** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

**(Mark One)**
| ý                                                | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                  |                                                                                          |   |
| **For the quarterly period ended September 30, 2001** |
|                                                  |                                                                                          |   |
| **or**                                                |
|                                                  |                                                                                          |   |
| o                                                     | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number 000-24289**

**CLICK2LEARN, INC.******(Exact nameof registrant as specified in its charter)

 
| **Delaware**                                                    | **91-1276003**                       |
|-----------------------------------------------------------------|--------------------------------------|
| (State or  other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
|                                                            |                                 |
| **110-110th Avenue 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 theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yesý       No o

The number of shares outstanding ofthe issuer’s Common Stock, par value $0.01, as of September 30, 2001 was20,424,009 shares.

**CLICK2LEARN, INC.**

**FORM 10 –Q**

**For the Quarter Ended September30, 2001**

**TABLE OF CONTENTS**

 
| **PART  I – FINANCIAL INFORMATION** |   |                                                                                                              |
|------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------|
|                                     |   |                                                                                                              |   |   |
| Item  1.                                 |   | Financial  Statements                                                                                             |   |   |
|                                     |   |                                                                                                              |   |   |
|                                     |   | Condensed Consolidated  Balance Sheets as of September 30, 2001 and December 31, 2000                             |   |   |
|                                     |   |                                                                                                              |   |   |
|                                     |   | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2001 and 2000 |   |   |
|                                     |   |                                                                                                              |   |   |
|                                     |   | Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2001 and 2000           |   |   |
|                                     |   |                                                                                                              |   |   |
|                                     |   | Notes  to Condensed Consolidated Financial Statements                                                             |   |   |
|                                     |   |                                                                                                              |   |   |
| Item  2.                                 |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |   |   |
|                                     |   |                                                                                                              |   |   |
| Item  3.                                 |   | Quantitative  and Qualitative Disclosures About Market Risk                                                       |   |   |
|                                     |   |                                                                                                              |   |   |
| **PART  II– OTHER INFORMATION**     |   |                                                                                                              |
|                                     |   |                                                                                                              |   |   |
| Item 1.                                  |   | Legal Proceedings                                                                                                 |   |   |
|                                     |   |                                                                                                              |   |   |
| Item 2.                                  |   | Change in Securities and Use of  Proceeds                                                                         |   |   |
|                                     |   |                                                                                                              |   |   |
| Item 3.                                  |   | Defaults upon Senior Securities                                                                                   |   |   |
|                                     |   |                                                                                                              |   |   |
| Item 4.                                  |   | Submission of Matters to a Vote of  Securities Holders                                                            |   |   |
|                                     |   |                                                                                                              |   |   |
| Item 5.                                  |   | Other Information                                                                                                 |   |   |
|                                     |   |                                                                                                              |   |   |
| Item 6.                                  |   | Exhibits  and Reports on Form 8-K                                                                                 |   |   |
|                                     |   |                                                                                                              |   |   |
| **SIGNATURES**                           |   |                                                                                                              |

