CAPELLA EDUCATION CO - FORM 10-Q

Attached files

file	filename
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - CAPELLA EDUCATION CO	cpla_10-qxex312x93015.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - CAPELLA EDUCATION CO	cpla_10-qxex311x93015.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - CAPELLA EDUCATION CO	cpla_10-qxex322x93015.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - CAPELLA EDUCATION CO	cpla_10-qxex321x93015.htm

Table of Contents

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, 2015



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

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

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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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.



Large accelerated filer	o	Accelerated filer	x

Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	o

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

The total number of shares of common stock outstanding as of October 22, 2015 was 11,925,978.

Table of Contents

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	26
Item 4	Mine Safety Disclosures	26
Item 5	Other Information	26
Item 6	Exhibits	27
SIGNATURES		28

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CAPELLA EDUCATION COMPANY

Consolidated Balance Sheets

(In thousands, except par value)



	As of September 30, 2015			As of December 31, 2014
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	97,213		$	94,003
Marketable securities, current	29,531			29,619
Accounts receivable, net of allowance of $6,848 at September 30, 2015 and $6,558 at December 31, 2014	18,441			17,902
Prepaid expenses and other current assets	16,333			9,007
Deferred income taxes	2,936			2,809
Total current assets	164,454			153,340
Marketable securities, non-current	42,991			43,430
Property and equipment, net	36,541			37,246
Goodwill	16,900			16,961
Intangibles, net	1,523			1,927
Other assets	1,923			1,453
Total assets	$	264,332		$	254,357
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	8,960		$	6,832
Accrued liabilities	29,833			23,410
Dividends payable	4,639			4,622
Income taxes payable	—			709
Deferred revenue	13,295			11,718
Total current liabilities	56,727			47,291
Deferred rent	2,099			2,440
Other liabilities	3,029			3,698
Deferred income taxes	5,291			5,894
Total liabilities	67,146			59,323

Shareholders’ equity:
Common stock, $0.01 par value: Authorized shares — 100,000; Issued and Outstanding shares — 11,976 at September 30, 2015 and 12,243 at December 31, 2014	120			122
Additional paid-in capital	115,025			112,417
Accumulated other comprehensive loss	(221		)	(335		)
Retained earnings	82,262			82,830
Total shareholders’ equity	197,186			195,034
Total liabilities and shareholders’ equity	$	264,332		$	254,357

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

Table of Contents

CAPELLA EDUCATION COMPANY

Consolidated Statements of Income

(In thousands, except per share amounts)



	Three Months Ended September 30,					Nine Months Ended September 30,
	2015		2014			2015			2014
	(Unaudited)
Revenues	$	103,711	$	103,097		$	320,792		$	313,525
Costs and expenses:
Instructional costs and services	48,221		47,143			142,651			139,973
Marketing and promotional	25,860		25,509			79,158			74,383
Admissions advisory	7,390		7,019			21,947			21,092
General and administrative	8,772		10,250			29,673			31,604
Lease amendment charges	—		—			—			2,690
Total costs and expenses	90,243		89,921			273,429			269,742
Operating income	13,468		13,176			47,363			43,783
Other income (expense), net	24		(46		)	(68		)	(559		)
Income before income taxes	13,492		13,130			47,295			43,224
Income tax expense	5,320		5,373			18,755			17,606
Net income	$	8,172	$	7,757		$	28,540		$	25,618
Net income per common share:
Basic	$	0.68	$	0.63		$	2.35		$	2.08
Diluted	$	0.67	$	0.62		$	2.31		$	2.04
Weighted average number of common shares outstanding:
Basic	12,027		12,268			12,146			12,301
Diluted	12,237		12,505			12,373			12,545
Cash dividends declared per common share	$	0.37	$	0.35		$	1.11		$	1.05

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

Table of Contents

CAPELLA EDUCATION COMPANY

Consolidated Statements of Comprehensive Income

(In thousands)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015		2014
	(Unaudited)
Net income	$	8,172		$	7,757		$	28,540	$	25,618
Other comprehensive income (loss):
Foreign currency translation gain (loss)	(24		)	137			47		(367		)
Unrealized gains (losses) on available for sale securities, net of tax	72			(9		)	67		8
Comprehensive income	$	8,220		$	7,885		$	28,654	$	25,259

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

Table of Contents

CAPELLA EDUCATION COMPANY

Consolidated Statements of Cash Flows

(In thousands)



	Nine Months Ended September 30,
	2015			2014
	(Unaudited)
Operating activities
Net income	$	28,540		$	25,618
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for bad debts	10,717			11,232
Depreciation and amortization	17,026			18,016
Amortization of investment discount/premium, net	1,702			1,319
Impairment of property and equipment	—			277
Loss on disposal of property and equipment	63			77
Share-based compensation	5,465			3,927
Excess tax benefits from share-based compensation	(422		)	(451		)
Deferred income taxes	(790		)	(537		)
Payment of contingent consideration	—			(906		)
Changes in operating assets and liabilities:
Accounts receivable	(11,285		)	(11,273		)
Prepaid expenses and other current assets	(4,327		)	(670		)
Accounts payable and accrued liabilities	7,458			(230		)
Income taxes payable	(3,813		)	149
Deferred rent	(341		)	(623		)
Deferred revenue	1,674			1,548
Net cash provided by operating activities	51,667			47,473
Investing activities
Capital expenditures	(16,478		)	(15,788		)
Investment in partnership interest	(470		)	(1,453		)
Purchases of marketable securities	(25,247		)	(48,957		)
Maturities of marketable securities	24,180			13,890
Net cash used in investing activities	(18,015		)	(52,308		)
Financing activities
Excess tax benefits from share-based compensation	422			451
Net proceeds from exercise of stock options	1,234			3,663
Payment of dividends	(13,570		)	(12,961		)
Repurchases of common stock	(18,500		)	(14,032		)
Payment of contingent consideration	—			(5,945		)
Net cash used in financing activities	(30,414		)	(28,824		)
Effect of foreign exchange rates on cash	(28		)	13
Net increase (decrease) in cash and cash equivalents	3,210			(33,646		)
Cash and cash equivalents at beginning of period	94,003			124,097
Cash and cash equivalents at end of period	$	97,213		$	90,451
Supplemental disclosures of cash flow information
Income taxes paid	$	23,331		$	18,327
Noncash transactions:
Purchase of equipment included in accounts payable and accrued liabilities	$	382		$	425
Declaration of cash dividend to be paid	$	4,500		$	4,346
Repurchases of common stock included in accrued liabilities	$	—		$	241

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

Table of Contents

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), Arden University, Ltd. (formerly known as Resource Development International Limited, or RDI), Sophia Learning, LLC (Sophia), and Capella Learning Solutions (CLS). The 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 2011, the Company acquired RDI, and in August 2015, RDI received confirmation that it met the criteria for university title in the United Kingdom (UK) and could begin operating as Arden University. Arden University is an independent provider of UK university distance learning qualifications that markets, develops and delivers programs worldwide via its offices and partners across Asia, North America, Africa and Europe. Sophia is an innovative learning platform leveraging technology to support self-paced learning, including credits eligible for transfer to over 2,000 colleges and universities. CLS provides online training solutions and services to corporate partners which are delivered through the Company's online learning platform. With the Company's focus on academic quality in an online delivery format, it has one reporting segment.

