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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, 2009

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ̈    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 |  | x                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|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 24, 2009, was 16,719,129.









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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 |  | 14  
|Item 3 Quantitative and Qualitative Disclosures About Market Risk                            |  | 20  
|Item 4 Controls and Procedures                                                               |  | 20  
|                                                                                             | 
|PART II  OTHER INFORMATION                                                                  |  |     
|                                                                                             | 
|Item 1 Legal Proceedings                                                                     |  | 21  
|Item 1A Risk Factors                                                                         |  | 21  
|Item 2 Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 21  
|Item 3 Defaults Upon Senior Securities                                                       |  | 22  
|Item 4 Submission of Matters to a Vote of Security Holders                                   |  | 22  
|Item 5 Other Information                                                                     |  | 22  
|Item 6 Exhibits                                                                              |  | 22  
|SIGNATURES                                                                                   |  | 24  



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##### Table of Contents

PART I  FINANCIAL INFORMATION



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

CAPELLA EDUCATION COMPANY

Consolidated Balance Sheets

(In thousands, except par value)



|                                                                                                 |  |                    |         |                        |   |         |  
|------------------------------------------------------------------------------------------------ |  | ------------------ | ------- | ---------------------- | - | ------- | -
|                                                                                                 |  | As of June 30,2009 |         | As of December 31,2008 |  
|                                                                                                 |  | (Unaudited)        |         |                        |  
|ASSETS                                                                                           |  |                    |         |                        |   |         |  
|Current assets:                                                                                  |  |                    |         |                        |   |         |  
|Cash and cash equivalents                                                                        |  | $                  | 60,894  |                        | $ | 31,225  |  
|Marketable securities                                                                            |  |                    | 85,857  |                        |   | 92,372  |  
|Accounts receivable, net of allowance of $1,340 at June 30, 2009 and $1,419 at December 31, 2008 |  |                    | 12,340  |                        |   | 11,949  |  
|Prepaid expenses and other current assets                                                        |  |                    | 7,448   |                        |   | 5,184   |  
|Deferred income taxes                                                                            |  |                    | 3,557   |                        |   | 3,477   |  
|                                                                                                 |  |                    |         |                        |   |         |  
|                                                                                                 |  |                   
|Total current assets                                                                             |  |                    | 170,096 |                        |   | 144,207 |  
|Property and equipment, net                                                                      |  |                    | 37,239  |                        |   | 35,349  |  
|                                                                                                 |  |                    |         |                        |   |         |  
|Total assets                                                                                     |  | $                  | 207,335 |                        | $ | 179,556 |  
|                                                                                                 |  |                    |         |                        |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                             |  |                    |         |                        |   |         |  
|Current liabilities:                                                                             |  |                    |         |                        |   |         |  
|Accounts payable                                                                                 |  | $                  | 5,814   |                        | $ | 2,227   |  
|Accrued liabilities                                                                              |  |                    | 23,519  |                        |   | 18,926  |  
|Income taxes payable                                                                             |  |                    |        |                        |   | 150     |  
|Deferred revenue                                                                                 |  |                    | 8,454   |                        |   | 9,495   |  
|                                                                                                 |  |                    |         |                        |   |         |  
|Total current liabilities                                                                        |  |                    | 37,787  |                        |   | 30,798  |  
|Deferred rent                                                                                    |  |                    | 2,814   |                        |   | 1,321   |  
|Other liabilities                                                                                |  |                    | 531     |                        |   | 531     |  
|Deferred income taxes                                                                            |  |                    | 6,278   |                        |   | 6,069   |  
|                                                                                                 |  |                    |         |                        |   |         |  
|Total liabilities                                                                                |  |                    | 47,410  |                        |   | 38,719  |  
|                                                                                                 |  |                   
|Shareholders equity:                                                                            |  |                    |         |                        |   |         |  
|Common stock, $0.01 par value:                                                                   |  |                    |         |                        |   |         |  
|Authorized shares  100,000                                                                      |  |                    |         |                        |   |         |  
|Issued and outstanding shares  16,709 at June 30, 2009 and 16,666 at December 31, 2008          |  |                    | 167     |                        |   | 166     |  
|Additional paid-in capital                                                                       |  |                    | 152,172 |                        |   | 151,445 |  
|Accumulated other comprehensive income                                                           |  |                    | 1,059   |                        |   | 575     |  
|Retained earnings (accumulated deficit)                                                          |  |                    | 6,527   |                        |   | (11,349 | )
|                                                                                                 |  |                    |         |                        |   |         |  
|Total shareholders equity                                                                       |  |                    | 159,925 |                        |   | 140,837 |  
|                                                                                                 |  |                    |         |                        |   |         |  
|Total liabilities and shareholders equity                                                       |  | $                  | 207,335 |                        | $ | 179,556 |  
|                                                                                                 |  |                    |         |                        |   |         |  

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,
|                                                      |  | 2009                       |        | 2008                     |   | 2009   |  | 2008
|                                                      |  | (Unaudited)               
|Revenues                                              |  | $                          | 80,096 |                          | $ | 66,049 |  | $    | 156,531 |  | $ | 131,300
|Costs and expenses:                                   |  |                            |        |                          |   |        |  |      |         |  |   |        
|Instructional costs and services                      |  |                            | 33,550 |                          |   | 30,844 |  |      | 64,632  |  |   | 59,860 
|Marketing and promotional                             |  |                            | 23,573 |                          |   | 19,573 |  |      | 48,405  |  |   | 40,966 
|General and administrative                            |  |                            | 8,719  |                          |   | 6,968  |  |      | 17,052  |  |   | 14,698 
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Total costs and expenses                              |  |                            | 65,842 |                          |   | 57,385 |  |      | 130,089 |  |   | 115,524
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Operating income                                      |  |                            | 14,254 |                          |   | 8,664  |  |      | 26,442  |  |   | 15,776 
|Other income, net                                     |  |                            | 702    |                          |   | 1,008  |  |      | 1,388   |  |   | 2,397  
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Income before income taxes                            |  |                            | 14,956 |                          |   | 9,672  |  |      | 27,830  |  |   | 18,173 
|Income tax expense                                    |  |                            | 5,416  |                          |   | 3,314  |  |      | 9,954   |  |   | 6,327  
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Net income                                            |  | $                          | 9,540  |                          | $ | 6,358  |  | $    | 17,876  |  | $ | 11,846 
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Net income per common share:                          |  |                            |        |                          |   |        |  |      |         |  |   |        
|Basic                                                 |  | $                          | 0.57   |                          | $ | 0.38   |  | $    | 1.07    |  | $ | 0.70   
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Diluted                                               |  | $                          | 0.56   |                          | $ | 0.37   |  | $    | 1.05    |  | $ | 0.67   
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Weighted average number of common shares outstanding: |  |                            |        |                          |   |        |  |      |         |  |   |        
|Basic                                                 |  |                            | 16,708 |                          |   | 16,740 |  |      | 16,701  |  |   | 17,028 
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        
|Diluted                                               |  |                            | 17,045 |                          |   | 17,303 |  |      | 17,046  |  |   | 17,599 
|                                                      |  |                            |        |                          |   |        |  |      |         |  |   |        

