e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
|
|
|
(Mark One)
|
|
|
þ
|
|
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
For the fiscal year ended
December 31, 2006
|
or
|
o
|
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
For the transition period
from to
|
Commission File Number:
001-33140
CAPELLA EDUCATION
COMPANY
(Exact name of registrant as
specified in its charter)
|
|
|
Minnesota
|
|
41-1717955
|
(State or other jurisdiction
of
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
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
|
|
|
Common stock, $.01 par
value
|
|
Nasdaq Global Market
|
Title of each class
|
|
Name of each exchange on which
registered
|
Securities registered pursuant to section 12(g) of the
Act:
NONE
(Title of class)
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
(§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer o Accelerated
filer o Non-accelerated
filer þ
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
On June 30, 2006, the last business day of the
registrants most recently completed second fiscal quarter,
the registrants common equity was not publicly traded. The
aggregate market value of the voting and non-voting common
equity held by
non-affiliates
computed by reference to the price at which the common equity
was last sold as of December 29, 2006, the last business
day of the registrants most recently completed fiscal
quarter, was approximately $179,971,030.
The total number of shares of common stock outstanding as of
January 31, 2007, was 16,012,220.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrants Definitive Proxy
Statement for its 2007 Annual Meeting of Stockholders (which is
expected to be filed with the Commission within 120 days
after the end of the registrants 2006 fiscal year) are
incorporated by reference into Part III of this Report.
CAPELLA
EDUCATION COMPANY
FORM 10-K
INDEX
PART I
CAUTIONARY
NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Annual Report on
Form 10-K
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
managements 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
Item 1A Risk Factors, below. The
performance of our business and our securities may be adversely
affected by these factors and by other factors common to other
businesses and investments, or to the general economy.
Forward-looking statements are qualified by some or all of these
risk factors. Therefore, you should consider these risk factors
with caution and form your own critical and independent
conclusions about the likely effect of these risk factors on our
future performance. Such forward-looking statements speak only
as of the date on which statements are made, and we undertake no
obligation to update any forward-looking statement to reflect
events or circumstances after the date on which such statement
is made to reflect the occurrence of unanticipated events or
circumstances. Readers should carefully review the disclosures
and the risk factors described in this and other documents we
file from time to time with the Securities and Exchange
Commission (SEC), including our reports on
Forms 10-Q
and 8-K to
be filed by the Company in fiscal 2007.
Overview
We are an exclusively online post-secondary education services
company. Through our wholly-owned subsidiary, Capella
University, we offer a variety of doctoral, masters and
bachelors programs in the following markets: health and
human services, business management and technology, and
education. Our academic offerings combine competency-based
curricula with the convenience and flexibility of an online
learning format. We design our offerings to help working adult
learners develop specific competencies that they can employ in
their workplace. We actively support and engage with our
learners throughout their programs to enhance their prospects
for successful program completion. We believe that the relevance
and convenience of our programs provide a quality educational
experience for our learners. At December 31, 2006, we
offered over 760 online courses and 13 academic programs with 75
specializations to approximately 18,000 learners.
In 2006, our
end-of-year
enrollment and revenues grew by approximately 23% and 21%,
respectively, as compared to 2005. To date, our growth has
resulted from a combination of: increased demand for our
programs; expansion of our program and degree offerings; our
ability to obtain specialized accreditations, licensures and
endorsements for certain programs we offer; establishment of
relationships with large corporate employers, the
U.S. Armed Forces and other colleges and universities; and
a growing acceptance of online education. We seek to achieve
growth in a manner that assures continued improvement in
educational quality and learner success while maintaining
compliance with regulatory standards. Additionally, we seek to
enhance our operational and financial performance by tracking
and analyzing quantifiable metrics that provide insight as to
the effectiveness of our business and educational processes. Our
exclusively online focus facilitates our ability to track a
variety of metrics.
1
Our
History
We were founded in 1991 as a Minnesota corporation. In 1993, we
established our wholly-owned university subsidiary, then named
The Graduate School of America, to offer doctoral and
masters 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 masters degree programs over the
Internet. Through our early entry into online education, we
believe we have gained extensive experience in the delivery of
effective online programs. 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
masters 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 bachelors degree
market, we changed our name to Capella Education Company and the
name of our university to Capella University. In 2000, we
introduced our bachelors degree completion program in
information technology, which provided instruction for the last
two years of a four-year bachelors degree. In 2004, we
expanded our addressable market through the introduction of our
four-year bachelors degree programs in business
administration and information technology as well as the
introduction of three masters level specializations in
education targeted at K-12 teachers. In 2005, we introduced two
masters level specializations in education targeted to
higher education and K-12 teachers as well as a masters in
business administration specialization in accounting. In 2006,
we introduced eight specializations including healthcare
management, accounting and information assurance and security.
Additionally, in November 2006, we completed an initial public
offering of our common stock. We are planning to introduce three
new programs and seven new specializations in the first quarter
of 2007.
Industry
The U.S. market for post-secondary education is a large,
growing market. Based on 2005 Integrated
Post-Secondary
Education Data System (IPEDS) data from the U.S. Department
of Education, National Center for Education Statistics (NCES),
revenue for post-secondary degree-granting educational
institutions exceeded $305 billion in academic year 2004.
This represents a compound annual growth rate of 3.7% from the
2000 academic year.
According to a 2006 publication by the NCES, the number of
post-secondary students enrolled as of the Fall of 2004 was
17.3 million and is expected to grow to 18.8 million
in 2010. We believe the forecasted growth in post-secondary
enrollment is a result of a number of factors, including the
expected increase in annual high school graduates from
2.9 million in 2002 to 3.3 million in 2010 (based on
estimates published by the NCES in 2005), the significant and
measurable personal income premium that is attributable to
post-secondary education, and an increase in demand by employers
for professional and skilled workers.
According to the U.S. Census Bureaus October 26,
2006 report, 64% of adults (persons 25 years of age or
older) did not possess a post-secondary degree. Of the
17.3 million post-secondary students enrolled as of the
Fall of 2004, the NCES estimated that 6.8 million were
adults, representing 39% of total enrollment. We expect that
adults will continue to represent a large, growing segment of
the post-secondary education market as they seek additional
education to secure better jobs, or to remain competitive or
advance in their current careers.
According to Eduventures, an education consulting and research
firm, many traditional, non-profit post-secondary education
providers have had difficulty meeting the increasing demand for
post-secondary education as a result of, among other factors, a
lack of funding and physical constraints on their ability to
admit additional students. Alternatively, many for-profit
institutions have been designed to meet this growing demand and
are becoming an increasingly popular alternative for working
adults. We believe that the focus of for-profit institutions on
education related to specific labor markets and on strong
customer service has made them an increasingly popular
alternative for working adults seeking additional education.
According to reports published by Eduventures (in 2004), the
revenue growth rate in fully-online education exceeded the
revenue growth rate in the for-profit segment of the
post-secondary market from 2001
2
to 2006. We believe that the higher growth in demand for
fully-online education is largely attributable to the
flexibility and convenience of this instructional format, as
well as the growing recognition of its educational efficacy.
Additionally, in 2006, Eduventures projected that the number of
students enrolled in fully-online programs at
Title IV-eligible,
degree-granting institutions would grow by approximately 24% in
2006 to reach approximately 1.5 million as of
December 31, 2006, and would grow to approximately
2.1 million by December 31, 2008. Eduventures also
projected that annual revenues generated from students enrolled
in fully-online programs at
Title IV-eligible,
degree-granting institutions would increase by more than 30% in
2006 to reach more than $8.1 billion in that year.
Competition
The post-secondary education market is highly fragmented and
competitive, with no private or public institution enjoying a
significant market share. We compete primarily with public and
private degree-granting regionally accredited colleges and
universities. Our competitors include both traditional colleges
and universities, as well as a number of for-profit institutions
offering online programs. Many of these colleges and
universities enroll working adults in addition to traditional 18
to 24 year-old students. In addition, many of those
colleges and universities offer a variety of distance education
initiatives. There are currently nine other public companies
operating in the post-secondary education market in which we
operate.
We believe that the competitive factors in the post-secondary
education market include the following:
|
|
|
|
|
relevant, practical and accredited program offerings;
|
|
|
|
regulatory approvals;
|
|
|
|
reputation of the college or university and marketability of the
degree;
|
|
|
|
convenient, flexible and dependable access to programs and
classes;
|
|
|
|
qualified and experienced faculty;
|
|
|
|
level of learner support;
|
|
|
|
cost of the program;
|
|
|
|
relative marketing and selling effectiveness; and
|
|
|
|
the time necessary to earn a degree.
|
Our
Competitive Strengths
We believe we have the following competitive strengths:
Commitment to Academic Quality. We are
committed to providing our learners with a rewarding and
challenging academic experience. Our commitment to academic
quality is a tenet of our culture, and we believe that quality
is an important consideration to those learners who choose
Capella University. Having originated as an institution
exclusively focused on graduate degree education, we have
historically promoted an educational experience based on high
academic standards. We have continued to apply this approach as
we have expanded our graduate and undergraduate programs. Today,
we believe that our commitment to academic quality is reflected
in our curricula, faculty, learner support services and academic
oversight process. The impact of this commitment is evident in
the satisfaction of our learners both during their educational
experience and following graduation.
Exclusive Focus on Online Education. In
contrast to institutions converting traditional, classroom-based
educational offerings to an online format, our academic programs
have been designed solely for online delivery. Our curriculum
design offers flexibility while promoting a high level of
interaction with other learners and faculty members. Our faculty
are specifically trained to deliver online education, and our
learner support infrastructure was developed to track learner
progress and performance to meet the needs of online learners.
As a result of our exclusive focus on online education, we
believe we have developed educational programs that meet the
needs of our learners in a convenient and effective manner.
3
Academic Programs and Specializations Designed for Working
Adults. We currently offer 13 academic
programs with 75 specializations, each designed to appeal to and
meet the educational objectives of working adults. The diversity
of our program portfolio allows us to target relevant portions
of the adult learner population and provide offerings in several
of the highest demand areas of study, such as business and
education. Our specializations are designed to attract learners
by providing depth within a program that is typically
unavailable in an unspecialized program and by addressing
specific competencies that learners can apply in their current
workplace.
Extensive Learner Support Services. We
provide extensive learner support services, both online and
telephonically. Our support services include: academic services,
such as advising, writing and research services; administrative
services, such as online class registration and transcript
requests; library services; financial aid counseling; and career
counseling services. We believe our commitment to providing high
quality, responsive and convenient learner support services
encourages course and degree completion and contributes to our
high learner satisfaction.
Experienced Management Team with Significant Business,
Academic and Marketing Expertise. Our
management team possesses extensive experience in business,
academic and marketing management as well as public company
experience, in many cases with organizations of much larger
scale and operational diversity than our organization. Our
management team is led by Stephen G. Shank, our Chairman and
Chief Executive Officer, who founded our company in 1991, and
who possesses over 12 years of experience serving as the
Chief Executive Officer of a public company. Our President and
Chief Operating Officer, Kenneth J. Sobaski, has over
17 years of public company experience in senior sales,
marketing and general management positions. Dr. Michael J.
Offerman, who has 24 years of academic management
experience, serves as President of Capella University and
oversees all of our academic activities. Lois M. Martin, our
Chief Financial Officer, serves on two public company boards of
directors and has held senior financial management positions in
public companies for over nine years. We integrate our
management through cross-functional teams to ensure that
business objectives are met while continuing to deliver academic
quality.
Our
Operating Strategy
We intend to pursue the following operating strategies using
cash on hand and future cash flows from operations:
Focus on Markets and Learners. We
believe that significant growth potential exists within each of
the three markets that comprise our existing portfolio of
academic programs and degree offerings. Within our specified
markets, we will continue to develop our existing
bachelors, masters and doctoral program offerings
while selectively adding new programs and specializations in
disciplines that we believe offer significant market potential
and in which we believe we can deliver a high quality learning
experience. In particular, we intend to emphasize growth in
targeted specializations in our masters and doctoral
programs for which we believe there is significant demand.
Examples include our recently launched masters and
doctoral specializations targeting K-12 education, community
college and healthcare management professionals within our
education and health and human services market verticals.
Building Capella Brand
Differentiation. We will continue to focus on
enhancing our brand differentiation as a quality, exclusively
online university for working adults within our specified
markets through a variety of integrated online and offline
advertising and direct media. We seek to appeal to prospective
learners who aspire to obtain a quality post-secondary
education, but for whom a traditional, classroom-based
educational experience is impractical. Additionally, we seek to
differentiate our brand from those of other educational
providers by communicating our ability to deliver high quality
educational programs in targeted specializations within each
learners chosen discipline. In order to optimize our
marketing investment, we regularly perform market tests, analyze
the results and refine our marketing approach based on the
findings. We believe increased brand differentiation and
awareness will contribute to continued enrollment growth in our
existing and future program offerings.
Increasing Enrollment Effectiveness. We
believe that it is important to focus on total enrollment
effectiveness from new enrollment through graduation. We have
invested substantial resources in performing
4
detailed market research that enables us to more effectively
segment our target market and identify potential learners best
suited for our educational experience. As a result, we will
continue to target our marketing and recruiting expenditures
towards segments of the market that we believe are more likely
to result in us enrolling learners who will complete their
programs, and we intend to increase expenditures targeted at
these segments. Simultaneously, we continue to increase our
enrollment effectiveness through improved enrollment tools and
processes to better manage the pipeline of potential applicants
and to help direct the communication and contact plans with our
current learners.
Delivering Both Superior Learning Outcomes and a Superior
Learner Experience. We are committed to
helping our learners reach their educational and professional
goals. This commitment guides the development of our curricula,
the recruitment and training of our faculty and staff, and the
design of our support services. We use the results of this
assessment to develop an understanding of the specific needs and
readiness of each individual learner at the start of a program.
Through the use of competency-based curricula and measurement of
course and program outcomes, we will continue to look for
opportunities to improve our learners educational
experience and increase the likelihood of learners successfully
completing degree programs. We believe our focus on learner
success complements our brand strategy and will continue to
enhance learner satisfaction, leading to higher levels of
engagement, retention and referrals.
Capella
University
Capella University is a post-secondary educational institution
accredited by The Higher Learning Commission of the North
Central Association of Colleges and Schools, one of six regional
institutional accrediting associations in the United States, and
is authorized to grant degrees by the State of Minnesota.
Our
Approach to Academic Quality
Some of the critical elements of our university that we believe
promote a high level of academic quality include:
Curricula. We design the curricula for our
programs around professional competencies desired for high
performance in each field. The particular competencies are
identified and validated through a variety of external sources
and reviews. There are specific learning outcomes for each
course as well as for the overall program, and we assess the
learners achievement of the expected learning outcomes
during his or her period of enrollment.
Faculty. We select our faculty based on their
academic credentials and teaching and practitioner experience.
Our faculty members tend to be scholars as well as
practitioners, and they bring relevant, practical experience
from their professional careers into the courses they teach.
Approximately 80% of our faculty members hold a doctoral degree
in their respective fields. We invest in the professional
development of our faculty members through training in online
teaching techniques as well as events and discussions designed
to foster sharing of best practices and a commitment to academic
quality.
Online Course Design. We employ a
comprehensive design framework to ensure that our online courses
offer a consistent learning experience, high quality
interaction, and the tools required for assessing learning
outcomes. We regularly assess course outcomes data as well as
learner assessments to identify opportunities for course
upgrades. We operate Blackboard Learning System, formerly known
as WebCT Vista, as our courseroom platform. Blackboard Learning
System provides discussion, testing and grading capabilities for
our online courseroom.
Learner Support. We establish teams comprised
of both academic and administrative personnel that are assigned
to serve as the primary support contact point for each of our
learners throughout the duration of their studies. Most of our
support services, including academic, administrative, library
and career counseling services are accessible online, allowing
users to access these services at a time and in a manner that is
convenient to them. We believe that a committed support network
is as important to maintaining learner motivation and commitment
as the knowledge and engagement of our faculty.
5
Academic Oversight. Our academic management
organization is structured to provide leadership and continuity
across our academic offerings. In addition to regular reviews by
accrediting bodies, our academic management team oversees
periodic examinations of our curricula by internal and external
reviewers. Internal reviews are performed by our assessment and
institutional research team to assess academic content, delivery
method and learning outcomes for each program. Our internal
academic oversight process is further strengthened by our
ability to track and analyze data and metrics related to learner
performance and satisfaction. External reviews are performed by
individuals with professional certifications in their fields to
provide additional evaluation and verification of program
quality and workplace applicability.
Accreditation. In addition to being accredited
by The Higher Learning Commission of the North Central
Association of Colleges and Schools, we also pursue specialized
accreditation, where appropriate, such as our accreditation from
the American Counseling Associations Council for the
Accreditation of Counseling and Related Educational Programs
(CACREP) for our mental health counseling and marital, couple,
and family counseling/therapy specializations within our
masters in human services program. Our commitment to
maintaining regional accreditation, and specialized
accreditation where appropriate, reflects our goal to provide
our learners with an academic experience commensurate with that
of traditional post-secondary educational institutions. In
addition to these traditional components of academic quality,
our approach to teaching and the online format of our programs
offers several features that enrich the learning experience:
Low student to faculty ratio. Our courses
average between 15 and 20 learners, providing each learner the
opportunity to interact directly with our faculty and to receive
individualized feedback and attention. We believe this adds to
the academic quality of our programs by ensuring that each
learner is encouraged to participate actively, thus enabling the
instructor to better evaluate the learners understanding
of course material.
Diverse learner population. Our online format
allows us to focus on adult learners as well as to attract a
diverse population of learners with a variety of professional
backgrounds and life experiences.
Practitioner-oriented course experience. Our
courses are designed to encourage our learners to incorporate
workplace issues or projects into their studies, providing
relevant context to many of the academic theories covered by our
curricula.
Time efficiency. While many campus-based
students are required to spend time commuting, parking, or
otherwise navigating a large campus, our online learning format
enables our learners to focus their time on course assignments
and discussions.
Residential colloquia experience. Our
residential colloquia allow doctoral learners to engage in
face-to-face
interaction with other learners and faculty, which provides for
a rich learning experience with relevant content.
Curricula
Our program offerings cover three markets: health and human
services, business management and technology, and education.
Within these markets, we offer 13 academic programs with 75
specializations as follows:
|
|
|
|
|
|
|
|
|
|
|
Programs
|
|
|
Specialization
|
|
|
Programs
|
|
|
Specialization
|
|
|
|
|
|
|
|
Doctor of Philosophy in
Organization and Management
|
|
|
General
Human Resource Management
Information Technology
Management
Leadership
|
|
|
Doctor of Psychology
Doctor of Philosophy in
Psychology
|
|
|
Clinical Psychology
Counseling Psychology
General Psychology
Industrial/Organizational
Psychology
Educational Psychology
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
Programs
|
|
|
Specialization
|
|
|
Programs
|
|
|
Specialization
|
|
|
|
|
|
|
|
Master of Science in Organization
and Management
Master of Business
Administration
|
|
|
General
Human Resource Management
Leadership
General Business
Accounting
Finance
Health Care Management
Information Technology
Management
Marketing
Project Management
|
|
|
Masters of Science in
Psychology
|
|
|
Clinical Psychology
Counseling Psychology
School Psychology
General Psychology
Industrial/Organizational
Psychology
Educational Psychology
Sport Psychology
|
Bachelor of Science in
Business
|
|
|
Accounting
Business Administration
Finance
Human Resource Management
Management and Leadership
Marketing
|
|
|
Doctor of Philosophy in
Human Services
|
|
|
General Human
Services
Criminal Justice
Counseling Studies
Health Care Administration
Management of Non-Profit
Agencies
Social and Community Services
|
Doctor of Philosophy in
Education
|
|
|
Leadership in
Educational
Administration
Leadership in Higher Education
Curriculum and Instruction
Post-Secondary and Adult Education
Instructional Design for Online Learning
Training and Performance Improvement
Professional Studies in Education
K-12 Studies in Education
|
|
|
Masters of Science in
Human Services
|
|
|
General Human
Services
Criminal Justice
Counseling Studies
Health Care Administration
Management of Non-Profit
Agencies
Marital, Couple, and Family Counseling/Therapy
Mental Health Counseling
Social and Community Services
|
Master of Science in
Education
|
|
|
Leadership in
Educational
Administration
Leadership in Higher Education
Curriculum and Instruction
Post-Secondary and Adult
Education
Instructional Design for Online
Learning
Training and Performance
Improvement
Professional Studies in
Education
K-12 Studies in Education
Reading and Literacy
Enrollment Management
|
|
|
Masters of Science in
Information Technology
Bachelor of Science in
Information Technology
|
|
|
General Information
Technology
Information Security
Network Architecture and Design
Project Management and
Leadership
System Design and Programming
General Information Technology
Graphics and Multimedia
Information Assurance and
Security
Network Technology
Project Management
Web Application Development
|
|
|
|
|
|
|
|
|
|
|
Courses are offered on a quarterly academic schedule, which
generally coincides with calendar quarters. We offer new
learners the flexibility to begin their introductory first
course in their program of study on the first day of classes in
any month. Learners then enroll in subsequent courses on a
regular quarterly course schedule. Depending on the program,
learners generally enroll in one to two courses per quarter.
Each course has a designated start date, and the majority of our
courses last for ten weeks.
7
The only exception to our exclusively online format is for
doctoral learners, and for certain masters degree
candidates pursuing professional licenses. These learners
participate in periodic residential colloquia, supervised
practicum and internships as a complement to their courses. The
colloquia typically last one week and are required, on average,
once per year for learners in applicable programs, while the
supervised practicum and internships vary in length based on the
program in which the learner is enrolled.
We also offer certificate programs, which consist of a series of
courses focused on a particular area of study, for learners who
seek to enhance their skills and knowledge. Online certificate
courses can be taken as part of a graduate degree program or on
a standalone basis. Certificate programs generally consist of
four courses. The duration of our certificate programs ranges
from two quarters to approximately two years.
Faculty
We seek to hire faculty who have teaching or practitioner
experience in their particular discipline and who possess
significant academic credentials. Approximately 80% of our
faculty members have a doctoral degree. We provide significant
training to new faculty members, including a seven-week online
development program focused on effective online teaching methods
and our online platform, prior to offering them a teaching
assignment. In addition, we provide professional development and
training for all faculty members on an ongoing basis. To
evaluate the performance of our faculty members, we periodically
monitor courseroom activity and assess learner performance
against course outcomes.
Our faculty consists of full-time academic administrators,
faculty chairs and core faculty as well as adjunct faculty. Our
full-time academic administrators primary responsibilities
are to monitor the quality and relevance of our curricula, to
recruit and manage teaching faculty and to ensure that we
maintain standards of accreditation. Our full-time faculty
chairs supervise the faculty in their respective
specializations. Our full-time core faculty teach courses in
their assigned specializations and serve as mentors to, and on
dissertation committees for, our doctoral learners. Our adjunct
faculty typically teach one to three courses per quarter in
their specializations. Of our 904 faculty members as of
December 31, 2006, 130 were full-time employees and the
remainder were adjunct faculty. In certain cases, we have
agreements with other post-secondary educational institutions to
provide faculty for certain courses.
Learner
Support Services
The learner support services we provide include:
Academic Services. We provide learners with a
variety of services designed to support their academic studies.
These services include new learner orientation, technical
support, academic advising, research services (particularly for
doctoral degree candidates), writing services and other online
tutoring. We also provide appropriate educational accommodations
to learners with documented disabilities through our disability
support services team.
Administrative Services. We provide learners
with the ability to access a variety of administrative services
both telephonically and via the Internet. For example, learners
can register for classes, apply for financial aid, pay their
tuition and access their transcripts online. We believe this
online accessibility provides the convenience and self-service
capabilities that our learners value. Our financial aid
counselors provide personalized online and telephonic support to
our learners.
Library Services. We provide learners with
online access to the Capella University Library. Our library
provides learners with access to a comprehensive collection of
online journals, eBooks and interlibrary loan services through
the University of Michigan. Our team of librarians is available
via e-mail
and phone to help with research, teaching and learning. They
offer tutorials, virtual instruction sessions, consultations on
research assignments and online research guides. Librarians also
attend our residential colloquia to teach library instruction
sessions and offer
one-on-one
research appointments.
Career Counseling Services. Our staff of
professional career counselors use a variety of tools, including
individualized phone, e-mail and
face-to-face
communications, online newsletters, online seminars and
conference calls to provide career planning services to learners
and alumni. Our counselors also assist our
8
recruitment staff with prospective learners selection of
the Capella University program and specialization that best
suits their professional aspirations.
Admissions
Capella Universitys admission process is designed to offer
access to prospective learners who seek the benefits of a
post-secondary education while providing realistic feedback to
prospects regarding their ability to successfully complete their
chosen program. As part of the first course in their program of
study, admitted learners are required to complete an orientation
to online education and a skills assessment, the results of
which enable us to develop an understanding of the specific
needs and readiness of each individual learner. Learners must
successfully complete the first course in their program of study
to continue their education.
Learners enrolling in our bachelors programs must have a
high school diploma or a GED and demonstrate competence in
writing and logical reasoning during the first course of their
program of study. Learners enrolling in our graduate programs
must have the requisite academic degree from an accredited
institution and a specified minimum grade point average. In
addition to our standard admission requirements, we require
applicants to some of our programs to provide additional
application material, information,
and/or
interview with, and be approved by, a faculty committee.
Marketing
We engage in a range of marketing activities to build the
Capella brand, differentiate us from other educational
providers, raise levels of awareness with prospective learners,
generate inquiries about enrollment, remind and motivate
existing learners to re-register each quarter, and stimulate
referrals from existing learners. These marketing activities
include Internet, print and direct mail advertising campaigns,
participation in seminars and trade shows, and development of
marketing channels through our corporate, U.S. Armed
Forces, healthcare and educational relationships. Online
advertising (targeted, direct and through aggregators) currently
generates our largest volume of prospective learners.
Our corporate, U.S. Armed Forces, healthcare and
educational relationships and discount programs are developed
and managed by our channel development teams. Our channel
development teams work with representatives in the various
organizations to help them understand the quality, impact and
value that our academic programs can provide, both for the
individuals in their organization and for the organization
itself. Our corporate alliance programs offer education
opportunities to employees of large companies and healthcare
institutions with a tuition discount. We offer a tuition
discount to all members of the U.S. Armed Forces, including
active duty members, veterans, national guard members,
reservists, civilian employees of the Department of Defense and
immediate family members of active duty personnel. We also have
arrangements with various educational institutions of the
U.S. Armed Forces pursuant to which we have agreed to
accept credits from certain military educational programs earned
by learners who meet our transfer requirements, which they can
apply toward a Capella University degree. We have also developed
our educational alliance program to allow graduates of community
colleges to matriculate into our programs and to recruit
community college faculty to attend our graduate programs with a
tuition discount. For the year ended December 31, 2006,
approximately 35% of our learners received a discount in
connection with one of our marketing relationships.
Enrollment
We offer different program start dates to new learners,
occurring approximately once per month. As of the last day of
classes in the quarter ended December 31, 2006, our
enrollment was 17,976 learners. Of the learners that responded
to our demographic survey, as of December 31, 2006,
approximately 66% were female and approximately 39% were of
color. Our learner population is geographically distributed
throughout the United States.
9
The following is a summary of our learners as of the last day of
classes in the quarter ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
Enrollment
|
|
|
|
Number of
|
|
|
%
|
|
|
|
Learners
|
|
|
of Total
|
|
|
Doctoral
|
|
|
7,473
|
|
|
|
41.6
|
%
|
Masters
|
|
|
7,685
|
|
|
|
42.7
|
%
|
Bachelors
|
|
|
2,729
|
|
|
|
15.2
|
%
|
Other
|
|
|
89
|
|
|
|
0.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
17,976
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
Tuition
and Fees
Our tuition rates vary by type and length of program and by
degree level, such as doctoral, masters or
bachelors. For all masters and bachelors
programs and for selected doctoral programs, tuition is
determined by the number of courses taken by each learner. For
the
2005-2006
academic year (the academic year that began in July 2005),
prices per course generally ranged from $1,400 to $1,950. The
price of the course will vary based upon the number of credit
hours, the degree level of the program and the discipline. For
the
2005-2006
academic year, the majority of doctoral programs were priced at
a fixed quarterly amount of $3,975 per learner, regardless
of the number of courses in which the learner was registered. In
January 2006, we adjusted our fixed quarterly tuition rate for
doctoral learners in their comprehensive exam or dissertation to
$3,200. In addition, if a learner in a doctoral program with
fixed quarterly tuition had paid for 16 quarters, completed all
coursework except for their comprehensive exam or dissertation
and met all colloquia requirements, the tuition rate was reduced
to $500 per quarter. Other in the table above
refers primarily to certificate-seeking learners. Certificate
programs generally consist of four courses, and the price of a
course depends on the number of credit hours, the degree level
of the program and the discipline. For the
2005-2006
academic year, prices per course in certificate programs
generally ranged from $1,400 to $1,925.
Capella University implemented a tuition increase in 10 of our
13 programs generally ranging from 2% to 6% for the
2006-2007
academic year (the academic year that began in July 2006). The
price increase resulted in prices per course generally ranging
from $1,460 to $1,995 for masters, bachelors and
certificate programs. The majority of doctoral programs were
priced at a fixed quarterly amount of $4,050 per learner,
regardless of the number of courses in which the learner was
registered. The fixed quarterly tuition for doctoral learners in
their comprehensive exam or dissertation increased to $3,240.
The reduced tuition rate for doctoral learners who have paid for
16 quarters, completed all coursework except for their
comprehensive exam or dissertation and met all colloquia
requirements increased from $500 to $810 per quarter.
Employees
and Adjunct Faculty
As of December 31, 2006, we had a total of 904 faculty
members, consisting of 130 full-time faculty and
774 part-time, adjunct faculty. Our adjunct faculty are
engaged through independent contractor agreements.
We engage our adjunct faculty on a
course-by-course
basis. Adjunct faculty are compensated a fixed amount per
learner for a base number of learners and a variable rate per
learner thereafter, which varies depending on discipline. In
addition to teaching assignments, adjunct faculty may be asked
to serve on learner committees, such as comprehensive
examination and dissertation committees, or assist with course
development. We have the right to cancel any teaching assignment
due to low enrollment or to cancel sections to create proper
class sizes. If a teaching assignment is canceled, we do not
compensate the adjunct faculty member for the assignment. Our
independent contractor agreements with adjunct faculty typically
have a
one-quarter
term, but we are not required to engage them to teach any
certain number of courses and have the right to terminate their
services upon written notice at any time.
As of December 31, 2006, we also employed 883 non-faculty
staff in university services, academic advising and academic
support, enrollment services, university administration,
financial aid, information
10
technology, human resources, corporate accounting, finance and
other administrative functions. None of our employees is a party
to any collective bargaining or similar agreement with us. We
consider our relationships with our employees to be satisfactory.
Intellectual
Property
Intellectual property is important to our business. We rely on a
combination of copyrights, trademarks, service marks, trade
secrets, domain names and agreements with third parties to
protect our proprietary rights. In many instances, our course
content is produced for us by faculty and other content experts
under work for hire agreements pursuant to which we own the
course content in return for a fixed development fee. In certain
limited cases, we license course content from a third party on a
royalty fee basis.
We have trademark or service mark registrations and pending
applications in the U.S. and select foreign jurisdictions for
the words CAPELLA, CAPELLA EDUCATION
COMPANY, and CAPELLA UNIVERSITY and
distinctive logos, along with various other trademarks and
service marks related to our specific offerings. We also own
domain name rights to
www.capellaeducation.com,
www.capella.edu and
www.capellauniversity.edu, as well as other
words and phrases important to our business.
Available
Information
The Companys Internet address is www.capellaeducation.com.
The Company makes available, free of charge through its website,
its Annual Reports on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
and amendments to those reports filed pursuant to
Section 13(a) or 15(d) of the Exchange Act, soon after they
are electronically filed with the SEC. In addition, the
Companys earnings conference calls and presentations to
the financial community are web cast live via the Companys
website. In addition to visiting the Companys website, you
may read and copy public reports the Company files with the SEC
at the SECs Public Reference Room at 100 F. Street, NE,
Washington DC 20549, or at www.sec.gov. You may obtain
information on the operation of the Public Reference Room by
calling the SEC at
1-800-SEC-0330.
