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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 June 30, 2008

or



| ̈ | 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.)

225 South Sixth Street, 9th Floor

Minneapolis, Minnesota 55402

(Address, including zip code, of
principal executive offices)

(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 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):



|                                                                       |  |                             
|---------------------------------------------------------------------- |  | ----------------------------
|                                                                       | 
|Large accelerated filer   ̈                                             |  | Accelerated filer  x        
|Non-accelerated filer   ̈ (Do not check if a smaller reporting company) |  | Smaller reporting company   ̈

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 July 28, 2008, was 16,649,922.









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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 |  | 10  
|Item 3 Quantitative and Qualitative Disclosures About Market Risk                            |  | 15  
|Item 4 Controls and Procedures                                                               |  | 16  
|                                                                                             | 
|PART II  OTHER INFORMATION                                                                  |  |     
|                                                                                             | 
|Item 1 Legal Proceedings                                                                     |  | 16  
|Item 1A Risk Factors                                                                         |  | 16  
|Item 2 Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 17  
|Item 3 Defaults Upon Senior Securities                                                       |  | 17  
|Item 4 Submission of Matters to a Vote of Security Holders                                   |  | 17  
|Item 5 Other Information                                                                     |  | 18  
|Item 6 Exhibits                                                                              |  | 18  
|SIGNATURES                                                                                   |  | 19  



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PART I  FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

CAPELLA EDUCATION COMPANY

Consolidated Balance Sheets

(In thousands, except par value)



|                                                                                               |  |                    |         |   |                        |   |         |  
|---------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ---------------------- | - | ------- | -
|                                                                                               |  | As of June 30,2008 |         |   | As of December 31,2007 |  
|                                                                                               |  | (Unaudited)        |         |   |                        |  
|ASSETS                                                                                         |  |                    |         |   |                        |   |         |  
|Current assets:                                                                                |  |                    |         |   |                        |   |         |  
|Cash and cash equivalents                                                                      |  | $                  | 8,342   |   |                        | $ | 60,600  |  
|Marketable securities                                                                          |  |                    | 98,932  |   |                        |   | 83,167  |  
|Accounts receivable, net of allowance of $2,011 at June 30, 2008 and $951 at December 31, 2007 |  |                    | 8,852   |   |                        |   | 7,557   |  
|Prepaid expenses and other current assets                                                      |  |                    | 7,469   |   |                        |   | 12,593  |  
|Deferred income taxes                                                                          |  |                    | 1,889   |   |                        |   | 1,896   |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total current assets                                                                           |  |                    | 125,484 |   |                        |   | 165,813 |  
|Property and equipment, net                                                                    |  |                    | 35,056  |   |                        |   | 34,462  |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total assets                                                                                   |  | $                  | 160,540 |   |                        | $ | 200,275 |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|                                                                                               |  |                   
|LIABILITIES AND SHAREHOLDERS EQUITY                                                           |  |                    |         |   |                        |   |         |  
|Current liabilities:                                                                           |  |                    |         |   |                        |   |         |  
|Accounts payable                                                                               |  | $                  | 4,764   |   |                        | $ | 6,089   |  
|Accrued liabilities                                                                            |  |                    | 18,072  |   |                        |   | 23,826  |  
|Deferred revenue                                                                               |  |                    | 7,875   |   |                        |   | 6,476   |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total current liabilities                                                                      |  |                    | 30,711  |   |                        |   | 36,391  |  
|Deferred rent                                                                                  |  |                    | 1,239   |   |                        |   | 1,167   |  
|Other liabilities                                                                              |  |                    | 335     |   |                        |   | 335     |  
|Deferred income taxes                                                                          |  |                    | 4,436   |   |                        |   | 5,508   |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total liabilities                                                                              |  |                    | 36,721  |   |                        |   | 43,401  |  
|Shareholders equity:                                                                          |  |                    |         |   |                        |   |         |  
|Common stock, $0.01 par value:                                                                 |  |                    |         |   |                        |   |         |  
|Authorized shares  100,000                                                                    |  |                    |         |   |                        |   |         |  
|Issued and outstanding shares  16,622 at June 30, 2008 and 17,363 at December 31, 2007        |  |                    | 166     |   |                        |   | 173     |  
|Additional paid-in capital                                                                     |  |                    | 152,540 |   |                        |   | 196,643 |  
|Accumulated other comprehensive income (loss)                                                  |  |                    | (596    | ) |                        |   | 195     |  
|Retained earnings (accumulated deficit)                                                        |  |                    | (28,291 | ) |                        |   | (40,137 | )
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total shareholders equity                                                                     |  |                    | 123,819 |   |                        |   | 156,874 |  
|                                                                                               |  |                    |         |   |                        |   |         |  
|Total liabilities and shareholders equity                                                     |  | $                  | 160,540 |   |                        | $ | 200,275 |  
|                                                                                               |  |                    |         |   |                        |   |         |  

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



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CAPELLA EDUCATION COMPANY

Consolidated Statements of Income

(In thousands, except per share amounts)



