Edgar Filing: ITT EDUCATIONAL SERVICES INC

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FORM 10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT

(MARK ONE)

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended DECEMBER 31, 2000

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

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NUMBER 1-13144

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

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

5975 CASTLE CREEK PARKWAY N. DRIVE 46250-0466
P.O. BOX 50466 (Zip Code)
INDIANAPOLIS, INDIANA
(Address of principal executive offices)

Registrant's telephone number, including area code (317) 594-9499

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on which registered
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE, INC.

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/

$714,579,869

Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock at February 27, 2001
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").

23,576,830

Number of shares of Common Stock, $.01 par value, outstanding at March 6,
2001.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following documents have been incorporated by reference into
this Annual Report on Form 10-K.

IDENTITY OF DOCUMENT PARTS OF FORM 10-K INTO WHICH DOCUMENT IS
INCORPORATED

Definitive Proxy Statement for the Annual PART III
Meeting of Shareholders to be held May 9,
2001

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ITT EDUCATIONAL SERVICES, INC.
INDIANAPOLIS, INDIANA
ANNUAL REPORT TO SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 2000

PART I

ITEM 1. BUSINESS.

YOU SHOULD KEEP IN MIND THE FOLLOWING POINTS AS YOU READ THIS REPORT:

- REFERENCES IN THIS DOCUMENT TO "WE," "US," "OUR" AND "ESI" REFER TO ITT
EDUCATIONAL SERVICES, INC. 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.

BACKGROUND

We are a Delaware corporation incorporated in 1946. Our principal executive
offices are located at 5975 Castle Creek Parkway, North Drive, Indianapolis,
Indiana 46250, and our telephone number is (317) 594-9499. From 1966 until our
initial public offering on December 27, 1994, we were wholly owned by ITT
Corporation, formerly a Delaware corporation and now known as ITT
Industries, Inc., an Indiana corporation ("Old ITT"). On September 29, 1995, ITT
Corporation, a Nevada corporation ("ITT") succeeded to the interests of Old ITT
in the beneficial ownership of 83.3% of our common stock. On February 23, 1998,
Starwood Hotels & Resorts Worldwide, Inc., a Maryland corporation ("Starwood
Hotels") acquired ITT. Public offerings of our common stock by ITT in June 1998
(the "June 1998 Offering") and February 1999 (the "February 1999 Offering") and
our repurchase of 1,500,000 shares of our common stock from ITT in
February 1999 completely eliminated ITT's beneficial ownership.

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 27,500 students. We currently have 70 institutes located in 28
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, 2000, approximately 99% of our students were
enrolled in a degree program. We have provided career-oriented education
programs for over 30 years and our institutes have graduated over 145,000
students since 1976.

We opened three new institutes in each of 1998 and 1999, two new institutes
in 2000 and one new institute in March 2001. In addition, in 2000 we expanded to
69 the number of institutes that offer our information technology ("IT")
curricula, began offering our computer and electronics engineering technology
("CEET") curriculum at 34 institutes and began offering our computer drafting
and design curriculum at 20 institutes ("CDD"). We plan to open one or two
additional new institutes in the remainder of 2001 and begin offering our CEET
and CDD curricula at most of our institutes in 2001. We intend to continue
expanding by opening new institutes and offering a broader range of programs at
our existing institutes, including several new IT programs.

BUSINESS 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. 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.

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 70
institutes provide significant potential for the introduction of existing
programs to a broader number of institutes. We believe that introducing new
programs at existing institutes will attract more students. In 2000, we
increased the number of program offerings at 65 existing institutes, and in 2001
we intend to increase the number of program offerings at approximately 67
existing institutes.

DEVELOP OR ACQUIRE ADDITIONAL DEGREE PROGRAMS. We plan to introduce degree
programs in additional fields of study and at different degree levels. In 2000,
we completed the introduction of our associate degree program in IT involving
computer network systems at all of our institutes and began offering our CEET
curriculum at 34 institutes and CDD curriculum at 20 institutes. In 2001, we
intend to complete the introduction of our CEET and CDD curricula at our
institutes and increase the number of institutes offering one or more of our
other three IT programs. 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. 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
2000. Our recently introduced CEET and CDD programs are each 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 academic and career
services and dedicating administrative resources to career services.

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 1998 and 1999, two new institutes in 2000 and one new
institute in March 2001. We plan to open one or two additional new institutes in
the remainder of 2001. New institutes open for less than 24 months had a total
of 762 students enrolled at December 31, 2000. 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. Our efforts to optimize school capacity and class size have helped us
to increase student 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 institutes. 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

As of December 31, 2000, we were teaching 21 degree programs and several
diploma programs in various fields of study. All of our institutes were teaching
degree or diploma programs involving IT, 68 institutes were teaching a degree
program involving electronics, and 59 institutes were teaching a degree program
involving drafting and design. The table below sets forth information regarding
the programs of study we were teaching as of December 31, 2000.

NUMBER OF INSTITUTES OFFERING AT
DECEMBER 31, 2000
------------------------------------------
MASTER BACHELOR ASSOCIATE
PROGRAM OF STUDY DEGREE DEGREE DEGREE DIPLOMA
---------------- -------- -------- --------- --------

Architectural Engineering Technology(1)..................... -- -- 3 --
Automated Manufacturing Technology(2)....................... -- 6 -- --
Chemical Technology......................................... -- -- 3 --
Computer-Aided Drafting and Design Technology(1)............ -- -- 8 --
Computer-Aided Drafting Technology(1)....................... -- -- 59 --
Computer Drafting and Design(1)............................. -- -- 20 --
Computer and Electronics Engineering Technology(2).......... -- -- 34 --
Computer Network Systems(3)................................. -- -- 64 5
Computer Visualization Technology(1)........................ -- 7 -- --
Electronics Engineering Technology.......................... -- 19 68 --
Industrial Design(1)........................................ -- 3 -- --
Multimedia(3)............................................... -- -- 15 --
Project Management.......................................... 1 -- -- --
Software Applications and Programming(3).................... -- -- 16 --
Telecommunications Engineering Technology(2)................ -- 3 -- --
Tool Engineering Technology(1).............................. -- -- 3 --
Web Development(3).......................................... -- -- 18 1
Other Programs of Study(4).................................. -- 1 3 2

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

(1) Drafting program.

(2) Electronics program.

(3) IT program. Depending on the location of the ITT Technical Institute, this
program of study may have been approved by the applicable state education
authority(ies) either as a separate program or one of as many as four
disciplines of one IT program of study. For purposes of this table, this
program is considered to be a separate program of study at every ITT
Technical Institute where it was taught.

(4) Other programs consist of Business Technology and Administration, Business
Management and Accounting, and Heating/Air Conditioning/Refrigeration.

As of December 31, 2000, approximately 33% of our students were enrolled in
IT programs, approximately 50% were enrolled in electronics programs and
approximately 16% were enrolled in drafting programs. We design our IT programs
to help graduates begin to prepare for careers in various fields involving IT by
offering students a broad-based foundation in a variety of technical skills used
in those fields. Graduates of our IT programs have obtained a variety of
entry-level positions in various fields involving IT, such as network
administrator, technical support, network technician and systems technician. We
design our electronics programs to help graduates begin to prepare for careers

in various fields involving electronics by offering students a practical
education with respect to specific electronic circuits and specialized
techniques. Graduates of our electronics programs have obtained a variety of
entry-level positions in various fields involving electronics, such as
electronics product design and fabrication, communications, computer technology,
industrial electronics, instrumentation, telecommunications and consumer
electronics. We design our drafting programs to help graduates begin to prepare
for careers in various fields involving drafting and design through the teaching
of computer-aided drafting techniques and conventional drafting methods.
Graduates of our drafting programs have obtained a variety of entry-level
positions in various fields involving drafting, such as computer-aided drafting,
electrical and electronics drafting, mechanical drafting, architectural and
construction drafting, civil drafting, interior design and landscape
architecture.

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 at least 12 academic quarters. We typically offer classes in
most programs in 3.5 to 5 hour sessions three or 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 employment opportunities concurrently with their studies.
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 and 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 who work full-time. Students may
generally begin the MPM program once the minimum number of applicants necessary
to start a new class has been assembled. Our Indianapolis institute is the only
institute that presently offers the 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 each 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 other institutes offering the same
programs 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 and sociology.

Tuition for a student entering an undergraduate program in December 2000 for
36 quarter credit hours (the minimum course load of a full-time student for an
academic year at traditional two- and four-year colleges) is $10,764 for the IT
programs, $10,044 for the CEET program and $10,044 for the CDD program. We
typically adjust the tuition cost per credit hour of the courses in the programs
of study offered at our institutes on an annual basis. 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.

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 and a web site address 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 that institute. We centrally establish, but implement at the
local level, recruiting policies and procedures, as well as standards for hiring
and training sales representatives. We employ sales representatives to assist in
local recruiting efforts. Approximately 380 of these representatives perform
their services solely in student recruitment offices located at each of our
institutes, while approximately 260 work outside these offices and visit the
homes of high school seniors and other prospective students. Our sales
representatives also make thousands of presentations to students at high
schools. These presentations promote our institutes and obtain information about
high school juniors and seniors who may be interested in attending our
institutes.

Local sales 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. 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.

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 either pass an
admissions examination administered by the school or demonstrate achievement of
a desired score on one of the two more widely reorganized college entrance
examinations. 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, that the student must 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, that the student must 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, 2000, approximately 92% of the students
were high school graduates and the remaining students possessed the recognized
equivalent of a high school diploma. Approximately 30% of the students were
19 years of age or younger, 36% were between 20 and 24 years of age, 20% were
between 25 and 30 years of age and 14% were age 31 or over. Male students
accounted for approximately 87% of total enrollment as of December 31, 2000,
while total minority enrollment at our institutes (based on applicable federal
classifications) was approximately 41%.

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 of our instructors.

Students who withdraw are most likely to do so before they begin their
second academic quarter of study at our institutes. Approximately 19% of all
students who enroll in our institutes withdraw before their second academic
quarter of study and approximately 31% 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 62% of all students who continue their education past their first
academic quarter complete their education at one of our institutes.

GRADUATE EMPLOYMENT

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
approximately 90% of the students graduating from our institutes' undergraduate
programs (other than those students who continued in a bachelor degree program
at one of our institutes) during 1999 obtained employment or were already
employed in fields involving their programs of study by May 31, 2000.

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 appropriate preparation, appearance and
conduct for interviews. We do not offer career services to students in the
graduate program of study.

Based on information from students and employers who responded to our
inquiries, we estimate that the average annual starting salary reported for the
1999 graduates of our institutes' undergraduate degree programs who obtained
employment or were already employed in fields involving their programs of study
was approximately $25,450.

The average annual salary 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 commission that accredits our institutes and the state education
authorities that regulate our institutes. 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 program
chairs for a program of study, and various categories of instructors. Our
institutes currently employ a total of approximately 1,400 full-time and 500
part-time faculty members.

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 150 people at our corporate headquarters in Indianapolis, Indiana.
We currently have approximately 3,030 full-time and 630 part-time employees. In
addition, we currently employ approximately 100 students as laboratory
assistants and in other part-time positions. 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
- data processing - network systems

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 - career services
- finance - library
- education

Managers located at our headquarters closely monitor the operating results
of each of our institutes and periodically 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.

FEDERAL AND OTHER FINANCIAL AID PROGRAMS

In 2000, we indirectly derived approximately 66% of our revenues from the
federal student financial aid programs under Title IV (the "Title IV Programs")
of the Higher Education Act of 1965, as amended (the "HEA"). Our institutes'
students also rely on state financial aid programs, family contributions, an
unaffiliated private loan program, scholarships, 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 Federal Family Education Loan ("FFEL") program, which accounted in
aggregate for approximately 56% of our revenues in 2000;

- the Federal Pell Grant ("Pell") program, which accounted in aggregate for
approximately 11% of our revenues in 2000;

- the William D. Ford Federal Direct Loan ("FDL") program, which accounted
in aggregate for approximately 3% of our revenues in 2000;

- 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 300 students and paid $1,572,000 in
student wages in 2000;

- the Federal Perkins Loan ("Perkins") program, which accounted in aggregate
for less than 1% of our revenues in 2000; and

- the Federal Supplemental Educational Opportunity Grant ("SEOG") program,
which accounted in aggregate for less than 1% of our revenues in 2000.

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 U.S. Department of Education ("DOE") under those
programs. In 2000, our 25% matching contribution amounted to $402,000 for the
Work-Study program, $1,000 for the Perkins program and $62,000 for the SEOG
program.

In 2000, we indirectly derived approximately 4% of our revenues from state
financial aid programs and our students were awarded approximately $1.6 million
in institutional scholarships. We also provide tuition discounts to our
full-time employees and their dependents to attend our institutes. For 2000, the
cost of these employee educational discounts was approximately $1.4 million.

In 2000, a loan program offered by an unaffiliated private funding source,
called the College Advantage Loan Program ("CALP"), was made available to
eligible students attending our institutes and their parents. The CALP is
intended to help fund any portion of the student's cost of education that is not
covered by federal and other financial aid sources. We have no financial
responsibility with respect to any of the loans made to eligible students or
their parents under the CALP. The CALP accounted in aggregate for 5% of our
revenues in 2000.

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.
Twenty-nine of our 70 institutes are main campuses and 41 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-seven of our 70 institutes currently participate in Title IV
Programs and the remaining three institutes are seeking eligibility to
participate.

The DOE and other regulatory authorities subject for-profit providers of
postsecondary education to increased scrutiny and regulation. 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.

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 "1998 HEA Amendments"). 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 Congress significantly reduced the amount of available Title IV
Program funding, 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 could 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 federal fiscal year, each institution participating in the FFEL and/or FDL
programs receives a 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 addition, if an institution
becomes ineligible to participate in the FFEL and FDL programs based on its
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. 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 a FFEL/FDL cohort default rate equal to or
greater than 25% for the 1998 federal fiscal year, the most recent year for
which the DOE has published FFEL/FDL official cohort default rates. None of our
campus groups had a FFEL/FDL preliminary cohort default rate equal to or greater
than 25% for the 1999 federal fiscal year, which preliminary rates were issued
by the DOE in February 2001.