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, |       
|                                                                                  |  | 2009                     |        |   | 2008 |  
|                                                                                  |  | (Unaudited)              |       
|Operating activities                                                              |  |                          |        |   |      |   |         |  
|Net income                                                                        |  | $                        | 17,876 |   |      | $ | 11,846  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |        |   |      |   |         |  
|Provision for bad debts                                                           |  |                          | 3,277  |   |      |   | 2,469   |  
|Depreciation and amortization                                                     |  |                          | 6,856  |   |      |   | 5,857   |  
|Amortization of investment premium                                                |  |                          | 891    |   |      |   | 942     |  
|Asset impairment                                                                  |  |                          | 10     |   |      |   | 11      |  
|Gain realized on sale of marketable securities                                    |  |                          |       |   |      |   | (216    | )
|Stock-based compensation                                                          |  |                          | 1,541  |   |      |   | 2,421   |  
|Excess tax benefits from stock-based compensation                                 |  |                          | (1,154 | ) |      |   | (1,364  | )
|Deferred income taxes                                                             |  |                          | (173   | ) |      |   | (587    | )
|Changes in operating assets and liabilities:                                      |  |                          |        |   |      |   |         |  
|Accounts receivable                                                               |  |                          | (3,668 | ) |      |   | (3,764  | )
|Prepaid expenses and other current assets                                         |  |                          | (1,138 | ) |      |   | 1,500   |  
|Accounts payable and accrued liabilities                                          |  |                          | 7,349  |   |      |   | (6,483  | )
|Income taxes payable                                                              |  |                          | (41    | ) |      |   | 5,071   |  
|Deferred rent                                                                     |  |                          | 1,493  |   |      |   | 72      |  
|Deferred revenue                                                                  |  |                          | (1,041 | ) |      |   | 1,399   |  
|                                                                                  |  |                          |        |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                          | 32,078 |   |      |   | 19,174  |  
|Investing activities                                                              |  |                          |        |   |      |   |         |  
|Capital expenditures                                                              |  |                          | (7,955 | ) |      |   | (7,058  | )
|Purchases of marketable securities                                                |  |                          |       |   |      |   | (72,255 | )
|Sales and maturities of marketable securities                                     |  |                          | 6,410  |   |      |   | 54,496  |  
|                                                                                  |  |                          |        |   |      |   |         |  
|Net cash used in investing activities                                             |  |                          | (1,545 | ) |      |   | (24,817 | )
|Financing activities                                                              |  |                          |        |   |      |   |         |  
|Excess tax benefits from stock-based compensation                                 |  |                          | 1,154  |   |      |   | 1,364   |  
|Net proceeds from exercise of stock options                                       |  |                          | 2,637  |   |      |   | 2,021   |  
|Repurchase of common stock                                                        |  |                          | (4,655 | ) |      |   | (50,000 | )
|                                                                                  |  |                          |        |   |      |   |         |  
|Net cash used in financing activities                                             |  |                          | (864   | ) |      |   | (46,615 | )
|                                                                                  |  |                          |        |   |      |   |         |  
|                                                                                  |  |                         
|Net increase (decrease) in cash and cash equivalents                              |  |                          | 29,669 |   |      |   | (52,258 | )
|Cash and cash equivalents at beginning of period                                  |  |                          | 31,225 |   |      |   | 60,600  |  
|                                                                                  |  |                          |        |   |      |   |         |  
|Cash and cash equivalents at end of period                                        |  | $                        | 60,894 |   |      | $ | 8,342   |  
|                                                                                  |  |                          |        |   |      |   |         |  
|                                                                                  |  |                         
|Supplemental disclosures of cash flow information                                 |  |                          |        |   |      |   |         |  
|Income taxes paid                                                                 |  | $                        | 10,188 |   |      | $ | 1,843   |  
|                                                                                  |  |                          |        |   |      |   |         |  
|                                                                                  |  |                         
|Noncash transactions:                                                             |  |                          |        |   |      |   |         |  
|Purchase of equipment included in accounts payable and accrued liabilities        |  | $                        | 1,151  |   |      | $ | 951     |  
|                                                                                  |  |                          |        |   |      |   |         |  

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



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CAPELLA EDUCATION COMPANY

Notes to Consolidated Financial Statements

(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 operating segment. The University is an online postsecondary
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, 2008 (2008 Annual Report on Form 10-K).

Marketable Securities

The Company accounts for marketable securities in accordance with the provisions of the Financial Accounting Standards Boards
(FASB) Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities(FAS 115). FAS 115 addresses the accounting and reporting for marketable fixed maturity and equity securities.
Management determines the appropriate designation of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. All of the Companys marketable securities are classified as available-for-sale as of
June 30, 2009 and December 31, 2008.

Available-for-sale marketable securities are carried at fair value as determined by quoted
market prices or other observable inputs that are either directly or indirectly observable in the marketplace for identical or similar assets, with unrealized gains and losses, net of tax, reported as a separate component of shareholders
equity. Management reviews the fair value of the portfolio at least monthly, and evaluates individual securities with fair values below amortized cost at the balance sheet date in accordance with FASB Staff Position (FSP) FAS 115-2 and FAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS 115-2). In order to determine whether an impairment is other than temporary, FSP FAS 115-2 requires management to conclude whether they intend to sell the impaired
security and whether it is not more likely than not that they will be required to sell the security before the recovery of its amortized cost basis. If management intends to sell an impaired debt security or it is more likely than not they will be
required to sell prior to recovery of its amortized cost basis, an other-than-temporary impairment is deemed to have occurred. The amount of the other-than-temporary impairment related to a credit loss or impairments on securities we have the intent
to sell before recovery are recognized in earnings and reflected as a reduction in the cost basis of the security. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes
in the fair value of all other available-for-sale securities as a component of shareholders equity in other comprehensive income or loss with no change to the cost basis of the security.

The cost of securities sold is based on the specific identification method. Amortization of premiums, accretion of discounts, interest and dividend
income and realized gains and losses are included in investment income. The Company classifies all marketable securities as current assets in accordance with Accounting Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting
Research Bulletins, because the assets are available to fund current operations.



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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.

Subsequent Events

The Company has reviewed and evaluated subsequent events and transactions for material subsequent events through July 28, 2009, the date the financial statements are issued.

Recent Accounting Pronouncements

In July 2009, the FASB issued Statement of Financial Accounting Standards No. 168, the FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles  a replacement of FASB Statement
No. 162 (FAS 168). With the issuance of FAS 168, the FASB Accounting Standards Codification (Codification) becomes the single source of authoritative U.S. accounting and reporting standards applicable for all nongovernmental entities, with
the exception of guidance issued by the Securities and Exchange Commission (SEC). The Codification does not change current U.S. GAAP, but changes the referencing of financial standards, and is intended to simplify user access to authoritative U.S.
GAAP by providing all the authoritative literature related to a particular topic in one place. The Codification is effective for interim and annual periods ending after September 15, 2009, and is effective for the Companys third quarter
of 2009. At that time, all references made to U.S. GAAP will use the new Codification numbering system prescribed by the FASB. We are currently evaluating the impact to the Companys financial reporting process of providing Codification
references in the Companys public filings. However, as the Codification is not intended to change or alter existing US GAAP, it is not expected to have any impact on the Companys consolidated financial position or results of
operations.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events (FAS
165), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. FAS 165 also requires entities
to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected. FAS 165 is effective for interim and annual periods ending after June 15, 2009. Accordingly, the Company has adopted
the provisions of FAS 165 and the adoption has not had a material impact on the Companys financial condition, results of operations, or disclosures.

In April 2009, the FASB issued three FSPs to address concerns about measuring the fair value of financial instruments when the markets become inactive and quoted prices may reflect distressed transactions, recording
impairment charges on investments in debt instruments, and requiring the disclosure of fair value of certain financial instruments in interim financial statements. The first Staff Position, FSP FAS 157-4, Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides additional guidance to highlight and expand on the factors that should be considered in estimating fair
value when there has been a significant decrease in market activity for a financial asset. The second Staff Position, FSP FAS 115-2, changes the method for determining whether an other-than-temporary impairment exists for debt securities and the
amount of an impairment charge to be recorded in earnings. The third Staff Position, FSP FAS 107-1 and APB 28-1,Interim Disclosures about Fair Value of Financial Instruments increases the frequency of fair value disclosures from annual only
to quarterly. All three FSPs are effective for interim periods ending after June 15, 2009, with the option to early adopt for interim periods ending after March 15, 2009. The FSPs were adopted by the Company on April 1, 2009 and the
impact on the Companys financial statements was not material.