|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|----------------------------------------------------- |  | ---------------------------------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------- |  | - | -------
|                                                      |  | Three Months EndedJune 30,                           |        | Six Months EndedJune 30,
|                                                      |  | 2008                                                 |        | 2007                     |   | 2008   |  | 2007
|                                                      |  | (Unaudited) (In thousands, except per share amounts)
|Revenues                                              |  | $                                                    | 66,049 |                          | $ | 53,918 |  | $    | 131,300 |  | $ | 106,742
|Costs and expenses:                                   |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Instructional costs and services                      |  |                                                      | 30,844 |                          |   | 24,587 |  |      | 59,860  |  |   | 48,110 
|Marketing and promotional                             |  |                                                      | 19,573 |                          |   | 16,850 |  |      | 40,966  |  |   | 35,170 
|General and administrative                            |  |                                                      | 6,968  |                          |   | 6,518  |  |      | 14,698  |  |   | 12,499 
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Total costs and expenses                              |  |                                                      | 57,385 |                          |   | 47,955 |  |      | 115,524 |  |   | 95,779 
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Operating income                                      |  |                                                      | 8,664  |                          |   | 5,963  |  |      | 15,776  |  |   | 10,963 
|Other income, net                                     |  |                                                      | 1,008  |                          |   | 1,132  |  |      | 2,397   |  |   | 2,224  
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Income before income taxes                            |  |                                                      | 9,672  |                          |   | 7,095  |  |      | 18,173  |  |   | 13,187 
|Income tax expense                                    |  |                                                      | 3,314  |                          |   | 2,312  |  |      | 6,327   |  |   | 4,560  
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Net income                                            |  | $                                                    | 6,358  |                          | $ | 4,783  |  | $    | 11,846  |  | $ | 8,627  
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Net income per common share:                          |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Basic                                                 |  | $                                                    | 0.38   |                          | $ | 0.29   |  | $    | 0.70    |  | $ | 0.53   
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Diluted                                               |  | $                                                    | 0.37   |                          | $ | 0.28   |  | $    | 0.67    |  | $ | 0.51   
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Weighted average number of common shares outstanding: |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Basic                                                 |  |                                                      | 16,740 |                          |   | 16,401 |  |      | 17,028  |  |   | 16,209 
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        
|Diluted                                               |  |                                                      | 17,303 |                          |   | 17,213 |  |      | 17,599  |  |   | 16,957 
|                                                      |  |                                                      |        |                          |   |        |  |      |         |  |   |        

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



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CAPELLA EDUCATION COMPANY

Consolidated Statements of Cash Flows

(In thousands)



|                                                                                  |  |                          |         |   |      |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | -------- | -
|                                                                                  |  | Six Months EndedJune 30, |        
|                                                                                  |  | 2008                     |         |   | 2007 |  
|                                                                                  |  | (Unaudited)              |        
|Operating activities                                                              |  |                          |         |   |      |   |          |  
|Net income                                                                        |  | $                        | 11,846  |   |      | $ | 8,627    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |         |   |      |   |          |  
|Provision for bad debts                                                           |  |                          | 2,469   |   |      |   | 1,605    |  
|Depreciation and amortization                                                     |  |                          | 5,857   |   |      |   | 4,750    |  
|Amortization of investment premium                                                |  |                          | 942     |   |      |   | 15       |  
|Asset impairment                                                                  |  |                          | 11      |   |      |   | 31       |  
|Gain realized on sale of marketable securities                                    |  |                          | (216    | ) |      |   |         |  
|Stock-based compensation                                                          |  |                          | 2,421   |   |      |   | 1,732    |  
|Excess tax benefits from stock-based compensation                                 |  |                          | (1,364  | ) |      |   | (2,025   | )
|Deferred income taxes                                                             |  |                          | (587    | ) |      |   | (417     | )
|Changes in operating assets and liabilities:                                      |  |                          |         |   |      |   |          |  
|Accounts receivable                                                               |  |                          | (3,764  | ) |      |   | (1,086   | )
|Prepaid expenses and other current assets                                         |  |                          | 6,571   |   |      |   | 1,539    |  
|Accounts payable and accrued liabilities                                          |  |                          | (6,483  | ) |      |   | 126      |  
|Deferred rent                                                                     |  |                          | 72      |   |      |   | (317     | )
|Deferred revenue                                                                  |  |                          | 1,399   |   |      |   | (586     | )
|                                                                                  |  |                          |         |   |      |   |          |  
|Net cash provided by operating activities                                         |  |                          | 19,174  |   |      |   | 13,994   |  
|Investing activities                                                              |  |                          |         |   |      |   |          |  
|Capital expenditures                                                              |  |                          | (7,058  | ) |      |   | (10,253  | )
|Purchases of marketable securities                                                |  |                          | (72,255 | ) |      |   | (138,302 | )
|Sales and maturities of marketable securities                                     |  |                          | 54,496  |   |      |   | 128,212  |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Net cash used in investing activities                                             |  |                          | (24,817 | ) |      |   | (20,343  | )
|Financing activities                                                              |  |                          |         |   |      |   |          |  
|Payments of capital lease obligations                                             |  |                          |        |   |      |   | (1       | )
|Excess tax benefits from stock-based compensation                                 |  |                          | 1,364   |   |      |   | 2,025    |  
|Proceeds from exercise of stock options                                           |  |                          | 2,021   |   |      |   | 4,823    |  
|Net proceeds from issuance of common stock                                        |  |                          |        |   |      |   | 11,041   |  
|Repurchase of common stock                                                        |  |                          | (50,000 | ) |      |   |         |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Net cash (used in) provided by financing activities                               |  |                          | (46,615 | ) |      |   | 17,888   |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Net (decrease) increase in cash and cash equivalents                              |  |                          | (52,258 | ) |      |   | 11,539   |  
|Cash and cash equivalents at beginning of period                                  |  |                          | 60,600  |   |      |   | 22,491   |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Cash and cash equivalents at end of period                                        |  | $                        | 8,342   |   |      | $ | 34,030   |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Supplemental disclosures of cash flow information                                 |  |                          |         |   |      |   |          |  
|Income taxes paid                                                                 |  | $                        | 1,843   |   |      | $ | 3,863    |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Noncash transactions:                                                             |  |                          |         |   |      |   |          |  
|Purchase of equipment included in accounts payable and accrued liabilities        |  | $                        | 951     |   |      | $ | 1,047    |  
|                                                                                  |  |                          |         |   |      |   |          |  
|Retirement of equipment financed through capital lease obligations                |  | $                        |        |   |      | $ | 11       |  
|                                                                                  |  |                          |         |   |      |   |          |  

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



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CAPELLA EDUCATION COMPANY

Notes to Consolidated Financial Statements

(In thousands, except per share
data)

(Unaudited)

1. Nature of
Business

Capella Education Company (the Company) was incorporated on December 27, 1991. Through its wholly-owned subsidiary,
Capella University (the University), the Company manages its business on the basis of one reportable segment. The University is an online post-secondary education services company that offers a variety of bachelors, masters and doctoral
degree programs primarily delivered to working adults. Capella University is accredited by The Higher Learning Commission and is a member of the North Central Association of Colleges and Schools (NCA).

2. Summary of Significant Accounting Policies

Consolidation

The consolidated financial statements include the accounts of the Company and the University, after
elimination of all 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 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 accounting principles generally
accepted in the United States 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 accounting principles generally accepted in the United States 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, 2007 (2007
Annual Report on Form 10-K).