REGULATION
Regulatory
Environment
Learners attending Capella University finance their education
through a combination of individual resources, private loans,
corporate reimbursement programs and federal financial aid
programs. Capella University participates in the federal
student financial aid programs authorized under Title IV.
In connection with a learners receipt of federal financial
aid, we are subject to extensive regulation by the Department of
Education, state education agencies and our accrediting agency,
The Higher Learning Commission of the North Central Association
of Colleges and Schools. Our business activities are planned and
implemented to achieve compliance with the rules and regulations
of the state, regional and federal agencies that regulate our
activities.
Accreditation
Capella University has been institutionally accredited since
1997 by The Higher Learning Commission of the North Central
Association of Colleges and Schools, a regional accrediting
agency recognized by the Secretary of the Department of
Education. We will seek to have our accreditation reaffirmed in
2007 as part of a regularly scheduled reaffirmation process.
Accreditation is a non-governmental system for recognizing
educational institutions and their programs for student
performance, governance, integrity, educational quality,
faculty, physical resources, administrative capability and
resources, and financial stability. In the United States, this
recognition comes primarily through private voluntary
associations that accredit institutions and programs of higher
education. These associations, or accrediting agencies,
establish criteria for accreditation, conduct peer-review
evaluations of institutions and professional programs for
accreditation and publicly designate those institutions that
meet their criteria. Accredited schools are subject to periodic
review by accrediting agencies to determine whether such schools
maintain the performance, integrity and quality required for
accreditation.
11
The Higher Learning Commission is the same accrediting agency
that accredits such universities as Northwestern University, the
University of Chicago, the University of Minnesota and other
degree-granting public and private colleges and universities in
its region (namely, the States of Arkansas, Arizona, Colorado,
Iowa, Illinois, Indiana, Kansas, Michigan, Minnesota, Missouri,
North Dakota, Nebraska, Ohio, Oklahoma, New Mexico, South
Dakota, Wisconsin, West Virginia and Wyoming).
Accreditation by The Higher Learning Commission is important to
us. Colleges and universities depend, in part, on accreditation
in evaluating transfers of credit and applications to graduate
schools. Prospective employers rely on accreditation information
in evaluating job candidates. Moreover, institutional
accreditation by an accrediting agency recognized by the
Secretary of the Department of Education is necessary for
eligibility to participate in Title IV programs.
State
Education Licensure
We are subject to extensive regulations by the states in which
we are authorized or licensed to operate. State laws typically
establish standards for instruction, qualifications of faculty,
administrative procedures, marketing, recruiting, financial
operations and other operational matters. State laws and
regulations may limit our ability to offer educational programs
and to award degrees.
We are authorized to offer our programs by the Minnesota Office
of Higher Education, the regulatory agency governing the State
of Minnesota, where Capella University is located. We are
required by the Higher Education Act to maintain authorization
from the Minnesota Office of Higher Education in order to
participate in Title IV programs.
In addition to Minnesota, Capella University is licensed or
authorized to operate or to offer degree programs in the
following states: Alabama, Arizona, Arkansas, Colorado, Florida,
Georgia, Illinois, Kentucky, Nevada, Ohio, Virginia, Washington,
West Virginia and Wisconsin. We are licensed or authorized in
these states because we have determined that our activities in
each state constitute a presence requiring licensure or
authorization by the state educational agency. In some cases,
the licensure or authorization is only for specific programs.
The increasing popularity and use of the Internet and other
online services for the delivery of education has led and may
lead to the adoption of new laws and regulatory practices in the
United States or foreign countries and new interpretations of
existing laws and regulations. These new laws, regulations and
interpretations may relate to issues such as the requirement
that online education institutions be licensed in one or more
jurisdictions where they have no physical location or other
presence. For instance, in some states, we are required to seek
licensure or authorization because our recruiters meet with
prospective students in the state. In other cases, the state
educational agency has required licensure or authorization
because we enroll students who reside in the state. New laws,
regulations or interpretations related to doing business over
the Internet could increase our cost of doing business and
affect our ability to recruit students in particular states,
which could, in turn, negatively affect enrollments and revenues
and have a material adverse effect on our business.
State
Professional Licensure
Many states have specific requirements that an individual must
satisfy in order to be licensed as a professional in a specified
field. Students often seek to obtain professional licensure in
their chosen fields following graduation. Their success in
obtaining licensure typically depends on several factors,
including the individual merits of the graduate and factors
specific to the institution from which the student graduated.
Due to varying requirements for professional licensure in each
state, Capella Universitys catalog informs learners of the
risks associated with obtaining professional licensure. In
addition, we semi-annually remind our learners that they need to
communicate directly with the state in which they intend to seek
licensure to fully understand the licensing requirements of that
state.
12
Nature of
Federal, State and Private Financial Support for Post-Secondary
Education
The federal government provides a substantial part of its
support for post-secondary education through Title IV
programs, in the form of grants and loans to students who can
use those funds at any institution that has been certified as
eligible by the Department of Education. Aid under Title IV
programs is primarily awarded on the basis of financial need,
generally defined as the difference between the cost of
attending the institution and the amount a student can
reasonably contribute to that cost. All recipients of
Title IV program funds must maintain satisfactory academic
progress in a timely manner toward completion of their program
of study. In addition, each such school must ensure that
Title IV program funds are properly accounted for and
disbursed in the correct amounts to eligible learners.
Capella University learners receive loans and grants to fund
their education under the following Title IV programs:
(1) the Federal Family Education Loan (FFEL) program and
(2) the Federal Pell Grant, or Pell, program. In 2006,
approximately 71% of our revenues (calculated on a cash basis)
were derived from tuition financed under Title IV programs.
1) FFEL. Under the FFEL program, banks
and other lending institutions make loans to learners. If a
learner defaults on a loan, payment is guaranteed by a federally
recognized guaranty agency, which is then reimbursed by the
Department of Education. Students with financial need qualify
for interest subsidies while in school and during grace periods.
In 2006, we derived approximately 70.6% of our revenues
(calculated on a cash basis) from the FFEL program.
2) Pell. Under the Pell program, the
Department of Education makes grants to students who demonstrate
financial need. In 2006, we derived approximately 0.4% of our
revenues (calculated on a cash basis) from the Pell program.
In addition to the programs stated above, eligible learners at
Capella University may participate in several other financial
aid programs or receive support from other governmental and
private sources, including the U.S. Department of Veterans
Affairs through the Minnesota Department of Veterans Affairs. In
certain situations, we may assist learners in accessing
alternative loan programs available to Capella Universitys
learners. Alternative loans are intended to cover the difference
between what the learner receives from all financial aid and the
full cost of the learners education. Finally, many Capella
University learners finance their own education or receive full
or partial tuition reimbursement from their employers.
Regulation
of Federal Student Financial Aid Programs
To be eligible to participate in Title IV programs, an
institution must comply with specific standards and procedures
set forth in the Higher Education Act and the regulations issued
thereunder by the Department of Education. An institution must,
among other things, be licensed or authorized to offer its
educational programs by the state within which it is physically
located (in our case, Minnesota) and maintain institutional
accreditation by a recognized accrediting agency. Capella
University is currently certified to participate in
Title IV programs through December 31, 2008.
The substantial amount of federal funds disbursed through
Title IV programs, the large number of students and
institutions participating in these programs and allegations of
fraud and abuse by certain for-profit institutions have caused
Congress to require the Department of Education to exercise
considerable regulatory oversight over for-profit institutions
of higher learning. Accrediting agencies and state education
agencies also have responsibilities for overseeing compliance of
institutions with Title IV program requirements.
Significant factors relating to Title IV programs that
could adversely affect us include the following:
Congressional Action. Congress
reauthorizes the Higher Education Act approximately every five
to eight years. Congress most recently reauthorized the Higher
Education Act in 1998. Because reauthorization had not yet been
completed in a timely manner, Congress extended the current
provisions of the Higher Education Act through June 30,
2007. The new Congress is in the process of reviewing the Higher
Education Act for purposes of reauthorization, but it is not
possible to predict with certainty when the reauthorization
process will be completed. If reauthorization is not completed
by June 30, 2007, Congress is expected to enact
13
legislation to further temporarily extend Title IV programs
as currently authorized under the Higher Education Act for a
period of months, not likely to exceed one year.
In addition, Congress reviews and determines appropriations for
Title IV programs on an annual basis through the budget and
appropriations process. A reduction in federal funding levels of
such programs could reduce the ability of certain learners to
finance their education. These changes, in turn, could lead to
lower enrollments at Capella University or require Capella
University to increase its reliance upon alternative sources of
learner financial aid. Given the significant percentage of
Capella Universitys revenues that are derived indirectly
from Title IV programs, the loss of or a significant
reduction in Title IV program funds available to Capella
Universitys learners could reduce its enrollment and
revenue and possibly have a material adverse effect on our
business. In addition, the regulations applicable to Capella
University have been subject to frequent revisions, many of
which have increased the level of scrutiny to which for-profit
post-secondary educational institutions are subjected and have
raised applicable standards. If Capella University were not to
continue to comply with such regulations, such non-compliance
might impair its ability to participate in Title IV
programs, offer programs or continue to operate. Certain of the
regulations applicable to Capella University are described below.
Distance Learning and Repeal of the 50%
Rules. Capella University offers all of
its existing degree programs via Internet-based
telecommunications from Capellas headquarters in
Minneapolis, Minnesota.
Prior to passage of the Higher Education Reconciliation Act as
part of the Deficit Reduction Act in 2006, the Higher Education
Act generally excluded from Title IV programs institutions
at which (1) more than 50% of the institutions
courses were offered via distance delivery methods, which
includes online courses, or (2) 50% or more of the
institutions students were enrolled in courses delivered
via correspondence methods, including online courses. Because
100% of Capella Universitys courses are online courses and
100% of its learners are enrolled in online courses, the 50%
Rules would have, absent the Distance Education Demonstration
Program (which provided the opportunity for Capella University
and its learners to provisionally participate in Title IV
programs) precluded Capella University and its learners from
participating in Title IV programs.
The 50% Rules were repealed for telecommunications courses
(which include online courses) as part of the Higher Education
Reconciliation Act, but remain in place for correspondence
courses. Accordingly, online institutions such as Capella
University, which offer their courses exclusively through
telecommunications, are no longer subject to the 50% Rules.
Following passage of the Higher Education Reconciliation Act,
the Department of Education also terminated the Demonstration
Program effective as of June 30, 2006. Because Capella
University is no longer subject to the 50% Rules, it is likewise
no longer dependent on the Demonstration Program to participate
in the Title IV Programs.
At least six lawsuits were filed challenging the
constitutionality of the Deficit Reduction Act in general, on
grounds that discrepancies exist between non-education related
provisions of the legislation passed in the House and Senate. In
the event that the Deficit Reduction Act is invalidated, the 50%
Rules could be reinstated, and Capella University and its
learners would not be in a position to participate in
Title IV programs until the 50% Rules were repealed via
alternative legislative action, or until Congress reinstated the
Demonstration Program or otherwise acted to permit the
participation of impacted Title IV participating
institutions.
Administrative Capability. Department
of Education regulations specify extensive criteria by which an
institution must establish that it has the requisite
administrative capability to participate in
Title IV programs. To meet the administrative capability
standards, an institution, among other things, must comply with
all applicable Title IV program regulations, must have
capable and sufficient personnel to administer its financial aid
programs, must have acceptable methods of defining and measuring
the satisfactory academic progress of its students, must not
have cohort default debt rates above specified levels, must have
various procedures in place for safeguarding federal funds, and
must not otherwise appear to lack administrative capability.
Failure to satisfy any of the standards or any other Department
of Education regulation, the Department of Education may:
require the repayment of Title IV funds; transfer the
institution from the advance system of payment of
Title IV funds to cash monitoring status or to the
reimbursement system of
14
payment; place the institution on provisional certification
status; or commence a proceeding to impose a fine or to limit,
suspend or terminate the participation of the institution in
Title IV programs.
Financial Responsibility. The Higher
Education Act and Department of Education regulations establish
extensive standards of financial responsibility that
institutions such as Capella University must satisfy in order to
participate in Title IV programs. These standards generally
require that an institution provide the resources necessary to
comply with Title IV program requirements and meet all of
its financial obligations, including required refunds and any
repayments to the Department of Education for liabilities
incurred in programs administered by the Department of Education.
The Department of Education evaluates institutions on an annual
basis for compliance with specified financial responsibility
standards utilizing a complex formula that uses line items from
the institutions audited financial statements. The
standards focus on three financial ratios: (1) equity ratio
(which measures the institutions capital resources,
financial viability and ability to borrow); (2) primary
reserve ratio (which measures the institutions ability to
support current operations from expendable resources); and
(3) net income ratio (which measures the institutions
ability to operate at a profit or within its means). An
institutions financial ratios must yield a composite score
of at least 1.5 for the institution to be deemed financially
responsible without the need for further federal oversight. We
have applied the financial responsibility standards to our
consolidated financial statements as of and for the years ended
December 31, 2006 and 2005, and calculated a composite
score of 3.0 for both years, which is the maximum score
attainable. We therefore believe that we meet the Department of
Educations financial responsibility standards.
Title IV Return of Funds. Under
the Department of Educations return of funds regulations,
an institution must first determine the amount of Title IV
program funds that a student earned. If the student
withdraws during the first 60% of any period of enrollment or
payment period, the amount of Title IV program funds that
the student earned is equal to a pro rata portion of the funds
for which the student would otherwise be eligible. If the
student withdraws after the 60% threshold, then the student has
earned 100% of the Title IV program funds. The institution
must return to the appropriate Title IV programs, in a
specified order, the lesser of (i) the unearned
Title IV program funds and (ii) the institutional
charges incurred by the student for the period multiplied by the
percentage of unearned Title IV program funds.
The 90/10 Rule. A
requirement of the Higher Education Act, commonly referred to as
the 90/10 Rule, applies only to proprietary
institutions of higher education, which includes Capella
University. Under this rule, an institution loses its
eligibility to participate in the Title IV programs, if, on
a cash accounting basis, it derives more than 90% of its
revenues for any fiscal year from Title IV program funds.
Any institution that violates the rule becomes ineligible to
participate in the Title IV programs as of the first day of
the fiscal year following the fiscal year in which it exceeds
90%, and it is unable to apply to regain its eligibility until
the next fiscal year. For the year ended December 31, 2006,
we derived approximately 71% of our revenues (calculated on a
cash basis) from Title IV program funds.
Student Loan Defaults. Under the
Higher Education Act, an educational institution may lose its
eligibility to participate in some or all of the Title IV
programs if defaults on the repayment of federally guaranteed
student loans by its students exceed certain levels. For each
federal fiscal year, a rate of student defaults (known as a
cohort default rate) is calculated for each
institution with 30 or more borrowers entering repayment in a
given federal fiscal year by determining the rate at which
borrowers who become subject to their repayment obligation in
that federal fiscal year default by the end of the following
federal fiscal year. For such institutions, the Department of
Education calculates a single cohort default rate for each
federal fiscal year that includes in the cohort all current or
former student borrowers at the institution who entered
repayment on any FFEL program loan during that year.
If the Department of Education notifies an institution that its
cohort default rates for each of the three most recent federal
fiscal years are 25% or greater, the institutions
participation in the FFEL program and Pell program ends
30 days after the notification, unless the institution
appeals in a timely manner that determination on specified
grounds and according to specified procedures. In addition, an
institutions participation in the FFEL program ends
30 days after notification that its most recent cohort
default rate is
15
greater than 40%, unless the institution timely appeals that
determination on specified grounds and according to specified
procedures.
Capella Universitys cohort default rates on FFEL program
loans for the 2004, 2003 and 2002 federal fiscal years, the
three most recent years for which information is available, were
2.2%, 1.8%, and 2.8%, respectively. The average cohort default
rates for four-year proprietary institutions nationally were
7.3%, 6.4%, and 7.3% in fiscal years 2004, 2003 and 2002,
respectively.
Incentive Compensation Rules. As a part
of an institutions program participation agreement with
the Department of Education and in accordance with the Higher
Education Act, the institution may not provide any commission,
bonus or other incentive payment to any person or entity engaged
in any student recruitment, admissions or financial aid awarding
activity based directly or indirectly on success in securing
enrollments or financial aid. Certain Department of Education
regulations clarify the incentive payment rule. The regulations
set forth 12 safe harbors, which describe payments
or arrangements that do not violate the incentive payment rule.
Failure to comply with the incentive compensation rules could
result in loss of eligibility to participate in federal student
financial aid programs or financial penalties. Although there
can be no assurance that the Department of Education would not
find deficiencies in Capella Universitys present or former
employee compensation and third-party contractual arrangements,
we believe that our employee compensation and
third-party
contractual arrangements comply with the incentive compensation
provisions of the Higher Education Act and Department of
Education regulations thereunder.
Compliance Reviews. We are subject to
announced and unannounced compliance reviews and audits by
various external agencies, including the Department of
Education, its Office of Inspector General (OIG),
state licensing agencies, agencies that guarantee FFEL loans,
the Department of Veterans Affairs and accrediting agencies. As
part of the Department of Educations ongoing monitoring of
institutions administration of Title IV programs, The
Higher Education Act and Department of Education regulations
also require institutions to annually submit a compliance audit
conducted by an independent certified public accountant in
accordance with Government Auditing Standards and applicable
audit standards of the Department of Education. In addition, to
enable the Secretary of Education to make a determination of
financial responsibility, institutions must annually submit
audited financial statements prepared in accordance with
Department of Education regulations.
The OIG is responsible for, among other things, promoting the
effectiveness and integrity of the Department of
Educations programs and operations. With respect to
educational institutions that participate in Title IV
funding programs, the OIG conducts its work primarily through
compliance audits and investigations. An OIG compliance audit
typically focuses on whether an institution administers federal
funds in accordance with applicable rules and regulations,
whereas an investigation typically indicates a concern regarding
potential fraud or abuse involving federal funds. The OIG has
informed us that it is conducting a compliance audit (and not an
investigation) of Capella University. The audit commenced on
April 10, 2006 and since then we have been periodically
providing the OIG with information, responding to follow up
inquires and facilitating site visits and access to our records.
The audit has focused on Capella Universitys
administration of Title IV funding programs for the
Title IV award years of
2002-2003,
2003-2004
and
2004-2005
(with each award year commencing on July 1st). Although the
2005-2006
aid year is not specifically under audit, our discussions with
OIG personnel have also covered activities during the
2005-2006
aid year, and we have included that aid year within the scope of
our internal analysis of this matter, as more fully explained in
the following paragraph.
Based on the field auditors preliminary audit exceptions,
which is a preliminary list of issues regarding Capella
Universitys compliance with Title IV rules and
requirements, and our verbal communications with the OIG audit
staff, we believe that 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 we
did not properly calculate the amount of Title IV funds
required to be returned for learners that withdrew from
Capella University without providing an official
notification of such withdrawal and without engaging in academic
activity prior to such withdrawal. We believe the OIGs
current review of administrative rules surrounding learner
engagement reflects our evolution of the application of these
rules to an online education
16
environment. Based on its review to date, the OIG audit staff
has identified certain learners for whom it believes proper
returns of Title IV funds were not made. If it is
determined that we improperly withheld any portion of these
funds, we would be required to return the improperly withheld
funds. As part of our internal process of continuously
evaluating and attempting to improve our policies and
procedures, prior to the initiation of the OIG audit we had
already begun modifying our policies and procedures for
determining whether a learner is engaged in any academic
activity. We developed these policies and procedures during
spring 2006 and fully implemented them for the financial aid
year
2006-2007.
For the three year audit period, and for the
2005-2006
aid year, we estimate that the total amount of Title IV
funds not returned for learners who withdrew without providing
official notification was less than $1.0 million, including
interest, but not including fines and penalties.
The OIG field audit staff is also reviewing certain of our
procedures for determining whether learners are enrolled in an
eligible educational program prior to our disbursing
Title IV funds to these learners. Such enrollment is a
prerequisite to a learners receipt of Title IV
funding. To date, specific inquiries by the OIG audit staff have
focused on our practice of noting learners anticipated
Title IV funding on their accounts prior to final
confirmation of such enrollment, and whether we timely returned
Title IV funds that could not be disbursed within required
timeframes to an eligible learner. While Capella University
believes that its practices did not result in a disbursement of
Title IV funds to ineligible learners, and that the
non-disbursed Title IV funds were properly and timely
returned, the OIG is still reviewing the matter.
During the course of the audit process, the OIG field audit
staff have also questioned certain other matters that we
presently believe, based on communications with the OIG audit
staff, to be of lesser significance. Those additional matters
include apparent discrepancies between our policy regarding
satisfactory academic progress as set forth in the Capella
University catalog and as set forth in other communications to
our learners; whether we properly performed and documented
student loan exit counseling for certain learners in the audit
sample; and, whether we properly reviewed the financial aid
histories of certain learners in the audit sample.
The OIG completed its field work in January 2007, and based on
our conversations with the OIG, we believe they will issue a
draft audit report for our response and comment sometime in
March 2007. We expect that the OIG will not issue a final report
for several months thereafter. Consistent with the OIGs
normal practices, the final audit report will be made public at
the time it is released to both us and to the Department of
Educations Office of Federal Student Aid
(FSA). FSA is responsible for primary oversight of
the Title IV funding programs. In the event that the OIG
identifies findings of noncompliance in its final audit report,
the OIG will recommend remedial action to FSA, which will
determine whether to require that we refund certain federal
student aid funds, modify our Title IV administration
procedures, impose fines or penalties or take other remedial
action. The possible effects of a finding of a regulatory
violation are described below in Potential Effect of
Regulatory Violations.
Potential Effect of Regulatory
Violations. If Capella University fails to
comply with the regulatory standards governing Title IV
programs, the Department of Education could impose one or more
sanctions, including transferring Capella University to the
reimbursement or cash monitoring system of payment, seeking to
require repayment of certain Title IV program funds,
requiring Capella University to post a letter of credit in favor
of the Department of Education as a condition for continued
Title IV certification, taking emergency action against
Capella University, referring the matter for criminal
prosecution or initiating proceedings to impose a fine or to
limit, condition, suspend or terminate the participation of
Capella University in Title IV programs. In addition, the
agencies that guarantee FFEL loans for Capella University
learners could initiate proceedings to limit, suspend or
terminate Capella Universitys eligibility to provide
guaranteed student loans in the event of certain regulatory
violations. If such sanctions or proceedings were imposed
against us and resulted in a substantial curtailment, or
termination, of Capella Universitys participation in
Title IV programs, our enrollments, revenues and results of
operations would be materially and adversely affected.
If Capella University lost its eligibility to participate in
Title IV programs, or if the amount of available federal
student financial aid were reduced, we would seek to arrange or
provide alternative sources of revenue or financial aid for
learners. Although we believe that one or more private
organizations would be willing to provide financial assistance
to learners attending Capella University, there is no assurance
that this would be
17
the case, and the interest rate and other terms of such
financial aid might not be as favorable as those for
Title IV program funds. We may be required to guarantee all
or part of such alternative assistance or might incur other
additional costs in connection with securing alternative sources
of financial aid. Accordingly, the loss of eligibility of
Capella University to participate in Title IV programs, or
a reduction in the amount of available federal student financial
aid, would be expected to have a material adverse effect on our
results of operations even if we could arrange or provide
alternative sources of revenue or student financial aid.
Capella University also may be subject, from time to time, to
complaints and lawsuits relating to regulatory compliance
brought not only by our regulatory agencies, but also by other
government agencies and third parties, such as present or former
learners or employees and other members of the public.
Restrictions on Adding Educational
Programs. State requirements and accrediting
agency standards may, in certain instances, limit our ability to
establish additional programs. Many states require approval
before institutions can add new programs under specified
conditions. The Higher Learning Commission, the Minnesota Office
of Higher Education, and other state educational regulatory
agencies that license or authorize us and our programs, require
institutions to notify them in advance of implementing new
programs, and upon notification may undertake a review of the
institutions licensure, authorization or accreditation.
Generally, if an institution eligible to participate in
Title IV programs adds an educational program after it has
been designated as an eligible institution, the institution must
apply to the Department of Education to have the additional
program designated as eligible. However, a degree-granting
institution is not obligated to obtain the Department of
Educations approval of additional programs that lead to an
associate, bachelors, professional or graduate degree at
the same degree level(s) previously approved by the Department
of Education. Similarly, an institution is not required to
obtain advance approval for new programs that both prepare
learners for gainful employment in the same or related
recognized occupation as an educational program that has
previously been designated as an eligible program at that
institution and meet certain minimum-length requirements.
However, the Department of Education, as a condition of
certification to participate in Title IV programs, can
require prior approval of such programs or otherwise restrict
the number of programs an institution may add. In the event that
an institution that is required to obtain the Department of
Educations express approval for the addition of a new
program fails to do so, and erroneously determines that the new
educational program is eligible for Title IV program funds,
the institution may be liable for repayment of Title IV
program funds received by the institution or learners in
connection with that program.
Eligibility and Certification
Procedures. Each institution must apply to
the Department of Education for continued certification to
participate in Title IV programs at least every six years,
or when it undergoes a change of control, and an institution may
come under the Department of Educations review when it
expands its activities in certain ways, such as opening an
additional location or, in certain cases, when it modifies
academic credentials that it offers. The Department of Education
may place an institution on provisional certification status if
it finds that the institution does not fully satisfy all of the
eligibility and certification standards. The Department of
Education may withdraw an institutions provisional
certification without advance notice if the Department of
Education determines that the institution is not fulfilling all
material requirements. In addition, the Department of Education
may more closely review an institution that is provisionally
certified if it applies for approval to open a new location, add
an educational program, acquire another school or make any other
significant change.
Change in Ownership Resulting in a Change of
Control. In addition to school acquisitions,
other types of transactions can also cause a change of control.
The Department of Education, most state education agencies and
our accrediting agency all have standards pertaining to the
change of control of schools, but these standards are not
uniform. Department of Education regulations describe some
transactions that constitute a change of control, including the
transfer of a controlling interest in the voting stock of an
institution or the institutions parent corporation. With
respect to a publicly traded corporation, Department of
Education regulations provide that a change of control occurs in
one of two ways: (i) if there is an event that would
obligate the corporation to file a Current Report on
Form 8-K
with the SEC disclosing a change of control or (ii) if the
corporation has a shareholder that owns at least 25% of the
total outstanding voting stock of the corporation and is the
largest shareholder of the corporation, and that shareholder
ceases to own at least
18
25% of such stock or ceases to be the largest shareholder. These
standards are subject to interpretation by the Department of
Education. A significant purchase or disposition of our voting
stock could be determined by the Department of Education to be a
change of control under this standard. Many states include the
sale of a controlling interest of common stock in the definition
of a change of control requiring approval. A change of control
under the definition of one of these agencies would require us
to seek approval of the change in ownership and control in order
to maintain our accreditation, state authorization or licensure.
The requirements to obtain such approval from the states and our
accrediting commission vary widely. In some cases, approval of
the change of ownership and control cannot be obtained until
after the transaction has occurred.
When a change of ownership resulting in a change of control
occurs at a for-profit institution, the Department of Education
applies a different set of financial tests to determine the
financial responsibility of the institution in conjunction with
its review and approval of the change of ownership. The
institution is required to submit a
same-day
audited balance sheet reflecting the financial condition of the
institution immediately following the change in ownership. The
institutions
same-day
balance sheet must demonstrate an acid test ratio of at least
1:1, which is calculated by adding cash and cash equivalents to
current accounts receivable and dividing the sum by total
current liabilities (and excluding all unsecured or
uncollateralized related party receivables). In addition, the
same-day
balance sheet must demonstrate positive tangible net worth. If
the institution does not satisfy these requirements, the
Department of Education may condition its approval of the change
of ownership on the institutions agreeing to letters of
credit, provisional certification,
and/or
additional monitoring requirements.
A change of control also could occur as a result of future
transactions in which Capella Education Company or Capella
University are involved. Some corporate reorganizations and some
changes in the board of directors are examples of such
transactions. Moreover, the potential adverse effects of a
change of control could influence future decisions by us and our
shareholders regarding the sale, purchase, transfer, issuance or
redemption of our stock. In addition, the adverse regulatory
effect of a change of control also could discourage bids for
shares of our common stock and could have an adverse effect on
the market price of our common stock.
Risks
Related to the Extensive Regulation of Our Business
If we
fail to comply with the extensive regulatory requirements for
our business, we could face significant restrictions on our
operations and monetary penalties, including loss of access to
federal loans and grants for our learners on which we are
substantially dependent.
In 2006, we derived approximately 71% of our revenues
(calculated on a cash basis) from federal student financial aid
programs, referred to in this report as Title IV programs,
administered by the U.S. Department of Education. A
significant percentage of our learners rely on the availability
of Title IV program funds to cover their cost of attendance
at Capella University and related educational expenses.
Title IV programs include educational loans for our
learners from both private lenders and the federal government at
below-market interest rates that are guaranteed by the federal
government in the event of default. Title IV programs also
include several income-based grant programs for learners with
the greatest economic need as determined in accordance with
Department of Education regulations. To participate in
Title IV programs, a school must receive and maintain
authorization by the appropriate state education agencies, be
accredited by an accrediting agency recognized by the Secretary
of the Department of Education and be certified as an eligible
institution by the Department of Education. As a result, we are
subject to extensive regulation by state education agencies, our
accrediting agency and the Department of Education. These
regulatory requirements cover the vast majority of our
operations, including our educational programs, facilities,
instructional and administrative staff, administrative
procedures, marketing, recruiting, financial operations and
financial condition. These regulatory requirements can also
affect our ability to acquire or open additional schools, to add
new or expand existing educational programs and to change our
corporate structure and ownership. The state education agencies,
our accrediting agency and the Department of Education
periodically revise their requirements and modify their
interpretations of existing requirements.
19
If we fail to comply with any of these regulatory requirements,
our regulatory agencies could impose monetary penalties, place
limitations on our operations, terminate our ability to grant
degrees and certificates, revoke our accreditation
and/or
terminate our eligibility to receive Title IV program
funds, each of which could adversely affect our financial
condition and results of operations. In addition, should we fail
to properly comply with the regulatory requirements set forth in
the following risk factors, and as a result be charged,
sanctioned, subjected to loss of a federal, state or agency
approval or authorization, or otherwise be penalized in some
way, our reputation could be damaged and such damage could have
a negative impact on our stock price. We cannot predict with
certainty how all of these regulatory requirements will be
applied or whether we will be able to comply with all of the
requirements in the future. We have described some of the most
significant regulatory risks that apply to us in the following
paragraphs.
We
must seek recertification to participate in Title IV
programs no less than every six years, and may, in certain
circumstances, be subject to review by the Department of
Education prior to seeking recertification.
An institution that is certified to participate in Title IV
programs must seek recertification from the Department of
Education at least every six years, or when it undergoes a
change of control. The recertification process includes the
electronic submission of a new Application for Approval to
Participate in the Federal Student Financial Aid Programs,
which includes information about the schools
administration, ownership, educational programs and compliance
with Department of Education regulations. The application is
accompanied by financial statements and documentation of
continued accreditation and state authorization. Our current
certification expires on December 31, 2008. Our application
for recertification will be due for submission no later than
September 30, 2008. The Department of Education may also
review our continued certification to participate in
Title IV programs in the event we expand our activities in
certain ways, such as opening an additional location or, in
certain cases, if we modify the academic credentials that we
offer. In addition, the Department of Education may withdraw our
certification without advance notice if it determines that we
are not fulfilling material requirements for continued
participation in Title IV programs. If the Department of
Education did not renew or withdrew our certification to
participate in Title IV programs, our learners would no
longer be able to receive Title IV program funds, which
would have a material adverse effect on our enrollments,
revenues and results of operations.
Congress
may change the law or reduce funding for Title IV programs,
which could reduce our learner population, revenues and profit
margin.
Congress reauthorizes the Higher Education Act of 1965, as
amended (the Higher Education Act) and other laws governing
Title IV programs approximately every five to eight years.