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. Twenty-six of our campus groups
(consisting of 61 institutes) had a Perkins cohort default rate in excess of 15%
for students who were scheduled to begin repayment in the 1998/1999 federal
award year, the most recent year for which such rates have been calculated.
Although the DOE could place these institutes on provisional certification
status based on their Perkins cohort default rates, it has not done so.

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. The DOE's
current standards of financial responsibility 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
regulations to our audited financial statements for our 2000 fiscal year results
in a composite score of 2.3.

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. When the DOE reviewed the applications of our campus groups to
reinstate their eligibility to participate in Title IV Programs after Starwood
Hotels acquired ITT, the DOE determined that each of our campus groups 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." If the DOE determines that an
institution does not satisfy the DOE's financial responsibility standards, that
institution may establish its financial responsibility on one of several
alternative bases, including posting a letter of credit in an amount equal to a
specified percentage of the total Title IV Program funds received by the
institution during the institution's most recently completed fiscal year and
agreeing to receive Title IV Program funds under an arrangement other than the
DOE's standard advance funding arrangement while being provisionally certified.

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 a material number of late
refunds (as defined by the DOE) in either of its two most recently completed
fiscal years. No review by the DOE, a state or a 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 applies 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.

RETURN OF FUNDS FOR WITHDRAWN STUDENTS. Prior to the 1998 HEA Amendments,
the HEA limited how much of a student's tuition and fees an institution could
retain for 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 federal government's limitation on how
much of a student's tuition and fees an institution could retain for a
withdrawing student ("Refund Policy"), but the standards of most state education
authorities that regulate our institutes (the "SEAs") and the Accrediting
Council for Independent Colleges and Schools ("ACICS") that accredits our
institutes continue to impose a Refund Policy. The 1998 HEA Amendments and their
implementing regulations impose a limit on the amount of Title IV Program funds
a withdrawing student can use to pay his or her education costs. This 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 return 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 ("Return Policy"). All
institutions were required to begin complying with the Return Policy no later
than October 7, 2000. We began complying with the Return Policy on October 7,
2000.

Program funds are generally paid sooner and are more collectible than payments
from other sources. We believe, however, that the incremental decrease in the
amount of Title IV Program funds that certain withdrawing students can use to
pay their education costs to our institutes will be largely offset by the
incremental increase in the education costs owed to us by withdrawing students
in certain states that we intend to collect and, therefore, we do not expect the
Return Policy to have a material adverse effect on our financial condition,
results of operations or cash flows.

THE "90/10" RULE. Under a provision of the HEA commonly referred to as the
"90/10" 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 90% of its applicable revenues for a
fiscal year from Title IV Programs. If any of our campus groups violated the
90/10 Rule for any fiscal year, it 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 its eligibility until the next fiscal year. Furthermore, if
one of our campus groups violated the 90/10 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 by the institution after the effective date of the loss of
eligibility. For our 2000 fiscal year, none of our campus groups derived more
than 74% of its revenues from Title IV Programs. For our 2000 fiscal year, the
range for our campus groups was from approximately 59% to approximately 74%.

In an effort to prevent any future loss of Title IV Program eligibility by
any of our campus groups as a result of the 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.

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. A violation of these
requirements could also subject the institution to other penalties. See
"--Compliance with Regulatory Standards and Effect of Regulatory Violations."

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.

Twenty-six of our campus groups (consisting of 61 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 "--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, and some have received recognition awards of minor monetary
value. The DOE has not issued regulations to clarify its interpretation of this
provision of the HEA, and the DOE's interpretations of this provision have been
inconsistent and generally have not been publicly disseminated. As a result, we
cannot assure you that the DOE will not find any deficiencies in our method of
compensation. In July 2000, we

received a subpoena from the DOE's Office of Inspector General ("OIG")
requesting information that related primarily to the compensation of our sales
representatives (the "OIG Investigation"). If adversely determined, the OIG
Investigation could cause the DOE to subject us to monetary fines or penalties
(including repaying a substantial portion of the Title IV Program funds that we
disbursed during the last several years) or other sanctions (including a
limitation, suspension or termination of our ability to participate in Title IV
Programs). Any substantial restrictions on our ITT Technical Institutes' ability
to participate in Title IV Programs would adversely affect our ability to enroll
students, expand the number of our institutes and increase the number of the
programs of study offered at our institutes.

In August 2000, the DOE advised us that, during the pendency of the OIG
Investigation, it will not approve any application submitted by any ITT
Technical Institute with respect to any change of ownership, additional
location, certification of initial or continuing eligibility, or extension of
course or program offerings (such as raising the level of programs offered at an
institution). The DOE has also advised us, however, that during the pendency of
the OIG Investigation, each of the ITT Technical Institutes that currently
participates in Title IV Programs remains eligible to participate in Title IV
Programs in accordance with the terms of its present eligibility and, if its
current period of eligibility expires, its eligibility will continue on a
month-to-month basis. See "--Additional Locations and Programs," "--Eligibility
and Certification Procedures," "--Compliance with Regulatory Standards and
Effect of Regulatory Violations," and "Business--Change in Control." A material
adverse effect on our expansion plans, financial condition, results of
operations and cash flows would result if the DOE's restrictions are not lifted
prior to 2003. We cannot assure you that the DOE will lift its restrictions
prior to 2003 or that the DOE will not place additional or other more severe
restrictions on our ITT Technical Institutes' ability to participate in Title IV
Programs.

In January 2001, the U.S. Department of Justice ("DOJ") informed us that we
are a defendant in a qui tam action brought under the False Claims Act, 31
U.S.C. Section 3730 (the "Qui Tam Action"), which we now believe caused the OIG
to institute the OIG Investigation. The Qui Tam Action, if adversely determined,
could result in our having to repay Title IV Program funds that we disbursed
during the last several years, which would be trebled under the False Claims
Act, and also to pay penalties. See "Legal Proceedings."

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 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.

ADDITIONAL LOCATIONS AND PROGRAMS. Our expansion plans assume we will be
able to continue to obtain the necessary DOE, ACICS 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 1998 through
2000, we established eight new additional locations, six of which are
participating and two of which are seeking to participate in Title IV Programs,
and added 167 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. In November 2000, the DOE issued
new regulations, effective July 1, 2001, that will permit an institution
participating in Title IV Programs to establish an additional location that can
participate in Title IV Programs immediately upon being reported to the DOE,
unless one of the

following restrictions applies, in which case the DOE must approve the
additional location before it can participate in Title IV Programs:

- the institution is provisionally certified to participate in Title IV
Programs (See "--Eligibility and Certification Procedures");

- the institution receives Title IV Program funds under the DOE's
reimbursement or cash monitoring payment method;

- the institution acquired the assets of another institution that provided
educational programs at that location during the preceding year and
participated in Title IV Programs during that year;

- the institution would be subject to loss of eligibility to participate in
Title IV Programs, because the additional location lost its eligibility to
participate in Title IV Programs as a result of high FFEL/FDL cohort
default rates; or

- the DOE previously notified the institution that it must apply for
approval to establish an additional location.

The DOE has advised us that, during the pendency of the OIG Investigation, the
DOE will not approve any application submitted by any of our campus groups for
an additional location. See "--Administrative Capability."

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 DOE has advised us that,
during the pendency of the OIG Investigation, the DOE will not approve any
extension of any of our campus groups' course or program offerings (such as
raising the level of programs offered at the institution). See "--Administrative
Capability."

The ACICS criteria generally permit an institution's main campus to
establish an additional location. Although the ACICS accreditation criteria may
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 accreditation criteria 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."

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. The current DOE certification
for all of our ITT Technical Institute campus groups extends through June 30,
2001. Accordingly, we have applied to the DOE to recertify all of our

campus groups. The DOE has advised us that, during the pendency of the OIG
Investigation, the DOE will not approve any application submitted by any of our
campus groups for recertification to participate in Title IV Programs. If the
OIG Investigation is still pending when the ITT Technical Institute campus
groups' current certifications to participate in Title IV Programs expire, each
of the ITT Technical Institutes that currently participate in Title IV Programs
will remain eligible to participate in Title IV Programs in accordance with the
terms of its present eligibility on a month-to-month basis. See
"--Administrative Capability." The DOE has normally required each of our campus
groups 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 affecting 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 in February 1998. 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. See "--Change in Control." The DOE also placed one
additional condition on the provisional certification of three campus groups
(consisting of five institutes), as follows:

- the DOE cited the San Antonio institute for having a FFEL/FDL cohort
default rate exceeding 25% for at least one of the three most recent
federal fiscal years for which such rates had been published, and advised
that institute 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 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.

The San Antonio institute now has an FFEL/FDL cohort default rate below 25%
for each of the three most recent federal fiscal years for which the DOE has
published FFEL/FDL official cohort default rates. In August 1998, the DOE
formally closed the DOE program review of the San Diego institute and the ACICS
formally reaccredited the Youngstown campus group. These developments will be
considered when all of our campus groups reapply to the DOE for continued
certification to participate in Title IV Programs in 2001. See "--Change in
Control."

TITLE IV PROGRAM FUNDS MANAGEMENT. DOE regulations govern how an
institution participating in Title IV Programs requests, maintains, disburses
and otherwise manages Title IV Program funds. These

regulations require institutions to disburse all Title IV Program funds by
payment period. For our institutes, the payment period is an academic quarter.
These regulations delay our receipt and disbursement of federal student loan
funds and prescribe time frames within which our campus groups must notify Title
IV Program fund recipients of certain information and return any undisbursed
Title IV Program funds. We do not believe that these regulations will have a
material adverse effect on our financial condition, results of operations or
cash flows.

AVAILABILITY OF LENDERS AND GUARANTORS. For a variety of reasons, 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 2000, one lender made approximately 71% 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 (a
FFEL program), which accounted in aggregate for 14% of our revenues in 2000, and
are not required to provide unsubsidized loans under the Federal Stafford Loan
program (a FFEL program), which accounted in aggregate for 25% of our revenues
in 2000.

During 2000, one student loan guaranty agency guaranteed approximately 95%
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. We do not 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 and typically conducts an annual 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 the ACICS. 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
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 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.
In July 2000, we were informed that the OIG had initiated an investigation,
which appears to relate primarily to the compensation of our sales
representatives. If the OIG Investigation causes the DOE to substantially limit,
suspend or terminate our institutes' participation in Title IV Programs or levy
significant monetary fines or penalties, there would be a material adverse
effect on our expansion plans, financial condition, results of operations and
cash flows. If any proceeding substantially limited our institutes'
participation in Title IV Programs or required the repayment of a substantial
sum of Title IV Program funds that our institutes disbursed in prior years, we
would be materially adversely affected, even if we could arrange or provide
alternative financing sources or repay those funds. 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. See "--Administrative Capability."

STATE AUTHORIZATION AND ACCREDITATION

We are subject to extensive and varying regulation in each of the 28 states
in which we currently operate an institute and in eight other states in which
our institutes recruit students. Each of our institutes must be authorized by
the applicable SEAs 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 institutes has received authorization from one or more
SEAs.

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
the SEAs and the ACICS. 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 2000, two of our
institutes were reviewed and granted initial accreditation by the ACICS.

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 the state to be accredited as a condition of
state authorization. All of our institutes are accredited by the ACICS, which is
an accrediting commission recognized by the DOE. None of our institutes is on
probation with the ACICS, but five institutes are subject to a financial review
and 14 institutes are subject to an outcomes review by ACICS. Under the ACICS
criteria, an institute that is subject to a financial or outcomes review must
periodically report its results in such areas to the ACICS and obtain permission
from the ACICS prior to applying to add a new program of study or establish an
additional location. We do not believe that these limitations will have a
material adverse effect on our expansion plans.

The loss of accreditation by one of our existing institutes or the failure
of a new 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.

CHANGE IN CONTROL

The DOE, the ACICS and most of the SEAs have laws, regulations and/or
criteria (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. 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 the consolidated corporation of which the institution is a part.
Under the DOE's Regulations issued in November 2000 that became effective
immediately, a change in control of a publicly traded corporation, such as ESI,
occurs when: (a) 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; or
(b) a controlling shareholder of the corporation ceases to be a controlling
shareholder. The DOE's Regulations define a "controlling shareholder" to:
(a) be a shareholder who holds or controls at least 25% or more of the voting
stock of the corporation and more shares of the voting stock than any other
shareholder; and (b) exclude a shareholder whose sole ownership of the
corporation's voting stock is held as a U.S. institutional investor, in mutual
funds, through a profit-sharing plan or in an Employee Stock Ownership Plan.
Most of the SEAs include the sale of a controlling interest of common stock in
the definition of a change in control. The ACICS defines a change in control of
a publicly traded corporation to include, among other things:

- a change in 50% or more of the voting members of the corporation's board
of directors in any rolling, 12-month period;

- a change in the number of voting members of the corporation's board of
directors in any rolling, 12-month period that allows a group of directors
to exercise control who could not exercise control before the change;

- the acquisition of 50% or more of the total outstanding voting shares of
the corporation by any entity; or

- any transaction that is deemed by an appropriate governmental agency to
constitute a change in control.

The change in control Regulations adopted by the DOE, the ACICS and the SEAs are
subject to varying interpretations as to whether a particular transaction
constitutes a change in control.