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

Recently Adopted Financial Accounting Pronouncements

The Company adopted the provisions of Financial Accounting
Standards Board (FASB) Statement No. 157 (FAS 157), Fair Value Measurements, on January 1, 2008. FAS 157 defines fair value, establishes a framework for measuring fair value in Generally Accepted Accounting Principles (GAAP), and expands
disclosures about fair value measurements. The implementation of this Statement was not material to the Companys consolidated financial position or results of operations.

3. 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. Diluted net income per common share increases the shares used in the per share calculation by the dilutive effects of options and restricted stock.

The table below is a reconciliation of the numerator and denominator in the basic and diluted net income per common share calculation.



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|                                                                                        |  |                            |        |                          |   |        |  |      |        |  |   |       
|--------------------------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                        |  | Three Months EndedJune 30, |        | Six Months EndedJune 30,
|                                                                                        |  | 2008                       |        | 2007                     |   | 2008   |  | 2007
|Numerator:                                                                              |  |                            |        |                          |   |        |  |      |        |  |   |       
|Net income                                                                              |  | $                          | 6,358  |                          | $ | 4,783  |  | $    | 11,846 |  | $ | 8,627 
|Denominator:                                                                            |  |                            |        |                          |   |        |  |      |        |  |   |       
|Denominator for basic net income per common share  weighted average shares outstanding |  |                            | 16,740 |                          |   | 16,401 |  |      | 17,028 |  |   | 16,209
|Effect of dilutive stock options and restricted stock                                   |  |                            | 563    |                          |   | 812    |  |      | 571    |  |   | 748   
|                                                                                        |  |                            |        |                          |   |        |  |      |        |  |   |       
|Denominator for diluted net income per common share                                     |  |                            | 17,303 |                          |   | 17,213 |  |      | 17,599 |  |   | 16,957
|                                                                                        |  |                            |        |                          |   |        |  |      |        |  |   |       
|Basic net income per common share                                                       |  | $                          | 0.38   |                          | $ | 0.29   |  | $    | 0.70   |  | $ | 0.53  
|Diluted net income per common share                                                     |  | $                          | 0.37   |                          | $ | 0.28   |  | $    | 0.67   |  | $ | 0.51  

Options to purchase 152 and 36 common shares, respectively, were outstanding but not included in
the computation of diluted net income per common share in the three months ended June 30, 2008 and 2007, respectively, because their effect would be antidilutive. Options to purchase 124 and 24 common shares, respectively, were outstanding but
not included in the computation of diluted net income per common share in the six months ended June 30, 2008 and 2007, respectively, because their effect would be antidilutive.

4. Accrued Liabilities

Accrued liabilities consist of the following:



|                                  |  |                   |        |                       |   |       
|--------------------------------- |  | ----------------- | ------ | --------------------- | - | ------
|                                  |  | As ofJune 30,2008 |        | As ofDecember 31,2007
|Accrued compensation and benefits |  | $                 | 4,755  |                       | $ | 8,879 
|Accrued instructional fees        |  |                   | 2,221  |                       |   | 4,767 
|Accrued vacation                  |  |                   | 1,697  |                       |   | 1,032 
|Customer deposits                 |  |                   | 1,756  |                       |   | 1,658 
|Other                             |  |                   | 7,643  |                       |   | 7,490 
|                                  |  |                   |        |                       |   |       
|                                  |  | $                 | 18,072 |                       | $ | 23,826
|                                  |  |                   |        |                       |   |       

5. Operating Lease Obligations

The Company leases its office facilities and certain office equipment under various noncancelable operating leases. Effective March 17, 2008, the
Company entered into an amendment of its current lease with Minneapolis 225 Holdings, LLC pursuant to which the Company will renew and expand its existing lease premises at 225 South Sixth Street in Minneapolis, Minnesota through 2015.

Future minimum lease commitments under the leases as of June 30, 2008, are as follows:



|                    |  |           |       
|------------------- |  | --------- | ------
|                    |  | Operating
|2008                |  | $         | 1,633 
|2009                |  |           | 4,002 
|2010                |  |           | 4,574 
|2011                |  |           | 5,097 
|2012                |  |           | 5,250 
|2013 and thereafter |  |           | 15,734
|                    |  |           |       
|Total               |  | $         | 36,290
|                    |  |           |       

The Company recognizes rent expense on a straight-line basis over the term of the leases, although
the leases may include escalation clauses that provide for lower rent payments at the start of the lease term and higher lease 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 part of deferred rent, in accrued liabilities or long-term
liabilities, as appropriate.

6. 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. The Company
does not believe that the outcome of any pending claims will have a material adverse impact on its consolidated financial position or results of operations.



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7. Common Stock

On March 3, 2008, the Company announced that its Board of Directors had authorized the Company to repurchase up to $50,000 of shares of common stock with no expiration date. As of June 30, 2008, the Company
had repurchased 858 shares for total consideration of $50,000.

8. Stock-Based Compensation

The table below reflects our stock-based compensation expense recognized in the consolidated statements of income for the three and six months ended
June 30, 2008 and 2007:



|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|------------------------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                                              |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                                              |  | 2008                       |       | 2007                     |   | 2008  |  | 2007
|Instructional costs and services                              |  | $                          | 458   |                          | $ | 337   |  | $    | 790   |  | $ | 587  
|Marketing and promotional                                     |  |                            | 265   |                          |   | 205   |  |      | 464   |  |   | 328  
|General and administrative                                    |  |                            | 656   |                          |   | 506   |  |      | 1,167 |  |   | 817  
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|Stock-based compensation expense included in operating income |  |                            | 1,379 |                          |   | 1,048 |  |      | 2,421 |  |   | 1,732
|Tax benefit                                                   |  |                            | 421   |                          |   | 267   |  |      | 705   |  |   | 417  
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|Stock-based compensation expense, net of tax                  |  | $                          | 958   |                          | $ | 781   |  | $    | 1,716 |  | $ | 1,315
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      