**CLICK2LEARN, INC.CONDENSED CONSOLIDATED BALANCESHEETS(In thousands)**
|                                                                                                           |   | **September 30, 2001** |   | **December 31, 2000** |   |
|----------------------------------------------------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                                                                                           |   |                   |   |                  |   |
| **Assets**                                                                                                     |   |                   |   |                  |   |
|                                                                                                           |   |                   |   |                  |   |
| Current assets:                                                                                                |   |                   |   |                  |   |
| Cash  and cash equivalents                                                                                     |   | $                      | 2,885  |                  | $      | 15,321 |   |
| Accounts receivable, net of allowance for  returns and doubtful accounts of $998 in 2001 and $962 in 2000 |   | 19,442                 |   | 14,969                |   |
| Inventories                                                                                                    |   | 79                     |   | 192                   |   |
| Prepaid royalties and licenses                                                                                 |   | 126                    |   | 237                   |   |
| Receivables from related companies                                                                             |   | 12                     |   | 11                    |   |
| Other                                                                                                          |   | 1,469                  |   | 894                   |   |
| Total current assets                                                                                           |   | 24,013                 |   | 31,624                |   |
| Property and equipment, net                                                                                    |   | 3,494                  |   | 2,695                 |   |
| Goodwill and other intangible assets, net                                                                      |   | 13,324                 |   | 10,006                |   |
| Other                                                                                                          |   | 897                    |   | 555                   |   |
| Total assets                                                                                                   |   | $                      | 41,728 |                  | $      | 44,880 |   |
|                                                                                                           |   |                   |   |                  |   |
|                                                                                                           |   |                   |   |                  |   |
| **Liabilities and Stockholders’  Equity**                                                                 |   |                   |   |                  |   |
|                                                                                                           |   |                   |   |                  |   |
| Current  liabilities:                                                                                          |   |                   |   |                  |   |
| Accounts payable                                                                                               |   | $                      | 3,308  |                  | $      | 2,978 |   |
| Accrued compensation and benefits                                                                              |   | 3,529                  |   | 3,810                 |   |
| Deferred revenue                                                                                               |   | 2,248                  |   | 1,680                 |   |
| Customer prepayments                                                                                           |   | 129                    |   | 428                   |   |
| Other                                                                                                          |   | 1,480                  |   | 927                   |   |
| Total current liabilities                                                                                      |   | 10,694                 |   | 9,823                 |   |
| Other noncurrent liabilities                                                                                   |   | 500                    |   | 4                     |   |
| Total liabilities                                                                                              |   | 11,194                 |   | 9,827                 |   |
|                                                                                                           |   |                   |   |                  |   |
| Stockholders’ equity:                                                                                     |   |                   |   |                  |   |
| Preferred stock                                                                                                |   | -                      |   | -                     |   |
| Common stock                                                                                                   |   | 205                    |   | 180                   |   |
| Additional paid-in capital                                                                                     |   | 233,750                |   | 227,766               |   |
| Accumulated deficit                                                                                            |   | (202,815               | )      | (192,313              | )      |
| Deferred stock compensation                                                                                    |   | (29                    | )      | (72                   | )      |
| Accumulated other comprehensive loss                                                                           |   | (577                   | )      | (508                  | )      |
| Total stockholders’ equity                                                                                |   | 30,534                 |   | 35,053                |   |
|                                                                                                           |   |                   |   |                  |   |
| Total liabilities and stockholders’ equity                                                                |   | $                      | 41,728 |                  | $      | 44,880 |   |

