##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from          to
 Commission File Number: 001-33140
 CAPELLA EDUCATION COMPANY
 (Exact name of registrant as specified in its charter)
 Minnesota
    
    41-1717955(State or other jurisdiction of
    
    (I.R.S. EmployerIncorporation or organization)
    
    Identification No.)
 225 South Sixth Street, 9 th Floor
Minneapolis, Minnesota 55402  (Address, including zip code, of principal executive offices)  (888) 227-3552
(Registrants telephone number, including area code)
 þ o
  o o þ
 o þ




---



##### 



CAPELLA EDUCATION COMPANY
FORM 10-Q
INDEX
 PagePART I  FINANCIAL INFORMATION



1Item 1 Financial Statements
    
    
    
    1Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    
    10Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    
    14Item 4 Controls and Procedures
    
    
    
    14PART II  OTHER INFORMATION



15Item 1 Legal Proceedings
    
    
    
    15Item 1A Risk Factors
    
    
    
    15Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    
    18Item 3 Defaults Upon Senior Securities
    
    
    
    19Item 4 Submission of Matters to a Vote of Security Holders
    
    
    
    19Item 5 Other Information
    
    
    
    19Item 6 Exhibits
    
    
    
    19SIGNATURES
    
    
    
    20CertificationCertificationCertificationCertification
  2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 CAPELLA EDUCATION COMPANY
Consolidated Balance Sheets
 As of March 31,
    
    
    As of December 31,2007
    
    
    2006(Unaudited)(In thousands, except par value)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    23,373
    
    
    $
    22,491Short-term marketable securities
    
    
    67,465
    
    
    
    65,170Accounts receivable, net of allowance of $938 at 3/31/2007 and $1,119 at 12/31/2006
    
    
    7,087
    
    
    
    7,401Prepaid expenses and other current assets
    
    
    3,827
    
    
    
    3,703Deferred income taxes
    
    
    1,797
    
    
    
    1,800Total current assets
    
    
    103,549
    
    
    
    100,565Property and equipment, net
    
    
    30,798
    
    
    
    28,749Total assets
    
    $
    134,347
    
    
    $
    129,314LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,934
    
    
    $
    5,113Accrued liabilities
    
    
    19,950
    
    
    
    18,598Income taxes payable
    
    
    2,467
    
    
    
    214Deferred revenue
    
    
    7,453
    
    
    
    7,488Current portion of capital lease obligations
    
    
    
    
    
    
    5Total current liabilities
    
    
    31,804
    
    
    
    31,418Deferred rent
    
    
    1,656
    
    
    
    1,813Capital lease obligations
    
    
    
    
    
    
    7Deferred income taxes
    
    
    2,181
    
    
    
    2,331Total liabilities
    
    
    35,641
    
    
    
    35,569Shareholders equity:Common stock, $0.01 par value:Authorized shares  100,000Issued and outstanding shares  16,028 at 3/31/2007 and 16,002 at 12/31/2006
    
    
    160
    
    
    
    160Additional paid-in capital
    
    
    157,627
    
    
    
    156,513Accumulated other comprehensive income (loss)
    
    
    (4
    )
    
    
    (7
    )Retained earnings (accumulated deficit)
    
    
    (59,077
    )
    
    
    (62,921
    )Total shareholders equity
    
    
    98,706
    
    
    
    93,745Total liabilities and shareholders equity
    
    $
    134,347
    
    
    $
    129,314
 The accompanying notes are an integral part of these consolidated financial statements.
 1




---



##### Table of Contents



CAPELLA EDUCATION COMPANY
Consolidated Statements of Income
 Three Months EndedMarch 31,2007
    
    
    2006(Unaudited)(In thousands, exceptper share amounts)Revenues
    
    $
    52,824
    
    
    $
    41,858Costs and expenses:Instructional costs and services
    
    
    23,523
    
    
    
    20,375Marketing and promotional
    
    
    18,320
    
    
    
    14,309General and administrative
    
    
    5,981
    
    
    
    5,290Total costs and expenses
    
    
    47,824
    
    
    
