CAPELLA EDUCATION CO - FORM 10-Q

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EX-32.2 - SECTION 906 CFO CERTIFICATION - CAPELLA EDUCATION CO	d236498dex322.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - CAPELLA EDUCATION CO	d236498dex321.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - CAPELLA EDUCATION CO	d236498dex311.htm
EX-10.2 - FIFTH AMENDMENT TO LEASE - CAPELLA EDUCATION CO	d236498dex102.htm
EX-10.1 - CAPELLA EDUCATION COMPANY INCENTIVE BONUS PLAN - CAPELLA EDUCATION CO	d236498dex101.htm
EX-10.3 - CREDIT AGREEMENT - CAPELLA EDUCATION CO	d236498dex103.htm
EXCEL - IDEA: XBRL DOCUMENT - CAPELLA EDUCATION CO	Financial_Report.xls
EX-31.2 - SECTION 302 CFO CERTIFICATION - CAPELLA EDUCATION CO	d236498dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

¨	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: 001-33140

CAPELLA EDUCATION COMPANY

(Exact name of registrant as specified in its charter)


Minnesota		41-1717955
(State or other jurisdiction of Incorporation or organization)		(I.R.S. Employer Identification No.)

Capella Tower 225 South Sixth Street, 9^th Floor Minneapolis, Minnesota		55402
(Address of principal executive offices)		(Zip code)

(888) 227-3552

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The total number of shares of common stock outstanding as of October 19, 2011, was 14,455,368.

CAPELLA EDUCATION COMPANY

FORM 10-Q

INDEX


		Page
	PART I – FINANCIAL INFORMATION

Item 1	Financial Statements		3
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3	Quantitative and Qualitative Disclosures About Market Risk		24
Item 4	Controls and Procedures		25

	PART II – OTHER INFORMATION

Item 1	Legal Proceedings		26
Item 1A	Risk Factors		26
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		26
Item 3	Defaults Upon Senior Securities		27
Item 4	Removed and Reserved		27
Item 5	Other Information		27
Item 6	Exhibits		28
SIGNATURES			30

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

CAPELLA EDUCATION COMPANY

Consolidated Balance Sheets

(In thousands, except par value)


	As of September 30, 2011		As of December 31, 2010
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	52,020	$	77,416
Marketable securities		86,441		115,818
Accounts receivable, net of allowance of $4,395 at September 30, 2011 and $3,783 at December 31, 2010		17,728		13,680
Prepaid expenses and other current assets		14,706		8,290
Deferred income taxes		2,063		2,444

Total current assets		172,958		217,648
Property and equipment, net		48,467		44,910
Goodwill		16,370		0
Intangibles, net		7,522		0

Total assets	$	245,317	$	262,558


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	8,348	$	4,599
Accrued liabilities		28,905		29,962
Income taxes payable		0		344
Deferred revenue		8,216		5,885

Total current liabilities		45,469		40,790
Deferred rent		4,231		3,466
Other liabilities		6,209		855
Deferred income taxes		13,815		7,838

Total liabilities		69,724		52,949

Redeemable noncontrolling interest		629		1,023

Shareholders’ equity:
Common stock, $0.01 par value:
Authorized shares — 100,000, issued and outstanding shares — 14,651 at September 30, 2011 and 16,306 at December 31, 2010		147		163
Additional paid-in capital		41,746		115,075
Accumulated other comprehensive income		422		758
Retained earnings		132,649		92,590

Total shareholders’ equity		174,964		208,586

Total liabilities and shareholders’ equity	$	245,317	$	262,558

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

CAPELLA EDUCATION COMPANY

Consolidated Statements of Income

(In thousands, except per share amounts)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	(Unaudited)

Revenues	$	102,306	$	105,010	$	320,061	$	311,400
Costs and expenses:
Instructional costs and services		42,523		43,035		127,528		122,196
Marketing and promotional		33,673		29,584		99,812		88,139
General and administrative		11,253		11,384		29,631		34,361
Reduction of workforce		0		0		1,862		0

Total costs and expenses		87,449		84,003		258,833		244,696

Operating income		14,857		21,007		61,228		66,704
Other income, net		477		504		1,474		1,530

Income before income taxes		15,334		21,511		62,702		68,234
Income tax expense		5,549		8,033		23,037		25,020

Net income		9,785		13,478		39,665		43,214
Net loss attributable to noncontrolling interest		149		0		394		0

Net income attributable to Capella Education Company	$	9,934	$	13,478	$	40,059	$	43,214


Net income attributable to Capella Education Company per common share:
Basic	$	0.66	$	0.81	$	2.57	$	2.58

Diluted	$	0.66	$	0.80	$	2.56	$	2.55


Weighted average number of common shares outstanding:
Basic		15,006		16,634		15,588		16,728

Diluted		15,062		16,807		15,668		16,954

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

CAPELLA EDUCATION COMPANY

Consolidated Statements of Comprehensive Income

(In thousands, except per share amounts)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(Unaudited)
Net income attributable to Capella Education Company	$	9,934		$	13,478		$	40,059		$	43,214
Other comprehensive income, net of tax:
Foreign currency translation loss		(7	)		0			(7	)		0
Unrealized losses on available for sale securities		(179	)		(139	)		(329	)		(278	)

Comprehensive income attributable to Capella Education Company	$	9,748		$	13,339		$	39,723		$	42,936

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

CAPELLA EDUCATION COMPANY

Consolidated Statements of Cash Flows

(In thousands)


	Nine Months Ended September 30,
	2011			2010
	(Unaudited)
Operating activities

Net income	$	39,665		$	43,214
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for bad debts		6,744			6,314
Depreciation and amortization		17,369			13,502
Amortization of investment discount/premium		1,663			1,440
Asset impairment		35			18
Gain on disposal of property and equipment		(38	)		0
Stock-based compensation		3,191			2,438
Excess tax benefits from stock-based compensation		(70	)		(4,144	)
Deferred income taxes		4,873			(21	)
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:
Accounts receivable		(9,453	)		(10,825	)
Prepaid expenses and other current assets		(5,596	)		(3,050	)
Accounts payable and accrued liabilities		(3,569	)		2,311
Income tax payable		(625	)		7
Deferred rent		765			401
Deferred revenue		756			1,204

Net cash provided by operating activities		55,710			52,809
Investing activities
Capital expenditures		(20,020	)		(19,244	)
Purchases of marketable securities		(3,500	)		(37,884	)
Payment for acquisition, net of cash acquired		(12,640	)		0
Sales and maturities of marketable securities		30,685			7,150

Net cash used in investing activities		(5,475	)		(49,978	)
Financing activities
Excess tax benefits from stock-based compensation		70			4,144
Net proceeds from exercise of stock options		1,558			6,175
Repurchase of common stock		(77,271	)		(36,457	)

Net cash used in financing activities		(75,643	)		(26,138	)


Effect of foreign exchange rates on cash		12			0


Net decrease in cash and cash equivalents		(25,396	)		(23,307	)
Cash and cash equivalents at beginning of period		77,416			102,405

Cash and cash equivalents at end of period	$	52,020		$	79,098


Supplemental disclosures of cash flow information
Income taxes paid	$	22,160		$	25,059

Noncash transactions:
Purchase of equipment included in accounts payable and accrued liabilities	$	1,277		$	1,760

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

CAPELLA EDUCATION COMPANY

Notes to Consolidated Financial Statements

(Unaudited)

1. Nature of Business

Capella Education Company (the Company) was incorporated on December 27, 1991, and is the parent company of its wholly owned subsidiaries, Capella University (the University) and Resource Development International Limited (RDI). Capella University, founded in 1993, is an online postsecondary education services company offering a variety of bachelor’s, master’s and doctoral degree programs primarily delivered to working adults. The University is accredited by The Higher Learning Commission and is a member of the North Central Association of Colleges and Schools. In July 2011, the Company acquired RDI, which is an independent provider of United Kingdom (UK) university distance learning qualifications and markets, develops and delivers programs worldwide via its offices and partners across Asia, North America, Africa and Europe. The Company is also the majority owner of the joint venture Sophia Learning, LLC (Sophia). Sophia provides a social teaching and learning platform that integrates education with technology.

2. Summary of Significant Accounting Policies

Consolidation

The consolidated financial statements include the accounts of the Company, the University, RDI and its subsidiaries, and Sophia, after elimination of intercompany accounts and transactions.

Unaudited Interim Financial Information

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of our consolidated results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. Preparation of the Company’s financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s consolidated financial statements and footnotes included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (2010 Annual Report on Form 10-K).

Marketable Securities

Management determines the appropriate designation of marketable securities at the time of purchase and re-evaluates such designation as of each balance sheet date. All of the Company’s marketable securities were designated as available-for-sale as of September 30, 2011 and December 31, 2010.

