability of shares of our common stock
for future sale, will have on the market price of our common stock prevailing
from time to time. Sales of substantial amounts of our common stock in the
public market following this offering, or the perception that such sales could
occur, could adversely affect the market price of our common stock and may make
it more difficult for us to sell our equity securities in the future at a time
and price which we deem appropriate.

Immediately after this offering and the stock repurchase, we will have
approximately 25,500,000 shares of common stock outstanding. The shares of our
common stock sold in this offering will be freely tradeable without restriction
or further registration under the Securities Act except for any of those shares
that are beneficially owned at any time by an "affiliate" of ESI within the
meaning of Rule 144 under the Securities Act (which sales will be subject to
the timing, volume and manner of sale limitations of Rule 144). The 950,000
outstanding shares of our common stock held by ITT after this offering and the
stock repurchase (no shares if the over-allotment option is exercised in full)
are "restricted" securities within the meaning of Rule 144 under the Securities
Act and may not be publicly resold, except in compliance with the registration
requirements of the Securities Act or pursuant to an exemption from
registration, including that provided by Rule 144 under the Securities Act. We
have agreed to file a post-effective amendment to the registration statement of
which this prospectus is a part, converting it into a shelf registration with
respect to any shares of our common stock that ITT continues to own after this
offering and the stock repurchase. See "Relationship with Selling Stockholder
and Related Transactions."

In general, under Rule 144 as currently in effect, if one year has elapsed
since the date of acquisition of beneficial ownership of restricted shares of
our common stock from us or any of our affiliates, the acquirer or subsequent
holder of such shares is entitled to sell within any three-month period a
number of such shares that does not exceed the greater of 1% of the then
outstanding shares of our common stock or the reported average weekly trading
volume of our common stock on national securities exchanges during the four
calendar weeks preceding such sale. Sales under Rule 144 are also subject to
certain provisions regarding the manner of sale,

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notice requirements and the availability of current public information about
us. If two years have elapsed since the date of acquisition of restricted
shares of our common stock from us or any of our affiliates and the acquiror or
subsequent holder is not deemed to have been an affiliate of us for at least 90
days prior to a proposed transaction, such person would be entitled to sell
such shares under Rule 144 without regard to the limitations described above.

We, our executive officers, ITT and Starwood Hotels have agreed not to offer,
sell, contract to sell, announce the intention to sell (other than general
announcements by ITT or Starwood Hotels regarding their intentions to dispose
of the Company's common stock), pledge or otherwise dispose of, directly or
indirectly, or file with the Commission a registration statement under the
Securities Act relating to, any shares of our common stock or securities or
other rights convertible into or exchangeable or exercisable for any shares of
our common stock, without the prior written consent of Credit Suisse First
Boston Corporation and Salomon Smith Barney Inc., for a period of 90 days after
the date of this Prospectus; provided, however, that such restrictions will not
apply to the stock repurchase or the filing of the post-effective amendment to
the registration statement, or affect our ability to grant options for our
common stock pursuant to our stock option plans or to issue our common stock
pursuant to the exercise of stock options currently outstanding or granted
pursuant to our stock option plans.

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UNDERWRITING

Under the terms and subject to the conditions contained in an Underwriting
Agreement dated January 26, 1999 (the "Underwriting Agreement"), the
underwriters named below (the "Underwriters"), for whom Credit Suisse First
Boston Corporation, Salomon Smith Barney Inc., Bear, Stearns & Co. Inc., BT
Alex. Brown Incorporated, Morgan Stanley & Co. Incorporated and NationsBanc
Montgomery Securities LLC are acting as the representatives (the
"Representatives"), have severally but not jointly agreed to purchase from ITT
the following respective numbers of shares of our common stock:

[Download Table]

Number of
Underwriter Shares
----------- ---------

Credit Suisse First Boston Corporation.......................... 1,487,500
Salomon Smith Barney Inc........................................ 1,487,500
Bear, Stearns & Co. Inc......................................... 743,750
BT Alex. Brown Incorporated..................................... 743,750
Morgan Stanley & Co. Incorporated............................... 743,750
NationsBanc Montgomery Securities LLC........................... 743,750
ABN AMRO Incorporated........................................... 150,000
Barrington Research Associates, Inc............................. 150,000
EVEREN Securities, Inc.......................................... 150,000
First Analysis Securities Corporation........................... 150,000
Invemed Associates, Inc......................................... 150,000
Legg Mason Wood Walker, Incorporated............................ 150,000
Charles Schwab & Co., Inc....................................... 150,000
---------
Total....................................................... 7,000,000
=========

The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will be
obligated to purchase all the shares of our common stock offered hereby (other
than those shares covered by the over-allotment option described below) if any
are purchased. The Underwriting Agreement provides that, in the event of a
default by an Underwriter, in certain circumstances the purchase commitments of
nondefaulting Underwriters may be increased or the Underwriting Agreement may
be terminated.

ITT has granted to the Underwriters an option, expiring at the close of
business on the 30th day after the date of this prospectus, to purchase up to
950,000 additional shares from it at the public offering price, less the
underwriting discounts and commissions, all as set forth on the cover page of
this prospectus. Such option may be exercised only to cover over-allotments in
the sale of the shares of our common stock offered by this prospectus. To the
extent such option is exercised, each Underwriter will become obligated,
subject to certain conditions, to purchase approximately the same percentage of
such additional shares of our common stock as it was obligated to purchase
pursuant to the Underwriting Agreement.

We and ITT have been advised by the Representatives that the Underwriters
propose to offer shares of our common stock to the public initially at the
public offering price set forth on the cover page of this prospectus and,
through the Representatives, to certain dealers at such price less a concession
of $0.77 per share, and the Underwriters and such dealers may allow a discount
of $0.10 per share on sales to certain other dealers. After the initial public
offering, the public offering price and concession and discount to dealers may
be changed by the Representatives.

424B4 71st Page of 91 TOC 1st Previous Next ↓Bottom Just 71st
The following table summarizes the compensation to be paid to the
Underwriters by the Selling Stockholder, and the expenses payable by ESI and
the Selling Stockholder. The following table does not give effect to the
reimbursement of ESI, pursuant to the Stock Repurchase Agreement, by the
Selling Stockholder of $1,000,000 for direct and indirect expenses incurred by
ESI in connection with this offering.

[Download Table]

Total
----------------------
Without With
Per Over- Over-
Share allotment allotment
----- ---------- -----------

Underwriting Discounts and Commissions
paid by the Selling Stockholder.......... $1.28 $8,925,000 $10,136,250
Expenses payable by ESI................... $0.11 $ 900,000 $ 900,000
Expenses payable by the Selling
Stockholder.............................. $0.02 $ 175,000 $ 175,000

We, our executive officers, ITT and Starwood Hotels have agreed not to offer,
sell, contract to sell, announce an intention to sell (other than general
announcements by ITT or Starwood Hotels regarding their intentions to dispose
of the Company's common stock), pledge or otherwise dispose of, directly or
indirectly, or file with the SEC a registration statement under the Securities
Act relating to, any shares of our common stock or securities or other rights
convertible into or exchangeable or exercisable for any shares of our common
stock, without the prior written consent of Credit Suisse First Boston
Corporation and Salomon Smith Barney Inc., for a period of 90 days after the
date of this prospectus; provided, however, that such restrictions will not
apply to the stock repurchase, or the filing of a post-effective amendment to
the registration statement of which this prospectus is a part, or affect our
ability to grant options for our common stock pursuant to our stock option
plans or to issue our common stock pursuant to the exercise of stock options
currently outstanding or granted pursuant to our stock plans.