    39,974Operating income
    
    
    5,000
    
    
    
    1,884Other income, net
    
    
    1,092
    
    
    
    916Income before income taxes
    
    
    6,092
    
    
    
    2,800Income tax expense
    
    
    2,248
    
    
    
    1,158Net income
    
    $
    3,844
    
    
    $
    1,642Net income per common share:Basic
    
    $
    0.24
    
    
    $
    0.14Diluted
    
    $
    0.23
    
    
    $
    0.14Weighted average number of common shares outstanding:Basic
    
    
    16,015
    
    
    
    11,653Diluted
    
    
    16,700
    
    
    
    11,988
 The accompanying notes are an integral part of these consolidated financial statements.
 2




---



##### Table of Contents



CAPELLA EDUCATION COMPANY
Consolidated Statements of Cash Flows
 Three Months Ended March 31,2007
    
    
    2006(Unaudited)(In thousands)Operating activitiesNet income
    
    $
    3,844
    
    
    $
    1,642Adjustments to reconcile net income to net cash provided by operating activities:Provision for bad debts
    
    
    700
    
    
    
    421Depreciation and amortization
    
    
    2,410
    
    
    
    2,059Amortization of investment discount/premium
    
    
    (65
    )
    
    
    (38
    )Asset impairment
    
    
    23
    
    
    
    7Stock-based compensation
    
    
    684
    
    
    
    784Noncash equity-related expense
    
    
    
    
    
    
    286Excess tax benefits from stock-based compensation
    
    
    (53
    )
    
    
    Deferred income taxes
    
    
    (150
    )
    
    
    (178
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (386
    )
    
    
    138Prepaid expenses and other assets
    
    
    (118
    )
    
    
    1,171Accounts payable and accrued liabilities
    
    
    (2,764
    )
    
    
    (1,617
    )Income taxes payable
    
    
    2,348
    
    
    
    1,308Deferred rent
    
    
    (157
    )
    
    
    (136
    )Deferred revenue
    
    
    (35
    )
    
    
    496Net cash provided by operating activities
    
    
    6,281
    
    
    
    6,343Investing activitiesCapital expenditures
    
    
    (3,556
    )
    
    
    (3,818
    )Purchases of marketable securities
    
    
    (71,412
    )
    
    
    (62,954
    )Sales of marketable securities
    
    
    69,188
    
    
    
    61,159Net cash used in investing activities
    
    
    (5,780
    )
    
    
    (5,613
    )Financing activitiesPayments of capital lease obligations and notes payable
    
    
    (1
    )
    
    
    (734
    )Excess tax benefits from stock-based compensation
    
    
    53
    
    
    
    Net proceeds from exercise and repurchase of stock options
    
    
    329
    
    
    
    (203
    )Employee Stock Ownership Plan distributions
    
    
    
    
    
    
    (10
    )Net cash provided by (used in) financing activities
    
    
    381
    
    
    
    (947
    )Net increase (decrease) in cash and cash equivalents
    
    
    882
    
    
    
    (217
    )Cash and cash equivalents at beginning of period
    
    
    22,491
    
    
    
    13,972Cash and cash equivalents at end of period
    
    $
    23,373
    
    
    $
    13,755Supplemental disclosures of cash flow informationInterest paid
    
    $
    
    
    
    $
    10Income taxes paid
    
    $
    49
    
    
    $
    27Noncash transactions:Purchase of equipment included in accounts payable and accrued liabilities
    
    $
    937
    
    
    $
    261Purchase of equipment through capital lease obligations
    
    $
    
    
    
    $
    16Reclassification of deferred initial public offering costs from prepaid expenses to equity
    
    $
    6
    
    
    $
    Retirement of equipment financed through capital lease obligations
    
    $
    11
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements.
 3




---



##### Table of Contents



CAPELLA EDUCATION COMPANY
Notes to Consolidated Financial Statements
(In thousands, except per share data)
 1. Nature of Business
  2. Summary of Significant Accounting Policies
 Consolidation
  Unaudited Interim Financial Information
  Marketable Securities
 Accounting for Certain
Investments in Debt and Equity Securities Restatement and Revision of Accounting Research Bulletins
 4