Available-for-sale marketable securities are carried at fair value as determined by quoted market prices or other inputs either directly or indirectly observable in the marketplace for identical or similar assets, with unrealized gains and losses, net of tax, recognized through accumulated comprehensive income within shareholders’ equity. Management reviews the fair value of the portfolio at least monthly, and evaluates individual securities with fair value below amortized cost at the balance sheet date. In order to determine whether impairment is other than temporary, management must conclude whether the Company intends to sell the impaired security and whether it is more likely than not that the Company will be required to sell the security before recovering its amortized cost basis.

If management intends to sell an impaired debt security or it is more likely than not the Company will be required to sell the security prior to recovering its amortized cost basis, an other-than-temporary impairment is deemed to have occurred. The amount of an other-than-temporary impairment related to a credit loss, or securities that management intends to sell before recovery, is recognized in earnings. The amount of an other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as other comprehensive income within shareholders’ equity.

The cost of securities sold is based on the specific identification method. Amortization of premiums, accretion of discounts, interest, dividend income and realized gains and losses are included in investment income. The contractual maturity date of available-for-sale securities is based on the days remaining to the effective maturity. Certain reclassifications have been made to the contractual maturities as of December 31, 2010 in Note 5 to align with current reporting methods. The Company classifies all marketable securities as current assets because the assets are available to fund current operations.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Contingencies

The Company accrues for costs associated with contingencies including, but not limited to, regulatory compliance and legal matters when such costs are probable and reasonably estimable. Liabilities established to provide for contingencies are adjusted as further information develops, circumstances change, or contingencies are resolved. The Company bases these accruals on management’s best estimate of such costs, which may vary from the ultimate cost and expenses associated with any such contingency.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price of an acquired business over the fair value assigned to the underlying assets acquired and assumed liabilities. At the time of an acquisition, the Company allocates the goodwill and related assets and liabilities to its respective reporting unit. The Company identifies its reporting unit by assessing whether the components of its operating segment constitutes businesses for which discrete financial information is available and management regularly reviews the operating results of those components. The Company assesses goodwill at least annually for impairment or more frequently if events occur or circumstances change between annual tests that would more likely than not reduce the fair value of the respective reporting unit below its carrying amount.

The Company tests for goodwill impairment at the reporting unit level by applying a two-step test. In the first step, the Company compares the fair value of the reporting unit to the carrying value of its net assets. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit, goodwill is not impaired and no further testing is required. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, the Company performs a second step to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. An impairment loss is recognized to the extent the implied fair value of the goodwill is less than the carrying amount of the goodwill.

Finite-lived intangible assets that are acquired in business combinations are recorded at fair market value on their acquisition date and are amortized on a straight-line basis to reflect the economic useful life of the asset. We do not currently have any infinite-lived intangible assets.

Foreign Currency Translation

The U.S. dollar is the functional currency of the Company’s entities operating in the United States (U.S.). The functional currency of the Company’s entities operating outside the U.S. is the currency of the primary economic environment in which the entity primarily generates and expends cash, which is generally the local currency. The assets and liabilities of these operations are translated to U.S. dollars using exchange rates in effect at the balance sheet dates. The resulting translation adjustments and the effect of exchange rate changes on intercompany transactions of a long-term investment nature are included in shareholders’ equity as a component of accumulated other comprehensive income (loss). Income and expense items are translated monthly at the average exchange rate for that period. The Company reports gains and losses from foreign exchange rate changes related to intercompany receivables and payables that are not of a long-term investment nature, as well as gains and losses from foreign currency denominated transactions, in the Consolidated Statements of Income.

Subsequent Events

The Company has evaluated events and transactions that occurred during the period subsequent to the balance sheet date. There have been no subsequent events that require recognition or disclosure in the financial statements.

Refer to the Company’s “Summary of Significant Accounting Policies” footnote included in its 2010 Annual Report on Form 10-K for a complete summary of the Company’s significant accounting policies.

3. Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) No. 2011-05, Comprehensive Income, which is included in Accounting Standards Codification (ASC) 220, Presentation of Comprehensive Income. This update improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The guidance requires all nonowner changes in shareholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company elected early adoption; therefore, the guidance will be effective for its interim and annual reporting periods beginning September 30, 2011, and applied retrospectively. The adoption of this guidance did not have a material impact on the Company’s financial condition, results of operations, or disclosures.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other, which is included in ASC 350, Testing Goodwill for Impairment. This update reduces the complexity, and potentially the cost, of testing goodwill for impairment. The guidance gives the Company the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, and in some cases skip the two-step impairment test. The guidance will be effective for the Company’s interim and annual reporting periods beginning January 1, 2012, and applied prospectively. The Company does not expect adoption of this guidance to have a material impact on its financial condition, results of operations, or disclosures.

4. Net Income Attributable to Capella Education Company per Common Share

Basic net income attributable to Capella Education Company per common share is based on the weighted average number of shares of common stock outstanding during the period. Dilutive shares are computed using the Treasury Stock method and include the incremental effect of shares that would be issued upon the assumed exercise of stock options and the vesting of restricted stock.

The following table presents a reconciliation of the numerator and denominator in the basic and diluted net income attributable to Capella Education Company per common share calculation.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	(in thousands, except per share data)
Numerator:
Net income attributable to Capella Education Company	$	9,934	$	13,478	$	40,059	$	43,214
Denominator:
Denominator for basic net income attributable to Capella Education Company per common share— weighted average shares outstanding		15,006		16,634		15,588		16,728
Effect of dilutive stock options and restricted stock		56		173		80		226

Denominator for diluted net income attributable to Capella Education Company per common share— weighted average shares outstanding	$	15,062	$	16,807	$	15,668	$	16,954

Basic net income attributable to Capella Education Company per common share	$	0.66	$	0.81	$	2.57	$	2.58
Diluted net income attributable to Capella Education Company per common share	$	0.66	$	0.80	$	2.56	$	2.55

Options to purchase 0.6 million and 0.1 million common shares were outstanding, but not included in the computation of diluted net income per common share in the three months ended September 30, 2011 and 2010, respectively, because their effect would be antidilutive.

Options to purchase 0.5 million and 0.1 million common shares were outstanding, but not included in the computation of diluted net income per common share in the nine months ended September 30, 2011 and 2010, respectively, because their effect would be antidilutive.

5. Marketable Securities

The following is a summary of available-for-sale securities:


	As of September 30, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
	(in thousands)
Tax-exempt municipal securities	$	85,756	$	685	$	0		$	86,441

Total	$	85,756	$	685	$	0		$	86,441


	As of December 31, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
	(in thousands)
Tax-exempt municipal securities	$	114,604	$	1,277	$	(63	)	$	115,818

Total	$	114,604	$	1,277	$	(63	)	$	115,818

The unrealized gains and losses on the Company’s investments in municipal securities as of September 30, 2011 and December 31, 2010 were caused by changes in market values primarily due to interest rate changes. The Company did not have any securities in an unrealized loss position as of September 30, 2011. No other-than-temporary impairment charges were recorded for the three and nine months ended September 30, 2011 and 2010.

The following table summarizes the remaining contractual maturities of the Company’s marketable securities:


	As of September 30, 2011		As of December 31, 2010
	(in thousands)
Due within one year	$	66,144	$	58,998
Due after one year through five years		20,297		56,820

	$	86,441	$	115,818

The following table is a summary of the proceeds from the sale and maturities of available-for-sale securities:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	(in thousands)
Maturities of marketable securities	$	13,225	$	6,150	$	30,685	$	6,150
Proceeds from the sale of marketable securities		0		1,000		0		1,000

	$	13,225	$	7,150	$	30,685	$	7,150

The Company did not record any gross realized gains or gross realized losses during the three and nine months ended September 30, 2011 and 2010.

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The Company classifies assets recorded at fair value under the fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. The fair value measurements are classified under the following hierarchy:

•

Level 1 – Observable inputs that reflect quoted market prices (unadjusted) for identical assets and liabilities in active markets;

•

Level 2 – Observable inputs, other than quoted market prices, that are either directly or indirectly observable in the marketplace for identical or similar assets and liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities; and

•

Level 3 – Unobservable inputs that are supported by little or no market activity that are significant to the fair value of assets or liabilities.

When available, the Company uses quoted market prices to determine fair value, and such measurements are classified within Level 1. In some cases where market prices are not available, the Company makes use of observable market-based inputs to calculate fair value, in which case the measurements are classified within Level 2. Currently, the Company does not have any measurements with cash, cash equivalents and marketable securities classified within Level 3.