When a change in control occurs under the DOE's regulations, an
institution's eligibility to continue to participate in Title IV Programs is
subject to review and the institution could lose its eligibility, with the
result that the institution would no longer be able to authorize or, with
limited exceptions, disburse Title IV Program funds to its students. Under the
HEA and the DOE's Regulations, the DOE may provisionally certify an institution
that is part of a publicly traded corporation for a temporary period following a
change in control, if the institution submits a materially complete application
for reinstatement within 10 business days after the institution knew or should
have known, based on SEC filings, that the change in control occurred. This
temporary certification enables the institution to continue to participate in
Title IV Programs pending the DOE's review of its complete application, if such
complete application is filed by the last day of the month following the month
in which the institution knew or should have known, based on SEC filings, that
the change of control occurred. For this purpose, a complete application must
include the most recent quarterly financial statements filed with the SEC, a
copy of all other SEC filings made after the close of the last fiscal year for
which the institution submitted a compliance audit to the DOE, and documentation
that the institution, including both the main campus and any additional
locations, is authorized by the appropriate SEA or SEAs and accredited by an
accrediting commission recognized by the DOE following the change in control.
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 make such a
determination can vary but, if the institution satisfies the application
criteria and time frames specified above in this paragraph, the institution will
be certified on a month-to-month basis while the DOE conducts its review.

The ACICS 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 ACICS criteria and procedures
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.

Many 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.

In March 1998, the DOE approved the reinstatement of our institutes'
participation in Title IV Programs following the change in control occasioned by
Starwood Hotels' acquisition of ITT. 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 the items identified by the DOE is in accordance with GAAP and
we have continued to communicate our position to the DOE, but we cannot assure
you that the DOE will agree with our position. If the DOE required us to use
certain accounting methods that differ from the methods we presently use, then
we could be forced to change certain of our accounting practices. We do not
believe that such a change would have a material adverse effect on our financial
condition or results of operations before the cumulative effect of any change in
accounting. Three of our campus groups (consisting of five institutes) each had
one additional condition placed on its provisional certification. See
"--Regulation of Federal Financial Aid Programs--Eligibility and Certification
Procedures."

A change in control could occur as a result of future transactions in which
we or our institutes are involved, such as some corporate reorganizations and
some changes in our board of directors. If a future transaction results in a
change in control of ESI or our institutes, we believe that we will be able to
obtain all necessary approvals from the SEAs and the ACICS. 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. We also cannot assure you that
we could obtain all of the necessary approvals from the DOE. The DOE has advised
us that, during the pendency of the OIG Investigation, the DOE will not approve
any application submitted by any of our campus groups with respect to any change
in control. See "Business--Regulation of Federal Financial Aid
Programs--Administrative Capability."

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 or following a change
in control;

- regain accreditation by the ACICS or have their accreditation temporarily
continued or reinstated by the ACICS; or

- regain eligibility to participate in Title IV Programs from the DOE or
receive temporary certification to continue to participate in Title IV
Programs pending further review by the DOE.

ITEM 2. 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 seven years. As of December 31, 2000, we leased 79 facilities for
71 institutes. Two of these leases were for institutes in their first year of
operation as of December 31, 2000, two of these leases were for facilities under
lease where we plan to open two new institutes in 2001, and eight of these
leases were for four institutes that each utilize two separate facilities.

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. 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, 2000, the
lease required payments of approximately $1.6 million over the remaining term of
the lease, which expires in 2003.

ITEM 3. LEGAL PROCEEDINGS.

We are subject to litigation in the ordinary course of our business. Among
the legal actions currently pending are:

(1) In January 2001, the U.S. Department of Justice ("DOJ") informed us that we
are a defendant in a qui tam action brought under the False Claims Act, 31
U.S.C. Section 3730, that is pending in the United States District Court for
the Southern District of Texas (the "Qui Tam Action"). A qui tam action is a
civil lawsuit brought by one or more individuals (a qui tam "relator") on
behalf of the federal government for an alleged submission to the federal
government of a false claim for payment. A qui tam action is always filed
under seal and remains under seal until the DOJ decides whether to intervene
in the litigation. Whenever a relator files a qui tam action, the DOJ
typically initiates an investigation in order to determine whether to
intervene in the litigation. If the DOJ

intervenes, it has primary control over the litigation. If the DOJ declines
to intervene, the relator may pursue the litigation on behalf of the federal
government and, if successful, receives a portion of the federal
government's recovery.

The DOJ has not decided whether to intervene in the Qui Tam Action. Thus,
the Qui Tam Action remains under seal and we have not been served with the
complaint. Since the Qui Tam Action is under seal, we do not know (or are
not permitted to disclose) the details of the complaint concerning, among
other things, the identity of the relator or relators, the theories of
liability or the amount of damages sought from us. We believe, however, that
the Qui Tam Action relates primarily to whether our sales representative
compensation plan violates the HEA and the DOE's regulations that prohibit
an institution participating in Title IV Programs from providing any
commission, bonus or other incentive payment based directly or indirectly on
success in securing enrollments to any person or entity engaged in any
student recruitment or admissions activity. The Qui Tam Action, if adversely
determined, could result in our having to repay Title IV Program funds that
we disbursed during the last several years, which would be trebled under the
False Claims Act, and also to pay penalties. We believe that we have
meritorious defenses to the Qui Tam Action and, if the action proceeds, we
intend to vigorously defend ourselves against the claims.

As previously reported, in July 2000, we received a subpoena from the DOE's
Office of Inspector General ("OIG") requesting information that related
primarily to the compensation of our sales representatives (the "OIG
Investigation"), which we now believe resulted from the Qui Tam Action. If
adversely determined, the OIG Investigation could cause the DOE to subject
us to monetary fines or penalties (including repaying a substantial portion
of the Title IV Program funds that we disbursed during the last several
years) or other sanctions (including a limitation, suspension or termination
of our ability to participate in Title IV Programs). Any substantial
restrictions on our ITT Technical Institutes' ability to participate in
Title IV Programs would adversely affect our ability to enroll students,
expand the number of our institutes and increase the number of the programs
of study offered at our institutes.

In August 2000, the DOE advised us that, during the pendency of the OIG
Investigation, it will not approve any application submitted by any ITT
Technical Institute with respect to any change of ownership, additional
location, certification of initial or continuing eligibility, or extension
of course or program offerings (such as raising the level of programs
offered at an institution). The DOE has also advised us, however, that
during the pendency of the OIG Investigation, each of the ITT Technical
Institutes that currently participates in Title IV Programs remains eligible
to participate in Title IV Programs in accordance with the terms of its
present eligibility and, if its current period of eligibility expires, its
eligibility will continue on a month-to-month basis. A material adverse
effect on our expansion plans, financial condition, results of operations
and cash flows would result if the DOE's restrictions are not lifted prior
to 2003. We cannot assure you that the DOE will lift its restrictions prior
to 2003 or that the DOE will not place additional or other more severe
restrictions on our ITT Technical Institutes' ability to participate in
Title IV Programs.

(2) CONTRERAS, ET AL. V. ITT EDUCATIONAL SERVICES, INC., ET AL. (Civil Action
No. CV788222), was filed on March 3, 2000 (served on January 19, 2001) in
the Superior Court of Santa Clara County in Santa Clara, California by five
former students of the ITT Technical Institute in Santa Clara, California.
The suit alleges, among other things, fraud, negligence, negligent
misrepresentation, breach of oral contract, and statutory violations of the
California Business and Professions Code and California Education Code by us
and three of our employees who reside in California. The claims relate
primarily to our marketing and recruitment practices and the quality of our
services. The plaintiffs seek compensatory damages, punitive damages,
exemplary damages, civil penalties, restitution on behalf of plaintiffs and
all other persons similarly situated, injunctive relief, attorney's fees and
costs. On February 6, 2001, the plaintiffs filed an amended complaint in
this action adding 57

plaintiffs, who are current and former students of the ITT Technical
Institute in either Santa Clara, California or Hayward, California.
Thirty-seven of the 62 plaintiffs graduated from their programs of study at
the ITT Technical Institutes, and 25 of those graduates or their employers
reported to us that they were employed in a field involving their education
at an average salary of $34,245. The written enrollment agreement between
each of the plaintiffs and us provides that all disputes between the parties
will be resolved through binding arbitration, instead of litigation. We will
be filing a motion with the court to compel the arbitration of each
plaintiff's claims in this action. We believe that we have meritorious
defenses, and we intend to vigorously defend ourself against the plaintiffs'
claims.

We cannot assure you of the ultimate outcome of any litigation involving us.
Based on the information currently available to 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. 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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of the holders of the common stock
during the fourth quarter of 2000.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our common stock is listed on the New York Stock Exchange ("NYSE") 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.

HIGH LOW
-------- --------

1999
First Quarter............................................... $40.357 $31.500
Second Quarter.............................................. 39.125 19.688
Third Quarter............................................... 28.625 15.000
Fourth Quarter.............................................. 24.000 14.750
2000
First Quarter............................................... $19.375 $10.750
Second Quarter.............................................. 23.250 15.375
Third Quarter............................................... 28.875 17.375
Fourth Quarter.............................................. 28.250 13.375

There were approximately 200 holders of record of our common stock on
March 6, 2001.

We did not pay a cash dividend in 1999 or 2000. 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.

ITEM 6. SELECTED FINANCIAL DATA:

The following selected financial data of ESI are qualified by reference to
and should be read with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements and other financial data included elsewhere in
this report.

YEAR ENDED DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)

STATEMENT OF INCOME DATA:
Revenues.................................. $347,524 $316,370 $291,375 $261,664 $232,319
Cost of educational services.............. 211,653 191,760 176,487 163,053 145,197
Student services and administrative
expenses................................ 94,156 86,953 81,522 72,388 66,546
Legal settlements......................... -- -- 12,858 -- --
Offering, change in control and other
one-time expenses....................... -- 900 1,872 -- --
-------- -------- -------- -------- --------
Total costs and expenses................ 305,809 279,613 272,739 235,441 211,743
Operating income.......................... 41,715 36,757 18,636 26,223 20,576
Interest income, net (a).................. 2,707 2,396 5,329 5,565 4,119
-------- -------- -------- -------- --------
Income before income taxes and cumulative
effect of change in accounting
principle............................... 44,422 39,153 23,965 31,788 24,695
Income taxes.............................. 16,937 14,802 10,024 12,665 9,844
-------- -------- -------- -------- --------
Income before cumulative effect of change
in accounting principle................. 27,485 24,351 13,941 19,123 14,851
Cumulative effect of change in accounting
principle, net of tax (b)............... (2,776) (823) -- -- --
-------- -------- -------- -------- --------
Net income................................ $ 24,709 $ 23,528 $ 13,941 $ 19,123 $ 14,851
-------- -------- -------- -------- --------
Earnings per share (c):
Basic................................... $ 1.03 $ 0.93 $ 0.52 $ 0.71 $ 0.55
Diluted................................. $ 1.02 $ 0.93 $ 0.51 $ 0.71 $ 0.55
======== ======== ======== ======== ========
OTHER OPERATING DATA:
EBITDA (d)................................ $ 56,234 $ 47,907 $ 27,918 $ 34,162 $ 28,069
Operating losses from new technical
institutes before income taxes (e)...... $ 4,051 $ 5,096 $ 5,257 $ 3,165 $ 5,721
Capital expenditures, net................. $ 29,393 $ 17,005 $ 11,381 $ 11,465 $ 7,868
Number of students at end of period....... 27,640 26,428 25,608 24,498 22,633
Number of technical institutes at
end of period........................... 69 67 65 62 59

AT DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------

BALANCE SHEET DATA:
Cash, restricted cash, cash invested with ITT
and marketable debt securities.............. $70,618 $67,961 $119,268 $98,689 $95,793
Total current assets.......................... 92,570 89,082 138,758 112,958 108,449
Property and equipment, less accumulated
depreciation................................ 46,560 31,686 24,985 22,886 19,360
Total assets.................................. 150,896 131,002 175,571 145,914 135,749
Total current liabilities..................... 79,926 68,622 70,241 55,946 65,405
Shareholders' equity.......................... 64,686 57,771 101,856 87,815 68,692

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

(a) See Note 3 of Notes to Consolidated Financial Statements for information
concerning intercompany interest between ESI and ITT.

(b) Cumulative effect of change in accounting principle, net of tax represents
institute start-up costs in 1999 and revenue recognition in accordance with
SAB 101 in 2000. Except for the selected quarterly financial data, ESI has
not presented proforma results for prior fiscal years due to immateriality.

(c) 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."

(d) EBITDA represents earnings before interest and financial charges, income
taxes, depreciation and amortization and cumulative effect of change in
accounting principle. 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.

(e) Operating losses from new technical institutes before income taxes
represents operating losses before income taxes, including amortization of
deferred start-up costs, for institutes in the first 24 months after their
first class start.

ITEM 7. 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 CONSOLIDATED FINANCIAL STATEMENTS AND NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS REPORT.

GENERAL

We operate 70 institutes in 28 states which provide technology-oriented
postsecondary education to approximately 27,500 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 federal student financial aid programs under Title IV ("Title IV
Programs") of the Higher Education Act of 1965, as amended, (the "HEA"). In
2000, we indirectly derived approximately 66% 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 accrediting commission that accredits our institutes grants
accreditation to a new institute as of its first class start date. The DOE's
certification process cannot commence until the first students begin classes.
DOE certification for a new location has generally taken approximately nine
months from the first class start date. In July 2000, we received a subpoena
from the DOE's Office of Inspector General ("OIG") requesting information that
related primarily to the compensation of our sales representatives (the "OIG
Investigation"). In August 2000, the DOE advised us that, during the pendency of
the OIG Investigation, it will not approve any application submitted by any ITT
Technical Institute with respect to any change of ownership, additional
location, certification of initial or continuing eligibility, or extension of
course or program offerings (such as raising the level of programs offered at an
institution). The DOE also advised us, however, that during the pendency of the
OIG Investigation, each of the ITT Technical Institutes that currently
participates in Title IV Programs remains eligible to participate in Title IV
Programs in accordance with the terms of its present eligibility and, if its
current period of eligibility expires, its eligibility will continue on a
month-to-month basis. The HEA and the DOE's regulations prohibit an institution
participating in Title IV Programs from providing any commission, bonus or other
incentive payment based directly or indirectly on success in securing
enrollments to any person or entity engaged in any student recruitment or
admissions activity. The DOE has not issued regulations to clarify its
interpretation of this provision of the HEA, and the DOE's interpretations of
this provision have been inconsistent and generally have not been publicly
disseminated. As a result, we cannot assure you that the DOE will not find any
deficiencies in our method of compensation. In January 2001, the U.S. Department
of Justice ("DOJ") informed us that we are a defendant in a qui tam action
brought under the False Claims Act, 31 U.S.C. Section 3730 (the "Qui Tam
Action"), which we now believe caused the OIG to institute the OIG
Investigation. If adversely determined, the OIG Investigation could cause the
DOE to subject us to monetary fines or penalties (including repaying a
substantial portion of the Title IV Program funds that we disbursed during the
last several years) or other sanctions (including a limitation, suspension or
termination of our ability to participate in Title IV Programs). Any substantial
restrictions on our ITT Technical Institutes' ability to participate in Title IV
Programs would adversely affect our ability to enroll students, expand the
number of our institutes and increase the number of the programs of study
offered at our institutes. In addition, a material adverse effect on our
expansion plans, financial condition, results of operations and cash flows would
result if the restrictions placed on us by the DOE in August 2000 are not lifted
prior to 2003. We cannot assure you that the DOE will lift its restrictions
prior to 2003 or that the DOE will not place additional or other more severe
restrictions on our ITT Technical Institutes' ability to participate in Title IV
Programs. The Qui Tam Action, if adversely determined, could result in our
having to repay Title IV Program funds that we disbursed during the last several
years, which would be trebled under the False Claims Act, and also to pay
penalties. See Note 10 of Notes to Consolidated Financial Statements.