The Underwriters have reserved for sale, at the initial public offering
price, up to 400,000 shares of our common stock for the ESI 401(k) Plan, which
has expressed an interest in purchasing such shares of our common stock in this
offering. The number of shares available for sale to the general public in the
offering will be reduced to the extent the ESI 401(k) Plan purchases such
reserved shares. Any reserved shares not so purchased will be offered by the
Underwriters to the general public on the same terms as the other shares
offered in this prospectus.

We and ITT have agreed to indemnify the Underwriters against certain
liabilities, including civil liabilities under the Securities Act, and,
together with Starwood Hotels, contribute to payments that the Underwriters may
be required to make in respect thereof.

Our common stock is listed on the NYSE under the symbol "ESI."

The Representatives, on behalf of the Underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act. Over-
allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase shares of our common stock so long as the stabilizing bids do not
exceed a specified maximum. Syndicate covering transactions involve purchases
of shares of our common stock in the open market after the distribution has
been completed in order to cover syndicate short positions. Penalty bids permit
the Representatives to reclaim a selling concession from a syndicate member
when the shares of our common stock originally sold by such syndicate member
are purchased in a syndicate covering transaction to cover syndicate short
positions. Such stabilizing transactions, syndicate covering transactions and
penalty bids may cause the price of the shares of our common stock to be higher
than it would otherwise be in the absence of such transactions. These
transactions may be effected on the NYSE or otherwise and, if commenced, may be
discontinued at any time.

Certain of the Underwriters have provided advisory and investment banking
services to us in the past, for which customary compensation has been received.

424B4 72nd Page of 91 TOC 1st Previous Next ↓Bottom Just 72nd
NOTICE TO CANADIAN RESIDENTS

Resale Restrictions

The distribution of our common stock in Canada is being made only on a
private placement basis exempt from the requirement that we and ITT prepare and
file a prospectus with the securities regulatory authorities in each province
where trades of our common stock are effected. Accordingly, any resale of our
common stock in Canada must be made in accordance with applicable securities
laws which will vary depending on the relevant jurisdiction, and which may
require resales to be made in accordance with available statutory exemptions or
pursuant to a discretionary exemption granted by the applicable Canadian
securities regulatory authority. Purchasers are advised to seek legal advice
prior to any resale of our common stock.

Representations of Purchasers

Each purchaser of our common stock in Canada who receives a purchase
confirmation will be deemed to represent to us, ITT and the dealer from whom
such purchase confirmation is received that (1) such purchaser is entitled
under applicable provincial securities laws to purchase our common stock
without the benefit of a prospectus qualified under such securities laws, (2)
where required by law, that such purchaser is purchasing as principal and not
as agent, and (3) such purchaser has reviewed the text above under "Resale
Restrictions."

Rights of Action (Ontario Purchasers)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available, including
common law rights of action for damages or rescission of rights of action under
the civil liability provisions of the U.S. federal securities laws.

Enforcement of Legal Rights

All of the issuer's directors and officers as well as the experts named in
this prospectus and ITT may be located outside of Canada and, as a result, it
may not be possible for Canadian purchasers to effect service of process within
Canada upon the issuer, such persons or ITT. All or a substantial portion of
the assets of the issuer, such persons and ITT may be located outside of Canada
and, as a result, it may not be possible to satisfy a judgment against the
issuer, such persons or ITT in Canada or to enforce a judgment obtained in
Canadian courts against the issuer, such persons or ITT outside of Canada.

Notice to British Columbia Residents

A purchaser of our common stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
shares of our common stock acquired by such purchaser pursuant to this
offering. Such report must be in the form attached to British Columbia
Securities Commission Blanket Order BOR #95/17, a copy of which may be obtained
from us. Only one such report must be filed in respect of shares of our common
stock acquired on the same date and under the same prospectus exemption.

Taxation and Eligibility for Investment

Canadian purchasers of our common stock should consult their own legal and
tax advisers with respect to the tax consequences of an investment our common
stock in their particular circumstances and with respect to the eligibility of
our common stock for investment by the purchaser under relevant Canadian
legislation.

424B4 73rd Page of 91 TOC 1st Previous Next ↓Bottom Just 73rd
CERTAIN U.S. FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF OUR COMMON STOCK

The following is a general discussion of certain United States ("U.S.")
federal income and estate tax consequences of the ownership and disposition of
our common stock applicable to a beneficial owner of our common stock that is a
"Non-U.S. Holder." As used herein, the term "Non-U.S. Holder" means a person or
entity other than (1) a citizen or individual resident of the U.S., (2) a
corporation or partnership created or organized in or under the laws of the
U.S. or any political subdivision thereof, (3) an estate the income of which is
subject to U.S. federal income tax regardless of its source, or (4) in general,
a trust if (a) a court within the U.S. is able to exercise primary supervision
over the administration of the trust and (b) one or more U.S. persons have the
authority to control all substantial decisions of the trust.

This discussion is based on the Internal Revenue Code of 1986, as amended
(the "Code"), existing and proposed regulations promulgated under the Code and
administrative and judicial interpretations of the Code, all as of the date of
this prospectus, and all of which are subject to change, possibly with
retroactive effect. This discussion does not address all aspects of U.S.
federal income and estate taxation that may be important to Non-U.S. Holders in
light of their particular circumstances (including tax consequences applicable
to certain former citizens or long-term residents of the U.S. and to certain
Non-U.S. Holders that are, or hold interests in common stock through,
partnerships or other fiscally transparent entities (including "hybrid
entities")) and does not address U.S. state and local or non-U.S. tax
consequences. Prospective Non-U.S. Holders are urged to consult their own tax
advisors with respect to the particular U.S. federal income and estate tax
consequences to them of owning and disposing of shares of our common stock, as
well as the tax consequences arising under the laws of any other taxing
jurisdiction.