Seeaccompanying notes to Condensed Consolidated Financial Statements

**CLICK2LEARN,INC.CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS(In thousands)**
|                                                           |   | **Three months ended****September 30,** |   | **Nine months ended****September 30,** |   |
|----------------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
|                                                           |   | **2001**                                |   | **2000**                               |   | **2001** |   | **2000** |   |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Revenue:                                                       |   |                                    |   |                                   |   |   |   |   |   |
| Tools                                                          |   | $                                       | 1,711  |                                   | $      | 1,808 |   | $ | 5,538 |   | $ | 6,533 |   |
| Content  services                                              |   | 3,466                                   |   | 6,048                                  |   | 14,361 |   | 16,064 |   |
| Platforms                                                      |   | 6,059                                   |   | 3,211                                  |   | 13,688 |   | 8,765 |   |
| Total  revenue                                                 |   | 11,236                                  |   | 11,067                                 |   | 33,587 |   | 31,362 |   |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Cost  of revenue:                                              |   |                                    |   |                                   |   |   |   |   |   |
| Tools                                                          |   | 438                                     |   | 430                                    |   | 1,374 |   | 1,412 |   |
| Content  services                                              |   | 3,820                                   |   | 4,721                                  |   | 13,607 |   | 12,824 |   |
| Platforms                                                      |   | 952                                     |   | 424                                    |   | 2,391 |   | 1,344 |   |
| Total  cost of revenue                                         |   | 5,210                                   |   | 5,575                                  |   | 17,372 |   | 15,580 |   |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Gross margin                                                   |   | 6,026                                   |   | 5,492                                  |   | 16,215 |   | 15,782 |   |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Operating expenses:                                            |   |                                    |   |                                   |   |   |   |   |   |
| Research and development                                       |   | 2,180                                   |   | 2,203                                  |   | 6,663 |   | 6,977 |   |
| Sales and marketing                                            |   | 4,546                                   |   | 6,974                                  |   | 14,205 |   | 15,962 |   |
| General and administrative                                     |   | 1,580                                   |   | 1,589                                  |   | 4,815 |   | 4,612 |   |
| Amortization of goodwill                                       |   | 473                                     |   | 235                                    |   | 1,023 |   | 705 |   |
| Total operating expenses                                       |   | 8,779                                   |   | 11,001                                 |   | 26,706 |   | 28,255 |   |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Loss from operations                                           |   | (2,753                                  | )      | (5,509                                 | )      | (10,491 | ) | (12,473 | ) |
| Other income, net                                              |   | 33                                      |   | 240                                    |   | 288 |   | 785 |   |
| Equity in losses of affiliate                                  |   | (100                                    | )      | (170                                   | )      | (300 | ) | (340 | ) |
| Net loss                                                       |   | $                                       | (2,820 | )                                      | $      | (5,439 | ) | $ | (10,503 | ) | $ | (12,029 | ) |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Net loss per share, basic and diluted                          |   | $                                       | (.014  | )                                      | $      | (0.32 | ) | $ | (0.55 | ) | $ | (0.72 | ) |
|                                                           |   |                                    |   |                                   |   |   |   |   |   |
| Weighted average common shares outstanding,  basic and diluted |   | 20,281                                  |   | 17,127                                 |   | 19,037 |   | 16,769 |   |

See accompanying notes to CondensedConsolidated Financial Statements

**CLICK2LEARN,INC.CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(In thousands)**
|                                                                         |   | **Nine months Ended  September 30,** |    |
|------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                         |   | **2001**                             |    | **2000** |   |
| Cash flows from operating activities:                                        |   |                                 |    |   |   |
| Net loss                                                                     |   | $                                    | (10,503 | ) | $ | (12,029 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities: |   |                                 |    |   |   |
| Depreciation and amortization                                                |   | 2,535                                |    | 1,914 |   |
| Write-off property and equipment                                             |   | -                                    |    | 1 |   |
| Stock compensation expense                                                   |   | 96                                   |    | 56 |   |
| Loss on affiliate                                                            |   | 300                                  |    | 340 |   |
| Changes in assets and liabilities:                                           |   |                                 |    |   |   |
| Accounts receivable                                                          |   | (4,378                               | )       | (2,586 | ) |
| Inventories                                                                  |   | 113                                  |    | 40 |   |
| Prepaid royalties and licenses                                               |   | 111                                  |    | (110 | ) |
| Receivables from related companies                                           |   | -                                    |    | 11 |   |
| Other current assets                                                         |   | (574                                 | )       | 1,387 |   |
| Accounts payable                                                             |   | (333                                 | )       | 1,316 |   |
| Accrued liabilities                                                          |   | (280                                 | )       | 1,324 |   |
| Deferred revenue                                                             |   | 568                                  |    | (150 | ) |
| Other current liabilities                                                    |   | (246)                                |    | (474 | ) |
| Net cash used in operating activities                                        |   | (12,591                              | )       | (8,960 | ) |
|                                                                         |   |                                 |    |   |   |
| Cash flows from investing activities:                                        |   |                                 |    |   |   |
| Purchase of property and equipment                                           |   | (1,779                               | )       | (1,526 | ) |
| Payments related to acquisitions, net of cash  acquired                      |   | 112                                  |    | - |   |
| Investment in Click2learn Japan KK                                           |   | (639                                 | )       | (740 | ) |
| Sale (purchase) of other assets                                              |   | (3                                   | )       | 159 |   |
| Net cash used in investing activities                                        |   | (2,309                               | )       | (2,107 | ) |
|                                                                         |   |                                 |    |   |   |
| Cash flows from financing activities:                                        |   |                                 |    |   |   |
| Borrowings under (repayment) of notes  and loans payable                |   | 996                                  |    | 14 |   |
| Proceeds from exercise of stock options and  stock purchase plan             |   | 1,538                                |    | 5,273 |   |
| Net cash provided by financing activities                                    |   | 2,534                                |    | 5,287 |   |
| Effect of foreign exchange rate changes                                      |   | (70                                  | )       | (175 | ) |
| Net decrease in cash and cash equivalents                                    |   | (12,436                              | )       | (5,955 | ) |
| Cash and cash equivalents at beginning of  period                            |   | 15,321                               |    | 19,481 |   |
| Cash and cash equivalents at end of period                                   |   | $                                    | 2,885   |   | $ | 13,526 |   |

