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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM 10-Q/A

(Amendment No.
1)



(Mark One)



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended June 30, 2003



Or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



Commission File Number 000-24289



CLICK2LEARN, INC.

(Exact name of
registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 91-1276003                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|110-110thAvenue NE, Bellevue,
Washington                       |  | 98004                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(425) 462-0501

(Registrants telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ̈No x



The number of shares outstanding of the issuers Common Stock, par value $0.01, as of July 15, 2003 was 32,397,808 shares.



Explanatory Note



We are filing this Amendment No. 1 to our Quarterly Report on Form 10-Q in response to comments received by us from the Staff of the Securities and
Exchange Commission. Unless otherwise stated, all information contained in the amendment is as of August 12, 2003, the filing date of our original Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2003. This amendment does not
change previously reported financial statements.



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##### Table of Contents

CLICK2LEARN, INC.



FORM 10 Q



For the Quarter Ended June 30, 2003



TABLE OF CONTENTS



|                               |  |                                                                                                             |  |   
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                                       
|PART I  FINANCIAL INFORMATION |  |                                                                                                            
|                               |  |                                                                                                            
|Item 1.                        |  | Financial Statements                                                                                        |  |   
|                               |  |                                                                                                            
|                               |  | Unaudited Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002                   |  | 3 
|                               |  |                                                                                                            
|                               |  | Unaudited Condensed Consolidated Statements of Operations for the three months ended June 30, 2003 and 2002 |  | 4 
|                               |  |                                                                                                            
|                               |  | Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2003 and 2002 |  | 5 
|                               |  |                                                                                                            
|                               |  | Notes to Unaudited Condensed Consolidated Financial Statements                                              |  | 6 
|                               |  |                                                                                                            
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |  | 13
|                               |  |                                                                                                            
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |  | 27
|                               |  |                                                                                                            
|Item 4.                        |  | Controls and Procedures                                                                                     |  | 27
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                            
|                               |  |                                                                                                            
|Item 1.                        |  | Legal Proceedings                                                                                           |  | 28
|                               |  |                                                                                                            
|Item 2.                        |  | Change in Securities and Use of Proceeds                                                                    |  | 28
|                               |  |                                                                                                            
|Item 3.                        |  | Defaults upon Senior Securities                                                                             |  | 28
|                               |  |                                                                                                            
|Item 4.                        |  | Submission of Matters to a Vote of Securities Holders                                                       |  | 28
|                               |  |                                                                                                            
|Item 5.                        |  | Other Information                                                                                           |  | 29
|                               |  |                                                                                                            
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                                            |  | 29
|                               | 
|SIGNATURES                     |  | 30                                                                                                         



2



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##### Table of Contents

PART I  FINANCIAL INFORMATION



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



CLICK2LEARN, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except share data)



|                                                                                                                                             |  |              |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                             |  | June 30,2003 |          |   | December 31,2002 |  
|Assets                                                                                                                                       |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                                              |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                    |  | $            | 15,750   |   |                  | $ | 3,586    |  
|Accounts receivable, net of allowance for returns and doubtful accounts of $861 in 2003 and $927 in 2002                                     |  |              | 9,458    |   |                  |   | 10,785   |  
|Prepaid royalties and licenses                                                                                                               |  |              | 76       |   |                  |   | 157      |  
|Other                                                                                                                                        |  |              | 1,352    |   |                  |   | 1,619    |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                                         |  |              | 26,636   |   |                  |   | 16,147   |  
|Property and equipment, net                                                                                                                  |  |              | 1,015    |   |                  |   | 1,214    |  
|Goodwill                                                                                                                                     |  |              | 2,877    |   |                  |   | 2,877    |  
|Intangible assets, net                                                                                                                       |  |              | 4,109    |   |                  |   | 4,636    |  
|Other                                                                                                                                        |  |              | 589      |   |                  |   | 599      |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                                 |  | $            | 35,226   |   |                  | $ | 25,473   |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|                                                                                                                                             |  |             
|Liabilities and Stockholders Equity                                                                                                         |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                                         |  |              |          |   |                  |   |          |  
|Accounts payable                                                                                                                             |  | $            | 1,426    |   |                  | $ | 2,934    |  
|Accrued compensation and benefits                                                                                                            |  |              | 2,254    |   |                  |   | 2,294    |  
|Deferred revenue                                                                                                                             |  |              | 4,377    |   |                  |   | 4,435    |  
|Short term debt                                                                                                                              |  |              | 3,213    |   |                  |   | 2,400    |  
|Other                                                                                                                                        |  |              | 935      |   |                  |   | 1,184    |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                                    |  |              | 12,205   |   |                  |   | 13,247   |  
|Other noncurrent liabilities                                                                                                                 |  |              | 222      |   |                  |   |         |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                                            |  |              | 12,427   |   |                  |   | 13,247   |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                        |  |              |          |   |                  |   |          |  
|Preferred stock, $0.01 par value; authorized 5,000,000 shares; issued and outstanding no shares in 2003 and 2002                             |  |              |         |   |                  |   |         |  
|Common stock, $0.01 par value; authorized 100,000,000 shares, issued and outstanding 32,397,808 shares in 2003 and 24,600,114 shares in
2002 |  |              | 325      |   |                  |   | 246      |  
|Additional paid-in capital                                                                                                                   |  |              | 254,619  |   |                  |   | 242,570  |  
|Accumulated deficit                                                                                                                          |  |              | (231,689 | ) |                  |   | (230,008 | )
|Accumulated other comprehensive loss                                                                                                         |  |              | (456     | ) |                  |   | (582     | )
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                   |  |              | 22,799   |   |                  |   | 12,226   |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                   |  | $            | 35,226   |   |                  | $ | 25,473   |  
|                                                                                                                                             |  |              |          |   |                  |   |          |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



3



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CLICK2LEARN, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)



|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                              |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                              |  | 2003                       |        |   | 2002                     |   |        | 2003 |  |   | 2002   |  
|Revenue:                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Platforms                                                     |  | $                          | 6,871  |   |                          | $ | 5,518  |      |  | $ | 13,423 |   |  | $ | 10,936 |  
|Tools                                                         |  |                            | 784    |   |                          |   | 1,236  |      |  |   | 1,558  |   |  |   | 2,495  |  
|Content services                                              |  |                            | 474    |   |                          |   | 848    |      |  |   | 1,148  |   |  |   | 1,481  |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                 |  |                            | 8,129  |   |                          |   | 7,602  |      |  |   | 16,129 |   |  |   | 14,912 |  
|Cost of revenue:                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Platforms                                                     |  |                            | 1,476  |   |                          |   | 1,480  |      |  |   | 3,050  |   |  |   | 3,054  |  
|Tools                                                         |  |                            | 133    |   |                          |   | 287    |      |  |   | 258    |   |  |   | 682    |  
|Content services                                              |  |                            | 445    |   |                          |   | 652    |      |  |   | 1,017  |   |  |   | 1,307  |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenue                                         |  |                            | 2,054  |   |                          |   | 2,419  |      |  |   | 4,325  |   |  |   | 5,043  |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                                  |  |                            | 6,075  |   |                          |   | 5,183  |      |  |   | 11,804 |   |  |   | 9,869  |  
|Operating expenses:                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Research and development                                      |  |                            | 1,913  |   |                          |   | 2,404  |      |  |   | 3,397  |   |  |   | 4,685  |  
|Sales and marketing                                           |  |                            | 3,499  |   |                          |   | 4,831  |      |  |   | 7,177  |   |  |   | 9,263  |  
|General and administrative                                    |  |                            | 1,411  |   |                          |   | 1,435  |      |  |   | 2,751  |   |  |   | 3,038  |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                      |  |                            | 6,823  |   |                          |   | 8,670  |      |  |   | 13,325 |   |  |   | 16,986 |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Operating loss from continuing operations                     |  |                            | (748   | ) |                          |   | (3,487 | )    |  |   | (1,521 | ) |  |   | (7,117 | )
|Other income (expense)                                        |  |                            | (46    | ) |                          |   | (3     | )    |  |   | (93    | ) |  |   | 13     |  
|Equity in losses of affiliate                                 |  |                            | (25    | ) |                          |   | (75    | )    |  |   | (50    | ) |  |   | (150   | )
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations before income taxes           |  |                            | (819   | ) |                          |   | (3,565 | )    |  |   | (1,664 | ) |  |   | (7,254 | )
|Income tax                                                    |  |                            | (7     | ) |                          |   |       |      |  |   | (17    | ) |  |   |       |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                               |  |                            | (826   | ) |                          |   | (3,565 | )    |  |   | (1,681 | ) |  |   | (7,254 | )
|Loss from discontinued operations                             |  |                            |       |   |                          |   | (656   | )    |  |   |       |   |  |   | (2,651 | )
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                      |  | $                          | (826   | ) |                          | $ | (4,221 | )    |  | $ | (1,681 | ) |  | $ | (9,905 | )
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Amounts per share, basic and diluted:                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                               |  | $                          | (0.03  | ) |                          | $ | (0.14  | )    |  | $ | (0.07  | ) |  | $ | (0.29  | )
|Loss from discontinued operations                             |  |                            |       |   |                          |   | (0.03  | )    |  |   |       |   |  |   | (0.11  | )
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                      |  | $                          | (0.03  | ) |                          | $ | (0.17  | )    |  | $ | (0.07  | ) |  | $ | (0.40  | )
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares outstanding, basic and diluted |  |                            | 25,757 |   |                          |   | 24,271 |      |  |   | 25,288 |   |  |   | 24,235 |  
|                                                              |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