Dividends

We do not anticipate paying any cash dividends on shares of our common stock
in the foreseeable future. See "Dividend Policy." In the event, however, that
we do pay dividends on shares of our common stock, a Non-U.S. Holder of our
common stock generally will be subject to withholding of U.S. federal income
tax at a rate of 30% of the gross amount of the dividend, or such lower rate as
may be specified by an income tax treaty between the U.S. and a foreign country
of which the Non-U.S. Holder is treated as a resident within the meaning of the
applicable tax treaty. Under currently effective U.S. Treasury regulations,
dividends paid to an address in a foreign country are presumed to be paid to a
resident of that country for purposes of the withholding discussed above
(unless the payor has knowledge to the contrary), and, under the current
interpretation of U.S. Treasury regulations, for purposes of determining the
applicability of a lower rate of withholding tax provided by a tax treaty.
Under U.S. Treasury regulations published on October 14, 1997, as amended by
U.S. Treasury regulations published on December 31, 1998 (the "New Withholding
Regulations"), a Non-U.S. Holder of our common stock who wishes to claim the
benefit of an applicable treaty rate (and avoid backup withholding as discussed
below) generally will be required to satisfy specified certification and other
requirements with respect to dividends paid after December 31, 1999 (and, in
certain circumstances, may be required to satisfy such certification and other
requirements with respect to dividends paid after December 31, 1998). In
addition, the New Withholding Regulations contain special rules regarding the
availability of treaty benefits for payments made to (1) foreign
intermediaries, (2) U.S. or foreign wholly-owned entities that are disregarded
for U.S. federal income tax purposes and (3) partnerships and other entities
that are treated as fiscally transparent in the U.S., the applicable income tax
treaty jurisdiction, or both. Prospective investors should consult their own
tax advisors regarding their entitlement to benefits under a relevant income
tax treaty and as to the effect, if any, of the New Withholding Regulations on
an investment in our common stock.

Dividends paid to a Non-U.S. Holder that are either (1) effectively connected
with the Non-U.S. Holder's conduct of a trade or business within the U.S. or
(2) if a tax treaty applies, attributable to a permanent establishment
maintained by the Non-U.S. Holder in the U.S., will not be subject to the
withholding tax (provided in either case the Non-U.S. Holder files the
appropriate documentation with ESI or its agent), but,

424B4 74th Page of 91 TOC 1st Previous Next ↓Bottom Just 74th
instead, will be subject to regular U.S. federal income tax at the graduated
rates in the same manner as if the Non-U.S. Holder were a U.S. resident. In
addition to such graduated tax, in the case of a Non-U.S. Holder that is a
corporation, effectively connected dividends or, if a tax treaty applies,
dividends attributable to a U.S. permanent establishment of the corporate Non-
U.S. Holder, may be subject to a "branch profits tax" which is imposed, under
certain circumstances, at a rate of 30% (or such lower rate as may be specified
by an applicable tax treaty) of the corporate Non-U.S. Holder's "effectively
connected earnings and profits," subject to certain adjustments.

A Non-U.S. Holder of our common stock that is eligible for a reduced rate of
U.S. withholding tax pursuant to a tax treaty may obtain a refund of any excess
amounts withheld by filing a timely claim for refund with the Internal Revenue
Service ("IRS").

Gain on Disposition of Our Common Stock

A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain recognized on a sale or other taxable disposition of our
common stock unless (1) the gain is effectively connected with a trade or
business of the Non-U.S. Holder in the U.S. or, if a tax treaty applies,
attributable to a U.S. permanent establishment of the Non-U.S. Holder, (2) in
the case of a Non-U.S. Holder who is a nonresident alien individual and holds
our common stock as a capital asset, such individual is present in the U.S. for
183 or more days in the taxable year of the sale or other disposition and
certain other conditions are met, or (3) we are or have been a "U.S. real
property holding corporation" for U.S. federal income tax purposes at any time
within the shorter of the five-year period preceding such disposition or the
period such Non-U.S. Holder held our common stock. A corporation is a "U.S.
real property holding corporation" if the fair market value of the U.S. real
property interests held by the corporation is 50% or more of the aggregate fair
market value of certain assets of the corporation. We believe that we are not
and have not been, and we do not anticipate becoming, a "U.S. real property
holding corporation." If we were, or were to become, a "U.S. real property
holding corporation," so long as our common stock is "regularly traded" on an
established securities market within the meaning of the Code, only a Non-U.S.
Holder that owns, directly or pursuant to certain attribution rules, more than
5% of our common stock (at any time during the shorter of the periods described
above) will be subject to U.S. federal income tax on the sale or other
disposition of our common stock on account of us being a "U.S. real property
holding corporation."

If an individual Non-U.S. Holder is described in clause (1) above, he or she
will be taxed on the net gain derived from the sale or other disposition at
regular graduated U.S. federal income tax rates. If an individual Non-U.S.
Holder falls under clause (2) above, he or she will be subject to a flat 30%
tax on the gain derived from the sale or other disposition, which may be offset
by certain U.S.-source capital losses (notwithstanding the fact that such
individual is not considered a resident of the U.S.). If a Non-U.S. Holder that
is a corporation falls under clause (1) above, it will be taxed on its net gain
derived from the sale or other disposition at regular graduated U.S. federal
income tax rates and may be subject to an additional branch profits tax at a
rate of 30% (or such lower rate as may be specified by an applicable tax
treaty) of the corporate Non-U.S. Holder's "effectively connected earnings and
profits," subject to certain adjustments.

Information Reporting Requirements and Backup Withholding

Generally, we must report annually to the IRS the amount of dividends paid to
a Non-U.S. Holder and the amount, if any, of tax withheld with respect to, such
Non-U.S. Holder. These information reporting requirements apply regardless of
whether withholding is required. A similar report is sent to the Non-U.S.
Holder. Pursuant to tax treaties or certain other agreements, the IRS may make
its reports available to tax authorities in the recipient's country of
residence.

Currently, U.S. backup withholding tax (which generally is a withholding tax
imposed at a rate of 31% on certain payments to persons that fail to furnish
the information required under the U.S. information reporting requirements)
will generally not apply to dividends paid on our common stock to a Non-U.S.
Holder at an

424B4 75th Page of 91 TOC 1st Previous Next ↓Bottom Just 75th
address outside the U.S., unless the payor has actual knowledge that the payee
is a U.S. person. Backup withholding tax generally will apply to dividends paid
on our common stock at addresses inside the U.S. to Non-U.S. Holders who fail
to provide certain identifying information in the manner required.

In addition, information reporting and backup withholding imposed at a rate
of 31% will apply to the proceeds of a disposition of our common stock paid to
or through a U.S. office of a broker unless the disposing holder, under
penalties of perjury, certifies as to its non-U.S. status or otherwise
establishes an exemption. Generally, U.S. information reporting and backup
withholding will not currently apply to a payment of disposition proceeds if
the payment is made outside the U.S. through a non-U.S. office of a non-U.S.
broker. However, U.S. information reporting requirements (but not backup
withholding) will apply to a payment of disposition proceeds outside the U.S.
if the payment is made through an office outside the U.S. of a broker that is
(1) a U.S. person, (2) a foreign person that derives 50% or more of its gross
income for certain periods from the conduct of a trade or business in the U.S.
or (3) a "controlled foreign corporation" for U.S. federal income tax purposes,
unless the broker maintains documentary evidence that the holder is a Non-U.S.
Holder and certain other conditions are met, or the holder otherwise
establishes an exemption.