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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. Dilutive shares are computed using the treasury stock method and include the
incremental effect of shares that would be issued upon the assumed exercise of stock options and the vesting of restricted stock.

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



|                                                                                        |  |                                       |        |                          |   |        |  |      |        |  |   |       
|--------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                        |  | Three Months EndedJune 30,            |        | Six Months EndedJune 30,
|                                                                                        |  | 2009                                  |        | 2008                     |   | 2009   |  | 2008
|                                                                                        |  | (in thousands, except per share data)
|Numerator:                                                                              |  |                                       |        |                          |   |        |  |      |        |  |   |       
|Net income                                                                              |  | $                                     | 9,540  |                          | $ | 6,358  |  | $    | 17,876 |  | $ | 11,846
|Denominator:                                                                            |  |                                       |        |                          |   |        |  |      |        |  |   |       
|Denominator for basic net income per common share  weighted average shares outstanding |  |                                       | 16,708 |                          |   | 16,740 |  |      | 16,701 |  |   | 17,028
|Effect of dilutive stock options and restricted stock                                   |  |                                       | 337    |                          |   | 563    |  |      | 345    |  |   | 571   
|                                                                                        |  |                                       |        |                          |   |        |  |      |        |  |   |       
|Denominator for diluted net income per common share                                     |  |                                       | 17,045 |                          |   | 17,303 |  |      | 17,046 |  |   | 17,599
|                                                                                        |  |                                       |        |                          |   |        |  |      |        |  |   |       
|Basic net income per common share                                                       |  | $                                     | 0.57   |                          | $ | 0.38   |  | $    | 1.07   |  | $ | 0.70  
|Diluted net income per common share                                                     |  | $                                     | 0.56   |                          | $ | 0.37   |  | $    | 1.05   |  | $ | 0.67  

Options to purchase 0.3 million and 0.2 million 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, 2009 and 2008, respectively, because their effect would be antidilutive. Options to purchase 0.3 million and
0.1 million 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, 2009 and 2008, respectively, because their effect would be antidilutive.

4. Marketable Securities

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



|                                |  |                   |        |                      |   |                         |  |   |                    |   |  |   |       
|------------------------------- |  | ----------------- | ------ | -------------------- | - | ----------------------- |  | - | ------------------ | - |  | - | ------
|                                |  | June 30, 2009    
|                                |  | AmortizedCost     |        | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | EstimatedFairValue
|                                |  | (in thousands)   
|Tax-exempt municipal securities |  | $                 | 84,172 |                      | $ | 1,685                   |  | $ |                   |   |  | $ | 85,857
|                                |  |                   |        |                      |   |                         |  |   |                    |   |  |   |       
|Total                           |  | $                 | 84,172 |                      | $ | 1,685                   |  | $ |                   |   |  | $ | 85,857
|                                |  |                   |        |                      |   |                         |  |   |                    |   |  |   |       
|                                | 
|                                |  | December 31, 2008
|                                |  | AmortizedCost     |        | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | EstimatedFairValue
|                                |  | (in thousands)   
|Tax-exempt municipal securities |  | $                 | 91,474 |                      | $ | 957                     |  | $ | (59                | ) |  | $ | 92,372
|                                |  |                   |        |                      |   |                         |  |   |                    |   |  |   |       
|Total                           |  | $                 | 91,474 |                      | $ | 957                     |  | $ | (59                | ) |  | $ | 92,372
|                                |  |                   |        |                      |   |                         |  |   |                    |   |  |   |       

The unrealized gains and losses on the Companys investments in municipal securities were
caused by changes in market values primarily due to interest rate changes and are included in accumulated other comprehensive income. The Company did not have any securities in an unrealized loss position as of June 30, 2009. All of our
securities in an unrealized loss position as of December 31, 2008 had been in an unrealized loss position for less than twelve months. There were no other-than-temporary impairment charges recorded during the first half of 2009.



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The remaining contractual maturities of the Companys marketable securities are shown below:



|                                      |  |                    |        |                        |   |       
|------------------------------------- |  | ------------------ | ------ | ---------------------- | - | ------
|                                      |  | As of June 30,2009 |        | As of December 31,2008
|                                      |  | (in thousands)    
|Due within one year                   |  | $                  | 8,972  |                        | $ | 14,580
|Due after one year through five years |  |                    | 49,846 |                        |   | 48,378
|Due after six through ten years       |  |                    | 7,337  |                        |   | 9,545 
|Due after ten years                   |  |                    | 19,702 |                        |   | 19,869
|                                      |  |                    |        |                        |   |       
|                                      |  | $                  | 85,857 |                        | $ | 92,372
|                                      |  |                    |        |                        |   |       

The following table is a summary of the proceeds from the sale of available-for-sale securities,
the gross realized gains and the gross realized losses on sales of investments classified as available-for-sale included in earnings for the three and six months ended June 30, 2009 and 2008:



|                                                             |  |                            |       |                          |   |        |  |      |       |  |   |       
|------------------------------------------------------------ |  | -------------------------- | ----- | ------------------------ | - | ------ |  | ---- | ----- |  | - | ------
|                                                             |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                                             |  | 2009                       |       | 2008                     |   | 2009   |  | 2008
|                                                             |  | (in thousands)            
|Proceeds from the sale and maturity of marketable securities |  | $                          | 6,410 |                          | $ | 16,486 |  | $    | 6,410 |  | $ | 54,496
|Gross realized gains                                         |  |                            |      |                          |   | 47     |  |      |      |  |   | 216   
|Gross realized losses                                        |  |                            |      |                          |   |       |  |      |      |  |   |      

On January 1, 2008, the Company adopted the provisions of FASB Statement No. 157 (FAS
157), Fair Value Measurements. FAS 157 defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements.

FAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction between market participants. FAS 157 also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs
(highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. In accordance with FAS 157, fair value measurements are classified under the
following hierarchy:



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



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



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

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



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The following tables summarizes certain fair value information for assets and liabilities measured at
fair value on a recurring basis as of June 30, 2009 and December 31, 2008:



|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  
|--------------------------------------- |  | -------------- | ------- | --------------------------------------------------------- | - | ----------------------------------------- |  | -------------------------------------- | ------ |  | - | -
|                                        |  |                |         | Fair Value Measurements as ofJune 30, 2009
Using         
|Description                             |  | Fair Value     |         | Quoted Pricesin ActiveMarkets forIdenticalAssets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservableInputs(Level 3)
|                                        |  | (in thousands)
|Cash and cash equivalents               |  | $              | 60,894  |                                                           | $ | 60,894                                    |  | $                                      |       |  | $ | 
|Marketable securities  municipal bonds |  | $              | 85,857  |                                                           | $ |                                          |  | $                                      | 85,857 |  | $ | 
|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  
|                                        |  | $              | 146,751 |                                                           | $ | 60,894                                    |  | $                                      | 85,857 |  | $ | 
|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  



|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  
|--------------------------------------- |  | -------------- | ------- | --------------------------------------------------------- | - | ----------------------------------------- |  | -------------------------------------- | ------ |  | - | -
|                                        |  |                |         | Fair Value Measurements as ofDecember 31, 2008 Using     
|Description                             |  | Fair Value     |         | Quoted Pricesin ActiveMarkets forIdenticalAssets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservableInputs(Level 3)
|                                        |  | (in thousands)
|Cash and cash equivalents               |  | $              | 31,225  |                                                           | $ | 31,225                                    |  | $                                      |       |  | $ | 
|Marketable securities  municipal bonds |  | $              | 92,372  |                                                           | $ |                                          |  | $                                      | 92,372 |  | $ | 
|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  
|                                        |  | $              | 123,597 |                                                           | $ | 31,225                                    |  | $                                      | 92,372 |  | $ | 
|                                        |  |                |         |                                                           |   |                                           |  |                                        |        |  |   |  

In accordance with FAS 157, the Company measures cash and cash equivalents at fair value primarily
using real-time quotes for transactions in active exchange markets involving identical assets. The Companys municipal bonds are classified within Level 2 and are valued using readily available pricing sources for comparable instruments
utilizing market observable inputs. The Company does not hold securities in inactive markets.