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CLICK2LEARN, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                                           |  |                          |         |   |      |   |        |  
|------------------------------------------------------------------------------------------ |  | ------------------------ | ------- | - | ---- | - | ------ | -
|                                                                                           |  | Six Months EndedJune 30, |        
|                                                                                           |  | 2003                     |         |   | 2002 |  
|Cash flows from operating activities:                                                      |  |                          |         |   |      |   |        |  
|Continuing operations:                                                                     |  |                          |         |   |      |   |        |  
|Net loss                                                                                   |  | $                        | (1,681  | ) |      | $ | (7,254 | )
|Adjustments to reconcile net loss to net cash provided by continuing operating activities: |  |                          |         |   |      |   |        |  
|Depreciation and amortization                                                              |  |                          | 1,168   |   |      |   | 1,196  |  
|Write-off property and equipment                                                           |  |                          |        |   |      |   | 270    |  
|Provision for returns and doubtful accounts                                                |  |                          | 317     |   |      |   | 833    |  
|Amortization of discount on debt                                                           |  |                          | 44      |   |      |   |       |  
|Stock compensation expense                                                                 |  |                          |        |   |      |   | 5      |  
|Equity losses of affiliate                                                                 |  |                          | 50      |   |      |   | 150    |  
|Net change in certain operating assets and liabilities                                     |  |                          | 236     |   |      |   | 5,100  |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash provided by continuing operating activities                                       |  |                          | 134     |   |      |   | 300    |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Discontinued operations:                                                                   |  |                          |         |   |      |   |        |  
|Loss from discontinued operations                                                          |  |                          |        |   |      |   | (2,651 | )
|Gain on sale of assets                                                                     |  |                          |        |   |      |   | (927   | )
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash used in discontinued operating activities                                         |  |                          |        |   |      |   | (3,578 | )
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash provided by (used in) operating activities                                        |  |                          | 134     |   |      |   | (3,278 | )
|                                                                                           |  |                          |         |   |      |   |        |  
|Cash flows from investing activities:                                                      |  |                          |         |   |      |   |        |  
|Continuing operations:                                                                     |  |                          |         |   |      |   |        |  
|Purchase of property and equipment                                                         |  |                          | (442    | ) |      |   | (2,880 | )
|Other                                                                                      |  |                          | (40     | ) |      |   | 16     |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash used in continuing investing activities                                           |  |                          | (482    | ) |      |   | (2,864 | )
|                                                                                           |  |                          |         |   |      |   |        |  
|Discontinued operations:                                                                   |  |                          |         |   |      |   |        |  
|Proceeds from sale of assets                                                               |  |                          |        |   |      |   | 1,000  |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash provided by discontinued activities                                               |  |                          |        |   |      |   | 1,000  |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash used in investing activities                                                      |  |                          | (482    | ) |      |   | (1,864 | )
|                                                                                           |  |                          |         |   |      |   |        |  
|Cash flows from financing activities:                                                      |  |                          |         |   |      |   |        |  
|Repayments on debt                                                                         |  |                          | (13,318 | ) |      |   | (263   | )
|Proceeds from borrowings                                                                   |  |                          | 13,576  |   |      |   | 400    |  
|Proceeds from exercise of stock options                                                    |  |                          |        |   |      |   | 95     |  
|Net proceeds from sale of common stock                                                     |  |                          | 12,128  |   |      |   | 335    |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net cash provided by financing activities                                                  |  |                          | 12,386  |   |      |   | 567    |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Effect of foreign exchange rate changes on cash                                            |  |                          | 126     |   |      |   | 1      |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                       |  |                          | 12,164  |   |      |   | (4,574 | )
|Cash and cash equivalents at beginning of period                                           |  |                          | 3,586   |   |      |   | 9,553  |  
|                                                                                           |  |                          |         |   |      |   |        |  
|Cash and cash equivalents at end of period                                                 |  | $                        | 15,750  |   |      | $ | 4,979  |  
|                                                                                           |  |                          |         |   |      |   |        |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



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##### Table of Contents

CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



(a) Description of Business



Click2learn, Inc. (Click2learn) develops, markets, distributes, and supports an integrated suite of enterprise
learning software products. Click2learns markets are worldwide and include a broad range of industries.



(b) Basis of Presentation



The
accompanying unaudited condensed consolidated financial statements of Click2learn, Inc., (Click2learn) include the accounts of Click2learn and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated
in consolidation.



These statements reflect all normal
recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. Interim results of operations for the three and six months ended June
30, 2003 are not necessarily indicative of the operating results for the full fiscal year. Factors that may affect such operating results, include, but are not limited to, those discussed in Factors That May Affect Future Results of
Operations. Certain information and footnote disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission.



These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in Click2learns Annual Report on Form 10-K for the year ended December 31, 2002.



(c) Other Current Assets



The following table sets forth the components of other current assets (in
thousands):



|                           |  |              |       |                  |   |      
|-------------------------- |  | ------------ | ----- | ---------------- | - | -----
|                           |  | June 30,2003 |       | December 31,2002
|Prepaid expense            |  | $            | 514   |                  | $ | 430  
|Prepaid insurance          |  |              | 497   |                  |   | 618  
|Other                      |  |              | 341   |                  |   | 571  
|                           |  |              |       |                  |   |      
|Total other current assets |  | $            | 1,352 |                  | $ | 1,619
|                           |  |              |       |                  |   |      



(d) Revenue Recognition



Click2learn recognizes revenue pursuant to the requirements of Statement of
Position No. 97-2, Software Revenue Recognition (SOP 97-2), as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements. Under SOP 97-2, revenue attributable to an element
in a customer arrangement is recognized when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does not require significant customization
of the software.



For all sales, Click2learn uses either a
binding purchase order or signed agreement, depending on the nature of the transaction, as evidence of an arrangement. Sales through its significant resellers are evidenced by a master agreement governing the relationship.



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##### Table of Contents

CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



For software license fees in single element arrangements and multiple element arrangements that do
not include customization or consulting services, delivery typically is deemed to occur when the product is shipped to customers.



At the time of each transaction, Click2learn assesses whether the fee associated with its revenue is fixed and determinable and whether or not collection
is probable. Click2learn assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after Click2learns normal payment terms, based upon a variable
matrix such as a minimum level of distribution or subject to refund (other than refunds for warranty claims or its uncured defaults), Click2learn accounts for the fee as not being fixed and determinable. In these cases, Click2learn defers revenue
and recognizes it when it becomes due and payable.



Click2learn
assesses the probability of collection based on a number of factors, including past transaction history with the customer and the current financial condition of the customer. Click2learn does not request collateral from its customers. If Click2learn
determines at the time of the transaction that collection of a fee is not probable, it defers revenue until payment is received.



For multiple element arrangements, when company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement,
but does not exist for one or more of the delivered elements in the arrangement, Click2learn recognizes revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, Click2learn defers revenue for
the fair value of its undelivered elements such as consulting services and product support and upgrades, and recognizes the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses,
when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support and upgrades of standard products for which no installation or customization is required based upon the amounts Click2learn charges when
support and upgrades are sold separately. For multiple element arrangements involving installation or customization, company-specific objective evidence is established for support and maintenance arrangements if its customers have an optional annual
renewal rate specified in the arrangement and the rate is substantive. Company-specific objective evidence is established for consulting and installation services based on the hourly rates Click2learn charges for its employees when they are
performing these services provided Click2learn has the ability to accurately estimate the hours required to complete a project based upon its experience with similar projects.



Professional services revenue is recognized from fixed price contracts as services are provided or by using the
percentage-of-completion method of accounting, based on the ratio of labor costs incurred to the total estimated project cost, for individual fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made in the period
in which such losses become evident. Professional services revenue from time and materials contracts and training services is recognized as revenue as services are performed.



Click2learn recognizes revenue from non-refundable minimum royalty agreements from distributors or resellers upon delivery
of product to the distributor or reseller, provided no significant obligations remain outstanding and the conditions of SOP 97-2 have been met. If minimum royalties are exceeded, the additional royalties are recognized as revenue when earned, based
on the contractual reporting obligations.



Revenue from
subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract. We typically bill these contracts in advance and record the deferred amounts in deferred revenue.



Revenue by license and service for the three and six months ended June
30, 2003 and 2002 is as follows (in thousands):



|              |  |                            |       |                          |   |       |  |      |        |  |   |       
|------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ------ |  | - | ------
|              |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|              |  | 2003                       |       | 2002                     |   | 2003  |  | 2002
|Revenue:      |  |                            |       |                          |   |       |  |      |        |  |   |       
|License       |  | $                          | 2,710 |                          | $ | 3,055 |  | $    | 4,945  |  | $ | 5,882 
|Service       |  |                            | 5,419 |                          |   | 4,546 |  |      | 11,184 |  |   | 9,030 
|              |  |                            |       |                          |   |       |  |      |        |  |   |       
|Total revenue |  | $                          | 8,129 |                          | $ | 7,601 |  | $    | 16,129 |  | $ | 14,912
|              |  |                            |       |                          |   |       |  |      |        |  |   |       



(e) Net Loss Per Share



Basic net loss per share is computed by dividing the net loss
by the weighted average number of common shares outstanding during the period. Diluted per share amounts reflect the weighted average



7



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CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



number of common and dilutive shares outstanding during the period. As Click2learn had a net loss in each of the periods presented, basic and diluted net
loss per share are the same.



Excluded from the computation of
diluted loss per share for the three and six months ended June 30, 2003 are options to acquire approximately 6,115,810 shares of common stock with a weighted average exercise price of $3.81 and warrants to purchase 6,937,055 shares of common stock
with a weighted average exercise price of $3.34 because their effects would be anti-dilutive. Options to acquire approximately 5,396,505 shares of common stock with a weighted average exercise price of $6.02 and warrants to purchase 3,633,686 shares
of common stock with a weighted exercise share price of $5.75 have been excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2002 because their effects would be anti-dilutive.