---



##### Table of Contents



Use of Estimates
  Contingencies
  Deferred Offering Costs
  3. Net Income Per Common Share
   Three Months EndedMarch 31,2007
    
    
    2006(Unaudited)Numerator:Net income
    
    $
    3,844
    
    
    $
    1,642Denominator:Denominator for basic net income per common share
 weighted average shares outstanding
    
    
    16,015
    
    
    
    11,653Effect of dilutive stock options and warrants
    
    
    685
    
    
    
    335Denominator for diluted net income per common share
    
    
    16,700
    
    
    
    11,988Basic net income per common share
    
    $
    0.24
    
    
    $
    0.14Diluted net income per common share
    
    $
    0.23
    
    
    $
    0.14
  4. Income Taxes
 Accounting for Uncertainty in
Income Taxes  an interpretation of FASB Statement No. 109
 5




---



##### Table of Contents



5. Accrued Liabilities
  As of
    
    
    As ofMarch 31,
    
    
    December 31,2007
    
    
    2006(Unaudited)Accrued compensation and benefits
    
    $
    4,574
    
    
    $
    3,618Accrued instructional fees
    
    
    4,192
    
    
    
    4,470Accrued vacation
    
    
    1,266
    
    
    
    1,047Customer deposits
    
    
    1,215
    
    
    
    1,218Other
    
    
    8,703
    
    
    
    8,245$
    19,950
    
    
    $
    18,598
 6. Litigation
  7. Stock-Based Compensation
  6




---



##### Table of Contents



Weighted-Plan Options
    
    
    AverageAvailable
    
    
    Outstanding
    
    
    Exercise PriceService-based Stock Options
    
    for Grant
    
    
    Incentive
    
    
    Non-Qualified
    
    
    per ShareBalance, December 31, 2006
    
    
    2,168
    
    
    
    978
    
    
    
    1,010
    
    
    $
    16.46Granted
    
    
    (28
    )
    
    
    
    
    
    
    28
    
    
    
    31.08Exercised
    
    
    
    
    
    
    (23
    )
    
    
    (3
    )
    
    
    12.67Canceled
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    11.71Balance, March 31, 2007 (unaudited)(a)
    
    
    2,140
    
    
    
    954
    
    
    
    1,035
    
    
    
    16.71
 
 (a)
    
    The total available for grant, after deducting the 190 outstanding
performance-based stock options, was 1,950. Weighted-Weighted-
    
    AverageAverage
    
    Remaining
    
    AggregateNumber of
    
    Exercise
    
    Contractual
    
    IntrinsicService-based Stock Options
    
    Shares
    
    Price
    
    Term
    
    ValueBalance at March 31, 2007 (unaudited)
    
    
    1,989
    
    
    $
    16.71
    
    
    
    6.6
    
    
    $
    33,487Vested and expected to vest, March 31, 2007 (unaudited)
    
    
    1,918
    
    
    $
    16.58
    
    
    
    6.5
    
    
    $
    32,523Exercisable, March 31, 2007 (unaudited)
    
    
    1,065
    
    
    $
    14.26
    
    
    
    5.5
    
    
    $
    20,534
    Proceeds from stock options exercised
    
    $
    329Tax benefits related to stock options exercised
    
    
    95Intrinsic value of stock options exercised
    
    
    477
  7




---



##### Table of Contents



Three MonthsEnded March 31,2007
    
    
    2006(Unaudited)Instructional costs and services
    
    $
    250
    
    
    $
    190Marketing and promotional
    
    
    123
    
    
    
    98General and administrative
    
    
    311
    
    
    
    496Stock-based compensation expense included in operating income
    
    
    684
    
    
    
    784Tax benefit
    
    
    150
    
    
    
    178Stock-based compensation expense, net of tax
    
    $
    534
    
    
    $
    606
  8. Regulatory Supervision and Oversight
     8




---



##### Table of Contents



9




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion of our historical results of operations and our liquidity and capital
resources should be read in conjunction with the consolidated financial statements and related
notes that appear elsewhere in this report.
 Forward-Looking Statements
   Overview
 Background
   10