Under the New Withholding Regulations, which generally are effective for
payments made after December 31, 1999 (but which, in certain circumstances, may
apply to payments made after December 31, 1998), the payment of dividends, and
the payment of proceeds from the disposition of our common stock through
brokers having certain connections with the U.S., may be subject to information
reporting and backup withholding at a rate of 31% unless certain IRS
certification requirements are satisfied or an exemption is otherwise
established. Prospective investors should consult with their own tax advisors
regarding the application of the New Withholding Regulations to their
particular circumstances.

Backup withholding is not an additional tax. Rather, the U.S. tax liability
of persons subject to backup withholding will be reduced by a credit for the
amount of tax withheld. If withholding results in an overpayment of taxes, a
refund may be obtained, provided that the required information is furnished to
the IRS.

Federal Estate Tax

Shares of our common stock owned or treated as owned by an individual who is
not a citizen or resident of the U.S. at the time of his or her death will be
includable in the individual's gross estate for U.S. federal estate tax
purposes, unless an applicable tax treaty provides otherwise, and may be
subject to U.S. federal estate tax. Estates of non-resident aliens are
generally allowed a statutory credit which has the effect of offsetting the
U.S. federal estate tax imposed on the first $60,000 of the taxable estate.

LEGAL MATTERS

Baker & Daniels, Indianapolis, Indiana, will verify the validity of our
common stock offered by this prospectus. Dewey Ballantine LLP, legal counsel
for the Underwriters, will be responsible for certain legal matters relating to
this offering.

EXPERTS

The financial statements as of December 31, 1998 and 1997 and for each of the
three years in the period ended December 31, 1998 included in this prospectus
have been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
accounting and auditing.

424B4 76th Page of 91 TOC 1st Previous Next ↓Bottom Just 76th
INDEX TO FINANCIAL STATEMENTS

[Download Table]

Page
----

Report of Independent Accountants........................................ F-2
Statements of Income and Retained Earnings for the years ended December
31, 1998, December 31, 1997 and December 31, 1996....................... F-3
Balance Sheets as of December 31, 1998 and December 31, 1997............. F-4
Statements of Cash Flows for years ended December 31, 1998, December 31,
1997 and December 31, 1996.............................................. F-5
Notes to Financial Statements............................................ F-6

F-1

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of
ITT Educational Services, Inc.

In our opinion, the accompanying balance sheets and the related statements of
income and retained earnings and of cash flows present fairly, in all material
respects, the financial position of ITT Educational Services, Inc. at December
31, 1998 and 1997, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.

PRICEWATERHOUSECOOPERS LLP
Indianapolis, Indiana
January 9, 1999

F-2

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ITT EDUCATIONAL SERVICES, INC.

STATEMENTS OF INCOME AND RETAINED EARNINGS
(In thousands, except per share data)

[Download Table]

Year Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------

Revenues
Tuition............................................ $248,399 $222,457 $196,692
Other educational.................................. 42,976 39,207 35,627
-------- -------- --------
Total revenues................................. 291,375 261,664 232,319
Costs and Expenses
Cost of educational services....................... 176,487 163,053 145,197
Student services and administrative expenses....... 81,522 72,388 66,546
Legal settlement................................... 12,858 -- --
Offering, change in control and other one-time
expenses.......................................... 1,872 -- --
-------- -------- --------
Total costs and expenses....................... 272,739 235,441 211,743
Operating income................................... 18,636 26,223 20,576
Interest income, net............................... 5,329 5,565 4,119
-------- -------- --------
Income before income taxes......................... 23,965 31,788 24,695
Income taxes....................................... 10,024 12,665 9,844
-------- -------- --------
Net income......................................... 13,941 19,123 14,851
Retained earnings, beginning of period............. 55,032 35,909 21,058
-------- -------- --------
Retained earnings, end of period................... $ 68,973 $ 55,032 $ 35,909
======== ======== ========
Earnings per common share:
Basic............................................ $ 0.52 $ 0.71 $ 0.55
Diluted.......................................... $ 0.51 $ 0.71 $ 0.55

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

F-3

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ITT EDUCATIONAL SERVICES, INC.

BALANCE SHEETS
(In thousands, except per share data)

[Download Table]

December 31,
-----------------
1998 1997
-------- --------
ASSETS
------

Current assets
Cash and cash equivalents.................................. $ 77,335 $ 29
Restricted cash............................................ 3,617 3,860
Cash invested with ITT Corporation......................... -- 94,800
Marketable debt securities................................. 38,316 --
Accounts receivable, less allowance for doubtful accounts
of $2,531 and $1,393...................................... 10,772 9,680
Deferred income tax........................................ 5,969 2,019
Prepaids and other current assets.......................... 2,749 2,570
-------- --------
Total current assets..................................... 138,758 112,958
Property and equipment, net.................................. 24,985 22,886
Direct marketing costs....................................... 7,915 6,882
Other assets................................................. 3,913 3,188
-------- --------
Total assets............................................. $175,571 $145,914
======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

Current liabilities
Accounts payable........................................... $ 15,992 $ 14,974
Accrued compensation and benefits.......................... 6,488 3,245
Accrued legal settlements.................................. 7,604 --
Other accrued liabilities.................................. 7,896 6,877
Deferred tuition revenue................................... 32,261 30,850
-------- --------
Total current liabilities................................ 70,241 55,946
Other liabilities............................................ 3,474 2,153
-------- --------
Total liabilities........................................ 73,715 58,099
-------- --------
Commitments and contingent liabilities (Note 10)
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,
27,011,202 and 26,999,952 issued and outstanding.......... 270 270
Capital surplus............................................ 32,613 32,513
Retained earnings.......................................... 68,973 55,032
-------- --------
Total shareholders' equity............................... 101,856 87,815
-------- --------
Total liabilities and shareholders' equity............... $175,571 $145,914
======== ========

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

F-4

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ITT EDUCATIONAL SERVICES, INC.

STATEMENTS OF CASH FLOWS
(In thousands)

[Download Table]

Year Ended December 31,
----------------------------
1998 1997 1996
-------- -------- --------

Cash flows from operating activities:
Net income..................................... $ 13,941 $ 19,123 $ 14,851
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................ 9,282 7,939 7,493
Provision for doubtful accounts.............. 4,326 2,354 1,738
Deferred taxes............................... (3,219) 202 (443)
Increase/decrease in operating assets and
liabilities:
Marketable debt securities................. (38,316) -- --
Accounts receivable........................ (5,418) (2,656) (3,524)
Direct marketing costs..................... (1,033) (1,108) (743)
Accounts payable and accrued liabilities... 13,474 2,958 3,083
Prepaids and other assets.................. (904) (1,769) 220
Deferred tuition revenue................... 1,411 (12,682) 3,469
-------- -------- --------
Net cash provided by (used for) operating
activities...................................... (6,456) 14,361 26,144
-------- -------- --------
Cash flows used for investing activities:
Capital expenditures, net...................... (11,381) (11,465) (7,868)
Net decrease (increase) in cash invested with
ITT Corporation............................... 94,800 (4,992) (17,923)
-------- -------- --------
Net cash provided by (used for) investing
activities...................................... 83,419 (16,457) (25,791)
-------- -------- --------
Cash flow provided by finance activities:
Exercise of stock options...................... 100 -- --
-------- -------- --------
Net increase (decrease) in cash, cash equivalents
and restricted cash............................. 77,063 (2,096) 353
Cash, cash equivalents and restricted cash at
beginning of period............................. 3,889 5,985 5,632
-------- -------- --------
Cash, cash equivalents and restricted cash at end
of period....................................... $ 80,952 $ 3,889 $ 5,985
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes................................. $ 12,757 $ 12,352 $ 10,051
Interest..................................... 238 291 273

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

F-5

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Dollar amounts in thousands, unless otherwise stated)

1. Ownership and Change in Control

From ITT Educational Services, Inc.'s (the "Company") initial public offering
in 1994 until June 9, 1998, ITT Corporation ("ITT") owned 83.3% of the
outstanding common stock of the Company.