Prior to January 1, 1999, we deferred certain direct costs incurred with
respect to a new institute prior to the first class start ("institute start-up
costs") and amortized them over the first year of operation after the first
class start. Beginning January 1, 1999, we began expensing institute start-up
costs as incurred. From January 1, 1995 through December 31, 2000, we opened 16
new institutes (six of which started classes in 1998 or 1999 and two of which
started classes in 2000). 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 $4.1 million for the year ended December 31, 2000,
$5.1 million for the year ended December 31, 1999 and $5.3 million for the year
ended December 31, 1998.

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. State regulations and
accrediting commission criteria 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. Prior to October 7, 2000, the DOE
regulations also imposed tuition refund requirements. Our statement of income
recognizes immediately the amount of tuition, if any, that we may retain after
payment of any refund.

In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements"
("SAB 101"). Effective January 1, 2000, we implemented SAB 101 and changed the
method by which we recognize the laboratory and application fees charged to a
student as revenue. We began recognizing those fees as revenue on a
straight-line basis over the average student's program length of 24 months.
Previously, we recognized the quarterly laboratory fee as revenue at the
beginning of each academic quarter and the application fee as revenue when we
received the fee. We recorded the cumulative effect of the change in accounting
as a one-time charge of $2.8 million, net of taxes, in the three months ended
March 31, 2000.

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. In March 1998, as part of the DOE's reinstatement of our institutes'
participation in Title IV Programs following our change in control resulting
from Starwood Hotels & Resorts Worldwide, Inc. ("Starwood Hotels") February 23,
1998 acquisition of ITT Corporation ("ITT"), the DOE, among other things,
directed us to revise our current accounting treatment of direct marketing,
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 the items
identified by the DOE is in accordance with GAAP and we have continued to
communicate our position to the DOE, but we cannot assure you that the DOE will
agree with our position. If the DOE required us to use certain accounting
methods that differ from the methods we presently use, then we could be forced
to change certain of our accounting policies. We do not believe that such a
change would have a material adverse effect on our financial condition or
results of operations before the cumulative effect of any change in accounting.

We have been performing our own cash management functions since February 5,
1998. Prior to February 5, 1998, ITT provided cash management services to us. We
have included the invested funds in the captions "cash and cash equivalents" and
"marketable debt securities" in the December 31, 2000 and 1999 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 original

maturity dates of less than 90 days 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.

In 1998, we began offering a new information technology program of study
involving computer network systems ("CNS") at three ITT Technical Institutes. We
began offering the CNS program at an additional 31 ITT Technical Institutes in
1999 and at an additional 35 ITT institutes in 2000. We incur a loss with
respect to each CNS program offered at an ITT Technical Institute until the
revenue from the number of enrolled students is high enough to offset the fixed
costs associated with the program offering (such as salaries, equipment
depreciation, rent and marketing), which typically has not occurred until the
program has been offered for three or four quarters. The initial amount of
capital required to offer the CNS program at an ITT Technical Institute is
approximately $0.2 million.

VARIATIONS IN QUARTERLY RESULTS OF OPERATIONS

Our quarterly results of operations have tended 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.
Prior to the first quarter of 2000, our first and third fiscal quarters had 13
weeks of earned tuition revenue, while our second and fourth quarters had only
11 weeks of earned tuition revenue because of two-week student vacation breaks
in June and December. Commencing with the first quarter of 2000, each of our
four quarters have 12 weeks of earned tuition revenue. 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 (27% of all new students in 2000) and September (34% of all new
students in 2000) 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.

The following table sets forth proforma revenues in each quarter during the
two prior fiscal years as if we had followed the SAB 101 revenue recognition
guidance and reported the same number of weeks of tuition revenue during each
period.

QUARTERLY REVENUE
(DOLLARS IN THOUSANDS)

2000 1999 PROFORMA 1998 PROFORMA
------------------- ------------------- -------------------
THREE-MONTH PERIOD ENDED AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------------------ -------- -------- -------- -------- -------- --------

March 31...................................... $ 81,192 23% $ 74,850 24% $ 67,488 23%
June 30....................................... 82,745 24 75,688 24 69,572 24
September 30.................................. 88,479 26 81,027 25 76,065 26
December 31................................... 95,108 27 84,810 27 77,809 27
-------- --- -------- --- -------- ---
Total for Year.............................. $347,524 100% $316,375 100% $290,934 100%
======== === ======== === ======== ===

RESULTS OF OPERATIONS

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

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Revenues.................................................... 100.0% 100.0% 100.0%
Cost of educational services................................ 60.9 60.6 60.6
Student services and administrative expenses................ 27.1 27.5 28.0
Legal settlements........................................... -- -- 4.4
Offering, change in control and other one-time expenses..... -- 0.3 0.6
----- ----- -----
Operating income............................................ 12.0 11.6 6.4
Interest income, net........................................ 0.8 0.8 1.8
----- ----- -----
Income before income taxes and cumulative effect of change
in accounting principle................................... 12.8% 12.4% 8.2%
===== ===== =====

YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999

REVENUES. Revenues increased $31.1 million, or 9.8%, to $347.5 million for
the year ended December 31, 2000 from $316.4 million for the year ended
December 31, 1999 primarily due to:

- a 5% increase in tuition rates in each of June 2000 (10% for the
information technology programs) and September 1999;

- a 3.2% increase in the total student enrollment at January 1, 2000
compared to January 1, 1999 (26,428 at January 1, 2000 compared to 25,608
at January 1, 1999); and

- a 2.9% increase in the number of first-time and re-entering students
beginning classes at our institutes (27,491 in 2000 compared to 26,716 in
1999).

The total student enrollment on December 31, 2000 was 27,640, an increase of
4.6% from the 26,428 total student enrollment on December 31, 1999.

COST OF EDUCATIONAL SERVICES. Cost of educational services increased
$19.9 million, or 10.4%, to $211.7 in 2000 from $191.8 million in 1999. 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;

- the costs associated with the CNS program offerings; and

- increased costs at new institutes (two in January 1999, one in
April 1999, one in March 2000 and one in December 2000).

Cost of educational services as a percentage of revenues increased to 60.9%
in 2000 from 60.6% in 1999. This increase was primarily due to the costs
associated with offering the CNS program at more schools in 2000 than in 1999
(an additional 35 institutes began offering the CNS program in 2000 compared to
an additional 31 in 1999), including salaries, equipment depreciation and rent.

STUDENT SERVICES AND ADMINISTRATIVE EXPENSES. Student services and
administrative expenses increased $7.2 million, or 8.3%, to $94.2 million in
2000 from $87.0 million in 1999. Student services and administrative expenses
decreased to 27.1% of revenues in 2000 compared to 27.5% of revenues in 1999
primarily because the percentage increase in the costs associated with the sales
representatives that we employed in 2000 was less than the percentage increase
in revenues in 2000. In addition, media

advertising costs in the year ended December 31, 2000 were 9.6% more than in the
year ended December 31, 1999, which was a slightly smaller increase than the
9.8% increase in revenues.

ONE-TIME EXPENSES. In 1999, we incurred net one-time expenses of
$0.9 million ($0.02 per share) associated with the costs of ITT's February 1999
public offering of our common stock (the "February 1999 Offering") and special
bonus payments to employees for extraordinary services, net of amounts
reimbursed by ITT. We did not incur any such expenses in 2000.

OPERATING INCOME. The following table sets forth our operating income (in
thousands) for the year ended December 31, 2000 and 1999:

YEAR ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------

Operating income as reported................................ $41,715 $36,757
Offering expenses, change in control and other one-time
expenses.................................................. -- 900
------- -------
Operating income before one-time expenses................... $41,715 $37,657
======= =======

INCOME TAXES. Our combined effective federal and state income tax rate in
2000 was 38.1% as compared to 37.8% in 1999.

NET INCOME. The following table sets forth our net income (in thousands)
for the year ended December 31, 2000 and 1999:

YEAR ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------

Net income (as reported).................................... $24,709 $23,528
Offering expenses, change in control and other one-time
expenses (after tax)...................................... -- 554
Cumulative effect of change in accounting principle (after
tax)...................................................... 2,776 823
------- -------
Net income before one-time expenses and cumulative effect of
change in accounting principle............................ $27,485 $24,905
======= =======

YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998

REVENUES. Revenues increased $25.0 million, or 8.6%, to $316.4 million for
the year ended December 31, 1999 from $291.4 million for the year ended
December 31, 1998 primarily due to:

- a 5% increase in tuition rates in each of September 1999 and 1998;

- a 4.5% increase in the total student enrollment at January 1, 1999
compared to January 1, 1998 (25,608 at January 1, 1999 compared to 24,498
at January 1, 1998); and

- a 9.0% increase in the number of first-time and re-entering students
beginning classes at our institutes (26,716 in 1999 compared to 24,521 in
1998).

The total student enrollment on December 31, 1999 was 26,428, an increase of
3.2% from the 25,608 total student enrollment on December 31, 1998.

COST OF EDUCATIONAL SERVICES. Cost of educational services increased
$15.3 million, or 8.7%, to $191.8 million in 1999 from $176.5 million in 1998.
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 in March 1998, one in June 1998,
one in October 1998, two in January 1999 and one in April 1999).

Cost of educational services as a percentage of revenues was 60.6% in 1999,
which was the same percentage as in 1998.

STUDENT SERVICES AND ADMINISTRATIVE EXPENSES. Student services and
administrative expenses increased $5.5 million, or 6.7%, to $87.0 million in
1999 from $81.5 million in 1998. Student services and administrative expenses
decreased to 27.5% of revenues in 1999 compared to 28.0% in 1998 primarily
because the percentage increase in the costs associated with the sales
representatives that we employed in 1999 was less than the percentage increase
in revenues in 1999. Media advertising costs in the year ended December 31, 1999
were 9.6% more than in the year ended December 31, 1998.

ONE-TIME EXPENSES. We recorded a $12.9 million ($0.28 per share) provision
for the settlement of certain legal proceedings and claims in 1998. (See
Note 10 of Notes to Consolidated Financial Statements). In 1999, we incurred net
one-time expenses of $0.9 million ($0.02 per share) associated with the costs of
the February 1999 Offering and special bonus payments to employees for
extraordinary services, net of amounts reimbursed by ITT. In June 1998, we
incurred total expenses of $1.1 million ($0.04 per share) for ITT's June 1998
public offering of our common stock (the "June 1998 Offering"). In addition, we
incurred expenses of $0.8 million ($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, 1999 and 1998:

YEAR ENDED
DECEMBER 31,
-------------------
1999 1998
-------- --------

Operating income as reported................................ $36,757 $18,636
Legal settlements........................................... -- 12,858
Offering expenses, change in control and other one-time
expenses.................................................. 900 1,872
------- -------
Operating income before one-time expenses................... $37,657 $33,366
======= =======

INTEREST INCOME. Interest income, net decreased $2.9 million in 1999
compared to 1998, which was primarily due to the reduction in our cash and cash
equivalents, restricted cash and marketable debt securities as a result of our
repurchase of 2.4 million shares of ESI common stock for $68.9 million
throughout 1999.

INCOME TAXES. Our combined effective federal and state income tax rate in
1998 was 41.8%. Our 1999 federal and state income tax rate was 37.8%, as a
result of lower state income taxes.

NET INCOME. The following table sets forth our net income (in thousands)
for the year ended December 31, 1999 and 1998:

YEAR ENDED
DECEMBER 31,
-------------------
1999 1998
-------- --------

Net income (as reported).................................... $23,528 $13,941
Legal settlements (after tax)............................... -- 7,715
Offering expenses, change in control and other one-time
expenses (after tax)...................................... 554 1,501
Cumulative effect of change in accounting principle (after
tax)...................................................... 823 --
------- -------
Net income before one-time expenses and cumulative effect of
change in accounting principle............................ $24,905 $23,157
======= =======

LIQUIDITY AND CAPITAL RESOURCES

In 2000, we indirectly derived approximately 66% 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.

Simultaneous with the close of the February 1999 Offering, we repurchased
1,500,000 shares of our common stock from ITT at the per share price to the
public of the shares sold in the February 1999 Offering, less underwriters'
commissions and discounts, for an aggregate cost of $49,088 (the "February 1999
Stock Repurchase").