The last reauthorization of the Higher Education Act was
completed in 1998, which extended authorization through
September 30, 2004. Because reauthorization had not yet
been completed in a timely manner, Congress extended the current
provisions of the Higher Education Act through June 30,
2007. Additionally, Congress reviews and determines
appropriations for Title IV programs on an annual basis
through the budget and appropriations process. There is no
assurance that reauthorization of the Higher Education Act will
happen, or that Congress will not enact changes that decrease
Title IV program funds available to students, including
students who attend our institution. A failure by Congress to
reauthorize or otherwise extend the provisions of the Higher
Education Act, or any action by Congress that significantly
reduces funding for Title IV programs or the ability of our
school or learners to participate in these programs, would
require us to arrange for non-federal sources of financial aid
and would materially decrease our enrollment. Such a decrease in
enrollment would have a material adverse effect on our revenues
and results of operations. Congressional action may also require
us to modify our practices in ways that could result in
increased administrative costs and decreased profit margin.
20
The
Office of Inspector General of the U.S. Department of
Education has commenced a compliance audit of Capella University
which is ongoing and which may result in repayment of
Title IV funds, interest, fines, penalties, remedial action
and damage to our reputation in the industry.
The Office of Inspector General (OIG) of the
U.S. Department of Education is responsible for, among
other things, promoting the effectiveness and integrity of the
Department of Educations programs and operations. With
respect to educational institutions that participate in the
Title IV funding programs, the OIG conducts its work
primarily through compliance audits and investigations. An OIG
compliance audit typically focuses upon whether an institution
administers federal funds in accordance with applicable rules
and regulations, whereas an investigation typically indicates a
concern regarding potential fraud or abuse involving federal
funds. In our case, the OIG has informed us that they are
conducting a compliance audit (and not an investigation) of
Capella University. The compliance audit commenced on
April 10, 2006 and since then we have been working with the
OIG to facilitate their audit. The period under audit is the
Title IV award years of
2002-2003,
2003-2004
and
2004-2005
(with each award year commencing on July 1st).
We do not yet know the full scope of the OIGs findings;
however, based on the field auditors preliminary audit
exceptions and our verbal communications with the OIG audit
staff, we believe that the audit is primarily focused upon
whether we properly calculated the amount of Title IV funds
required to be returned for learners that withdrew from Capella
University without providing an official notification of
withdrawal and without engaging in any academic activity prior
to such withdrawal. Based on its review to date, the OIG audit
staff has identified several such learners for whom it believes
proper returns of Title IV funds were not made. If it is
determined that we improperly withheld any portion of these
funds, we would be required to return the improperly withheld
funds, with interest (and possibly fines and penalties). As part
of our internal process of continuously evaluating and
attempting to improve our policies and procedures, prior to the
initiation of the OIG audit we had already begun modifying our
policies and procedures for determining whether a learner is
engaged in any academic activity. We developed these policies
and procedures during spring 2006 and fully implemented them for
the
2006-2007
financial aid year. For the three year audit period, and for
that portion of the
2005-2006
award year prior to our change in policies and procedures
described above, we estimate that the total amount of the
Title IV funds not returned for learners who withdrew
without providing official notification was less than
$1.0 million, including interest, but not including any
fines or penalties.
We believe the audit is also focused upon our policies and
procedures for disbursing Title IV funding to learners, and
focused to a lesser extent on our communication to our learners
of our satisfactory academic progress policy, our exit
counseling for federal student loan recipients, and our review
of learners financial aid histories prior to disbursing
Title IV funding. See Item 1
Business Regulation Regulation of
Federal Student Financial Aid Programs Compliance
Reviews for information about the OIG audit staffs
inquiries.
The OIG completed its field work in January 2007, and based on
our conversations with the OIG, we believe they will issue a
draft audit report for our response and comment sometime in
March 2007. We expect that the OIG will not issue a final report
until several months thereafter. In the event that the OIG
identifies findings of noncompliance in its final report, the
OIG will likely recommend remedial actions to the Office of
Federal Student Aid, which will determine whether to require
Capella University to refund certain federal student aid funds,
modify our Title IV administration procedures, impose fines
or penalties or take other remedial action. Because of the
ongoing nature of the OIG audit, we can neither know nor predict
with certainty the ultimate extent of the draft or final audit
findings, or the potential liability or remedial actions that
might result. These findings and related remedial action may
have an adverse impact on our reputation in the industry, our
cash flows and results of operations and our ability to recruit
learners, and may have an adverse effect on our stock price. The
possible effects of a finding of a regulatory violation
(including refunds, fines, penalties and limitations,
conditions, suspension or termination of our participation in
Title IV programs) are described more fully in
Item 1 Business
Regulation Regulation of Federal Student Financial
Aid Programs Potential Effect of Regulatory
Violations.
21
If we
fail to maintain our institutional accreditation, we would lose
our ability to participate in Title IV
programs.
Capella University is accredited by The Higher Learning
Commission of the North Central Association of Colleges and
Schools, one of six regional accrediting agencies recognized by
the Secretary of the Department of Education as a reliable
indicator of educational quality. Accreditation by a recognized
accrediting agency is required for an institution to become and
remain eligible to participate in Title IV programs. In
2007, we will seek to have our accreditation reaffirmed with The
Higher Learning Commission as part of a regularly scheduled
accreditation reaffirmation process. The Higher Learning
Commission may impose restrictions on our accreditation or may
not renew our accreditation. To remain accredited we must
continuously meet certain criteria and standards relating to,
among other things, performance, governance, institutional
integrity, educational quality, faculty, administrative
capability, resources and financial stability. Failure to meet
any of these criteria or standards could result in the loss of
accreditation at the discretion of The Higher Learning
Commission. The Department of Education has recently held
hearings on possible changes in accreditation rules; changes in
the accreditation rules could negatively impact our ability to
comply and could increase our cost of compliance. The loss of
accreditation would, among other things, render our learners and
us ineligible to participate in Title IV programs, reduce
the marketability of a Capella degree and have a material
adverse effect on our enrollments, revenues and results of
operations.
If
Capella University does not maintain its authorization in
Minnesota, it may not operate or participate in Title IV
programs.
A school that grants degrees, diplomas or certificates must be
authorized by the relevant education agency of the state in
which it is located. Capella University is deemed to be located
in the State of Minnesota and is authorized by the Minnesota
Office of Higher Education. State authorization is also required
for our learners to be eligible to receive funding under
Title IV programs. Such authorization may be lost or
withdrawn if Capella University fails to submit renewal
applications and other required submissions to the state in a
timely manner, or if Capella University fails to comply with
material requirements under Minnesota statutes and rules for
continued authorization. Loss of state authorization by Capella
University from the Minnesota Office of Higher Education would
terminate our ability to provide educational services as well as
our eligibility to participate in Title IV programs.
Our
regulatory environment and our reputation may be negatively
influenced by the actions of other
for-profit
institutions.
We are one of a number of for-profit institutions serving the
post-secondary education market. In recent years, regulatory
investigations and civil litigation have been commenced against
several companies that own for-profit educational institutions.
These investigations and lawsuits have alleged, among other
things, deceptive trade practices and non-compliance with
Department of Education regulations. These allegations have
attracted adverse media coverage and have been the subject of
federal and state legislative hearings. Although the media,
regulatory and legislative focus has been primarily upon the
allegations made against these specific companies, broader
allegations against the overall for-profit school sector may
negatively impact public perceptions of other for-profit
educational institutions, including Capella University. Adverse
media coverage regarding other companies in the for-profit
school sector or regarding us directly could damage our
reputation, could result in lower enrollments, revenues and
operating profit, and could have a negative impact on our stock
price. Such allegations could also result in increased scrutiny
and regulation by the Department of Education, Congress,
accrediting bodies, state legislatures or other governmental
authorities on all for-profit institutions, including us.
We are
subject to sanctions if we fail to correctly calculate and
timely return Title IV program funds for learners who
withdraw before completing their educational
program.
A school participating in Title IV programs must correctly
calculate the amount of unearned Title IV program funds
that have been disbursed to students who withdraw from their
educational programs before completion and must return those
unearned funds in a timely manner, generally within 30 days
(45 days
22
beginning September 8, 2006) of the date the school
determines that the student has withdrawn. Under Department of
Education regulations, late returns of Title IV program
funds for 5% or more of students sampled on the
institutions annual compliance audit constitutes material
non-compliance. If unearned funds are not properly calculated
and timely returned, we may have to post a letter of credit in
favor of the Department of Education or otherwise be sanctioned
by the Department of Education, which could increase our cost of
regulatory compliance and adversely affect our results of
operations. As described in Item 1
Business Regulation Regulation of
Federal Student Financial Aid Programs Compliance
Reviews, we are currently subject to an OIG audit which we
understand includes a review of the amount of Title IV
program funds that we returned for learners who withdrew from
their educational programs before completion and without
providing official notification of such withdrawal.
A
failure to demonstrate financial responsibility may
result in the loss of eligibility by Capella University to
participate in Title IV programs or require the posting of
a letter of credit in order to maintain eligibility to
participate in Title IV programs.
To participate in Title IV programs, an eligible
institution must satisfy specific measures of financial
responsibility prescribed by the Department of Education, or
post a letter of credit in favor of the Department of Education
and possibly accept other conditions on its participation in
Title IV programs. The Department of Education may also
apply such measures of financial responsibility to the operating
company and ownership entities of an eligible institution and,
if such measures are not satisfied by the operating company or
ownership entities, require the institution to post a letter of
credit in favor of the Department of Education and possibly
accept other conditions on its participation in Title IV
programs. Any obligation to post a letter of credit could
increase our costs of regulatory compliance. If Capella
University is unable to secure a letter of credit, it would lose
its eligibility to participate in Title IV programs. In
addition to the obligation to post a letter of credit, an
institution that is determined by the Department of Education
not to be financially responsible can be transferred from the
advance system of payment of Title IV funds to
cash monitoring status or to the reimbursement
system of payment. Limitations on, or termination of, Capella
Universitys participation in Title IV programs as a
result of its failure to demonstrate financial responsibility
would limit Capella Universitys learners access to
Title IV program funds, which could significantly reduce
our enrollments and revenues and materially and adversely affect
our results of operations.
A
failure to demonstrate administrative capability may
result in the loss of Capella Universitys eligibility to
participate in Title IV programs.
Department of Education regulations specify extensive criteria
an institution must satisfy to establish that it has the
requisite administrative capability to participate
in Title IV programs. These criteria require, among other
things, that the institution:
|
|
|
|
|
comply with all applicable Title IV program regulations;
|
|
|
|
have capable and sufficient personnel to administer the federal
student financial aid programs;
|
|
|
|
have acceptable methods of defining and measuring the
satisfactory academic progress of its students;
|
|
|
|
not have cohort default debt rates above specified levels;
|
|
|
|
have various procedures in place for safeguarding federal funds;
|
|
|
|
not be, and not have any principal or affiliate who is, debarred
or suspended from federal contracting or engaging in activity
that is cause for debarment or suspension;
|
|
|
|
provide financial aid counseling to its students;
|
|
|
|
refer to the Department of Educations Office of Inspector
General any credible information indicating that any applicant,
student, employee or agent of the institution has been engaged
in any fraud or other illegal conduct involving Title IV
programs;
|
|
|
|
submit in a timely manner all reports and financial statements
required by the regulations; and
|
23
|
|
|
|
|
not otherwise appear to lack administrative capability.
|
If an institution fails to satisfy any of these criteria or
comply with any other Department of Education regulations, the
Department of Education may:
|
|
|
|
|
require the repayment of Title IV funds;
|
|
|
|
transfer the institution from the advance system of
payment of Title IV funds to cash monitoring status or to
the reimbursement system of payment;
|
|
|
|
place the institution on provisional certification
status; or
|
|
|
|
commence a proceeding to impose a fine or to limit, suspend or
terminate the participation of the institution in Title IV
programs.
|
If we are found not to have satisfied the Department of
Educations administrative capability
requirements we could be limited in our access to, or lose,
Title IV program funding, which would significantly reduce
our enrollment and revenues and materially and adversely affect
our results of operations.
We are
subject to sanctions if we pay impermissible commissions,
bonuses or other incentive payments to individuals involved in
certain recruiting, admissions or financial aid
activities.
A school participating in Title IV programs may not provide
any commission, bonus or other incentive payment to any person
involved in student recruiting or admission activities or in
making decisions regarding the awarding of Title IV program
funds based on success in enrolling students or securing
financial aid. If we violate this law, we could be fined or
otherwise sanctioned by the Department of Education. Any such
fines or sanctions could harm our reputation, impose significant
costs on us, and have a material adverse effect on our results
of operations.
Our
failure to comply with regulations of various states could
result in actions taken by those states that would have a
material adverse effect on our enrollments, revenues and results
of operations.
Various states impose regulatory requirements on educational
institutions operating within their boundaries. Several states
have sought to assert jurisdiction over online educational
institutions that have no physical location or other presence in
the state but offer educational services to students who reside
in the state, or that advertise to or recruit prospective
students in the state. State regulatory requirements for online
education are inconsistent between states and not well developed
in many jurisdictions. As such, these requirements change
frequently and, in some instances, are not clear or are left to
the discretion of state employees or agents. Our changing
business and the constantly changing regulatory environment
require us to continually evaluate our state regulatory
compliance activities. In the event we are found not to be in
compliance, and a state seeks to restrict one or more of our
business activities within its boundaries, we may not be able to
recruit learners from that state and may have to cease providing
service to learners in that state.
Capella University is subject to extensive regulations by the
states in which it is authorized or licensed. In addition to
Minnesota, Capella University is authorized or licensed in the
following 14 states for all or some
24
of its programs because we have determined that our activities
in these states constitute a presence or otherwise require
authorization or licensure by the respective state educational
agencies:
|
|
|
State
|
|
Capella University Activity Constituting Presence Requiring
Licensure or Authorization
|
|
Alabama
|
|
Agreement with a former provider
of library services to Capella students.
|
Arizona
|
|
State agency broadly interprets
presence requiring licensure to include the offering of degree
programs by distance education; Capella also conducts in-state
colloquia.
|
Arkansas
|
|
Agreement with Wal-Mart Stores,
Inc. under which Wal-Mart employees located in Arkansas receive
discounted tuition for certain Capella University programs.
|
Colorado
|
|
No determination of presence;
authorization granted in order to have marketing and recruiting
agents in the state.
|
Florida
|
|
Recruiting activities in the state.
|
Georgia
|
|
Direct marketing and recruiting
activities in the state.
|
Illinois
|
|
Authorization to conduct in-state
colloquia.
|
Kentucky
|
|
Direct marketing and recruiting
activities in the state.
|
Nevada
|
|
Direct marketing and recruiting
activities in the state; agreements with community colleges.
|
Ohio
|
|
Direct marketing and recruiting
activities in the state for select programs.
|
Virginia
|
|
Direct marketing and recruiting
activities in the state; agreements with community colleges.
|
Washington
|
|
Direct marketing and recruiting
activities in the state; agreements with community colleges.
|
West Virginia
|
|
Direct marketing and recruiting
activities in the state.
|
Wisconsin
|
|
State agency broadly interprets
licensure requirements to cover all institutions serving
residents of the state.
|
As of the last day of classes for the quarter ended
December 31, 2006, the number of learners living in each of
these states (other than Minnesota, Florida and Georgia) was
less than 5% of our total enrollment. As of the last day of
classes for the quarter ended December 31, 2006,
approximately 5% of our learners lived in Minnesota,
approximately 6% lived in Florida and approximately 8% lived in
Georgia.
In some cases, the licensure or authorization is only for
specific programs. In the majority of these states, Capella
University has determined that separate licensure or
authorization for its certificate programs is not necessary,
although approval of certificate programs is required and has
been obtained from the States of Arizona, Florida and Ohio.
State laws typically establish standards for instruction,
qualifications of faculty, administrative procedures, marketing,
recruiting, financial operations and other operational matters.
State laws and regulations may limit our ability to offer
educational programs and award degrees. Some states may also
prescribe financial regulations that are different from those of
the Department of Education. Capella University is required to
post surety bonds in several states. If we fail to comply with
state licensing or authorization requirements, we may be subject
to the loss of state licensure or authorization. Although we
believe that the only state licensure or authorization that is
necessary for Capella University to participate in Title IV
programs is our authorization from the Minnesota Office of
Higher Education, loss of licensure or authorization in other
states could prohibit us from recruiting or enrolling students
in those states, reduce significantly our enrollments and
revenues and have a material adverse effect on our results of
operations.
The
inability of our graduates to obtain licensure in their chosen
professional fields of study could reduce our enrollments and
revenues, and potentially lead to litigation that could be
costly to us.
Certain of our graduates seek professional licensure in their
chosen fields following graduation. Their success in obtaining
licensure depends on several factors, including the individual
merits of the learner, but also may depend on whether the
institution and the program were approved by the state or by a
professional association, whether the program from which the
learner graduated meets all state requirements and whether the
institution is accredited. Certain states have refused to
license students who graduate from programs that do not meet
specific types of accreditation, residency or other state
requirements. In the past, certain states have refused to
license learners from particular Capella University programs due
to the fact that the program did not meet one or more of the
states specific licensure requirements. We have had to
respond to claims
25
brought against us by former learners as a result of such
refusal. Certain states have denied our graduates professional
licensure because the Capella University program from which they
graduated did not have a sufficient number of residency hours,
did not satisfy state coursework requirements or was not
accredited by a specific third party (such as the American
Psychological Association). In the event that one or more states
refuses to recognize our learners for professional licensure in
the future based on factors relating to our institution or
programs, the potential growth of our programs would be
negatively impacted which could have a material adverse effect
on our results of operations. In addition, we could be exposed
to litigation that would force us to incur legal and other
expenses that could have a material adverse effect on our
results of operations.
If
regulators do not approve or delay their approval of
transactions involving a change of control of our company, our
ability to participate in Title IV programs may be
impaired.
If we or Capella University experience a change of control under
the standards of applicable state education agencies, The Higher
Learning Commission or the Department of Education, we must seek
the approval of each relevant regulatory agency. Transactions or
events that constitute a change of control include significant
acquisitions or dispositions of an institutions common
stock and significant changes in the composition of an
institutions board of directors. Some of these
transactions or events may be beyond our control. The potential
adverse effects of a change of control with respect to
participation in Title IV programs could influence future
decisions by us and our shareholders regarding the sale,
purchase, transfer, issuance or redemption of our common stock.
In addition, the adverse regulatory effect of a change of
control finding also could discourage bids for your shares of
our common stock and could have an adverse effect on the market
price of your shares.
Government
and regulatory agencies and third parties may conduct compliance
reviews, bring claims or initiate litigation against
us.
Because we operate in a highly regulated industry, we are
subject to compliance reviews and claims of non-compliance and
lawsuits by government agencies, regulatory agencies and third
parties, including claims brought by third parties on behalf of
the federal government. If the results of these reviews or
proceedings are unfavorable to us, or if we are unable to defend
successfully against lawsuits or claims, we may be required to
pay money damages or be subject to fines, limitations, loss of
Title IV funding, injunctions or other penalties. Even if
we adequately address issues raised by an agency review or
successfully defend a lawsuit or claim, we may have to divert
significant financial and management resources from our ongoing
business operations to address issues raised by those reviews or
to defend against those lawsuits or claims. Claims and lawsuits
brought against us may damage our reputation, even if such
claims and lawsuits are without merit.
We may
lose eligibility to participate in Title IV programs if our
student loan default rates are too high, which would
significantly reduce our learner population.
An educational institution may lose its eligibility to
participate in some or all Title IV programs if, for three
consecutive federal fiscal years, 25% or more of its students
who were required to begin repaying their student loans in the
relevant fiscal year default on their payment by the end of the
next federal fiscal year. In addition, an institution may lose
its eligibility to participate in some or all Title IV
programs if its default rate exceeds 40% in the most recent
federal fiscal year for which default rates have been calculated
by the Department of Education. Capella Universitys
default rates on the Federal Family Education Loan, or FFEL,
program loans for the 2004, 2003 and 2002 federal fiscal years,
the three most recent years for which information is available,
were 2.2%, 1.8% and 2.8%, respectively. If Capella University
loses its eligibility to participate in Title IV programs
because of high student loan default rates, our learners would
no longer be eligible to receive Title IV program funds
under various government-sponsored financial aid programs, which
would significantly reduce our enrollments and revenues and have
a material adverse effect on our results of operations.
26
We may
lose eligibility to participate in Title IV programs if the
50% Rules are reinstated temporarily or permanently, which would
significantly reduce our learner population and have an adverse
effect on our revenues and operating profits.
Prior to passage of the Higher Education Reconciliation Act of
2006, which was part of the Deficit Reduction Act of 2006, the
Higher Education Act generally excluded from Title IV
program participation institutions at which (1) more than
50% of the institutions courses were offered via
correspondence, including online courses, or (2) 50% or
more of the institutions students were enrolled in
correspondence courses, including online courses. As an
exclusively online university, the so called 50%
Rules, enacted in 1992, would otherwise have precluded us
from participating in Title IV programs. However, in 1998,
Congress authorized the Department of Education to establish and
administer the Distance Education Demonstration Program, or the
Demonstration Program, to assess the viability of providing
Title IV program funds to institutions that offered online
educational programs. We were accepted as a participant in the
program and, by virtue of our participation in the program, our
learners were able to access Title IV program funds.
The 50% Rules were repealed for telecommunications courses
(including online courses) as part of the Higher Education
Reconciliation Act, and the Demonstration Program was thereafter
terminated. As a result, our learners continue to be able to
access Title IV Funds. At least six lawsuits were filed
challenging the constitutionality of the Deficit Reduction Act
in general, on grounds that discrepancies exist between
non-education related provisions of the legislation passed in
the House and Senate. At least four of these cases have been
dismissed at the U.S. District Court level, although at
least two of those dismissals are currently being appealed. In
the event litigation challenging the Deficit Reduction Act is
successful, the 50% Rules could be reinstated and, barring
reinstatement of the Demonstration Program or additional
legislative action, our learners would not be able to access
Title IV program funds. If our learners were temporarily or
permanently unable to access Title IV funds, many would not
be able to continue their educations at Capella University,
which would significantly reduce our enrollments, revenues and
operating profits.
We may
lose eligibility to participate in Title IV programs if the
percentage of our revenue derived from those programs is too
high, which would significantly reduce our learner
population.
A for-profit institution loses its eligibility to participate in
Title IV programs if, on a cash accounting basis, it
derives more than 90% of its revenue from those programs in any
fiscal year. In 2006, under the regulatory formula prescribed by
the Department of Education, we derived approximately 71% of our
revenues (calculated on a cash basis) from Title IV
programs. If we lose our eligibility to participate in
Title IV programs because more than 90% of our revenues are
derived from Title IV program funds in any year, our
learners would no longer be eligible to receive Title IV
program funds under various government-sponsored financial aid
programs, which would significantly reduce our enrollments and
revenues and have a material adverse effect on our results of
operations and financial condition.
Risks
Related to Our Business
Our
success depends in part on our ability to update and expand the
content of existing programs and develop new programs and
specializations on a timely basis and in a cost-effective
manner.
The updates and expansions of our existing programs and the
development of new programs and specializations may not be
accepted by existing or prospective learners or employers. If we
cannot respond to changes in market requirements, our business
may be adversely affected. Even if we are able to develop
acceptable new programs, we may not be able to introduce these
new programs as quickly as learners require or as quickly as our
competitors introduce competing programs. To offer a new
academic program, we may be required to obtain appropriate
federal, state and accrediting agency approvals, which may be
conditioned or delayed in a manner that could significantly
affect our growth plans. In addition, to be eligible for federal
student financial aid programs, a new academic program may need
to be certified by the Department of Education. If we are unable
to respond adequately to changes in market requirements due to
financial constraints or other factors, our ability to attract
and retain learners could be impaired and our financial results
could suffer.
27
Establishing new academic programs or modifying existing
programs requires us to make investments in management and
capital expenditures, incur marketing expenses and reallocate
other resources. We may have limited experience with the courses
in new areas and may need to modify our systems and strategy or
enter into arrangements with other educational institutions to
provide new programs effectively and profitably. If we are
unable to increase the number of learners, or offer new programs
in a cost-effective manner, or are otherwise unable to manage
effectively the operations of newly established academic
programs, our results of operations and financial condition
could be adversely affected.
Our
financial performance depends on our ability to continue to
develop awareness among, and attract and retain, working adult
learners.
Building awareness of Capella University and the programs we
offer among working adult learners is critical to our ability to
attract prospective learners. It is also critical to our success
that we convert these prospective learners to enrolled learners
in a cost effective manner and that these enrolled learners
remain active in our programs. Some of the factors that could
prevent us from successfully enrolling and retaining learners in
our programs include:
|
|
|
|
|
the emergence of more successful competitors;
|
|
|
|
factors related to our marketing, including the costs of
Internet advertising and broad-based branding campaigns;
|
|
|
|
performance problems with our online systems;
|
|
|
|
failure to maintain accreditation;
|
|
|
|
learner dissatisfaction with our services and programs;
|
|
|
|
adverse publicity regarding us, our competitors or online or
for-profit education generally;
|
|
|
|
price reductions by competitors that we are unwilling or unable
to match;
|
|
|
|
a decline in the acceptance of online education; and
|
|
|
|
a decrease in the perceived or actual economic benefits that
learners derive from our programs.
|
If we are unable to continue to develop awareness of Capella
University and the programs we offer, and to enroll and retain
learners, our enrollments would suffer and our ability to
increase revenues and maintain profitability would be
significantly impaired.
Strong
competition in the post-secondary education market, especially
in the online education market, could decrease our market share,
increase our cost of acquiring learners and put downward
pressure on our tuition rates.
Post-secondary education is highly competitive. We compete with
traditional public and private two-year and four-year colleges
as well as other for-profit schools. Traditional colleges and
universities may offer programs similar to ours at lower tuition
levels as a result of government subsidies, government and
foundation grants, tax-deductible contributions and other
financial sources not available to for-profit institutions. In
addition, some of our competitors, including both traditional
colleges and universities and other for-profit schools, have
substantially greater name recognition and financial and other
resources than we have, which may enable them to compete more
effectively for potential learners and decrease our market
share. We also expect to face increased competition as a result
of new entrants to the online education market, including
established colleges and universities that had not previously
offered online education programs. Moreover, one or more of our
competitors may obtain specialized accreditations that improve
their competitive positions against us.
We may not be able to compete successfully against current or
future competitors and may face competitive pressures that could
adversely affect our business or results of operations. For
example, as the market continues to mature, certain of our
competitors have begun to reduce tuition rates. We may therefore
28
be required to reduce our tuition or increase spending in
response to competition in order to retain or attract learners
or pursue new market opportunities. We may also face increased
competition in maintaining and developing new marketing
relationships with corporations, particularly as corporations
become more selective as to which online universities they will
encourage their current employees to attend and from which
online universities they will hire prospective employees. These
competitive factors could cause our enrollments, revenues and
profitability to significantly decrease.
We
operate in a highly competitive market with rapid technological
change, and we may not have the resources needed to compete
successfully.
Online education is a highly competitive market that is
characterized by rapid changes in our learners
technological requirements and expectations and evolving market
standards. Competitors vary in size and organization from
traditional colleges and universities to for-profit schools,
corporate universities and software companies providing online
education and training software. Each of these competitors may
develop platforms or other technologies that are superior to the
platform and technology we use. We may not have the resources
necessary to acquire or compete with technologies being
developed by our competitors, which may render our online
delivery format less competitive or obsolete.
System
disruptions and vulnerability from security risks to our online
computer networks could impact our ability to generate revenue
and damage the reputation of Capella University, limiting our
ability to attract and retain learners; we are currently
migrating to a new enterprise resource planning system, and
unplanned costs
and/or
decreases in productivity could adversely impact our financial
results.
The performance and reliability of our technology infrastructure
is critical to our reputation and ability to attract and retain
learners. Any system error or failure, or a sudden and
significant increase in bandwidth usage, could result in the
unavailability of our courseroom platform, damaging our ability
to generate revenue. Our technology infrastructure could be
vulnerable to interruption or malfunction due to events beyond
our control, including natural disasters, terrorist activities
and telecommunications failures. In the Fall of 2005 we
completed the transfer of our learners to a new courseroom
platform, Blackboard Learning System, formerly known as WebCT
Vista, and we recently migrated this courseroom platform to a
new server system.
We are currently replacing our individual software applications
with a comprehensive enterprise resource planning system. The
implementation of this enterprise resource planning system is
projected to continue into 2008. The enterprise resource
planning system is a large-scale project to which our employees
and contractors continue to devote substantial time. Our
in-house expertise, including the expertise of our contractors,
related to large-scale enterprise resource planning system
implementations is limited, and an implementation of this scope
by its nature gives rise to risk of system interruption or
failure. Implementation of the enterprise resource planning
system may result in unplanned and unbudgeted costs, which could
have a material adverse effect on our financial results. During
and after implementation, we may experience decreases in
productivity in excess of planned levels as our employees
transition to and begin to use the new system, and such
decreases could have a material adverse effect on our financial
results.
During 2003 and 2004, we experienced intermittent failures of
our courseroom platform that prevented learners from accessing
their courses. We may experience additional interruptions or
failures in our computer systems as a result of our ongoing
implementation of our enterprise resource planning system, or
our recently implemented new courseroom platform and server
system. Any interruption to our technology infrastructure could
have a material adverse effect on our ability to attract and
retain learners and could require us to incur additional
expenses to correct or mitigate the interruption.
Our computer networks may also be vulnerable to unauthorized
access, computer hackers, computer viruses and other security
problems. A user who circumvents security measures could
misappropriate proprietary information or cause interruptions or
malfunctions in operations. As a result, we may be required to
expend significant resources to protect against the threat of
these security breaches or to alleviate problems caused by these
breaches. We engage with multiple security assessment providers
on a periodic basis to review and assess our security. We
utilize this information to audit ourselves to ensure that we
are continually
29
monitoring the security of our technology infrastructure.
However, we cannot assure you that these security assessments
and audits will protect our computer networks against the threat
of security breaches.
At
present we derive a significant portion of our revenues and,
after the full allocation of corporate overhead expenses, all of
our operating income from our doctoral programs.
Our origins are as an online university primarily for doctoral
learners. Despite the expansion of our program offerings to
include both masters and bachelors degrees, our
doctoral learner community remains an integral part of the
success of our business model. At December 31, 2006,
learners seeking doctoral, masters and bachelors
degrees represented 42%, 43% and 15%, respectively, of our
enrollment. Due to the relative size, maturity and economics of
our doctoral programs, for the year ended December 31,
2006, doctoral learners accounted for approximately
$98.9 million, or 55%, of our revenues, and, after the full
allocation of corporate overhead expenses, all of our operating
income. Prior to the full allocation of corporate overhead
expenses, our doctoral programs accounted for most of our
operating income in these periods. If we were to experience any
learner, regulatory, reputational, instructional or other event
that adversely affected our doctoral offerings, our results of
operations could be significantly and adversely affected.
We
recently transitioned our library services and resources
in-house, and we will now have responsibility for providing
library services directly to our learners. We have limited
experience providing such services and any inability to do so
effectively could limit our ability to attract and retain
learners, and adversely affect our enrollments, revenues and
operating profits.
Our library services and resources have been provided by the
Sheridan Libraries at The Johns Hopkins University under an
agreement between The Johns Hopkins University and us. We
provided notice of our intent to terminate that agreement in
June 2006, and effective January 31, 2007, we completed the
transition of those services and resources in-house. Most of the
library services that were performed by The Johns Hopkins
University are now performed in-house by our own employees. We
have limited experience in providing library services in-house,
and to do so we will have to hire personnel, including
approximately six in-house librarians. Certain functions
performed by The Johns Hopkins University, such as interlibrary
loan coordination, have been outsourced to a third party
university.
It is possible that we may not be able to provide library
services in-house and through the third party university as
successfully or as cost-effectively as we are currently
planning. If we are not able to successfully provide in-house
certain of the library services formerly performed by The Johns
Hopkins University, or if the third party university does not
perform as expected, the quality of our overall program would
suffer, which would in turn decrease our enrollments, revenues
and operating profits. If we are not able to provide such
services as cost-effectively as planned, our operating profits
would be adversely affected.
We may
experience declines in our revenue and enrollment growth rates,
and our growth may place a strain on our
resources.
We have experienced significant growth since we established our
university in 1993. However, while we have continued to achieve
growth in revenues and enrollment
year-over-year,
these growth rates have declined in recent periods and may
continue to decline in the future. Specifically, we expect
additional competitors to enter the online educational market
and increased competition for online education offerings,
including from colleges and universities that provide blended
educational programs involving both classroom and online
components.