See accompanying notes to Condensed ConsolidatedFinancial Statements

**CLICK2LEARN,INC.NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSSEPTEMBER 30, 2001 AND 2000**

**UnauditedInterim Financial Information**

             Theaccompanying unaudited condensed consolidated financial statements ofClick2learn, Inc. (“Click2learn”) include the accounts of Click2learn and itswholly-owned subsidiaries.  Allsignificant intercompany transactions have been eliminated in consolidation.These statements reflect all normal recurring adjustments which are, in theopinion of management, necessary for a fair presentation of the financialposition and results of operations for the periods presented.  These condensed consolidated financialstatements and notes should be read in conjunction with Click2learn’s auditedconsolidated financial statements included in Click2learn’s Annual Report onForm 10-K for the fiscal year ended December 31, 2000. Certain information andfootnote disclosures normally included in financial statements prepared inconformity with generally accepted accounting principles have been condensed oromitted pursuant to the rules and regulations of the Securities and ExchangeCommission. Interim results of operations for the three and nine months endedSeptember 30, 2001 are not necessarily indicative of the operating results forthe full fiscal year.  Factors that mayaffect such operating results, include, but are not limited to, those discussedin **“FactorsThat May Affect Future Results of Operations”**.

**Net Loss Per Share**

             Basicnet loss per share is computed by dividing the net loss by the weighted averagenumber of common shares outstanding during the period.  Diluted earnings per share is computed bydividing the net loss by the weighted average number of common and dilutiveshares outstanding during the period. As Click2learn had a net loss in each ofthe periods presented, basic and diluted net loss per share are the same.

             Excludedfrom the computation of diluted earnings per share for the three and ninemonths ended September 30, 2001 are options to acquire approximately 5,471,945shares of common stock with a weighted average exercise price of $6.92 andwarrants to purchase 1,621,652 shares of common stock with a weighted averageexercise price of $9.36 because their effects would be anti-dilutive. Optionsto acquire approximately 5,064,307 shares of common stock with a weightedaverage exercise price of $8.96 and warrants to purchase 1,426,313 shares ofcommon stock with a weighted exercise share price of $8.61 have been excludedfrom the computation of diluted earnings per share for the three and ninemonths ended September 30, 2000 because their effects would be anti-dilutive.

**Revenue Recognition**

             Click2learnrecognizes revenue in accordance with Statement of Position 97-2 (“SOP 97-2”), *SoftwareRevenue Recognition*, issued by the American Institute of CertifiedPublic Accountants, which, as modified, stipulates that revenue recognized fromsoftware arrangements is to be allocated to each element of the arrangementbased upon the relative fair values of the elements, such as software products,upgrades, enhancements, post-contract customer support, installation ortraining, using evidence which is specific to the vendor.  If such evidence of fair value for eachelement does not exist, all revenue from the arrangement is deferred until suchtime that fair value does exist or until all elements are delivered.  Revenue from software licenses is recognizedupon shipment provided no significant obligations remain outstanding andcollection of the resulting receivable is probable.  An allowance for returns is provided at the time of thesale.  Revenue from support agreementsis recognized over the life of the contract.