During 1999 and 2000, our Board of Directors authorized us to repurchase in
aggregate up to 4,000,000 outstanding shares of our common stock in the open
market or through privately negotiated transactions in accordance with
Rule 10b-18 of the Securities Exchange Act of 1934, as amended. Subsequent to
the February 1999 Stock Repurchase, we repurchased 919,000 shares of our common
stock in 1999 at an average cost of $21.57 per share, or $19.8 million in total.
In 2000, we repurchased 1,144,200 shares of our common stock at an average cost
of $15.89 per share, or $18.2 million in total. All of the repurchased shares of
our common stock became treasury shares upon repurchase and most of the
repurchased shares continue to be held as treasury shares. We may elect to
repurchase additional shares of our common stock from time to time in the
future, depending on market conditions and other considerations. The purpose of
the stock repurchase program is to help us achieve our long-term goal of
enhancing shareholder value.

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. Our net cash items
(consisting of cash and cash equivalents, restricted cash and marketable debt
securities) increased from $68.0 million at December 31, 1999 to $70.6 million
at December 31, 2000. Excluding the $18.2 million used to repurchase 1,144,200
shares of our common stock, cash items increased $20.8 million. Marketable debt
securities and cash equivalents ranged from a low of $18.4 million in May 2000
to a high of $71.6 million in November 2000.

We have generated positive cash flows from operations for the past five
years. Cash flows from operations in 2000 was $50.1 million (excluding the
$6.5 million decrease in marketable debt securities),

an increase of $16.1 million from $34.0 million (excluding the $23.2 million
decrease in marketable debt securities) in 1999. This increase was primarily due
to higher cash flows from operations caused by the increase in income and
accelerated cash collections from students associated with their use of a
supplemental student loan program, called the College Advantage Loan Program
("CALP"), that was made available to our students by a private funding source
beginning in January 2000. CALP offers eligible students and their parents loans
to pay the students' cost of education that federal and state student financial
aid sources do not fully cover. CALP loans are non-recourse to us and are
disbursed once for each academic year at the start of the first academic quarter
of the student's academic year.

At December 31, 2000, we had positive working capital of $12.6 million.
Deferred revenue, which represents the unrecognized portion of revenue received
from students, increased $19.1 million to $55.7 million at December 31, 2000
from $36.6 million at December 31, 1999. This increase was primarily due to the
students' use of the CALP, our implementation of SAB 101 and increased tuition
revenue resulting from higher tuition rates and a larger number of students.

An institution may lose its eligibility to participate in some or all of the
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, if an institution becomes
ineligible to participate in the FFEL and FDL programs following the publication
of its 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.

Prior to the October 1998 amendments to the HEA ("1998 HEA Amendments"), the
HEA limited how much of a student's tuition and fees an institution could retain
for 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 federal government's limitation on how
much of a student's tuition and fees an institution could retain for a
withdrawing student ("Refund Policy"), but the standards of most of the state
education authorities that regulate our institutes (the "SEAs") and the
Accrediting Council for Independent Colleges and Schools ("ACICS") that
accredits our institutes continue to impose a Refund Policy. The 1998 HEA
Amendments and their implementing regulations impose a limit on the amount of
Title IV Program funds a withdrawing student can use to pay his or her education
costs. This 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 return 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 ("Return Policy"). We began complying with the Return Policy on
October 7, 2000.

The federal government's substitution of the Return Policy for its Refund
Policy may, in many states depending on when a student withdraws during an
academic quarter, increase the portion of the student's education costs owed to
the ITT Technical Institute upon withdrawal and/or reduce the amount of Title IV
Program funds that the withdrawing student can use to pay his or her education
costs. In these instances, we expect that many withdrawing students will be
unable to pay all of their education costs and that we will be unable to collect
a significant portion of these costs. Title IV Program funds are generally paid
sooner and are more collectible than payments from other sources. We believe,
however, that the incremental decrease in the amount of Title IV Program funds
that certain withdrawing students can use to pay their education costs to our
institutes will be largely offset by the incremental increase in the education
costs owed to us by withdrawing students in certain states that we intend to
collect and, therefore, we do not expect the Return Policy to have a material
adverse effect on our financial condition, results of operations or cash flows.

Under a provision of the HEA commonly referred to as the "90/10" 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 90% of its applicable revenues for a fiscal year from Title IV
Programs. For our 2000 fiscal year, the range of our campus groups was from
approximately 59% to approximately 74%.

The DOE, the ACICS and most of the SEAs have laws, regulations and/or
criteria (collectively, "Regulations") pertaining to the 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's eligibility to continue to participate in Title IV Programs is
subject to review and the institution could lose its eligibility, with the
result that the institution would no longer be able to authorize or, with
limited exceptions, disburse Title IV Program funds to its students. The DOE may
provisionally certify an institution for a temporary period following a change
in control. 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
make such a determination can vary but, if the institution submits a materially
complete application for reinstatement within 10 business days after the change
in control, the institution will be certified while the DOE conducts its review.

A change in control could occur as a result of future transactions in which
we or our institutes are involved, such as some corporate reorganizations and
some changes in our board of directors. 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, in a timely
manner, to be reauthorized by their SEAs, reaccredited by the ACICS or
recertified by the DOE to participate in Title IV Programs. The DOE has advised
us that, during the pendency of the OIG Investigation, the DOE will not approve
any application submitted by any of our campus groups with respect to any change
in control. See Note 10 of Notes to Consolidated Financial Statements.

Our capital assets consist primarily of classroom and laboratory equipment
(such as computers, electronic equipment and robotic systems), classroom and
office furniture, software and leasehold improvements. We lease all of our
building facilities. Capital expenditures totaled $29.4 million during 2000 and
included expenditures of $10.2 million to expand curricula offerings at existing
institutes, $7.1 million for equipment used in our revised electronics
engineering technology ("EET") curriculum, $5.3 million to replace or add
furniture or equipment at existing institutes, $2.0 million on leasehold
improvements, $0.8 million for new ITT Technical Institutes and $4.0 million for
software that was developed or purchased to enhance our current information
systems. Leasehold improvements represent part of our continuing effort to
maintain our existing facilities in good condition. Capital expenditures
increased by $12.4 million to $29.4 million in 2000 from $17.0 million in 1999,
principally due to the incremental expenditure of $3 million ($10 million in
2000 compared to $7 million in 1999)

for the continued roll-out of our information technology program involving CNS
and the $7.1 million for equipment used in our revised EET curriculum. 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 2001 capital expenditures will be approximately $30 million, of
which approximately $7 million will be used to exchange the existing computer
equipment used in our current computer-aided drafting curriculum for computer
equipment that can also be used in our information technology curriculum, and
approximately $10 million will be used to acquire additional equipment for our
information technology programs. 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 do not believe that any reduction in cash and cash equivalents or
marketable debt securities that may result from its use to effect any future
stock repurchases will 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.

FACTORS THAT MAY AFFECT FUTURE RESULTS

This report contains certain forward looking statements that involve a
number of risks and uncertainties. Among the factors that could cause actual
results to differ materially are the following: business conditions and growth
in the postsecondary education industry and in the general economy; changes in
federal and state governmental regulations with respect to education and
accreditation standards, or the interpretation or enforcement thereof,
including, but not limited to, the level of government funding for, and our
eligibility to participate in, student financial aid programs utilized by our
students; the results of the OIG Investigation which, if adversely determined,
could cause the DOE to subject us to monetary fines or penalties or other
sanctions (including a limitation, suspension or termination of our ability to
participate in federal student financial aid programs) that could adversely
affect our ability to enroll students, expand the number of our institutes and
increase the number of the programs of study offered at our institutes; the
results of the Qui Tam Action which, if adversely determined, could result in a
demand for repayment of Title IV Program funds, trebled under the False Claims
Act, and penalties; our ability to hire and retain qualified faculty; effects of
any change in ownership of us resulting in a change in control of us, including,
but not limited to, the consequences of such changes on the accreditation and
federal and state regulation of the institutes; our ability to implement our
growth strategies, including our information technology programs; receptivity of
students and employers to our existing program offerings and new curricula; and
loss of lender access to our students for student loans.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information required by this Item appears in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--General."

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this Item appears on pages F-1 through F-21
herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required by this Item concerning our directors, nominees for
director, executive officers and disclosure of delinquent filers is incorporated
herein by reference to ESI's definitive Proxy Statement for our 2001 Annual
Meeting of Shareholders, to be filed with the SEC pursuant to Regulation 14A
within 120 days after the end of our last fiscal year.

ITEM 11. EXECUTIVE COMPENSATION.

The information required by this Item concerning remuneration of our
officers and directors and information concerning material transactions
involving such officers and directors is incorporated herein by reference to
ESI's definitive Proxy Statement for our 2001 Annual Meeting of Shareholders
which will be filed with the SEC pursuant to Regulation 14A within 120 days
after the end of our last fiscal year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information required by this Item concerning the stock ownership of
management and five percent beneficial owners is incorporated herein by
reference to ESI's definitive Proxy Statement for our 2001 Annual Meeting of
Shareholders which will be filed with the SEC pursuant to Regulation 14A within
120 days after the end of our last fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to ESI's definitive
Proxy Statement for our 2001 Annual Meeting of Shareholders which will be filed
with the SEC pursuant to Regulation 14A within 120 days after the end of our
last fiscal year.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) 1. Financial Statements:

PAGE NO. IN
THIS FILING
-----------

Report of Independent Accountants........................... F-1

Consolidated Statements of Income for the years ended
December 1, 2000, December 31, 1999 and December 31,
1998...................................................... F-2

Consolidated Balance Sheets as of December 31, 2000 and
December 31, 1999......................................... F-3

Consolidated Statements of Cash Flows for the years ended
December 31, 2000, December 31, 1999 and December 31,
1998...................................................... F-4

Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2000, December 31, 1999 and
December 31, 1998......................................... F-5

Notes to Consolidated Financial Statements.................. F-6

2. Financial Statement Schedules:

Schedule II--Valuation and Qualifying Accounts of the Company for the
years ended December 31, 2000, December 31, 1999 and December 31, 1998
appear on page F-19.

3. Quarterly Results for 2000 and 1999 (unaudited) appear on pages F-20
through F-21.

4. Exhibits:

A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits appearing on pages S-3 through S-4, which
immediately precedes such exhibits, and is incorporated herein by reference.

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the quarter ended December 31,
2000.

REPORT OF INDEPENDENT ACCOUNTANTS

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

In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 36 present fairly, in all material
respects, the financial position of ITT Educational Services, Inc. and its
subsidiaries at December 31, 2000 and 1999, and the results of their operations
and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial
statement schedules listed in the index appearing under Item 14(a)(2) on page 36
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, 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 our opinion.

As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of revenue recognition for certain fees effective January 1,
2000 and adopted AICPA Statement of Position 98-5, "Reporting on the Costs of
Start-Up Activities" in 1999.

/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP

Indianapolis, Indiana
January 19, 2001, except for Note 10,
as to which the date is February 6, 2001

F-1

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

REVENUES.................................................... $347,524 $316,370 $291,375
COSTS AND EXPENSES
Cost of educational services................................ 211,653 191,760 176,487
Student services and administrative expenses................ 94,156 86,953 81,522
Legal settlements........................................... -- -- 12,858
Offering, change in control and other one-time expenses..... -- 900 1,872
-------- -------- --------
Total costs and expenses.................................. 305,809 279,613 272,739
-------- -------- --------
Operating income............................................ 41,715 36,757 18,636
Interest income, net........................................ 2,707 2,396 5,329
-------- -------- --------
Income before income taxes and cumulative effect of change
in accounting principle................................... 44,422 39,153 23,965
Income taxes................................................ 16,937 14,802 10,024
-------- -------- --------
Income before cumulative effect of change in accounting
principle................................................. 27,485 24,351 13,941
Cumulative effect of change in accounting principle, net of
tax (Note 2).............................................. (2,776) (823) --
-------- -------- --------
Net income.................................................. $ 24,709 $ 23,528 $ 13,941
======== ======== ========
Earnings (loss) per common share (basic):
Income before cumulative effect of change in accounting
principle............................................... $ 1.14 $ 0.96 $ 0.52
Cumulative effect of change in accounting principle, net
of tax.................................................. (0.11) (0.03) --
-------- -------- --------
Net income................................................ $ 1.03 $ 0.93 $ 0.52
======== ======== ========
Earnings (loss) per common share (diluted):
Income before cumulative effect of change in accounting
principle............................................... $ 1.14 $ 0.96 $ 0.51
Cumulative effect of change in accounting principle, net
of tax.................................................. (0.12) (0.03) --
-------- -------- --------
Net income................................................ $ 1.02 $ 0.93 $ 0.51
======== ======== ========

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

F-2

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

DECEMBER 31,
-------------------
2000 1999
-------- --------

ASSETS
Current assets
Cash and cash equivalents................................. $ 56,366 $ 48,510
Restricted cash........................................... 5,666 4,354
Marketable debt securities................................ 8,586 15,097
Accounts receivable, less allowance for doubtful accounts
of $3,419 and $2,972.................................... 12,414 11,685
Deferred and prepaid income tax........................... 3,420 5,441
Prepaids and other current assets......................... 6,118 3,995
-------- --------
Total current assets.................................... 92,570 89,082
Property and equipment, net................................. 46,560 31,686
Direct marketing costs...................................... 10,094 8,712
Other assets................................................ 1,672 1,522
-------- --------
Total assets............................................ $150,896 $131,002
======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 16,274 $ 17,730
Accrued compensation and benefits......................... 4,454 8,576
Other accrued liabilities................................. 3,547 5,751
Deferred revenue.......................................... 55,651 36,565
-------- --------
Total current liabilities............................... 79,926 68,622
Deferred income tax......................................... 5,056 3,535
Other liabilities........................................... 1,228 1,074
-------- --------
Total liabilities....................................... 86,210 73,231
-------- --------
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, 150,000,000 shares
authorized, 27,034,452 issued........................... 270 270
Capital surplus........................................... 33,938 33,912
Retained earnings......................................... 117,115 92,501
Treasury stock, 3,537,463 and 2,419,000 shares, at cost... (86,637) (68,912)
-------- --------
Total shareholders' equity.............................. 64,686 57,771
-------- --------
Total liabilities and shareholders' equity.............. $150,896 $131,002
======== ========