2. Summary of Significant Accounting Policies

Consolidation

The consolidated financial statements include the accounts of the Company, the University, CLS, Arden University and its subsidiaries, and Sophia, after elimination of intercompany accounts and transactions. Arden University operates on a fiscal year ending October 31, which is also the date used for consolidation.

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 the Company's 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, 2014 (2014 Annual Report on Form 10-K).

Refer to the Company’s “Summary of Significant Accounting Policies” footnote included within the 2014 Annual Report on Form 10-K for a complete summary of the Company’s significant accounting policies.

3. Recent Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which is included in Accounting Standards Codification (ASC) 470, Debt. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, which clarified the guidance contained in ASU 2015-03 to continue to allow debt issuance costs related to line-of-credit arrangements to be recognized as an asset and amortized ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The guidance will be effective for the Company's annual reporting period beginning January 1, 2016, and applied on a retrospective basis; early adoption is also permitted. The Company does not expect adoption of this guidance to have a material impact on its financial condition, results of operations, or disclosures.

Table of Contents

In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis, which is included in ASC 810, Consolidation. This update changes the guidance with respect to the analyses that a reporting entity must perform to determine whether it should consolidate certain types of legal entities under the variable interest consolidation model. All legal entities are subject to reevaluation under the revised consolidation model. The new guidance affects the following areas: (1) limited partnerships and similar legal entities, (2) evaluating fees paid to a decision maker or a service provider as a variable interest, (3) the effect of fee arrangements on the primary beneficiary determination, (4) the effect of related parties on the primary beneficiary determination, and (5) certain investment funds. The guidance will be effective for the Company's interim and annual reporting periods beginning January 1, 2016. The standard allows the Company to transition to the new model using either a full or modified retrospective approach, and early adoption is permitted. The Company does not expect adoption of this guidance to have a material impact on its financial condition, results of operations, or disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern, which is included in ASC 205, Presentation of Financial Statements. This update provides an explicit requirement for management to assess an entity's ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The guidance will be effective for the Company's annual reporting period beginning January 1, 2017, and applied prospectively; early adoption is also permitted. The Company does not expect adoption of this guidance to have a material impact on its financial condition, results of operations, or disclosures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which is included in ASC 606, Revenue from Contracts with Customers. This ASU is a comprehensive new revenue recognition model that creates a single source of revenue guidance for all companies in all industries. The model is more principles-based than current guidance, and is primarily based on recognizing revenue at an amount that reflects consideration to which the entity expects to be entitled to in exchange for transferring goods or services to a customer. The standard allows the Company to transition to the new model using either a full or modified retrospective approach. Under the original ASU, the guidance was effective for the Company's interim and annual reporting periods beginning January 1, 2017, and early adoption was not permitted. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers, Deferral of the Effective Date, which formally defers the effective date of the new revenue standard for public entities by one year. As a result, the updated revenue guidance will be effective for the Company's interim and annual reporting periods beginning January 1, 2018, and early adoption is permitted as of the original effective date contained within the original standard. The Company is still evaluating the impact this standard will have on its business practices, financial condition, results of operations, and disclosures.

The Company has reviewed and considered all other recent accounting pronouncements and believes there are none that could potentially have a material impact on its business practices, financial condition, results of operations, or disclosures.

4. Net Income per Common Share

Basic net income 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, settlement of restricted stock, and satisfaction of service conditions for market stock units.

The following table presents a reconciliation of the numerator and denominator in the basic and diluted net income per common share calculation, in thousands, except per share data:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Numerator:
Net income	$	8,172	$	7,757	$	28,540	$	25,618
Denominator:
Denominator for basic net income per common share— weighted average shares outstanding	12,027		12,268		12,146		12,301
Effect of dilutive stock options, restricted stock, and market stock units	210		237		227		244
Denominator for diluted net income per common share— weighted average shares outstanding	12,237		12,505		12,373		12,545
Basic net income per common share	$	0.68	$	0.63	$	2.35	$	2.08
Diluted net income per common share	$	0.67	$	0.62	$	2.31	$	2.04

Table of Contents

Options to purchase common shares were outstanding, but not included in the computation of diluted net income per common share, because their effect would be anti-dilutive. The following table summarizes these securities, in thousands:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2015	2014	2015	2014
Anti-dilutive securities excluded from diluted earnings per share calculation	307	232	283	213

5. Marketable Securities

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



	As of September 30, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
Tax-exempt municipal securities	$	66,079	$	89	$	(5	)	$	66,163
Corporate debt securities	6,372		1		(14		)	6,359
Total	$	72,451	$	90	$	(19	)	$	72,522

	As of December 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
Tax-exempt municipal securities	$	65,708	$	31	$	(71	)	$	65,668
Corporate debt securities	7,379		4		(2		)	7,381
Total	$	73,087	$	35	$	(73	)	$	73,049

The unrealized gains and losses on the Company’s investments in municipal and corporate debt securities as of September 30, 2015 and December 31, 2014 were caused by changes in market values primarily due to interest rate changes. All of the Company's securities which were in an unrealized loss position as of September 30, 2015 had been in an unrealized loss position for less than twelve months. The Company does not intend to sell these securities, and it is not more likely than not that the Company will be required to sell these securities prior to the recovery of their amortized cost basis, which may be at maturity. No other-than-temporary impairment charges were recorded during the three and nine months ended September 30, 2015 and 2014.

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



	As of September 30, 2015		As of December 31, 2014
Due within one year	$	29,531	$	29,619
Due after one year through five years	42,991		43,430
Total	$	72,522	$	73,049

The following table summarizes the proceeds from the maturities of available-for-sale securities, in thousands:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Maturities of marketable securities	$	7,695	$	6,915	$	24,180	$	13,890
Total	$	7,695	$	6,915	$	24,180	$	13,890

The Company did not record any gross realized gains or gross realized losses in net income during the three and nine months ended September 30, 2015 and 2014. Additionally, there were no proceeds from sales of marketable securities prior to maturity during the three and nine months ended September 30, 2015 and 2014.