The change in common stock and additional paid-in capital reflects the
private placement to accredited investors of 7,460,000 shares of our common stock and warrants to purchase an additional 2,611,225 shares of our common stock on June 20, 2003 and stock purchase for the Employee Stock Purchase Plan on January 31,
2003.



(f) Derivative Financial Instruments



Click2learn had no derivative financial instruments outstanding at June 30,
2003 or December 31, 2002.



(g) Comprehensive Loss and Accumulated Other
Comprehensive Loss



The following table sets forth the
components of comprehensive loss for the periods presented below (in thousands):



|                                        |  |                            |      |   |                          |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------- |  | -------------------------- | ---- | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                        |  | Three Months EndedJune 30, |      |   | Six Months EndedJune 30, |  
|                                        |  | 2003                       |      |   | 2002                     |   |        | 2003 |  |   | 2002   |  
|Net loss                                |  | $                          | (826 | ) |                          | $ | (4,221 | )    |  | $ | (1,681 | ) |  | $ | (9,905 | )
|Foreign currency translation adjustment |  |                            | 66   |   |                          |   | 83     |      |  |   | 126    |   |  |   | 1      |  
|                                        |  |                            |      |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total comprehensive loss                |  | $                          | (760 | ) |                          | $ | (4,138 | )    |  | $ | (1,555 | ) |  | $ | (9,904 | )
|                                        |  |                            |      |   |                          |   |        |      |  |   |        |   |  |   |        |  



Accumulated other
comprehensive loss at June 30, 2003 and 2002 consists of foreign currency translation adjustments.



(h) Stock-Based Compensation



Click2learn applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees,and related interpretations including
Financial Accounting Standards Board Interpretation No. 44 (FIN 44),Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB 25, to account for its fixed-plan stock options. Under this method,
compensation expense is recorded only if the current market price of the underlying stock exceeded the exercise price on the date of the grant. Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based
Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, Click2learn has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net loss if the fair-value-based method had been applied to all outstanding and
unvested awards in each period (in thousands):



|                                                                                                                            |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                            |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                                                            |  | 2003                       |        |   | 2002                     |   |        | 2003 |  |   | 2002   |  
|Net loss, as reported                                                                                                       |  | $                          | (826   | ) |                          | $ | (4,221 | )    |  | $ | (1,681 | ) |  | $ | (9,905  | )
|Add stock-based employee compensation expenses included in reported net loss, net of tax                                    |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   | 5       |  
|Deduct total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax |  | $                          | (1,058 | ) |                          | $ | (1,488 | )    |  | $ | (2,201 | ) |  | $ | (3,083  | )
|                                                                                                                            |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Pro forma net loss                                                                                                          |  | $                          | (1,884 | ) |                          | $ | (5,709 | )    |  | $ | (3,882 | ) |  | $ | (12,988 | )
|                                                                                                                            |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per share:                                                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|As reported                                                                                                                 |  | $                          | (0.03  | ) |                          | $ | (0.17  | )    |  | $ | (0.07  | ) |  | $ | (0.40   | )
|Pro forma                                                                                                                   |  | $                          | (0.07  | ) |                          | $ | (0.24  | )    |  | $ | (0.15  | ) |  | $ | (0.54   | )



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CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(i) New Accounting Policies



In November 2002, the EITF reached a consensus on Issue No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables.
EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. EITF 00-21 will be effective for periods beginning after June 15, 2003. The adoption of
EITF 00-21 is not expected to have a material impact on Click2learns financial position and results of operations.



In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51. FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31, 2003. For public enterprises with a variable interest in a variable interest entity created before February 1, 2003, FIN 46 applies to that enterprise no later than the beginning of
the first interim or annual reporting period beginning after June 15, 2003. The application of FIN 46 is not expected to have a material effect on Click2learns financial statements. FIN 46 requires certain disclosures in financial statements
issued after January 31, 2003 if it is reasonably possible that Click2learn will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. Click2learn has no variable interest entities as of June
30, 2003.



In April 2003, the FASB issued SFAS No. 149
(SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relations designated after June
30, 2003, except for those provisions of SFAS No. 149, which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the provisions that are currently in effect
should continue to be applied in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist,
should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 is not expected to have a material effect on Click2learns financial statements.



In May 2003, the FASB issued SFAS No. 150 (SFAS No. 150),
Accounting for Certain Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified



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##### Table of Contents

CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



after May 31, 2003, and otherwise is effective for Click2learn beginning September 1, 2003. The adoption of SFAS No. 150 is not expected to have a material
effect on Click2learns financial statements.



NOTE 2: DISCONTINUED
OPERATIONS



During January 2002, Click2learn sold certain
assets of its content development business, including equipment and a customer list to NIIT (USA), Inc. (NIIT), the U.S. operations of NIIT Limited, a global custom software development firm, under an Asset Purchase agreement for $1
million, resulting in a gain of $927,000 based on the book value of those assets. As a result of the transaction with NIIT, Click2learn significantly reduced the headcount of its custom content development business and closed certain facilities.
During the third quarter of 2002, Click2learn completed the discontinuation of its remaining custom content development business by early termination of its contract to develop content for the Washington Army National Guard. As part of the
negotiation to terminate the contract, Click2learn agreed to forego the collection of $4.5 million in accounts receivable. Results related to its custom content development business for the year ended December 31, 2002 and prior years have been
reclassified as income (loss) from discontinued operations.



Summary operating results of the discontinued operations were as follows (in thousands):



|                                  |  |                                       |      |   |                                     |   |        |  
|--------------------------------- |  | ------------------------------------- | ---- | - | ----------------------------------- | - | ------ | -
|                                  |  | For the ThreeMonths EndedJune 30,2002 |      |   | For the SixMonths EndedJune 30,2002 |  
|Revenues                          |  | $                                     | 27   |   |                                     | $ | 248    |  
|Cost of revenues                  |  | $                                     | (683 | ) |                                     | $ | (2,243 | )
|Operating expenses                |  | $                                     |     |   |                                     | $ | (1,583 | )
|Other income                      |  | $                                     |     |   |                                     | $ | 927    |  
|                                  |  |                                       |      |   |                                     |   |        |  
|Loss from discontinued operations |  | $                                     | (655 | ) |                                     | $ | (2,651 | )
|                                  |  |                                       |      |   |                                     |   |        |  



NOTE 3: BANK CREDIT FACILITY



In December 2002, Click2learn consolidated its existing
$4 million working capital line of credit and $1 million term loan facility with Silicon Valley Bank into a new $10 million working capital line. Under the new facility Click2learn will continue to repay the remaining balance of the term loan in
accordance with the original terms (monthly payments of $41,666.67 plus interest ending October 1, 2003), but the unpaid balance of the term loan will not be available under the line of credit. The term loan and the working capital line will bear
interest at the greater of Silicon Valley Bank prime rate plus 2.25% or 7.0% and have minimum monthly interest of $8,500 per month regardless of the loan balances.



The credit facility is collateralized by a security interest in all of Click2learns assets. Covenants in the loan
agreements include restrictions on Click2learns ability to pay dividends or make other distributions, make acquisitions or investments, merge or consolidate with others or dispose of assets, as well as financial covenants limiting the amount
of net losses during any three month period and requiring Click2learn to maintain certain levels of minimum tangible net worth. If not renewed, the working capital line terminates and any advances made are due on December 6, 2004.



Under the working capital line of credit, the principal amount of $2,757,000
was outstanding as of June 30, 2003. Borrowings outstanding under the term loan were $167,000 at June 30, 2003 all of which is repayable in 2003. As of June 30, 2003, Click2learn was in compliance with the loans covenants.Click2learn
has a note payable of which $408,500 is current and reported as short term debt and $222,000 is reported as long-term debt. The total amount due under this note payable will be paid off during the three month period ended September 30, 2003.
Aggregate short-term debt of $3.2 million at June 30, 2003 is presented net of debt discount of $133,000 attributable to the issuance of common stock warrants.



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CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



NOTE 4: GUARANTEES



Click2learn adopted FIN 45 during the quarter ended December 31, 2002. In the ordinary course of business, Click2learn is not subject to potential
obligations under guarantees that fall within the scope of FIN 45 except for standard indemnification and warranty provisions that are contained within many of our customer license and service agreements, and give rise only to the disclosure
requirements prescribed by FIN 45.



Indemnification and
warranty provisions contained within our customer license and service agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally does not exceed 90 days following delivery of our
products. We have not incurred significant obligations under customer indemnification or warranty provision historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain accruals for potential
customer indemnification or warranty-related obligations.



NOTE 5: SEGMENT
INFORMATION



Click2learns internal reporting
includes the three reportable segments: Platforms, Tools, and Content Services. Platforms revenue includes software licenses, subscription and hosting fees, implementation, customization, consulting, training and support related to the Aspen suite,
the Ingenium learning management system, which is the precursor product to the Aspen Learning Management Server, and the e-Learning Network, which is no longer offered to new customers. Tools revenue includes software licenses, technical support and
training related to the ToolBook line of products. Content Services revenue includes the placement of Click2learn personnel at customer sites on a time and material basis, the resale of third party off the shelf training content and license and
hosting fees for our Rapid e-Learning Development System, which is no longer offered to new customers.



Click2learns operating committee, which includes its Chief Executive Officer and Chief Financial Officer, has been identified as the Chief Operating
Decision Maker (CODM) as it assesses the performance of the business units and decides how to allocate resources to the business units. Segment income is the measure of profit and loss that the CODM uses to assess performance and make decisions.
Segment income represents revenue less cost of revenue incurred within the operating segments as presented in Click2learns consolidated statements of operations. Click2learn does not allocate operating expenses including research and
development, sales and marketing, general and administrative, or amortization of goodwill to its operating segments. In addition, other income (expense) are also not allocated to operating segments.