---



##### Table of Contents



Critical Accounting Policies and Use of Estimates
  Results of Operations
  Three MonthsEnded March 31,2007
    
    
    2006Revenues
    
    
    100.0
    %
    
    
    100.0
    %Costs and expenses
Instructional costs and services
    
    
    44.5
    
    
    
    48.7Marketing and promotional
    
    
    34.7
    
    
    
    34.2General and administrative
    
    
    11.3
    
    
    
    12.6Total costs and expenses
    
    
    90.5
    
    
    
    95.5Operating income
    
    
    9.5
    
    
    
    4.5Other income, net
    
    
    2.1
    
    
    
    2.2Income before income taxes
    
    
    11.6
    
    
    
    6.7Income tax expense
    
    
    4.3
    
    
    
    2.8Net income
    
    
    7.3
    %
    
    
    3.9
    %
 Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006
 Revenues.
 Instructional costs and services expenses.
 11




---



##### Table of Contents



Marketing and promotional expenses.
 General and administrative expenses.
 Other income, net.
 Income tax expense.
 Net income.
 Liquidity and Capital Resources
 Liquidity
    12




---



##### Table of Contents



Operating Activities
  Investing Activities
     Financing Activities
  Regulatory Supervision and Oversight
  13




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
  
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  14




---



##### Table of Contents



Changes in internal control over financial reporting.
  
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  The Office of Inspector General of
the U.S. Department of Education has commenced a compliance audit of Capella University which is
ongoing and which may result in repayment of Title IV funds, interest, fines, penalties, remedial
action, and damage to our reputation in the industry
   15




---



##### Table of Contents



If Capella University does not
maintain its authorization in Minnesota, it may not operate or participate in Title IV programs.
 Investigations by state attorneys general, Congress and governmental agencies regarding
relationships between loan providers and education institutions and their financial aid
officers may have a material and adverse impact on our reputation and results of
operations.
  16




---



##### Table of Contents



17




---



##### Table of Contents



Our regulatory environment and our reputation may be
negatively influenced by the actions of other for-profit institutions
 Our regulatory environment and our reputation may be negatively influenced by the actions
of other post-secondary educational institutions.
  We may not be able to retain our
key personnel or hire and retain the personnel we need to sustain and grow our business
   
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 Recent Sales of Unregistered Securities
  18




---



##### Table of Contents



Purchases of Equity Securities by the Issuer and Affiliated Purchasers
  Total Number of
    
    Approximate DollarShares Purchased as
    
    Value of SharesPart of Publicly
    
    That May Yet BeTotal Number of
    
    Average Price Paid
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Shares Purchased
    
    per Share
    
    Programs
    
    Plans or Programs1/1/2007 to 1/31/2007
    
    
    8,371
    
    
    $
    25.03
    
    
    
    
    
    
    
    2/1/2007 to 2/28/2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3/1/2007 to 3/31/2007
    
    
    1,846
    
    
    $
    32.15
    
    
    
    
    
    
    
    Total
    
    
    10,217
    
    
    $
    26.31
    
    
    
    
    
    
    
    
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  Number
    
    Description
    
    Method of Filing3.1
    
    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*
    
    Annual Incentive Plan  Management Employees 
2007
    
    Incorporated by
reference to Exhibit
10.1 to the
Companys Current
Report on Form 8-K
filed with the SEC
on February 15,
2007.31.1
    
    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.
 
 *
    
    Management contract or compensatory plan or arrangement. 19




---



##### Table of Contents



SIGNATURES
   /s/ Stephen G. Shank
    
    May 7, 2007Stephen G. ShankChairman and Chief Executive Officer(Principal Executive Officer)/s/ Lois M. Martin
    
    May 7, 2007Lois M. MartinSenior Vice President and ChiefFinancial Officer (Principal Financial Officer)/s/ Amy L. Drifka
    
    May 7, 2007Amy L. DrifkaVice President and Controller(Principal Accounting Officer)
 20