The tables below summarize stock option activity and other stock option information for the
periods indicated:



|                                |  |                    |   |  |                         |   |  |                                         |   |  |   |      
|------------------------------- |  | ------------------ | - |  | ----------------------- | - |  | --------------------------------------- | - |  | - | -----
|Service-based Stock Options     |  | Availablefor Grant |   |  | Plan OptionsOutstanding |   |  | Weighted-AverageExercise Priceper Share
|                                |  | Incentive          |   |  | Non-Qualified           |   | 
|Balance, December 31, 2007      |  | 1,795              |   |  | 505                     |   |  | 768                                     |   |  | $ | 23.24
|Granted                         |  | (98                | ) |  |                        |   |  | 98                                      |   |  |   | 60.96
|Exercised                       |  |                   |   |  | (79                     | ) |  | (32                                     | ) |  |   | 17.08
|Canceled                        |  | 21                 |   |  | (6                      | ) |  | (17                                     | ) |  |   | 30.06
|                                |  |                    |   |  |                         |   |  |                                         |   |  |   |      
|Balance, June 30, 2008          |  | 1,718              |   |  | 420                     |   |  | 817                                     |   |  |   | 26.66
|                                |  |                    |   |  |                         |   |  |                                         |   |  |   |      
|                                |  |                    |   | 
|Performance-based Stock Options |  |                    |   |  |                         |   |  |                                         |   |  |  
|Balance, December 31, 2007      |  |                    |   |  |                        |   |  | 50                                      |   |  | $ | 20.00
|Exercised                       |  |                    |   |  |                        |   |  | (6                                      | ) |  |   | 20.00
|                                |  |                    |   |  |                         |   |  |                                         |   |  |   |      
|Balance, June 30, 2008          |  |                    |   |  |                        |   |  | 44                                      |   |  |   | 20.00
|                                |  |                    |   |  |                         |   |  |                                         |   |  |   |      

The outstanding performance-based stock options had a weighted-average remaining contractual life
of 7.6 years and an aggregate intrinsic value of $1,727 at June 30, 2008.



|                                           |  |                 |  |                               |       |                                          |     |                         |   |       
|------------------------------------------ |  | --------------- |  | ----------------------------- | ----- | ---------------------------------------- | --- | ----------------------- | - | ------
|Service-based Stock Options                |  | Number ofShares |  | Weighted-AverageExercisePrice |       | Weighted-AverageRemainingContractualTerm |     | AggregateIntrinsicValue
|Balance at June 30, 2008                   |  | 1,237           |  | $                             | 26.66 |                                          | 6.3 |                         | $ | 41,496
|Vested and expected to vest, June 30, 2008 |  | 1,191           |  | $                             | 26.35 |                                          | 6.3 |                         | $ | 40,309
|Exercisable, June 30, 2008                 |  | 525             |  | $                             | 19.28 |                                          | 5.8 |                         | $ | 21,288

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the
difference between the Companys closing stock price on June 30, 2008 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their
options on June 30, 2008. The amount of aggregate intrinsic value will change based on the fair market value of the Companys stock.



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Restricted stock activity for the three months ended June 30, 2008 is summarized as follows:



|                           |  |                 |  |                                               |      
|-------------------------- |  | --------------- |  | --------------------------------------------- | -----
|Restricted Stock           |  | Numberof Shares |  | Weighted-AverageGrant DateFair Valueper Share
|Balance, December 31, 2007 |  | 1               |  | $                                             | 51.69
|Granted                    |  | 4               |  |                                               | 53.69
|Vested                     |  |                |  |                                               |     
|Forfeited                  |  |                |  |                                               |     
|                           |  |                 |  |                                               |      
|Balance, June 30, 2008     |  | 5               |  | $                                             | 53.26
|                           |  |                 |  |                                               |      

The following table summarizes information regarding all stock option exercises for the periods
indicated:



|                                                |  |                            |       |                          |   |       |  |      |       |  |   |      
|----------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                                |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                                |  | 2008                       |       | 2007                     |   | 2008  |  | 2007
|Proceeds from stock options exercised           |  | $                          | 1,383 |                          | $ | 4,494 |  | $    | 2,021 |  | $ | 4,823
|Tax benefits related to stock options exercised |  |                            | 1,013 |                          |   | 2,774 |  |      | 1,447 |  |   | 2,869
|Intrinsic value of stock options exercised      |  |                            | 3.340 |                          |   | 7,856 |  |      | 5,002 |  |   | 8,333

Intrinsic value of stock options exercised is estimated by taking the difference between the
Companys closing stock price on the date of exercise and the exercise price, multiplied by the number of options exercised for each option holder and then aggregated.

As of June 30, 2008, total compensation cost related to nonvested service-based stock options not yet recognized was $8,176, which is expected to be
recognized over the next 25 months on a weighted-average basis.

9. Fair Value Measurements

The following table summarizes certain fair value information at June 30, 2008 for assets and liabilities measured at fair value on a recurring
basis:



|                                   |  |            |         |                                                           |   |                                           |  |                                        |        |  |   |  
|---------------------------------- |  | ---------- | ------- | --------------------------------------------------------- | - | ----------------------------------------- |  | -------------------------------------- | ------ |  | - | -
|                                   |  |            |         | Fair Value Measurements Using                            
|Description                        |  | Fair Value |         | Quoted Pricesin ActiveMarkets forIdenticalAssets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservableInputs(Level
3)
|Cash and cash equivalents          |  | $          | 8,342   |                                                           | $ | 8,342                                     |  | $                                      |       |  | $ | 
|Marketable securities  Municipals |  | $          | 98,932  |                                                           | $ |                                          |  | $                                      | 98,932 |  | $ | 
|                                   |  |            |         |                                                           |   |                                           |  |                                        |        |  |   |  
|                                   |  | $          | 107,274 |                                                           | $ | 8,342                                     |  | $                                      | 98,932 |  | $ | 
|                                   |  |            |         |                                                           |   |                                           |  |                                        |        |  |   |  

10. Regulatory Supervision and Oversight

The 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 the Company subsequently



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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. The Company responded to the final report on April 8,
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, the most significant potential financial
exposure pertains to repayments to the Department of Education 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 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. For the three year audit period, and for the 2005-2006 aid year, the Company estimates that the total amount of Title IV funds not returned for learners who withdrew without providing official
notification was less than $1,000 including interest, but not including fines and penalties.