The growth that we have experienced in the past, as well as any
future growth that we experience, may place a significant strain
on our resources and increase demands on our management
information and reporting systems and financial management
controls. If we are unable to manage our growth effectively
while maintaining appropriate internal controls, we may
experience operating inefficiencies that could increase our
costs and adversely affect our profitability and results of
operations.
30
We
rely on exclusive proprietary rights and intellectual property
that may not be adequately protected under current laws, and we
encounter disputes from time to time relating to our use of
intellectual property of third parties.
Our success depends in part on our ability to protect our
proprietary rights. We rely on a combination of copyrights,
trademarks, service marks, trade secrets, domain names and
agreements to protect our proprietary rights. We rely on service
mark and trademark protection in the United States and select
foreign jurisdictions to protect our rights to the marks
CAPELLA, CAPELLA EDUCATION COMPANY, and
CAPELLA UNIVERSITY, as well as distinctive logos and
other marks associated with our services. We rely on agreements
under which we obtain rights to use course content developed by
faculty members and other third party content experts. We cannot
assure you that these measures will be adequate, that we have
secured, or will be able to secure, appropriate protections for
all of our proprietary rights in the United States or select
foreign jurisdictions, or that third parties will not infringe
upon or violate our proprietary rights. Despite our efforts to
protect these rights, unauthorized third parties may attempt to
duplicate or copy the proprietary aspects of our curricula,
online resource material and other content. Our
managements attention may be diverted by these attempts
and we may need to use funds in litigation to protect our
proprietary rights against any infringement or violation.
We may encounter disputes from time to time over rights and
obligations concerning intellectual property, and we may not
prevail in these disputes. In certain instances, we may not have
obtained sufficient rights in the content of a course. Third
parties may raise a claim against us alleging an infringement or
violation of the intellectual property of that third party. Some
third party intellectual property rights may be extremely broad,
and it may not be possible for us to conduct our operations in
such a way as to avoid those intellectual property rights. Any
such intellectual property claim could subject us to costly
litigation and impose a significant strain on our financial
resources and management personnel regardless of whether such
claim has merit. Our general liability and cyber liability
insurance may not cover potential claims of this type adequately
or at all, and we may be required to alter the content of our
classes or pay monetary damages, which may be significant.
We may
incur liability for the unauthorized duplication or distribution
of class materials posted online for class
discussions.
In some instances, our faculty members or our learners may post
various articles or other third party content on class
discussion boards. We may incur liability for the unauthorized
duplication or distribution of this material posted online for
class discussions. Third parties may raise claims against us for
the unauthorized duplication of this material. Any such claims
could subject us to costly litigation and impose a significant
strain on our financial resources and management personnel
regardless of whether the claims have merit. Our general
liability insurance may not cover potential claims of this type
adequately or at all, and we may be required to alter the
content of our courses or pay monetary damages.
A
reclassification of our adjunct faculty by authorities may have
a material adverse effect on our results of
operations.
Adjunct faculty comprised approximately 86% of our faculty
population at December 31, 2006. We classify our adjunct
faculty as independent contractors, as opposed to employees.
Because we classify our adjunct faculty as independent
contractors, we do not withhold federal or state income or other
employment related taxes, make federal or state unemployment tax
or Federal Insurance Contributions Act, or FICA, payments or
provide workers compensation insurance with respect to our
adjunct faculty. 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 may challenge our classification as incorrect and
assert that our adjunct faculty members must be classified as
employees. 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 2006, we estimate our
additional tax, workers compensation insurance and payroll
31
processing payments would have been approximately
$1.6 million for that year. The amount of additional tax
and insurance payments would increase in the future as the total
amount we pay to adjunct faculty increases. 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 financial condition
and results of operations.
We may
not be able to retain our key personnel or hire and retain the
personnel we need to sustain and grow our
business.
Our success to date has depended, and will continue to depend,
largely on the skills, efforts and motivation of our executive
officers, who generally have significant experience with our
company and within the education industry. Our Chairman and
Chief Executive Officer, Stephen Shank, is 63 years old and
has been our Chief Executive Officer since he founded Capella in
1991. Mr. Shank is also the Chancellor of Capella
University. To facilitate an orderly development and transition
of leadership, our board of directors has been engaged in
ongoing succession planning. Mr. Shank has advised the
board that at such point as clear Chief Executive Officer
succession capability has been established, and no earlier than
2008, he would relinquish his duties as Chief Executive Officer.
As one means to facilitate Mr. Shanks eventual
transition, the board established the position of Chief
Operating Officer.
Our success also depends in large part upon our ability to
attract and retain highly qualified faculty, school directors,
administrators and corporate management. Due to the nature of
our business, we face significant competition in attracting and
retaining personnel who possess the skill sets we seek. In
addition, key personnel may leave us and subsequently compete
against us. We do not carry life insurance on our key personnel
for our benefit. The loss of the services of any of our key
personnel, or our failure to attract and retain other qualified
and experienced personnel on acceptable terms, could impair our
ability to successfully sustain and grow our business, which
could in turn materially and adversely affect our results of
operations.
Our
learner population and revenues could decrease if the government
tuition assistance offered to U.S. Armed Forces personnel
is reduced or eliminated, if the tuition discounts which we
offer to U.S. Armed Forces personnel are reduced or
eliminated, or if our informal arrangements with any military
bases deteriorate.
Active duty members of the U.S. Armed Forces are eligible
to receive tuition assistance from the government, which they
may use to pursue post-secondary degrees. We offer tuition
discounts generally ranging from 10% to 15% to all members of
the U.S. Armed Forces and immediate family members of
active duty U.S. Armed Forces personnel. For the year ended
December 31, 2006, approximately 18% of our learners
received a U.S. Armed Forces tuition discount. During 2006,
we provided approximately $3.0 million of such discounts.
We also have non-exclusive agreements with various educational
institutions of the U.S. Armed Forces pursuant to which we
have agreed to accept credits toward a Capella University degree
from certain military educational programs. These agreements
generally may be terminated by either party upon 30 to
45 days notice. Additionally, we have informal arrangements
with several military bases pursuant to which the bases make
information about Capella University available to interested
service members. Each of these informal arrangements is not
binding on either party and either party could end the
arrangement at any time. If our informal arrangement with any
military base deteriorates or ends, our efforts to recruit
learners from that base will be impaired. In the event that
governmental tuition assistance programs to active duty members
of the U.S. Armed Forces are reduced or eliminated, if our
tuition discount program which we offer U.S. Armed Forces
personnel and their immediate family members is reduced or
eliminated, or if our informal arrangements with any military
base deteriorates, this could materially and adversely affect
our revenues and results of operations.
Our
expenses may cause us to incur operating losses if we are
unsuccessful in achieving growth.
Our expenses are based, in significant part, on our estimates of
future revenues and are largely fixed in the short term. As a
result, we may be unable to adjust our spending in a timely
manner if our revenues fall short of our expectations.
Accordingly, any significant shortfall in revenues in relation
to our expectations
32
would have an immediate and material adverse effect on our
profitability. In addition, as our business grows, we anticipate
increasing our operating expenses to expand our program
offerings, marketing initiatives and administrative
organization. Any such expansion could cause material losses to
the extent we do not generate additional revenues sufficient to
cover those expenses.
Seasonal
and other fluctuations in our results of operations could
adversely affect the trading price of our common
stock.
In reviewing our results of operations, you should not focus on
quarter-to-quarter
comparisons. Our results in any quarter may not indicate the
results we may achieve in any subsequent quarter or for the full
year. Our revenues and operating results normally fluctuate as a
result of seasonal variations in our business, principally due
to changes in enrollment. Learner population varies as a result
of new enrollments, graduations and learner attrition. While our
number of enrolled learners has grown in each sequential quarter
over the past three years, the number of enrolled learners has
been proportionally greatest in the fourth quarter of each
respective year. A significant portion of our general and
administrative expenses do not vary proportionately with
fluctuations in revenues. We expect quarterly fluctuations in
operating results to continue as a result of seasonal enrollment
patterns. Such patterns may change, however, as a result of new
program introductions, the timing of seminars and events and
increased enrollments of learners. These fluctuations may result
in volatility or have an adverse effect on the market price of
our common stock.
Our
current success and future growth depend on the continued
acceptance of the Internet and the corresponding growth in users
seeking educational services on the Internet.
Our business relies on the Internet for its success. A number of
factors could inhibit the continued acceptance of the Internet
and adversely affect our profitability, including:
|
|
|
|
|
inadequate Internet infrastructure;
|
|
|
|
security and privacy concerns; and
|
|
|
|
the unavailability of cost-effective Internet service and other
technological factors.
|
If Internet use decreases, or if the number of Internet users
seeking educational services on the Internet does not increase,
our business may not grow as planned.
Government
regulations relating to the Internet could increase our cost of
doing business, affect our ability to grow or otherwise have a
material adverse effect on our business.
The increasing popularity and use of the Internet and other
online services has led and may lead to the adoption of new laws
and regulatory practices in the United States or foreign
countries and to new interpretations of existing laws and
regulations. These new laws and interpretations may relate to
issues such as online privacy, copyrights, trademarks and
service marks, sales taxes, fair business practices and the
requirement that online education institutions qualify to do
business as foreign corporations or be licensed in one or more
jurisdictions where they have no physical location or other
presence. New laws, regulations or interpretations related to
doing business over the Internet could increase our costs and
materially and adversely affect our enrollments, revenues and
results of operations.
An
increase in interest rates could adversely affect our ability to
attract and retain learners.
Approximately 71% of our revenues (calculated on a cash basis)
for the year ended December 31, 2006, were derived from
Title IV programs, which involve subsidized student
borrowing. Additionally, many of our learners finance their
education through private, unsubsidized borrowing. Interest
rates have reached relatively low levels in recent years,
creating a favorable borrowing environment for learners.
However, interest rates are currently increasing. Much of the
financing our learners receive is tied to floating interest
rates. In addition, in the event Congress decreases the amount
available for federal student aid, our learners may have to pay
higher, unsubsidized interest rates. Therefore, any future
increase in interest rates will result in a corresponding
increase in educational costs to our existing and prospective
learners, which could result in a significant
33
reduction in our learner population and revenues. Higher
interest rates could also contribute to higher default rates
with respect to our learners repayment of their education
loans. Higher default rates may in turn adversely impact our
eligibility to participate in some or all Title IV
programs, which could result in a significant reduction in our
learner population and our profitability.
The
price of our common stock may fluctuate
significantly.
Volatility in the market price of our common stock may prevent
you from being able to sell your shares at or above the price
you paid for your shares. The market price of our common stock
could fluctuate significantly for various reasons, which include:
|
|
|
|
|
our quarterly or annual earnings or those of other companies in
our industry;
|
|
|
|
the publics reaction to our press releases, our other
public announcements and our filings with the SEC;
|
|
|
|
changes in earnings estimates or recommendations by research
analysts who track our common stock or the stocks of other
companies in our industry;
|
|
|
|
changes in our number of enrolled learners;
|
|
|
|
new laws or regulations or new interpretations of laws or
regulations applicable to our business;
|
|
|
|
seasonal variations in our learner population;
|
|
|
|
changes in accounting standards, policies, guidance,
interpretations or principles;
|
|
|
|
changes in general conditions in the U.S. and global economies
or financial markets, including those resulting from war,
incidents of terrorism or responses to such events;
|
|
|
|
litigation involving our company or investigations or audits by
regulators into the operations of our company or our
competitors; and
|
|
|
|
sales of common stock by our directors, executive officers and
significant shareholders.
|
In addition, in recent years, the stock market has experienced
extreme price and volume fluctuations. This volatility has had a
significant impact on the market price of securities issued by
many companies, including companies in our industry. The changes
frequently appear to occur without regard to the operating
performance of these companies. The price of our common stock
could fluctuate based upon factors that have little or nothing
to do with our company, and these fluctuations could materially
reduce our stock price.
Future
sales of our common stock in the public market could lower our
stock price.
We may sell additional shares of common stock in future public
offerings. We may also issue additional shares of common stock
to finance future acquisitions. As of December 31, 2006, we
had 16,002,371 outstanding shares of common stock. This number
includes 4,600,000 shares registered in our initial public
offering, which are freely tradable in the public market.
10,817,587 shares of our common stock, or 67.6% of our
total outstanding shares, are restricted from immediate resale
under the federal securities laws and
lock-up
agreements entered into between certain of our shareholders and
the underwriters of our initial public offering, but may be sold
into the market in the near future. These shares will become
available for sale at various times following the expiration of
the lock-up
agreements which, without the prior consent of Credit Suisse
Securities (USA) LLC, is 180 days (subject to an extension
of no more than 34 days as a result of an earnings release
by us or the occurrence of material news or a material event
relating to us) after November 9, 2006, subject to volume
limitations and
manner-of-sale
requirements under Rule 144 of the Securities Act of 1933
(the Securities Act). However, Credit Suisse Securities (USA)
LLC may release all or a portion of these shares subject to
lock-up
agreements at any time without notice. The period immediately
following expiration of the
lock-up
agreements may experience relatively higher levels of selling
activity.
In addition, we have an effective
S-8
registration statement under the Securities Act pursuant to
which we have registered 4,192,890 shares of our common
stock issuable under our stock incentive plans. As a result,
34
shares issued under our stock incentive plans covered by the
S-8
registration statement are eligible for resale in the public
market without restriction, subject to certain Rule 144
limitations applicable to affiliates and, to the extent
applicable, the
lock-up
agreements described above.
Certain of our existing shareholders are parties to a
registration rights agreement with us relating to
4,652,062 shares of our common stock. Under that agreement,
these shareholders will have the right, after the expiration of
the lock-up
period, to require us to effect the registration of these
shares. In addition, if we propose to register, or are required
to register following the exercise of a demand
registration right as described in the previous sentence, any of
our shares of common stock under the Securities Act, all the
shareholders who are parties to the registration rights
agreement (and Legg Mason Wood Walker, Incorporated, with
respect to 266,326 shares that it purchased pursuant to
warrants that contained registration rights) will be entitled to
include these shares of common stock in that registration.
In accordance with the terms of our employee stock purchase
plan, we may offer to our employees shares of our common stock
under our employee stock purchase plan at a per share price
below the then-current market price of our common stock. The
discount would give our employees incentives to purchase shares
of our common stock under the employee stock purchase plan. We
have not yet implemented the employee stock purchase plan, but
should we do so, we would also likely file an
S-8
registration statement to register up to 450,000 shares of
our common stock thereunder. Our employees would then be able to
sell all or some of the shares purchased under the employee
stock purchase plan in the open market.
We cannot predict the size of future issuances of our common
stock or the effect, if any, that future issuances and sales of
shares of our common stock will have on the market price of our
common stock. Sales of substantial amounts of our common stock
(including shares issued in connection with an acquisition and
shares issued under our stock incentive plans and employee stock
purchase plan), or the perception that such sales could occur,
may adversely affect prevailing market prices for our common
stock.
Our
executive officers, directors and principal existing
shareholders own a large percentage of our voting stock, which
may allow them to collectively control substantially all matters
requiring shareholder approval and, in the case of certain of
our principal shareholders, have other unique rights that may
afford them access to our management.
Our directors, executive officers and principal existing
shareholders beneficially owned approximately
10,441,898 shares, or 62.1%, of our common stock as of
December 31, 2006. Our directors and executive officers
beneficially owned in the aggregate approximately
6,475,834 shares, or 38.5%, of our common stock as of such
date, including approximately 2,511,724 shares, or 15.5%,
of our common stock beneficially owned by Stephen Shank, our
Chief Executive Officer and Chairman of our Board of Directors.
Our principal existing shareholders consist of Forstmann
Little & Co. Equity Partnership-VI, L.P. (Forstmann
VI), Forstmann Little & Co. Equity Partnership-VII,
L.P. (Forstmann VII) and Forstmann Little & Co.
Subordinated Debt and Equity Buyout Partnership-VIII, L.P.
(Forstmann VIII), which we refer to as the Forstmann
Little entities in this Annual Report on
Form 10-K,
Cherry Tree Ventures IV, L.P., Cherry Tree Core Growth Fund,
L.L.L.P. and InfoPower L.L.L.P., which we refer to as the
Cherry Tree entities in this Annual Report on
Form 10-K,
TCV V, L.P. and TCV Member Fund L.P., which we refer
to as the entities affiliated with Technology Crossover
Ventures in this Annual Report on
Form 10-K,
Maveron Equity Partners 2000, L.P., Maveron Equity Partners
2000-B, L.P. and MEP 2000 Associates LLC, which we refer to as
the Maveron entities in this Annual Report on
Form 10-K,
and Insight-Salmon River LLC, Insight Venture Partners IV, L.P.,
Salmon River Capital I LLC, Salmon River CIP LLC, Salmon River
Capital II, L.P., Insight Venture Partners IV
(Fund B), L.P., Insight Venture Partners IV (Co-Investors),
L.P. and Insight Venture Partners (Cayman) IV, L.P., which we
refer to as the Salmon River and Insight entities in
this Annual Report on
Form 10-K.
Our principal existing shareholders beneficially owned
approximately 7,248,721 shares, or 45.3%, of our common
stock as of December 31, 2006. In addition to their
shareholdings, Forstmann VI also has the right to designate one
person for election to our board of directors. Moreover,
Forstmann VI, Maveron Equity Partners 2000, L.P., TH Lee, Putnam
Investment Trust TH Lee, Putnam Emerging
Opportunities Portfolio and TCV V, L.P. also have the right
to inspect our books and records, to visit and inspect any of
our properties and to discuss our affairs, finances, and
accounts with our officers, lawyers, and accountants. In
addition, the Forstmann
35
Little entities also have the right to consult and advise
management on our significant business issues, including
managements proposed annual operating plans.
Accordingly, if some or all of these shareholders decided to act
in concert, they could control us through their ability to
determine the outcome of the election of our directors, to amend
our articles of incorporation and bylaws and to take other
actions requiring the vote or consent of shareholders, including
mergers, going private transactions and other extraordinary
transactions, and the terms of any of these transactions. The
ownership positions of these shareholders may have the effect of
delaying, deterring or preventing a change in control or a
change in the composition of our board of directors. These
shareholders may also use their contractual rights, including
access to management, and their large ownership position to
address their own interests, which may be different from those
of our other shareholders.
Our
articles of incorporation, bylaws, Minnesota law and regulations
of state and federal education agencies may discourage takeovers
and business combinations that our shareholders might consider
in their best interests.
Anti-takeover provisions of our articles of incorporation,
bylaws, Minnesota law and regulations of state and federal
education agencies could diminish the opportunity for
shareholders to participate in acquisition proposals at a price
above the then-current market price of our common stock. For
example, while we have no present plans to issue any preferred
stock, our board of directors, without further shareholder
approval, may issue shares of undesignated preferred stock and
fix the powers, preferences, rights and limitations of such
class or series, which could adversely affect the voting power
of your shares. In addition, our bylaws provide for an advance
notice procedure for nomination of candidates to our board of
directors that could have the effect of delaying, deterring or
preventing a change in control. Further, as a Minnesota
corporation, we are subject to provisions of the Minnesota
Business Corporation Act, or MBCA, regarding business
combinations, which can deter attempted takeovers in
certain situations. The approval requirements of the Department
of Education, our regional accrediting agency and state
education agencies for a change in control transaction could
also delay, deter or prevent a transaction that would result in
a change in control. We may, in the future, consider adopting
additional anti-takeover measures. The authority of our board to
issue undesignated preferred or other capital stock and the
anti-takeover provisions of the MBCA, as well as other current
and any future anti-takeover measures adopted by us, may, in
certain circumstances, delay, deter or prevent takeover attempts
and other changes in control of the company not approved by our
board of directors.
Being
a public company will increase our expenses and administrative
workload.
As a public company with listed equity securities since our
November 2006 initial public offering, we must comply with new
laws, regulations and requirements, certain provisions of the
Sarbanes-Oxley Act of 2002, related SEC regulations and
requirements of The Nasdaq Stock Market, Inc. with which we were
not required to comply as a private company. Complying with
these statutes, regulations and requirements will occupy a
significant amount of the time of our board of directors and
management and will increase our costs and expenses. We estimate
that incremental annual public company costs will be between
$2.5 million and $3.0 million. We have recently or
will need to:
|
|
|
|
|
create or expand the roles and duties of our board of directors,
our board committees and management;
|
|
|
|
institute more comprehensive compliance and internal audit
functions;
|
|
|
|
evaluate and maintain our system of internal control over
financial reporting, and report on managements assessment
thereof, in compliance with the requirements of Section 404
of the
Sarbanes-Oxley
Act of 2002 and the related rules and regulations of the SEC and
the Public Company Accounting Oversight Board;
|
|
|
|
prepare and distribute periodic public reports in compliance
with our obligations under the federal securities laws;
|
|
|
|
implement more comprehensive internal policies, such as those
relating to disclosure controls and procedures and insider
trading;
|
36
|
|
|
|
|
involve and retain to a greater degree outside counsel and
accountants in the above activities;
|
|
|
|
hire investor relations support personnel; and
|
|
|
|
hire additional personnel to perform external reporting and
internal accounting functions, including tax accounting
functions.
|
If we fail to take some of these actions, in particular with
respect to our internal audit and accounting functions and our
compliance function, our ability to timely and accurately report
our financial results could be impaired.
In addition, we also expect that being a public company subject
to these rules and regulations will make it more expensive for
us to obtain director and officer liability insurance, and we
may be required to accept reduced coverage or incur
substantially higher costs to obtain coverage. These factors
could also make it more difficult for us to attract and retain
qualified members of our board of directors, particularly to
serve on our audit and compensation committees, and qualified
executive officers.
We
will be exposed to risks relating to evaluations of controls
required by Section 404 of the
Sarbanes-Oxley
Act of 2002.
We are in the process of evaluating our internal controls
systems to allow management to report on, and our independent
auditors to attest to, our internal control over financial
reporting. We are required to comply with Section 404 with
respect to our fiscal year ending December 31, 2007. With
the assistance of outside consultants who specialize in
preparing companies to comply with Section 404 of the
Sarbanes Oxley Act of 2002, we began our process evaluation and
subsequent remediation work in the second half of 2004. In
connection with our evaluation, we have identified a number of
control deficiencies, some of which have been remedied. In 2005
and 2006, we continued our remediation work and expanded our
process evaluation through internal process reviews. However, we
cannot be certain as to the timing of completion of our
evaluation, testing and remediation actions or the impact of the
same on our operations. Furthermore, upon completion of this
process, we may identify control deficiencies of varying degrees
of severity under applicable SEC and Public Company Accounting
Oversight Board rules and regulations that remain unremediated.
As a public company, we will be required to report, among other
things, control deficiencies that constitute a material
weakness or changes in internal controls that materially
affect, or are reasonably likely to materially affect, internal
controls over financial reporting. A material
weakness is a significant deficiency, or combination of
significant deficiencies that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. If we
fail to implement the requirements of Section 404 in a
timely manner, we might be subject to sanctions or investigation
by regulatory authorities such as the SEC or The Nasdaq Stock
Market, Inc., and if we fail to remedy any material weakness,
our financial statements may be inaccurate, we may face
restricted access to the capital markets, and our stock price
may be adversely affected.
|
|
Item 1B.
|
Unresolved
Staff Comments
|
None.
Our corporate headquarters occupies approximately
203,000 square feet in Minneapolis, Minnesota, under a
lease which expires in October 2010. Renewal terms under this
lease allow for us to extend the current lease for up to two
additional five-year terms. We also lease approximately
91,500 square feet in a second facility in Minneapolis that
houses our enrollment services and learner services functions.
That lease expires in February 2009. Renewal terms under this
lease allow for us to extend the current lease for up to two
additional two-year terms. We believe our existing facilities
are adequate for current requirements and that additional space
can be obtained on commercially reasonable terms to meet future
requirements.
37
|
|
Item 3.
|
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 4.
|
Submission
of Matters to a Vote of Security Holders
|
No matters were voted upon by shareholders during the fourth
quarter of 2006.
EXECUTIVE
OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning our executive
officers:
|
|
|
|
|
|
|
Name
|
|
Age
|
|
Position
|
|
Stephen G. Shank
|
|
|
63
|
|
|
Chairman and Chief Executive
Officer (Mr. Shank also serves as Chancellor and as a
director of Capella University)
|
Kenneth J. Sobaski
|
|
|
51
|
|
|
President and Chief Operating
Officer (Mr. Sobaski also serves as a director of Capella
University)
|
Michael J. Offerman
|
|
|
59
|
|
|
Senior Vice President
(Dr. Offerman also serves as President of Capella
University)
|
Lois M. Martin
|
|
|
44
|
|
|
Senior Vice President and Chief
Financial Officer
|
Paul A. Schroeder
|
|
|
47
|
|
|
Senior Vice President, Operations
and Business Transformation
|
Reed A. Watson
|
|
|
48
|
|
|
Senior Vice President, Marketing
|
Scott M. Henkel
|
|
|
52
|
|
|
Vice President and Chief
Information Officer
|
Gregory W. Thom
|
|
|
50
|
|
|
Vice President, General Counsel,
and Secretary
|
Elizabeth M. Rausch
|
|
|
55
|
|
|
Vice President, Human Resources
|
Stephen G. Shank founded our company in 1991 and has been
serving as our Chairman and Chief Executive Officer since that
time. Mr. Shank also has been serving as Chancellor of
Capella University since 2001, and as emeritus director of
Capella University from 2003 to 2006. Mr. Shank is
currently a voting director of Capella University.
Mr. Shank served as a member of the board of directors of
Capella University from 1993 through 2003. From 1979 to 1991,
Mr. Shank was Chairman and Chief Executive Officer of Tonka
Corporation, an NYSE-listed manufacturer of toys and games.
Mr. Shank is a member of the board of directors of Tennant
Company, an NYSE-listed manufacturer of cleaning solutions.
Mr. Shank earned a B.A. from the University of Iowa, an
M.A. from the Fletcher School, a joint program of Tufts and
Harvard Universities, and a J.D. from Harvard Law School.
Kenneth J. Sobaski joined our company in February 2006
and has been serving as our President and Chief Operating
Officer since that time. Mr. Sobaski was elected a member
of the Capella University Board of Directors on
February 23, 2007. From April 2002 to April 2005,
Mr. Sobaski served as an officer and Vice President ,
Sales, Marketing and Business Development of Polaris Industries
Inc., a publicly held manufacturer of power sports products, and
from September 2001 to April 2002, he served as an officer and
Vice President , Marketing and Business Development of Polaris
Industries. From 1999 to 2001, he served as the President of
ConAgra Grocery Brands of ConAgra Foods, Inc.
Mr. Sobaskis prior experience also includes executive
marketing, general management and sales positions for a number
of consumer product marketing companies, including The Pillsbury
Company, The Drackett Company (a division of Bristol-Myers
Squibb), Kraft Foods, Inc. and General Mills, Inc.
Mr. Sobaski earned his B.A. from St. Olaf College, and an
M.B.A. from Northwestern Universitys Kellogg School of
Management.
Dr. Michael J. Offerman joined our company in 2001
and has been serving as our Senior Vice President since that
time. Dr. Offerman also has served as President of Capella
University since 2001. In March 2007,
38
we announced a new university leadership structure and a
national search for a new university president.
Dr. Offerman will continue to serve as President until the
national search for a new president is successfully completed.
At that time he will assume the position of Vice
Chairman External University Initiatives. In his new
role Dr. Offerman will continue and expand upon his recent
national work with other institutions on such matters as
accountability, learning outcomes transparency, and potential
partnerships. Dr. Offerman was also a director of
Capella University from 2001 to 2006. From 1994 to 2001,
Dr. Offerman served as Dean of the Division of Continuing
Education at the University of Wisconsin-Extension, the
University of Wisconsins institution dedicated to the
development and delivery of continuing education and online
programs. Dr. Offerman also has served on a number of
national boards, including the American Council on Education,
the University Continuing Education Association, and the
National Technology Advisory Board. Dr. Offerman earned a
B.A. from the University of Iowa, an M.S. from the University of
Wisconsin-Milwaukee and an Ed.D. from Northern Illinois
University.
Lois M. Martin joined our company in 2004 and has been
serving as our Senior Vice President and Chief Financial
Officer since that time. From 2002 to 2004, Ms. Martin
served as Executive Vice President and Chief Financial Officer
at World Data Products, and from 1993 to 2001, Ms. Martin
served in a number of executive positions, including Senior Vice
President and Chief Financial Officer, at Deluxe Corporation.
Ms. Martin is a member of the board of directors of ADC,
Inc., a publicly held global supplier of network infrastructure,
and MTS Systems Corporation, a publicly held, global
manufacturer of mechanical testing solutions. She was also a
member of the board of directors of eFunds Corporation, an
NYSE-listed company offering integrated information, payment and
technology solutions, in 2000. From 1996 to 2001,
Ms. Martin also served as Secretary/Treasurer for the
Deluxe Corporation Foundation and the W.R. Hotchkiss Foundation,
a provider of education and other grant funding to non-profit
organizations. Ms. Martin began her career at Coopers and
Lybrand (now PricewaterhouseCoopers LLP), where she earned her
C.P.A. designation. Ms. Martin earned a B.A. from Augustana
College.
Paul A. Schroeder has been serving as a Senior Vice
President of Capella University from April 2006 to February
2007, primarily responsible for the
day-to-day
operations of Capella University. In addition, he has been
serving as a Senior Vice President of Capella Education Company
since 2004. In March 2007 he became Senior Vice President,
Operations and Business Transformation for Capella Education
Company. In his new role, Mr. Schroeder is responsible for
aligning and integrating the
end-to-end
operations of Capella in order to deliver the superior
experience the University wants for its learners.
Mr. Schroeder also served as director of Capella University
from 2003 to 2006. From 2004 to March 2006, Mr. Schroeder
served as our Senior Vice President, Business Management, from
2003 to 2004, Mr. Schroeder served as our Senior Vice
President, Business and Technology and from 2001 to 2003,
Mr. Schroeder served as our Senior Vice President and Chief
Financial Officer. From 1997 to 2001, Mr. Schroeder held
various executive management positions, including Senior Vice
President, General Manager and Chief Financial Officer, with
Datacard Group, a privately held company providing hardware and
software solutions to the financial card and government ID
markets. From 1984 to 1997, Mr. Schroeder held a variety of
financial management positions at NCR Corporation, an
NYSE-listed technology systems and services company.
Mr. Schroeder earned a B.A. from Haverford College and an
M.B.A. from Northwestern Universitys Kellogg School of
Management. He also completed additional graduate work at the
University of Illinois.
Reed A. Watson joined our company in June 2006 and has
been serving as our Senior Vice President, Marketing since that
time. Prior to joining us, he served as Vice President, Consumer
Strategy & Insights for Select Comfort Corporation, a
Nasdaq-listed mattress and bedding company, from 2005 to 2006,
as President of Watson Management Consulting, a privately held
management consulting firm, from 2002 to 2005 and as Executive
Vice President Ì Chief Marketing Officer of
SimonDelivers.com, a privately held online grocery company, from
1999 to 2001. Mr. Watsons prior experience also
includes serving in various executive positions in marketing and
general management for companies including Recovery Engineering
Inc., Pillsbury Company and Kraft Foods, Inc. He earned his
B.A. degree from Northwestern University and his M.B.A. from
Northwestern Universitys Kellogg School of Management.
Scott M. Henkel joined our company in 2004 and has been
serving as our Vice President and Chief Information Officer
since that time. From 1994 to 2003, Mr. Henkel served as
Chief Information Officer and
39
Vice President of Software Engineering at Datacard Group.
Mr. Henkel earned a B.A. from Metropolitan
State University and an M.B.A. in finance from the College
of St. Thomas.
Gregory W. Thom joined our company in 2003 and has been
serving as Vice President, General Counsel, and Secretary since
that time. From 2002 to 2003, Mr. Thom served as Vice
President, Global Sales and Distribution at Datacard Group. From
2000 to 2002, Mr. Thom served as Vice President, Government
Solutions at Datacard Group. From 1994 to 2000, Mr. Thom
served as Vice President, General Counsel and Secretary at
Datacard Group. From 1991 to 1994, Mr. Thom was an attorney
with Dorsey & Whitney LLP, a Minneapolis-based law
firm. Mr. Thom earned a B.A. from Bethel College, an M.B.A.
from the University of Connecticut and a J.D. from William
Mitchell College of Law.
Elizabeth M. Rausch joined our company in 1999 and has
been serving as our Vice President, Human Resources since 2000.