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

F-3

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Cash flows provided by (used for) operating activities:
Net income................................................ $24,709 $23,528 $13,941
Adjustments to reconcile net income to net cash provided
by operating activities:
Cumulative effect of change in accounting principle..... 2,776 823 --
Depreciation and amortization........................... 14,519 11,150 9,282
Provision for doubtful accounts......................... 5,104 4,362 4,326
Deferred taxes.......................................... 3,091 4,311 (3,219)
Increase/decrease in operating assets and liabilities:
Marketable debt securities............................ 6,511 23,219 (38,316)
Accounts receivable................................... (5,833) (5,275) (5,418)
Direct marketing costs................................ (1,382) (797) (1,033)
Accounts payable and accrued liabilities.............. (5,183) (7,379) 13,474
Prepaids and other assets............................. (2,273) (1,056) (904)
Deferred revenue...................................... 14,609 4,304 1,411
------- ------- -------
Net cash provided by (used for) operating activities........ 56,648 57,190 (6,456)
------- ------- -------
Cash flows provided by (used for) investing activities:
Capital expenditures, net................................. (29,393) (17,005) (11,381)
Net decrease in cash invested with ITT Corporation........ -- -- 94,800
------- ------- -------
Net cash provided by (used for) investing activities........ (29,393) (17,005) 83,419
------- ------- -------
Cash flows provided by (used for) finance activities:
Purchase of treasury stock................................ (18,181) (68,912) --
Exercise of stock options................................. 94 639 100
------- ------- -------
Net cash provided by (used for) finance activities.......... (18,087) (68,273) 100
------- ------- -------
Net increase (decrease) in cash, cash equivalents and
restricted cash........................................... 9,168 (28,088) 77,063
Cash, cash equivalents and restricted cash at beginning of
period.................................................... 52,864 80,952 3,889
------- ------- -------
Cash, cash equivalents and restricted cash at end of
period.................................................... $62,032 $52,864 $80,952
======= ======= =======
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes............................................ $11,642 $12,867 $12,757
Interest................................................ 243 174 238
Non-cash financing activities:
Issuance of treasury stock for incentive plan........... $ 293 $ -- $ --

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

F-4

ITT EDUCATIONAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(IN THOUSANDS)

COMMON STOCK TREASURY STOCK
------------------- CAPITAL RETAINED -------------------
SHARES AMOUNT SURPLUS EARNINGS SHARES AMOUNT
-------- -------- -------- -------- -------- --------

Balance as of December 31, 1997............... 27,000 $270 $32,513 $ 55,032 -- $ --
Exercise of stock options..................... 11 -- 100 -- -- --
Net income for 1998........................... -- -- -- 13,941 -- --
------ ---- ------- -------- ------ --------
Balance as of December 31, 1998............... 27,011 270 32,613 68,973 -- --
Exercise of stock options..................... 23 -- 639 -- -- --
Purchase of treasury stock.................... -- -- -- -- (2,419) (68,912)
Settlement of ITT intercompany matters........ -- -- 660 -- -- --
Net income for 1999........................... -- -- -- 23,528 -- --
------ ---- ------- -------- ------ --------
Balance as of December 31, 1999............... 27,034 270 33,912 92,501 (2,419) (68,912)
Exercise of stock options..................... -- -- 26 -- 4 68
Purchase of treasury stock.................... -- -- -- -- (1,144) (18,181)
Issue treasury stock for employee incentive
plan........................................ -- -- -- (95) 22 388
Net income for 2000........................... -- -- -- 24,709 -- --
------ ---- ------- -------- ------ --------
Balance as of December 31, 2000............... 27,034 $270 $33,938 $117,115 (3,537) $(86,637)
====== ==== ======= ======== ====== ========

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

F-5

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

1. OWNERSHIP AND CHANGE IN CONTROL

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

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
ESI 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. ESI believes that it is in compliance with or
satisfies these DOE conditions (see Note 10).

On June 9, 1998, ITT sold 13,050,000 shares of ESI's common stock held by
ITT to the public (48.3% of the outstanding shares) (the "June 1998 Offering").
After the June 1998 Offering, ITT owned 35% of the outstanding shares of ESI
common stock. The June 1998 Offering did not constitute a change in control of
ESI under the DOE's regulations.

On February 1, 1999, ITT sold 7,950,000 shares of ESI common stock held by
ITT to the public (the "February 1999 Offering"). The February 1999 Offering did
not constitute a change in control of ESI under the DOE's regulations.
Simultaneous with the close of the February 1999 Offering, ESI repurchased
1,500,000 shares of ESI common stock from ITT at the February 1999 Offering
price to the public, less underwriters' commissions and discounts, for an
aggregate cost of $49,088 (the "February 1999 Stock Repurchase"). Following the
February 1999 Offering and February 1999 Stock Repurchase, ITT no longer owned
any shares of ESI common stock.

In conjunction with the February 1999 Offering, ITT paid ESI $2,100 related
to the settlement of various intercompany matters, of which $660 is included in
capital surplus.

During 1999 and 2000, ESI's Board of Directors authorized ESI to repurchase
in aggregate up to 4,000,000 outstanding shares of ESI common stock in the open
market or through privately negotiated transactions in accordance with
Rule 10b-18 of the Securities Exchange Act of 1934, as amended. Subsequent to
the February 1999 Stock Repurchase, ESI repurchased 919,000 shares of ESI common
stock in 1999 at an average cost of $21.57 per share or $19,800 in total. In
2000, ESI repurchased 1,144,200 shares of ESI common stock at an average cost of
$15.89 per share or $18,181 in total. All of the repurchased shares of ESI
common stock became treasury shares upon repurchase. ESI may elect to repurchase
additional shares of ESI common stock from time to time in the future, depending
on market conditions and other considerations. The purpose of the stock
repurchase program is to help ESI achieve its long-term goal of enhancing
shareholder value.

2. SUMMARY OF ACCOUNTING PRINCIPLES AND POLICIES

BUSINESS ACTIVITIES. ESI is a leading proprietary postsecondary education
system primarily offering career-focused, technical degree programs of study. At
December 31, 2000, ESI operated 69 technical institutes throughout the United
States. ESI maintains its corporate headquarters in Indianapolis, Indiana.

F-6

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of ESI and its wholly-owned subsidiaries. All significant
intercompany balances and transactions are eliminated in consolidation.

USE OF ESTIMATES. The preparation of these financial statements, in
conformity with generally accepted accounting principles, includes estimates
that are determined by ESI'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 original maturity dates of less than 90 days 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, 2000, 1999, and 1998
consists of:

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Net realized gains (losses) on the sale of trading
securities................................................ $ (235) $ (98) $ 11
Interest and dividend income, net........................... 2,674 2,880 4,926
Change in net unrealized holding gain (loss)................ 314 (354) 85
------ ------ ------
$2,753 $2,428 $5,022
====== ====== ======

PROPERTY AND EQUIPMENT. ESI 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 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.

ESI adopted the American Institute of Certified Public Accountants (the
"AICPA") Statement of Position ("SOP") 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" effective July 1,
1998, which increased net income by $508 ($0.02 per share) in the year ended
December 31, 1998. Costs incurred prior to the initial application of this SOP,
whether or not capitalized, were not adjusted to the amounts that would have
been capitalized had this SOP been in effect when those costs were incurred.
Estimated useful lives generally range from three to eight years for capitalized
software.

FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts reported in the
balance sheets for cash and cash equivalents, restricted cash, accounts
receivable, accounts payable, other accrued liabilities and deferred revenue
approximate fair value because of the immediate or short-term maturity of these
financial instruments. 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 tuition 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 or ESI policy recorded as an expense. On an
individual student

F-7

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

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 revenue. Textbook sales and the related cost of the textbooks are
recognized at the beginning of each academic quarter with respect to students
who are attending courses in which textbooks are charged separately from
tuition. For those students who are attending courses in which the cost of
textbooks is included in the tuition, the cost of the textbooks is amortized on
a straight-line basis over the applicable course length. Academic fees, which
are charged only one time to students on their first day of class attendance,
are recognized as revenue on a straight-line basis over the average course
length of 24 months. If a student discontinues training, all unrecognized
revenue relating to his or her academic fee is recognized upon the student's
departure.

In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). ESI began following the guidance provided by SAB 101 effective
January 1, 2000 and recorded a cumulative effect of change in accounting of
$4,477, less $1,701 of deferred taxes. In conformity with SAB 101, ESI changed
the method by which it recognizes the laboratory and application fees charged to
a student as revenue. Previously, the quarterly laboratory fee was recognized as
revenue at the beginning of each academic quarter and the application fee was
recognized as revenue when ESI received the fee. As of January 1, 2000,
application and laboratory fees are recognized as revenue on a straight-line
basis over the average course length of 24 months. If a student discontinues
training, all unrecognized revenue relating to those fees is recognized upon the
student's departure.

Effective with its first fiscal quarter of 2000, ESI began reporting 12
weeks of tuition revenue in each of its four fiscal quarters. Previously, ESI's
first and third fiscal quarters each had 13 weeks of tuition revenue while the
second and fourth fiscal quarters each had 11 weeks of tuition revenue. ESI
elected to standardize the number of weeks of revenue reported in each fiscal
quarter, because the timing of student breaks in a calendar quarter was expected
to fluctuate from quarter to quarter during subsequent years. The total number
of weeks of school during each year remains at 48.

Except for the selected quarterly financial data, ESI has not presented
proforma results for prior fiscal years due to immateriality.

ADVERTISING COSTS. ESI 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 application 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 $10,094 and $8,712 at December 31, 2000 and December 31, 1999,
respectively, net of accumulated amortization of $8,872 and $8,015 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, deferred start-up costs included in
other assets in the balance sheet totaled $1,354 net of accumulated amortization
of $511. In conformity with AICPA SOP 98-5, "Reporting on the Costs of Start-Up
Activities," ESI expensed the $1,354 of institute start-up costs, less $531 of
deferred taxes, as a cumulative effect of a change in accounting principle in
the first

F-8

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

quarter of 1999. This new accounting requirement did not have a significant
effect on 1999 income before the cumulative effect of the accounting change.

OFFERING, CHANGE IN CONTROL AND OTHER ONE-TIME EXPENSES. In 1999, ESI
incurred net one-time expenses of $900 associated with the costs of the
February 1999 Offering and special bonus payments to employees for extraordinary
services, net of amounts reimbursed by ITT. In 1998, ESI incurred expenses of
$1,117 for the June 1998 Offering and expenses of $755 associated with its
change in control and establishment of new employee benefit plans.

INCOME TAXES. ESI 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 ESI's books (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 ESI, as calculated under the tax sharing policy, and
reflected the funding through the cash invested with ITT Corporation account.

Since June 9, 1998, ESI has filed its own federal income tax returns, paid
its own federal income taxes and recorded all deferred income taxes on its
books.

EARNINGS PER COMMON SHARE. Earnings per common share for all periods have
been calculated in conformity with Statement of Financial Accounting Standard
No. 128, "Earnings Per Share." This data is based on historical net income and
the average number of shares of ESI common stock outstanding during each period.

AVERAGE SHARES OUTSTANDING
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)

Basic....................................................... 24,018 25,235 27,002
Diluted..................................................... 24,185 25,380 27,185

The difference in the number of shares used to calculate basic and diluted
earnings per share represents the average number of shares issued under ESI's
stock option plans less shares assumed to be purchased with proceeds from the
exercise of those stock options.

3. RELATED PARTY TRANSACTIONS

Prior to the June 1998 Offering, the relationship between ESI and ITT was
governed by various agreements summarized as follows:

INTERCOMPANY ACTIVITIES. ITT provided ESI with certain centralized treasury
and financing functions. ESI transferred all unrestricted cash receipts to ITT
and received funds from ITT for all disbursements. ESI earned interest on the
average net cash balance held by ITT, at an interest rate that

F-9

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

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 ESI'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. On February 5, 1998, ITT transferred
approximately $83,000 to ESI and, since that date, ESI has been performing its
own cash management function.

ESI'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 ESI
using allocation methods management believes were reasonable. ESI paid a
processing fee related to its participation in ITT's consolidated medical plan.

TAX AGREEMENT. ITT and ESI participated in a tax agreement that provided,
among other things, that ESI would pay ITT, with respect to federal income taxes
for each period that ESI was included in ITT's consolidated federal return, the
amount that ESI 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 ESI, ESI paid ITT an amount as if it filed a separate tax return. With
respect to ITT's consolidated federal and state returns, ESI will be responsible
for any deficiencies assessed with respect to such returns if such deficiencies
relate to ESI. Similarly, ESI will be entitled to all refunds paid with respect
to such returns that relate to ESI. ESI will be responsible for all taxes,
including assessments, if any, for prior years with respect to all other taxes
payable by ESI.

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

4. FINANCIAL AID PROGRAMS

ESI participates in various federal student financial aid programs under
Title IV ("Title IV Programs") of the Higher Education Act of 1965, as amended
("HEA"). Approximately 66% of ESI's 2000 revenue was derived from funds
distributed under these programs.

ESI participates in the Federal Perkins Loan ("Perkins") program and
administers on behalf of the federal government a pool of Perkins student loans
which aggregated $6,782 and $7,579 at December 31, 2000 and 1999, respectively.
ESI has recorded in its financial statements only its aggregate mandatory
contributions to this program which at December 31, 2000 and 1999 aggregated
$1,458 and $1,547, respectively. ESI has provided $1,016 and $980, respectively,
for potential losses related to funds committed by ESI at December 31, 2000 and
1999.

The Title IV Programs are administered by ESI in separate accounts as
required by government regulation. ESI is required to administer the funds in
accordance with the requirements of HEA and DOE regulations and must use due
diligence in approving and disbursing funds and servicing loans. In the event
ESI does not comply with federal requirements, or if student loan default rates
rise to a level considered excessive by the federal government, ESI 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.