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 1998. Although the process for
reauthorization of the HEA is underway, there is no assurance on when or if it will be completed. Because reauthorization has not yet been completed in a timely manner, Congress has extended the current provisions of the HEA through August 15, 2008,
and it is expected to be reauthorized prior to that time. Additionally, Congress reviews and determines appropriations for Title IV programs on an annual basis through the budget and appropriations processes. As of June 30, 2008, programs in
which the Capella Universitys learners participate are operative and sufficiently funded.

11. Subsequent Event

On July 30, 2008, the Companys Board of Directors authorized the Company to repurchase up to $60,000 of shares of common stock with no
expiration date.



|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, 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, 2007, as updated in our subsequent reports filed with the SEC, including any updates found in Part II, Item 1A of
this report 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



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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 Securities and Exchange Commission (SEC).

Overview

Background

We are an
exclusively online post-secondary education services company. Our wholly owned subsidiary, Capella University, is a regionally accredited university that offers a variety of undergraduate and graduate degree programs primarily for working adults. At
June 30, 2008, we offered over 950 courses and 19 degree programs with 104 specializations at the undergraduate and graduate levels to more than 23,700 learners.

We were founded in 1991, and in 1993 we established our wholly owned university subsidiary, then named The Graduate School of America, to offer doctoral and masters degrees through distance learning programs in
management, education, human services and interdisciplinary studies. In 1995, we launched our online format for delivery of our doctoral and masters degree programs over the Internet. In 1997, our university subsidiary received accreditation
from the North Central Association of Colleges and Schools (later renamed The Higher Learning Commission of the North Central Association of Colleges and Schools). In 1998, we began the expansion of our original portfolio of academic programs by
introducing doctoral and masters degrees in psychology and a master of business administration degree. In 1999, to expand the reach of our brand in anticipation of moving into the bachelors degree market, we changed our name to Capella
Education Company and the name of our university to Capella University. In 2000, we introduced our bachelors degree completion program in information technology, which provided instruction for the last two years of a four-year bachelors
degree. In 2001, we introduced our bachelors degree completion program in business. In 2004, we introduced our four-year bachelors degree programs in business and information technology, as well as three masters-level
specializations in education targeted at K-12 teachers. In November 2006, we completed an initial public offering of our common stock. In May 2007, we completed a follow-on offering of our common stock. Additionally, during 2007, we introduced six
new degree programs and 31 new specializations, including our first ever specializations in Public Safety and nine new PhD specializations. During the first half of 2008, we completed a $50 million stock repurchase program and Capella
Universitys accreditation was reaffirmed by The Higher Learning Commission (HLC). We implemented an enterprise resource planning (ERP) system from 2006 through 2008. The final module was implemented in July 2008. We have introduced eight new
specializations and two new programs through July 2008.

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, 2007. During the six months
ended June 30, 2008, there have been no significant changes in our critical accounting policies.

Results of Operations

The following table sets forth statements of operations data as a percentage of revenues for each of the periods indicated:



|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  
|-------------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                                 |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                                 |  | 2008                       |   |  | 2007                     |   |  | 2008  |   |  | 2007  |  
|Revenues                         |  | 100.0                      | % |  | 100.0                    | % |  | 100.0 | % |  | 100.0 | %
|Costs and expenses:              |  |                            |   |  |                          |   |  |       |   |  |       |  
|Instructional costs and services |  | 46.7                       |   |  | 45.6                     |   |  | 45.6  |   |  | 45.1  |  
|Marketing and promotional        |  | 29.6                       |   |  | 31.3                     |   |  | 31.2  |   |  | 32.9  |  
|General and administrative       |  | 10.6                       |   |  | 12.0                     |   |  | 11.2  |   |  | 11.7  |  
|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  
|Total costs and expenses         |  | 86.9                       |   |  | 88.9                     |   |  | 88.0  |   |  | 89.7  |  
|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  
|Operating income                 |  | 13.1                       |   |  | 11.1                     |   |  | 12.0  |   |  | 10.3  |  
|Other income, net                |  | 1.5                        |   |  | 2.1                      |   |  | 1.8   |   |  | 2.1   |  
|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  
|Income before income taxes       |  | 14.6                       |   |  | 13.2                     |   |  | 13.8  |   |  | 12.4  |  
|Income tax expense               |  | 5.0                        |   |  | 4.3                      |   |  | 4.8   |   |  | 4.3   |  
|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  
|Net income                       |  | 9.6                        | % |  | 8.9                      | % |  | 9.0   | % |  | 8.1   | %
|                                 |  |                            |   |  |                          |   |  |       |   |  |       |  



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Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

Revenues.Our revenues for the three months ended June 30, 2008 were $66.0 million, representing an increase of $12.1
million, or 22.5%, as compared to $53.9 million for the three months ended June 30, 2007. This increase was primarily driven by 19.3 percentage points from increased enrollments and 4.5 percentage points from the impact of pricing increases,
partially offset by a 0.6 percentage point decrease from a larger proportion of masters and bachelors learners, who generated less revenue per learner than our doctoral learners. End-of-period enrollment increased 19.0% in 2008 compared
to 2007. Tuition increases in 2007 generally ranged from 3% to 6% and were implemented in July 2007.

Instructional costs and
services expenses.Our instructional costs and services expenses for the three months ended June 30, 2008 were $30.8 million, representing an increase of $6.3 million, or 25.4%, as compared to $24.6 million for the three months ended
June 30, 2007. This increase was primarily due to increases in instructional pay and learner support services resulting from increased enrollments. In addition, we had greater learner support services and depreciation expenses as a result of
our ERP implementation. Information technology expenses increased as a result of a higher mix of expensed versus capitalized software projects in 2008 compared to 2007. Finally, colloquia and graduation expenses increased due to greater attendance
at these events in the second quarter.

Our instructional costs and services expenses as a percentage of revenues increased by 1.1
percentage points to 46.7% for the three months ended June 30, 2008, from 45.6% for the three months ended June 30, 2007. This increase was primarily due to increases in learner support services and depreciation expenses as a result of our
ERP implementation; an increase in information technology expenses related to a higher mix of expensed versus capitalized software projects in 2008 compared to 2007; and an increase in expenses related to a faculty development event which took place
during the second quarter of 2008. These increases were partially offset by a decrease in the ratio between faculty compensation and revenue and a decrease in accrued bonus expense.