There is no intersegment revenue. Click2learns CODM does not review
total assets or depreciation and amortization by operating segment. The accounting policies for reported segments are the same as Click2learn as a whole.



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CLICK2LEARN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Revenues by geographic region which are based on the location of the customers are as follows (in
thousands):



|         |  |                                   |       |                                 |   |       |  |      |        |  |   |       
|-------- |  | --------------------------------- | ----- | ------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|         |  | For the ThreeMonths EndedJune 30, |       | For the SixMonths EndedJune 30,
|         |  | 2003                              |       | 2002                            |   | 2003  |  | 2002
|Revenue: |  |                                   |       |                                 |   |       |  |      |        |  |   |       
|US       |  | $                                 | 6,809 |                                 | $ | 6,916 |  | $    | 14,005 |  | $ | 13,434
|UK       |  |                                   | 835   |                                 |   | 111   |  |      | 1,224  |  |   | 480   
|Other    |  |                                   | 485   |                                 |   | 575   |  |      | 900    |  |   | 998   
|         |  |                                   |       |                                 |   |       |  |      |        |  |   |       
|         |  | $                                 | 8,129 |                                 | $ | 7,602 |  | $    | 16,129 |  | $ | 14,912
|         |  |                                   |       |                                 |   |       |  |      |        |  |   |       



Long-lived assets by
geographic location are as follows (in thousands):



|                   |  |              |       |                  |   |      
|------------------ |  | ------------ | ----- | ---------------- | - | -----
|                   |  | June 30,2003 |       | December 31,2002
|Long-lived assets: |  |              |       |                  |   |      
|US                 |  | $            | 7,773 |                  | $ | 8,596
|Other              |  |              | 228   |                  |   | 131  
|                   |  |              |       |                  |   |      
|                   |  | $            | 8,001 |                  | $ | 8,727
|                   |  |              |       |                  |   |      



Long-lived assets represent property,
plant, and equipment, goodwill and other intangible assets, net of accumulated depreciation and amortization.



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|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- |  | -------------------------------------------------------------------------------------



This Quarterly Report includes forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. This Act provides a safe harbor for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and
provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Quarterly Report are
forward-looking. Such forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. Such forward-looking statements include, among others, those
statements including the words expect, anticipate, intend, believe and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that
might cause or contribute to such differences include, but are not limited to those discussed in the section Managements Discussion and Analysis of Financial Condition and Results of Operations  Factors That May Affect Future
Results of Operations. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the
forward-looking statements or reflect events or circumstances after the date of this document.



Overview



We are a
leading developer and provider of enterprise learning solutions for companies, government agencies and educational institutions. We design, develop, market, license and support an integrated suite of enterprise software products and related services
that allow our customers to cost-effectively create, personalize and manage the delivery of learning and knowledge content. Our flagship product, the Aspen Enterprise Productivity Suite, combines collaborative content development, comprehensive
learning management and virtual classroom systems into a single, integrated product suite with a unified architecture and user experience. We provide our products and services to customers across a broad range of industries including financial
services, accounting, healthcare, insurance, technology, manufacturing, telecommunications, transportation, utilities, government and education.



We report revenue in three separate categories related to the different components of our business:



| |  | Platforms revenue includes software licenses, subscription and hosting fees, implementation, customization, consulting, training and support related to the Aspen suite, our Ingenium
learning management system, which is the precursor product to the Aspen Learning Management Server, and our e-Learning Network, which is no longer offered to new customers.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Tools revenue includes software licenses, technical support and training related to our ToolBook line of products.
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | Content Services revenue includes the placement of Click2learn personnel at customer sites on a time and material basis, the resale of third party off the shelf training content and
license and hosting fees for our Rapid e-Learning Development System, which is no longer offered to new customers. During 2002 we discontinued our custom content development business, which had been the primary source of revenue from Content
Services in prior years. Prior years revenue and expenses for this portion of the business have been reclassified as income or loss from discontinued operations.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Critical Accounting Policies and Estimates



Our critical accounting policies and estimates are as follows:



| |  | Revenue recognition
| | - | -------------------



| |  | Estimating allowances for sales returns and the allowance for doubtful accounts
| | - | -------------------------------------------------------------------------------



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| |  | Valuation of goodwill
| | - | ---------------------



| |  | Valuation of long-lived assets
| | - | ------------------------------



Revenue Recognition.We recognize revenue pursuant to the requirements of Statement of Position No. 97-2, Software Revenue Recognition
(SOP 97-2), as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements. Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when
persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does not require significant customization of the software.



For all sales, we use either a binding purchase order or signed agreement,
depending on the nature of the transaction, as evidence of an arrangement. Sales through our significant resellers are evidenced by a master agreement governing the relationship.



For software license fees in single element arrangements and multiple element arrangements, which do not include
customization or consulting services, delivery typically is deemed to occur when the product is shipped to customers.



At the time of each transaction, we assess whether the fee associated with our revenue is fixed and determinable and whether or not collection is
probable. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, based upon a variable matrix such as a minimum level
of distribution or subject to refund (other than refunds for warranty claims or our uncured defaults), we account for the fee as not being fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable.



We assess the probability of collection based on a number of
factors, including past transaction history with the customer and the current financial condition of the customer. We do not request collateral from our customers. If we determine at the time of the transaction that collection of a fee is not
probable, we defer revenue until payment is received.



For
multiple element arrangements, when company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements in the arrangement, we recognize
revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, we defer revenue for the fair value of its undelivered elements such as consulting services and product support and upgrades, and
recognize the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses, when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support
and upgrades of standard products for which no installation or customization is required based upon the amounts we charge when support and upgrades are sold separately. For multiple element arrangements involving installation or customization,
company-specific objective evidence is established for support and maintenance arrangements if our customers have an optional annual renewal rate specified in the arrangement and the rate is substantive. Company-specific objective evidence is
established for consulting and installation services based on the hourly rates we charge for our employees when they are performing these services provided we have the ability to accurately estimate the hours required to complete a project based
upon our experience with similar projects.



Professional
services revenue is recognized from fixed price contracts as services are provided or by using the percentage-of-completion method of accounting, based on the ratio of labor costs incurred to the total estimated project cost, for individual
fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses become evident. Professional services revenue from time and materials contracts and training services is recognized as
revenue as services are performed.



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##### Table of Contents

We recognize revenue from non-refundable minimum royalty agreements from distributors or resellers upon
delivery of product to the distributor or reseller, provided no significant obligations remain outstanding and the conditions of SOP 97-2 have been met. If minimum royalties are exceeded, the additional royalties are recognized as revenue when
earned, based on the contractual reporting obligations.



Revenue from subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract. We typically bill these contracts in advance and record the deferred amounts in deferred
revenue.



Allowances for Sales Returns and Doubtful
Accounts.The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reported period. Specifically, we must make estimates of future product returns related to current period product revenue. We analyze historical returns, current economic trends, and changes in
customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant judgments and estimates must be made and used in connection with establishing reserves for sales returns and the
allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our revenue for any period if we made different judgments or utilized different estimates. Similarly, we must make estimates of the
uncollectability of our accounts receivable. We specifically analyze accounts receivable greater than 90 days and analyze historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the
adequacy of the allowance for doubtful accounts.



Valuation
of Goodwill.We assess the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicate the fair value of a reporting unit to which goodwill relates is less than its carrying value. Factors we consider
important which could trigger an impairment review include poor economic performance relative to expected historical or projected future operating results, significant negative industry, economic or company specific trends and changes in the manner
of our use of the assets or the plans for our business. If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill based upon the annual test or the existence of one or more of the above
indicators of impairment, then we would measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating the fair value
of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of reporting unit goodwill. To the extent the
carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference.



Valuation of Long Lived Assets. SFAS 144 provides a single accounting model for disposal of long-lived assets. SFAS
144 also changes the criteria for classifying an asset as held for sale and broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. We
adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144 did not affect our consolidated financial position or results of operations as of January 1, 2002. The broadened definition of discontinued operations with SFAS 144 has affected the
presentation and disclosure of our results of operations for the year ended 2002 and prior years presented for comparison. In accordance with SFAS 144, we review long-lived assets, such as property, plant, and equipment, and purchased intangibles
subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We measure recoverability of assets to be held and used by comparing the carrying amount of an
asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, we recognize an impairment charge as the amount by which the carrying amount of the
asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and
liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.



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##### Table of Contents

Results of Operations for the Three and Six Months Ended June 30, 2003 Compared to the Three and Six Months Ended June
30, 2002



In accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-lived Assets, the financial statements and managements discussion and analysis present results from continuing operations with revenue and expenses related
to our discontinued custom content development business as loss from discontinued operations. See Loss from Discontinued Operations for additional information regarding the discontinuance of the custom content development business and
the amount of revenue and costs that have been reclassified to loss from discontinued operations.



Revenue.For the three and six-month periods ended June 30, 2003 total revenue increased 7% and 8% to $8.1 million and $16.1 million as compared to
$7.6 million and $14.9 million for the same periods ended June 30, 2002. The increase in revenue is attributed to revenue growth from the Platforms category offset by declining revenue from the Tools and Content Services categories.