From 1999 to 2000, Ms. Rausch served as our Director, Human
Resources. From 1985 to 1999, Ms. Rausch served as Director
and Manager of Human Resources at Marigold Foods, Inc., a
regional food and dairy processing organization. Ms. Rausch
earned a B.A. from the University of Minnesota and a M.S. degree
from Mankato State University. Ms. Rausch has provided
notice of her intention to leave the Company on or about
May 31, 2007.
PART II
|
|
Item 5.
|
Market
for Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
|
Market
Information
Our common stock began trading on the Nasdaq Global Market on
November 10, 2006 under the symbol CPLA. Prior
to November 10, 2006, there was no public market for our
common stock. The following table sets forth, for the period
indicated, the high and low sales price of the Companys
common stock as reported on the Nasdaq Global Market.
|
|
|
|
|
|
|
|
|
2006
|
|
High
|
|
|
Low
|
|
|
Fourth Quarter (November 10,
2006 December 31, 2006)
|
|
$
|
26.68
|
|
|
$
|
23.29
|
|
Holders
As of January 31, 2007, there were approximately 140
holders of record of our common stock.
Dividends
On November 21, 2006, we paid a special distribution to our
shareholders of record as of October 3, 2006 in the
aggregate amount of $72.6 million, which equaled the gross
proceeds received by us from our initial public offering in
November 2006, excluding the proceeds received by us from the
underwriters exercise of their over-allotment option. We
do not anticipate declaring or paying any additional cash
dividends on our common stock in the foreseeable future. The
payment of any dividends in the future will be at the discretion
of our board of directors and will depend upon our financial
condition, results of operations, earnings, capital
requirements, contractual restrictions, outstanding indebtedness
and other factors deemed relevant by our board.
40
Performance
Graph
The following graph shows a comparison from November 10,
2006 (the date our common stock commenced trading on the Nasdaq
Global Market) through December 29, 2006 of cumulative
total return for our common stock, companies we deem to be in
our industry peer group, and the Nasdaq Composite Index. The
companies included in the industry peer group consist of Apollo
Group, Inc. (APOL), ITT Educational Services, Inc. (ESI),
Laureate Education, Inc. (LAUR), and Strayer Education, Inc.
(STRA). Such returns are based on historical results and are not
intended to suggest future performance. The performance graph
assumes $100 was invested on November 10, 2006 in either
our common stock, the companies in our peer group (weighted
based on market capitalization as of such date), or the Nasdaq
Composite Index. Data for the Nasdaq Composite and our peer
group assume reinvestment of dividends. There has not been a
record date for dividends to be paid on our common stock since
it commenced trading on the Nasdaq Global Market, and we have no
present plans to declare any dividends.
Recent
Sales of Unregistered Securities
Since January 1, 2006, we have granted options to purchase
827,998 shares of our common stock to officers, directors
and employees under our 2005 stock incentive plans at an
exercise price of $20.00 per share. During the same period,
we issued and sold 121,482 shares of our common stock
pursuant to option exercises at prices ranging from $4.50 to
$20.00 per share. These sales were made in reliance on
Section 4(2) of the Securities Act of 1933 and
Rule 506 and Rule 701 promulgated under the Securities
Act of 1933, except that shares of our common stock issued
pursuant to option exercises on or after November 15, 2006
were registered on our Registration Statement on
Form S-8
(Registration
No. 333-138742).
Use of
Proceeds from our Initial Public Offering
On November 15, 2006, we completed an initial public
offering of our common stock pursuant to a registration
statement on
Form S-1
(File
No. 333-124119)
that was declared effective by the SEC on November 9, 2006.
A total of 4,600,000 shares of common stock were offered by
us and existing shareholders under the final prospectus, all of
which were sold at a price per share of $20.00. We issued
4,232,140 shares of common stock and the selling
shareholders offered 367,860 shares of common stock. The
managing underwriters of our offering were Credit Suisse
Securities (USA) LLC, Banc of America Securities LLC,
Piper Jaffray & Co. and Stifel,
Nicolaus & Company, Incorporated. The aggregate gross
proceeds of the shares offered and sold by us totalled
$84.6 million and the aggregate gross proceeds to the
selling shareholders totalled $7.4 million. We did not
receive any proceeds from the sale of shares by the selling
shareholders. In connection with the offering, we paid an
aggregate of $9.7 million in expense, consisting of
$5.9 million in
41
underwriting discounts and commissions to the underwriters, and
other expenses totalling $3.8 million in connection with
the offering.
After deducting the underwriting discounts and commissions and
the other offering expenses, we received net proceeds from our
initial public offering of approximately $75.0 million. We
used $72.6 million of the net proceeds to pay the special
distribution described above to our shareholders of record as of
October 3, 2006. The remaining approximately
$2.3 million of net proceeds from the offering were used
for working capital. Of the $72.6 million special
distribution paid with the net proceeds from the offering,
$44.6 million was paid to our directors, officers and other
affiliates, in their capacity as shareholders of the Company.
Purchases
of Equity Securities by the Issuer and Affiliated
Purchasers
Purchases of Capella Education Company common stock made by an
affiliate of the company, the Capella Education Company Employee
Stock Ownership Plan, during the three months ended
December 31, 2006, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Approximate Dollar
|
|
|
|
|
|
|
|
|
|
Shares Purchased as
|
|
|
Value of Shares
|
|
|
|
|
|
|
|
|
|
Part of Publicly
|
|
|
That May Yet Be
|
|
|
|
Total Number of
|
|
|
Average Price Paid
|
|
|
Announced Plans or
|
|
|
Purchased Under the
|
|
Period
|
|
Shares Purchased
|
|
|
per Share
|
|
|
Programs
|
|
|
Plans or Programs
|
|
|
10/1/2006
to 10/31/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/2006
to 11/30/2006
|
|
|
48,392
|
|
|
$
|
25.27
|
|
|
|
|
|
|
|
|
|
12/1/2006
to 12/31/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
48,392
|
|
|
$
|
25.27
|
|
|
|
|
|
|
|
|
|
All shares of common stock reflected in the table were purchased
by the Employee Stock Ownership Plan in open-market transactions
with the proceeds of the special distribution that was paid to
the Employee Stock Ownership Plan on November 21, 2006. The
Company does not have a publicly announced plan or program for
the repurchase of its common stock.
42
|
|
Item 6.
|
Selected
Financial Data
|
The following table sets forth our selected consolidated
financial and operating data as of the dates and for the periods
indicated. You should read this data together with
Item 7 Managements Discussion and
Analysis of Financial Condition and Results of Operations
and our consolidated financial statements and related notes,
included elsewhere in this Annual Report on
Form 10-K.
The selected consolidated statement of operations data for each
of the years in the three-year period ended December 31,
2006, and the selected consolidated balance sheet data as of
December 31, 2006 and 2005, have been derived from our
audited consolidated financial statements, which are included
elsewhere in this Annual Report on
Form 10-K.
The selected consolidated statements of operations data for the
years ended December 31, 2003 and 2002, and selected
consolidated balance sheet data as of December 31, 2004,
2003 and 2002, have been derived from our audited consolidated
financial statements not included in this Annual Report on
Form 10-K.
Historical results are not necessarily indicative of the results
of operations to be expected for future periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
|
2006(a)
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
|
|
|
(In thousands, except per share and enrollment data)
|
|
|
|
|
|
Statement of Operations
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
179,881
|
|
|
$
|
149,240
|
|
|
$
|
117,689
|
|
|
$
|
81,785
|
|
|
$
|
49,556
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
83,627
|
|
|
|
71,243
|
|
|
|
58,850
|
|
|
|
43,759
|
|
|
|
28,074
|
|
|
|
|
|
Selling and promotional
|
|
|
56,646
|
|
|
|
45,623
|
|
|
|
35,089
|
|
|
|
22,246
|
|
|
|
15,894
|
|
|
|
|
|
General and administrative
|
|
|
21,765
|
|
|
|
17,501
|
|
|
|
13,885
|
|
|
|
11,710
|
|
|
|
11,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
162,038
|
|
|
|
134,367
|
|
|
|
107,824
|
|
|
|
77,715
|
|
|
|
55,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
17,843
|
|
|
|
14,873
|
|
|
|
9,865
|
|
|
|
4,070
|
|
|
|
(5,994
|
)
|
|
|
|
|
Other income, net
|
|
|
4,472
|
|
|
|
2,306
|
|
|
|
724
|
|
|
|
427
|
|
|
|
327
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
22,315
|
|
|
|
17,179
|
|
|
|
10,589
|
|
|
|
4,497
|
|
|
|
(5,667
|
)
|
|
|
|
|
Income tax expense (benefit)
|
|
|
8,904
|
|
|
|
6,929
|
|
|
|
(8,196
|
)
|
|
|
104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
13,411
|
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
|
$
|
4,393
|
|
|
$
|
(5,667
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.09
|
|
|
$
|
0.89
|
|
|
$
|
1.68
|
|
|
$
|
0.41
|
|
|
$
|
(0.58
|
)
|
|
|
|
|
Diluted
|
|
$
|
1.06
|
|
|
$
|
0.86
|
|
|
$
|
1.62
|
|
|
$
|
0.39
|
|
|
$
|
(0.58
|
)
|
|
|
|
|
Weighted average number of common
shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
12,271
|
|
|
|
11,476
|
|
|
|
11,189
|
|
|
|
10,804
|
|
|
|
9,698
|
|
|
|
|
|
Diluted
|
|
|
12,629
|
|
|
|
11,975
|
|
|
|
11,599
|
|
|
|
11,154
|
|
|
|
9,698
|
|
|
|
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and
amortization(b)
|
|
$
|
8,195
|
|
|
$
|
6,474
|
|
|
$
|
5,454
|
|
|
$
|
4,177
|
|
|
$
|
3,108
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
$
|
28,901
|
|
|
$
|
28,940
|
|
|
$
|
16,049
|
|
|
$
|
15,399
|
|
|
$
|
123
|
|
|
|
|
|
Capital expenditures
|
|
$
|
15,354
|
|
|
$
|
9,079
|
|
|
$
|
7,541
|
|
|
$
|
3,719
|
|
|
$
|
3,805
|
|
|
|
|
|
EBITDA(c)
|
|
$
|
26,038
|
|
|
$
|
21,347
|
|
|
$
|
15,319
|
|
|
$
|
8,247
|
|
|
$
|
(2,886
|
)
|
|
|
|
|
Enrollment(d)
|
|
|
17,976
|
|
|
|
14,613
|
|
|
|
12,252
|
|
|
|
9,313
|
|
|
|
6,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
Consolidated Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and
short-term marketable securities
|
|
$
|
87,661
|
|
|
$
|
72,133
|
|
|
$
|
49,980
|
|
|
$
|
41,190
|
|
|
$
|
22,060
|
|
|
|
|
|
Working
capital(e)
|
|
|
69,147
|
|
|
|
53,718
|
|
|
|
37,935
|
|
|
|
27,516
|
|
|
|
15,340
|
|
|
|
|
|
Total assets
|
|
|
129,314
|
|
|
|
106,562
|
|
|
|
80,026
|
|
|
|
55,402
|
|
|
|
35,380
|
|
|
|
|
|
Total redeemable preferred stock
|
|
|
|
|
|
|
57,646
|
|
|
|
57,646
|
|
|
|
57,646
|
|
|
|
50,401
|
|
|
|
|
|
Shareholders equity (deficit)
|
|
|
93,745
|
|
|
|
14,414
|
|
|
|
(5
|
)
|
|
|
(20,416
|
)
|
|
|
(26,250
|
)
|
|
|
|
|
|
|
|
(a) |
|
Operating income, income before income taxes and EBITDA for the
year ended December 31, 2006 included $4.2 million of
stock-based compensation expense recognized under
FAS 123(R). Net income |
43
|
|
|
|
|
and net income per common share for the year ended
December 31, 2006 included $3.1 million of stock-based
compensation expense recognized under FAS 123(R). In
accordance with the modified prospective transition method
provided under FAS 123(R), our consolidated financial
statements for prior periods have not been restated to reflect,
and do not include, the impact of FAS 123(R). |
|
|
|
(b) |
|
Depreciation and amortization is calculated using the
straight-line method over the estimated useful lives of the
assets. Amortization includes amounts related to purchased
software, capitalized website development costs and internally
developed software. |
|
(c) |
|
EBITDA consists of net income minus other income, net plus
income tax expense (benefit) and plus depreciation and
amortization. Other income, net consists primarily of interest
income earned on
short-term
marketable securities, net of any interest expense for capital
leases and notes payable. We use EBITDA as a measure of
operating performance. However, EBITDA is not a recognized
measurement under U.S. generally accepted accounting
principles, or GAAP, and when analyzing our operating
performance, investors should use EBITDA in addition to, and not
as an alternative for, net income (loss) as determined in
accordance with GAAP. Because not all companies use identical
calculations, our presentation of EBITDA may not be comparable
to similarly titled measures of other companies. Furthermore,
EBITDA is not intended to be a measure of free cash flow, as it
does not consider certain cash requirements such as tax payments. |
We believe EBITDA is useful to investors in evaluating our
operating performance and liquidity because it is widely used to
measure a companys operating performance without regard to
items such as depreciation and amortization. Depreciation and
amortization can vary depending upon accounting methods and the
book value of assets. We believe EBITDA presents a meaningful
measure of corporate performance exclusive of our capital
structure and the method by which assets were acquired.
Our management uses EBITDA:
|
|
|
|
|
as a measurement of operating performance, because it assists us
in comparing our performance on a consistent basis, as it
removes depreciation, amortization, interest and taxes; and
|
|
|
|
in presentations to the members of our board of directors to
enable our board to have the same measurement basis of operating
performance as is used by management to compare our current
operating results with corresponding prior periods and with the
results of other companies in our industry.
|
The following table provides a reconciliation of net income
(loss) to EBITDA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(In thousands)
|
|
|
Net income (loss)
|
|
$
|
13,411
|
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
|
$
|
4,393
|
|
|
$
|
(5,667
|
)
|
Other income, net
|
|
|
(4,472
|
)
|
|
|
(2,306
|
)
|
|
|
(724
|
)
|
|
|
(427
|
)
|
|
|
(327
|
)
|
Income tax expense (benefit)
|
|
|
8,904
|
|
|
|
6,929
|
|
|
|
(8,196
|
)
|
|
|
104
|
|
|
|
|
|
Depreciation and amortization
|
|
|
8,195
|
|
|
|
6,474
|
|
|
|
5,454
|
|
|
|
4,177
|
|
|
|
3,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
26,038
|
|
|
$
|
21,347
|
|
|
$
|
15,319
|
|
|
$
|
8,247
|
|
|
$
|
(2,886
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(d) |
|
Enrollment reflects the total number of learners registered in a
course as of the last day of classes for such periods. |
|
(e) |
|
Working capital is calculated by subtracting total current
liabilities from total current assets. |
|
|
Item 7.
|
Managements
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.
44
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 delivered
to working adults. At December 31, 2006, we offered over
760 courses and 13 academic programs with 75 specializations at
the graduate and undergraduate levels to approximately 18,000
learners.
We were founded in 1991, and in 1993, we established our
wholly-owned university subsidiary, then named The Graduate
School of America, to offer doctoral and masters 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
masters 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 masters 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 bachelors degree
market, we changed our name to Capella Education Company and the
name of our university to Capella University. In 2000, we
introduced our bachelors degree completion program in
information technology, which provided instruction for the last
two years of a four-year bachelors degree. In 2001, we
introduced our bachelors degree completion program in
business administration. In 2004, we introduced our four-year
bachelors degree programs in business administration and
information technology, as well as three masters level
specializations in education targeted at K-12 teachers. In 2005,
we introduced two masters level specializations in
education targeted to higher education and K-12 teachers as well
as a masters in business administration specialization in
accounting. In 2006, we introduced eight specializations
including healthcare management, accounting and information
assurance and security. Additionally, in November 2006, we
completed an initial public offering of our common stock. We are
planning to introduce three new programs and seven new
specializations in the first quarter of 2007.
Regulation
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 (the OIG) of the Department of
Education has informed the Company that it is conducting a
compliance audit of the University. The OIG is responsible for,
among other things, promoting the effectiveness and integrity of
the Department of Educations programs and operations. The
audit commenced on April 10, 2006 and since then the
Company has been periodically providing the OIG with
information, responding to follow up inquiries and facilitating
site visits and access to the Companys records. The OIG
completed its field work in January 2007 and the Company expects
to receive a draft report sometime in 2007. Based on the field
auditors preliminary audit exceptions, which is a
preliminary list of issues regarding Capella Universitys
compliance with Title IV rules and requirements, and our
verbal communications with the OIG audit staff, the Company
believes that 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
Company did not properly calculate the amount of Title IV
funds required to be returned for learners that withdrew from
Capella University without providing an official notification of
such withdrawal and without engaging in academic activity prior
to such withdrawal. If it is determined that we improperly
withheld any portion of these funds, we would be required to
return the improperly withheld funds. For the three year audit
period, and for the
2005-2006
aid year, we estimate that the total amount of Title IV
funds not returned for learners who withdrew without providing
official notification was less than $1.0 million, including
interest, but not including fines and penalties.
45
Our
key financial results metrics
Revenues. Revenues consist principally
of tuition, application and graduation fees, and commissions we
earn from bookstore and publication sales. Factors affecting our
revenues include: (i) the number of enrollments;
(ii) the number of courses per learner; (iii) our
degree and program mix; (iv) the number of programs and
specializations we offer; and (v) annual tuition
adjustments.
Enrollments for a particular time period are defined as the
number of learners registered in a course on the last day of
classes within that period. We offer monthly start options for
newly enrolled learners. Learners who start their program in the
second or third month of a quarter transition to a quarterly
schedule beginning in their second quarter. Enrollments are a
function of the number of continuing learners at the beginning
of each period and new enrollments during the period, which are
offset by graduations, withdrawals and inactive learners during
the period. Inactive learners for a particular period include
learners who are not registered in a class and, therefore, are
not generating revenues for that period, but who have not
withdrawn from Capella University. We believe that our
enrollments are influenced by the attractiveness of our program
offerings and learning experience, the effectiveness of our
marketing and recruiting efforts, the quality of our
instructors, the number of programs and specializations we
offer, the availability of federal and other funding, the length
of our educational programs, the seasonality of our enrollments
and general economic conditions.
The following is a summary of our learners as of the last day of
classes for the years ended December 31, 2006, 2005 and
2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Doctoral
|
|
|
7,473
|
|
|
|
6,471
|
|
|
|
5,611
|
|
Masters
|
|
|
7,685
|
|
|
|
5,640
|
|
|
|
4,543
|
|
Bachelors
|
|
|
2,729
|
|
|
|
2,380
|
|
|
|
1,859
|
|
Other
|
|
|
89
|
|
|
|
122
|
|
|
|
239
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
17,976
|
|
|
|
14,613
|
|
|
|
12,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tuition and Fees. Our tuition rates
vary by type and length of program and by degree level, such as
doctoral, masters or bachelors. For all
masters and bachelors programs and for selected
doctoral programs, tuition is determined by the number of
courses taken by each learner. For the
2005-2006
academic year (the academic year that began in July 2005),
prices per course generally ranged from $1,400 to $1,950. The
price of the course will vary based upon the number of credit
hours, the degree level of the program and the discipline. For
the
2005-2006
academic year, the majority of doctoral programs were priced at
a fixed quarterly amount of $3,975 per learner, regardless
of the number of courses in which the learner was registered. In
January 2006, we adjusted our fixed quarterly tuition rate for
doctoral learners in their comprehensive exam or dissertation to
$3,200. In addition, if a learner in a doctoral program with
fixed quarterly tuition had paid for 16 quarters, completed all
coursework except for their comprehensive exam or dissertation
and met all colloquia requirements, the tuition rate was reduced
to $500 per quarter. Based on prices from the
2005-2006
academic year, we estimate that full tuition was in the mid
$50,000 range for a four-year bachelors program, ranged
from approximately $17,000 to $28,000 for a masters
program, and ranged from approximately $31,000 to $62,000 for a
doctoral program. These amounts and ranges assume no reductions
for transfer credits. Many of our learners reduce their total
program costs at Capella University by transferring credits
earned at other institutions. Other in the table
above refers primarily to certificate-seeking learners.
Certificate programs generally consist of four courses, and the
price of a course depends on the number of credit hours, the
degree level of the program and the discipline. For the
2005-2006
academic year, prices per course in certificate programs
generally ranged from $1,400 to $1,925.
Capella University implemented a tuition increase in 10 of our
13 programs generally ranging from 2% to 6% for the
2006-2007
academic year (the academic year that began in July 2006). The
price increase resulted in prices per course generally ranging
from $1,460 to $1,995 for masters, bachelors and certificate
programs. The majority of doctoral programs were priced at a
fixed quarterly amount of $4,050 per learner, regardless of
the number of courses in which the learner was registered. The
fixed quarterly tuition for
46
doctoral learners in their comprehensive exam or dissertation
increased to $3,240. The reduced tuition rate for doctoral
learners who have paid for 16 quarters, completed all coursework
except for their comprehensive exam or dissertation and met all
colloquia requirements increased from $500 to $810 per
quarter. Based on prices from the
2006-2007
academic year, we estimate that full tuition is in the low
$50,000 range for a
four-year
bachelors program, from approximately $18,000 to $29,000
for a masters program, and from approximately $33,000 to
$60,000 for a doctoral program. The high end of the range for
the doctoral program has decreased slightly from the prior year
due to the implementation of a discount program for learners in
the Psychology program who take more than one course per
quarter. These amounts and ranges assume no reductions for
transfer credits. Many of our learners reduce their total
program costs at Capella University by transferring credits
earned at other institutions.
A large portion of our learners rely on funds received under
various government-sponsored student financial aid programs,
predominantly Title IV programs, to pay a substantial
portion of their tuition and other education-related expenses.
In the years ended December 31, 2006, 2005 and 2004
approximately 71%, 67% and 64%, respectively, of our revenues
(calculated on a cash basis) were attributable to funds derived
from Title IV programs. In addition to Title IV
funding, our learners receive financial aid from other
governmental sources or finance their education through private
financing institutions or with their own funds.
Costs and expenses. We categorize our
costs and expenses as (i) instructional costs and services
expenses, (ii) selling and promotional expenses and
(iii) general and administrative expenses.
Instructional costs and services expenses are items of expense
directly attributable to the educational services we provide our
learners. This expense category includes salaries and benefits
of full-time faculty, administrators and academic advisors, and
costs associated with adjunct faculty. Instructional pay for
adjunct faculty varies across programs and is primarily
dependent on the number of learners taught. Instructional costs
and services expenses also include costs of educational
supplies, costs associated with academic records and other
university services, and an allocation of facility, admissions
and human resources costs, stock-based compensation expense,
depreciation and amortization and information technology costs
that are attributable to providing educational services to our
learners.
Selling and promotional expenses include salaries and benefits
of personnel engaged in recruitment and promotion, as well as
costs associated with advertising and the production of
marketing materials related to new enrollments and current
learners. Our selling and promotional expenses are generally
affected by the cost of advertising media, the efficiency of our
selling efforts, salaries and benefits for our sales personnel,
and the number of advertising initiatives for new and existing
academic programs. Selling and promotional expenses also include
an allocation of facility, admissions and human resources costs,
stock-based compensation expense, depreciation and amortization
and information technology costs that are attributable to
selling and promotional efforts.
General and administrative expenses include salaries and
benefits of employees engaged in corporate management, finance,
compliance and other corporate functions, together with an
allocation of facility and human resources costs, stock-based
compensation expense, depreciation and amortization and
information technology costs attributable to such functions.
General and administrative expenses also include bad debt
expense and any charges associated with asset impairments.
Other income, net. Other income, net
consists primarily of interest income earned on cash, cash
equivalents and short-term marketable securities, net of any
interest expense for capital leases and notes payable.
Factors
affecting comparability
We set forth below selected factors that we believe have had, or
are expected to have, a significant effect on the comparability
of recent or future results of operations:
Stock option expense. On
January 1, 2006, we adopted Statement of Financial
Accounting Standards No. 123(R), Share-based Payment
(FAS 123(R)), which requires the measurement and
recognition of compensation expense for stock-based payment
awards made to employees and directors, including employee
47
stock options. FAS 123(R) eliminates the ability to account
for stock-based compensation transactions using the footnote
disclosure-only provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25), and instead requires that such transactions
be recognized and reflected in our financial statements using a
fair-value-based method. In March 2005, the Securities and
Exchange Commission issued Staff Accounting
Bulletin No. 107 (SAB 107), relating to
FAS 123(R). We have applied the provisions of SAB 107
in our adoption of FAS 123(R).
We have adopted FAS 123(R) using the modified prospective
method, which requires the application of the accounting
standard as of January 1, 2006. Our financial statements
for the year ended December 31, 2006 reflect the impact of
FAS 123(R). In accordance with the modified prospective
transition method, our consolidated financial statements for the
years ended December 31, 2005 and 2004 have not been
restated to reflect, and do not include, the impact of
FAS 123(R).
As a result of adopting FAS 123(R) on January 1, 2006,
our income before income taxes and net income for the year ended
December 31, 2006 are $4.2 million and
$3.1 million lower, respectively, than if we had continued
to account for stock-based compensation under APB 25. Basic
and diluted net income per share for the year ended
December 31, 2006 were $0.26 and $0.25 lower, respectively,
than if we had continued to account for stock-based compensation
under APB 25.
The table below reflects our stock-based compensation expense
recognized in the consolidated statements of income for the year
ended December 31, 2006 (in thousands):
|
|
|
|
|
Instructional costs and services
|
|
$
|
748
|
|
Selling and promotional
|
|
|
357
|
|
General and administrative
|
|
|
3,074
|
|
|
|
|
|
|
Stock-based compensation expense
included in operating income
|
|
|
4,179
|
|
Tax benefit
|
|
|
1,075
|
|
|
|
|
|
|
Stock-based compensation expense,
net of tax
|
|
$
|
3,104
|
|
|
|
|
|
|
Prior to the adoption of FAS 123(R), we presented all tax
benefits of deductions resulting from the exercise of stock
options as operating cash flows in our consolidated statement of
cash flows. FAS 123(R) requires the cash flows resulting
from the tax benefits resulting from tax deductions in excess of
the compensation cost recognized for those stock options (excess
tax benefits) to be classified as financing cash flows. The
$0.08 million excess tax benefit classified as a financing
cash inflow for the year ended December 31, 2006 would have
been classified as an operating cash inflow if we had not
adopted FAS 123(R).
Income tax benefits resulting from reversal of valuation
allowance. In the period from our inception
through 2002, we incurred significant operating losses that
resulted in a net operating loss carryforward for tax purposes
and net deferred tax assets. Until 2004, we provided a 100%
valuation allowance for all net deferred tax assets. Due to
achieving three years of cumulative taxable income in 2004 and
because we expected to be profitable in future years, we
concluded that it was more likely than not that substantially
all of our net deferred tax assets would be realized. As a
result, in accordance with Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes
(FAS 109), all of the valuation allowance
applied to net deferred tax assets was reversed during the year
ended December 31, 2004. Reversal of the valuation
allowance resulted in a non-recurring non-cash income tax
benefit totaling $12.9 million, which accounted for 68% of
our net income of $18.8 million in the year ended
December 31, 2004.
Critical
Accounting Policies and Use of Estimates
The discussion of our financial condition and results of
operations is based upon our financial statements, which have
been prepared in accordance with U.S. generally accepted
accounting principles, or GAAP. During the preparation of these
financial statements, we are required to make estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenues, costs and expenses and related
disclosures. On an ongoing basis, we evaluate our estimates and
assumptions, including those related to revenue recognition,
allowance for doubtful accounts, impairment of long-lived
assets, contingencies, stock-based compensation expense and
48
income taxes. We base our estimates on historical experience and
on various other assumptions that we believe are reasonable
under the circumstances. The results of our analysis form the
basis for making assumptions about the carrying values of assets
and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under
different assumptions or conditions, and the impact of such
differences may be material to our consolidated financial
statements.
We believe that the following critical accounting policies
involve our more significant judgments and estimates used in the
preparation of our consolidated financial statements:
Revenue recognition. Tuition revenue
represented approximately 98.5% of our revenues recognized for
each of the years ended December 31, 2006, 2005 and 2004.
Course tuition revenue is deferred and recognized as revenue
ratably over the period of instruction, which is generally from
one and a half to three months. Colloquia tuition revenue is
recognized over the length of the colloquia, which ranges from
two days to two weeks. Deferred revenue in any period represents
the excess of tuition and fees received as compared to tuition
and fees recognized in revenue on the consolidated statement of
operations and is reflected as a current liability on our
consolidated balance sheet.
Allowance for doubtful accounts. We
maintain an allowance for doubtful accounts for estimated losses
resulting from the inability, failure or refusal of our learners
to make required payments. We determine the allowance for
doubtful accounts amount based on an analysis of the accounts
receivable detail and historical write-off experience.
In establishing our credit practices, we seek to strike an
appropriate balance between prudent learner credit policies and
learner retention. Accordingly, we periodically review and alter
learner credit policies to achieve that objective by restricting
or expanding the availability of credit we extend. Changes to
credit practices may impact enrollments, revenues, accounts
receivables, our allowance for doubtful accounts and bad debt
expense. If changes in credit practices result in higher
receivable balances, if the financial condition of our learners
deteriorates resulting in an impairment of their ability to pay,
or if we underestimate the allowances required, additions to our
allowance for doubtful accounts may be necessary, which will
result in increased general and administrative expenses in the
period such determination is made.
Impairment of long-lived assets. We
review our long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. We measure the recoverability of
an asset by a comparison of the carrying amount of an asset to
undiscounted future net cash flows expected to be generated by
the asset. If the asset is considered to be impaired, the
impairment to be recognized is measured by the amount by which
the carrying amount of the asset exceeds the fair value of the
asset. If we determine that an assets carrying value is
impaired, we will record a write-down of the carrying value of
the identified asset and charge the impairment as an operating
expense in the period in which the determination is made. During
the years ended December 31, 2006, 2005 and 2004, we
recorded impairment charges of $0.06 million,
$0.2 million and $1.0 million, respectively. The
impairment charge recorded in 2004 consisted primarily of the
write-off of previously capitalized software development costs
for software projects that were abandoned due to our decision to
implement an enterprise resource planning system. Capitalized
software costs represent our long-lived assets that are most
subject to the risk of impairment from changes in our business
strategy and ongoing technological developments. As of
December 31, 2006, we had recorded capitalized software
costs with a net book value totaling $17.0 million. Our
impairment loss calculation is subject to uncertainties because
management must use judgment to forecast estimated future cash
flows and fair values and to determine the useful lives of the
assets. If actual results are not consistent with our
assumptions and estimates regarding these factors, we may be
exposed to losses that could be material. Changes in strategy or
market conditions, or significant technological developments,
could significantly impact these judgments and require
adjustments to recorded asset balances.
Contingencies. We accrue 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.
We base these accruals on managements estimate of such
costs, which may vary from the ultimate cost and expenses
associated with any such contingency.
49
Stock-based compensation. On
January 1, 2006, we adopted FAS 123(R), which requires
the measurement and recognition of compensation expense for
stock-based payment awards made to employees and directors,
including employee stock options. FAS 123(R) eliminates the
ability to account for stock-based compensation transactions
using the footnote disclosure-only provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), and instead requires that
such transactions be recognized and reflected in our financial
statements using a fair-value-based method. In March 2005, the
Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 (SAB 107), relating to
FAS 123(R). We have applied the provisions of SAB 107
in our adoption of FAS 123(R).
We adopted FAS 123(R) using the modified prospective
method, which requires the application of the accounting
standard as of January 1, 2006. Our financial statements as
of and for the year ended December 31, 2006 reflect the
impact of FAS 123(R). In accordance with the modified
prospective transition method, our consolidated financial
statements for the years ended December 31, 2005 and 2004
have not been restated to reflect, and do not include, the
impact of FAS 123(R).
Prior to the adoption of FAS 123(R), we accounted for
stock-based awards to employees and directors using the
intrinsic value method in accordance with APB 25 as allowed
under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (FAS 123).
Under the intrinsic value method, no stock-based compensation
expense had been recognized in our consolidated statement of
income because the exercise price of our stock options granted
to employees and directors equaled the fair market value of the
underlying stock at the date of grant. We recognized stock-based
compensation of $0.2 million in 2005, related to a
modification of the terms of specific stock options.