The following tables summarize certain information for assets measured at fair value on a recurring basis:


	Fair Value Measurements as of September 30, 2011 Using
Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash and cash equivalents:
Cash	$	5,969	$	5,969	$	0	$	0
Money market funds		21,161		21,161		0		0
Variable rate demand notes		24,890		24,890		0		0

Total cash and cash equivalents	$	52,020	$	52,020	$	0	$	0


Marketable securities:
Tax-exempt municipal securities	$	86,441	$	0	$	86,441	$	0

Total marketable securities	$	86,441	$	0	$	86,441	$	0


	Fair Value Measurements as of December 31, 2010 Using
Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash and cash equivalents:
Money market funds	$	43,141	$	43,141	$	0	$	0
Variable rate demand notes		34,275		34,275		0		0

Total cash and cash equivalents	$	77,416	$	77,416	$	0	$	0


Marketable securities:
Tax-exempt municipal securities	$	115,818	$	0	$	115,818	$	0

Total marketable securities	$	115,818	$	0	$	115,818	$	0

The Company measures cash and cash equivalents at fair value primarily using real-time quotes for transactions in active exchange markets involving identical assets. The variable rate demand notes contain a feature allowing the Company to require payment by the issuer on a daily or weekly basis. As a result, these securities are highly liquid and are classified as cash and cash equivalents. The Company’s marketable securities are classified within Level 2 and are valued using readily available pricing sources for comparable instruments utilizing market observable inputs. The Company does not hold securities in inactive markets. The Company did not have any transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy during the first nine months of 2011.

6. Accrued Liabilities

Accrued liabilities consist of the following:


	As of September 30, 2011		As of December 31, 2010
	(in thousands)
Accrued compensation and benefits	$	5,288	$	14,055
Accrued instructional		6,093		4,544
Accrued vacation		2,154		1,867
Other		15,370		9,496

	$	28,905	$	29,962

“Other” in the table above consists primarily of vendor invoices accrued in the normal course of business.

In February 2011, we implemented a strategic reduction of workforce by eliminating approximately 120 positions and incurred charges of approximately $1.9 million in the nine months ended September 30, 2011. As of September 30, 2011 there was no remaining liability related to the reduction of workforce.

7. Commitments and Contingencies

Leasehold Agreements

The Company leases its office facilities and certain office equipment under various noncancelable operating leases and has contractual obligations related to certain software license agreements. Effective August 29, 2011, the Company entered into an amendment of its current lease with Minneapolis 225 Holdings, LLC pursuant to which the Company renewed and extended its existing lease for premises at 225 South Sixth Street in Minneapolis, Minnesota through 2018.

Future minimum lease commitments under the leases as of September 30, 2011, are as follows:


	Operating
	(in thousands)
2011	$	1,647
2012		6,695
2013		6,277
2014		6,441
2015		6,539
2016 and thereafter		19,941

Total	$	47,540

The Company recognizes rent expense on a straight-line basis over the term of the lease, although the lease may include escalation clauses providing for lower payments at the beginning of the lease term and higher payments at the end of the lease term. Cash or lease incentives received from lessors are recognized on a straight-line basis as a reduction to rent from the date the Company takes possession of the property through the end of the lease term. The Company records the unamortized portion of the incentive as a component of deferred rent, in accrued liabilities or long-term liabilities, as appropriate.

Revolving Credit Facility

On September 30, 2011, the Company entered into an unsecured revolving credit agreement (the Credit Agreement) with Bank of America, N.A., and certain other lenders. The Credit Agreement provides $100.0 million of borrowing capacity (the credit facility), with an increase option of an additional $50.0 million. The Credit Agreement has a term of five years ending September 30, 2016.

Borrowings under the Credit Agreement bear interest at a rate equal to LIBOR plus an applicable rate of 1.75% to 2.25% based on the Company’s consolidated leverage ratio or, at the Company’s option, an alternative base rate (defined as the higher of (a) the federal funds rate plus 0.5%, (b) Bank of America’s prime rate, or (c) the one-month LIBOR plus 1.0%) plus an applicable rate of 0.75% to 1.25% based on the Company’s consolidated leverage ratio. The Credit Agreement requires payment of a commitment fee, based on the Company’s consolidated leverage ratio, charged on the unused credit facility. Outstanding letters of credits are also charged a fee, based on the Company’s consolidated leverage ratio. The Company capitalized approximately $0.5 million of transaction costs related to the credit facility, which will be amortized over a period of five years.

The Credit Agreement contains certain covenants that, among other things, require maintenance of certain financial ratios, as defined in the agreement. Failure to comply with the covenants contained in the Credit Agreement will constitute an event of default and could result in termination of the agreement and require payment of all outstanding borrowings. As of September 30, 2011, there were no borrowings under the credit facility and the Company was in compliance with all debt covenants.

Line of Credit

The Company’s previous $10.0 million line of credit facility with Wells Fargo Bank, set to expire July 31, 2012, was terminated upon entering into the Credit Agreement. The $1.6 million letter of credit issued under the previous line of credit was cancelled and released by the Department of Education on July 20, 2011. There were no borrowings under the Wells Fargo Bank credit facility as of and for the nine months ended September 30, 2011, and as of and for the year ended December 31, 2010.

Litigation

On November 5, 2010, a purported securities class action lawsuit captioned Police Pension Fund of Peoria, Individually, and on Behalf of All Others Similarly Situated v. Capella Education Company, J. Kevin Gilligan and Lois M. Martin, was filed in the U.S. District Court for the District of Minnesota. The complaint names the Company and certain senior executives as defendants, and alleges the Company and the named defendants made false or misleading public statements about our business and prospects during the time period from February 16, 2010 through August 13, 2010 in violation of federal securities laws, and that these statements artificially inflated the trading price of the Company’s common stock to the detriment of shareholders who purchased shares during that time. The plaintiff seeks compensatory damages for the purported class. Since that time, substantially similar complaints making similar allegations against the same defendants for the same purported class period were filed with the federal court. Pursuant to the Private Securities Litigation Reform Act of 1995, on April 13, 2011, the Court appointed Oklahoma Firefighters Pension and Retirement System as lead plaintiff and Abraham, Fruchter and Twersley, LLP, as lead counsel. A consolidated amended complaint, captioned Oklahoma Firefighters Pension and Retirement System, Individually and on Behalf of All Others Similarly Situated, v. Capella Education Company, J. Kevin Gilligan, Lois M. Martin and Amy L. Ronneberg, was filed on June 27, 2011. The Company filed a motion to dismiss the plaintiff’s complaint on September 2, 2011, and a hearing on that motion is currently scheduled for December 21, 2011.

Discovery in this case has not yet begun. Because of the many questions of fact and law that may arise, the outcome of this legal proceeding is uncertain at this point. Based on information available to the Company at present, it cannot reasonably estimate a range of loss for this action and, accordingly, has not accrued any liability associated with this action.

In the ordinary conduct of business, the Company is subject to various lawsuits and claims covering a wide range of matters including, but not limited to, claims involving learners or graduates and routine employment matters. While the outcome of these matters is uncertain, the Company does not believe the outcome of these matters will have a material adverse impact on its consolidated financial position or results of operations.

8. Stock Repurchase Program

The Company’s stock repurchase program was announced in March 2008. The Board of Directors authorizes repurchases of outstanding shares of common stock, from time to time, depending on market conditions and other considerations. A summary of the Company’s comprehensive stock repurchase activity for fiscal year 2010 through September 30, 2011, all of which was part of our publicly announced program, is presented below:


	(in thousands)
Board authorizations:
August 2010	$	60,662
February 2011		65,000

Total amount authorized		125,662
Total value of shares repurchased		90,873

Residual authorization	$	34,789

In addition to the Board authorizations outlined above, the Company executed a separate authorization under the stock repurchase program in July 2008 for repurchases up to an aggregate amount of $60.0 million in value of common stock, which has been fully utilized.

During the nine months ended September 30, 2011, the Company repurchased 1.7 million shares for total consideration of $78.1 million. Due to timing, cash payments made for these share repurchases were $77.3 million. The Company repurchased 0.5 million shares for total consideration of $36.5 million during the nine months ended September 30, 2010.

As of September 30, 2011, the Company had purchased an aggregate of 2.9 million shares under the program’s outstanding authorizations at an average price per share of $52.45 totaling $150.9 million.

9. Stock-Based Compensation

The following table presents the Company’s stock-based compensation expense recognized in the consolidated statements of income:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	(in thousands)
Instructional costs and services	$	317	$	334	$	835	$	733
Marketing and promotional		150		125		420		286
General and administrative		814		613		1,936		1,419

Stock-based compensation expense included in operating income		1,281		1,072		3,191		2,438
Tax benefit from stock-based compensation expense		460		398		1,177		909

Stock-based compensation expense, net of tax	$	821	$	674	$	2,014	$	1,529

10. Noncontrolling Interest

Sophia became a majority owned subsidiary of the Company in 2010. The equity interest in Sophia not owned by the Company is reported as noncontrolling interest on the consolidated balance sheet of the Company. Losses incurred by Sophia were charged to the Company and to the noncontrolling interest holder based on ownership percentage.