As of June 30, 2009, the Company does
not have any liabilities that were required to be measured at fair value in accordance with FAS 157 on a recurring basis.

5. Accrued Liabilities

Accrued liabilities consist of the following:



|                                  |  |                   |        |                       |   |       
|--------------------------------- |  | ----------------- | ------ | --------------------- | - | ------
|                                  |  | As ofJune 30,2009 |        | As ofDecember 31,2008
|                                  |  | (in thousands)   
|Accrued compensation and benefits |  | $                 | 6,285  |                       | $ | 6,903 
|Accrued instructional             |  |                   | 2,965  |                       |   | 2,526 
|Accrued vacation                  |  |                   | 2,023  |                       |   | 1,400 
|Customer deposits                 |  |                   | 1,521  |                       |   | 1,370 
|Other                             |  |                   | 10,725 |                       |   | 6,727 
|                                  |  |                   |        |                       |   |       
|                                  |  | $                 | 23,519 |                       | $ | 18,926
|                                  |  |                   |        |                       |   |       



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6. Commitments and Contingencies

Leasehold Agreements

The Company leases its office facilities and certain office equipment under
various noncancelable operating leases. Future minimum lease commitments under the leases as of June 30, 2009, are as follows:



|                    |  |                |       
|------------------- |  | -------------- | ------
|                    |  | Operating     
|                    |  | (in thousands)
|2009                |  | $              | 2,093 
|2010                |  |                | 4,603 
|2011                |  |                | 5,106 
|2012                |  |                | 5,259 
|2013                |  |                | 5,417 
|2014 and thereafter |  |                | 10,344
|                    |  |                |       
|Total               |  | $              | 32,822
|                    |  |                |       

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 and lease incentives received from lessors are recognized on a straight-line
basis as a reduction to rent expense from the date the Company takes possession of the property through the end of the lease term. The Company records the unamortized portion of the incentive as a part of deferred rent, in accrued liabilities or
long-term liabilities, as appropriate.

Line of Credit

The Company maintains an unsecured $10.0 million line of credit with Wells Fargo Bank. The line of credit expired on June 30, 2009 and was renewed through June 30, 2010. There have been no borrowings under
this line of credit at June 30, 2009 or December 31, 2008. An unsecured letter of credit in the amount of $1.1 million, which expires on July 31, 2009, was issued under the $10.0 million line of credit in favor of the Department of
Education in connection with its annual review of student lending activities. On July 15, 2009, the Company renewed the letter of credit through July 31, 2010 and increased the amount to $1.4 million.

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.

7. Common Stock

During the first half of 2008, the Company commenced and completed a $50.0 million stock repurchase program. Under this program the Company repurchased
0.9 million shares for a total consideration of $50.0 million.

During the second half of 2008, the Company commenced an additional
stock repurchase program for up to $60.0 million of the Companys common stock. As of June 30, 2009, the Company had repurchased 0.3 million shares under this program for total consideration of $13.0 million. Cash spent on the
purchase of shares during the six months ended June 30, 2009 totaled $4.7 million.

8. Stock-Based Compensation

The table below reflects the Companys stock-based compensation expense recognized in the consolidated statements of income for the three and six
months ended June 30, 2009 and 2008:



|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|------------------------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                                              |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                                              |  | 2009                       |       | 2008                     |   | 2009  |  | 2008
|                                                              |  | (in thousands)             |       | (in thousands)          
|Instructional costs and services                              |  | $                          | 308   |                          | $ | 458   |  | $    | 432   |  | $ | 790  
|Marketing and promotional                                     |  |                            | 124   |                          |   | 265   |  |      | 208   |  |   | 464  
|General and administrative                                    |  |                            | 695   |                          |   | 656   |  |      | 901   |  |   | 1,167
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|Stock-based compensation expense included in operating income |  |                            | 1,127 |                          |   | 1,379 |  |      | 1,541 |  |   | 2,421
|Tax benefit                                                   |  |                            | 353   |                          |   | 421   |  |      | 488   |  |   | 705  
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      
|Stock-based compensation expense, net of tax                  |  | $                          | 774   |                          | $ | 958   |  | $    | 1,053 |  | $ | 1,716
|                                                              |  |                            |       |                          |   |       |  |      |       |  |   |      



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



|                                |  |                                       |           |  |                         |               |  |                                         |   |  |   |      
|------------------------------- |  | ------------------------------------- | --------- |  | ----------------------- | ------------- |  | --------------------------------------- | - |  | - | -----
|                                |  | Availablefor Grant                    |           |  | Plan OptionsOutstanding |               |  | Weighted-AverageExercise Priceper Share
|Service-based Stock Options     |  |                                       | Incentive |  |                         | Non-Qualified |  |                                        
|                                |  | (in thousands, except per share data)
|Balance, December 31, 2008      |  | 1,742                                 |           |  | 310                     |               |  | 692                                     |   |  | $ | 31.39
|Granted                         |  | (147                                  | )         |  |                        |               |  | 147                                     |   |  |   | 52.80
|Exercised                       |  |                                      |           |  | (47                     | )             |  | (88                                     | ) |  |   | 19.50
|Canceled                        |  | 67                                    |           |  | (1                      | )             |  | (66                                     | ) |  |   | 44.65
|                                |  |                                       |           |  |                         |               |  |                                         |   |  |   |      
|Balance, June 30, 2009          |  | 1,662                                 |           |  | 262                     |               |  | 685                                     |   |  | $ | 35.48
|                                |  |                                       |           |  |                         |               |  |                                         |   |  |   |      
|                                |  |                                       |           | 
|Performance-based Stock Options |  |                                       |           |  |                         |               |  |                                         |   |  |  
|Balance, December 31, 2008      |  |                                       |           |  |                        |               |  | 30                                      |   |  | $ | 20.00
|Exercised                       |  |                                       |           |  |                        |               |  |                                        |   |  |   |     
|                                |  |                                       |           |  |                         |               |  |                                         |   |  |   |      
|Balance, June 30, 2009          |  |                                       |           |  |                        |               |  | 30                                      |   |  | $ | 20.00
|                                |  |                                       |           |  |                         |               |  |                                         |   |  |   |      

The outstanding performance-based stock options had a weighted-average remaining contractual life
of 6.6 years and an aggregate intrinsic value of $1.2 million at June 30, 2009.



|                                           |  |                                              |  |                               |       |                                          |     |                         |   |       
|------------------------------------------ |  | -------------------------------------------- |  | ----------------------------- | ----- | ---------------------------------------- | --- | ----------------------- | - | ------
|Service-based Stock Options                |  | Number ofShares                              |  | Weighted-AverageExercisePrice |       | Weighted-AverageRemainingContractualTerm |     | AggregateIntrinsicValue
|                                           |  | (in thousands, except contractual term data)
|Balance at June 30, 2009                   |  | 947                                          |  | $                             | 35.48 |                                          | 5.4 |                         | $ | 23,818
|Vested and expected to vest, June 30, 2009 |  | 906                                          |  | $                             | 34.94 |                                          | 5.4 |                         | $ | 23,279
|Exercisable, June 30, 2009                 |  | 449                                          |  | $                             | 25.10 |                                          | 4.9 |                         | $ | 15,872

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, 2009 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, 2009. The amount of aggregate intrinsic value will change based on the fair market value of the Companys stock.