Because no market for our common stock existed prior to our
initial public offering, our board of directors determined the
fair value of our common stock based upon several factors,
particularly recent sales of our stock to and by investors and
our annual independent valuation of our common stock prepared
for purposes of valuing our contributions to our Employee Stock
Ownership Plan (ESOP).
Under FAS 123(R), the amount of compensation expense will
vary depending on numerous factors, including the number and
vesting period of option grants, the expected life of the
grants, the publicly traded stock price of the security
underlying the options, the volatility of the stock price and
the estimated forfeiture rate. Of the 2.2 million shares
subject to outstanding stock options as of December 31,
2006, 2.0 million related to service-based stock options
which vest ratably over a specific period, usually four years.
Compensation expense relating to these options is recognized
ratably over the vesting period, resulting in the recognition of
$2.6 million of compensation expense in 2006. Approximately
0.2 million of our outstanding stock options as of
December 31, 2006 were performance-based stock options
granted in 2006 in lieu of a portion of the cash bonus under our
2006 Annual Incentive Plan for Management Employees. On
December 31, 2006, 74.5% of these options ultimately vested
based on meeting certain performance thresholds related to
planned revenue and income before income taxes, resulting in the
recognition of $1.6 million of compensation expense in 2006.
At December 31, 2006, total compensation expense related to
nonvested service-based stock options net yet recognized was
$6.7 million, which is expected to be recognized over
32 months on a weighted-average basis.
In determining stock-based compensation expense, FAS 123(R)
will continue to require significant management judgment and
assumptions concerning such factors as term, volatility and
forfeitures. For more information concerning our adoption of
FAS 123(R) and its effects on our results of operations,
see
Item 7-
Managements Discussion and Analysis of Financial Condition
and Results of Operations-Factors affecting comparability- Stock
Option Expense of this report and Notes 2 and 12 to
our consolidated financial statements included elsewhere in this
report.
Accounting for income taxes. We account
for income taxes utilizing FAS 109, which prescribes the
use of the asset and liability method to compute the differences
between the tax bases of assets and liabilities and the related
financial amounts, using currently enacted tax laws. Valuation
allowances are established, when necessary, to reduce deferred
tax assets to the amount that more likely than not will be
realized. Realization of
50
the deferred tax assets, net of deferred tax liabilities, is
principally dependent upon achievement of projected future
taxable income offset by deferred tax liabilities. We exercise
significant judgment in determining our provisions for income
taxes, our deferred tax assets and liabilities and our future
taxable income for purposes of assessing our ability to utilize
any future tax benefit from our deferred tax assets or other
elements of the tax provision. Although we believe that our tax
estimates are reasonable, the ultimate tax determination
involves significant judgments that could become subject to
examination by tax authorities in the ordinary course of
business. We periodically assess the likelihood of adverse
outcomes resulting from these examinations to determine the
impact on our deferred taxes and income tax liabilities and the
adequacy of our provision for income taxes. Changes in income
tax legislation, statutory income tax rates, or future taxable
income levels, among other things, could materially impact our
valuation of income tax assets and liabilities and could cause
our income tax provision to vary significantly among financial
reporting periods.
Results
of Operations
The following table sets forth statements of operations data as
a percentage of revenues for each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Revenues
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
46.5
|
|
|
|
47.7
|
|
|
|
50.0
|
|
Selling and promotional
|
|
|
31.5
|
|
|
|
30.6
|
|
|
|
29.8
|
|
General and administrative
|
|
|
12.1
|
|
|
|
11.7
|
|
|
|
11.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
90.1
|
|
|
|
90.0
|
|
|
|
91.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
9.9
|
|
|
|
10.0
|
|
|
|
8.4
|
|
Other income, net
|
|
|
2.5
|
|
|
|
1.5
|
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
12.4
|
|
|
|
11.5
|
|
|
|
9.0
|
|
Income tax expense (benefit)
|
|
|
4.9
|
|
|
|
4.6
|
|
|
|
(7.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
7.5
|
%
|
|
|
6.9
|
%
|
|
|
16.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended December 31, 2006 Compared to Year Ended
December 31, 2005
Revenues. Our revenues for the year
ended December 31, 2006, were $179.9 million,
representing an increase of $30.7 million, or 20.5%, as
compared to revenues of $149.2 million for the year ended
December 31, 2005. Of this increase, 19.0 percentage
points were due to increased enrollments and 4.6 percentage
points were due to tuition increases, which was partially offset
by a 2.3 percentage point decrease due to a larger
proportion of masters learners, who generated less revenue
per learner than our doctoral learners.
End-of-period
enrollment increased 23.0% in 2006 compared to 2005. Tuition
increases in 2005 generally ranged from 4% to 11% and were
implemented during July 2005. Tuition increases in 2006
generally ranged from 2% to 6% and were implemented during July
2006.
Instructional costs and services
expenses. Our instructional costs and
services expenses for the year ended December 31, 2006,
were $83.6 million, representing an increase of
$12.4 million, or 17.4%, as compared to instructional costs
and services expenses of $71.2 million for the year ended
December 31, 2005. This increase was primarily due to
increases in instructional pay due to the increase in
enrollments, an increase in depreciation expense and technology
expense related to providing educational services, an increase
in learner support services and stock-based compensation expense
recorded in 2006 as a result of the adoption of FAS 123(R).
Our instructional costs and services expenses as a percentage of
revenues decreased by 1.2 percentage points to 46.5% for
the year ended December 31, 2006, as compared to 47.7% for
the year ended December 31, 2005. This improvement in 2006
was driven by improvements in our variable cost structure due to
continuously working on process improvements, including more
efficient course scheduling
51
and use of faculty and improved fixed cost leverage with respect
to our university administration expenses and facilities
expenses.
Selling and promotional expenses. Our
selling and promotional expenses for the year ended
December 31, 2006, were $56.6 million, representing an
increase of $11.0 million, or 24.2%, as compared to selling
and promotional expenses of $45.6 million for the year
ended December 31, 2005. This increase was primarily
attributable to an increase in marketing and advertising
expenses to attract more learners to our existing programs, an
increase in brand awareness spending, an increase in online
advertising spending and an increase in learner recruiting
personnel. Our selling and promotional expenses as a percentage
of revenues increased by 0.9 percentage points to 31.5% for
the year ended December 31, 2006, from 30.6% for the year
ended December 31, 2005, due to an increase in marketing
and advertising expenses to attract more learners to our
existing programs and an increase in brand differentiation
spending.
General and administrative
expenses. Our general and administrative
expenses for the year ended December 31, 2006, were
$21.8 million, representing an increase of
$4.3 million, or 24.4%, as compared to general and
administrative expenses of $17.5 million for the year ended
December 31, 2005. This increase was primarily attributable
to $3.1 million in stock-based compensation expense
recorded in 2006 as a result of the adoption of FAS 123(R),
an increase in spending related to the enterprise resource
planning system, and accruals related to certain contingencies.
Our general and administrative expenses as a percentage of
revenues increased by 0.4 percentage points to 12.1% for
the year ended December 31, 2006, from 11.7% for the year
ended December 31, 2005, due to the factors described above
offset by improved fixed cost leverage with respect to our
executive administrative and finance related expenses.
Other income, net. Other income, net
increased by $2.2 million, or 93.9%, to $4.5 million
for the year ended December 31, 2006, from
$2.3 million for the year ended December 31, 2005. The
increase was principally due to higher interest rates and higher
average cash and short-term marketable securities balances
throughout 2006. We anticipate a reduction in other income, net
in 2007 due to the use of tax-exempt investments, which
typically earn lower interest rates.
Income tax expense (benefit). We
recognized tax expense for the year ended December 31, 2006
and 2005 of $8.9 million and $6.9 million,
respectively, or at effective tax rates of 39.9% and 40.3%,
respectively. The decrease in our effective tax rate from 2005
to 2006 was primarily due to a one-time tax benefit related to
the dividend portion of the special distribution to our Employee
Stock Ownership Plan (ESOP) from the proceeds of our initial
public offering of common stock, which is deductible for tax
purposes, and tax planning strategies. We anticipate a slight
reduction in our effective tax rate in 2007 due to the use of
tax-exempt investments.
Net income. Net income was
$13.4 million for the year ended December 31, 2006,
compared to net income of $10.3 million for the year ended
December 31, 2005, an increase of $3.2 million,
because of the factors discussed above, including the effects of
$3.1 million from stock-based compensation expense, net of
tax, that was recognized in 2006.
Year
Ended December 31, 2005 Compared to Year Ended
December 31, 2004
Revenues. Our revenues for the year
ended December 31, 2005, were $149.2 million,
representing an increase of $31.5 million, or 26.8%, as
compared to revenues of $117.7 million for the year ended
December 31, 2004. Of this increase, 17.8 percentage
points were due to increased enrollments and 5.9 percentage
points were due to tuition increases, which was partially offset
by a 0.8 percentage point decrease due to a larger
proportion of bachelors and masters learners, who
generated less revenue per learner than our doctoral learners.
End-of-period
enrollment increased 19.3% in 2005 compared to 2004. Tuition
increases generally ranged from 3% to 7% and were implemented
during July 2004.
Instructional costs and services
expenses. Our instructional costs and
services expenses for the year ended December 31, 2005,
were $71.2 million, representing an increase of
$12.3 million, or 21.1%, as compared to instructional costs
and services expenses of $58.9 million for the year ended
December 31, 2004. This increase was primarily due to
increases in instructional pay due to the increase in
enrollments. Our
52
instructional costs and services expenses as a percentage of
revenues decreased by 2.3 percentage points to 47.7% for
the year ended December 31, 2005, as compared to 50.0% for
the year ended December 31, 2004. This improvement in 2005
was driven by higher tuition increases than faculty pay rate
increases, and our information technology-related projects that
resulted in a higher mix of costs that were capitalized versus
costs that were expensed due to the nature of the projects.
Selling and promotional expenses. Our
selling and promotional expenses for the year ended
December 31, 2005, were $45.6 million, representing an
increase of $10.5 million, or 30.0%, as compared to selling
and promotional expenses of $35.1 million for the year
ended December 31, 2004. This increase was primarily
attributable to an increase in recruitment personnel, an
increase in marketing and advertising expenses to attract more
learners to our existing programs, and an increase in the cost
of online advertising. Our selling and promotional expenses as a
percentage of revenues increased by 0.8 percentage points
to 30.6% for the year ended December 31, 2005, from 29.8%
for the year ended December 31, 2004, as a result of the
factors described above.
General and administrative
expenses. Our general and administrative
expenses for the year ended December 31, 2005, were
$17.5 million, representing an increase of
$3.6 million, or 26.0%, as compared to general and
administrative expenses of $13.9 million for the year ended
December 31, 2004. This increase was primarily attributable
to an increase in administrative costs resulting from
investments to further develop our corporate infrastructure
through the implementation of an enterprise resource planning
system and an increase in our personnel in preparation of
becoming a public company. General and administrative expenses
as a percentage of revenues remained relatively flat at 11.7%
for the years ended December 31, 2005 and 2004.
Other income, net. Other income, net
increased by $1.6 million, or greater than 100%, to
$2.3 million for the year ended December 31, 2005,
from $0.7 million for the year ended December 31,
2004. The increase was principally due to higher interest rates
and higher average cash and short-term marketable securities
balances throughout 2005.
Income tax expense (benefit). We
recognized tax expense for the year ended December 31, 2005
of $6.9 million, or at an effective tax rate of
approximately 40.3%. We recognized a net tax benefit for the
year ended December 31, 2004, of $8.2 million. The tax
benefit recorded in 2004 included a non-recurring, non-cash tax
benefit for the complete reversal of our valuation allowance on
our net deferred tax assets of $12.9 million, offset by tax
expense of $4.3 million on 2004 pretax earnings and
$0.4 million relating to a change in our estimate of the
income tax rates applied to our net deferred tax assets.
Net income. Net income was
$10.3 million for the year ended December 31, 2005,
compared to net income of $18.8 million for the year ended
December 31, 2004, a decrease of $8.5 million, because
of the factors discussed above.
53
Quarterly
Results and Seasonality
The following tables set forth certain unaudited financial and
operating data in each quarter during the years ended
December 31, 2006 and 2005. The unaudited information
reflects all adjustments, which include only normal and
recurring adjustments, necessary to present fairly the
information shown.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
|
Second Quarter
|
|
|
Third Quarter
|
|
|
Fourth Quarter
|
|
|
|
(In thousands, except for per share and enrollment data)
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
41,858
|
|
|
$
|
43,518
|
|
|
$
|
43,902
|
|
|
$
|
50,603
|
|
Operating income
|
|
|
1,884
|
|
|
|
4,203
|
|
|
|
4,063
|
|
|
|
7,693
|
|
Net income
|
|
|
1,642
|
|
|
|
3,055
|
|
|
|
3,041
|
|
|
|
5,673
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.14
|
|
|
$
|
0.26
|
|
|
$
|
0.26
|
|
|
$
|
0.40
|
|
Diluted
|
|
$
|
0.14
|
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
$
|
0.39
|
|
Enrollment
|
|
|
15,792
|
|
|
|
16,078
|
|
|
|
16,374
|
|
|
|
17,976
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
34,610
|
|
|
$
|
35,408
|
|
|
$
|
37,303
|
|
|
$
|
41,919
|
|
Operating income
|
|
|
4,145
|
|
|
|
3,523
|
|
|
|
2,925
|
|
|
|
4,280
|
|
Net income
|
|
|
2,705
|
|
|
|
2,356
|
|
|
|
2,204
|
|
|
|
2,985
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.24
|
|
|
$
|
0.21
|
|
|
$
|
0.19
|
|
|
$
|
0.26
|
|
Diluted
|
|
$
|
0.23
|
|
|
$
|
0.20
|
|
|
$
|
0.18
|
|
|
$
|
0.25
|
|
Enrollment
|
|
|
12,955
|
|
|
|
13,208
|
|
|
|
13,308
|
|
|
|
14,613
|
|
Our revenues and operating results normally fluctuate as a
result of seasonal variations in our business, principally due
to changes in enrollment. Learner population varies as a result
of new enrollments, graduations and learner attrition. While the
number of enrollments has grown in each sequential quarter over
these periods, the sequential quarterly increase in enrollments
has been the greatest in the fourth quarter of each respective
year, which corresponds with a traditional Fall school start.
The larger relative increases in enrollments in the fourth
quarter have resulted in larger sequential increases in revenue
during the fourth quarter than in other quarters. A significant
portion of our general and administrative expenses does not vary
proportionately with fluctuations in revenues, resulting in
larger relative increases in operating income in the fourth
quarter relative to increases between other quarters. In
addition, we typically implement tuition increases at the
beginning of an academic year, which coincides with the start of
the third quarter of each fiscal year. We expect quarterly
fluctuations in operating results to continue as a result of
these seasonal patterns.
In addition to our recurring seasonal patterns described above,
our quarterly revenue may be impacted by the timing of our
colloquia tuition revenue resulting from week-long gatherings of
our doctoral learners for in-depth,
face-to-face
instruction. We typically have five to eight colloquia per year.
For example, our revenues for the first quarter of 2006 were
slightly lower than our revenues for the fourth quarter of 2005,
partially due to a decrease of approximately $0.7 million
in colloquia tuition revenue. Our quarterly operating results
may fluctuate in the future based on the timing and number of
our colloquia.
On January 1, 2006, we adopted FAS 123(R), which
requires the measurement and recognition of compensation expense
for stock-based payment awards made to employees and directors,
including employee stock options. FAS 123(R)eliminates the
ability to account for stock-based compensation transactions
using the footnote disclosure-only provisions of APB 25,
and instead requires that such transactions be recognized and
reflected in our financial statements using a fair-value method.
As a result of adopting FAS 123(R) on January 1, 2006,
our income before income taxes and net income for the year ended
December 31, 2006 were $4.2 million and
$3.1 million lower, respectively, than if we had continued
to account for stock-based compensation under APB 25. Basic
and diluted earnings per share for the year ended
December 31, 2006 are
54
$0.26 and $0.25 lower, respectively, than if we had continued to
account for stock-based compensation under APB 25.
Under FAS 123(R), the amount of compensation expense will
vary depending on numerous factors, including the number and
vesting period of option grants, the expected life of the
grants, the publicly traded stock price of the security
underlying the options, the volatility of the stock price, and
the estimated forfeiture rate.
Liquidity
and Capital Resources
Liquidity
We financed our operating activities and capital expenditures
during the years ended December 31, 2006, 2005 and 2004,
primarily through cash provided by operating activities. Our
cash, cash equivalents and
short-term
marketable securities were $87.7 million,
$72.1 million and $50.0 million at December 31,
2006, 2005 and 2004, respectively.
In August 2004, we entered into an unsecured $10.0 million
line of credit with Wells Fargo Bank. The line of credit has an
expiration date of June 30, 2007. There have been no
borrowings to date under this line of credit, therefore
$10.0 million is available. Any borrowings would bear
interest at a rate of either LIBOR plus 2.5% or the banks
prime rate, at our discretion on the borrowing date.
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 short-term
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 for the year ended
December 31, 2006, was $28.9 million, which is
consistent with cash provided by operating activities for the
year ended December 31, 2005. There was a $4.9 million
decrease in 2006 related to various working capital items and
decrease of $3.3 million related to a change in net
deferred tax assets. These factors were offset by an increase of
$3.2 million in net income and $4.2 million of
non-cash stock-based compensation expense as a result of the
adoption of FAS 123(R) for the year ended December 31,
2006 as compared to the year ended December 31, 2005.
Net cash provided by operating activities during the year ended
December 31, 2005, was $28.9 million, an increase of
$12.9 million, or 80.3%, from $16.0 million during the
year ended December 31, 2004. The increase was primarily
due to a $2.2 million increase in non-cash related expenses
for the provision for bad debt, depreciation and amortization
and equity related expense and a decrease of $14.6 million
in deferred income taxes, offset by a decrease in net income by
$8.5 million primarily related to the result of the
non-cash reversal of the valuation allowance in 2004.
Investing
Activities
Our cash used in investing activities is primarily related to
the purchase of property and equipment and investment in
short-term marketable securities. Net cash used in investing
activities was $22.0 million, $22.6 million and
$12.2 million for the years ended December 31, 2006,
2005 and 2004, respectively. Investment in short-term marketable
securities consists of purchases and sales of auction rate,
asset-backed, U.S. agency and corporate debt securities,
repurchase agreements and money market funds.
Net purchases of these securities were $6.6 million,
$13.5 million and $4.7 million during the years ended
December 31, 2006, 2005 and 2004, respectively. Capital
expenditures were $15.4 million, $9.1 million and
55
$7.5 million for the years ended December 31, 2006,
2005 and 2004, respectively. The increase in 2006 was due to the
investments in integrating most of our business systems with an
enterprise resource planning system. The increase in 2005 was
due to the investment in integrating most of our business
systems with an enterprise resource planning system, the
expansion of our existing corporate facilities and classroom
technology and other systems and equipment that support our
program offerings.
We lease all of our facilities. We expect to make future
payments on existing leases from cash generated from operations.
Financing
Activities
Net cash provided by financing activities was $1.6 million,
$2.2 million and $0.3 million, for the years ended
December 31, 2006, 2005 and 2004, respectively. Financing
activities during 2006 were primarily related to net cash
proceeds from our initial public offering, after deducting
underwriter commission and offering expenses, of
$76.5 million and net proceeds of $0.4 million from
stock option exercises. Net proceeds from the initial public
offering were largely offset by the special distribution paid in
November 2006 of $72.6 million and $2.7 million of
payments on two notes payable.
The financing activities during 2005 and 2004 were primarily
related to stock option exercises and warrants exercised in
2005. We received proceeds from the exercise of stock options of
$0.3 million and $0.9 million in 2005 and 2004,
respectively. We received proceeds from the exercise of warrants
of $3.0 million in 2005. In 2005, the proceeds from stock
option exercises and warrants were partially offset by the
payments on capital lease obligations and notes payable of
$1.3 million.
Contractual
Obligations
The following table sets forth, as of December 31, 2006,
the aggregate amounts of our significant contractual obligations
and commitments with definitive payment terms due in each of the
periods presented (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less Than
|
|
|
|
|
|
|
|
|
More Than
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
|
Capital leases
|
|
$
|
12
|
|
|
$
|
5
|
|
|
$
|
7
|
|
|
$
|
|
|
|
$
|
|
|
Operating
leases(a)
|
|
|
9,745
|
|
|
|
2,773
|
|
|
|
6,972
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$
|
9,757
|
|
|
$
|
2,778
|
|
|
$
|
6,979
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Minimum lease commitments for our headquarters and miscellaneous
office equipment. |
Off-Balance
Sheet Arrangements
We do not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on our
financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures
or capital resources that is material to investors.
Impact
of Inflation
We believe that inflation has not had a material impact on our
results of operations for the years ended December 31,
2006, 2005 or 2004. There can be no assurance that future
inflation will not have an adverse impact on our operating
results and financial condition.
Recent
Accounting Pronouncements
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109 (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income
taxes by prescribing the recognition threshold a tax position is
required to meet before being recognized in the
56
financial statements. It also provides guidance on
derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after
December 15, 2006. We are currently evaluating the effect
that the adoption of FIN 48 will have on our financial
condition and results of operations.
|
|
Item 7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
Market
Risk
We have no derivative financial instruments or derivative
commodity instruments. We believe the risk related to marketable
securities is limited due to the adherence to our investment
policy that requires marketable securities to have a minimum
Standard & Poors rating of A minus (or
equivalent). All of our marketable securities as of
December 31, 2006, 2005 and 2004, consisted of cash
equivalents and marketable securities rated A minus or higher.
Interest
Rate Risk
We manage interest rate risk by investing excess funds in cash
equivalents and marketable securities bearing 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 December 31, 2006, 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.
57
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
CAPELLA
EDUCATION COMPANY
Index to
Consolidated Financial Statements
58
Report of
Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Capella Education Company
We have audited the accompanying consolidated balance sheets of
Capella Education Company (the Company) as of December 31,
2006 and 2005, and the related consolidated statements of
income, shareholders equity (deficit), and cash flows for
each of the three years in the period ended December 31,
2006. Our audits also included the financial statement schedule
listed in Item 15(a). These financial statements and
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. We were not engaged to perform an
audit of the Companys internal control over financial
reporting. Our audits included consideration of internal control
over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances but not for
the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Capella Education Company at
December 31, 2006 and 2005, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2006, in conformity with
U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken
as a whole, presents fairly, in all material respects, the
information set forth therein.
As discussed in Note 2 Summary of Significant
Accounting Policies, to the Consolidated Financial Statements,
effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment, using the modified prospective
method.
Minneapolis, Minnesota
February 13, 2007
59
CAPELLA
EDUCATION COMPANY
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except par value)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
22,491
|
|
|
$
|
13,972
|
|
Short-term marketable securities
|
|
|
65,170
|
|
|
|
58,161
|
|
Accounts receivable, net of
allowance of $1,119 in 2006 and $1,299 in 2005
|
|
|
7,401
|
|
|
|
7,720
|
|
Prepaid expenses and other current
assets
|
|
|
3,703
|
|
|
|
4,758
|
|
Deferred income taxes
|
|
|
1,800
|
|
|
|
1,243
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
100,565
|
|
|
|
85,854
|
|
Property and equipment, net
|
|
|
28,749
|
|
|
|
19,559
|
|
Deferred income taxes
|
|
|
|
|
|
|
1,149
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
129,314
|
|
|
$
|
106,562
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES, REDEEMABLE
PREFERRED STOCK AND SHAREHOLDERS EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
5,113
|
|
|
$
|
4,222
|
|
Accrued liabilities
|
|
|
18,598
|
|
|
|
17,223
|
|
Income taxes payable
|
|
|
214
|
|
|
|
|
|
Deferred revenue
|
|
|
7,488
|
|
|
|
8,044
|
|
Notes payable and current portion
of capital lease obligations
|
|
|
5
|
|
|
|
2,647
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
31,418
|
|
|
|
32,136
|
|
Deferred rent
|
|
|
1,813
|
|
|
|
2,366
|
|
Capital lease obligations
|
|
|
7
|
|
|
|
|
|
Deferred income taxes
|
|
|
2,331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
35,569
|
|
|
|
34,502
|
|
Redeemable preferred stock:
|
|
|
|
|
|
|
|
|
Class E Redeemable Convertible
Preferred Stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
Authorized shares 2,596
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 0 in 2006 and 2,596 in 2005
|
|
|
|
|
|
|
34,985
|
|
Class G Redeemable Convertible
Preferred Stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
Authorized shares 2,185
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 0 in 2006 and 2,185 in 2005
|
|
|
|
|
|
|
22,661
|
|
|
|
|
|
|
|
|
|
|
Total redeemable preferred stock
|
|
|
|
|
|
|
57,646
|
|
Shareholders equity:
|
|
|
|
|
|
|
|
|
Class A Convertible Preferred
Stock, $1.00 par value:
|
|
|
|
|
|
|
|
|
Authorized shares 3,000
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 0 in 2006 and 2,810 in 2005
|
|
|
|
|
|
|
2,810
|
|
Class B Convertible Preferred
Stock, $2.50 par value:
|
|
|
|
|
|
|
|
|
Authorized shares 1,180
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 0 in 2006 and 460 in 2005
|
|
|
|
|
|
|
1,150
|
|
Class D Convertible Preferred
Stock, $4.50 par value:
|
|
|
|
|
|
|
|
|
Authorized shares 1,022
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 0 in 2006 and 1,022 in 2005
|
|
|
|
|
|
|
4,600
|
|
Common stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
Authorized shares
100,000
|
|
|
|
|
|
|
|
|
Issued and outstanding
shares 16,002 in 2006 and 2,431 in 2005
|
|
|
160
|
|
|
|
24
|
|
Additional paid-in capital
|
|
|
156,513
|
|
|
|
9,527
|
|
Accumulated other comprehensive
income (loss)
|
|
|
(7
|
)
|
|
|
(8
|
)
|
Retained earnings (accumulated
deficit)
|
|
|
(62,921
|
)
|
|
|
(3,689
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
93,745
|
|
|
|
14,414
|
|
|
|
|
|
|
|
|
|
|
Total liabilities, redeemable
preferred stock and shareholders equity
|
|
$
|
129,314
|
|
|
$
|
106,562
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
60
CAPELLA
EDUCATION COMPANY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands, except per share amounts)
|
|
|
Revenues
|
|
$
|
179,881
|
|
|
$
|
149,240
|
|
|
$
|
117,689
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
83,627
|
|
|
|
71,243
|
|
|
|
58,850
|
|
Selling and promotional
|
|
|
56,646
|
|
|
|
45,623
|
|
|
|
35,089
|
|
General and administrative
|
|
|
21,765
|
|
|
|
17,501
|
|
|
|
13,885
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
162,038
|
|
|
|
134,367
|
|
|
|
107,824
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
17,843
|
|
|
|
14,873
|
|
|
|
9,865
|
|
Other income, net
|
|
|
4,472
|
|
|
|
2,306
|
|
|
|
724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
22,315
|
|
|
|
17,179
|
|
|
|
10,589
|
|
Income tax expense (benefit)
|
|
|
8,904
|
|
|
|
6,929
|
|
|
|
(8,196
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
13,411
|
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.09
|
|
|
$
|
0.89
|
|
|
$
|
1.68
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
1.06
|
|
|
$
|
0.86
|
|
|
$
|
1.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common
shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
12,271
|
|
|
|
11,476
|
|
|
|
11,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
12,629
|
|
|
|
11,975
|
|
|
|
11,599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
61
CAPELLA
EDUCATION COMPANY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A
|
|
|
Class B
|
|
|
Class D
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Retained
|
|
|
|
|
|
|
|
|
|
Convertible
|
|
|
Convertible
|
|
|
Convertible
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
Other
|
|
|
Earnings/
|
|
|
|
|
|
|
|
|
|
Preferred Stock
|
|
|
Preferred Stock
|
|
|
Preferred Stock
|
|
|
Common Stock
|
|
|
Paid-In
|
|
|
Deferred
|
|
|
Comprehensive
|
|
|
(Accumulated
|
|
|
|
|
|
Comprehensive
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Compensation
|
|
|
Income (Loss)
|
|
|
Deficit)
|
|
|
Total
|
|
|
Income
|
|
|
|
(In thousands)
|
|
|
Balance at December 31, 2003
|
|
|
2,810
|
|
|
$
|
2,810
|
|
|
|
460
|
|
|
$
|
1,150
|
|
|
|
1,022
|
|
|
$
|
4,600
|
|
|
|
1,826
|
|
|
$
|
18
|
|
|
$
|
3,734
|
|
|
$
|
(4
|
)
|
|
$
|
|
|
|
$
|
(32,724
|
)
|
|
$
|
(20,416
|
)
|
|
|
|
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
205
|
|
|
|
2
|
|
|
|
856
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
858
|
|
|
|
|
|
Income tax benefits associated with
stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
150
|
|
|
|
|
|
Issuance of common stock to the
Employee Stock Ownership Plan
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
47
|
|
|
|
|
|
|
|
641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
641
|
|
|
|
|
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
Employee Stock Ownership Plan
distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
(27
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(27
|
)
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,785
|
|
|
|
18,785
|
|
|
$
|
18,785
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
2,810
|
|
|
|
2,810
|
|
|
|
460
|
|
|
|
1,150
|
|
|
|
1,022
|
|
|
|
4,600
|
|
|
|
2,074
|
|
|
|
20
|
|
|
|
5,354
|
|
|
|
|
|
|
|
|
|
|
|
(13,939
|
)
|
|
|
(5
|
)
|
|
$
|
18,785
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52
|
|
|
|
1
|
|
|
|
277
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
278
|
|
|
|
|
|
Exercise of stock warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
271
|
|
|
|
3
|
|
|
|
3,036
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,039
|
|
|
|
|
|
Issuance of common stock to the
Employee Stock Ownership Plan
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46
|
|
|
|
|
|
|
|
928
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
928
|
|
|
|
|
|
Employee Stock Ownership Plan
distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(12
|
)
|
|
|
|
|
|
|
(280
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(280
|
)
|
|
|
|
|
Issuance of restricted stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
50
|
|
|
|
(50
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
|
|
19
|
|
|
|
|
|
Cancellation of restricted stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
(50
|
)
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
(19
|
)
|
|
|
|
|
Stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
202
|
|
|
|
|
|
Income tax benefits associated with
stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,250
|
|
|
|
10,250
|
|
|
$
|
10,250
|
|
Unrealized loss on marketable
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
(8
|
)
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
2,810
|
|
|
|
2,810
|
|
|
|
460
|
|
|
|
1,150
|
|
|
|
1,022
|
|
|
|
4,600
|
|
|
|
2,431
|
|
|
|
24
|
|
|
|
9,527
|
|
|
|
|
|
|
|
(8
|
)
|
|
|
(3,689
|
)
|
|
|
14,414
|
|
|
$
|
10,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
99
|
|
|
|
1
|
|
|
|
797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
798
|
|
|
|
|
|
Repurchase of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(412
|
)
|
|
|
|
|
Stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,179
|
|
|
|
|
|
Income tax benefits associated with
stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
166
|
|
|
|
|
|
Employee Stock Ownership Plan
contribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62
|
|
|
|
1
|
|
|
|
1,240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,241
|
|
|
|
|
|
Employee Stock Ownership Plan
distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
|
|
|
|
Issuance of common stock, net of
underwriters commissions and offering costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,232
|
|
|
|
42
|
|
|
|
74,908
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
74,950
|
|
|
|
|
|
Conversion of convertible preferred
stock
|
|
|
(2,810
|
)
|
|
|
(2,810
|
)
|
|
|
(460
|
)
|
|
|
(1,150
|
)
|
|
|
(1,022
|
)
|
|
|
(4,600
|
)
|
|
|
4,292
|
|
|
|
43
|
|
|
|
8,517
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of redeemable
convertible preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,886
|
|
|
|
49
|
|
|
|
57,597
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57,646
|
|
|
|
|
|
Payment of special distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(72,643
|
)
|
|
|
(72,643
|
)
|
|
|
|
|
Net Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,411
|
|
|
|
13,411
|
|
|
$
|
13,411
|
|
Unrealized gain on marketable
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
1
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
|
|
16,002
|
|
|
$
|
160
|
|
|
$
|
156,513
|
|
|
$
|
|
|
|
$
|
(7
|
)
|
|
$
|
(62,921
|
)
|
|
$
|
93,745
|
|
|
$
|
13,412
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
62
CAPELLA
EDUCATION COMPANY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
13,411
|
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for bad debts
|
|
|
2,855
|
|
|
|
2,263
|
|
|
|
1,376
|
|
Depreciation and amortization
|
|
|
8,195
|
|
|
|
6,474
|
|
|
|
5,454
|
|
Amortization of investment
discount/premium
|
|
|
(366
|
)
|
|
|
(158
|
)
|
|
|
|
|
Gain on disposal of assets
|
|
|
|
|
|
|
(35
|
)
|
|
|
|
|
Asset impairment
|
|
|
63
|
|
|
|
156
|
|
|
|
1,020
|
|
Stock-based compensation
|
|
|
4,179
|
|
|
|
|
|
|
|
|
|
Noncash equity-related expense
|
|
|
169
|
|
|
|
1,381
|
|
|
|
1,135
|
|
Excess tax benefits from
stock-based compensation
|
|
|
(79
|
)
|
|
|
|
|
|
|
|
|
Deferred income taxes
|
|
|
2,926
|
|
|
|
6,203
|
|
|
|
(8,445
|
)
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2,536
|
)
|
|
|
(4,106
|
)
|
|
|
(4,278
|
)
|
Prepaid expenses and other assets
|
|
|
(627
|
)
|
|
|
(409
|
)
|
|
|
(1,905
|
)
|
Accounts payable and accrued
liabilities
|
|
|
1,274
|
|
|
|
3,329
|
|
|
|
268
|
|
Income taxes payable
|
|
|
546
|
|
|
|
(292
|
)
|
|
|
140
|
|
Deferred rent
|
|
|
(553
|
)
|
|
|
2,366
|
|
|
|
|
|
Deferred revenue
|
|
|
(556
|
)
|
|
|
1,518
|
|
|
|
2,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
28,901
|
|
|
|
28,940
|
|
|
|
16,049
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
(15,354
|
)
|
|
|
(9,079
|
)
|
|
|
(7,541
|
)
|
Purchases of marketable securities
|
|
|
(181,980
|
)
|
|
|
(59,879
|
)
|
|
|
(39,700
|
)
|
Sales of marketable securities
|
|
|
175,340
|
|
|
|
46,360
|
|
|
|
35,050
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(21,994
|
)
|
|
|
(22,598
|
)
|
|
|
(12,191
|
)
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments of capital lease
obligations and notes payable
|
|
|
(2,666
|
)
|
|
|
(1,278
|
)
|
|
|
(629
|
)
|
Change in restricted cash
|
|
|
|
|
|
|
391
|
|
|
|
80
|
|
Excess tax benefits from
stock-based compensation
|
|
|
79
|
|
|
|
|
|
|
|
|
|
Net proceeds from exercise and
repurchase of stock options
|
|
|
386
|
|
|
|
278
|
|
|
|
858
|
|
Proceeds from exercise of warrants
|
|
|
|
|
|
|
3,039
|
|
|
|
|
|
Employee Stock Ownership Plan
distributions
|
|
|
(6
|
)
|
|
|
(280
|
)
|
|
|
(27
|
)
|
Net proceeds from issuance of
common stock
|
|
|
76,462
|
|
|
|
|
|
|
|
|
|
Payment of special distribution
|
|
|
(72,643
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing
activities
|
|
|
1,612
|
|
|
|
2,150
|
|
|
|
282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
|
8,519
|
|
|
|
8,492
|
|
|
|
4,140
|
|
Cash and cash equivalents at
beginning of year
|
|
|
13,972
|
|
|
|
5,480
|
|
|
|
1,340
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
22,491
|
|
|
$
|
13,972
|
|
|
$
|
5,480
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash
flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
24
|
|
|
$
|
23
|
|
|
$
|
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes paid
|
|
$
|
5,433
|
|
|
$
|
1,080
|
|
|
$
|
109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncash transactions:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of equipment and increase
in prepaid asset through proceeds from issuance of notes payable
|
|
$
|
|
|
|
$
|
3,595
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of equipment included in
accounts payable and accrued liabilities
|
|
$
|
2,078
|
|
|
$
|
2,477
|
|
|
$
|
1,445
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of equipment through
capital lease obligations
|
|
$
|
16
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock to the
Employee Stock Ownership Plan
|
|
$
|
1,241
|
|
|
$
|
928
|
|
|
$
|
641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification of deferred
initial public offering costs from prepaid expenses to equity
|
|
$
|
1,512
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
63
CAPELLA
EDUCATION COMPANY
(In
thousands, except per share data)
Capella Education Company (the Company) was incorporated on
December 27, 1991. Through its wholly-owned subsidiary,
Capella University (the University), the Company manages its
business on the basis of one reportable segment. The University
is an online post-secondary education services company that
offers a variety of bachelors, masters and doctoral
degree programs primarily delivered to working adults. Capella
University is accredited by The Higher Learning Commission of
the North Central Association of Colleges and Schools.