Platforms revenue grew 25% and 23% to $6.9 million and $13.4 million for
the three and six-month periods ended June 30, 2003 as compared to $5.5 million and $10.9 million for the comparable periods ended June 30, 2002. In general list pricing for Platform license and services was unchanged as compared to 2002 levels,
however, due to the improving high tech spending environment discounting decreased as compared to the year ago period to less than 50%. In 2002 discounting regularly exceeded the 50% level. Total Platform revenue increased primarily due to increased
service revenue of $4.6 million as compared to $3.2 million in the year ago period. Aspen grew to represent 98% of all Platform related revenue or $6.7 million up from 85% or $4.7 million in the second quarter of 2002. Legacy products such as
Ingenium and the e-Learning Network fell to $134,000 in the period down from $852,000 for the quarter ended June 30, 2002 as Aspen has replaced these products as our principal Platform offering. We believe that future growth in total revenue is
dependant on continuing to increase Platforms revenue and in particular Aspen related revenue.



Tools revenue declined 37% and 38% to $784,000 and $1.6 million, $447,000 and $832,000 from license, $337,000 and $726,000 from services, for the three
and six-month periods ended June 30, 2003 as compared to $1.2 million and $2.5 million, $710,000 and $1.4 million from license, $525,000 and $1.1 million from services, for the periods ended June 30, 2002. Although we recently increased our research
and development investment from less than $100,000 per quarter to approximately $170,000 to create a new version release, we expect Tools revenue to remain at current levels or to decline over the next six months.



Content Services revenue declined 44% and 22% to $474,000 and $1.1 million
for the three and six-month periods ended June 30, 2003 as compared to $848,000 and $1.5 million for the periods ended June 30, 2002. Current Content Services revenue is derived primarily from the placement of temporary personnel at our
clients locations on an hourly basis. Due to the economic downturn, demand for temporary labor resources is down. We believe that Content Services revenue will remain at current levels or decline over the next six months.



Cost of Revenue. For the three and six-month periods ended June 30,
2003 total cost of revenue decreased 15% and 14% to $2.1 million and $4.3 million as compared to $2.4 million and $5.0 million for the same periods ended June 30, 2002. The decrease is primarily due to lower costs as a percentage of revenue related
to our Platform revenue and declines in Tools and Content Services costs as a result of lower revenue over these periods.



Platform cost of revenue was unchanged at $1.5 million and $3.1 million for the three and six-month periods ended June 30, 2003 and June 30, 2002.
Platform cost of revenue as a percentage of Platform revenue was 21% and 23% for the three and six-month periods ended June 30, 2003 down from 27% and 28% for the same periods ended June 30, 2002. The decline as a percentage of revenue is due to
shifting of services payroll to Hyderabad, India reducing compensation costs $200,000 and $400,000 as compared to the three and six-month periods ended June 30, 2002 while allowing for higher production. This cost decline was offset by an increase
of $200,000 and $400,000 in U.S.A. costs as compared to the three and six-month periods ended June 30, 2002 resulting from personnel added to our data center.



Tools cost of revenue declined 53% and 62% to $133,000 and $258,000 for the three and six-month periods ended June 30, 2003
as compared to $287,000 and $682,000 for the same period ended June 30, 2002. The decline is a result of lower Tools revenue.



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Content Services cost of revenue declined 32% and 22% to $445,000 and $1 million for the three and
six-month periods ended June 30, 2003 as compared to $652,000 and $1.3 million for the same period ended June 30, 2002. The decline is a result of lower Content Services revenue.



Operating Expenses



Research and Development. For the three and six-month periods ended June 30, 2003 total cost declined 20% and 28% to $1.9 million and $3.4 million
as compared to $2.4 million and $4.7 million for the same periods ended June 30, 2002. The decline is a result of shifting payroll to India where individual salaries are lower than U.S.A. equivalents. This allowed us to increase total research and
development staff while lowering compensation cost in 2003 approximately $500,000 and $1.3 million as compared to the three and six-month periods ended June 30, 2002. We anticipate that research and development costs will increase during 2003 as a
result of an increase in amortization costs related to acquired technology of $240,000 per quarter and anticipated increases in staffing necessary for upcoming releases of the Aspen platform.



Sales and Marketing.For the three and six-month periods ended
June 30, 2003 total cost declined 28% and 23% to $3.5 million and $7.2 million as compared to $4.8 million and $9.3 million for the same periods ended June 30, 2002. The decline is a result of headcount reductions of 42%, which resulted in decreased
compensation and travel expenses of approximately $1.3 million and $2.1 million as compared to the three and six-month periods ended June 30, 2002.



General and Administrative.For the three and six-month periods ended June 30, 2003 total cost declined 2% and 9% to $1.4 million and $2.8 million
as compared to $1.4 million and $3.0 million for the same periods ended June 30, 2002. The decline is a result of lower headcount in 2003 resulting in approximately $100,000 and $250,000 less salary expense for the three and six-month periods ended
June 30, 2003, offset by an increase in general operating expenses of approximately $100,000 for the three month period and no change for the six month period as compared to 2002.



Other Income (Expense). For the three and six-months ended June 30, 2003 other expenses were $46,000 and $93,000.
These amounts are primarily interest on borrowing from Silicon Valley Bank. For the same periods ended June 30, 2002 the company did not have any material other income or expenses.



Equity in Losses of Affiliate. Losses from affiliates relate to our joint venture with Softbank in Japan, Click2learn
Japan KK. We use the equity method of accounting whereby we record our ownership portion of the joint ventures net income or loss. For the three and six month periods ended June 30, 2003 our losses from affiliates were $25,000 and $50,000 compared
to $75,000 and $150,000 for the periods ended June 30, 2002.



Loss from Discontinued Operations. In 2003 we have not had losses from discontinued operations. For the three and six month periods ended June 30, 2002 losses from the discontinuation of our custom development business were $656,000
and $2.7 million respectively.



Recent Accounting Pronouncements



In November 2002, the EITF reached a consensus on Issue
No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating
activities. EITF 00-21 will be effective for periods beginning after June 15, 2003. The adoption of EITF 00-21 is not expected to have a material impact on Click2learns financial position and results of operations.



In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in
variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For public enterprises with a variable interest in a variable interest entity created before February
1, 2003, FIN 46 applies to that enterprise no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003. The application of FIN 46 is



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not expected to have a material effect on our financial statements. FIN 46 requires certain disclosures in our financial statements issued after January 31,
2003 if it is reasonably possible that we will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. We have no variable interest entities as of March 31, 2003.



In April 2003, the FASB issued SFAS No. 149 (SFAS No. 149),
Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relations designated after June 30, 2003, except for those
provisions of SFAS No. 149 which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the provisions that are currently in effect should continue to be applied
in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing
contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 is not expected to have a material effect on Click2learns financial statements.



In May 2003, the FASB issued SFAS No. 150 (SFAS No. 150), Accounting for Certain Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer
classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for Click2learn beginning September
1, 2003. The adoption of SFAS No. 150 is not expected to have a material effect on Click2learns financial statements.



Liquidity and Capital Resources



At June 30, 2003, our principal source of liquidity was $15.8 million of cash and $9.5 million of accounts receivable, up from $3.6 million of cash and
down from $10.8 million of accounts receivable on December 31, 2002. The change in cash is due primarily to the sale of common stock and warrants during June that resulted in net cash proceeds of approximately $11.9 million. The change in accounts
receivable is due primarily to improved collection efforts. We believe our risk on current Platform-related receivables is low given the general financial strength of our customers. As of June 30, 2003, we had one significant account, a receivable
of approximately $500,000 from an international customer, over 90 days past due for which we believe collectibility is at risk. We increased our bad debt reserve for this account in 2002. At June 30, 2003 we had no other significant collectibility
or billing problems with any major customers or classes of customers.



Although we have not made any significant changes in our payment terms, as a result of the discontinuance of our custom content development business we are able to collect more quickly on our receivables generally than in prior periods,
when a significant portion of our revenue was from custom content development contracts. This is because a typical custom development contract was invoiced on the achievement of contract milestones, although revenue was recognized using the
percentage of completion method as the services were performed. As a result, there was often significant time elapsed between the performance of the services and invoicing the client. Thus, the receivables from such contracts remained uncollected
for longer periods than those from software licenses or other services. While we expect to be able to collect on our receivables more quickly going forward, we may offer extended payment terms to customers in certain circumstances from time to time.
To the extent that we offer such extended payment terms, they will result in a longer collection period for accounts receivable and slower cash inflows from operations.



At June 30, 2003, we had cash and cash equivalents totaling $15.8 million, up from $3.6 million at December 31, 2002.
The increase in cash was primarily the result of positive cash flows from operations during the six month period ended June 30, 2003 and net cash proceeds of approximately $11.9 million



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from the sale of stock and warrants in June. Based on our positive operating cash flows of $134,000 year-to-date and our current cash balance of $15.8
million, we anticipate that our cash and cash equivalents will be sufficient to meet our working capital needs and capital expenditures for at least the next 12 months. However, we will continue to monitor our cash and liquidity and will seek
additional financing or make additional expense reductions if it becomes required.



Net cash used in investing activities was $482,000 in the six months ended June 30, 2003. Net cash used in investing activities was primarily used for purchases of equipment. As of June 30, 2003, we had no material
commitments for capital expenditures and had commitments under non-cancelable operating leases with terms in excess of one year of $5.8 million through 2008.



Cash provided by financing activities was $12.4 million in the six months ended June 30, 2003, resulting primarily from draws against the Silicon Valley
Bank credit facility, net of payments on debt, of approximately $300,000; net cash proceeds of approximately $11.9 million from the sale of common stock and warrants in June; and approximately $200,000 received from purchases under our Employee
Stock Purchase Plan. Cash from borrowings was approximately $13.6 million, while cash used for payments on debt was $13.3 million in the six months ended June 30, 2003.