Marketing and promotional expenses.Our marketing and promotional expenses for the three months ended June 30, 2008 were $19.6
million, representing an increase of $2.7 million, or 16.2%, as compared to $16.9 million for the three months ended June 30, 2007. This increase was driven by greater spending in online media and recruitment staffing. Our marketing and
promotional expenses as a percentage of revenues decreased by 1.7 percentage points to 29.6% for the three months ended June 30, 2008, from 31.3% for the three months ended June 30, 2007. This decline as a percent of revenues was planned,
and reflects a combination of a greater percentage of expected annual new enrollment marketing spending in the second quarter of 2007 compared to 2008, alignment of lead generation with the capacity of our enrollment counselors, marketing
efficiencies across total enrollments, and a decrease in accrued bonus expense.

General and administrative expenses.Our
general and administrative expenses for the three months ended June 30, 2008 were $7.0 million, representing an increase of $0.5 million, or 6.9%, as compared to $6.5 million for the three months ended June 30, 2007. This increase was
driven by increased investments in infrastructure to support current and future growth, as well as an increase in bad debt expense due to short term disruptions in our collection efforts and temporarily increased credit limits granted to select
learners who had experienced billing issues resulting from the ERP implementation. These increases were partially offset by a decrease in accrued bonus expense and information technology expenses as there were fewer employees dedicated to the ERP
system implementation. We anticipate a severance charge of $0.7 million to $0.8 million for the three months ended September 30, 2008.

Our general and administrative expenses as a percentage of revenues were 10.6%, a decrease of 1.4 percentage points for the three months ended June 30, 2008, compared to 12.0% for the three months ended June 30, 2007. This
decrease was driven by a decrease in accrued bonus expense and information technology expenses as there were fewer employees dedicated to the ERP system implementation. This decrease was partially offset by increased legal costs incurred in the
normal course of our business and an increase in bad debt expense due to short term disruptions in our collection efforts and temporarily increased credit limits granted to select learners who had experienced billing issues resulting from the ERP
implementation.

Other income, net.Other income, net decreased by $0.1 million, or 11.0%, to $1.0 million for the three
months ended June 30, 2008, from $1.1 million for the three months ended June 30, 2007. The decrease was principally due to a decrease in interest income levels from lower interest rates earned in 2008 partially offset by higher average
cash and marketable securities balances.



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Income tax expense.We recognized tax expense for the three months ended June 30, 2008
and 2007 of $3.3 million and $2.3 million, respectively, or at effective tax rates of 34.3% and 32.6%, respectively. The increase in our effective tax rate in the second quarter of 2008 from 2007 reflects a decrease in the impact of tax-exempt
interest, an increase in the impact of non-deductible meals and entertainment expenses, and a slight increase in our state effective tax rate.

Net income.Net income was $6.4 million for the three months ended June 30, 2008, compared to net income of $4.8 million for the three months ended June 30, 2007, an increase of $1.6 million, because of the factors
discussed above.

Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

Revenues.Our revenues for the six months ended June 30, 2008 were $131.3 million, representing an increase of $24.6 million, or 23.0%,
as compared to $106.7 million for the six months ended June 30, 2007. This increase was primarily driven by 19.7 percentage points from increased enrollments and 4.5 percentage points from tuition increases, partially offset by a 0.8 percentage
point decrease from a larger proportion of masters and bachelors learners, who generated less revenue per learner than our doctoral learners. End-of-period enrollment increased 19.0% in 2007 compared to 2006. Tuition increases in 2007
generally ranged from 3% to 6% and were implemented during July 2007.

Instructional costs and services expenses.Our
instructional costs and services expenses for the six months ended June 30, 2008 were $59.9 million, representing an increase of $11.8 million, or 24.4%, as compared to $48.1 million for the six months ended June 30, 2007. This increase
was primarily due to increases in instructional pay and learner support services resulting from increased enrollments. In addition, we had greater learner support services and depreciation expenses as a result of our ERP implementation. Information
technology expenses increased as a result of a higher mix of expensed versus capitalized software projects in 2008 compared to 2007.

Our
instructional costs and services expenses as a percentage of revenues increased by 0.5 percentage points to 45.6% for the six months ended June 30, 2008, as compared to 45.1% for the six months ended June 30, 2007. This increase was
primarily due to increases in learner support services and depreciation expenses as a result of our ERP implementation and an increase in information technology expenses related to a higher mix of expensed versus capitalized software projects in
2008 compared to 2007. These increases were partially offset by a decrease in the ratio between faculty compensation and revenue and a decrease in accrued bonus expense.

Marketing and promotional expenses.Our marketing and promotional expenses for the six months ended June 30, 2008 were $41.0 million, representing an increase of $5.8 million, or 16.5%, as compared
to $35.2 million for the six months ended June 30, 2007. This increase was driven by greater spending in online media and recruitment staffing. Our marketing and promotional expenses as a percentage of revenues decreased by 1.7 percentage
points to 31.2% for the six months ended June 30, 2008, from 32.9% for the six months ended June 30, 2007. This decline as a percent of revenues was planned, and reflects a combination of a greater percentage of expected annual new
enrollment marketing spending in the first half of 2007 compared to 2008, alignment of lead generation with the capacity of our enrollment counselors, marketing efficiencies across total enrollments, and a decrease in accrued bonus expense.

General and administrative expenses.Our general and administrative expenses for the six months ended June 30, 2008
were $14.7 million, representing an increase of $2.2 million or 17.6%, as compared to $12.5 million for the six months ended June 30, 2007. This increase was driven by increased investments in infrastructure to support current and future
growth, and an increase in bad debt expense due to short term disruptions in our collection efforts and temporarily increased credit limits granted to select learners who had experienced billing issues resulting from the ERP implementation. These
increases were partially offset by a decrease in accrued bonus expense.

Our general and administrative expenses as a percentage of
revenues were 11.2%, a decrease of 0.5 percentage points for the six months ended June 30, 2008, compared to 11.7% for the six months ended June 30, 2007. This decrease was primarily due to a decrease in accrued bonus expense partially
offset by an increase in bad debt expense due to short term disruptions in our collection efforts and temporarily increased credit limits granted to select learners who had experienced billing issues resulting from the ERP implementation.