There is a put option within the Sophia Learning, LLC agreement which permits the noncontrolling interest to put its shares to the Company within a specified time period. Since these shares are outside the control of the Company, the noncontrolling interest is considered contingently redeemable and thus is presented in mezzanine equity in the consolidated balance sheet. Pursuant to authoritative guidance, if the value of the contingently redeemable noncontrolling interest is less than the fair market value, and it is probable the contingency related to the put option will be met, then the carrying value of the contingently redeemable noncontrolling interest must be adjusted to fair market value through a charge directly to retained earnings. Although the Company has determined that it is probable that the put option will be exercised based upon the passage of time, the Company determined that a charge to retained earnings was not needed at September 30, 2011, as the value of the contingently redeemable noncontrolling interest approximated fair market value. The Company based this determination on the short time period from its latest investment in Sophia and September 30, 2011, and the current business activities at Sophia. Unobservable inputs are employed in determining the fair value of the redeemable noncontrolling interest and as such it is considered a Level 3 fair value measurement.

11. Acquisition of RDI

On July 15, 2011, the Company acquired 100% of the share capital of RDI for £7.9 million (approximately $12.6 million), net of cash acquired. RDI is an independent provider of UK university distance learning qualifications and markets, develops and delivers these programs worldwide via its offices and partners across Asia, North America, Africa and Europe. RDI’s online distance learning offerings span from degree-entry programs to doctoral level programs and are offered in a variety of disciplines, including business, management, psychology, law, and computing.

As a result of years of investment in its academic infrastructure, RDI has applied to the British Government for Taught Degree Awarding Powers (TDAP). If awarded, TDAP will enable RDI to independently validate its own degrees going forward under the auspices of the Quality Assurance Agency, a Government body that reviews the standards and quality of all UK universities. Under the terms of the agreement, the Company will make an additional payment of £4.0 million (approximately $6.4 million) if TDAP is granted to RDI.

The Company has preliminarily measured the fair value of the assets acquired and liabilities assumed in accordance with ASC 805 Business Combinations. The Company recorded goodwill of $16.4 million, and capitalized $7.6 million of intangible assets primarily consisting of partner and student relationships, trademark and trade name, learning model, and internally developed software. The estimated useful lives of the intangible assets range from two to ten years. The Company also recorded a liability of $5.7 million for the fair value of the TDAP contingent consideration, which is included in other liabilities as of September 30, 2011, and has recorded the acquired deferred revenue at its fair value of $1.6 million. The Company assumed net liabilities of £1.6 million (approximately $2.6 million) in this transaction.

The Company is in the process of finalizing the third party valuations of the intangible assets and contingent consideration values; thus, the preliminary measurements of intangible assets, goodwill, contingent consideration, and deferred income tax are subject to change as we finalize the purchase accounting for this transaction. The results of operations of RDI have been included in the Company’s consolidated results of operations since the date of acquisition.

12. Regulatory Supervision and Oversight

Capella University is subject to extensive regulation by federal and state governmental agencies and accrediting bodies. In particular, the Higher Education Act (HEA) and the regulations promulgated thereunder by the U.S. Department of Education (DOE) subject the University to significant regulatory scrutiny on the basis of numerous standards that schools must satisfy to participate in the various types of federal learner financial assistance under Title IV Programs.

To participate in the Title IV Programs, an institution must be authorized to offer its programs of instruction by the relevant agencies of the state in which it is located, accredited by an accrediting agency recognized by the DOE and certified as eligible by the DOE. The DOE will certify an institution to participate in the Title IV programs only after the institution has demonstrated compliance with the HEA and the DOE’s extensive academic, administrative, and financial regulations regarding institutional eligibility. An institution must also demonstrate its compliance with these requirements to the DOE on an ongoing basis. The Company performs periodic reviews of its compliance with the various applicable regulatory requirements. The Company has not been notified by any of the various regulatory agencies of any significant noncompliance matters that would adversely impact its ability to participate in Title IV programs; however, the Office of Inspector General (OIG) has conducted a compliance audit of Capella University. The audit

commenced on April 10, 2006 and we subsequently provided the OIG with periodic information, responded to follow up inquiries and facilitated site visits and access to Capella University’s records. The OIG completed its field work in January 2007 and the Company received a draft audit report on August 23, 2007. Capella University provided written comments on the draft report to the OIG on September 25, 2007. On March 7, 2008, the OIG’s final report was issued to the Acting Chief Operating Officer (COO) for Federal Student Aid (FSA), which is responsible for primary oversight of the Title IV funding programs. The Company responded to the final report on April 8, 2008. In 2009, Capella University provided FSA staff with certain additional requested information for financial aid years 2002-2003 through 2007-2008. The FSA will subsequently issue final findings and requirements for Capella University. The FSA may take certain actions, including requiring that we refund certain federal student aid funds, requiring us to modify our Title IV administration procedures, and/or requiring us to pay fines or penalties.

Based on the final audit report for the financial aid years 2002-2003 through 2004-2005, the most significant potential financial exposure from the audit pertains to repayments to the Department of Education that could be required if the OIG concludes that Capella University did not properly calculate the amount of Title IV funds required to be returned for learners that withdrew without providing an official notification of such withdrawal and without engaging in academic activity prior to such withdrawal. If it is determined that Capella University improperly withheld any portion of these funds, Capella University would be required to return the improperly withheld funds. The Company and the OIG have differing interpretations of the relevant regulations regarding what constitutes engagement in the unofficial withdrawal context. As the Company interprets the engagement requirement, it currently estimates that for the three year audit period, and for the subsequent aid years through 2007-2008, the total amount of Title IV funds not returned—for learners who withdrew without providing official notification and without engaging as required in the relevant regulations—was approximately $1.0 million including interest, but not including fines and penalties. If this difference of interpretation is ultimately resolved in a manner adverse to the Company, then the total amount of Title IV funds not returned for learners who withdrew without providing official notification would be greater than the amount the Company has currently estimated.

Political and budgetary concerns significantly affect the Title IV Programs. Congress reauthorizes the HEA and other laws governing Title IV Programs approximately every five to eight years. The last reauthorization of the HEA was completed in August 2008. Additionally, Congress reviews and determines appropriations for Title IV programs on an annual basis through the budget and appropriations processes. As of September 30, 2011, programs in which the Company’s learners participate are operative and sufficiently funded.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our historical results of operations and our liquidity and capital resources should be read in conjunction with the consolidated financial statements and related notes that appear elsewhere in this report.

Forward-Looking Statements

Statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). In addition, certain statements in our future filings with the Securities and Exchange Commission (SEC), in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to, statements regarding: proposed new programs; regulatory developments; projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance; and statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. Words such as “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar expressions, as well as statements in future tense, are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, as updated in our subsequent reports filed with the SEC, including any updates found in Part II, Item 1A of this or other Quarterly Reports on Form 10-Q. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC.

Executive Overview

We are an online postsecondary education services company. Our wholly owned subsidiaries and joint venture include the following:

•

Capella University (the University), a wholly owned subsidiary, is a regionally accredited university offering a variety of undergraduate and graduate degree programs primarily for working adults.

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Resource Development International Limited. (RDI), a wholly owned subsidiary, is an independent provider of United Kingdom (UK) university distance learning qualifications and markets, develops and delivers these programs worldwide via its offices and partners across Asia, North America, Africa and Europe.

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Sophia Learning, LLC (Sophia), a joint venture in which we are the majority owner, is a social teaching and learning platform that integrates education with technology.

We believe we have the right operating strategies in place to continually differentiate ourselves in our markets and drive growth by supporting learner success, producing affordable degrees, expanding our brand, serving a broader set of our learner’s professional needs and establishing new growth platforms. Technology and the talent of our faculty and employees enable these strategies. We believe these strategies and enablers will allow us to continue to deliver high quality, affordable education, resulting in continued growth over the long-term. We will continue to invest in these enablers to strengthen the foundation and future of our business.

Key Trends, Developments and Challenges

The following developments and trends present opportunities, challenges and risks toward achieving our goal of providing attractive returns to our shareholders:

•

Introduction of new programs and specializations. In 2010, we launched eight new degree programs and fifteen new specializations. In the first nine months of 2011, we introduced three new degree programs and nine new specializations across our markets, and expect to continue to introduce additional degree programs and specializations in the future, as we believe this will further position Capella for long-term success. Certain types of new programs or specializations may require the Department of Education (DOE or Department) notification and/or approval, which could have an impact on the anticipated timeframe to launch new offerings.

We invest in program and specialization development, as well as support infrastructure and marketing and selling when introducing new programs and specializations. Associated revenues depend upon enrollment, and in many cases are lower during the period of new program and specialization introduction. During the period of new program and specialization introduction, the rate of growth of revenues and operating income has been, and in the future may be, adversely affected in part due to these factors. As our newer programs and specializations develop, we anticipate increases in enrollment, more cost-effective delivery of instructional and support services and more efficient marketing and promotional processes.

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Establishing new growth platforms. We seek to drive long-term growth that is an extension of our core competencies into new markets. We are pursuing this extension through the formation of a small business development team that is exploring early stage opportunities. This may result in increased new business development costs focused on researching, identifying and cultivating these new opportunities.