Restricted
stock activity for the six months ended June 30, 2009 is summarized as follows:



|                           |  |                                      |   |  |                                               |      
|-------------------------- |  | ------------------------------------ | - |  | --------------------------------------------- | -----
|Restricted Stock           |  | Numberof Shares                      |   |  | Weighted-AverageGrant DateFair Valueper Share
|                           |  | (in thousands, exceptper share data)
|Balance, December 31, 2008 |  | 4                                    |   |  | $                                             | 53.45
|Granted                    |  | 32                                   |   |  |                                               | 51.97
|Vested                     |  | (1                                   | ) |  |                                               | 53.69
|Forfeited                  |  |                                     |   |  |                                               |     
|                           |  |                                      |   |  |                                               |      
|Balance, June 30, 2009     |  | 35                                   |   |  | $                                             | 52.10
|                           |  |                                      |   |  |                                               |      

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



|                                                |  |                            |       |                          |   |       |  |      |       |  |   |      
|----------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                                |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                                |  | 2009                       |       | 2008                     |   | 2009  |  | 2008
|                                                |  | (in thousands)            
|Proceeds from stock options exercised           |  | $                          | 986   |                          | $ | 1,383 |  | $    | 2,637 |  | $ | 2,021
|Tax benefits related to stock options exercised |  |                            | 404   |                          |   | 1,013 |  |      | 1,234 |  |   | 1,447
|Intrinsic value of stock options exercised      |  |                            | 1,697 |                          |   | 3,340 |  |      | 4,760 |  |   | 5,002



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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, 2009, total compensation cost related to nonvested service-based stock options not yet recognized was $10.2 million, which is
expected to be recognized over the next 29 months on a weighted-average basis.

9. 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 the University. The audit commenced on April 10, 2006 and the Company 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. The Company provided written comments on the
draft report to the OIG on September 25, 2007. On March 7, 2008, the OIGs final report was issued to the Acting Chief Operating Officer (COO) for Federal Student Aid (FSA), which is responsible for primary oversight of the Title IV
funding programs. The Company responded to the final report on April 8, 2008. Recently, the Company provided FSA staff with certain additional requested information for financial aid years 2002-2003 through 2006-2007. The FSA will subsequently
issue final findings and requirements for Capella University. The FSA may take certain actions, including requiring that the Company refund certain federal student aid funds, requiring the Company to modify its Title IV administration procedures,
and/or requiring the Company to pay fines or penalties.

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

Political and budgetary concerns significantly affect the Title IV Programs. Congress reauthorizes the HEA and other laws governing Title
IV Programs approximately every five to eight years. The last reauthorization of the HEA was completed in August 2008. Additionally, Congress reviews and determines appropriations for Title IV programs on an annual basis through the budget and
appropriations processes. As of June 30, 2009, programs in which the Companys learners participate are operative and sufficiently funded.

In the new Obama administrations 2010 budget request, the Department of Education proposed to eliminate the Federal Family Education Loan Program (FFELP) and instead require all Title IV student loans to be
administered through the Federal Direct Loan Program (FDLP) commencing July 1, 2010. The Company is qualified and approved to participate in the FDLP program and has pilot tested direct loans to certain of its learner groups. Beginning
with the 2010-2011 financial aid year on July 1, 2010, we expect to have the Companys entire learner base transitioned to the FDLP. If the



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Company experiences a disruption in its ability to process student loans, either because of administrative challenges on the Companys part or the
inability of the Department of Education to process the substantial increase in direct loans, the Companys business, financial condition, results of operations and cash flows could be adversely and materially affected. Proposals by the new
administration and the current economic downturn may result in other policy and program changes in the Department of Education which may present challenges for the Companys business.



|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, 2008, as updated in our subsequent reports filed with the SEC, including any updates found in Part II, Item 1A of
this or other reports on Form 10-Q. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements
are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such
forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect
the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with 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.

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. At June 30, 2009, we offered over 1,050 courses and 28 degree programs with 123 specializations at the
undergraduate and graduate levels to more than 29,000 learners.

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. We implemented an enterprise resource planning (ERP) system from 2006 through



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2008 in which the final module was implemented in July 2008. During the first half of 2008 we commenced and completed a $50.0 million stock repurchase
program, and during the third quarter of 2008 we commenced an additional stock repurchase program for up to $60.0 million of our common stock.

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, 2008. Other than with respect to the critical accounting policy below, there have been no significant changes in our critical accounting policies during the six months ended June 30, 2009.

Marketable SecuritiesOther than temporary impairments. Available-for-sale marketable securities are carried at fair value as
determined by quoted market prices or other observable inputs that are either directly or indirectly observable in the marketplace for identical or similar assets, with unrealized gains and losses, net of tax, reported as a separate component of
shareholders equity. Management reviews the fair value of the portfolio at least monthly, and evaluates individual securities with fair values below amortized cost at the balance sheet date in accordance with FSP FAS 115-2. In order to
determine whether an impairment is other than temporary, FSP FAS 115-2 requires us to conclude whether we intend to sell the impaired security and whether it is not more likely than not that we will be required to sell the security before the
recovery of its amortized cost basis. If we intend to sell an impaired debt security or it is more likely than not we will be required to sell prior to recovery of its amortized cost basis, an other-than-temporary impairment is deemed to have
occurred. The amount of the other-than-temporary impairment related to a credit loss or impairments on securities we have the intent to sell before recovery are recognized in earnings and reflected as a reduction in the cost basis of the
security. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of shareholders equity
in other comprehensive income or loss with no change to the cost basis of the security. There were no other-than-temporary impairment charges recorded during the first half of 2009.

Results of Operations

Three Months Ended June 30, 2009 Compared to Three Months Ended
June 30, 2008

The following selected financial data table should be referenced in connection with a review of the discussion
of our results of operations for the three months ended June 30, 2009:



|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|-------------------------------- |  | --------------------------- | ------ | - | -------- | - | ------ | ------------- |  | - | ------------ | - |  | ----- | - |  | ----------- | - |  | ---- | - |  | ---- | -
|                                 |  | Three Months Ended June 30, |       
|                                 |  | $ (in thousands)            |        |   | $ Change |   |        | % Change      |  |   | % of Revenue |  
|                                 |  | 2009                        |        |   | 2008     |   |        | 2009 vs. 2008 |  |   | 2009         |   |  | 2008  |   |  | 2009vs.2008 |  
|Revenues                         |  | $                           | 80,096 |   |          | $ | 66,049 |               |  | $ | 14,047       |   |  | 21.3  | % |  | 100         | % |  | 100  | % |  | 0.0  | %
|Costs and expenses:              |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Instructional costs and services |  |                             | 33,550 |   |          |   | 30,844 |               |  |   | 2,706        |   |  | 8.8   |   |  | 41.9        |   |  | 46.7 |   |  | (4.8 | )
|Marketing and promotional        |  |                             | 23,573 |   |          |   | 19,573 |               |  |   | 4,000        |   |  | 20.4  |   |  | 29.4        |   |  | 29.6 |   |  | (0.2 | )
|General and administrative       |  |                             | 8,719  |   |          |   | 6,968  |               |  |   | 1,751        |   |  | 25.1  |   |  | 10.9        |   |  | 10.6 |   |  | 0.3  |  
|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Total costs and expenses         |  |                             | 65,842 |   |          |   | 57,385 |               |  |   | 8,457        |   |  | 14.7  |   |  | 82.2        |   |  | 86.9 |   |  | (4.7 | )
|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Operating income                 |  |                             | 14,254 |   |          |   | 8,664  |               |  |   | 5,590        |   |  | 64.5  |   |  | 17.8        |   |  | 13.1 |   |  | 4.7  |  
|Other income, net                |  |                             | 702    |   |          |   | 1,008  |               |  |   | (306         | ) |  | (30.4 | ) |  | 0.9         |   |  | 1.5  |   |  | (0.6 | )
|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Income before income taxes       |  |                             | 14,956 |   |          |   | 9,672  |               |  |   | 5,284        |   |  | 54.6  |   |  | 18.7        |   |  | 14.6 |   |  | 4.1  |  
|Income tax expense               |  |                             | 5,416  |   |          |   | 3,314  |               |  |   | 2,102        |   |  | 63.4  |   |  | 6.8         |   |  | 5.0  |   |  | 1.8  |  
|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Effective Tax Rate               |  |                             | 36.2   | % |          |   | 34.3   | %             |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Net income                       |  | $                           | 9,540  |   |          | $ | 6,358  |               |  | $ | 3,182        |   |  | 50.0  | % |  | 11.9        | % |  | 9.6  | % |  | 2.3  | %
|                                 |  |                             |        |   |          |   |        |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  