Table of Contents

6. Fair Value Measurements

The following tables summarize certain information for assets and liabilities measured at fair value on a recurring basis, in thousands:



	Fair Value Measurements as of September 30, 2015 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)
Assets:
Cash and cash equivalents:
Cash	$	74,315	$	74,315	$	—	$	—
Money market funds	22,898		22,898		—		—
Marketable securities:
Tax-exempt municipal securities	66,163		—		66,163		—
Corporate debt securities	6,359		—		6,359		—
Total assets at fair value on a recurring basis	$	169,735	$	97,213	$	72,522	$	—



	Fair Value Measurements as of December 31, 2014 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)
Assets:
Cash and cash equivalents:
Cash	$	64,004	$	64,004	$	—	$	—
Money market funds	29,999		29,999		—		—
Marketable securities:
Tax-exempt municipal securities	65,668		—		65,668		—
Corporate debt securities	7,381		—		7,381		—
Total assets at fair value on a recurring basis	$	167,052	$	94,003	$	73,049	$	—

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 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 three and nine months ended September 30, 2015 and 2014.

The Company did not have any liabilities requiring fair value measurement as of September 30, 2015.

Level 3 Measurements

RDI Contingent Consideration

In connection with the acquisition of RDI, the Company was required to make an additional payment to the former shareholders of RDI when RDI was awarded Taught Degree Awarding Powers (TDAP) by the British government.

On April 14, 2014, RDI received notice from the British government that it had successfully been awarded TDAP. TDAP enables RDI to independently validate its own degrees under the auspices of the Quality Assurance Agency, a government body that reviews the standards and quality of all UK universities. Pursuant to the terms of the acquisition agreement in 2011, the Company made an additional payment of £4.0 million (approximately $6.9 million) to the former shareholders of RDI on May 12, 2014.

Prior to payment, the contingent consideration was classified as a liability under ASC 805, Business Combinations (ASC 805), which required the Company to re-measure the liability at fair value at each reporting date until it was extinguished. The

Table of Contents

Company classified the RDI contingent consideration liability within Level 3 of the fair value measurement hierarchy as its fair value was determined using inputs not readily observable in the market.

The following table presents a reconciliation of the fair value of the RDI contingent consideration, in thousands:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Balance, beginning of period	$	—	$	—	$	—	$	6,304
Increase in RDI contingent consideration liability	—		—		—		547
Payment of RDI contingent consideration liability	—		—		—		(6,851		)
Balance, end of period	$	—	$	—	$	—	$	—

The change in the fair value of the RDI contingent consideration liability was recorded in other expense, net in the consolidated statements of income during the nine months ended September 30, 2014.

7. Accrued Liabilities

Accrued liabilities consist of the following, in thousands:



	As of September 30, 2015		As of December 31, 2014
Accrued compensation and benefits	$	8,962	$	7,482
Accrued instructional	5,015		4,361
Accrued vacation	1,997		1,234
Accrued invoices	10,590		8,238
Other⁽¹⁾	3,269		2,095
Total	$	29,833	$	23,410

(1) "Other" consists primarily of the current portion of deferred rent, customer deposits, and other miscellaneous accruals.

8. Commitments and Contingencies

Operating Leases

The Company leases its office facilities and certain office equipment under various noncancelable operating leases. Effective August 29, 2011, the Company entered into an amendment of its 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 October 31, 2018. Renewal terms under this lease allow the Company to extend the lease for up to two additional five-year terms.

On April 3, 2014, the Company accepted notice to activate an amendment to this lease. Pursuant to the amendment, in June 2014, the Company returned 54,940 square feet of its previously leased space of 426,165 square feet. Employees located in this area were relocated to other areas within the Company's remaining space. The Company recorded a charge of approximately $2.6 million during the nine months ended September 30, 2014 in connection with this amendment, which is included within the lease amendment charge line item of the consolidated statements of income.

The Company also consolidated certain of its other leased office space resulting in an additional charge of $0.1 million during the nine months ended September 30, 2014. This amount is included within the lease amendment charge line item of the consolidated statements of income.

The following presents the Company's future minimum lease commitments as of September 30, 2015, in thousands:

Table of Contents



2015	$	1,570
2016	6,165
2017	5,943
2018	4,876
2019	—
2020 and thereafter	—
Total	$	18,554

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 of rent expense 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, within the accrued liabilities balance, or as part of 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 expires on September 30, 2016, and the Company intends to renew the agreement prior to its currently scheduled expiration date.

Borrowings under the Credit Agreement bear interest at a rate equal to the London Interbank Offered Rate (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. The Company recorded commitment fee expenses of $0.1 million and $0.2 million in other income (expense), net, for the three months ended September 30, 2015 and 2014, and the nine months ended September 30, 2015 and 2014, respectively. Outstanding letters of credit are also charged a fee, based on the Company’s consolidated leverage ratio. The Company capitalized approximately $0.5 million of debt issuance costs related to the credit facility, which are being amortized on a straight-line basis over a period of five years. The remaining unamortized portion of debt issuance costs are not significant. Interest expense for the amortization of debt issuance costs is recorded in other expense, net.

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, 2015, there were no borrowings under the credit facility, and the Company was in compliance with all debt covenants.

Litigation

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 there are any significant matters as of September 30, 2015 that are probable or estimable, for which the outcome could have a material adverse impact on its consolidated financial position or results of operations.

9. Share Repurchase Program and Dividends

Share Repurchase Program

The Company announced its current share repurchase program in July 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 share repurchase activity from the program's commencement through September 30, 2015, all of which was part of its publicly announced program, is presented below, in thousands:

Table of Contents



Board authorizations:
July 2008	$	60,000
August 2010	60,662
February 2011	65,000
December 2011	50,000
August 2013	50,000
Total amount authorized	285,662
Total value of shares repurchased	272,117
Residual authorization	$	13,545

The following table summarizes shares repurchased, in thousands:



	Nine Months Ended September 30,
	2015		2014
Shares repurchased	330		237
Total consideration, excluding commissions	$	18,487	$	14,263

As of September 30, 2015, the Company had purchased an aggregate of 6.0 million shares under the program’s outstanding authorizations at an average price per share of $45.55 totaling $272.1 million, excluding commissions.

Dividends

During the nine months ended September 30, 2015, the Company declared the following cash dividends, in thousands except per share amounts:



Declaration Date	Record Date	Payment Date	Dividend per Share		Total Dividend Amount
February 19, 2015	March 12, 2015	April 15, 2015	$	0.37	$	4,580
May 5, 2015	June 3, 2015	July 15, 2015	$	0.37	$	4,561
August 6, 2015	August 26, 2015	October 15, 2015	$	0.37	$	4,500

During the three months ended September 30, 2015, the dividend of $0.37 per outstanding share of common stock declared on August 6, 2015 was recorded as a reduction to retained earnings. Of the total dividend amount declared in the current quarter, $4.5 million is attributable to shares of common stock outstanding as of the record date and restricted stock units (RSUs) expected to vest in the next twelve months. This amount, along with the portion of dividends declared in prior quarters related to unvested RSUs, is included within dividends payable in the Company's consolidated balance sheet as of September 30, 2015. The remaining balance is attributable to dividends declared on restricted stock units expected to vest subsequent to the next twelve months and is classified as other liabilities in the Company's consolidated balance sheet as of September 30, 2015. Dividends declared on RSUs are forfeitable prior to vesting. All future dividends are subject to declaration by the Company's Board of Directors and may be adjusted due to future business needs or other factors deemed relevant by the Board of Directors.