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RDI Acquisition. In July 2011, we acquired RDI to access the fast-growing international higher education market. RDI has a significant presence in the UK and certain Commonwealth countries. Although we believe the acquisition will have a positive impact on our revenue growth, there are certain factors that may result in lower revenue growth, including regulation changes in the UK Border Agency’s acceptance of visas or changes in RDI’s university partner relationships. Currently, RDI partners with several universities to validate degrees since RDI does not have its own Taught Degree Awarding Powers.

For the fourth quarter of 2011 and in 2012, we expect the financial results of RDI to be dilutive to our earnings, in part related to the effects of purchase accounting on deferred revenues, amortization of intangibles and integration expenses.

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Competition for high-quality inquiries. As the industry has evolved to address regulatory concerns, competition for high-quality inquiries has increased across all degree levels. The increased competition has resulted in higher costs to acquire high-quality inquiries, especially through aggregator channels. In addition, conversion rates are under pressure due to lower consumer demand and increased competition for high-quality inquiries. We are responding to the higher competition by reinforcing our commitment to quality inquiries within our targeted professional markets through a more strategic shift towards brand-focused marketing.

However, even with the positive changes we have made to date, we continue to see increased pricing on quality inquiries and a reduction in the number of quality inquiries. Therefore, we anticipate a greater need for marketing tests, increased brand spending, such as traditional media including television advertising, and selectively applying tools such as

scholarships, in our marketing efforts. Building our brand awareness may put considerable pressure on marketing expenses in the near term, however we believe this should produce long-term efficiencies for our channel strategy. We expect the increased competition for high-quality inquiries to continue to adversely impact our new enrollment and marketing spend, and therefore also impact active enrollments, revenue and operating margins in 2011 and potentially beyond.

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Current market environment. The market continues to present challenging conditions. We survey prospective learners on a regular basis and continue to see hesitation to take on the financial responsibility of a university education in the current market environment. The decision cycle for prospective learners has almost doubled compared to the first half of 2010. Although the primary trend remains to not act on the desire to pursue a college degree in this economic environment, we remain focused on attracting the right learners and continue to strengthen our current product offerings.

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Initiative on improving graduation rates through high standards of academic quality and rigor. As we continue to position Capella to drive sustainable growth, we are focused on improving graduation rates while maintaining a high standard of academic quality and rigor. In order to further increase our focus on improving the learner experience and attracting learners who are more likely to persist in our programs, we recently implemented various measures likely to affect our growth and profitability, at least in the near term, including the following:

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Continuing increased investment in faculty development through the formation of the Center for Teaching and Learning Excellence and innovative tools such as the technology offered through Sophia;

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Upgrading our learning and data platforms;

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Adopting new tools to better support learners’ education financing decisions, such as our Responsible Borrowing Calculator, designed to help learners calculate the amount of learner borrowing necessary to achieve their educational objectives and to motivate them to not incur unnecessary student loan debt;

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Transitioning our marketing approaches to more effectively identify learners with the ability to succeed in our educational programs, including reduced emphasis on the utilization of third parties for inquiry generation;

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Requiring all bachelors’ learners who enroll in Capella University without transfer credits to complete an academic readiness pre-assessment;

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Better aligning our enrollment, admissions and other employees to our learners’ success by resetting individual objectives and measures and implementing new compensation structures, including eliminating all enrollment-related factors from compensation for our enrollment counselors and certain other personnel effective January 1, 2011; and,

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Expanding our actionable analytics capabilities even further to learner and faculty interaction, with the goal to refine the collection of course room activity data, identify activities which have the greatest impact on persistence, and establish data driven best practices and expectations.

We expect some of these initiatives may adversely impact our new and active enrollment and revenue in 2011, and potentially beyond. However, we believe these efforts are in the best interest of our learners and over the long-term will improve graduation rates, which, in turn, will position us for more sustainable long-term growth.

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New Enrollment Growth. We have historically experienced double-digit new enrollment growth. During the first nine months of 2011, we experienced negative new enrollment growth and expect continued new enrollment pressure. We expect negative new enrollment growth to adversely impact our active enrollments, revenues, financial condition, results of operations and cash flows.

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Reduction of workforce. In February 2011, we implemented a strategic reduction of workforce by eliminating approximately 120 positions and incurred charges of approximately $1.9 million in the first nine months of 2011 in connection with this reduction in employment. We expect to realize related employee compensation expense reductions and other discretionary spending reductions of approximately $12.0 to $12.5 million annualized.

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Regulatory Environment

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Rulemaking by the U.S. Department of Education. In 2010, the DOE issued new Title IV program integrity rules that address numerous topics. The most significant to our business are the following:

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Adoption of a definition of “gainful employment” for purposes of the requirement for Title IV student financial aid that a program of study offered by a proprietary institution prepare learners for gainful employment in a recognized occupation;

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Implementation of standards for state authorization of institutions of higher education; and

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Implementation of standards around the new program approval section of gainful employment.

The Department published final regulations on October 29, 2010, including disclosure and reporting provisions related to gainful employment metrics. Most of the October 29, 2010 final rules were effective July 1, 2011.

In addition to the final program integrity rules, current rulemaking by the DOE has amended the return of funds regulations to require an institution to determine the amount of Title IV program funds that a learner “earned” based on when the learner stopped participating in the course instead of when the learner withdrew from the course. The amended regulation went into effect on July 1, 2011, and as anticipated, has adversely impacted our bad debt expense.

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Gainful Employment. Under the Higher Education Act, proprietary schools are eligible to participate in Title IV programs under the condition that they provide educational programs that lead to “gainful employment in a recognized occupation.” On October 29, 2010, and June 13, 2011, the Department published final regulations on gainful employment.

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Disclosures. Effective July 1, 2011, proprietary institutions of higher education as well as public and not-for profit institutions offering postsecondary non-degree programs must provide prospective students with the types of employment associated with the program, total cost of the program, completion rate, job placement rate, if applicable, and median loan debt of program completers.

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Reporting. Effective October 1, 2011, institutions must annually submit information to the Department about students who complete a program leading to gainful employment in a recognized occupation, including the amount of debt incurred under private loans or institutional finance plans, graduation information, and end of year enrollment information.

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New Program Approval. Effective July 1, 2011, the final regulations require institutions to notify the Department at least 90 days before the start of new educational programs leading to gainful employment in recognized occupations. This notification must include information on the need for the program, a wage analysis, an institutional program review and approval process, and a demonstration of accreditation. An institution is not required to obtain formal Department approval if the notification is submitted at least 90 days prior to the first day of class. However, if the Department decides during the course of review that an approval is warranted, a notice will be sent to the institution at least 30 days prior to the first day of class with a request for additional information. The Department issued a Notice of Proposed Rulemaking on the subject of New Program Approval on September 26, 2011. Significant proposed changes include: Institutions must notify the Department of a new program only if the program is a) a program substantially similar to a program that is failing to meet both gainful employment debt metrics; b) a program that is outside the scope of the institution’s accreditation; or c) the Secretary notifies the institution that it must apply for approval. Capella believes that the proposed rules would significantly reduce our reporting burden and are better aligned with the intent and scope of gainful employment.

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Debt-to-Earnings Ratio and Loan Repayment Rate. The metrics used to define gainful employment in the final rule are based on debt-to-earnings and loan repayment rates, but with changes from the proposed rule issued July 2010.

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Summary of the final regulation. A program leads to gainful employment in a recognized occupation if it meets one of the following metrics:

(1)

Loan Repayment Rate - at least 35 percent of former students are repaying their loans. The repayment rate generally is measured using the student’s third and fourth year of repayment, with a few exceptions. If there are 30 or fewer borrowers in a two-year period, the repayment rate period will be expanded to include borrowers in the third, fourth, fifth and sixth years. If there are still fewer than 30 borrowers after that point, the program is considered to have passed the metric.

(2)

Debt to Earnings Ratio - either (a) the estimated annual loan repayment of a typical graduate does not exceed 30 percent of his or her discretionary income (income above 150% of the poverty level), or (b) the estimated annual loan payment of a typical graduate does not exceed 12 percent of his or her total earnings. The ratios generally will be based upon students in their third and fourth years after graduation, with the same exceptions pertaining to small cohort programs described immediately above, for the repayment rate metric. Debt will be calculated based upon the program’s median debt, which will include private loans. Annual payments will be calculated based on a 10-year standard repayment plan for certificate and associates degree programs, 15 years for bachelor’s and master’s programs, and 20 years for graduate and professional programs. Debt incurred for living expenses is excluded from the calculation.

(3)

If a program fails both the Loan Repayment and Debt to Earnings metrics –

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After one failure, the institution must provide a warning to students disclosing the amount by which the program missed minimal acceptable performance and the program’s plans for improvement and establish a three-day waiting period before a student can enroll.

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After two failures within three years, the institution must provide a warning to prospective and enrolled students in the failing program stating: the plan it intends to take in response, the risks associated with enrolling or continuing in the program, that the student should “expect to have difficulty repaying” the loans, and if the school chooses to discontinue the program at this stage, the timeline for doing so.

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After three failures within four years, the program loses eligibility for federal student aid. Institutions cannot then reestablish the program’s eligibility for at least three years.