Revenues.The increase in revenues compared to prior year is primarily driven by
19.5 percentage points from increased enrollments and 4.0 percentage points from the impact of pricing increases, offset by a 2.2 percentage point decrease from a larger proportion of masters and bachelors learners, who generated less
revenue per learner than our doctoral learners. Similar to our historical trends, we expect a continued slight shift in enrollments to a larger proportion of masters and bachelors learners. End-of-period enrollment increased 23.4% at
June 30, 2009 compared to June 30, 2008.



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Instructional costs and services expenses.Our instructional costs and services expenses
increased compared to prior year primarily due to increased total faculty compensation to support increased enrollments, an increase in facilities expense as a result of co-locating personnel into a single location and increased depreciation due to
the enterprise resource planning (ERP) system implementations in 2008.

Our instructional costs and services expenses as a percentage of
revenues decreased primarily due to scale of fixed costs and productivity gains across our learner support functions, registrars office and university administration functions and lower information technology expenses as a result of fewer
information technology projects related to instructional areas in 2009 compared to 2008.

Marketing and promotional expenses.Our marketing and promotional expenses increased compared to prior year primarily driven by an increase in inquiry spend, an increase in recruitment staffing, and an increase in information technology expenses as a result of a larger number
of projects focused on obtaining greater marketing efficiencies.

Our marketing and promotional expenses as a percentage of revenues
decreased slightly compared to prior year. This decrease primarily reflects increased efficiencies in inquiry generation, favorable inquiry pricing as a result of the current economic conditions, and a shift in inquiry mix contributing to lower
inquiry costs. This improvement was partially offset by an increase in information technology expense due to a larger number of projects focused on obtaining greater sales and marketing efficiencies and an increase in recruitment staffing.

General and administrative expenses.Our general and administrative expenses increased compared to prior year due primarily
to increases in bad debt expense due to current payment trends, severance costs and the timing of executive related expenses.

Our general
and administrative expenses as a percentage of revenues increased slightly over prior year primarily attributable to the timing of executive related expenses, severance costs, and higher bad debt expense. These were partially offset by scale in our
finance and legal departments.

Other income, net.Other income, net decreased compared to prior year principally due to a
decrease in interest income levels as a result of lower interest rates during 2009 compared to 2008, partially offset by a higher average cash balance.

Income tax expense.Our effective tax rate increased compared to prior year primarily due to a decrease in the favorable impact of tax-exempt interest.

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



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##### Table of Contents

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008

The following selected financial data table should be referenced in connection with a review of the discussion of our results of
operations for the six months ended June 30, 2009:



|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|-------------------------------- |  | ------------------------- | ------- | - | -------- | - | ------- | ------------- |  | - | ------------ | - |  | ----- | - |  | ----------- | - |  | ---- | - |  | ---- | -
|                                 |  | Six Months Ended June 30, |        
|                                 |  | $ (in thousands)          |         |   | $ Change |   |         | % Change      |  |   | % of Revenue |  
|                                 |  | 2009                      |         |   | 2008     |   |         | 2009 vs. 2008 |  |   | 2009         |   |  | 2008  |   |  | 2009vs.2008 |  
|Revenues                         |  | $                         | 156,531 |   |          | $ | 131,300 |               |  | $ | 25,231       |   |  | 19.2  | % |  | 100         | % |  | 100  | % |  | 0.0  | %
|Costs and expenses:              |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Instructional costs and services |  |                           | 64,632  |   |          |   | 59,860  |               |  |   | 4,772        |   |  | 8.0   |   |  | 41.3        |   |  | 45.6 |   |  | (4.3 | )
|Marketing and promotional        |  |                           | 48,405  |   |          |   | 40,966  |               |  |   | 7,439        |   |  | 18.2  |   |  | 30.9        |   |  | 31.2 |   |  | (0.3 | )
|General and administrative       |  |                           | 17,052  |   |          |   | 14,698  |               |  |   | 2,354        |   |  | 16.0  |   |  | 10.9        |   |  | 11.2 |   |  | (0.3 | )
|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Total costs and expenses         |  |                           | 130,089 |   |          |   | 115,524 |               |  |   | 14,565       |   |  | 12.6  |   |  | 83.1        |   |  | 88.0 |   |  | (4.9 | )
|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Operating income                 |  |                           | 26,442  |   |          |   | 15,776  |               |  |   | 10,666       |   |  | 67.6  |   |  | 16.9        |   |  | 12.0 |   |  | 4.9  |  
|Other income, net                |  |                           | 1,388   |   |          |   | 2,397   |               |  |   | (1,009       | ) |  | (42.1 | ) |  | 0.9         |   |  | 1.8  |   |  | (0.9 | )
|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Income before income taxes       |  |                           | 27,830  |   |          |   | 18,173  |               |  |   | 9,657        |   |  | 53.1  |   |  | 17.8        |   |  | 13.8 |   |  | 4.0  |  
|Income tax expense               |  |                           | 9,954   |   |          |   | 6,327   |               |  |   | 3,627        |   |  | 57.3  |   |  | 6.4         |   |  | 4.8  |   |  | 1.6  |  
|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Effective Tax Rate               |  |                           | 35.8    | % |          |   | 34.8    | %             |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  
|Net income                       |  | $                         | 17,876  |   |          | $ | 11,846  |               |  | $ | 6,030        |   |  | 50.9  | % |  | 11.4        | % |  | 9.0  | % |  | 2.4  | %
|                                 |  |                           |         |   |          |   |         |               |  |   |              |   |  |       |   |  |             |   |  |      |   |  |      |  

Revenues.The increase in revenues compared to prior year is primarily driven by
17.0 percentage points from increased enrollments and 4.0 percentage points from the impact of pricing increases, partially offset by a 1.8 percentage point decrease from a larger proportion of masters and bachelors learners, who
generated less revenue per learner than our doctoral learners. Similar to our historical trends, we expect a continued slight shift in enrollments to a larger proportion of masters and bachelors learners. End-of-period enrollment
increased 23.4% at June 30, 2009 compared to June 30, 2008.

Instructional costs and services expenses.Our
instructional costs and services expenses increased compared to prior year primarily due to increased total faculty compensation to support increased enrollments, an increase in facilities expense as a result of co-locating personnel into a single
location and increased depreciation due to the ERP system implementations in 2008. These increases were partially offset by lower information technology expenses as a result of fewer information technology projects related to instructional areas in
2009 compared to 2008.