10. Share-Based Compensation

The table below reflects the Company’s share-based compensation expense recognized in the consolidated statements of income, in thousands:

Table of Contents



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Instructional costs and services	$	199	$	238	$	626	$	546
Marketing and promotional	154		102		423		149
Admissions advisory	11		14		29		44
General and administrative	1,207		815		4,387		3,188
Share-based compensation expense included in operating income	1,571		1,169		5,465		3,927
Tax benefit from share-based compensation expense	586		431		2,038		1,270
Share-based compensation expense, net of tax	$	985	$	738	$	3,427	$	2,657

11. Other Investments

At September 30, 2015, the Company held a $1.9 million investment in a limited partnership, with a commitment to invest up to an additional $2.8 million through February 2024. During the nine months ended September 30, 2015, the Company made investments totaling $470 thousand in the partnership. The partnership invests in innovative companies in the health care field. The Company's investment comprises less than 3.0% of the total partnership interest; accordingly, the Company designated the investment as a cost method investment and classified it within other assets in the consolidated balance sheets as of September 30, 2015 and December 31, 2014.

12. Accumulated Other Comprehensive Loss

The following table summarizes the components of accumulated other comprehensive loss, in thousands:



	Foreign Currency Translation Loss			Unrealized Gain (Loss) on Marketable Securities			Accumulated Other Comprehensive Loss⁽¹⁾
Beginning balance, December 31, 2014	$	(311	)	$	(24	)	$	(335	)
Other comprehensive income	47			67			114
Ending balance, September 30, 2015	$	(264	)	$	43		$	(221	)


(1)	Accumulated other comprehensive loss is presented net of tax of $28 thousand and $14 thousand as of September 30, 2015 and December 31, 2014, respectively.

There were no reclassifications out of accumulated other comprehensive loss to net income for the three and nine months ended September 30, 2015 and 2014.

13. Regulatory Supervision and Oversight

Political and budgetary concerns can significantly affect the Title IV Programs. Congress reauthorizes the Higher Education Act (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, 2015, Title IV programs in which the University's learners participate are operative and sufficiently funded.

Table of Contents

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 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 of 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,” “predict,” “potential,” “continue,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” "confident," 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 which may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those suggested by 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, 2014, as updated in our subsequent reports filed with the SEC, including any updates or circumstances described in 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 other factors common to businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risks. Therefore, you should consider these risk factors with caution and form your own independent conclusions about the likely effect of these risks on our future performance. 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 such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review all the disclosures and 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. As of September 30, 2015, our wholly owned subsidiaries included the following:


•	Capella University (the University) is a regionally accredited university that offers a variety of undergraduate and graduate degree programs for working adult professionals.


•	Arden University, Ltd., formerly known as Resource Development International Limited (RDI), is an independent provider of United Kingdom (UK) university distance learning qualifications that markets, develops and delivers programs worldwide via its offices and partners across Asia, North America, Africa and Europe.


•	Sophia Learning, LLC (Sophia) is an innovative learning platform leveraging technology to support self-paced learning, including credits eligible for transfer to over 2,000 college and universities.


•	Capella Learning Solutions (CLS) provides online training solutions and services to corporate partners which are delivered through the Company's online learning platform.

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, optimizing our comprehensive marketing strategy, 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:

Table of Contents

•

Innovation. We operate in a very competitive market environment. While we have demonstrated that we can effectively compete and differentiate in our market, we will need to continue to innovate. Innovations will include leveraging our competency-based learning infrastructure to develop new academic models, such as Flexpath, and developing new business models to drive long-term results.We will need to balance investments that may put pressure on near-term operating income performance with our goal to achieve operating performance improvements and deliver short and long-term shareholder value.

•

Enrollment and persistence. New enrollment and learner persistence improvements are key drivers for total enrollment and revenue growth as well as the Company’s operating performance. New enrollment is an early indicator of future growth, and early cohort persistence is an indicator of the sustainability of growth. These metrics should be viewed over multiple quarters since quarterly volatility is common.

In the third quarter of 2015, new enrollment grew by 2.3 percent compared to 11.9 percent in the same period in 2014. New enrollment is calculated from the last day a new learner can drop a course without financial penalty. Compared to the same period in the prior year, early cohort persistence improved by approximately three percent in the third quarter of 2015. Early cohort persistence measures the four-quarter weighted moving average new cohort persistence rate during a learner's first four quarters of enrollment.

New enrollment growth characteristics tend to differ by degree program due to different market dynamics. In the third quarter of 2015, overall new enrollment growth was led by our master’s programs, partially offset by new enrollment declines in our bachelor's and doctoral programs.

In the third quarter of 2015, total enrollment grew by 4.2 percent compared to 2.1 percent in the same period in 2014. Total enrollment growth was primarily driven by strong growth in our master's programs and growth in our bachelor's programs, partially offset by total enrollment declines in our doctoral programs.

•

Doctoral enrollment. During the third quarter of 2015, year-over-year doctoral total enrollment declined by 4.2 percent. It will take time for our doctoral programs to return to enrollment growth due to a combination of factors, including the extended decision cycles for prospects at the doctoral level, stronger doctoral graduations, as well as our continued learner success efforts at the doctoral level. Our doctoral offerings are comprised of professional doctorate programs and PhD programs. Enrollment in our professional doctorate programs has increased. At the same time, PhD enrollment, which represents the largest component of our doctoral offerings, has been declining. The primary difference between PhD and professional doctorate programs is the intent and deliverable of the independent research phase. Compared to a PhD, professional doctorate programs can sometimes offer a more affordable and direct path to the educational goals of certain professionals.

As part of our doctoral learner success initiative, we are focusing on learners that are not making sufficient and timely academic progress in the comprehensive and dissertation phase of their programs. In our doctoral offering, market demand for professional doctorate programs is currently stronger than for PhD programs. We are supporting the return to doctoral growth by focusing on redesigning our program offerings, improving affordability, and expanding our doctoral portfolio, including creating new professional doctorate programs. The doctoral learner success initiatives and the continued pressure on doctoral enrollment growth are expected to negatively impact our operating performance, especially in the near-term.