In December 2002 we consolidated our existing $4 million working capital line of credit and $1 million term loan
facility with Silicon Valley Bank into a new $10 million working capital line. Under the new facility we will continue to repay the remaining balance of the term loan in accordance with the original terms (monthly payments of $41,666.67 plus
interest ending October 1, 2003), and the unpaid balance of the term loan will not be available for new loans under the line of credit. The term loan and the working capital line will bear interest at the greater of Silicon Valley Bank prime rate
plus 2.25% or 7.0% and have minimum monthly interest of $8,500 per month regardless of the loan balances. The credit facility is collateralized by a security interest in all of our assets. Covenants in the loan agreements include restrictions on our
ability to pay dividends or make other distributions, make acquisitions or investments, merge or consolidate with others or dispose of assets, as well as financial covenants limiting the amount of net losses during any three-month period to $1.6
million and requiring us to maintain certain levels of minimum tangible net worth as follows for the fiscal quarters ending: June 30, 2003: $6,000,000; September 30, 2003: $5,000,000; December 31, 2003 and each fiscal quarter ending thereafter:
$4,500,000 plus (i) 100% of all consideration received by us for equity securities and subordinated debt, plus (ii) 50% of our net income in each fiscal quarter during the loan term. The failure to meet those covenants could prevent us from
accessing the working capital line and result in the acceleration of any balances under the working capital line and term loan. If not renewed the working capital line terminates and any advances made are due on December 6, 2004. At June 30, 2003,
we had a balance of $167,000 on the term loan facility and $2.6 million on the working capital line, net of debt discount of $133,000.



The amount available under the working capital line of credit as of June 30, 2003 is 65% of our eligible accounts receivable, approximately equal to our
ending loan balance of $2.8 million. This percentage may be adjusted up or down based on a quarterly analysis by the bank. Eligible accounts receivable are those accounts receivable that the bank determines in its good faith business judgment to
include in the borrowing base. Certain accounts, such as accounts that are over 90 days past due, unbilled receivables and foreign or government accounts, are not currently eligible. Although we may take steps to include foreign and government
accounts in our borrowing base, there is additional cost involved and we have not deemed it necessary to do so to date. As a result of this limitation on eligible accounts, the entire $10 million is not currently available to us under the line of
credit and the entire $10 million may not become available in the future. Moreover, because the amount available for borrowing under our agreement is based on our eligible accounts receivable, we may from time to time become over-advanced under the
line of credit if our eligible accounts receivable decrease, either because they have been collected but not applied against the existing obligations in the case of the term loan or because they have become ineligible under the terms of the
agreement. In such a case we may be required to immediately repay a portion of the amount borrowed sufficient to bring the total amount owed to no more than the total availability under the loan facility.



Click2learn has a note payable of which $408,500 is current and reported as
short-term debt and $222,000 is reported as long-term debt. The total amount due under this note payable will be paid off during the three month period ended September 30, 2003.



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Our long-term liquidity will be affected by numerous factors, including demand for our Aspen platform,
the level and timing of revenue, the collection of our receivables, the availability of our line of credit, the extent to which we raise additional funds from investors, the timing and extent to which we invest in new technology, the expenses of
sales and marketing and new product development, the extent to which competitors are successful in developing their own products and services and increasing their own market share, acquisitions of businesses or technologies and other factors. To the
extent that our existing capital resources are insufficient to fund our activities, we may need to raise additional funds. Such additional funding, if needed, may not be available on attractive terms or at all. If adequate funds are not available on
acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our products, fund expansion, respond to competitive pressures or take advantage of business
opportunities.



Our contractual commitments at June 30, 2003
are substantially similar to those at December 31, 2002 disclosed in our annual report on Form 10-K.



Factors That May Affect Future Results of Operations



Our quarterly operating results are uncertain and may fluctuate significantly, which could negatively affect the value of your investment.



Our operating results are difficult to predict accurately and have varied significantly from quarter to quarter and are
likely to continue to fluctuate as a result of a variety of factors, many of which we cannot control. Factors that may adversely affect our quarterly operating results include:



| |  | the size and timing of product orders and the timing and execution of professional services engagements;
| | - | --------------------------------------------------------------------------------------------------------



| |  | the mix of revenue from products and services;
| | - | ----------------------------------------------



| |  | the mix of products sold;
| | - | -------------------------



| |  | the ability to meet client project milestones;
| | - | ----------------------------------------------



| |  | the market acceptance of our products and services;
| | - | ---------------------------------------------------



| |  | our ability to develop and market new or enhanced products and services in a timely manner and the market acceptance of these products and services;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the timing of revenue and expense recognition; and
| | - | --------------------------------------------------



| |  | recognition of impairment of existing assets.
| | - | ---------------------------------------------



Our future revenue is difficult to predict and we may not be able to adjust spending in response to revenue shortfalls. Our limited operating history with
our current enterprise learning solutions and the emerging nature of the enterprise learning market make prediction of future revenue and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and largely are
fixed in the short term. If we are unable to predict future revenue accurately, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall.



Our business may not generate the cash needed to finance our operations, and for that and other reasons we may need additional financing
in the future, which we may be unable to obtain.



Although
our business generated positive cash flow from operations over the first six months of 2003 and we expect to generate positive cash flow from operations at currently anticipated revenue levels and revenue mix during the second half of 2003, we may
not achieve expected revenue levels or revenue mix and our business may not maintain positive cash flow. If our business does not generate the cash needed to finance our operations, we may need to obtain additional financing or take steps to
restrict our operations in order to conserve existing cash. In addition, poor financial results or unanticipated expenses could give rise to additional financing requirements. We may be unable to obtain financing on terms favorable to us, or at all.
If we need to obtain financing and adequate funds are not available or are not available on acceptable terms, we may be required to make further expense reductions, which could



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significantly restrict our operations and limit our ability to enhance our products, fund expansion, respond to competitive pressures or take advantage of
business opportunities.



A deterioration of general economic conditions may
materially and adversely affect our business.



Our revenue
is subject to fluctuation as a result of general economic conditions and overall spending in the technology and enterprise software sectors. A significant portion of our revenue is derived from the sale of products and services to large companies or
government agencies, which historically have reduced their expenditures for enterprise software applications during economic downturns. In recent quarters, our sales force has experienced increased delays, cancellations or reductions in scope of
sales opportunities as a result of the downturn in the economy. Further war or acts of terrorism may cause the economy to weaken further, which could result in organizations further delaying, canceling, or reducing capital expenditures generally and
spending on enterprise software applications in particular. Such delays, cancellations or reductions could adversely affect our business.



We have a history of losses and may have continued losses in the future.



We incurred a net loss of approximately $1.7 million for the six months ended June 30, 2003. As of June 30, 2003, our accumulated deficit was $231.7
million. Although our business generated positive cash flow from operations over the six-month period ending June 30, 2003, we have not yet achieved profitability and may not do so during 2003. Even if we do achieve profitability, we may be unable
to sustain or increase profitability on a quarterly or annual basis.



We
have a limited operating history with the Aspen suite, which makes it difficult to predict our future performance.



The primary focus of our business is and throughout 2003 will continue to be the Aspen suite. We released the first version of the Aspen suite in
September 2001 and released the first major upgrade in September 2002. Accordingly, we have a limited operating history on which to evaluate our current business and future prospects. Our limited operating history with the Aspen suite makes it
difficult to predict our future performance and may not provide investors with a meaningful basis for evaluating an investment in our common stock.



The enterprise learning software market is in the early stages of development and may not grow to a sufficient size or at a sufficient rate to sustain our business.



The enterprise learning software market is in the early
stages of development, and may not grow to a sufficient size or at a sufficient rate for our business to succeed. Corporate training and education historically have been conducted primarily through classroom instruction. Although technology-based
training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market. Accordingly, our success will depend on the extent to which companies implement enterprise learning
software solutions for the design, development, delivery and management of their corporate learning needs.



Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or
compete with their existing investments. Even if companies implement enterprise learning software solutions, they may still choose to develop such solutions internally. If the use of enterprise learning software does not become widespread or if
companies choose to develop such software internally rather than acquiring it from third parties, then our enterprise learning software may not be commercially successful.



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We face risks encountered in emerging markets and may be unsuccessful in addressing these risks.



We face risks frequently encountered in new and rapidly evolving markets.
Specific risks we face relate to the demand for and market acceptance of our enterprise learning solutions. We may fail to adequately address these risks, and therefore our business may suffer. To address these risks, we must:



| |  | effectively market our enterprise learning software to new and existing customers;
| | - | ----------------------------------------------------------------------------------



| |  | continue to enhance the technology upon which our enterprise learning software is based;
| | - | ----------------------------------------------------------------------------------------



| |  | successfully implement our enterprise learning software for our customers and generate continuing revenue from those customers; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | address and establish new technologies and technology standards.
| | - | ----------------------------------------------------------------



We face intense competition from other enterprise learning software providers and may be unable to compete successfully.



The enterprise learning software market is highly fragmented and competitive, with no single
firm accounting for a dominant market share. Our competitors vary in size, scope and the breadth of products and services offered. We face competition from:



| |  | other developers of enterprise learning systems;
| | - | ------------------------------------------------



| |  | providers of other enterprise software solutions;
| | - | -------------------------------------------------



| |  | large professional consulting firms and in-house IT departments; and
| | - | --------------------------------------------------------------------



| |  | developers of web authoring tools.
| | - | ----------------------------------



There are relatively low barriers to entry in the enterprise learning market and new competitors may enter this market in the future. Increased
competition may result in price reductions, reduced gross margins and loss of market share. We may not be able to contend effectively with such increased competition. In particular, vendors of other enterprise software applications such as
enterprise resource planning, human resource management or customer relationship management have begun to offer learning delivery and management functionality to extend their current product lines within their existing customer base. Although these
offerings may not offer the same functionality as our Aspen suite, bundling these offerings with the remainder of their solutions could diminish our ability to sell our products and services to their customers and announcements by these companies of
future products could delay purchasing decisions by their customers and our prospects, either of which could adversely affect our business.