Other income, net.Other income, net increased by $0.2 million, or 7.8%, to $2.4 million for the six months ended
June 30, 2008, from $2.2 million for the six months ended June 30, 2007. The increase was primarily due to increased levels of interest income on higher average cash and marketable securities balances, partially offset by lower interest
rates in 2008.



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Income tax expense.We recognized tax expense for the six months ended June 30, 2008
and 2007 of $6.3 million and $4.6 million, respectively, or at effective tax rates of 34.8% and 34.6%, respectively.

Net income.Net income was $11.8 million for the six months ended June 30, 2008, compared to net income of $8.6 million for the six months ended June 30, 2007, an increase of $3.2 million, because of the factors discussed above.

Liquidity and Capital Resources

Liquidity

We financed our operating activities and capital expenditures during the six months ended June 30, 2008 and 2007 primarily
through cash provided by operating activities. Our cash, cash equivalents and marketable securities were $107.3 million and $143.8 million at June 30, 2008 and December 31, 2007, respectively. Our cash, cash equivalents and marketable
securities decreased primarily due to the share repurchase program announced in March 2008. This repurchase program was completed in the second quarter of 2008 and, as of June 30, 2008, we had repurchased 0.9 million shares for total
consideration of $50.0 million. On July 30, 2008, our Board of Directors authorized us to repurchase up to $60.0 million of shares of common stock with no expiration date.

We had a higher cash and cash equivalents balance at the beginning of 2008 due to cash received from stock option exercises and redemption of certain
securities converted to cash and cash equivalents in light of market conditions, which occurred during the fourth quarter of 2007. During the first half of 2008, some of this cash and cash equivalents balance was used to purchase marketable
securities as well as to fund the share repurchase program.

In August 2004, we entered into an unsecured $10.0 million line of credit with
Wells Fargo Bank. The line of credit expires on June 30, 2009. There have been no borrowings under this line of credit at June 30, 2008 or December 31, 2007.

A significant portion 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 started July 1, 2008. Loan funds are generally provided by lenders in multiple disbursements for each academic year. The disbursements are usually received by the
start of the second week of the term. These factors, together with the timing of our learners beginning their programs, affect our operating cash flow.

Based on our current level of operations and anticipated growth, we believe that our cash flow from 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.

Operating Activities

Net cash provided by operating activities was $19.2 million and $14.0 million for the six months ended June 30, 2008 and 2007,
respectively. The increase from 2007 to 2008 was primarily due to a $3.2 million increase in net income, a $2.0 million increase in depreciation and bad debt expense, and lower tax payments due to timing. This was offset by a decrease in cash from
operating assets and liabilities.

Investing Activities

Our cash used in investing activities is primarily related to the purchase of property and equipment and investments in marketable securities. Net cash
used in investing activities was $24.8 million and $20.3 million for the six months ended June 30, 2008 and 2007, respectively. Investments in marketable securities consist primarily of purchases, sales and maturities of taxable or tax-exempt
municipal securities.

Net purchases of these securities were $17.8 million and $10.1 million during the six months ended June 30,
2008 and 2007, respectively. This increase was driven by lower sales of marketable securities due to the higher cash and cash equivalents balance at December 31, 2007 than December 31, 2006, as we did not require additional sales of
securities to fund our normal operations and the share repurchase program. Capital expenditures were $7.1 million and $10.3 million for the six months ended June 30, 2008 and 2007, respectively. The decrease from 2007 was primarily due to the
higher mix of capitalized work performed on the ERP system in 2007 to complete the implementation in 2008.

We lease all of our facilities.
We expect to make future payments on existing leases from cash generated from operations. Effective March 17, 2008, we entered into an amendment of our current lease with Minneapolis 225 Holdings, LLC pursuant to which we will renew and expand
our existing lease premises at 225 South Sixth Street in Minneapolis, Minnesota through 2015.



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Financing Activities

Net cash used in financing activities was $46.6 million for the six months ended June 30, 2008, and net cash provided by financing activities was
$17.9 million for the six months ended June 30, 2007. Financing activities during the six months ended June 30, 2008 were primarily related to the repurchase of common stock in the amount of $50.0 million, partially offset by $2.0 million
in proceeds from stock option exercises and $1.4 million in excess tax benefits from stock option exercises. Financing activities during the six months ended June 30, 2007 were primarily related to proceeds of $11.0 million from the issuance of
common stock in our May 2007 follow-on offering, $4.8 million in proceeds from stock option exercises and $2.0 million in excess tax benefits.

Contractual Obligations

The following table sets forth, as of June 30, 2008, the aggregate amounts of our
significant contractual obligations and commitments with definitive payment terms due in each of the periods presented (in thousands):



|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       
|----------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ---------------- | - | ------ |  | - | ------
|                              |  | Payments Due by Period
|                              |  | Total                  |        | Less than1 Year |   | 1-3 Years |  | 3-5 Years |       | More than5 Years
|Operating leases(a)           |  | $                      | 36,290 |                 | $ | 1,633     |  | $         | 8,576 |                  | $ | 10,347 |  | $ | 15,734
|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       
|Total contractual obligations |  | $                      | 36,290 |                 | $ | 1,633     |  | $         | 8,576 |                  | $ | 10,347 |  | $ | 15,734
|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       



|(a) | Minimum lease commitments for our headquarters and miscellaneous
office equipment. Effective March 17, 2008, we entered into an amendment of our current lease with Minneapolis 225 Holdings, LLC pursuant to which we will renew and expand our existing lease premises at 225 South Sixth Street in Minneapolis,
Minnesota through 2015.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Regulation and Oversight

We perform periodic reviews of our compliance with the various applicable regulatory requirements. We have 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 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. 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, the most significant potential financial exposure pertains to repayments to the Department of
Education 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 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. For the
three year audit period, and for the 2005-2006 aid year, we estimate that the total amount of Title IV funds not returned for learners who withdrew without providing official notification was less than $1.0 million, including interest, but not
including fines and penalties.



|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 marketable securities is limited due to the adherence to our investment policy that requires marketable securities to have a minimum Standard & Poors rating of A minus (or equivalent). All of our marketable securities as of
June 30, 2008 and December 31, 2007 consisted of cash equivalents and marketable securities rated A minus or higher.