|
|
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.
Revenue
Recognition
The Companys revenues consist of tuition, application and
graduation fees and commissions we earn from bookstore and
publication sales. Tuition revenue is deferred and recognized as
revenue ratably over the period of instruction. Colloquia
tuition revenue is recognized over the length of the colloquia,
which ranges from two days to two weeks. Application fee revenue
is deferred and recognized ratably over the average expected
term of a learner at the University. Learners are billed a
graduation fee upon applying for graduation for services
provided in connection with evaluating compliance with
graduation requirements. Graduation fee revenue is deferred and
recognized ratably over the expected application assessment
period for learners not expected to attend commencement
ceremonies or over the period prior to the next commencement
ceremony to account for learners who attend the ceremony.
Deferred revenue represents the excess of tuition and fee
payments received as compared to tuition and fees earned and is
reflected as a current liability in the accompanying
consolidated financial statements. The Company also receives
commissions from a third-party bookstore based on sales of
textbooks and related school materials to the Companys
learners. Commission revenue is recognized as it is earned in
conjunction with sales of textbooks and related materials to the
Companys learners.
Cash
and Cash Equivalents
The Company considers all highly liquid marketable securities
with maturities of three months or less at the time of purchase
to be cash equivalents. Cash equivalents are carried at market
value.
Marketable
Securities
The Company accounts for marketable securities in accordance
with the provisions of the Financial Accounting Standards
Boards (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
classification of debt securities at the time of purchase and
reevaluates such designation as of each balance sheet date. All
of the Companys marketable securities are classified as
available-for-sale
as of December 31, 2006 and 2005.
Available-for-sale
marketable securities are carried at fair value as determined by
quoted market prices, with unrealized gains and losses, net of
tax, reported as a separate component of shareholders
equity. Unrealized losses considered to be
other-than-temporary
are recognized currently in earnings. 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. Included in marketable
64
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
securities are certain auction rate and corporate debt
securities that contain interest rate reset dates at regular
intervals, allowing for the Company to liquidate the marketable
securities within three months throughout the term of the
contract. 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.
Allowance
for Doubtful Accounts
The Company records an allowance for doubtful accounts for
estimated losses resulting from the inability, failure or
refusal of its learners to make required payments. The Company
determines its allowance for doubtful accounts amount based on
an analysis of the accounts receivable detail and historical
write-off experience. Bad debt expense is recorded as a general
and administrative expense in the consolidated statement of
income. The Company generally writes off accounts receivable
balances deemed uncollectible prior to sending the accounts to
collection agencies.
Concentration
of Credit Risk
Financial instruments, which potentially subject the Company to
credit risk, consist primarily of marketable securities and
accounts receivable.
Management believes that the credit risk related to marketable
securities is limited due to the adherence to an investment
policy that requires marketable securities to have a minimum
Standard & Poors rating of A minus (or
equivalent). All of the Companys marketable securities as
of December 31, 2006 and 2005 consist of cash equivalents
and investments rated A minus or higher, further limiting the
Companys credit risk related to marketable securities.
Management believes that the credit risk related to accounts
receivable is limited due to the large number and diversity of
learners that principally comprise the Companys customer
base. The Companys credit risk with respect to these
accounts receivable is mitigated through the participation of a
majority of the learners in federally funded financial aid
programs.
Approximately 71%, 67% and 64% of the Companys revenues
(calculated on a cash basis) were collected from funds
distributed under Title IV Programs of the Higher Education
Act (Title IV Programs) for the years ended
December 31, 2006, 2005 and 2004, respectively. The
financial aid and assistance programs are subject to political
and budgetary considerations. There is no assurance that such
funding will be maintained at current levels.
Extensive and complex regulations govern the financial
assistance programs in which the Companys learners
participate. The Companys administration of these programs
is periodically reviewed by various regulatory agencies. Any
regulatory violation could be the basis for the initiation of
potential adverse actions, including a suspension, limitation,
or termination proceeding, which could have a material adverse
effect on the Company.
If the University were to lose its eligibility to participate in
federal student financial aid programs, the learners at the
University would lose access to funds derived from those
programs and would have to seek alternative sources of funds to
pay their tuition and fees. See Note 15 for further
information on the regulatory environment in which the Company
operates.
Property
and Equipment
Property and equipment are stated at cost. Computer software is
included in property and equipment and consists of purchased
software, capitalized Web site development costs and internally
developed software. Capitalized Web site development costs
consist mainly of salaries and outside development fees directly
65
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
related to Web sites and various databases. Web site content
development is expensed as incurred. Internally developed
software represents qualifying salary and consulting costs for
time spent on developing internal use software in accordance
with Statement of Position
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. Depreciation is provided
using the straight-line method over the estimated useful lives
of the assets, as follows:
|
|
|
|
|
Computer equipment
|
|
|
2-3 years
|
|
Furniture and office equipment
|
|
|
5-7 years
|
|
Computer software
|
|
|
3-7 years
|
|
Leasehold improvements and assets recorded under capital leases
are amortized over the related lease term or estimated useful
life, whichever is shorter.
Income
Taxes
The Company accounts for income taxes as prescribed by Statement
of Financial Accounting Standards No. 109, Accounting
for Income Taxes (FAS 109). FAS 109 prescribes the
use of the asset and liability method to compute the differences
between the tax bases of assets and liabilities and the related
financial amounts using currently enacted tax laws. Valuation
allowances are established, when necessary, to reduce deferred
tax assets to the amount that more likely than not will be
realized.
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 managements estimate of such costs, which may vary from
the ultimate cost and expenses associated with any such
contingency.
Impairment
of Long-Lived Assets
The Company reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to undiscounted
future net cash flows expected to be generated by the assets. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. The
Company recorded impairment charges of $63, $156 and $1,020
during 2006, 2005 and 2004, respectively.
The impairment charges primarily consist of the write-off of
previously capitalized internal software development costs for
software projects that were abandoned. These charges are
recorded in general and administrative expenses in the
consolidated statements of income.
66
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Advertising
The Company expenses advertising costs as
incurred. Advertising costs for 2006, 2005 and 2004 were
$30,307, $22,859 and $17,825, respectively.
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 and, since our preferred stock participated in receipt of
dividends equally to common stockholders, also reflects the
dilutive effects of the outstanding shares of our preferred
stock. Diluted net income per common share increases the shares
used in the per share calculation by the dilutive effects of
options and warrants.
The table below is a reconciliation of the numerator and
denominator in the basic and diluted net income per common share
calculation.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
13,411
|
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic net income
per common share weighted average shares
outstanding
|
|
|
12,271
|
|
|
|
11,476
|
|
|
|
11,189
|
|
Effect of dilutive stock options
and warrants
|
|
|
358
|
|
|
|
499
|
|
|
|
410
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted net income
per common share
|
|
|
12,629
|
|
|
|
11,975
|
|
|
|
11,599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per common share
|
|
$
|
1.09
|
|
|
$
|
0.89
|
|
|
$
|
1.68
|
|
Diluted net income per common share
|
|
$
|
1.06
|
|
|
$
|
0.86
|
|
|
$
|
1.62
|
|
Options to purchase 728, 0 and 206 common shares, respectively,
were outstanding but not included in the computation of diluted
net income per common share in 2006, 2005 and 2004,
respectively, because their effect would be antidilutive. The
incremental shares included for the effect of dilutive stock
options do not include assumed tax benefits related to
non-qualified stock options until the fourth quarter of 2004,
which is the first period the Company had not fully reserved for
its net deferred tax assets with a valuation allowance.
Deferred
Initial Public Offering Costs
The Company had deferred approximately $1,512 of costs that were
directly attributable to its initial public offering of common
stock as of December 31, 2005. Such costs were deferred as
of December 31, 2005 since the registration process was
expected to be completed in 2006. The deferred offering costs
were included in prepaid expenses and other current assets in
the consolidated balance sheet in 2005. Upon completion of the
initial public offering in 2006, all deferred initial public
offering costs were included in additional paid-in capital as a
reduction to the initial public offering proceeds.
Comprehensive
Income
Comprehensive income includes net income and all changes in the
Companys equity during a period from non-owner sources
which consists exclusively of unrealized gains and losses on
available-for-sale
marketable securities.
67
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Stock-Based
Compensation
On January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123(R), Share-based
Payment (FAS 123(R)), which requires the measurement
and recognition of compensation expense for stock-based payment
awards made to employees and directors, including employee stock
options. FAS 123(R) eliminates the ability to account for
stock-based compensation transactions using the footnote
disclosure-only provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25), and instead requires that such transactions
be recognized and reflected in the Companys consolidated
financial statements using a fair-value-based method. In March
2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 (SAB 107), relating
to FAS 123(R). The Company has applied the provisions of
SAB 107 in its adoption of FAS 123(R).
The Company adopted FAS 123(R) using the modified
prospective method, which requires the application of the
accounting standard as of January 1, 2006. The consolidated
financial statements as of and for the year ended
December 31, 2006 reflect the impact of FAS 123(R). In
accordance with the modified prospective transition method, the
Companys consolidated financial statements for the years
ended December 31, 2005 and 2004 have not been restated to
reflect, and do not include, the impact of FAS 123(R).
Prior to the adoption of FAS 123(R), the Company accounted
for stock-based awards to employees and directors using the
intrinsic value method in accordance with APB 25 as allowed
under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (FAS 123).
Under the intrinsic value method, no stock-based compensation
expense had been recognized in the Companys consolidated
statements of income because the exercise price of stock options
granted to employees and directors equaled the fair market value
of the underlying stock at the date of grant. The Company
recognized stock-based compensation of $202 in 2005, related to
a modification of the terms of specific stock options. See
Note 12 for pro forma information had compensation expense
been determined based on the fair value of options at grant
dates computed in accordance with FAS 123.
As a result of adopting FAS 123(R) on January 1, 2006,
the Companys income before income taxes and net income for
the year ended December 31, 2006 are $4,179 and $3,104
lower, respectively, than if the Company had continued to
account for stock-based compensation under APB 25. Basic
and diluted earnings per share for the year ended
December 31, 2006 are $0.26 and $0.25 lower, respectively,
than if the Company had continued to account for stock-based
compensation under APB 25.
Prior to the adoption of FAS 123(R), the Company presented
all tax benefits of deductions resulting from the exercise of
stock options as operating cash flows in the consolidated
statements of cash flows. FAS 123(R)requires the cash flows
resulting from the tax benefits resulting from tax deductions in
excess of the compensation cost recognized for those options
(excess tax benefits) to be classified as financing cash flows.
The $79 excess tax benefit classified as a financing cash inflow
for the year ended December 31, 2006 would have been
classified as an operating cash inflow if the company had not
adopted FAS 123(R).
New
Accounting Standards
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109 (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income
taxes by prescribing the recognition threshold a tax position is
required to meet before being recognized in the financial
statements. It also provides guidance on derecognition,
classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for
fiscal years beginning after December 15, 2006. The Company
is currently evaluating the effect that the adoption of
FIN 48 will have on its financial condition and results of
operations.
68
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
The following is a summary of
available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
(Losses)
|
|
|
Value
|
|
|
Auction rate
|
|
$
|
35,100
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
35,100
|
|
Corporate debt
|
|
|
29,282
|
|
|
|
6
|
|
|
|
(16
|
)
|
|
|
29,272
|
|
U.S. Agency
|
|
|
799
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
798
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
65,181
|
|
|
$
|
6
|
|
|
$
|
(17
|
)
|
|
$
|
65,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
(Losses)
|
|
|
Value
|
|
|
Auction rate
|
|
$
|
44,775
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
44,775
|
|
Corporate debt
|
|
|
8,550
|
|
|
|
2
|
|
|
|
(8
|
)
|
|
|
8,544
|
|
U.S. Agency
|
|
|
4,851
|
|
|
|
|
|
|
|
(9
|
)
|
|
|
4,842
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
58,176
|
|
|
$
|
2
|
|
|
$
|
(17
|
)
|
|
$
|
58,161
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The unrealized gains and losses on the Companys
investments in U.S. agency and corporate debt were caused
by interest rate changes. The cash flows of the agency
instruments are guaranteed by an agency of the
U.S. government while corporate securities are backed by
the issuing companys credit worthiness. It is expected
that the securities would not be settled at a price less than
the amortized cost of the Companys marketable securities
and, therefore, the Company does not consider those investments
to be
other-than-temporarily
impaired as of December 31, 2006.
The remaining contractual maturities of the Companys
marketable securities are shown below:
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Due in one year or less
|
|
$
|
13,575
|
|
|
$
|
11,382
|
|
Due in one to five years
|
|
|
8,426
|
|
|
|
2,004
|
|
Due after ten years
|
|
|
43,169
|
|
|
|
44,775
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
65,170
|
|
|
$
|
58,161
|
|
|
|
|
|
|
|
|
|
|
Included in marketable securities are certain auction rate and
corporate debt securities that contain interest rate reset dates
at regular intervals, allowing for the Company to liquidate the
marketable securities within three months throughout the term of
the contract. 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.
Gross realized gains and losses resulting from the sale of
available-for-sale
securities were $6 and $5, respectively, in 2006. Gross realized
gains and losses resulting from the sale of
available-for-sale
securities were zero in 2005 and 2004.
69
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
|
|
4.
|
Property
and Equipment
|
Property and equipment consist of the following:
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Computer software
|
|
$
|
30,871
|
|
|
$
|
18,469
|
|
Computer equipment
|
|
|
12,531
|
|
|
|
10,235
|
|
Furniture and office equipment
|
|
|
8,059
|
|
|
|
6,612
|
|
Leasehold improvements
|
|
|
1,975
|
|
|
|
1,318
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53,436
|
|
|
|
36,634
|
|
Less accumulated depreciation and
amortization
|
|
|
(24,687
|
)
|
|
|
(17,075
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
28,749
|
|
|
$
|
19,559
|
|
|
|
|
|
|
|
|
|
|
Accrued liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Accrued instructional fees
|
|
$
|
4,470
|
|
|
$
|
3,189
|
|
Accrued compensation and benefits
|
|
|
3,618
|
|
|
|
4,510
|
|
Accrued vacation
|
|
|
1,047
|
|
|
|
1,386
|
|
Customer deposits
|
|
|
1,218
|
|
|
|
1,010
|
|
Other
|
|
|
8,245
|
|
|
|
7,128
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
18,598
|
|
|
$
|
17,223
|
|
|
|
|
|
|
|
|
|
|
|
|
6.
|
Financing
Arrangements
|
The Company entered into an unsecured $10,000 line of credit in
August 2004 with Wells Fargo Bank. The line of credit has an
expiration date of June 30, 2007. Any borrowings under the
line of credit would bear interest at a rate of either LIBOR
plus 2.5% or the Banks prime rate, at the Companys
discretion on the borrowing date. There have been no borrowings
to date under the line of credit.
The Company entered into agreements in 2005 to borrow $3,595 to
finance asset purchases related to its enterprise resource
planning system. The notes were repaid in full in 2006.
|
|
7.
|
Operating
and Capital Lease Obligations
|
The Company leases its office facilities and certain office
equipment under various noncancelable lease arrangements, which
have been accounted for as operating or capital leases, as
appropriate.
70
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Future minimum lease commitments under the leases as of
December 31, 2006, are as follows:
|
|
|
|
|
|
|
|
|
|
|
Capital
|
|
|
Operating
|
|
|
2007
|
|
$
|
5
|
|
|
$
|
2,773
|
|
2008
|
|
|
5
|
|
|
|
2,803
|
|
2009
|
|
|
2
|
|
|
|
2,305
|
|
2010
|
|
|
|
|
|
|
1,864
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum payments
|
|
$
|
12
|
|
|
$
|
9,745
|
|
|
|
|
|
|
|
|
|
|
Less amount representing interest
|
|
|
|
|
|
|
|
|
Present value of net minimum
payments
|
|
|
12
|
|
|
|
|
|
Less current portion
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion of capital lease
obligations
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets under capital leases with a cost of $16 and $92 and
accumulated depreciation of $4 and $85 at December 31, 2006
and 2005, respectively, are included in computer equipment,
furniture and office equipment, and computer software (see
Note 4). Amortization of the related lease assets is
included with depreciation expense.
The Company recognizes rent expense on a straight-line basis
over the term of the lease, although the lease may include
escalation clauses that provide for lower rent payments at the
start of the lease term and higher lease payments at the end of
the lease term. Cash or lease incentives received from lessors
are recognized on a straight-line basis as a reduction to rent
from the date the Company takes possession of the property
through the end of the lease term. The Company records the
unamortized portion of the incentive as a part of deferred rent,
in accrued liabilities or long-term liabilities, as appropriate.
Total rent expense and related taxes and operating expenses
under operating leases for the years ended December 2006, 2005
and 2004 were $5,369, $5,036, and $2,940, respectively.
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.
On November 10, 2006, the Company sold 3,632 shares of
common stock and the selling shareholders sold 368 shares
of common stock in an initial public offering for $63,790 in net
cash proceeds, after deducting underwriting commission and
offering expenses of $8,853. On November 13, 2006, the
underwriters exercised their over-allotment option in full to
purchase 600 shares of common stock for $11,160 in net cash
proceeds, after deducting underwriter commission of $840. Upon
completion of the initial public offering, the Company paid a
special distribution in the amount of $72,643, which is equal to
the total gross proceeds from the sale of common stock by the
Company in the offering, not including the proceeds received by
the Company from the underwriters exercise of their
over-allotment option. The special distribution was paid on an
as if converted basis to the common, preferred, and redeemable
preferred shareholders of record as of October 3, 2006.
71
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Each class of the Companys preferred and redeemable
preferred stock was converted to common stock upon the
consummation of the initial public offering.
The Company amended its articles of incorporation, effective
upon the completion of the initial public offering, to change
the par value of its common stock from $0.10 per share to
$0.01 per share. The consolidated financial statements have
been retroactively adjusted for the change in par value.
As of December 31, 2005, including the redeemable preferred
stock in Note 11, the Company was authorized to issue
13,000 shares of preferred stock, of which
3,017 shares were available for issuance.
The Class A, Class B and Class D preferred stock
had certain voting and registration rights and had preference
over common stock upon liquidation. The Class B and
Class D shares ranked equal to each other and to the
Class E and Class G shares, and all ranked senior to
the Class A shares with respect to liquidation preference.
The holders of convertible preferred stock were entitled to
receive dividends in an amount determined by the Board of
Directors, if declared by the Board of Directors. However, in no
event would any dividend have been paid on any common shares
unless equal or greater dividends were paid on the convertible
preferred shares on an as if converted basis.
The convertible preferred stock was convertible at any time into
shares of common stock at the option of the shareholder. The
conversion price was subject to adjustments related to any stock
splits, dividends, sales of common stock, or merger of the
Company. The convertible preferred stock was converted into
common stock upon the closing of the initial public offering in
November 2006.
|
|
11.
|
Redeemable
Preferred Stock
|
The Class E and Class G redeemable convertible
preferred stock had certain voting and registration rights and
had preference over common stock upon liquidation. The
Class E and Class G shares ranked equal to each other
and to the Class B and Class D shares, and all ranked
senior to the Class A shares with respect to liquidation
preference.
The holders of redeemable convertible preferred stock were
entitled to receive dividends in an amount determined by the
Board of Directors, if declared by the Board of Directors.
However, in no event would any dividend have been paid on any
common shares unless equal or greater dividends were paid on the
redeemable convertible preferred shares on an as if converted
basis.
The redeemable convertible preferred stock was convertible at
any time into shares of common stock at the option of the
shareholder. The conversion price was subject to adjustments
related to any stock splits, dividends, sales of common stock,
or merger of the Company. The redeemable convertible preferred
stock was converted into common stock upon the closing of the
initial public offering in November 2006.
|
|
12.
|
Stock-Based
Compensation
|
The Company has three stock-based compensation plans, which are
described below. The compensation cost that has been charged
against income during the year ended December 31, 2006 for
those plans was $2,614 for service-based stock options and
$1,565 for performance-based stock options. The total income tax
benefit recognized in the statement of income for stock-based
compensation arrangements during the year ended
December 31, 2006 was $492 for service-based stock options
and $583 for performance-based stock options.
72
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Stock-based
compensation plans
During 2005, the Company implemented a stock option plan that
includes both incentive stock options and non-qualified stock
options to be granted to employees, directors, officers, and
others (the 2005 Plan). On May 25, 2006 the Board of
Directors approved a change to the Companys stock option
policy in which the Company will only issue non-qualified stock
options for future grants. At December 31, 2006, the
maximum number of shares of common stock reserved under the 2005
Plan is 3,013 shares. The Board of Directors establishes
the terms and conditions of all stock option grants, subject to
the 2005 Plan and applicable provisions of the Internal Revenue
Code (the Code). Under the 2005 Plan, options must be granted at
an exercise price not less than the fair market value of the
Companys common stock on the grant date. Prior to the
initial public offering in November 2006, the valuation used to
determine the fair market value of the Companys common
stock at each grant date was performed internally and
contemporaneously with the issuance of the options. The options
expire on the date determined by the Board of Directors but may
not extend more than ten years from the grant date for options
granted prior to August 2, 2006. On August 2, 2006 the
Board of Directors approved a change to the Companys stock
option policy to shorten the contractual term from ten years to
seven years for future grants. The options generally become
exercisable over a four-year period. Canceled options become
available for reissuance under the 2005 Plan.
The Company has also issued stock options under two discontinued
plans (the 1993 and 1999 Plans). Stock options issued pursuant
to the 1993 and 1999 Plans are still outstanding; however,
unexercised options that are canceled upon termination of
employment are not available for reissuance.
During the year ended December 31, 2006, the Company
granted performance-based stock options to purchase
255 shares of common stock in lieu of a portion of the cash
bonus under the Companys 2006 Annual Incentive Plan for
Management Employees. On December 31, 2006, 74.5% of these
stock options ultimately vested based on meeting certain
performance thresholds related to planned revenue and operating
income. The remaining 25.5% of these performance-based stock
options were canceled.
Stock-based compensation expense recognized in the
Companys consolidated statements of income during the year
ended December 31, 2006 included compensation expense for
stock-based payment awards granted prior to, but not yet vested
as of December 31, 2005, based on the grant date fair value
estimated in accordance with the pro forma provisions of
FAS 123 and compensation expense for the stock-based
payment awards granted subsequent to December 31, 2005,
based on the grant date fair value estimated in accordance with
the provisions of FAS 123(R). As stock-based compensation
expense recognized in the consolidated statements of income is
based on awards ultimately expected to vest, it has been reduced
for estimated forfeitures. FAS 123(R) requires forfeitures
to be estimated at the time of grant and revised, if necessary,
in subsequent periods if actual forfeitures differ from those
estimates. In the Companys pro forma information required
under FAS 123 for the periods prior to fiscal 2006, the
calculation of pro forma expense also reflects estimates of
forfeitures which are adjusted in subsequent periods as actual
forfeitures differ from the original estimates.
The Companys determination of fair value of stock-based
payment awards on the date of grant using an option-pricing
model is affected by the Companys stock price as well as
assumptions regarding a number of highly complex and subjective
variables. These variables include, but are not limited to the
Companys expected stock price volatility over the term of
the awards and actual and projected employee stock option
exercise behaviors.
73
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
Option activity is summarized as follows, in thousands except
per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Plan Options
|
|
|
Average
|
|
|
|
Available
|
|
|
Outstanding
|
|
|
Exercise Price
|
|
Service-based Stock Options
|
|
for Grant
|
|
|
Incentive
|
|
|
Non-Qualified
|
|
|
per Share
|
|
|
Balance, December 31, 2005
|
|
|
1,318
|
|
|
|
1,120
|
|
|
|
594
|
|
|
$
|
14.67
|
|
Granted
|
|
|
(573
|
)
|
|
|
107
|
|
|
|
466
|
|
|
|
20.00
|
|
Exercised
|
|
|
|
|
|
|
(119
|
)
|
|
|
(3
|
)
|
|
|
10.25
|
|
Canceled
|
|
|
23
|
|
|
|
(130
|
)
|
|
|
(47
|
)
|
|
|
14.56
|
|
Shares reserved for issuance
|
|
|
1,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2006(a)
|
|
|
2,168
|
|
|
|
978
|
|
|
|
1,010
|
|
|
|
16.46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The total available for grant, including the 190 outstanding
performance-based stock options, was 1,978. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
Service-based Stock Options
|
|
Shares
|
|
|
Price
|
|
|
Term
|
|
|
Value
|
|
|
Balance at December 31, 2006
|
|
|
1,988
|
|
|
$
|
16.46
|
|
|
|
6.8
|
|
|
$
|
15,500
|
|
Vested and expected to vest,
December 31, 2006
|
|
|
1,908
|
|
|
$
|
16.32
|
|
|
|
6.7
|
|
|
$
|
15,125
|
|
Exercisable, December 31, 2006
|
|
|
1,033
|
|
|
$
|
13.94
|
|
|
|
5.6
|
|
|
$
|
10,652
|
|
The aggregate intrinsic value in the table above represents the
total pre-tax intrinsic value (the difference between the
Companys closing stock price on the last day of the year
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 December 31,
2006. The amount of aggregate intrinsic value will change based
on the fair market value of the Companys stock.
During the year ended December 31, 2006, the Company
granted performance-based stock options to purchase
255 shares of common stock at a weighted-average exercise
price per share of $20.00 and with a weighted-average remaining
contractual life of 9.1 years. The aggregate intrinsic
value of these options was $809 at December 31, 2006. At
December 31, 2006, 74.5% of these performance-based stock
options vested and were exercisable based on meeting certain
performance thresholds related to planned revenue and income
before income taxes. The remaining 25.5% of these
performance-based stock options were canceled.
The following table summarizes information regarding all stock
option exercises for the year ended December 31, 2006 (in
thousands):
|
|
|
|
|
Proceeds from stock options
exercised
|
|
$
|
798
|
|
Tax benefits related to stock
options exercised
|
|
|
166
|
|
Intrinsic value of stock options
exercised
|
|
|
1,357
|
|
Intrinsic value of stock options exercised is estimated by
taking the difference between the Companys 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.
74
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
The table below reflects our stock-based compensation expense
recognized in the consolidated statements of income for the year
ended December 31, 2006 (in thousands):
|
|
|
|
|
Instructional costs and services
|
|
$
|
748
|
|
Selling and promotional
|
|
|
357
|
|
General and administrative
|
|
|
3,074
|
|
|
|
|
|
|
Stock-based compensation expense
included in operating income
|
|
|
4,179
|
|
Tax benefit
|
|
|
1,075
|
|
|
|
|
|
|
Stock-based compensation expense,
net of tax
|
|
$
|
3,104
|
|
|
|
|
|
|
As of December 31, 2006, total compensation cost related to
nonvested service-based stock options not yet recognized was
$6,710, which is expected to be recognized over the next
32 months on a weighted-average basis.