Certain of our existing and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other
resources and therefore may be able to respond more quickly to new or changing opportunities, technologies, standards and customer requirements or to compete more aggressively on pricing. Price competition would likely result in reduced gross
margins and may prevent the Aspen suite from yielding results sufficient for our business to succeed.



Strategic relationships are important in expanding the distribution reach of companies in the enterprise learning market. If our competitors were to
establish strategic relationships to resell or distribute their products through their strategic partners, our ability to market and sell products and services successfully may be substantially diminished. In addition, the existence or announcement
of strategic relationships involving our competitors could adversely affect our ability to attract and retain customers.



International operations may impose substantial burdens on our resources, divert managements attention or otherwise harm our business.



We rely on independent partners in foreign countries to help conduct our
international operations and sales and marketing efforts. Our success in international markets consequently will depend to a large



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degree on the success of these independent partners, over which we have little control. If they are unwilling or unable to dedicate sufficient resources to
our relationships, our international operations will suffer.



We rely on our operations in Hyderabad, India to enable us to complete customer implementation projects and new releases of the Aspen suite on time and within our established budgets. Should our operations in Hyderabad be disrupted for any
significant period of time, it could prevent us from completing customer implementations or new releases of the Aspen suite in a timely manner, which could cause our business to suffer.



Our efforts in Hyderabad and elsewhere abroad are subject to a number of risks inherent in international operations,
including:



| |  | diversion of management attention;
| | - | ----------------------------------



| |  | difficulties and costs of staffing and managing foreign offices;
| | - | ----------------------------------------------------------------



| |  | different learning styles and cultures;
| | - | ---------------------------------------



| |  | numerous and potentially conflicting regulatory requirements;
| | - | -------------------------------------------------------------



| |  | export controls, import tariffs and other barriers to trade;
| | - | ------------------------------------------------------------



| |  | changes in laws or governmental policies;
| | - | -----------------------------------------



| |  | reduced protection of intellectual property rights;
| | - | ---------------------------------------------------



| |  | regional political and economic instability; and
| | - | ------------------------------------------------



| |  | fluctuations in currency exchange rates.
| | - | ----------------------------------------



Our debt covenants may significantly restrict our operations.



We are subject to numerous covenants in our agreement with Silicon Valley Bank that impose financial and operating restrictions on our business if we wish
to maintain availability of the credit facility. These restrictions may affect our ability to operate our business, may limit our ability to take advantage of potential business opportunities as they arise, and may adversely affect the conduct of
our current business. These covenants place restrictions on our ability to, among other things:



| |  | incur debt with parties other than Silicon Valley Bank;
| | - | -------------------------------------------------------



| |  | pay dividends, redeem or repurchase our stock or make other distributions;
| | - | --------------------------------------------------------------------------



| |  | make acquisitions or investments;
| | - | ---------------------------------



| |  | engage in new or different businesses;
| | - | --------------------------------------



| |  | change our capital structure;
| | - | -----------------------------



| |  | use assets as security in other transactions;
| | - | ---------------------------------------------



| |  | enter into transactions with affiliates or outside the ordinary course of business;
| | - | -----------------------------------------------------------------------------------



| |  | merge or consolidate with others or acquire assets outside the ordinary course of business;
| | - | -------------------------------------------------------------------------------------------



| |  | dispose of assets or use asset sale proceeds;
| | - | ---------------------------------------------



| |  | create liens on our assets; and
| | - | -------------------------------



| |  | extend or guaranty credit.
| | - | --------------------------



In addition, the terms of our indebtedness require that we meet certain financial covenants related to maximum net losses and minimum tangible net worth.
The covenants governing our existing indebtedness restrict our operations and those of our subsidiaries, and these limitations could impair our ability to meet such financial covenants. In addition, our ability to meet these financial covenants and
to comply with other provisions governing our indebtedness may be affected by changes in economic or business conditions or other events beyond our control. Moreover, failure to comply with our debt-related obligations could result in an event of
default that, if not cured or waived, could result in an acceleration of our indebtedness. We are currently in compliance with these covenants, but we cannot assure you that we will not violate these covenants in the future. In the past, we have on
occasion violated certain of the covenants under our loan agreements with Silicon Valley Bank and the bank has waived those violations



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without cost to us. However, we cannot assure you that the bank will waive any future violations at no cost to us, or at all.



Moreover, because the amount available for borrowing under our agreement is
based on our eligible accounts receivable, we may from time to time become over-advanced under the line of credit if our eligible accounts receivable decrease, either because they have been collected but not applied against the existing obligations
or because they have become ineligible under the terms of the agreement. In such a case we may be required to immediately repay a portion of the amount borrowed sufficient to bring the total amount owed to no more than the total availability under
the loan facility.



The loss of the services of our senior executives and
key personnel would likely cause our business to suffer.



Our success depends to a significant degree on the performance of the senior management team and other key employees. The loss of any of these individuals could harm our business. We do not have employment agreements with several of our
executives or with any other key employees, and we do not maintain key person life insurance for any officers or key employees.



Our success also depends on our ability to attract, integrate, motivate and retain highly skilled technical, sales and marketing and professional services
personnel. Competition for qualified personnel in the enterprise software industry is intense. To the extent we are unable to attract and retain skilled personnel our business will suffer.



Our Aspen suite is a new product and may contain defects or otherwise perform improperly.



Our Aspen suite was initially released in September 2001,
and the first major version upgrade was released in September 2002. We anticipate continuing to add new features, functionality and components. Complex enterprise software products frequently contain errors or failures, especially when first
introduced or when new versions are released. Because the Aspen products are complex software packages with new features and functionality being added and new versions being released on a regular basis, there is a greater likelihood that they may
contain such errors. In addition, since the Aspen suite is targeted at enterprise customers with large numbers of users, customers and potential customers may have a greater sensitivity to product defects or product integration than the market for
software products generally. To date we have experienced errors in the Aspen platform, in particular when new versions or functionality is first released, although such errors have not had a material impact on our business and generally have been
corrected shortly after discovery. Although we have not experienced this to date, serious product errors could result in loss of revenue or delay in market acceptance, diversion of development resources, damage to our reputation, or increased
service and warranty costs.



We may not be able to adapt to rapidly changing
technology and evolving industry standards.



The enterprise
learning software market is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. The introduction of new products and services embodying new
technologies and the emergence of new industry standards may render our products and services obsolete. Our success depends on our ability to adapt to a rapidly changing landscape and to offer new products and services to address our customers
changing demands. We may experience difficulties that delay or prevent the successful design, development, introduction or marketing of our products and services. To the extent we in fact experience such delays, we may experience difficulty in
attracting new customers and may lose existing customers.



If we are unable
to build the Click2learn and Aspen brands, we may be unable to grow our business.



We believe that establishing and maintaining the Click2learn and Aspen brands will be critical to the success of our enterprise learning strategy and that the importance of brand recognition will increase as



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the market for enterprise learning software products grows. If our brand building strategy is unsuccessful, our business could be materially harmed.



We face the risk of liability for failures to meet unique customer
requirements, and the risk of cost overruns on fixed-price projects.



The failure or inability to meet a customers unique expectations or requirements in the performance of services could impair our reputation or result in a claim for damages, regardless of our responsibility for
the failure. Although generally we attempt to limit contractually our liability for damages arising from product defects and other mistakes in rendering professional services, these contractual protections are not always obtained and may not be
enforced or otherwise may not protect us from liability. Our insurance may not be sufficient to cover these claims. In addition, most of our professional services projects are performed on a fixed-price basis rather than on a time and materials
basis. If we do not complete fixed-price engagements within budget, on time and to clients satisfaction, we bear the risk of cost overruns.



Security and privacy breaches could subject us to litigation and liability.



We host certain of our customers enterprise learning software implementations at our data center and provide access to
that software using the Internet. The Internet is a public network and data is sent over this network from many sources. Although we take reasonable steps in accordance with current industry practices to ensure the security of our hosting systems
and customer data, computer viruses could be introduced into our systems or those of our customers, which could disrupt the operation of our hosting systems or make them inaccessible to users. We depend on Internet service providers and
telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations. Each of these has experienced significant outages in the past and
could experience outages, delays and other difficulties due to system failures unrelated to our systems, which could cause our customers to believe we were at fault and withhold payments due to us.



We could become subject to litigation and liability if third parties
penetrate security for our hosting systems or otherwise misappropriate our users confidential information or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new discoveries in the
field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or cause interruptions in
our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service interruptions.



Acquisitions or investments may drain capital and equity resources, divert
managements attention or otherwise harm our business.



In the future we may acquire or make investments in other businesses, products or technologies. Such acquisitions or investments may require that we pay significant cash, issue stock or incur substantial debt. In addition, such acquisitions
or investments may require significant managerial attention, which may be diverted from our other operations. These capital, equity and managerial commitments may impair the operation of our business. Furthermore, acquired businesses may not be
effectively integrated, may be unable to maintain key pre-acquisition business relationships, may contribute to increased fixed costs and may expose us to unanticipated liabilities.



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Our intellectual property may become subject to legal challenges, unauthorized use or infringement, any of which could
diminish the value of our products and services.



Our
success depends in large part on our proprietary technology. We rely on a combination of copyrights, trademarks, trade secret laws, restrictions on disclosure and other methods to protect our proprietary technology. We do not have patents for any of
the technology underlying our Aspen platform. If we fail to successfully enforce our intellectual property rights, the value of these rights, and consequently the value of our products and services to our customers, could diminish substantially. It
may be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization, and it may be possible for third parties to independently develop substantially equivalent intellectual
property.