Although the final rules regarding gainful employment metrics provide opportunities to address program deficiencies before the loss of Title IV eligibility, the continuing eligibility of our educational programs for Title IV funding is at risk due to factors beyond our control, such as changes in the actual or deemed income level of our graduates, changes in student borrowing levels, increases in interest rates, changes in the federal poverty income level relevant for calculating discretionary income, changes in the percentage of our former students who are current in repayment of their student loans, and other factors. In addition, even though deficiencies in the metrics may be correctible on a timely basis, the disclosure requirements to students following a failure to meet the standards may adversely impact enrollment in that program and may adversely impact the reputation of our educational institution. The exposure to these external factors may reduce our ability to confidently offer or continue certain types of programs for which there is market demand, thus impacting our ability to maintain or grow our business.

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US Congressional Hearings. The Health, Education, Labor and Pensions Committee of the U. S. Senate (HELP Committee) has held a series of hearings, initially in June 2010 and most recently on June 7, 2011, focused on the proprietary education sector and student loan debt. We believe that future hearings on the for-profit sector may be held. In addition, other Congressional hearings have been or are expected to be held regarding various aspects of the education industry that may affect our business, including hearings before the House Education and Workforce Committee and the Senate Homeland Security and Governmental Affairs’ Subcommittee on Federal Financial Management, Government Information, Federal Services and International Security. We have been and intend to continue being responsive to the requests of the HELP Committee. Any action by Congress that significantly reduces Title IV program funding or the eligibility of Capella University or our learners to participate in Title IV programs would have a material adverse effect on our financial condition, results of operations and cash flows.

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Recently Enacted Laws. The Budget Control Act of 2011 was signed into law on August 2, 2011. The law contains provisions that eliminate the subsidized Stafford loan program for graduate learners effective July 1, 2012. In the subsidized Stafford loan program, the federal government pays the interest that accrues while the learner is in school. The learner is then responsible for the interest that accrues after they leave the institution. Graduate learners can still obtain federal financial aid through the unsubsidized Stafford loan program. In the unsubsidized Stafford loan program, the learner can choose to either pay the interest that accrues while they are in school or defer payments on the interest until they leave the institution – both accrue at 6.8%. Graduate learners can still participate in the subsidized Stafford loan program until July 1, 2012. The impact to Capella will manifest in slightly larger debt loads and monthly debt payments for our exiting students.

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Title IV Compliance Audit of Capella University. We perform periodic reviews and self audits of our compliance with the various applicable regulatory requirements of the DOE and state regulatory authorities. We have not been notified by any of the various regulatory agencies of any significant noncompliance matters that would adversely impact our ability to participate in Title IV programs, however, the Office of Inspector General (OIG) of the DOE has conducted a compliance audit of Capella University. The audit commenced on April 10, 2006 and we subsequently provided the OIG with periodic information, responded to follow up inquiries and facilitated site visits and access to the Company’s records. The OIG completed its field work in January 2007 and the Company received a draft audit report on August 23, 2007. Capella University provided written comments on the draft audit report to the OIG on September 25, 2007. On March 7, 2008, the OIG’s final report was issued to the Acting Chief Operating Officer (COO) for Federal Student Aid (FSA), which is responsible for primary oversight of the Title IV funding programs. We responded to the final report on April 8, 2008. In 2009, we provided FSA staff with certain requested information for financial aid years 2002-2003 through 2006-2007. The FSA will subsequently issue final findings and requirements for Capella University. The FSA may take certain actions, including requiring that we refund certain federal student aid funds, requiring us to modify our Title IV administration procedures, and/or requiring us to pay fines or penalties.

Based on the final audit report for the financial aid years 2002-2003 through 2004-2005, the most significant potential financial exposure pertains to repayments to the DOE that could be required if the FSA concludes that Capella University did not properly calculate the amount of Title IV funds required to be returned for learners that withdrew without providing an official notification of such withdrawal and without engaging in the course room prior to such withdrawal. If the FSA determines that Capella University improperly withheld any portion of these funds, Capella University would be required to return the improperly withheld funds. We and the OIG have differing interpretations of the relevant regulations regarding what constitutes engagement in the unofficial withdrawal context. As we interpret the engagement requirement, we currently estimate that for the three year audit period, and for the subsequent aid years through 2007-2008, the total amount of Title IV funds not returned, for learners who withdrew without providing official notification and without engaging as required in the relevant regulations, was approximately $1.0 million including interest, but not including fines and penalties. If this difference of interpretation is ultimately resolved in a manner adverse to us, then the total amount of Title IV funds not returned for learners who withdrew without providing official notification would be greater than the amount we have currently estimated.

Recent Events

The following events occurred in the third quarter of 2011:

•

On July 15, 2011, we purchased 100% of the share capital of RDI. The transaction, which was financed with cash on hand, is expected to be dilutive in 2011 and 2012. Refer to Note 11, Acquisition of RDI, for additional discussion.

•

Effective August 29, 2011, we entered into an amendment of its current lease with Minneapolis 225 Holdings, LLC pursuant to which we renewed and extended our existing lease for premises at 225 South Sixth Street in Minneapolis, Minnesota through 2018. Refer to Note 7, Commitments and Contingencies, for additional discussion.

•

On September 30, 2011, we entered into a revolving credit agreement, providing $100.0 million of borrowing capacity, with an increase option of an additional $50.0 million. The agreement has a term of five years ending September 30, 2016. Refer to Note 7, Commitments and Contingencies, for additional discussion.

Critical Accounting Policies and Use of Estimates

Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. During the nine months ended September 30, 2011, we added the following critical accounting policy.

Goodwill and Intangible Assets

Results of Operations

Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010

The following selected financial data table should be referenced in connection with a review of the discussion of our results of operations for the three months ended September 30, 2011:


	Three Months Ended September 30,
	$ (in thousands, unaudited)						$ Change			% Change			% of Revenue
	2011			2010			2011 vs. 2010						2011			2010			2011 vs. 2010
Revenues	$	102,306		$	105,010		$	(2,704	)		(2.6	)%		100.0	%		100.0	%		0.0	%
Costs and expenses:
Instructional costs and services		42,523			43,035			(512	)		(1.2	)		41.6			41.0			0.6
Marketing and promotional		33,673			29,584			4,089			13.8			32.9			28.2			4.7
General and administrative		11,253			11,384			(131	)		(1.2	)		11.0			10.8			0.2

Total costs and expenses		87,449			84,003			3,446			4.1			85.5			80.0			5.5

Operating income		14,857			21,007			(6,150	)		(29.3	)		14.5			20.0			(5.5	)
Other income, net		477			504			(27	)		(5.4	)		0.5			0.5			0.0

Income before income taxes		15,334			21,511			(6,177	)		(28.7	)		15.0			20.5			(5.5	)
Income tax expense		5,549			8,033			(2,484	)		(30.9	)		5.4			7.6			(2.2	)

Effective tax rate		36.2	%		37.3	%
Net income		9,785			13,478			(3,693	)		(27.4	)		9.6			12.9			(3.3	)
Net loss attributable to noncontrolling interest		149			0			149			100.0			0.1			0.0			0.1

Net income attributable to Capella Education Company	$	9,934		$	13,478		$	(3,544	)		(26.3	)%		9.7	%		12.9	%		(3.2	)%

Revenues. The decrease in revenues compared to the same quarter in prior year is primarily driven by 5.3 percentage points related to decreased enrollments at September 30, 2011 compared to the same period in 2010. The decrease in enrollments is slightly offset by 1.9 percentage points from the impact of price increases and a 0.8 percentage point increase related to a larger proportion of doctoral learners who generate more revenue per learner than our master’s or bachelor’s learners. Tuition increases in 2011 generally ranged from zero to seven percent and were implemented in July 2011.

Instructional costs and services expenses. Instructional costs and services expenses decreased compared to the same quarter in the prior year primarily as a result of a decreased cost per learner this quarter, driven by efficiencies gained in the course room. This decrease was slightly offset by an increase in depreciation and amortization expense due to increased capital investments in late 2010 and 2011, as compared to 2009 and 2010, related to the learner experience and academic quality.

Instructional costs and services as a percentage of revenue increased compared to the same quarter in the prior year primarily due to an increase in depreciation and amortization expense due to increased capital investments in late 2010 and 2011, as compared to 2009 and 2010, related to the learner experience and academic quality. This increase was partially offset by a decrease in cost per learner driven by efficiencies gained in the course room.

Marketing and promotional expenses. Marketing and promotional expenses, and marketing and promotional expenses as a percent of revenues, increased compared to the same quarter in the prior year primarily as a result of increased core marketing efforts and brand advertising, which focused on improving conversion rates and new enrollment growth, and an increase in the cost per inquiry. This increase is slightly offset by a reduction in engagement and enrollment services workforce due to lower inquiries and new enrollment volume.