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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 June 30, 2008, a 10% increase or decrease in interest rates would not have a material impact on our future earnings, fair values, or cash flows related to investments in cash equivalents or interest earning
marketable securities.



|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 are effective, as of June 30, 2008,
in ensuring that material information relating to us 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.

In 2008, we completed the implementation of our ERP system designed to increase the efficiency of processing transactions and to produce more accurate and
timely information for our learner-facing departments.

Except for the preceding change, 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
|------- | -----------------

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. We are not at this time a party, as plaintiff or defendant, to any legal proceedings which, individually or in the aggregate, would be
expected to have a material adverse effect on our business, financial condition or results of operation.



|Item 1A. | Risk Factors
|-------- | ------------

Other than with respect to the risk
factor below, there have been no material changes to the risk factors disclosed in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2007, as updated in our Quarterly Report of Form 10-Q for
the quarter ended March 31, 2008. The risk factor entitled System disruptions and vulnerability from security risks to our online computer networks could impact our ability to generate revenue and damage the reputation of Capella
University, limiting our ability to attract and retain learners. We are currently migrating to a new enterprise resource planning system, and unplanned costs and decreases in productivity could adversely impact our financial results is
revised by adding the following as a new sentence at the end of the second paragraph of the risk factor:

Following installation of our
enterprise resource planning system, we may experience difficulties in using the system and our learners and prospective learners may have difficulties using and accepting the system and related new processes. Such difficulties could have a material
adverse effect on our enrollment and financial results.



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##### Table of Contents

|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 June 30, 2008, the Company used $28.2 million to repurchase shares of common stock under its repurchase program(1). The Company had no remaining authorization for common stock repurchases at June 30, 2008, as the $50.0 million share repurchase program was completed. On July 30, 2008,
our Board of Directors authorized us to repurchase up to $60.0 million of shares of common stock with no expiration date.

A summary of the
Companys share repurchases during the quarter is set forth below:



|                      |  |                                 |  |                             |       |                                                                              |         |                                                                                      |   |           
|--------------------- |  | ------------------------------- |  | --------------------------- | ----- | ---------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------------ | - | ----------
|Period                |  | Total Number ofShares Purchased |  | Average Price Paidper Share |       | Total Number ofShares Purchased asPart of PubliclyAnnounced Plans orPrograms |         | Approximate DollarValue of Shares ThatMay Yet BePurchased Under thePlans or Programs
|4/1/2008 to 4/30/2008 |  | 263,792                         |  | $                           | 60.11 |                                                                              | 263,792 |                                                                                      | $ | 12,392,269
|5/1/2008 to 5/31/2008 |  | 134,392                         |  | $                           | 61.52 |                                                                              | 134,392 |                                                                                      | $ | 4,124,278 
|6/1/2008 to 6/30/2008 |  | 66,747                          |  | $                           | 61.79 |                                                                              | 66,747  |                                                                                      | $ |          
|                      |  |                                 |  |                             |       |                                                                              |         |                                                                                      |   |           
|Total                 |  | 464,931                         |  | $                           | 60.76 |                                                                              | 464,931 |                                                                                      | $ |          



|(1) | The Companys repurchase program was announced on
March 3, 2008 for repurchases up to an aggregate amount of $50.0 million in value of common stock with no expiration date. As of June 30, 2008, we had purchased 858,443 shares under this program at an average price of $58.24 totaling $50.0
million. Cash spent during the second quarter on the purchase of shares totaled $31.7 million. The amount of cash expended includes $3.5 million for shares purchased March 27, March 28, and March 31, 2008, but due to timing the
cash payments for these purchases were made April 1, April 2, and April 3, 2008, respectively.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

At our Annual Meeting of Shareholders held on May 13, 2008, shareholders voted on the following proposals:

1. Election of
Directors:



|                  |  |            |  |         
|----------------- |  | ---------- |  | --------
|                  |  | For        |  | Withhold
|Mark N. Greene    |  | 16,195,365 |  | 240,463 
|Jody G. Miller    |  | 16,361,161 |  | 74,667  
|James A. Mitchell |  | 16,362,297 |  | 73,531  
|Stephen G. Shank  |  | 16,361,912 |  | 73,916  
|Andrew M. Slavitt |  | 16,318,640 |  | 117,188 
|David W. Smith    |  | 16,362,257 |  | 73,571  
|Jeffrey W. Taylor |  | 16,318,757 |  | 117,071 
|Sandra E. Taylor  |  | 16,361,627 |  | 74,201  
|Darrell R. Tukua  |  | 16,361,642 |  | 74,186  

2. To approve the Capella Education Company Annual Incentive Plan.



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##### Table of Contents

|           |  |         |  |         |  |                
|---------- |  | ------- |  | ------- |  | ---------------
|For        |  | Against |  | Abstain |  | Broker Non-Vote
|16,039,720 |  | 375,468 |  | 20,640  |  |               

3. To ratify the appointment of Ernst & Young LLP as our independent auditors for the
fiscal year ending December 31, 2008.



|           |  |         |  |         |  |                
|---------- |  | ------- |  | ------- |  | ---------------
|For        |  | Against |  | Abstain |  | Broker Non-Vote
|16,168,408 |  | 239,999 |  | 27,421  |  |               

There were 17,200,801 shares of our common stock entitled to vote at the meeting, and a total of
16,435,828 shares (95.55%) were represented at the meeting.



|Item 5. | Other Information
|------- | -----------------

None.



|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 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 Annual Incentive Bonus Plan                                                                                              |  | 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.                                                                                                                                  



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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/ STEPHEN G. SHANK

July 31, 2008Stephen G. ShankChairman and Chief Executive Officer(Principal Executive Officer)/s/ LOIS M. MARTIN

July 31, 2008Lois M. MartinSenior Vice President and ChiefFinancial Officer (Principal Financial Officer)/s/ AMY L. RONNEBERG

July 31, 2008Amy L. RonnebergVice President and Controller(Principal Accounting Officer)




19