•

Learner success. As we continue to position Capella to drive sustainable growth, we are focused on improving learner success rates particularly in the first four quarters of enrollment while maintaining a high standard of academic quality and rigor. The first four quarters of enrollment are particularly critical because learners tend to persist at a very high rate after that period. In the third quarter of 2015, we achieved a three percent improvement in early cohort persistence over the prior year. Going forward, we will increasingly focus on the entire learner lifecycle. Certain initiatives to improve learner success can affect our growth and profitability in the near-term. However, we believe these efforts are in the best interest of our learners and over the long-term will enhance Capella’s brand and reputation, which, in turn, positions us for more sustainable long-term growth. Learner success initiatives include the following:


•	Investing in our actionable analytics capabilities to further leverage data, refine our models, and accurately predict the likelihood of prospective, new, and current learners persisting to critical thresholds of success;


•	Providing timely and clear information to our learners, faculty, advisors and staff to help learners persist and successfully complete their programs;

Table of Contents


•	Redesigning programs to remove barriers for learner progression and to deliver operational process efficiencies;


•	Piloting, implementing, and optimizing programs such as assessments and orientations to create personalized pathways for different learner groups which focus on transitioning learners into the online environment, creating a supportive community, and providing a proactive support structure;


•	Optimizing our marketing approaches to increase emphasis on attracting learners who are more likely to persist in our programs;


•	Promoting affordability and encouraging learners to persist by offering learner success grants to new learners who meet admissions requirements, enroll, apply within certain timeframes, and stay continuously enrolled; and,


•	Diversifying outside of Capella University by creating innovative new learning technologies which have potential to increase affordability and better serve the life-long learning needs of working adult professionals and therefore increase learner success.

•

Comprehensive marketing strategy. During 2014 and continuing into 2015, we made significant strides in shifting from a demand driven strategy towards a comprehensive marketing strategy which is focused on building relationships with prospective learners early in their decision cycle. This strategy is also designed to attract prospective learners that are committed to and able to succeed in their academic endeavors. The marketing strategy includes:


•	Introducing prospective learners to Capella with a differentiated message in channels such as mass media and strategic relationships with employers and professional organizations,


•	Connecting with prospective learners by generating and nurturing inquiries through direct media such as natural search, our website, and display media, and


•	Engaging with prospective learners by developing meaningful relationships such as through social media or direct engagement.

Our comprehensive marketing strategy is designed to produce long-term efficiencies and increase our ability to attract high-quality learners on a sustainable basis. We will continue to optimize our strategy and develop our marketing analytics capabilities to continue to deliver long-term sustainable growth. Some of our initiatives may adversely impact our new enrollment, revenues, and operating margins for a period as we pursue improved long-term results. However, our return to annual total enrollment growth gives us confidence that we have the right strategy in place.

•

Establishing new growth platforms. We seek to drive long-term growth that is an extension of our core competencies into new and expanded markets. One of our key growth platforms is FlexPath. In 2013, we received approval to offer a new learning model called FlexPath for two programs. In 2014, we received approval for four additional programs, and in September 2015, we received Higher Learning Commission approval to begin offering the Registered Nurse-to-Bachelor of Science in Nursing (RN-to-BSN) specialization in the FlexPath model. We are awaiting Department of Education approval for the RN-to-BSN specialization for Title IV eligibility.

We continue to test and refine the academic model and have started our work on developing a sustainable business model for FlexPath. FlexPath is a new learning model that decouples from the credit-hour requirements and allows learners to complete coursework at their own pace and complete activities to demonstrate specific competencies by the end of the learner’s 12-week subscription period. Capella University was the first institution with approval from the Higher Learning Commission and the Department of Education to offer and provide Title IV funding for programs at the Bachelor's and graduate level. Only a few other universities received approvals by their accreditor and the Department of Education to offer similar programs. These approvals allow learners enrolled in FlexPath to apply for federal financial aid. We believe this direct assessment model provides an opportunity to expand our served market and drive affordability through lower tuition costs, reduced time to completion, and increased flexibility. We are making steady progress in developing FlexPath programs, but important work remains. Our goal is to ensure learners have the right experience and that we understand what our learners need to succeed.


•	Redesign of programs and specializations. We continue to evaluate our existing offerings for opportunities to drive affordability and speed to competency, enhance learner success, meet employer needs, maintain programmatic approvals and fulfill evolving regulatory standards. Utilizing our competency based curriculum mapping, we are

Table of Contents

focused on maximizing efficiencies in our existing programs while delivering even better learning and career outcomes.

•

Arden University performance. In July 2011, we acquired RDI, and in August 2015, RDI received confirmation that it met the criteria for university title in the United Kingdom (UK) and could begin operating as Arden University. Arden University is an independent provider of UK university distance learning qualifications that markets, develops and delivers programs worldwide via its offices and partners across Asia, North America, Africa and Europe while serving the fast-growing online international higher education market. Arden University expects to begin developing UK degrees later in 2015. Although the acquisition has had a positive impact on our revenue growth, Arden University has been dilutive to our earnings since the acquisition date and is expected to be dilutive to our earnings throughout the remainder of 2015. If this trend continues and operating improvements are not realized, some or all of the goodwill associated with the Arden University reporting unit could become impaired in the future. We believe the fair value of the Arden University reporting unit remains in excess of the carrying value as of September 30, 2015. Management will assess goodwill for impairment in the fourth quarter of 2015.

Regulatory Environment

The following summarizes significant regulatory matters applicable to our business. For a more detailed discussion of the regulatory environment and related risks, refer to Part 2, Item 7, Key Trends, Developments and Challenges, and Regulatory Environment in our 2014 Annual Report on Form 10-K.

•

U.S. Legislation and Congressional Activity. In recent years, there has been increased focus by members of the U.S. Congress on the role that proprietary educational institutions play in higher education. Congressional hearings and roundtable discussions have been held, and more are expected to be held in the future, regarding various aspects of the education industry including federal financial aid and military education funding that may result in regulatory changes that affect our business.

We cannot predict what legislation, if any, may emanate from Congressional committee hearings or what impact such legislation might have on proprietary institutions and our business in particular. Congressional scrutiny of proprietary institutions increases the likelihood of legislation that will adversely impact our business. In addition, when Congress addresses federal budget deficits, financial aid programs are a potential target for reduction.

If Congress reduced the amount of available Title IV program funding, we would attempt to arrange for alternative sources of financial aid for our students, but private sources would not be able to provide as much funding to our students or on terms comparable to Title IV. In addition, private funding sources could require us to guarantee all or part of this assistance and we might incur other additional costs. For these reasons, private, alternative sources of student financial aid would only partly offset, if at all, the impact on our business of reduced Title IV program funding, and would not be a practical alternative in the case of a significant reduction in Title IV financial aid.