F-10

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

5. RESTRICTED CASH

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

6. PROPERTY AND EQUIPMENT

Fixed assets include the following:

DECEMBER 31,
-------------------
2000 1999
-------- --------

Furniture and equipment..................................... $100,243 $81,407
Leasehold improvements...................................... 12,505 10,185
Capitalized software........................................ 7,983 3,982
Land and land improvements.................................. 110 110
Construction in progress.................................... 655 342
-------- -------
121,496 96,026
Less accumulated depreciation............................... (74,936) (64,340)
-------- -------
$ 46,560 $31,686
======== =======

7. TAXES

The provision for income taxes attributable to earnings before income taxes
and cumulative effect of change in accounting principle includes the following:

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Current
Federal................................................ $12,455 $ 9,667 $11,052
State.................................................. 1,391 824 2,191
------- ------- -------
13,846 10,491 13,243
Deferred
Federal................................................ 2,682 3,524 (2,686)
State.................................................. 409 787 (533)
------- ------- -------
3,091 4,311 (3,219)
------- ------- -------
$16,937 $14,802 $10,024
======= ======= =======

F-11

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

Deferred tax assets (liabilities) include the following:

DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Direct marketing costs................................... $(3,835) $(3,417) $(3,105)
Capitalized software..................................... (2,716) (1,516) --
Deferred revenue......................................... 1,748 -- --
Legal settlements........................................ -- -- 2,983
Institute start-up costs................................. -- -- (531)
Depreciation............................................. 1,078 783 607
Reserves and other....................................... 1,278 3,093 3,209
------- ------- -------
Net deferred tax assets (liabilities).................... $(2,447) $(1,057) $ 3,163
======= ======= =======

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

YEAR ENDED DECEMBER 31,
--------------------------------------
2000 1999 1998
-------- -------- --------

Statutory U.S. federal income tax rate..................... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit................. 2.6% 2.6% 4.1%
Non-deductible offering expenses........................... -- 0.8% 1.5%
Permanent differences and other............................ 0.5% (0.6)% 1.2%
---- ---- ----
Effective income tax rate.................................. 38.1% 37.8% 41.8%
==== ==== ====

The tax benefit associated with the exercise of non-qualified stock options
reduced taxes currently payable by $8 and $135 in 2000 and 1999, respectively,
and was recorded as an increase to capital surplus.

8. RETIREMENT PLANS

EMPLOYEE PENSION BENEFITS. Prior to June 9, 1998, ESI participated in the
Retirement Plan for Salaried Employees of ITT Corporation which covered
substantially all employees of ESI. 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. ITT charged ESI $1,858 for pension expense for the year
ended December 31, 1998.

Effective June 9, 1998, ESI 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.

During 1999, ESI adopted the ESI Excess Pension Plan, a non-qualified
unfunded retirement plan, which covers a select group of management, and that
provides for payment of those benefits at retirement that cannot be paid from
the qualified ESI pension plan due to federal statutory limits on the amount of
benefits that can be paid and compensation that can be recognized under a
tax-qualified retirement plan. The practical effect of the ESI Excess Pension
Plan is to provide retirement benefits to all employees on a uniform basis.

F-12

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

The following tables are based on an actuarial valuation date as of
September 30 and amounts recognized in ESI's consolidated financial statements
as of December 31:

Net periodic benefit cost:

SEVEN MONTHS
YEAR ENDED YEAR ENDED ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------

Service cost......................... $4,316 $4,336 $2,217
Interest cost........................ 531 178 --
Expected return on assets............ (630) (15) --
Recognized net actuarial
loss/(gain)........................ -- 26 --
------ ------ ------
Net periodic pension cost............ $4,217 $4,525 $2,217
====== ====== ======

Change in benefit obligation:

YEAR ENDED YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999
------------------ ------------------

Projected benefit obligation at beginning of
period............................................ $ 7,330 $ 2,744
Service cost........................................ 4,316 4,336
Actuarial loss...................................... 146 102
Interest cost....................................... 531 178
Benefits paid....................................... (158) (30)
------- -------
Projected benefit obligation at end of period....... 12,165 7,330
Fair value of plan assets........................... 10,211 2,058
------- -------
Funded status....................................... (1,954) (5,272)
Unrecognized net actuarial loss..................... 935 664
------- -------
Accrued benefit cost................................ $(1,019) $(4,608)
======= =======

Change in plan assets:

YEAR ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------

Fair value of plan assets at beginning of year............. $ 2,058 $ --
Actual return on plan assets............................... 506 (47)
Employer contributions..................................... 7,805 2,135
Benefits paid.............................................. (158) (30)
------- ------
Fair value of plan assets at end of year................... $10,211 $2,058
======= ======

F-13

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

Weighted-average assumptions as of September 30, 2000, 1999 and 1998:

2000 1999 1998
-------- -------- --------

Discount rate at beginning of year.................. 7.50% 6.50% --
Discount rate at end of year........................ 7.75% 7.50% 6.50%
Expected return on plan assets...................... 9.00% 9.00% 9.00%
Rate of compensation increase....................... 4.50% 4.50% 4.50%

RETIREMENT SAVINGS PLAN. Prior to May 16, 1998, ESI participated in The ITT
401K Retirement Savings Plan, a defined contribution plan which covered
substantially all employees of ESI. ESI'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 & 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 ESI. Effective May 16, 1998, ESI adopted its own 401(k)
plan, a defined contribution plan which covers substantially all employees of
ESI and operates similarly to The ITT 401K Retirement Savings Plan. ESI's
non-matching and matching contributions under its 401(k) plan are made in the
form of shares of ESI common stock. For the years ended December 31, 2000, 1999,
and 1998, the costs of providing this benefit (including an allocation of the
administrative costs of the plan) were $2,134, $2,126, and $2,109, respectively.

9. STOCK OPTION AND KEY EMPLOYEE INCENTIVE PLANS

ESI 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"). During 1999, ESI established
the 1999 Outside Directors Stock Option Plan ("1999 Stock Plan"), which provides
for awards of non-qualified stock options to non-employee directors. ESI 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 Plans. ESI 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 ESI
common stock at the measurement date over the exercise price.

Under the 1994 Plan, a maximum of 405,000 shares of ESI 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 ESI common stock may be issued upon exercise of options.
Under the 1999 Stock Plan, a maximum of 250,000 shares of ESI common stock may
be issued upon exercise of options. Under all Plans, the option price may not be
less than 100% of the fair market value of ESI common stock on the date of
grant. Under the 1994 Plan and 1997 Plan, the options will vest and become
exercisable in three equal annual installments commencing with the first
anniversary of the grant. Under the 1999 Stock Plan, the options will vest and
become exercisable on the first anniversary of the grant, except that options
issued during 1999 were immediately vested and

F-14

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

exercisable. The options outstanding, granted, exercised and forfeited for the
three years ended December 31, 2000 are as follows:

2000 1999 1998
-------------------- -------------------- -------------------
AVERAGE AVERAGE AVERAGE
# OF OPTION # OF OPTION # OF OPTION
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- -------- --------

Outstanding at beginning of year............. 1,246,500 $23.26 793,750 $17.67 405,000 $13.46
Granted...................................... 503,500 13.57 507,500 32.31 405,000 21.69
Exercised.................................... (4,000) 21.68 (23,250) 21.69 (11,250) 8.89
Forfeited.................................... (35,000) 23.74 (31,500) 29.39 (5,000) 21.69
--------- ------ --------- ------ ------- ------
Outstanding at end of year................... 1,711,000 $20.40 1,246,500 $23.26 793,750 $17.67
========= ====== ========= ====== ======= ======

EXERCISE PRICE RANGE
----------------------------------------------------------------------
$4.44 $8.89-$16.06 $18.25-$24.25 $34.12-$36.25 TOTAL
---------- ------------ ------------- ------------- ----------

Options outstanding at year end.... 135,000 602,000 574,000 400,000 1,711,000
Weighted average exercise price on
options outstanding.............. $ 4.44 $ 13.04 $ 22.22 $ 34.26 $ 20.40
Remaining contractual life......... 4.0 years 8.3 years 7.0 years 8.1 years 7.5 years
Options exercisable at year end.... 135,000 112,500 453,750 133,333 834,583
Weighted average exercise price on
options exercisable.............. $ 4.44 $ 10.72 $ 22.38 $ 34.26 $ 19.81

ESI issued 4,000, 23,250, and 11,250 shares of common stock for proceeds of
$94, $639 and $100 in conjunction with the exercise of stock options during
2000, 1999, and 1998, respectively.

If compensation costs for the plans had been determined based on the fair
value of the stock options at grant date consistent with SFAS No. 123, ESI's net
income and earnings per share for the years ended December 31, 2000, 1999 and
1998 would have been reduced to the proforma amounts indicated below:

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Proforma
Net income................................................ $21,994 $20,729 $12,554
Basic earnings per share.................................. 0.92 0.82 0.46
Diluted earnings per share................................ 0.91 0.82 0.46
As reported
Net income................................................ $24,709 $23,528 $13,941
Basic earnings per share.................................. 1.03 0.93 0.52
Diluted earnings per share................................ 1.02 0.93 0.51

F-15

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

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, 2000:

YEAR ENDED DECEMBER 31,
--------------------------------------
2000 1999 1998
-------- -------- --------

Risk-free interest rates.................................... 6.6% 4.9% 5.3%
Expected lives (in years)................................... 5 5 5
Volatility.................................................. 47% 39% 41%
Dividend yield.............................................. None None None

In January 2001, the Compensation Committee of the Board of Directors
awarded additional stock options for 524,500 shares of ESI common stock. The
effective date of this award was January 23, 2001 and the exercise price is
$19.44.

During 2000, ESI issued 21,737 treasury shares of ESI common stock to key
executives in partial payment of amounts due under ESI's 1999 incentive plans.

10. COMMITMENTS AND CONTINGENT LIABILITIES

LEASE COMMITMENTS. ESI 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 14 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 ESI has not entered into any
significant guarantees related to the leases. ESI 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 $26,445, $24,360, and $22,329 for the year ended
December 31, 2000, 1999 and 1998, respectively.

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, 2000 are as follows:

2001........................................................ $ 25,417
2002........................................................ 24,654
2003........................................................ 24,510
2004........................................................ 22,433
2005........................................................ 12,856
Later Years................................................. 28,839
--------
$138,709
========

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

CONTINGENT LIABILITIES. In December 1994, ESI entered into an agreement
with an unaffiliated, private funding source to provide loans to students of
certain technical institutes. The agreement requires ESI to guarantee repayment
of the loans. Outstanding loans at December 31, 2000 aggregated

F-16

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

$2,405. Additionally, ESI 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.

ESI has a number of pending legal and other claims arising in the normal
course of business. In January 2001, the U.S. Department of Justice ("DOJ")
informed ESI that it was a defendant in a qui tam action brought under the False
Claims Act, 31 U.S.C. Section 3730, that is pending in the United States
District Court for the Southern District of Texas (the "Qui Tam Action"). A qui
tam action is a civil lawsuit brought by one or more individuals (a qui tam
"relator") on behalf of the federal government for an alleged submission to the
federal government of a false claim for payment. A qui tam action is always
filed under seal and remains under seal until the DOJ decides whether to
intervene in the litigation. Whenever a relator files a qui tam action, the DOJ
typically initiates an investigation in order to determine whether to intervene
in the litigation. If the DOJ intervenes, it has primary control over the
litigation. If the DOJ declines to intervene, the relator may pursue the
litigation on behalf of the federal government and, if successful, receives a
portion of the federal government's recovery.

The DOJ has not decided whether to intervene in the Qui Tam Action. Thus,
the Qui Tam Action remains under seal and ESI has not been served with the
complaint. Since the Qui Tam Action is under seal, ESI does not know (or is not
permitted to disclose) the details of the complaint concerning, among other
things, the identity of the relator or relators, the theories of liability or
the amount of damages sought from ESI. ESI believes, however, that the Qui Tam
Action relates primarily to whether its sales representative compensation plan
violates the HEA and the DOE's regulations that prohibit an institution
participating in Title IV Programs from providing any commission, bonus or other
incentive payment based directly or indirectly on success in securing
enrollments to any person or entity engaged in any student recruitment or
admissions activity. The Qui Tam Action, if adversely determined, could result
in ESI having to repay Title IV Program funds that it disbursed during the last
several years, which would be trebled under the False Claims Act, and also to
pay penalties. ESI believes that it has meritorious defenses to the Qui Tam
Action and, if the action proceeds, ESI intends to vigorously defend itself
against the claims.

In July 2000, ESI received a subpoena from the DOE's Office of Inspector
General ("OIG") requesting information that related primarily to the
compensation of its sales representatives (the "OIG Investigation"), which ESI
now believes resulted from the Qui Tam Action. If adversely determined, the OIG
Investigation could cause the DOE to subject ESI to monetary fines or penalties
(including repaying a substantial portion of the Title IV Program funds that ESI
disbursed during the last several years) or other sanctions (including a
limitation, suspension or termination of ESI's ability to participate in Title
IV Programs). Any substantial restrictions on the ITT Technical Institutes'
ability to participate in Title IV Programs would adversely affect ESI's ability
to enroll students, expand the number of its institutes and increase the number
of the programs of study offered at its institutes.

In August 2000, the DOE advised ESI that, during the pendency of the OIG
Investigation, it will not approve any application submitted by any ITT
Technical Institute with respect to any change of ownership, additional
location, certification of initial or continuing eligibility, or extension of
course or program offerings (such as raising the level of programs offered at an
institution). The DOE also advised ESI, however, that during the pendency of the
OIG investigation, each of the ITT Technical Institutes that currently
participates in Title IV Programs remains eligible to participate in Title IV
Programs in accordance with the terms of its present eligibility and, if its
current period of eligibility

F-17

ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(DOLLAR AMOUNTS IN THOUSANDS, UNLESS OTHERWISE STATED)

expires, its eligibility will continue on a month-to-month basis. A material
adverse effect on ESI's expansion plans, financial condition, results of
operations and cash flows would result if the DOE's restrictions are not lifted
prior to 2003. ESI cannot assure anyone that the DOE will lift its restrictions
prior to 2003 or that the DOE will not place additional or other more severe
restrictions on the ITT Technical Institutes' ability to participate in Title IV
Programs.