Litigation may be necessary in the future to enforce
our intellectual property rights, to protect trade secrets or to determine the validity and scope of the proprietary rights of others. From time to time we have received, and may in the future receive, notice of claims of infringement of other
parties proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. They could also delay product shipment or require us to develop non-infringing technology or enter into royalty or
licensing agreements, which agreements may not be available on reasonable terms, or at all.



Our products include third-party technology, the loss of which could materially harm our business.



We use some licensed third-party technology components in our products. Future licenses to this technology may not be available to us on commercially
reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or could force us to discontinue offering portions of our enterprise learning
solutions until equivalent technology, if available, is identified, licensed and integrated. Furthermore, we may become subject to legal claims related to licensed technology based on product liability, infringement of intellectual property or other
legal theories.



Our stock price has been and may continue to be volatile.



The trading price of our common stock has been and is
likely to continue to be highly volatile. For example, during the 52-week period ended June 30, 2003, the price of our common stock ranged from $0.23 to $4.90 per share. Our stock price is subject to continued fluctuations in response to a number of
factors, including:



| |  | actual or anticipated variations in quarterly operating results;
| | - | ----------------------------------------------------------------



| |  | changes in financial estimates or recommendations by securities analysts;
| | - | -------------------------------------------------------------------------



| |  | conditions or trends in the learning and enterprise software markets;
| | - | ---------------------------------------------------------------------



| |  | announcements by us or our competitors of significant customer wins, technological innovations, new products or services;
| | - | -------------------------------------------------------------------------------------------------------------------------



| |  | announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| |  | additions or departures of key personnel;
| | - | -----------------------------------------



| |  | sales of our common stock; and
| | - | ------------------------------



| |  | general market conditions.
| | - | --------------------------



The stock market in general, and the market for enterprise software and technology companies in particular, recently has experienced extreme price and
volume fluctuations that have been unrelated or disproportionate to the operating performance of many of the affected companies. These broad market and industry factors may depress our stock price, regardless of our operating performance.



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In the past, companies that have experienced volatility in the market price of their stock have been
subject to securities class action litigation. We may be the targets of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our managements attention, which could seriously harm
our business.



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



Market Rate Risk.We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.



Interest Rate Risk.We hold our assets primarily in cash and cash equivalents, such as short-term marketable debt securities, money market funds and other cash equivalents. We minimize risk by investing in financial instruments with
maturity of three months or less. As a result, if market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2002, the fair value of cash and cash equivalents would not change by a material amount.



Foreign Currency Exchange Risk.We have foreign
currency risk as a result of foreign subsidiary activities. For the three and six months ended June 30, 2003, international revenue from foreign subsidiaries accounted for approximately 9% and 8%, respectively, of total revenue. All foreign
subsidiaries use the local currency as their functional currency.



Our exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which costs incurred in the United States are charged to the foreign subsidiaries. These intercompany accounts are typically denominated in the
functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are
translated in U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations for the six months
ended June 30, 2003 was not material. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results.



|Item 4. |  | Controls and Procedures
|------- |  | -----------------------



Click2learn maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to
the Securities Exchange Act of 1934 (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms. Our principal executive and
financial officers have evaluated our disclosure controls and procedures as of the end of the period covered by this report and have determined that such disclosure controls and procedures are effective.



No changes were made to our internal control over financial reporting in
connection with this evaluation that has materially affected, or is reasonably like to materially affect, our internal control over financial reporting.



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PART IIOTHER INFORMATION



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



Not applicable.



|Item 2. |  | Changes In Securities and Use of Proceeds
|------- |  | -----------------------------------------



On June 20, 2003, we sold to certain accredited investors a total of 7,460,644 shares of our common stock at a price of $1.668 per share in a private
placement transaction. We also sold warrants to purchase 2,611,225 shares of common stock at an exercise price of $1.90 per share. The purchase price for the warrants was $0.125 per warrant. Craig-Hallum Capital Group LLC acted as placement agent in
the transaction. The aggregate offering price for the shares and warrants was approximately $12,771,000 and the placement agent received a fee of $703,392 for its services along with warrants for the purchase of an additional 373,032 shares on the
same terms as the warrants issued to investors.



The sale of
shares and warrants was made only to accredited investors pursuant to Rule 506 of Regulation D under the Securities Act of 1933 as amended (the Act) and was therefore exempt under the Act. A registration statement on Form S-3 was filed
subsequent to the end of the fiscal quarter with respect to the resale of the shares sold in the private placement and issuable upon exercise of warrants.



The warrants have a term of five years. They become exercisable on December 21, 2003 and remain exercisable at any time prior to their expiration in whole
or in part upon the payment of the exercise price for the number of shares with respect to which the warrants are being exercised. In addition, the warrants may be exercised on a net exercise basis, pursuant to which the exercise price for an
exercise of warrants is paid by the cancellation of a portion of the shares being exercised having a fair market value equal to the exercise price for all the shares being exercised. However, a net exercise may only be made if there is not an
effective registration statement in place on the date of such exercise covering the resale of the warrant shares and the warrant shares cannot be resold pursuant to Rule 144(k).



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



Not applicable.



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



The 2003 Annual Meeting of the Stockholders of Click2learn was held on May 28, 2003 at 110 110thAvenue NE, Bellevue, Washington. The meeting was held pursuant to a Notice of Annual Meeting of Stockholders mailed to the stockholders on or about April 23,
2003. Two proposals were submitted to the stockholders and approved at the annual meeting, as follows:



Proposal 1:Election of Kevin M. Oakes, Ronald S. Posner and Jonathan Morgan as Class II directors to serve until the annual meeting of the
stockholders to be held in 2006. The number of votes cast for or withheld from each nominee, both in person and by proxy, was as follows:



|               |  |                |  |                  |  |                
|-------------- |  | -------------- |  | ---------------- |  | ---------------
|               |  | Kevin M. Oakes |  | Ronald S. Posner |  | Jonathan Morgan
|Votes For      |  | 21,351,985     |  | 18,294,674       |  | 21,625,035     
|Votes Withheld |  | 309,455        |  | 3,366,766        |  | 36,405         



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Proposal 2:Ratification of the appointment of KPMG LLP as our independent accountants to perform
the audit of our financial statements for 2003. The number of votes cast for, cast against or abstaining from Proposal 2, both in person and by proxy, was as follows:



|              |  |           
|------------- |  | ----------
|Votes For     |  | 21,648,758
|Votes Against |  | 5,105     
|Abstaining    |  | 7,577     



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



Changes to Audit Committee.On July 2, 2003, Ronald S. Posner resigned as a member and as Chairman of the Audit Committee. Mr. Posner
resigned from the Audit Committee because his current schedule did not permit him to devote the time he felt was appropriate to devote as a member of the Audit Committee. There has been no disagreement between Click2learn and Mr. Posner on any
matter relating to Click2learns policies or practices. As a result of Mr. Posners resignation, the Board reduced the size of the Audit Committee from four directors to three and appointed Jonathan Morgan as Chairman. Mr. Posner will
continue to serve as a member of the Board.



|Item 6. |  | Exhibits and Reports on Form 8-K
|------- |  | --------------------------------



| | (a) | Exhibits.
| | --- | ---------



|      |        |  |                                                                                                                                                                              
|----- | ------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.01 | (1)(2) |  | Employment Agreement dated as of June 26, 2003 between Click2learn and Sudheer Koneru.                                                                                       
|      |       
|10.02 | (1)(2) |  | Employment Agreement dated as of June 26, 2003 between Click2learn and Srinivasan Chandrasekar.                                                                              
|      |       
|31.1  |        |  | Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|      |       
|31.2  |        |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                           
|      |       
|32.1  |        |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

|(1) | Previously filed with Click2learns quarterly report on Form 10-Q for the quarter ended June 30, 2003.
|--- | ------------------------------------------------------------------------------------------------------

|(2) | Management contract or compensatory plan or arrangement.
|--- | --------------------------------------------------------



| | (b) | Reports on Form 8-K.
| | --- | --------------------



A report on Form 8-K dated June 20, 2003 was filed announcing the private placement to accredited investors of 7,460,000 shares of our
common stock and warrants to purchase an additional 2,611,225 shares of our common stock. No financial statements were filed with such report.



A report on Form 8-K dated June 2, 2003 was filed announcing changes to the executive management team. No financial statements were filed
with such report.



A report on Form 8-K dated
April 24, 2003 was filed announcing results of operations for the three months ended March 31, 2003. No financial statements were filed with such report.



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SIGNATURES



Pursuant to the
requirements 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.



|                       |  |  |                                                                                                                                            |                       
|---------------------- |  |  | ------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------
|                       |  |  |                                                                                                                                            | CLICK2LEARN, INC.     
|                       |  | 
|February 10, 2004 Date |  |  |                                                                                                                                            | /s/    John D. Atherly
|                       |  |  |                                                                                                                                           
|                       |  |  | John D. AtherlyVice President, Finance and Administrationand Chief Financial Officer(Duly Authorized Officer and Chief Accounting Officer)



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Exhibit List



|      |        |  |                                                                                                                                                                              
|----- | ------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      |       
|10.01 | (1)(2) |  | Employment Agreement dated as of June 26, 2003 between Click2learn and Sudheer Koneru.                                                                                       
|      |       
|10.02 | (1)(2) |  | Employment Agreement dated as of June 26, 2003 between Click2learn and Srinivasan Chandrasekar.                                                                              
|      |       
|31.1  |        |  | Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|      |       
|31.2  |        |  | Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|      |       
|32.1  |        |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



|(1) | Previously filed on Click2learns quarterly report on Form 10-Q for the quarter ended June 30, 2003.
|--- | ----------------------------------------------------------------------------------------------------



|(2) | Management contract or compensatory plan or arrangement.
|--- | --------------------------------------------------------



31