•

College Rating System. On December 19, 2014, the U.S. Department of Education released a draft of a College Ratings Framework which was intended to serve as a discussion document on the best way to measure access, affordability and outcomes. The Department requested feedback by February 17, 2015 with the expressed goal of having a rating system in place by the end of 2015. On June 25, 2015, the Department of Education announced that it no longer intended to introduce a college ratings system and instead would create a consumer-facing tool for students and families, which was released on September 12, 2015 as an update to the College Scorecard. We support the Department of Education in its efforts to increase transparency. It will remain challenging for consumers to make comparisons given the incomplete data sets and methodologies used to determine the metrics for each institution and also given the significant differences in learner populations across institutions.

•

Gainful Employment. The Department of Education published a final rule on October 30, 2014 that went into effect on July 1, 2015. Litigation surrounding this rule has been unsuccessful thus far as the U.S. District Court for the District of Colombia found in favor of the Department of Education on June 23, 2015. The plaintiff announced on July 2, 2015 that it would appeal the District Court decision and filed its appellate brief with the United States Court of Appeals for the District of Columbia Circuit on September 29, 2015. Oral argument for the appeal is scheduled for January 22, 2016. The final rule applies to all Gainful Employment (GE) programs, which include non-degree programs at public and private non-profit institutions, and all programs offered by for-profit institutions. The rule establishes a “debt-to-earnings” ratio that GE programs must satisfy over the course of annual measurement periods to remain eligible for Title IV federal student aid. In August 2015, the Department of Education released debt-related data for each program, which will be used in the initial debt-to-earnings calculation to be performed late

Table of Contents

r in 2016. We do not know which of our programs, if any, will be impacted by the debt-to-earnings ratio requirements and will not know until we receive earnings data from the Department of Education, which we expect in mid-2016. We have taken and continue to take steps to avoid or mitigate potential adverse consequences, but it remains possible that one or more of our programs could be determined to be in the “zone” or “fail” the initial or future calculations, as those terms are defined in the rule. The final rule also requires institutions to provide certifications regarding a GE program’s satisfaction of programmatic accreditation and state licensure requirements as part of the institutional program participation agreements with the Department of Education. The certification requirements are scheduled to become effective December 31, 2015 in connection with the Department of Education's program participation agreement recertification; however, new programs introduced prior to December 31, 2015 must be certified to establish eligibility for Title IV federal financial aid. We are working with the Department to clarify various issues related to the new certification requirements. The final rule also includes requirements for the reporting of student and program data by institutions to the Department of Education and expands the disclosure requirements that have been in effect since July 1, 2011. The rule makes other conforming and technical revisions to the Title IV program participation agreement and related regulations. Refer to the more detailed discussion of recent rulemaking and regulatory activity pertaining to the area of Gainful Employment within the Regulatory Environment section of our 2014 Annual Report on Form 10-K.

•

Program Integrity and Improvement. On November 20, 2013, the Department of Education announced another round of negotiated rulemaking to focus on the following issues: cash management of funds provided under the Title IV Federal Student Aid programs, including the use of debit cards and the handling of Title IV credit balances; state authorization for programs offered through distance education or correspondence education; state authorization for foreign locations of institutions located in a State; clock to credit hour conversion; definition of “adverse credit” for borrowers in the Federal Direct PLUS Loan Program; and application of the repeat coursework provisions to graduate and undergraduate programs. Negotiations took place in February, March, and April, 2014. An additional session took place in May, 2014 to examine the remaining issues and take a consensus vote on the entire rule making package. The Committee did not reach consensus at this session, and the development of the draft rule shifted back to the Department of Education.

•

Current negotiated rulemaking. On August 8, 2014, the Department of Education published a Notice of Proposed Rulemaking ("NPRM") on the definition of “adverse credit” for borrowers in the Federal Direct PLUS Loan Program. The NPRM reflects agreed upon language established by the negotiated rulemaking committee. The public comment period ended on September 8, 2014, and a final rule was published on October 23, 2014 establishing an effective date of July 1, 2015. On May 18, 2015, the Department of Education published a NPRM on cash management, clock-to-credit-hour conversion, and repeat coursework. The public comment period ended on July 2, 2015, and final rules have not yet been published as of September 30, 2015. On December 19, 2014, the Department of Education announced its intention to establish a negotiated rulemaking committee to: (1) develop regulations to establish a new Pay as You Earn ("PAYE") repayment plan for those not covered by the existing Pay as You Earn Repayment Plan in the Federal Direct Loan Program; and (2) set forth procedures for Federal Family Education Loan (FFEL) Program loan holders to use in identifying U.S. military servicemembers who may be eligible to receive a lower interest rate on their FFEL Program loans. The committee met in February, March and April of 2015 and reached consensus on all issues. On July 9, 2015, the Department issued an NPRM on the PAYE issue which expands the set of criteria that enables borrowers to qualify for the program. Public comments were due August 10, 2015. No other NPRM's have been issued.

•

State Authorization Reciprocity Agreement (SARA). SARA is a nationwide state regulatory initiative intended to make distance education courses more accessible to students across state lines and make it easier for states to regulate and institutions to participate in interstate distance education. On January 27, 2015, Minnesota became the 19^th state to join SARA, and on March 6, 2015, Capella University was approved as an institutional participant in SARA.

•

Student Loan Cohort Default Rates. To remain eligible to participate in Title IV programs, an educational institution's student loan cohort default rates must remain below certain specified levels. Under current regulations, if an institution's three-year cohort default rate exceeds 30% for three consecutive years or 40% for any given year, it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate. Capella University's three-year cohort default rates for the 2012 and 2011 cohorts are 8.9% and 13.0%, respectively. The average cohort default rates for proprietary institutions nationally were 15.8% and 19.1% in fiscal years 2012 and 2011 respectively.

Table of Contents

•

Higher Learning Commission. The Higher Learning Commission, Capella University’s accrediting body, is developing new standards and an approval process under which it evaluates new competency-based education and direct assessment programs such as FlexPath. In 2015, we received approval to begin offering the RN-to-BSN degree pathway program under the FlexPath model from the Higher Learning Commission. Accreditors, including the Higher Learning Commission, are developing a robust evaluative framework and high standards, which we believe is foundational to realize the underlying potential of direct assessment programs.

Critical Accounting Policies and Use of Estimates

Our critical accounting policies are disclosed in our 2014 Annual Report on Form 10-K. During the nine months ended September 30, 2015, there have been no significant changes to our critical accounting policies.