Prior to January 1, 2006, had compensation expense been
determined based on the fair value of the options at grant dates
computed in accordance with FAS 123, the pro forma amounts
would be as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
Net income
|
|
$
|
10,250
|
|
|
$
|
18,785
|
|
Stock-based compensation expense
included in net income as reported
|
|
|
202
|
|
|
|
4
|
|
Compensation expense determined
under fair- value-based method, net of tax
|
|
|
(1,966
|
)
|
|
|
(2,154
|
)
|
|
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$
|
8,486
|
|
|
$
|
16,635
|
|
|
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
Basic as reported
|
|
$
|
0.89
|
|
|
$
|
1.68
|
|
Basic pro forma
|
|
$
|
0.74
|
|
|
$
|
1.49
|
|
Diluted as reported
|
|
$
|
0.86
|
|
|
$
|
1.62
|
|
Diluted pro forma
|
|
$
|
0.71
|
|
|
$
|
1.45
|
|
The fair value of our service-based stock options was estimated
as of the date of grant using the Black-Scholes option pricing
model with the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
2006
|
|
|
(Pro Forma)
|
|
|
(Pro Forma)
|
|
|
Expected life (in
years)(1)
|
|
|
4.25-6.25
|
|
|
|
6.0
|
|
|
|
6.0
|
|
Expected
volatility(2)
|
|
|
45.6
|
%
|
|
|
38.5
|
%
|
|
|
44.1
|
%
|
Risk-free interest
rate(3)
|
|
|
4.4-5.1
|
%
|
|
|
3.9-4.4
|
%
|
|
|
3.9
|
%
|
Dividend
yield(4)
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Weighted-average fair value of
options granted
|
|
$
|
9.84
|
|
|
$
|
8.87
|
|
|
$
|
8.54
|
|
|
|
|
(1) |
|
For the year ended December 31, 2006, the expected option
life was determined using the simplified method for estimating
expected option life for service-based stock options. Prior to
the year ended December 31, 2006, the expected option life
was based on the average expected option life experienced by our
peer group of post-secondary education companies. |
|
(2) |
|
As the Companys stock had not been publicly traded prior
to November 2006, the expected volatility assumption for the
year ended December 31, 2006 reflects a detailed evaluation
of the stock price of its |
75
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
|
|
|
|
|
peer group of public post-secondary education companies for a
period equal to the expected life of the options, starting from
the date they went public. Prior to the year ended
December 31, 2006 the expected volatility assumption
reflects the public disclosures of the Companys peer group
of post-secondary education companies. |
|
(3) |
|
The risk-free interest rate assumption is based upon the
U.S. Treasury zero coupon yield curve on the grant date for
a maturity similar to the expected life of the options. |
|
(4) |
|
The dividend yield assumption is based on the Companys
history and expectation of regular dividend payments. |
The assumptions discussed above were also used to value the
performance-based stock options granted during the year ended
December 31, 2006 except for the expected life, which was
four years. The expected option life for performance-based stock
options was determined based on the evaluation of certain
qualitative factors including the Companys historical
experience and the Companys competitors historical
experience. The weighted-average fair value of performance-based
stock options granted was $8.22.
In June 1998, the Company issued warrants to purchase
5 shares of common stock at $4.50 per share to an
officer of the Company for personally guaranteeing a note. These
warrants were exercised during 2005. The estimated fair value
assigned to these warrants was deemed to be immaterial.
In addition, in 1998, the Company issued warrants to purchase 10
and 131 shares of common stock at $4.50 and $5.40 per
share, respectively, in connection with the issuance of the
Class D Convertible Preferred Stock. During 2005, 131
warrants were exercised and the remaining 10 warrants expired.
In May 2000, the Company issued warrants to purchase
135 shares of common stock at $17.10 per share in
connection with the issuance of the Class E Redeemable
Convertible Preferred Stock. These warrants were exercised
during 2005.
The Company has deferred tax assets and liabilities that reflect
the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Deferred tax assets are subject to periodic recoverability
assessments. Realization of the deferred tax assets, net of
deferred tax liabilities is principally dependent upon
achievement of projected future taxable income. Given the
uncertainty of future taxable income, the Company had provided a
valuation allowance for all net deferred tax assets for all
periods prior to 2004. Because the Company achieved three years
of cumulative taxable income in 2004 and expected profitability
in future years, the Company concluded in 2004 that it is more
likely than not that all of its net deferred tax assets will be
realized. As a result, in accordance with FAS 109, the
valuation allowance applied to such net deferred tax assets of
$12,863 at December 31, 2003, was reversed during the year
ended December 31, 2004.
At December 31, 2006, the Company had a net operating loss
carryforward of approximately $4,379 for state income tax
purposes that is available to offset future taxable income. The
net operating loss carryforwards expire at various dates through
2022. The Companys current federal tax provisions in 2005
and 2004 represent recognition of alternative minimum tax due
for the respective periods.
76
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
The components of income tax expense (benefit) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
5,670
|
|
|
$
|
345
|
|
|
$
|
187
|
|
State
|
|
|
312
|
|
|
|
381
|
|
|
|
62
|
|
Deferred
|
|
|
2,922
|
|
|
|
6,203
|
|
|
|
(8,445
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
8,904
|
|
|
$
|
6,929
|
|
|
$
|
(8,196
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A reconciliation of income tax computed at the
U.S. statutory rate to the effective income tax rate is as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Statutory rate
|
|
|
35.0
|
%
|
|
|
35.0
|
%
|
|
|
35.0
|
%
|
State income taxes
|
|
|
2.6
|
|
|
|
2.6
|
|
|
|
3.5
|
|
FAS 123R expense related to
incentive stock options
|
|
|
2.0
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
0.3
|
|
|
|
2.7
|
|
|
|
2.0
|
|
Change in rate applied to deferred
tax assets and liabilities
|
|
|
|
|
|
|
|
|
|
|
3.6
|
|
Change in valuation allowance
|
|
|
|
|
|
|
|
|
|
|
(121.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
39.9
|
%
|
|
|
40.3
|
%
|
|
|
(77.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Significant components of the Companys deferred income tax
assets and liabilities as of December 31, 2006 and 2005,
are as follows:
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
179
|
|
|
$
|
1,878
|
|
Accounts receivable
|
|
|
419
|
|
|
|
489
|
|
Alternative minimum tax credit
|
|
|
87
|
|
|
|
646
|
|
Goodwill
|
|
|
75
|
|
|
|
89
|
|
Accrued liabilities
|
|
|
2,179
|
|
|
|
1,810
|
|
Nonqualified stock options
|
|
|
1,075
|
|
|
|
|
|
Other
|
|
|
3
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,017
|
|
|
|
4,917
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(4,548
|
)
|
|
|
(2,525
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,548
|
)
|
|
|
(2,525
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset (liability)
|
|
$
|
(531
|
)
|
|
$
|
2,392
|
|
|
|
|
|
|
|
|
|
|
The Company adjusted the federal and state income tax rates used
to record its net deferred tax assets in 2004 based upon an
updated evaluation of the income tax benefits that will likely
exist when the net deferred tax assets are realized on future
tax returns. During 2006 and 2005, the Company also recorded tax
benefits of
77
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
approximately $166 and $10 directly to additional paid-in
capital related to the exercise of non-qualified stock options
and disqualifying dispositions of incentive stock options.
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 DOEs 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 (the OIG) of the Department of
Education has informed the Company that it is conducting a
compliance audit of the University. The OIG is responsible for,
among other things, promoting the effectiveness and integrity of
the Department of Educations programs and operations. The
audit commenced on April 10, 2006 and since then the
Company has been periodically providing the OIG with
information, responding to follow up inquiries and facilitating
site visits and access to the Companys records. The OIG
completed its field work in January 2007 and the Company expects
to receive a draft report sometime in 2007. Based on the field
auditors preliminary audit exceptions, which is a
preliminary list of issues regarding Capella Universitys
compliance with Title IV rules and requirements, and our
verbal communications with the OIG audit staff, the Company
believes that 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
Company did not properly calculate the amount of Title IV
funds required to be returned for learners that withdrew from
Capella University without providing an official notification of
such withdrawal and without engaging in academic activity prior
to such withdrawal. If it is determined that we improperly
withheld any portion of these funds, we would be required to
return the improperly withheld funds. For the three year audit
period, and for the
2005-2006
aid year, we estimate that the total amount of Title IV
funds not returned for learners who withdrew without providing
official notification was less than $1.0 million, including
interest, but not including fines and penalties.
Political and budgetary concerns significantly affect the
Title IV Programs. Congress reauthorizes the HEA and other
laws governing Title IV Programs approximately every five
to eight years. The last reauthorization of the HEA was
completed in 1998. Although the process for reauthorization of
the HEA is underway, there is no assurance on when or if it will
be completed. Because reauthorization has not yet been completed
in a timely manner, Congress has extended the current provisions
of the HEA through June 30, 2007. Additionally, Congress
reviews and determines appropriations for Title IV programs
on an annual basis through the budget and appropriations
processes. As of December 31, 2006, programs in which the
Companys learners participate are operative and
sufficiently funded.
As an exclusively online university, the 50% Rule,
enacted in 1992, would preclude the Companys learners from
participating in Title IV programs. However, the 50% Rule
was repealed (effective July 1, 2006) as part of the
Higher Education Reconciliation Act, which was part of the
Deficit Reduction Act signed into law by President Bush on
February 8, 2006. The Deficit Reduction Act is currently
being challenged in
78
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
court by private plaintiffs alleging that the act is invalid due
to discrepancies between non-education related provisions of the
House and Senate bills. Although the legal challenges do not
relate to the 50% Rule, an invalidation of the Deficit Reduction
Act could reinstate the provisions of the 50% Rule. Therefore,
should the plaintiffs prevail in the pending litigation, the
Company may need to find alternative ways of either qualifying
for Title IV or providing alternative student financing
vehicles.
|
|
16.
|
Other
Employee Benefit Plans
|
The Company sponsors an employee retirement savings plan, which
qualifies under Section 401(k) of the Internal Revenue Code
(the Code). The plan provides eligible employees with an
opportunity to make tax-deferred contributions into a long-term
investment and savings program. All employees over the age of 18
are eligible to participate in the plan. The plan allows
eligible employees to contribute up to 100% of their annual
compensation. Contributions are subject to certain limitations.
The plan allows the Company to consider making a discretionary
contribution; however, there is no requirement that it do so.
Effective July 1, 2006, the Company elected to match 100%
on the first 2%, and 50% on the next 4%, of the employee
contributions. No employer contributions were made for the year
ended December 31, 2004. Effective April 1, 2005, the
Company elected to match 50% on the first 4% of the employee
contributions. Employer contributions and related expense were
$1,467 and $689 for the years ended December 31, 2006 and
2005, respectively.
In 1999, the Company adopted a qualified ESOP in which the
Company may contribute to its employees, at its discretion,
common stock of the Company. Historically, the Company has
chosen to contribute 3% of employee compensation on an annual
basis. During the year ended December 31, 2006, the Company
elected to contribute common stock with a value equal to 1% of
employee compensation for the six months ended June 30,
2006. Shares related to 2006 compensation expense will be
contributed in 2007. During 2006, the Company contributed
62 shares to the plan related to 2005 compensation expense.
During 2005, the Company contributed 46 shares to the plan
related to 2004 compensation expense. During 2004, the Company
contributed 47 shares to the plan related to 2003
compensation expense. Contributions vest over three years,
except in the event of retirement, disability, or death, in
which case the participants shares become fully vested and
nonforfeitable. Prior to the initial public offering in November
2006, the Company had an obligation to repurchase, at fair
market value determined by annual independent valuation, the
allocated shares in the above events, as the shares were not
readily tradable on an established securities market. The
Company recognized $169, $1,209 and $1,131 of compensation
expense in 2006, 2005 and 2004, respectively, related to the
ESOP contributions.
Upon completion of the Companys initial public offering in
November 2006, the Company paid a special distribution in the
amount of $72,643 to its shareholders, including the
Companys ESOP. The ESOP purchased shares of the
Companys common stock with the portion of the special
distribution allocated to nonvested participants in the ESOP.
Vested participants in the ESOP were given the right to elect to
receive a cash payment of a portion of the special distribution
allocated to their ESOP account. The ESOP purchased shares of
the Companys common stock in the open market with the
remaining amounts it received from the special distribution. The
total number of shares purchased by the ESOP with proceeds from
the special distribution was 48 shares.
In May 2005, the Company adopted the Capella Education Company
Employee Stock Purchase Plan, referred to as the ESPP. The
Company has reserved an aggregate of 450 shares of its
common stock for issuance under the ESPP. The ESPP permits
eligible employees to utilize up to 10% of their compensation to
purchase the Companys common stock at price of no less
than 85% of the fair market value per share of the
Companys common stock at the beginning or the end of the
relevant offering period, whichever is less. The compensation
committee of the Board of Directors will administer the ESPP.
The Company had not implemented this plan as of
December 31, 2006.
79
CAPELLA
EDUCATION COMPANY
Notes to
Consolidated Financial
Statements (Continued)
|
|
17.
|
Quarterly
Financial Summary (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Total
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
41,858
|
|
|
$
|
43,518
|
|
|
$
|
43,902
|
|
|
$
|
50,603
|
|
|
$
|
179,881
|
|
Operating income
|
|
|
1,884
|
|
|
|
4,203
|
|
|
|
4,063
|
|
|
|
7,693
|
|
|
|
17,843
|
|
Net income
|
|
|
1,642
|
|
|
|
3,055
|
|
|
|
3,041
|
|
|
|
5,673
|
|
|
|
13,411
|
|
Net income per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.14
|
|
|
$
|
0.26
|
|
|
$
|
0.26
|
|
|
$
|
0.40
|
|
|
$
|
1.09
|
|
Diluted
|
|
$
|
0.14
|
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
$
|
0.39
|
|
|
$
|
1.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Total
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
34,610
|
|
|
$
|
35,408
|
|
|
$
|
37,303
|
|
|
$
|
41,919
|
|
|
$
|
149,240
|
|
Operating income
|
|
|
4,145
|
|
|
|
3,523
|
|
|
|
2,925
|
|
|
|
4,280
|
|
|
|
14,873
|
|
Net income
|
|
|
2,705
|
|
|
|
2,356
|
|
|
|
2,204
|
|
|
|
2,985
|
|
|
|
10,250
|
|
Net income per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.24
|
|
|
$
|
0.21
|
|
|
$
|
0.19
|
|
|
$
|
0.26
|
|
|
$
|
0.89
|
|
Diluted
|
|
$
|
0.23
|
|
|
$
|
0.20
|
|
|
$
|
0.18
|
|
|
$
|
0.25
|
|
|
$
|
0.86
|
|
80
|
|
Item 9.
|
Changes
in and Disagreements With Accountants on Accounting and
Financial Disclosure
|
None.
|
|
Item 9A.
|
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
companys disclosure controls and procedures are effective,
as of December 31, 2006, in ensuring that material
information relating to us required to be disclosed by us in
reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time
periods specified in the SEC rules and forms. Disclosure
controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to
be disclosed by an issuer in reports it files or submits under
the Securities Exchange Act is accumulated and communicated to
management, including its principal executive officer or
officers and principal financial officer or officers, or persons
performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.
Changes
in internal control over financial reporting.
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.
|
|
Item 9B.
|
Other
Information
|
None.
PART III
Certain information required by Part III is incorporated by
reference from our definitive Proxy Statement for the our 2007
Annual Meeting of Shareholders (the Proxy
Statement), which will be filed with the SEC pursuant to
Regulation 14A within 120 days after December 31,
2006. Except for those portions specifically incorporated in
this
Form 10-K
by reference to our Proxy Statement, no other portions of the
Proxy Statement are deemed to be filed as part of this
Form 10-K.
|
|
Item 10.
|
Directors,
Executive Officers, and Corporate Governance
|
Incorporated into this item by reference is the information
under Election of Directors Directors and
Director Nominees, Election of Directors
Committees of Our Board of Directors, Election of
Directors Code of Business Conduct and
Section 16(a) Beneficial Ownership Reporting
Compliance in our Proxy Statement. Information regarding
our executive officers required by this item is set forth in
Part I of this Annual Report on
Form 10-K.
|
|
Item 11.
|
Executive
Compensation
|
Incorporated into this item by reference is the information
under Election of Directors Compensation
Committee Interlocks and Insider Participation and
Executive Compensation in our Proxy Statement.
81
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
Incorporated into this item by reference is the information
under Equity Compensation Plan Information and
Security Ownership of Certain Beneficial Owners and
Management in our Proxy Statement.
|
|
Item 13.
|
Certain
Relationships and Related Party Transactions, and Director
Independence
|
Incorporated into this item by reference is the information
under Certain Relationships and Related Party
Transactions and Election of Directors
Director Independence in our Proxy Statement.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
Incorporated into this item by reference is the information
under Ratification of Independent Public Accounting
Firm Fees and Ratification of
Independent Public Accounting Firm Approval of
independent Registered Public Accounting Firm Services and
Fees and in our Proxy Statement.
PART IV
|
|
Item 15.
|
Exhibits
and Financial Statement Schedule
|
(a) Documents filed as Part of this Annual Report on
Form 10-K:
1. Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the years ended
December 31, 2006, 2005 and 2004
Consolidated Statement of Shareholders Equity (Deficit)
for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
2. Financial Statement Schedule:
Schedule II Valuation and Qualifying Accounts
Other schedules are omitted because they are not required.
(b) Exhibits
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
3
|
.1
|
|
Amended and Restated Articles of
Incorporation.
|
|
Incorporated by reference to
Exhibit 3.1 to the Companys Current Report on
Form 8-K
filed with the SEC on November 11, 2006.
|
|
3
|
.2
|
|
Amended and Restated By-Laws.
|
|
Incorporated by reference to
Exhibit 3.4 to Amendment No. 3 to the Companys
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 Companys
Registration Statement on
Form S-1
filed with the SEC on October 19, 2006.
|
82
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
4
|
.2
|
|
Third Amended and Restated Co-Sale
and Board Representation Agreement, dated as of January 22,
2003, by and among the Registrant and the shareholders named
therein.
|
|
Incorporated by reference to
Exhibit 4.2 to the Companys Registration Statement on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.3
|
|
Second Amended and Restated
Investor Rights Agreement, dated as of January 22, 2003, by
and among the Registrant and the shareholders named therein.
|
|
Incorporated by reference to
Exhibit 4.7 to the Companys Registration Statement on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.4
|
|
Warrant, dated as of June 16,
1998, issued by the Registrant to Legg Mason Wood Walker,
Incorporated.
|
|
Incorporated by reference to
Exhibit 4.8 to the Companys Registration Statement on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.5
|
|
Amendment No. 1 to Warrant,
dated as of April 20, 2000, by and between the Registrant
and Legg Mason Wood Walker, Incorporated.
|
|
Incorporated by reference to
Exhibit 4.9 to the Companys Registration Statement on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.6
|
|
Amendment No. 2 to Warrant,
dated as of February 21, 2002, by and between the
Registrant and Legg Mason Wood Walker, Incorporated.
|
|
Incorporated by reference to
Exhibit 4.10 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.7
|
|
Amendment No. 3 to Warrant,
dated as of January 22, 2003, by and between the Registrant
and Legg Mason Wood Walker, Incorporated.
|
|
Incorporated by reference to
Exhibit 4.11 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.8
|
|
Warrant, dated as of May 11,
2000, issued by the Registrant to Legg Mason Wood Walker,
Incorporated.
|
|
Incorporated by reference to
Exhibit 4.12 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.9
|
|
Amendment No. 1 to Warrant,
dated as of February 21, 2002, by and between the
Registrant and Legg Mason Wood Walker, Incorporated.
|
|
Incorporated by reference to
Exhibit 4.13 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.10
|
|
Amendment No. 2 to Warrant,
dated as of January 22, 2003, by and between the Registrant
and Legg Mason Wood Walker, Incorporated.
|
|
Incorporated by reference to
Exhibit 4.14 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.11
|
|
Exchange Agreement, dated as of
January 22, 2003, by and among the Registrant and the
shareholders named therein.
|
|
Incorporated by reference to
Exhibit 4.15 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.12
|
|
Class F Convertible Preferred
Stock Purchase Agreement, dated as of January 31, 2002, by
and among the Registrant and the shareholders named therein.
|
|
Incorporated by reference to
Exhibit 4.17 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
4
|
.13
|
|
Class E Convertible Preferred
Stock Purchase Agreement, dated as of April 20, 2000, by
and among the Registrant and the shareholders named therein.
|
|
Incorporated by reference to
Exhibit 4.18 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.1*
|
|
Capella Education Company 2005
Stock Incentive Plan.
|
|
Incorporated by reference to
Exhibit 10.1 to Amendment No. 1 to the Companys
Registration Statement on
Form S-1
filed with the SEC on June 3, 2005.
|
|
10
|
.2*
|
|
Forms of Option Agreements for the
Capella Education Company 2005 Stock Incentive Plan.
|
|
Incorporated by reference to
Exhibit 10.2 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.3*
|
|
Capella Education Company 1999
Stock Option Plan, as amended.
|
|
Incorporated by reference to
Exhibit 10.3 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
83
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
10
|
.4*
|
|
Form of Non-Statutory Stock Option
Agreement (Director) for the Capella Education Company 1999
Stock Option Plan.
|
|
Incorporated by reference to
Exhibit 10.4 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.5*
|
|
Form of Non-Statutory Stock Option
Agreement (Employee) for the Capella Education Company 1999
Stock Option Plan.
|
|
Incorporated by reference to
Exhibit 10.5 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.6*
|
|
Form of Incentive Stock Option
Agreement for the Capella Education Company 1999 Stock Option
Plan.
|
|
Incorporated by reference to
Exhibit 10.6 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.7*
|
|
Learning Ventures International,
Inc. 1993 Stock Option Plan, as amended.
|
|
Incorporated by reference to
Exhibit 10.7 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.8*
|
|
Form of Option Agreement for the
Learning Ventures International, Inc. 1993 Stock Option Plan.
|
|
Incorporated by reference to
Exhibit 10.8 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.9*
|
|
Capella Education Company Employee
Stock Ownership Plan and the First Amendment thereto.
|
|
Incorporated by reference to
Exhibit 10.9 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.10*
|
|
Capella Education Company
Retirement Plan with Adoption Agreement and EGTRRA Amendment.
|
|
Incorporated by reference to
Exhibit 10.10 to Amendment No. 1 to the Companys
Registration Statement on
Form S-1
filed with the SEC on June 3, 2005.
|
|
10
|
.11*
|
|
Capella Education Company
Executive Severance Plan.
|
|
Incorporated by reference to
Exhibit 10.11 to Amendment No. 3 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 6, 2006.
|
|
10
|
.12*
|
|
Capella Education Company Employee
Stock Purchase Plan.
|
|
Incorporated by reference to
Exhibit 10.12 to Amendment No. 1 to the Companys
Registration Statement on
Form S-1
filed with the SEC on June 3, 2005.
|
|
10
|
.13*
|
|
Confidentiality, Non-Competition
and Inventions Agreement, dated as of April 16, 2001, by
and between the Registrant and Michael J. Offerman.
|
|
Incorporated by reference to
Exhibit 10.14 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.14*
|
|
Confidentiality, Non-Competition
and Inventions Agreement, dated as of May 9, 2001, by and
between the Registrant and Paul A. Schroeder.
|
|
Incorporated by reference to
Exhibit 10.15 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.15*
|
|
Form of Confidentiality,
Non-Competition and Inventions Agreement (executed by Scott M.
Henkel).
|
|
Incorporated by reference to
Exhibit 10.16 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.16*
|
|
Offer Letter, dated as of
March 9, 2001, by and between the Registrant and Paul A.
Schroeder.
|
|
Incorporated by reference to
Exhibit 10.17 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.17*
|
|
Offer Letter, dated as of
November 10, 2003, by and between the Registrant and
Michael J. Offerman.
|
|
Incorporated by reference to
Exhibit 10.18 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.18*
|
|
Offer Letter, dated as of
December 22, 2003, by and between the Registrant and Scott
M. Henkel.
|
|
Incorporated by reference to
Exhibit 10.19 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
84
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
10
|
.19*
|
|
Form of Nondisclosure Agreement
(executed by Scott M. Henkel, Paul A. Schroeder, Stephen G.
Shank, Michael J. Offerman and Lois M. Martin).
|
|
Incorporated by reference to
Exhibit 10.21 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.20
|
|
Office Lease, dated as of
February 23, 2004, by and between the Registrant and 601
Second Avenue Limited Partnership.
|
|
Incorporated by reference to
Exhibit 10.22 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.21
|
|
Short Term Office Space Lease,
dated as of February 23, 2004, by and between the
Registrant and 601 Second Avenue Limited Partnership.
|
|
Incorporated by reference to
Exhibit 10.23 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.22
|
|
Memorandum of Lease, dated as of
March 10, 2004, by and between the Registrant and 601
Second Avenue Limited Partnership.
|
|
Incorporated by reference to
Exhibit 10.24 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.23
|
|
Office Lease, dated as of
June 28, 2000, as amended, by and between the Registrant
and 222 South Ninth Street Limited Partnership and ND
Properties, Inc. as successor in interest to 222 South Ninth
Street Limited Partnership.
|
|
Incorporated by reference to
Exhibit 10.25 to the Companys Registration Statement
on
Form S-1
filed with the SEC on April 18, 2005.
|
|
10
|
.24*
|
|
Capella Education Company Annual
Incentive Plan for Management Employees 2006.
|
|
Incorporated by reference to
Exhibit 10.26 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.25*
|
|
Form of Performance Vesting Option
Agreement (Annual Incentive Plan for Management
Employees 2006) for the Capella Education Company
2005 Stock Incentive Plan.
|
|
Incorporated by reference to
Exhibit 10.27 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.26*
|
|
Offer Letter, dated
October 20, 2004, by and between the Registrant and Lois M.
Martin.
|
|
Incorporated by reference to
Exhibit 10.28 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.27*
|
|
Offer Letter, dated
February 21, 2006, by and between the Registrant and
Kenneth J. Sobaski.
|
|
Incorporated by reference to
Exhibit 10.29 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.28*
|
|
Confidentiality, Non-Competition
and Inventions Agreement dated as of February 27, 2006, by
and between the Registrant and Kenneth J. Sobaski.
|
|
Incorporated by reference to
Exhibit 10.30 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.29*
|
|
Offer Letter, dated June 6,
2006, by and between the Registrant and Reed Watson.
|
|
Incorporated by reference to
Exhibit 10.31 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.30*
|
|
Confidentiality, Non-Competition
and Inventions Agreement dated as of June 20, 2006, by and
between the Registrant and Reed Watson.
|
|
Incorporated by reference to
Exhibit 10.32 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.31*
|
|
Employment Agreement dated
May 30, 2006 between Capella Education Company and Michael
J. Offerman.
|
|
Incorporated by reference to
Exhibit 10.33 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
85
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
10
|
.32*
|
|
Amendment to Confidentiality,
Non-Competition and Inventions Agreement, dated June 16,
2005, by and between the Registrant and Michael J. Offerman.
|
|
Incorporated by reference to
Exhibit 10.34 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.33*
|
|
Employment Agreement dated
May 30, 2006 between Capella Education Company and Paul A.
Schroeder.
|
|
Incorporated by reference to
Exhibit 10.35 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.34
|
|
First Amendment to Lease, dated as
of May 16, 2006, by and between the Registrant and 601
Second Avenue Limited Partnership.
|
|
Incorporated by reference to
Exhibit 10.36 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.35
|
|
Letter Agreement, dated
July 5, 2006, between the Registrant and ASB Minneapolis
225 Holdings, LLC
|
|
Incorporated by reference to
Exhibit 10.37 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.36
|
|
Amendment No. 3 to Lease
Agreement, dated as of June 16, 2005, by and between the
Registrant and ND Properties, Inc. and ND Properties of
Delaware, Inc.
|
|
Incorporated by reference to
Exhibit 10.38 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.37*
|
|
Amendments to Capella Education
Company Retirement Plan dated as of April 20, 2006 and
June 1, 2006.
|
|
Incorporated by reference to
Exhibit 10.39 to Amendment No. 2 to the Companys
Registration Statement on
Form S-1
filed with the SEC on August 29, 2006.
|
|
10
|
.38*
|
|
Amendment 1 to Employment
Agreement dated August 25, 2006 between Paul A. Schroeder
and Capella Education Company
|
|
Incorporated by reference to
Exhibit 10.40 to Amendment No. 3 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 6, 2006.
|
|
10
|
.39*
|
|
Amendment 1 to Employment
Agreement dated August 25, 2006 between Michael J. Offerman
and Capella Education Company
|
|
Incorporated by reference to
Exhibit 10.41 to Amendment No. 3 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 6, 2006.
|
|
10
|
.40*
|
|
Amendment No. 1 to Capella
Education Company 2005 Stock Incentive Plan.
|
|
Incorporated by reference to
Exhibit 10.42 to Amendment No. 3 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 6, 2006.
|
|
10
|
.41*
|
|
Capella Education Company Senior
Executive Severance Plan.
|
|
Incorporated by reference to
Exhibit 10.43 to Amendment No. 3 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 6, 2006.
|
|
10
|
.42*
|
|
Second Amendment to the Capella
Education Company Employee Stock Ownership Plan.
|
|
Incorporated by reference to
Exhibit 10.44 to Amendment No. 5 to the Companys
Registration Statement on
Form S-1
filed with the SEC on October 27, 2006.
|
|
10
|
.43*
|
|
Annual Incentive Plan
Management Employees 2007
|
|
Incorporated by reference to
Exhibit 10.1 to the Companys Current Report on
Form 8-K
filed with the SEC on February 15, 2007.
|
|
21
|
|
|
Subsidiaries of the Registrant.
|
|
Filed electronically.
|
|
23
|
|
|
Consent of Ernst & Young
LLP.
|
|
Filed electronically.
|
|
24
|
|
|
Powers of Attorney.
|
|
Filed electronically.
|
86
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Method of Filing
|
|
|
31
|
.1
|
|
Certification of the Chief
Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
Filed electronically.
|
|
31
|
.2
|
|
Certification of the 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. |
87
CAPELLA
EDUCATION COMPANY
Schedule II
Valuation and Qualifying Accounts
Fiscal
Years 2006, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
Beginning
|
|
|
Charged to
|
|
|
|
|
|
Ending
|
|
|
|
Balance
|
|
|
Expense
|
|
|
Deductions
|
|
|
Balance
|
|
|
|
(In thousands)
|
|
|
Allowance accounts for the
years ended:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
Allowance for doubtful accounts
|
|
$
|
1,299
|
|
|
$
|
2,855
|
|
|
$
|
(3,035
|
)(a)
|
|
$
|
1,119
|
|
December 31, 2005
Allowance for doubtful accounts
|
|
|
1,065
|
|
|
|
2,263
|
|
|
|
(2,029
|
)(a)
|
|
|
1,299
|
|
December 31, 2004
Allowance for doubtful accounts
|
|
|
713
|
|
|
|
1,376
|
|
|
|
(1,024
|
)(a)
|
|
|
1,065
|
|
Deferred tax asset valuation
allowance
|
|
|
12,863
|
|
|
|
|
|
|
|
(12,863
|
)(b)
|
|
|
|
|
|
|
|
(a) |
|
Write-off of accounts receivables. |
|
(b) |
|
Reversal of deferred tax valuation allowance as a result of
achieving three years of cumulative taxable income in 2004 along
with expectations of future profitability. |
88
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
Lois M. Martin
Senior Vice President and Chief
Financial Officer
Date: March 5, 2007
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
|
|
Signatures
|
|
Title
|
|
Date
|
|
/s/ Stephen
G. Shank*
Stephen
G. Shank
|
|
Chairman and Chief Executive
Officer
(Principal Executive Officer)
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Lois
M. Martin
Lois
M. Martin
|
|
Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Amy
L. Drifka*
Amy
L. Drifka
|
|
Vice President and Controller
(Principal Accounting Officer)
|
|
March 5, 2007
|
|
|
|
|
|
/s/ S.
Joshua
Lewis*
S.
Joshua Lewis
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ James
A. Mitchell*
James
A. Mitchell
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ David
W. Smith*
David
W. Smith
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Gordon
A. Holmes*
Gordon
A. Holmes
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Jody
G. Miller*
Jody
G. Miller
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Jeffrey
W. Taylor*
Jeffrey
W. Taylor
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Darrell
R. Tukua*
Darrell
R. Tukua
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Jon
Q.
Reynolds, Jr.*
Jon
Q. Reynolds, Jr.
|
|
Director
|
|
March 5, 2007
|
|
|
|
|
|
/s/ Sandra
E. Taylor*
Sandra
E. Taylor
|
|
Director
|
|
March 5, 2007
|
|
|
* |
Lois M. Martin, by signing her name hereto, does hereby sign
this document on behalf of each of the above-named officers
and/or directors of the Registrant pursuant to powers of
attorney duly executed by such persons.
|
Lois M. Martin
Attorney-in-Fact
89