On February 23, 1998, Starwood Hotels & Resorts Worldwide, Inc. ("Starwood
Hotels") completed the acquisition of ITT (the "Merger") and ITT became a
subsidiary of Starwood Hotels. As a result of the Merger, a change in control
of the Company occurred under regulations of the U.S. Department of Education
("DOE") and each ITT Technical Institute campus group became ineligible to
participate in federal student financial aid programs. Effective March 20,
1998, the eligibility of each ITT Technical Institute campus group to
participate in federal student financial aid programs was reinstated by the DOE
with certain conditions imposed by the DOE. The Company believes that it is in
compliance with or satisfies these DOE conditions.

On June 9, 1998, ITT sold 13,050,000 shares of the Company's common stock
held by ITT to the public (48.3% of the outstanding shares) (the "June 1998
Offering"). ITT presently owns 35% of the outstanding shares of the Company's
common stock. The June 1998 Offering did not constitute a change in control
under the DOE's regulations. In December 1998, the Company filed a registration
statement with the Securities and Exchange Commission, which was not effective
as of December 31, 1998, relating to the offering of shares of the Company's
common stock to the public ("the Offering"). The Offering contemplates the sale
of 7,000,000 shares, together with an underwriters' over-allotment option to
purchase up to 950,000 additional shares, of the Company's common stock held by
ITT. The Offering does not constitute a change in control under the DOE's
regulations. Simultaneous with the close of the Offering in 1999, the Company
intends to repurchase 1,500,000 shares of its common stock from ITT at an
aggregate cost not to exceed $49,260.

2. Summary of Accounting Principles and Policies

Business Activities. The Company is a leading proprietary postsecondary
education system primarily offering career-focused, technical degree programs
of study. At December 31, 1998, the Company operated 65 technical institutes
throughout the United States. The Company maintains its corporate headquarters
in Indianapolis, Indiana.

Use of Estimates. The preparation of these financial statements, in
conformity with generally accepted accounting principles, includes estimates
that are determined by the Company's management.

Cash Equivalents and Marketable Debt Securities. Marketable debt securities
are classified as trading securities and have maturity dates in excess of 90
days at the time of purchase and are recorded at their market value. Debt
securities with maturity dates less than 90 days at the time of purchase are
included in cash and cash equivalents and are recorded at cost, which
approximates market value. The cost of securities sold is based on the first-
in, first-out method.

Investment income for the year ended December 31, 1998 consists of:

[Download Table]

Net realized gains on the sale of trading securities.............. $ 11
Interest and dividend income, net................................. 4,926
Change in net unrealized holding gain............................. 85
------
$5,022
======

Property and Equipment. The Company includes all property and equipment in
the financial statements at cost. Provisions for depreciation of property and
equipment have generally been made using the straight-line

F-6

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

method for financial reporting purposes and accelerated methods for tax
purposes. Estimated useful lives
generally range from three to ten years for furniture and equipment and
leasehold improvements. Maintenance, repairs and renewals not of a capital
nature are expensed as incurred. Fully depreciated assets no longer in use are
removed from both the asset and accumulated depreciation accounts in the year
of their retirement. Any gains or losses on dispositions are credited or
charged to income, as appropriate.

Fair Value of Financial Instruments. The carrying amounts reported in the
balance sheets for cash and cash equivalents, restricted cash, cash invested
with ITT Corporation, accounts receivable, accounts payable, other accrued
liabilities and deferred tuition revenue approximate fair value because of the
immediate or short-term maturity of these financial instruments. Marketable
debt securities are recorded at their market value.

Recognition of Revenues. Tuition revenues are recorded on a straight-line
basis over the length of the applicable course. If a student discontinues
training, the revenue related to the remainder of that academic quarter is
recorded with the amount of refund resulting from the application of federal,
state or accreditation requirements recorded as an expense. On an individual
student basis, tuition earned in excess of cash received is recorded as
accounts receivable, and cash received in excess of tuition earned is recorded
as deferred tuition revenue.

Other educational revenues are comprised of laboratory fees and textbook
sales. Laboratory fees are recorded as revenue at the beginning of each
academic quarter. Textbook sales are recognized when they occur.

Advertising Costs. The Company expenses all advertising costs as incurred.

Direct Marketing Costs. Direct costs incurred relating to the enrollment of
new students are capitalized using the successful efforts method. Direct
marketing costs include recruiting representatives' salaries, employee benefits
and other direct costs less enrollment fees. Direct marketing costs are
amortized on an accelerated basis over the average course length of 24 months
commencing on the start date. Direct marketing costs on the balance sheet
totaled $7,915 and $6,882 at December 31, 1998 and December 31, 1997,
respectively, net of accumulated amortization of $6,895 and $5,861 at those
dates, respectively.

Institute Start-Up Costs. Deferred institute start-up costs consist of all
direct costs (excluding advertising costs) incurred at a new institute from the
date a lease for a technical institute facility is entered into until the first
class start. Such capitalized costs are amortized on a straight-line basis over
a one-year period. At December 31, 1998 and December 31, 1997, deferred start-
up costs included in other assets in the balance sheet totaled $1,353 and
$1,316, respectively, net of accumulated amortization of $511 and $174 at such
dates, respectively. In conformity with Statement of Position ("SOP") 98-5,
"Reporting on the Costs of Start-Up Activities," the Company intends to expense
the $1,353 of institute start-up costs, less $531 of deferred taxes, as a
cumulative effect of a change in accounting principle in the first quarter of
1999.

Offering, Change in Control and Other One-Time Expenses. The Company incurred
total expenses for the June 1998 Offering of $1,117. In addition, the Company
incurred expenses of $755 associated with its change in control and
establishment of new employee benefit plans.