Results of Operations

Three Months Ended September 30, 2015 Compared to Three Months Ended September 30, 2014

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, 2015:



	Three Months Ended September 30,
	(Unaudited)						$ Change			% Change		% of Revenue
$ in thousands	2015			2014			2015 vs. 2014					2015		2014		2015 vs. 2014
Revenues	$	103,711		$	103,097		$	614		0.6	%	100.0	%	100.0	%	0.0	%
Costs and expenses:
Instructional costs and services	48,221			47,143			1,078			2.3		46.5		45.7		0.8
Marketing and promotional	25,860			25,509			351			1.4		24.9		24.7		0.2
Admissions advisory	7,390			7,019			371			5.3		7.1		6.8		0.3
General and administrative	8,772			10,250			(1,478		)	(14.4	)	8.5		9.9		(1.4	)
Total costs and expenses	90,243			89,921			322			0.4		87.0		87.2		(0.2	)
Operating income	13,468			13,176			292			2.2		13.0		12.8		0.2
Other income (expense), net	24			(46		)	70			(152.2	)	—		(0.1	)	0.1
Income before income taxes	13,492			13,130			362			2.8		13.0		12.7		0.3
Income tax expense	5,320			5,373			(53		)	(1.0	)	5.1		5.2		(0.1	)
Effective tax rate	39.4		%	40.9		%
Net income	$	8,172		$	7,757		$	415		5.4	%	7.9	%	7.5	%	0.4	%

Revenues. The increase in revenues compared to the same quarter in the prior year was primarily related to Capella University total enrollment growth of 4.2 percent in 2015, weighted average tuition price increases of less than two percent, which were implemented in July 2015, and an overall increase in average courses per learner. These increases were partially offset by a larger proportion of undergraduate learners who generate less revenue per learner than our Doctoral learners, the timing of new enrollment starts, an increase in discounts and grants to support our initiatives to improve learner success and drive persistence, and a decrease in non-Capella University revenues.

Instructional costs and services expenses. Instructional costs and services expenses, and instructional costs and services expenses as a percent of revenue, increased compared to the same quarter in the prior year primarily due to higher bookstore fees, increased staffing levels to support our initiatives to improve learner success and drive total enrollment growth, and an increase in bad debt expense. This overall increase was partially offset by a decrease in non-Capella University expenses.

Marketing and promotional expenses. Marketing and promotional expenses, and marketing and promotional expenses as a percent of revenue, increased compared to the same quarter in the prior year primarily driven by additional employee expenses as a result of increased staffing levels to support new initiatives and products and increased market research expenses related to market development.

Admissions advisory expenses. Admissions advisory expenses, and admission advisory expenses as a percent of revenue, increased compared to the same quarter in the prior year primarily due to increased enrollment services and admissions staffing to support higher Capella University inquiry volume and enrollment growth.

General and administrative expenses. General and administrative expenses, and general and administrative expenses as a percent of revenue, decreased compared to the same quarter in the prior year primarily due to decreased incentive

Table of Contents

compensation expense, lower non-Capella University expenses, and a reduction in employee expenses driven by lower staffing levels. This overall decrease was partially offset by higher share-based compensation expense.

Other income (expense), net. Other income (expense), net was $24 thousand of income for the three months ended September 30, 2015, and $46 thousand of expense for the three months ended September 30, 2014. This change is primarily related to foreign currency fluctuations as well as an increase in interest income earned on marketable securities.

Income tax expense. The decrease in our effective tax rate compared to the same quarter in the prior year was primarily driven by a decrease in foreign operating losses in the current period. We do not receive a benefit on these losses due to the establishment of a full valuation allowance.

Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014

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, 2015:



	Nine Months Ended September 30,
	(Unaudited)						$ Change			% Change		% of Revenue
$ in thousands	2015			2014			2015 vs. 2014					2015		2014		2015 vs. 2014
Revenues	$	320,792		$	313,525		$	7,267		2.3	%	100.0	%	100.0	%	0.0	%
Costs and expenses:
Instructional costs and services	142,651			139,973			2,678			1.9		44.5		44.6		(0.1	)
Marketing and promotional	79,158			74,383			4,775			6.4		24.7		23.7		1.0
Admissions advisory	21,947			21,092			855			4.1		6.8		6.7		0.1
General and administrative	29,673			31,604			(1,931		)	(6.1	)	9.2		10.1		(0.9	)
Lease amendment charges	—			2,690			(2,690		)	(100.0	)	—		0.9		(0.9	)
Total costs and expenses	273,429			269,742			3,687			1.4		85.2		86.0		(0.8	)
Operating income	47,363			43,783			3,580			8.2		14.8		14.0		0.8
Other expense, net	(68		)	(559		)	491			(87.8	)	(0.1	)	(0.2	)	0.1
Income before income taxes	47,295			43,224			4,071			9.4		14.7		13.8		0.9
Income tax expense	18,755			17,606			1,149			6.5		5.8		5.6		0.2
Effective tax rate	39.7		%	40.7		%
Net income	$	28,540		$	25,618		$	2,922		11.4	%	8.9	%	8.2	%	0.7	%

Revenues. The increase in revenues compared to the same period in the prior year was primarily related to Capella University quarterly average total enrollment growth of 4.4 percent in 2015, weighted average tuition price increases of approximately two percent, and an overall increase in average courses per learner. These increases were partially offset by a larger proportion of undergraduate learners who generate less revenue per learner than our Doctoral learners, an increase in discounts and grants to support our initiatives to improve learner success and drive persistence, and a decrease in non-Capella University revenues.

Instructional costs and services expenses. Instructional costs and services expenses increased compared to the same period in the prior year primarily due to higher bookstore fees and increased staffing levels to support our initiatives to improve learner success and drive total enrollment growth. As a percent of revenue, instructional costs and services expenses decreased as a result of lower non-Capella University expenses, reduced rent expense due to the lease amendment that occurred in the prior year, and a decrease in bad debt expense.

Marketing and promotional expenses. Marketing and promotional expenses, and marketing and promotional expenses as a percent of revenue, increased compared to the same period of the prior year primarily driven by increased investments in our marketing campaigns and advertising initiatives, as well as additional employee expenses as a result of increased staffing levels to support new marketing initiatives.

Admissions advisory expenses. Admissions advisory expenses, and admissions advisory expenses as a percent of revenue, increased compared to the same period in the prior year primarily due to increased enrollment services and admissions staffing to support higher Capella University inquiry volume and enrollment growth.

General and administrative expenses. General and administrative expenses, and general and administrative expenses as a percent of revenue, decreased compared to the same period in the prior year primarily as a result of decreased incentive

Table of Contents

compensation expense, a reduction in employee expenses driven by lower staffing levels, as well as reduced expenses related to monitoring and shaping government regulations. This overall decrease was partially offset by higher share-based compensation expense.

Lease amendment charges. On April 9, 2014, we accepted notice to activate a lease amendment to our current lease for our premises at 225 South Sixth Street in Minneapolis, Minnesota. During the period ended September 30, 2014, we recorded a one-time charge of $2.6 million in connection with this amendment, and also consolidated other leased office space resulting in an additional charge of $0.1 million.