Our instructional costs and services expenses as a percentage of revenues decreased primarily due to scale of fixed
costs and productivity gains across our learner support, registrars office and university administration functions and lower information technology expenses as a result of fewer information technology projects related to instructional areas in
2009 compared to 2008. These decreases were partially offset by an increase in facility expenses as a result of co-locating personnel into a single location.

Marketing and promotional expenses.Our marketing and promotional expenses increased compared to prior year primarily driven by an increase in inquiry spend, increased information technology expenses as
a result of a larger number of projects focused on obtaining greater marketing efficiencies and an increase in recruitment staffing.

Our
marketing and promotional expenses as a percentage of revenues decreased slightly compared to prior year. This decrease primarily reflects increased efficiencies in inquiry generation, favorable inquiry pricing as a result of the current economic
conditions, and a shift in inquiry mix contributing to lower inquiry costs. This improvement was partially offset by an increase in information technology expense as a result of a larger number of projects focused on obtaining greater sales and
marketing efficiencies and an increase in recruitment staffing.

General and administrative expenses.Our general and
administrative expenses increased compared to prior year due to increases in bad debt expense due to current trends within certain categories of learners, severance costs and the timing of executive related expenses. The increase was partially
offset by a decrease in information technology costs related to the ERP system implemented in 2008.



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Our general and administrative expenses as a percentage of revenues decreased primarily due to the
comparatively higher information technology expenses in the first half of 2008 from the ERP implementation. This was partially offset by the timing of executive related expenses, severance costs, and higher bad debt as described above.

Other income, net.Other income, net decreased compared to prior year principally due to a decrease in interest income levels as a
result of lower interest rates during 2009 compared to 2008, partially offset by a higher average cash balance.

Income tax expense.Our effective tax rate increased as compared to prior year primarily due to a decrease in the favorable impact of tax-exempt interest.

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

Liquidity and Capital Resources

Liquidity

We financed our
operating activities and capital expenditures during the six months ended June 30, 2009 and 2008 through cash provided by operating activities. Our cash, cash equivalents and marketable securities were $146.8 million and $123.6 million at
June 30, 2009 and December 31, 2008, respectively. Our cash, cash equivalents and marketable securities increased primarily due to strong cash flow from operations and a decrease in share repurchase activity during the first half of 2009.

We maintain an unsecured $10.0 million line of credit with Wells Fargo Bank. The line of credit expired on June 30, 2009 and was
renewed through June 30, 2010. There have been no borrowings under this line of credit at June 30, 2009 or December 31, 2008. An unsecured letter of credit in the amount of $1.1 million, which expires on July 31, 2009, was issued
under the $10.0 million line of credit in favor of the Department of Education in connection with its annual review of student lending activities. On July 15, 2009, we renewed the letter of credit through July 31, 2010 and increased the
amount to $1.4 million.

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 starts July 1. 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 $32.1 million and $19.2
million for the six months ended June 30, 2009 and 2008, respectively. The increase from 2008 to 2009 was primarily due to a $6.0 million increase in net income, a $13.8 million increase in accounts payable and accrued liabilities primarily due
to the timing of invoice payments and an increase in cash flow from the changes in the amounts of accrued bonus expense. These increases were partially offset by a decrease in income taxes payable primarily due to the timing of the first and second
quarter 2009 federal and state estimated tax payments made during second quarter 2009.

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 $1.5 million and $24.8 million for the six months ended June 30, 2009 and 2008, respectively. Investments in marketable securities consist primarily of purchases, sales and maturities of tax-exempt municipal
securities. Net sales of these securities was $6.4 million and net purchases of these securities were $17.8 million during the six months ended June 30, 2009 and 2008, respectively.

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



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Capital expenditures were $8.0 million and $7.1 million for the six months ended June 30, 2009 and
2008, respectively. The slight increase in 2009 from 2008 was primarily due to the timing of cash payments for capital projects focused on enhancing faculty engagement and improving learning outcomes.

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

Financing Activities

Net cash
used in financing activities was $0.9 million and $46.6 million for the six months ended June 30, 2009 and 2008, respectively. Financing activities during the six months ended June 30, 2009 were related to the repurchase of common stock in
the amount of $4.7 million, partially offset by $2.6 million in proceeds from stock option exercises and $1.2 million in excess tax benefits from stock option exercises.

In 2008, financing activities during the first half 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. The reduction in common stock repurchases during the first half of 2009 compared to 2008 reflects our decision to preserve our liquidity by retaining our cash and cash equivalents
balances due to the current economic conditions.

Contractual Obligations

The following table sets forth, as of June 30, 2009, the aggregate amounts of our significant contractual obligations and commitments with definitive
payment terms due in each of the periods presented:



|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       
|----------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ---------------- | - | ------ |  | - | ------
|                              |  | Payments Due by Period
|(in thousands)                |  | Total                  |        | Less than1 Year |   | 1-3 Years |  | 3-5 Years |       | More than5 Years
|Operating leases(a)           |  | $                      | 32,822 |                 | $ | 2,093     |  | $         | 9,709 |                  | $ | 10,676 |  | $ | 10,344
|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       
|Total contractual obligations |  | $                      | 32,822 |                 | $ | 2,093     |  | $         | 9,709 |                  | $ | 10,676 |  | $ | 10,344
|                              |  |                        |        |                 |   |           |  |           |       |                  |   |        |  |   |       



|(a) | Minimum lease commitments for our headquarters and miscellaneous office equipment.
|--- | ----------------------------------------------------------------------------------

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 for the three financial aid years 2002-2003 through 2004-2005. 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. Recently, the Company provided FSA staff with certain requested information for financial aid years 2002-2003 through 2006-2007. The FSA
will subsequently issue final findings and requirements for Capella University. The FSA may take certain actions, including requiring that we refund certain federal student aid funds, requiring us to modify our Title IV administration procedures,
and/or requiring us to pay fines or penalties.

Based on the final audit report for the financial aid years 2002-2003 through 2004-2005,
the most significant potential financial exposure pertains to repayments to the 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 the course room prior to such withdrawal. If the FSA determines that Capella University improperly withheld any portion of
these funds, Capella



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University would be required to return the improperly withheld funds. We and the OIG have differing interpretations of the relevant regulations regarding
what constitutes engagement in the unofficial withdrawal context. As we interpret the engagement requirement, the Company currently estimates that for the three year audit period, and for the subsequent aid years through 2007-2008, the total amount
of Title IV funds not returnedfor learners who withdrew without providing official notification and without engaging as required in the relevant regulationswas approximately $1.0 million including interest, but not including fines and
penalties. If this difference of interpretation is ultimately resolved in a manner adverse to us, then the total amount of Title IV funds not returned for learners who withdrew without providing official notification would be greater than the amount
we have currently estimated.

In the new Obama administrations 2010 budget request, the Department of Education proposed to eliminate
the Federal Family Education Loan Program (FFELP) and instead require all Title IV student loans to be administered through the Federal Direct Loan Program (FDLP) commencing July 1, 2010. We are qualified and approved to participate
in the FDLP program and have pilot tested direct loans to certain learner groups. Beginning with the 2010-2011 financial aid year on July 1, 2010, we expect to have our entire learner base transitioned to the FDLP. If we experience a disruption
in our ability to process student loans, either because of administrative challenges on our part or the inability of the Department of Education to process the substantial increase in direct loans, our business, financial condition, results of
operations and cash flows could be adversely and materially affected. Proposals by the new administration and the current economic downturn may result in other policy and program changes in the Department of Education which may present challenges
for our business.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

Market Risk

We have no derivative financial instruments or derivative commodity instruments. We believe the risk
related to cash equivalents and marketable securities is limited due to the adherence to our investment policy which focuses on capital preservation and liquidity. In addition, all investments must have a minimum Standard & Poors
rating of A minus (or equivalent). All of our cash equivalents and marketable securities as of June 30, 2009 and December 31, 2008 were rated A minus or higher. In addition, we utilize money managers who conduct initial and ongoing credit
analysis on our investment portfolio to monitor and minimize the potential impact of market risk associated with our cash, cash equivalents and marketable securities. Despite the investment risk mitigation strategies we employ, we may incur
investment losses as a result of unusual and unpredictable market developments and we may experience reduced investment earnings if the yields on investments deemed to be low risk remain low or decline further in this time of economic uncertainty.
In addition, unusual and unpredictable market developments may also create liquidity challenges for certain of the assets in our investment portfolio.