General and administrative expenses. General and administrative expenses decreased compared to the same quarter in the prior year primarily due to greater investments in market research in third quarter 2010 compared to third quarter 2011, and a decrease in estimated bonus expense. This decrease was slightly offset by higher depreciation and amortization expense related to increased capital investments and increased bad debt expense due to the new Title IV program rules.

General and administrative expenses as a percentage of revenue increased compared to the same quarter in the prior year primarily due to greater investments in market research in third quarter 2010 compared to third quarter 2011, and a decrease in estimated bonus expense. This decrease was slightly offset by higher depreciation and amortization expense related to increased capital investments and increased bad debt expense due to the new Title IV program rules.

Other income, net. Other income, net decreased compared to the same quarter in the prior year primarily due to reduced interest income levels as a result of lower average cash, cash equivalents and marketable securities balances.

Income tax expense. The main driver of the decrease in our effective tax rate is a decrease in our state effective rate due to apportionment changes in key states.

Net income. Net income decreased due to the factors discussed above.

Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010

The following selected financial data table should be referenced in connection with a review of the discussion of our results of operations for the nine months ended September 30, 2011:


	Nine Months Ended September 30,
	$ (in thousands, unaudited)						$ Change			% Change			% of Revenue
	2011			2010			2011 vs. 2010						2011			2010			2011 vs. 2010
Revenues	$	320,061		$	311,400		$	8,661			2.8	%		100.0	%		100.0	%		0.0	%
Costs and expenses:
Instructional costs and services		127,528			122,196			5,332			4.4			39.8			39.3			0.5
Marketing and promotional		99,812			88,139			11,673			13.2			31.2			28.3			2.9
General and administrative		29,631			34,361			(4,730	)		(13.8	)		9.3			11.0			(1.7	)
Reduction of workforce		1,862			0			1,862			100.0			0.6			0.0			0.6

Total costs and expenses		258,833			244,696			14,137			5.8			80.9			78.6			2.3

Operating income		61,228			66,704			(5,476	)		(8.2	)		19.1			21.4			(2.3	)
Other income, net		1,474			1,530			(56	)		(3.7	)		0.5			0.5			0.0

Income before income taxes		62,702			68,234			(5,532	)		(8.1	)		19.6			21.9			(2.3	)
Income tax expense		23,037			25,020			(1,983	)		(7.9	)		7.2			8.0			(0.8	)

Effective tax rate		36.7	%		36.7	%
Net income		39,665			43,214			(3,549	)		(8.2	)		12.4			13.9			(1.5	)
Net loss attributable to noncontrolling interest		394			0			394						0.1			0.0			0.1

Net income attributable to Capella Education Company	$	40,059		$	43,214		$	(3,155	)		(7.3	)%		12.5	%		13.9	%		(1.4	)%

Revenues. The increase in revenues compared to the same period in prior year is primarily driven by 2.0 percentage points from the impact of price increases, a 0.6 percent increase in enrollments, and a 0.2 percentage point increase related to a larger proportion of doctoral learns who generate more revenue per learner than our master’s or bachelor’s learners. Tuition increases in 2011 generally ranged from zero to seven percent and were implemented in July 2011.

Instructional costs and services expenses. Instructional costs and services expenses increased compared to the same period in the prior year primarily due to an increase in depreciation and amortization expense as a result of increased capital investments in 2010 and 2011, as compared to 2009 and 2010, related to the learner experience and academic quality, and continued investment in curriculum and course room development. These increases were slightly offset by a decrease in estimated bonus expense.

Instructional costs and services expenses as a percentage of revenue increased compared to the same period in the prior year primarily due to an increase in depreciation and amortization expense as a result of increased capital investments in 2010 and 2011, as compared to 2009 and 2010, related to the learner experience and academic quality. These increases were slightly offset by a decrease in cost per learner driven by efficiencies gained in the course room.

Marketing and promotional expenses. Marketing and promotional expenses, and marketing and promotional expenses as a percent of revenues, increased compared to the same period in the prior year primarily as a result of increased core marketing efforts and brand advertising, which focused on improving conversion rates and new enrollment growth, and an increase in the cost per inquiry. This increase is offset by a reduction in engagement and enrollment services workforce due to lower inquiries and new enrollment volume.

General and administrative expenses. General and administrative expenses, and general and administrative expenses as a percentage of revenue, decreased compared to the same period in the prior year due to greater investments in market research in 2010 compared to 2011, and a decrease in estimated bonus expense.

Reduction of workforce expenses. In February 2011, we implemented a strategic reduction of workforce by eliminating approximately 120 positions and incurred charges of approximately $1.9 million in the nine months ended September 30, 2011. As of September 30, 2011, there was no remaining liability related to the reduction of workforce. We expect to realize related employee compensation expense reductions and other discretionary spending reductions of approximately $12.0 to $12.5 million annualized.

Other income, net. Other income, net decreased compared to the same period in the prior year primarily due to reduced interest income levels as a result of lower average cash, cash equivalents and marketable securities balances.

Income tax expense. Our effective tax rate remained flat compared to the same period in the prior year.

Net income. Net income decreased due to the factors discussed above.

Liquidity and Capital Resources

Liquidity

We financed our operations and capital expenditures during the nine months ended September 30, 2011 and 2010 through cash provided by operating activities. Our cash, cash equivalents and marketable securities were $138.5 million and $193.2 million at September 30, 2011 and December 31, 2010, respectively. Our cash, cash equivalents and marketable securities decreased primarily due to an increase in share repurchase activity during the nine months ended September 30, 2011.

On September 30, 2011, we entered into an unsecured revolving credit agreement (the Credit Agreement) with Bank of America, N.A., and certain other lenders. The Credit Agreement provides $100.0 million of borrowing capacity, with an increase option of an additional $50.0 million. The Credit Agreement has a term of five years ending September 30, 2016. As of September 30, 2011, there were no borrowings under the credit facility and we were in compliance with all debt covenants.

Our previous $10.0 million line of credit facility with Wells Fargo Bank, set to expire July 31, 2012, was terminated upon entering into the Credit Agreement. The $1.6 million letter of credit issued under the previous line of credit was cancelled and released by the Department of Education on July 20, 2011. There were no borrowings under the Wells Fargo Bank credit facility as of and for the nine months ended September 30, 2011, and as of and for the year ended December 31, 2010.

Significant portions of our revenues are derived from Title IV programs. Federal regulations dictate the timing of disbursements under Title IV programs. Learners must apply for new loans and grants each academic year, which begins July 1. Loan funds are provided through the William D. Ford Direct Loan program in multiple disbursements for each academic year. The disbursements are usually received by the beginning of the third week of the term. These factors, together with the timing of when our learners begin their programs, affect our operating cash flow. Based on current market conditions and recent regulatory or legislative actions, we do not anticipate any significant near-term disruptions in the availability of Title IV funding for our learners.

On July 15, 2011, the Company acquired 100% of the share capital of RDI for £7.9 million (approximately $12.6 million), net of cash acquired. In connection with the agreement, we will make an additional payment of £4.0 million (approximately $6.4 million) if RDI is granted Taught Degree Awarding Power (TDAP).

Based on our current level of operations and anticipated growth, we believe our cash provided by operations and other sources of liquidity, including cash, cash equivalents and marketable securities, will provide adequate funds for ongoing operations and planned capital expenditures for the foreseeable future. We can further supplement our liquidity position with the $100.0 million credit facility entered into on September 30, 2011 to fund our operations or to fund strategic investments, if needed.

Operating Activities

Net cash provided by operating activities was $55.7 million and $52.8 million for the nine months ended September 30, 2011 and 2010, respectively. The increase from 2010 to 2011 was primarily due to an increase in depreciation and amortization as a result of increased capital investments in 2010 and 2011, as compared to 2009 and 2010, related to improving the learner experience and academic quality; and a decrease in excess tax benefits from stock-based compensation as a result of fewer exercises of stock-based compensation and higher stock prices in 2010 compared to 2011.

The increase in net cash provided by operating activities is slightly offset by a decrease in accounts payable and accrued liabilities primarily due to a decrease in accrued bonus expense, and timing of payroll payments and vendor invoices.

Investing Activities

Our cash used in investing activities is primarily related to the purchase or maturity of investments in marketable securities, investments in property and equipment, and the acquisition of RDI. Net cash used in investing activities was $5.5 million for the nine months ended September 30, 2011 and $50.0 million for the nine months ended September 30, 2010. Investments in marketable securities consist of purchases and maturities of tax-exempt municipal securities. Net (purchases) and maturities of these securities were $27.2 million during the nine months ended September 30, 2011, and ($30.7) million during the nine months ended September 30, 2010. The net change is attributable to higher purchases of marketable securities in 2010 compared to 2011, and maturities of marketable securities in 2011 that are now held as cash and cash equivalents at September 30, 2011.