Other expense, net. Other expense, net was $68 thousand and $559 thousand for the nine months ended September 30, 2015 and September 30, 2014, respectively. The decrease compared to the same period in the prior year is primarily attributable to the impact of the change in fair value of the RDI contingent consideration liability in the prior year, which was paid in 2014.

Income tax expense. Income tax expense increased compared to the same period in the prior year, while the effective tax rate decreased over the same period. The decrease in the effective tax rate was primarily driven by a decrease in foreign operating losses in the current period. We do not receive a benefit on these losses due to the establishment of a full valuation allowance.

Liquidity and Capital Resources

Liquidity

We financed our operating activities and capital expenditures during the nine months ended September 30, 2015 and 2014 primarily through cash provided by operating activities. Our cash and cash equivalents were $97.2 million and $94.0 million at September 30, 2015 and December 31, 2014, respectively. Our cash and cash equivalents increased primarily due to cash provided by operating activities, which was partially offset by share repurchases, capital expenditures, and payments of cash dividends.

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 term ends September 30, 2016, and the Company intends to renew the agreement prior to its currently scheduled expiration date. As of September 30, 2015, there were no borrowings under the credit facility, and we were in compliance with all debt covenants.

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.

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 to fund our operations or to fund strategic investments, if needed.

Operating Activities

Net cash provided by operating activities was $51.7 million and $47.5 million for the nine months ended September 30, 2015 and 2014, respectively. The increase was primarily due to an increase in net income and share-based compensation expense, as well as the effects of changes in operating assets and liabilities, including an increase in accounts payable and accrued liabilities due to the timing of payroll and the general timing of vendor invoices. The overall increase was partially offset by decreases in income taxes payable and increases in prepaid expenses and other current assets.

Investing Activities

Net cash used in investing activities is primarily related to investments in property and equipment and the purchase of investments in marketable securities, net of maturities. Net cash used in investing activities was $18.0 million and $52.3 million for the nine months ended September 30, 2015 and 2014, respectively.

Table of Contents

Cash used in investing activities for the nine months ended September 30, 2015 consisted primarily of investments in property and equipment, as well as purchases of marketable securities, which were offset by maturities of marketable securities. Net purchases and maturities of marketable securities resulted in cash outflows of $1.1 million and $35.1 million during the nine months ended September 30, 2015 and September 30, 2014, respectively.

We believe the credit quality and liquidity of our investment portfolio as of September 30, 2015 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 $16.5 million and $15.8 million for the nine months ended September 30, 2015 and 2014, respectively, which primarily consisted of investments in foundational infrastructure, the development and refinement of courses, and marketing infrastructure to enhance efficiencies and analytics capabilities.

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 $30.4 million and $28.8 million for the nine months ended September 30, 2015 and 2014, respectively. Cash payments of dividends were $13.6 million and $13.0 million for the nine months ended September 30, 2015 and September 30, 2014, respectively. Additionally, in the first nine months of 2015, we repurchased $18.5 million of common stock under our share repurchase program compared to $14.0 million in the first nine months of 2014. As a result of the achievement of TDAP, we made an additional payment of £4.0 million (approximately $6.9 million) to the former shareholders of RDI on May 12, 2014. For the nine months ended September 30, 2014, net cash used in financing activities of approximately $6.0 million reflects the initial fair value of the RDI contingent consideration liability recorded at acquisition, while the remaining amount of $0.9 million included within cash flows from operating activities represents the accumulated change in fair value of the RDI contingent consideration liability.

Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk

The Company has no derivative financial instruments or derivative commodity instruments, and believes 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 the Company's cash equivalents and marketable securities were rated A- or higher as of September 30, 2015 and December 31, 2014, by at least one rating agency. In addition, the Company utilizes 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 its cash, cash equivalents and marketable securities. Despite the investment risk mitigation strategies the Company employs, we may incur investment losses as a result of unusual and unpredictable market developments and 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 the Company's investment portfolio.

Interest Rate Risk

The Company manages 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. The Company's future investment income may fall short of expectations due to changes in interest rates or it may suffer losses in principal if it is forced to sell securities that have declined in market value due to changes in interest rates. At September 30, 2015, a 10% increase or decrease in interest rates would not have a material impact on the Company's future earnings, fair values, or cash flows.

Foreign Currency Exchange Risk

The Company uses the U.S. dollar as its reporting currency. The functional currencies of its foreign subsidiaries are generally the local currencies. Accordingly, the Company's 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 effect at the balance sheet dates. These translation adjustments are recorded in accumulated other comprehensive income;


•	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 and are not denominated in the functional currencies of the respective entities, as well as gains and losses from foreign currency transactions. These items are recorded in other expense, net in the consolidated statements of income.

The Company has not used derivative contracts to hedge foreign currency exchange rate fluctuations.

Table of Contents

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of its management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of its 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, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective, as of September 30, 2015, in ensuring that material information required to be disclosed by the Company in reports that it files or submits 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 the Company's 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, the Company's internal control over financial reporting.

Table of Contents

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company is a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of 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 the Company's 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 the Company's Form 10-K for the year ended December 31, 2014.

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, 2015, the Company repurchased $7.5 million of common stock under its share repurchase program.⁽¹⁾Its remaining authorization for common stock repurchases was $13.5 million at September 30, 2015. The following presents the Company's share repurchases during the quarter ended September 30, 2015:



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
7/1/2015 to 7/31/2015	68,154	$	53.41	68,154	$	17,404,805
8/1/2015 to 8/31/2015	65,184	49.69		65,184	14,166,057
9/1/2015 to 9/30/2015	12,844	48.38		12,844	13,544,656
Total	146,182	51.31		146,182	13,544,656

(1)

The Company announced its current share repurchase program in July 2008. As of September 30, 2015, the Company's Board of Directors has authorized repurchases up to an aggregate amount of $285.7 million in value of common stock under the current program. The Board of Directors authorizes the Company to repurchase outstanding shares of common stock, from time to time, depending on market conditions and other considerations. There is no expiration date on the repurchase authorizations, and repurchases occur at the Company's discretion.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Table of Contents

Item 6. Exhibits

(a) Exhibits



Number	Description	Method of Filing

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 20, 2006.

3.2	Second Amended and Restated By-Laws.	Incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K filed with the SEC on December 10, 2008.

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 20, 2006.

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⁾	Filed electronically.

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

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

EX-101.DEF	XBRL Taxonomy Extension Definition Linkbase Document⁽¹⁾	Filed electronically.

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

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

⁽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.

Table of Contents

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 27, 2015

J. Kevin Gilligan

Chief Executive Officer

(Principal Executive Officer)

/s/ Steven L. Polacek

October 27, 2015

Steven L. Polacek

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

Attached files

Stock widget

Investing forum

CAPELLA EDUCATION CO Reports