Interest Rate Risk

We manage interest rate risk by investing excess funds in cash equivalents
and marketable securities bearing a combination of fixed and variable interest rates, which are tied to various market indices. Our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in
principal if we are forced to sell securities that have declined in market value due to changes in interest rates. At June 30, 2009, 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, 2009,
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.



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Changes in Internal Control over Financial Reporting

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

PART II  OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

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, 2008. Our current risk factor captioned A
reclassification of our adjunct faculty may have a material adverse effect on our results of operations is restated as follows:

A
reclassification of our adjunct faculty may have a material adverse effect on our results of operations.

Adjunct faculty comprised
approximately 84% of our faculty population at December 31, 2008. We classify our adjunct faculty as independent contractors, as opposed to employees. Because we classify our adjunct faculty as independent contractors, with respect to these
individuals we do not withhold federal or state income or other employment-related taxes, make federal or state unemployment tax or Federal Insurance Contributions Act (FICA) payments, provide workers compensation insurance or provide certain
benefits available to our employees. The determination of whether adjunct faculty members are properly classified as independent contractors or as employees is based upon the facts and circumstances of our relationship with our adjunct faculty
members. Federal or state authorities or current or former adjunct faculty members may challenge our classification as incorrect and assert that our adjunct faculty members must be classified as employees. During 2008, the Internal Revenue Service
(IRS) commenced a payroll tax audit of Capella University for the 2006 tax year. As part of that audit, the IRS has requested information about our adjunct faculty, and has specifically questioned our adjunct faculty classification.

The IRS has not yet completed its payroll tax audit and we continue to supply information to, and have discussions with, the IRS regarding the correct
classification of our adjunct faculty members and any required payments. In the event that we were to reclassify our adjunct faculty as employees, we would be required to withhold the appropriate taxes, make unemployment tax and FICA payments and
pay for workers compensation insurance and additional payroll processing costs. If we had reclassified our adjunct faculty members as employees for 2008, we estimate our additional tax, workers compensation insurance and payroll
processing payments for 2008 would have been approximately $2.5 million. We expect the additional tax and insurance payments will continue to increase in the future, as we continue to hire additional faculty to support our growth in learners.
In addition to these known costs, we could be subject to retroactive taxes and penalties, which may be significant, by federal and state authorities, which could adversely affect our business, financial condition, results of operations and cash
flows. In the event that we were to reclassify our adjunct faculty as employees, we could also be required to permit these individuals to participate in certain of our employee benefit plans, perhaps retroactively.



|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, 2009, the Company used $3.1 million to repurchase shares of common stock under its repurchase program.(1)The Companys remaining authorization for common stock repurchases was $47.1 million at June 30, 2009.



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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 |        | Dollar Value ofShares That MayYet BePurchased Under thePlans or Programs
|4/1/2009 to 4/30/2009 |  | 32,000                          |  | $                           | 50.28 |                                                                              | 32,000 |                                                                          | $ | 48,519,218
|5/1/2009 to 5/31/2009 |  | 28,241                          |  | $                           | 49.85 |                                                                              | 28,241 |                                                                          | $ | 47,111,330
|6/1/2009 to 6/30/2009 |  | 1,002                           |  | $                           | 52.28 |                                                                              | 1,002  |                                                                          | $ | 47,058,942
|                      |  |                                 |  |                             |       |                                                                              |        |                                                                          |   |           
|Total                 |  | 61,243                          |  | $                           | 50.12 |                                                                              | 61,243 |                                                                          | $ | 47,058,942



|(1) | The Companys repurchase program was announced in July 2008 for repurchases up to an aggregate amount of $60.0 million in value of common stock with no expiration date. As of
June 30, 2009, we had purchased 0.3 million shares under this program at an average price of $47.35 totaling $13.0 million. Cash spent on the purchase of shares during the three months ended June 30, 2009 totaled $3.1 million.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|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 12, 2009, shareholders voted on the following proposals:

1. Election of
Directors:



|                  |  |            |  |         
|----------------- |  | ---------- |  | --------
|                  |  | For        |  | Withhold
|J. Kevin Gilligan |  | 15,708,236 |  | 74,705  
|Mark N. Greene    |  | 15,762,938 |  | 20,003  
|Jody G. Miller    |  | 15,767,008 |  | 15,933  
|James A. Mitchell |  | 15,761,607 |  | 21,334  
|Stephen G. Shank  |  | 15,661,369 |  | 121,572 
|Andrew M. Slavitt |  | 15,671,661 |  | 111,280 
|David W. Smith    |  | 15,661,217 |  | 121,724 
|Jeffrey W. Taylor |  | 15,670,979 |  | 111,962 
|Sandra E. Taylor  |  | 15,767,472 |  | 15,469  
|Darrell R. Tukua  |  | 15,762,328 |  | 20,613  

2. To ratify the appointment of Ernst & Young LLP as our independent auditors for the
fiscal year ending December 31, 2009:



|           |  |         |  |         |  |                
|---------- |  | ------- |  | ------- |  | ---------------
|For        |  | Against |  | Abstain |  | Broker Non-Vote
|15,651,861 |  | 118,773 |  | 12,306  |  |               

There were 16,727,122 shares of our common stock entitled to vote at the meeting, and a total of
15,782,941 shares (94.36%) 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.



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|       |  |                                                                                                                                                    |  |                                                                                                                                                        
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                        |  | Method of Filing                                                                                                                                       
|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*  |  | Form of Restricted Stock Unit Agreement (Employee), under the Capella Education Company 2005 Stock Incentive Plan.                                 |  | Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on May 15, 2009.                              
|       |  |                                                                                                                                                   
|10.2*  |  | Form of Restricted Stock Unit Agreement (Non-Employee Director), under the Capella Education Company 2005 Stock Incentive Plan.                    |  | Incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on May 29, 2009.                              
|       |  |                                                                                                                                                   
|10.3   |  | Third Amendment to Lease, dated June 10, 2009, by and
between the Registrant and Minneapolis 225 Holdings, LLC                                     |  | 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.                                                                                                                                  



|* | Management contract or compensatory plan or arrangement.
|- | --------------------------------------------------------



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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/ J. KEVIN GILLIGAN                           |  | July 28, 2009
| |  |  |  | J. Kevin Gilligan                               |  |              
| |  |  |  | Chief Executive Officer                         |  |              
| |  |  |  | (Principal Executive Officer)                   |  |              
| |  |  | 
| |  |  |  | /S/ LOIS M. MARTIN                              |  | July 28, 2009
| |  |  |  | Lois M. Martin                                  |  |              
| |  |  |  | Senior Vice President and Chief                 |  |              
| |  |  |  | Financial Officer (Principal Financial Officer) |  |              
| |  |  | 
| |  |  |  | /S/ AMY L. RONNEBERG                            |  | July 28, 2009
| |  |  |  | Amy L. Ronneberg                                |  |              
| |  |  |  | Vice President and Controller                   |  |              
| |  |  |  | (Principal Accounting Officer)                  |  |              



24