In January 2001, ESI was served in the CONTRERAS, ET AL. V. ITT EDUCATIONAL
SERVICES, INC., ET AL. legal action. This lawsuit was filed on March 3, 2000 in
the Superior Court of Santa Clara County, California by five former students of
the ITT Technical Institute in Santa Clara, California. The suit alleges, among
other things, fraud, negligence, negligent misrepresentation, breach of oral
contract, and statutory violations of the California Business and Professions
Code and California Education Code by ESI and three of its employees who reside
in California. The claims relate primarily to ESI's marketing and recruitment
practices and the quality of its services. The plaintiffs seek compensatory
damages, punitive damages, exemplary damages, civil penalties, restitution on
behalf of the plaintiffs and all other persons similarly situated, injunctive
relief, attorney's fees and costs. On February 6, 2001, the plaintiffs filed an
amended complaint in this action adding 57 plaintiffs, who are current and
former students of the ITT Technical Institutes in either Santa Clara,
California or Hayward, California. Thirty-seven of the 62 plaintiffs graduated
from their programs of study at the ITT Technical Institutes, and 25 of those
graduates or their employers reported to ESI that they were employed in a field
involving their education at an average salary of $34,245. The written
enrollment agreement between each of the plaintiffs and ESI provides that all
disputes between the parties will be resolved through binding arbitration,
instead of litigation. ESI will be filing a motion with the court to compel the
arbitration of each plaintiff's claims in this action. ESI believes that it has
meritorious defenses and intends to vigorously defend itself against the
plaintiffs' claims.

In September 1998, ESI 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
ESI'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, ESI received
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. ESI recorded a $12,858 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, based on the information currently available
to it, the ultimate outcome of the pending legal and other claims should not
have a material adverse effect on ESI's financial condition, results of
operations or cash flows.

Since March 20, 1998, all of ESI's schools have been operating under a
three-year provisional certification from the DOE that allows the schools to
continue to participate in various Title IV Programs. The provisional
certification includes DOE imposed conditions related to certain accounting
matters. No agreement between the DOE and ESI has been reached with respect to
the fulfillment of certain of these conditions, because the DOE still has this
matter under review. If the DOE required ESI to use certain accounting methods
that differ from the methods presently used by ESI, then ESI could be forced to
change certain of its accounting policies.

F-18

SCHEDULE II

ITT EDUCATIONAL SERVICES, INC.

VALUATION AND QUALIFYING ACCOUNTS

FOR THREE YEARS ENDED DECEMBER 31, 2000

(IN THOUSANDS)

BALANCE
BALANCE AT CHARGED AT END
BEGINNING TO WRITE- OF
DESCRIPTION OF PERIOD EXPENSES OFFS PERIOD
------------------------------------------------------- ---------- -------- -------- --------

Allowance for Doubtful Accounts:
Year Ended December 31, 2000........................... $2,972 $5,104 $(4,657) $3,419
Year Ended December 31, 1999........................... $2,531 $4,362 $(3,921) $2,972
Year Ended December 31, 1998........................... $1,393 $4,326 $(3,188) $2,531

FFEL Reserve (1):
Year Ended December 31, 2000........................... $ 980 $ 36 $ -- $1,016
Year Ended December 31, 1999........................... $ 972 $ 8 $ -- $ 980
Year Ended December 31, 1998........................... $ 971 $ 1 $ -- $ 972

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

(1) Represents Federal Family Education Loan/Perkins Loan programs.

F-19

ITT EDUCATIONAL SERVICES, INC.

QUARTERLY RESULTS

FOR 2000 AND 1999

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

THREE MONTHS ENDED
-----------------------------------------
1999 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 YEAR
---- -------- -------- -------- -------- --------

Revenues...................................... $79,972 $70,638 $87,465 $78,295 $316,370
Cost and expenses............................. $68,885 $69,048 $71,735 $69,945 $279,613
Operating income (a).......................... $11,087 $ 1,590 $15,730 $ 8,350 $ 36,757
Interest income, net.......................... $ 855 $ 436 $ 422 $ 683 $ 2,396
Income before cumulative effect of change in
accounting principle........................ $ 7,342 $ 1,251 $10,050 $ 5,708 $ 24,351
Cumulative effect of change in accounting
principle, net of tax....................... $ (823) -- -- -- $ (823)
Net income (a)................................ $ 6,519 $ 1,251 $10,050 $ 5,708 $ 23,528
Earnings per share (a)
Basic....................................... $ 0.25 $ 0.05 $ 0.40 $ 0.23 $ 0.93
Diluted..................................... $ 0.25 $ 0.05 $ 0.40 $ 0.23 $ 0.93

1999 PROFORMA (b)
-----------------

Revenues...................................... $74,850 $75,688 $81,027 $84,810 $316,375
Cost and expenses............................. $68,885 $69,048 $71,735 $69,945 $279,613
Operating income (c).......................... $ 5,965 $ 6,640 $ 9,292 $14,865 $ 36,762
Interest income, net.......................... $ 855 $ 436 $ 422 $ 683 $ 2,396
Income before cumulative effect of change in
accounting principle........................ $ 4,193 $ 4,369 $ 6,044 $ 9,825 $ 24,431
Cumulative effect of change in accounting
principle, net of tax....................... $ (823) -- -- -- $ (823)
Net income (c)................................ $ 3,370 $ 4,369 $ 6,044 $ 9,825 $ 23,608
Earnings per share (c)
Basic....................................... $ 0.13 $ 0.17 $ 0.24 $ 0.40 $ 0.93
Diluted..................................... $ 0.13 $ 0.17 $ 0.24 $ 0.40 $ 0.93

2000
----

Revenues...................................... $81,192 $82,745 $88,479 $95,108 $347,524
Cost and expenses............................. $75,399 $77,050 $77,018 $76,342 $305,809
Operating income.............................. $ 5,793 $ 5,695 $11,461 $18,766 $ 41,715
Interest income, net.......................... $ 628 $ 527 $ 593 $ 959 $ 2,707
Income before cumulative effect of change in
accounting principle........................ $ 3,981 $ 3,859 $ 7,473 $12,172 $ 27,485
Cumulative effect of change in accounting
principle, net of tax....................... $(2,776) -- -- -- $ (2,776)
Net income.................................... $ 1,205 $ 3,859 $ 7,473 $12,172 $ 24,709
Earnings per share (d)
Basic....................................... $ 0.05 $ 0.16 $ 0.31 $ 0.51 $ 1.03
Diluted..................................... $ 0.05 $ 0.16 $ 0.31 $ 0.51 $ 1.02

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

(a) Includes one-time expenses of $900 ($554 after taxes) for offering expenses
associated with the February 1999 Offering. Excluding these one-time
expenses and the cumulative effect of the change in accounting principle for
institute start-up costs, operating income, net income, and earnings per
share for the year ended December 31, 1999 would have been $37,657, $24,905
and $0.98, respectively.

F-20

ITT EDUCATIONAL SERVICES, INC.

QUARTERLY RESULTS

FOR 2000 AND 1999

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

(b) This table sets forth proforma results in each quarter and for the year as
if we had followed the SAB 101 revenue recognition guidance and reported the
same number of weeks of tuition during each period.

(c) Includes one-time expenses of $900 ($554 after taxes) for offering expenses
associated with the February 1999 Offering. Excluding these one-time
expenses and the cumulative effect of the change in accounting principle for
institute start-up costs, operating income, net income, and earnings per
share for the year ended December 31, 1999 would have been $37,661, $24,985
and $0.98, respectively.

(d) Excluding the cumulative effect of the change in accounting principle for
revenue recognition under SAB 101, both basic and diluted earnings per share
for the year ended December 31, 2000 would have been $1.14.

F-21

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

ITT EDUCATIONAL SERVICES, INC.

By: /s/ RENE R. CHAMPAGNE
-----------------------------------------
Rene R. Champagne
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE
OFFICER

Dated: March 29, 2001

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

Chairman, President, Chief
/s/ RENE R. CHAMPAGNE Executive Officer and
------------------------------------------- Director (Principal March 29, 2001
Rene R. Champagne Executive Officer)

Senior Vice President and
/s/ GENE A. BAUGH Chief Financial Officer
------------------------------------------- (Principal Financial March 29, 2001
Gene A. Baugh Officer and Principal
Accounting Officer)

/s/ RAND V. ARASKOG
------------------------------------------- Director March 29, 2001
Rand V. Araskog

/s/ JOHN E. DEAN
------------------------------------------- Director March 29, 2001
John E. Dean

/s/ JAMES D. FOWLER, JR.
------------------------------------------- Director March 29, 2001
James D. Fowler, Jr.

/s/ LESLIE LENKOWSKY
------------------------------------------- Director March 29, 2001
Leslie Lenkowsky

/s/ HARRIS N. MILLER
------------------------------------------- Director March 29, 2001
Harris N. Miller

S-1

SIGNATURE TITLE DATE
--------- ----- ----

/s/ DANIEL P. WEADOCK
------------------------------------------- Director March 29, 2001
Daniel P. Weadock

/s/ VIN WEBER
------------------------------------------- Director March 29, 2001
Vin Weber

S-2

INDEX TO EXHIBITS

PAGE NO.
EXHIBIT IN THIS
NO. DESCRIPTION FILING
--------------------- ------------------------------------------------------------ ---------

3.1 (1) Restated Certificate of Incorporation, as Amended to
Date

3.2 (2) Restated By-laws, as Amended to Date

10.1 (3) Registration Rights Agreement between ESI and ITT

10.2 (3) Tax Sharing Agreement between ESI and ITT

10.3 (3) Intercompany Agreement between ESI and ITT

10.4 (3) Trade Name and Service Mark License Agreement between
ESI and ITT

10.5 (3) Employee Benefits and Administrative Services Agreement
between ESI and ITT

10.6 (3) Treasury Services and Credit Facilities Agreement
between ESI and ITT

10.7 *(4) ITT Educational Services, Inc. 1994 Stock Option Plan

10.8 *(5) 1997 ITT Educational Services, Inc. Incentive Stock
Plan

10.9 (6) Employee Benefits Agreement between ESI and ITT

10.10 (6) Income Tax Sharing Agreement between ESI, ITT and
Starwood Hotels & Resorts Worldwide, Inc

10.11 (6) Trade Name and Service Mark License Agreement between
ESI and ITT Sheraton Corporation

10.12 (7) Amended and Restated Registration Rights Agreement
between ESI and ITT

10.13 (8) Stockholder Agreement between ESI and ITT

10.14 *(9) ESI 401(k) Plan

10.15 *(6) ESI Excess Savings Plan

10.16 *(10) ESI Pension Plan

10.17 (11) Stock Repurchase Agreement between ESI and ITT

10.18 (12) First Amendment to Trade Name and Service Mark License
Agreement between ESI and ITT Sheraton Corporation

10.19 *(1) ESI Excess Pension Plan

10.20 *(13) 1999 Outside Directors Stock Option Plan

10.21 *(14) ESI Non-Employee Directors Deferred Compensation Plan

10.22 *(15) ESI Executive Deferred Bonus Compensation Plan

10.23 *(16) First Amendment of ESI Pension Plan

10.24 (16) Second Amendment to Trade Name and Service Mark License
Agreement between ESI and ITT Manufacturing Enterprises,
Inc. (assignee of ITT Sheraton Corporation)

S-3

PAGE NO.
EXHIBIT IN THIS
NO. DESCRIPTION FILING
--------------------- ------------------------------------------------------------ ---------

10.25 *(16) First Amendment to ESI Excess Savings Plan

11 Statement re Computation of Per Share Earnings

23 Consent of PricewaterhouseCoopers LLP

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

* The indicated exhibit is a management contract, compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.

(1) The copy of this exhibit filed as the same exhibit number to ESI's 1999
second fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(2) The copy of this exhibit filed as the same exhibit number to ESI's
Registration Statement on Form S-8 (Registration No. 33-38883) is
incorporated herein by reference.

(3) The copy of this exhibit filed as the same exhibit number to ESI's 1994
Annual Report on Form 10-K is incorporated herein by reference.

(4) The copy of this exhibit filed as the same exhibit number to ESI's
Registration Statement on Form S-1 (Registration No. 33-78272) is
incorporated herein by reference.

(5) The copy of this exhibit filed as the same exhibit number to ESI's 1997
second fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(6) The copy of this exhibit filed as the same exhibit number to ESI's 1998
second fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(7) The copy of this exhibit filed as Exhibit 99.2 to Starwood Hotels & Resorts
Worldwide, Inc.'s and ITT's Amendment No. 1 to Schedule 13D dated June 29,
1998 is incorporated herein by reference.

(8) The copy of this exhibit filed as Exhibit 99.1 to Starwood Hotels & Resorts
Worldwide, Inc.'s and ITT's Amendment No. 1 to Schedule 13D dated June 29,
1998 is incorporated herein by reference.

(9) The copy of this exhibit filed as Exhibit 4.3 to ESI's Registration
Statement on Form S-8 (Registration No. 333-55903) is incorporated herein
by reference.

(10) The copy of this exhibit filed as the same exhibit number to ESI's 1998
third fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(11) The copy of this exhibit filed as Exhibit 99.1 to ESI's current report on
Form 8-K dated December 21, 1998 is incorporated herein by reference.

(12) The copy of this exhibit filed as the same exhibit number to ESI's 1998
Annual Report on Form 10-K is incorporated herein by reference.

(13) The copy of this exhibit filed as Exhibit 4.3 to ESI's Registration
Statement on Form S-8 (Registration No. 333-84871) is incorporated herein
by reference.

(14) The copy of this exhibit filed as the same exhibit number to ESI's 1999
third fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(15) The copy of this exhibit filed as the same exhibit number to ESI's 2000
first fiscal quarter report on Form 10-Q is incorporated herein by
reference.

(16) The copy of this exhibit filed as the same exhibit number to ESI's 2000
third fiscal quarter report on Form 10-Q is incorporated herein by
reference.

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