Costs of Computer Software Developed or Obtained for Internal Use. The
American Institute of Certified Public Accountants (the "AICPA") issued SOP 98-
1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," in March 1998. SOP 98-1 provides guidance on accounting for
costs of computer software developed or obtained for internal use and requires
costs incurred in the application development stage (whether internal or
external) to be capitalized. Costs incurred prior to initial application of
this SOP, whether or not capitalized, should not be adjusted to the amounts
that would have been capitalized had this SOP been in effect when those costs
were incurred. The Company adopted this SOP effective July 1, 1998, which
increased net income by $508 ($0.02 per share) in the year ended December 31,
1998.

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Income Taxes. The Company was included in the consolidated U.S. federal
income tax return of ITT prior to June 9, 1998 and determined its income tax
provision principally on a separate return basis in conformity with Statement
of Financial Accounting Standards ("SFAS") No. 109. Under a tax sharing policy
with ITT, income taxes were allocated to members of the U.S. consolidated group
based principally on the amounts they would pay or receive if they filed a
separate income tax return. Deferred income taxes were provided on the
differences in the book and tax basis of assets and liabilities recorded on the
books of the Company (temporary differences) at the statutory tax rates
expected to be in effect when such differences reversed. Temporary differences
related to SFAS No. 106, SFAS No. 112, pension and self-insurance costs were
recorded on the books of ITT where the related assets and liabilities were
recorded. ITT paid current federal income taxes on behalf of the Company, as
calculated under the tax sharing policy, and reflected the funding through the
cash invested with ITT Corporation account.

Beginning June 9, 1998, the Company started filing its own federal income tax
returns, paying its own federal income taxes and recording all deferred income
taxes on its books.

Earnings Per Common Share. Earnings per common share for all periods have
been calculated in conformity with SFAS No. 128, "Earnings Per Share." Such
data is based on historical net income and the average number of shares of the
Company's common stock outstanding during each period. The number of average
shares outstanding utilized for basic earnings per share were 27,001,542 in
1998 and 26,999,952 in 1997 and 1996. Average shares outstanding utilized for
diluted earnings per share were approximately 27,185,000, 27,105,000 and
27,092,000 for 1998, 1997 and 1996, respectively. The difference in shares
utilized in calculating basic and diluted earnings per share represents the
average number of shares issued under the Company's stock option plan less
shares assumed to be purchased with proceeds from the exercise of the stock
options.

3. Related Party Transactions

At December 31, 1998, and during the three-year period then ended, the
relationship between the Company and ITT was governed by various agreements
summarized as follows:

Intercompany Activities. ITT provided the Company with certain centralized
treasury and financing functions. The Company transferred all unrestricted cash
receipts to ITT and received funds from ITT for all disbursements. The Company
earned interest on the average net cash balance held by ITT, at an interest
rate that was set for a 12-month period and was 30 basis points over the most
recently published rate for 12-month treasury bills. The net of all such cash
transfers as well as charges from ITT for expenses related to the Company's
participation in ITT's plans (such as pensions, medical insurance, federal
income taxes, etc.) resulted in a net balance of cash invested with ITT of
$94,800 at December 31, 1997. On February 5, 1998, ITT transferred
approximately $83,000 to the Company and, since that date, the Company has been
performing its own cash management function.

ITT also provided certain risk management and pension management services to
the Company until June 9, 1998. The fee (contract service charge) for such
services was 0.25% of the Company's annual revenue. The contract service
charges were $15, $654 and $578 for the years ended December 31, 1998, 1997 and
1996, respectively.

The Company's employees participated in certain employee benefit programs
which were sponsored and administered by ITT until June 9, 1998. Administrative
costs relating to these services and participation in these plans were charged
to the Company using allocation methods management believes were reasonable.
The Company paid a processing fee related to its participation in ITT's
consolidated medical plan. The processing fees were $159 and $280 in 1997 and
1996, respectively.

F-8

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Tax Agreement. ITT and the Company participated in a tax agreement that
provided, among other things, that the Company would pay ITT, with respect to
federal income taxes for each period that the Company was included in ITT's
consolidated federal return, the amount that the Company would have been
required to pay had it filed a separate federal income tax return under the tax
sharing policy described in Note 2.

Similarly, with respect to state, corporate, franchise or income taxes for
those states where ITT filed a combined or consolidated state return that
included the Company, the Company paid ITT an amount as if it filed a separate
tax return. With respect to ITT's consolidated federal and state returns, the
Company will be responsible for any deficiencies assessed with respect to such
returns if such deficiencies relate to the Company. Similarly, the Company will
be entitled to all refunds paid with respect to such returns that relate to the
Company. The Company will be responsible for all taxes, including assessments,
if any, for prior years with respect to all other taxes payable by the Company.

Management believes the statements of income include a reasonable allocation
of costs incurred by ITT which benefited the Company. The aforementioned
agreements were modified in connection with the June 1998 Offering.

4. Financial Aid Programs

The Company participates in various Title IV Programs. Approximately 69% of
the Company's 1998 revenue was derived from funds distributed under these
programs.

The Company participates in the Federal Perkins Loan ("Perkins") program and
administers on behalf of the federal government a pool of Perkins student loans
which aggregated $8,565 and $8,517 at December 31, 1998 and 1997, respectively.
The Company has recorded in its financial statements only its aggregate
mandatory contributions to this program which at December 31, 1998 and 1997
aggregated $1,581 and $1,588, respectively. The Company has provided $972 and
$971, respectively, for potential losses related to funds committed by the
Company at December 31, 1998 and 1997.

The Title IV Programs are administered by the Company in separate accounts as
required by government regulation. The Company is required to administer the
funds in accordance with the requirements of the Higher Education Act of 1965,
as amended, and DOE regulations and must use due diligence in approving and
disbursing funds and servicing loans. In the event the Company does not comply
with federal requirements, or if student loan default rates rise to a level
considered excessive by the federal government, the Company could lose its
eligibility to participate in the Title IV Programs or could be required to
repay funds determined to have been improperly disbursed. Management believes
that it is in substantial compliance with the federal requirements.

5. Restricted Cash

The Company participates in the Electronic Funds Transfer ("EFT") program
through the DOE. All monies transferred to the Company via the EFT system are
subject to certain holding period restrictions, generally from three to seven
days, before they can be drawn into the Company's cash account. Such amounts
are classified as restricted cash until they are applied to the students'
accounts.