We believe the credit quality and liquidity of our investment portfolio as of September 30, 2011 is strong. The unrealized gains and losses of the portfolio may remain volatile as changes in the general interest rate environment and supply/demand fluctuations of the securities within our portfolio impact daily market valuations. To mitigate the risk associated with this market volatility, we deploy a relatively conservative investment strategy focused on capital preservation and liquidity. But even with this approach, we may incur investment losses as a result of unusual and unpredictable market developments and we may experience reduced investment earnings if the yields on investments deemed to be low risk remain low or decline further due to unpredictable market developments. In addition, these unusual and unpredictable market developments may also create liquidity challenges for certain of the assets in our investment portfolio.

Capital expenditures were $20.0 million and $19.2 million for the nine months ended September 30, 2011 and 2010, respectively, and primarily consist of investments related to improving the learner experience and academic quality.

During the nine months ended September 30, 2011, we used $12.6 million in cash as payment for the acquisition of RDI, net of cash acquired.

We lease all of our facilities. We expect to make future payments on existing leases from cash generated from operations.

Financing Activities

Net cash used in financing activities was $75.6 million and $26.1 million for the nine months ended September 30, 2011 and 2010, respectively. In the first nine months of 2011, we repurchased $78.1 million of common stock under our repurchase program compared to $36.5 million in the first nine months of 2010. Due to timing, cash payments made for shares repurchased in the first nine months of 2011 were $77.3 million.

Contractual Obligations

The following table sets forth, as of September 30, 2011, the aggregate amounts of our significant contractual obligations and commitments with definitive payment terms due in each of the periods presented:


	Payments Due by Period
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
	(in thousands)
Operating leases ^(a)	$	47,540	$	8,342	$	12,718	$	13,241	$	13,239

Total contractual obligations	$	47,540	$	8,342	$	12,718	$	13,241	$	13,239

^(a)	Minimum lease commitments for our headquarters, RDI’s office space, miscellaneous office equipment and software license agreements.

Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at September 30, 2011, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $0.2 million of unrecognized tax benefits have been excluded from the Contractual Obligations table above.

Due to the uncertainty with respect to the timing of future borrowings associated with our credit facility, we are unable to make reasonably reliable estimates of any commitment fees charged on the unused portion of the credit facility. Therefore, the maximum estimated commitment fee of $0.4 million per annum is excluded from the Contractual Obligations table above.

Additionally, as the timing of when RDI may be awarded Taught Degree Awarding Powers (TDAP) is uncertain, the contingent consideration of $5.7 million is excluded from the Contractual Obligations table above. The $5.7 million is included in other liabilities as of September 30, 2011.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market Risk

We have no derivative financial instruments or derivative commodity instruments. We believe the risk related to cash equivalents and marketable securities is limited due to the adherence to our investment policy, which focuses on capital preservation and liquidity. In

addition, all investments must have a minimum Standard & Poor’s rating of A minus (or equivalent) by at least one agency at the purchase date. All of our cash equivalents and marketable securities as of September 30, 2011 and December 31, 2010 were rated A minus or higher. In addition, we utilize money managers who conduct initial and ongoing credit analysis on our investment portfolio to monitor and minimize the potential impact of market risk associated with our cash, cash equivalents and marketable securities. Despite the investment risk mitigation strategies we employ, we may incur investment losses as a result of unusual and unpredictable market developments and we may experience reduced investment earnings if the yields on investments deemed to be low risk remain low or decline further in this time of economic uncertainty. Unusual and unpredictable market developments may also create liquidity challenges for certain assets in our investment portfolio.

Interest Rate Risk

We manage interest rate risk by investing excess funds in cash equivalents and marketable securities bearing a combination of fixed and variable interest rates, which are tied to various market indices. Our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. At September 30, 2011, a 10% increase or decrease in interest rates would not have a material impact on our future earnings, fair values, or cash flows.

Foreign Currency Exchange Risk

We use the U.S. dollar as our reporting currency. The functional currencies of our foreign subsidiaries are generally the local currencies. Accordingly, our foreign currency exchange risk is related to the following exposures:

•

Adjustments resulting from the translation of assets and liabilities of the foreign subsidiaries into U.S. dollars using exchange rates in the effect at the balance sheet dates. These translation adjustments are recorded in accumulated other comprehensive income (loss);

•

Earnings volatility translation of income and expense items of the foreign subsidiaries using an average monthly exchange rate for the respective periods, and;

•

Gains and losses resulting from foreign exchange rate changes related to intercompany receivables and payables that are not of a long-term investment nature, as well as gains and losses from foreign currency transactions. These items are recorded in other income, net in the Consolidated Statements of Income.

We have not used derivative contracts to hedge foreign currency exchange rate fluctuations.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act).

Based upon that evaluation, our chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective, as of September 30, 2011, in ensuring that material information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in reports it files or submits under the Securities Exchange Act is accumulated and communicated to management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

Discovery in this case has not yet begun. Because of the many questions of fact and law that may arise, the outcome of this legal proceeding is uncertain at this point. Based on information available to us at present, we cannot reasonably estimate a range of loss for this action and, accordingly, have not accrued any liability associated with this action.

From time to time, we are a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business. While the outcomes of these matters are uncertain, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Item 1A.

Risk Factors

There have been no material changes to the risk factors disclosed in the “Risk Factors” section as updated in our Form 10-Q for the quarter ended June 30, 2011.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

During the three months ended September 30, 2011, we used $25.2 million to repurchase shares of common stock under our repurchase program.⁽¹⁾Our remaining authorization for common stock repurchases was $34.8 million at September 30, 2011.

The following presents our share repurchases during the quarter ended September 30, 2011:


Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Dollar Value of Shares That May Yet be Purchased Under the Plans or Programs
7/1/2011 to 7/31/2011		201,232	$	44.75		201,232	$	50,981,300
8/1/2011 to 8/31/2011		261,064		34.39		261,064		42,004,611
9/1/2011 to 9/30/2011		231,320		31.19		231,320		34,788,904

Total		693,616	$	36.33		693,616	$	34,788,904

⁽¹⁾

The Company’s share repurchase program was announced in March 2008. Our Board of Directors authorizes us to repurchase outstanding shares of common stock, from time to time, depending on market conditions and other considerations. In August 2010 our Board of Directors authorized $60.7 million in value of common stock under our stock repurchase program and an additional increase in February 2011 of $65.0 million in share repurchases, resulting in total authorization for

repurchases up to an aggregate amount of $125.7 million in value of common stock. The Company executed a separate authorization under the stock repurchase program in July 2008 for repurchases up to an aggregate amount of $60.0 million in value of common stock, which has been fully utilized. There is no expiration date on the repurchase authorizations and repurchases occur at our discretion.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Removed and Reserved

Item 5.

Other Information

None.

Item 6.

Exhibits

(a) Exhibits


Number	Description	Method of Filing

2.1	Agreement, dated July 15, 2011, by and among John Holden and Others and Capella Education Company for the sale and purchase of the entire issued share capital of Resource Development International Limited (excluding schedules and exhibits, which we agree to furnish supplementally to the Securities and Exchange Commission upon request).	Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on July 15, 2011.

3.1	Amended and Restated Articles of Incorporation.	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on November 11, 2006.

3.2	Amended and Restated By-Laws.	Incorporated by reference to Exhibit 3.4 to Amendment No. 3 to the Company’s Registration Statement on Form S-1 filed with the SEC on October 6, 2006.

4.1	Specimen of common stock certificate.	Incorporated by reference to Exhibit 4.1 to Amendment No. 4 to the Company’s Registration Statement on Form S-1 filed with the SEC on October 19, 2006.

10.1*	Capella Education Company Incentive Bonus Plan.	Filed electronically.

10.2	Fifth Amendment to Lease, dated as of August 29, 2011, by and between the Registrant and Minneapolis 225 Holdings, LLC.	Filed electronically.

10.3	Credit Agreement dated September 30, 2011, among Capella Education Company, identified therein as the Borrower; Bank of America, N.A. as Administrative Agent; Merrill Lynch, Pierce, Fenner & Smith as the lead Arranger; and certain other lenders (the “Credit Agreement”).	Filed electronically.

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed electronically.

31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed electronically.

32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed electronically.

32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed electronically.

EX-101.INS	XBRL Instance Document⁽¹⁾

EX-101.SCH	XBRL Taxonomy Extension Schema Document⁽¹⁾

EX-101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document⁽¹⁾

EX-101.LAB	XBRL Taxonomy Extension Label Linkbase Document⁽¹⁾

EX-101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document⁽¹⁾

*	Management contract or compensatory plan or arrangement.

⁽¹⁾

The XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing or document.

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.


CAPELLA EDUCATION COMPANY

/s/ J. Kevin Gilligan
		October 25, 2011
J. Kevin Gilligan
Chief Executive Officer
(Principal Executive Officer)

/s/ Steven L. Polacek
		October 25, 2011
Steven L. Polacek
Senior Vice President and Chief
Financial Officer (Principal Financial Officer)

/s/ Amy L. Ronneberg
		October 25, 2011
Amy L. Ronneberg
Vice President and Corporate Controller
(Principal Accounting Officer)

Large accelerated filer

Accelerated filer

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Smaller reporting company