F-9

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

6. Property and Equipment

Fixed assets include the following:

[Download Table]

December 31,
------------------
1998 1997
-------- --------

Furniture and equipment............................... $ 70,581 $ 62,514
Leasehold improvements................................ 8,699 7,848
Land and land improvements............................ 110 110
Construction in progress.............................. 583 325
-------- --------
79,973 70,797
Less accumulated depreciation......................... (54,988) (47,911)
-------- --------
$ 24,985 $ 22,886
======== ========

7. Taxes

The provision for income taxes includes the following:

[Download Table]

Year Ended December 31,
------------------------
1998 1997 1996
------- ------- -------

Current
Federal....................................... $11,052 $10,399 $ 8,673
State......................................... 2,191 2,064 1,614
------- ------- -------
13,243 12,463 10,287
Deferred
Federal....................................... (2,686) 168 (370)
State......................................... (533) 34 (73)
------- ------- -------
(3,219) 202 (443)
------- ------- -------
$10,024 $12,665 $ 9,844
======= ======= =======

Deferred tax assets (liabilities) include the following:

[Download Table]

December 31,
-------------------------
1998 1997 1996
------- ------- -------

Direct marketing costs........................ $(3,105) $(2,698) $(2,263)
Legal settlements............................. 2,983 -- --
Institute start-up costs...................... (531) (516) (204)
Depreciation.................................. 607 759 785
Reserves and other............................ 3,209 2,399 1,828
------- ------- -------
Net deferred tax assets (liabilities)......... $ 3,163 $ (56) $ 146
======= ======= =======

F-10

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Differences between effective income tax rates and the statutory U.S. federal
income tax rates are as follows:

[Download Table]

Year Ended
December 31,
----------------
1998 1997 1996
---- ---- ----

Statutory U.S. federal income tax rate.................. 35.0% 35.0% 35.0%
State income taxes, net of federal benefit.............. 4.1% 4.1% 4.1%
Non-deductible June 1998 Offering expenses.............. 1.5% -- --
Permanent differences and other......................... 1.2% 0.7% 0.8%
---- ---- ----
Effective income tax rate............................... 41.8% 39.8% 39.9%
==== ==== ====

8. Retirement Plans

Employee Pension Benefits. Prior to June 9, 1998, the Company participated in
the Retirement Plan for Salaried Employees of ITT Corporation which covered
substantially all employees of the Company. ITT determined the aggregate amount
of pension expense on a consolidated basis based on actuarial calculations and
such expense was allocated to participating units on the basis of compensation
covered by the plan. Effective June 9, 1998, the Company adopted its own non-
contributory defined benefit pension plan. This plan, commonly referred to as a
cash balance plan, provides benefits based upon annual employee earnings times
established percentages of pay based on age and years of service. Charges to
the Company by ITT for pension expense for the years ended December 31, 1998,
1997 and 1996 were $1,858, $4,458 and $3,783, respectively. The net periodic
benefit cost for the Company's plan for the year ended December 31, 1998 was
comprised of a service cost of $2,217.

The following is information on the Company's plan for 1998:

Change in benefit obligation:

[Download Table]

Projected benefit obligation at beginning of period............. $ --
Service cost.................................................... 2,217
Actuarial loss.................................................. 527
-------
Projected benefit obligation at end of period................... $ 2,744
-------
Funded status................................................... $(2,744)
Unrecognized net actuarial loss................................. 527
-------
Accrued benefit cost............................................ $(2,217)
=======

The accumulated benefit obligation at September 30, 1998 is $1,551. The plan
does not have any assets as of December 31, 1998, and the Company intends to
make its first funding contribution to the plan in 1999.

Weighted-average assumptions as of September 30, 1998:

[Download Table]

Discount rate........................................................ 6.5%
Expected return on plan assets....................................... 9.0%
Rate of compensation increase........................................ 4.5%

Retirement Savings Plan. Prior to May 16, 1998, the Company participated in
The ITT 401K Retirement Savings Plan, a defined contribution plan which covered
substantially all employees of the Company. The Company's non-matching and
matching contributions under this plan were provided for through the issuance
of common shares of ITT until February 23, 1998 and paired shares of Starwood
Hotels and Starwood Hotels &

F-11

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Resorts, a Maryland real estate investment trust, until May 16, 1998. The costs
of the non-matching and matching Company contributions were charged by ITT to
the Company. Effective May 16, 1998, the Company adopted its own 401(k) plan, a
defined contribution plan which covers substantially all employees of the
Company and operates similar to The ITT 401K Retirement Savings Plan. The
Company's non-matching and matching contributions under its 401(k) plan are
made in the form of shares of the Company's common stock. For the years ended
December 31, 1998, 1997 and 1996, the costs of providing this benefit
(including an allocation of the administrative costs of the plan) were $2,109,
$2,104 and $1,749, respectively.

9. Stock Option and Key Employee Incentive Plans

The Company adopted and the stockholders approved the ITT Educational
Services, Inc. 1994 Stock Option Plan ("1994 Plan") and the 1997 ITT
Educational Services, Inc. Incentive Stock Plan ("1997 Plan"). The Company has
adopted the disclosure only provisions of SFAS No. 123, "Accounting for Stock-
Based Compensation." Accordingly, no compensation cost has been recognized in
the financial statements for the 1994 Plan or the 1997 Plan. The Company has
elected, as permitted by the standard, to continue following its intrinsic
value based method of accounting for stock options consistent with APB Opinion
No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic method,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's common stock at the measurement date over
the exercise price.

Under the 1994 Plan, a maximum of 405,000 shares of the Company's common
stock may be issued upon exercise of options. Under the 1997 Plan, a maximum of
1.5% of the outstanding common shares may be issued each year commencing in
1997, with any unissued shares issuable in later years. Under the 1997 Plan, a
maximum of 4,050,000 shares of the Company's common stock may be issued upon
exercise of options. The option price may not be less than 100% of the fair
market value of the Company's common stock on the date of grant and the options
will vest and become exercisable in three equal annual installments commencing
with the first anniversary of the grant. The options outstanding, granted,
exercised and forfeited for the three years ended December 31, 1998 are as
follows:

[Download Table]

1998 1997 1996
---------------- --------------- ---------------
Average Average Average
# of Option # of Option # of Option
Shares Price Shares Price Shares Price
------- ------- ------- ------- ------- -------

Outstanding at beginning of
year........................ 405,000 $13.46 258,750 $ 7.37 191,250 $ 5.75
Granted...................... 405,000 21.69 146,250 24.25 67,500 11.94
Exercised.................... (11,250) 8.89
Forfeited.................... (5,000) 21.69
------- ------ ------- ------ ------- ------
Outstanding at end of year... 793,750 $17.67 405,000 $13.46 258,750 $ 7.37
======= ====== ======= ====== ======= ======

[Download Table]

Exercise Price Range
----------------------------------------------
$4.44 $8.89-$11.94 $21.69-$24.25 Total
-------- ------------ ------------- ----------

Options outstanding at year
end........................... 135,000 112,500 546,250 793,750
Weighted average exercise
price......................... $ 4.44 $ 10.72 $ 22.38 $ 17.67
Remaining contractual life..... 6 years 7 years 8.8 years 8.1 years
Options exercisable at year
end........................... 135,000 90,000 48,750 273,750
Weighted average exercise
price......................... $ 4.44 $ 10.42 $ 24.25 $ 9.93

During 1998, the Company issued 11,250 shares of common stock for proceeds of
$100 in conjunction with the exercise of stock options.

F-12

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Compensation costs for the 1994 Plan, calculated in accordance with SFAS No.
123, are not significant for the year ended December 31, 1996. If compensation
costs had been determined based on the fair value of the stock options at grant
date consistent with SFAS No. 123, the Company's net income and earnings per
share for the years ended December 31, 1998 and 1997 would have been reduced to
the proforma amounts indicated below:

[Download Table]

Year Ended
December 31,
---------------
1998 1997
------- -------

Proforma
Net income............................................. $12,554 $18,519
Basic earnings per share............................... 0.46 0.69
Diluted earnings per share............................. 0.46 0.68
As reported
Net income............................................. $13,941 $19,123
Basic earnings per share............................... 0.52 0.71
Diluted earnings per share............................. 0.51 0.71

The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for the
three years ended December 31, 1998:

[Download Table]

Year Ended
December 31,
----------------
1998 1997 1996
---- ---- ----

Risk-free interest rates................................ 5.3% 6.6% 5.7%
Expected lives (in years)............................... 5 10 10
Volatility.............................................. 41% 46% 46%
Dividend yield.......................................... None None None

In October 1998, the Compensation Committee of the Board of Directors awarded
additional stock options for 409,500 shares of the Company's common stock. The
effective date of this award will be the date of the Offering and the exercise
price will be equal to the offering price of the shares of the Company's common
stock sold in the Offering.

10. Commitments and Contingent Liabilities

Lease Commitments. The Company leases substantially all of its facilities
under operating lease agreements. A majority of the operating leases contain
renewal options that can be exercised after the initial lease term. Renewal
options are generally for periods of one to five years. All operating leases
will expire over the next 12 years and management expects that leases will be
renewed or replaced by other leases in the normal course of business. There are
no material restrictions imposed by the lease agreements, and the Company has
not entered into any significant guarantees related to the leases. The Company
is required to make additional payments under the operating lease terms for
taxes, insurance and other operating expenses incurred during the operating
lease period.

Rent expense was composed of the following:

[Download Table]

Year Ended December 31,
-----------------------
1998 1997 1996
------- ------- -------

Minimum rentals................................... $21,408 $18,961 $17,131
Contingent rentals................................ 246 272 249
------- ------- -------
$21,654 $19,233 $17,380
======= ======= =======

F-13

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Future minimum rental payments required under operating leases that have
initial or remaining non-cancelable lease terms in excess of one year as of
December 31, 1998 are as follows:

[Download Table]

1999............................................................. $ 21,564
2000............................................................. 22,798
2001............................................................. 19,270
2002............................................................. 17,328
2003............................................................. 16,300
Later Years...................................................... 36,378
--------
$133,638
========

Operating leases related to two institutes that are still in the
developmental phase at December 31, 1998 include special clauses that allow the
Company to terminate the lease within one year of signing the lease if the new
school is not accredited. If this were to occur, the Company would be liable,
at the date of termination, for an agreed upon termination cost based on the
lessor's tenant improvement costs. The future minimum rental payments schedule
above includes such termination costs for the two institutes. If the institutes
are accredited as expected, aggregate additional minimum rental payments of
$3,010 will be required over the lease term.

Rent expense and future minimum rental payments related to equipment leases
are not material.

Contingent Liabilities. In December 1994, the Company entered into an
agreement with an unaffiliated, private funding source to provide loans to
students of certain technical institutes. The agreement requires the Company to
guarantee repayment of the loans. Outstanding loans at December 31, 1998
aggregated $1,768. Additionally, the Company is required to maintain on deposit
with the lender 15% of the aggregate principal balance of the outstanding
loans. This interest bearing deposit is included in other assets in the balance
sheet.

The Company has a number of pending legal and other claims arising in the
normal course of business. In September 1998, the Company agreed to settle
eight legal proceedings (including Eldredge, et al. v. ITT Educational
Services, Inc., et al.) involving 25 former students and the claims of 15 other
former students that related primarily to the Company's marketing and
recruitment practices and included allegations of misrepresentation, fraud and
violations of certain federal and state statutes. As part of the settlement of
these legal proceedings and claims, the Company is seeking court approval of a
class settlement of the claims of (a) approximately 1,200 other persons who
attended an associate degree program in hospitality at the ITT Technical
Institute in Maitland, San Diego, Portland or Indianapolis and (b)
approximately 19,000 other persons who attended any technology program at any
ITT Technical Institute in California from January 1, 1990 through December 31,
1997. If the Company obtains court approval of the class settlements, the
members of each class may still elect to opt out of the settlement and pursue
any claims they may have against the Company. The Company recorded a $12.9
million provision for legal settlements in the year ended December 31, 1998 as
a result of the settlement of these legal proceedings and claims.

In the opinion of management, the ultimate outcome of the pending legal and
other claims, excluding the settlement discussed above, should not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.

F-14

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ITT Educational Services, Inc.

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Dates Referenced Herein and Documents Incorporated by Reference

		Referenced-On Page
This ‘424B4’ Filing	Date	First	Last	Other Filings

	6/9/03	63
	10/1/00	11	44	4
	6/1/00	56
	1/1/00	14	30
	12/31/99	14	75	10-K405, 11-K
	9/9/99	28
	6/30/99	28		10-Q
	3/31/99	29	60	10-Q
	2/1/99	1		8-K
Filed on:	1/27/99
	1/26/99	1	70
	1/20/99	7	66
	1/11/99	3		8-K
	1/9/99	77
	1/7/99	3		8-K
	12/31/98	4	89	10-K405, 11-K
	12/21/98	3		8-K
	12/15/98	31
	11/20/98	7
	9/30/98	3	86	10-Q
	7/1/98	46	82
	6/30/98	3		10-Q
	6/9/98	21	86
	5/16/98	62	87
	5/15/98	62
	4/24/98	33
	4/17/98	3		8-K/A
	4/16/98	3		8-K, 8-K/A
	4/8/98	3		8-K
	4/6/98	58
	3/31/98	3		10-Q, 8-K
	3/20/98	81
	3/10/98	3		8-K
	2/25/98	61
	2/23/98	32	86	3, 8-K
	2/5/98	8	83
	1/1/98	9	62
	12/31/97	3	89	10-K
	10/14/97	73
	9/22/97	59
	8/14/97	57
	7/1/97	23	50
	6/30/97	24		10-Q
	1/31/97	58
	1/24/97	57
	1/1/97	22	24
	12/31/96	18	88	10-K, 10-K/A
	11/4/96	2
	4/15/96	2
	1/1/96	24
	12/31/95	18
	12/19/95	32	61
	9/29/95	32
	6/8/95	56
	12/31/94	18
	12/27/94	32
	12/20/94	3
	6/16/94	3
	1/1/94	5	34
	12/31/93	4	32
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Filing Submission 0000950131-99-000363 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

Itt Educational Services Inc – ‘424B4’ on 1/27/99

As of: Wednesday, 1/27/99 · Accession #: 950131-99-363 · File #: 333-69201

Previous ‘424B4’: ‘424B4’ on 6/4/98 · Latest ‘424B4’: This Filing

Prospectus — Rule 424(b)(4)Filing Table of Contents

Document Table of Contents

Dates Referenced Herein and Documents Incorporated by Reference

Prospectus — Rule 424(b)(4)
Filing Table of Contents