             Professionalservices revenue is recognized from fixed price contracts as services areprovided or by using the percentage-of-completion method of accounting, basedon the ratio of costs incurred to the total estimated project cost, forindividual fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made inthe period in which such losses become evident.

             Revenuefrom the e-Learning Network includes site fees, hosting, royalties, and contentsales. The revenues are determined by individual contracts, one to three yearsin length, which specify functionality of the site and the commerce conductedon the site. The e-Learning Network fees are recognized ratably over the lifeof the contract.  Royalty revenue isrecognized as earned. Content revenue is either recognized evenly over the lifeof the contract for course usage on bundled curriculum courses or recognized atthe time of the purchase of individual e-Learning courses.   Revenues from tangible goods, includingbooks, videotapes and CD-ROMs are recognized at the time of shipment.

**Comprehensive Loss**

             Thefollowing table sets forth the components of comprehensive loss for the periodspresented below:
|                                     |   | **Three Months   Ended September 30,** |       | **Nine months Ended   September 30,** |       |
|------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                     |   | **2001**                               |       | **2000**                              |       | **2001** |   | **2000** |   |
|                                     |   |                                   | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Net  loss                                |   | $                                      | (2,820     | )                                     | $          | (5,439 | ) | $ | (10,503 | ) | $ | (12,029 | ) |
| Foreign  currency translation adjustment |   | (11                                    | )          | (33                                   | )          | (70 | ) | (175 | ) |
| Total  comprehensive loss                |   | $                                      | (2,831     | )                                     | $          | (5,472 | ) | $ | (10,573 | ) | $ | (12,204 | ) |

** **

**DerivativeFinancial Instruments**

             Effective January 1, 2001, Click2learn adopted Statementof Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities” (“SFAS 133”).  The adoption of SFAS 133 did not impact Click2learn’sconsolidated financial statements as of January 1, 2001.

             SFAS 133, as amended, requires that all derivativeinstruments be recorded on the balance sheet at fair value.  Changes in the fair value of derivatives arerecorded each period in current results of operations or other comprehensiveincome (loss) depending on whether a derivative is designated as part of ahedge transaction, and if so, the type of risk being hedged.

             For a derivative designated as a fair value hedge, thegain or loss of the derivative in the period of change and the offsetting lossor gain of the hedged item attributed to the hedged risk are recognized inresults of operations.  For a derivativedesignated as a cash flow hedge, the effective portion of the derivative’s gainor loss is initially reported as a component of other comprehensive income(loss) and subsequently reclassified into results of operations when the hedgedexposure affects results of operations. The ineffective portion of the gain or loss of a cash flow hedge isrecognized immediately in results of operations.  For a derivative not designated as a hedging instrument, the gainor loss is recognized in results of operations in the period of change.

             Click2learn had no derivative financial instrumentsoutstanding at September 30, 2001.

**Recent AccountingPronouncements**

             InJuly 2001, the Financial Accounting Standards Board issues Statement No. 141"Business Combinations" and Statement No. 142 "Goodwill andOther Intangible Assets." Statement No. 141 requires business combinationsinitiated after June 30, 2001 to be accounted for using the purchase method ofaccounting, and specifies criteria for recognizing intangible assets acquiredin a business combination. Statement No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized, butinstead be tested for impairment at least annually. Intangible assets withdefinite useful lives will continue to be amortized over their respectiveestimated useful lives. Click2learn plans to adopt the provisions of StatementNo. 141 and 142 effective January 1, 2002. Because of the extensive effortneeded to comply with adopting Statements 141 and 142, it is not practicable toreasonably estimate the impact of adopting these Statements on Click2learn'sfinancial statements at the date of this report, including whether anytransitional impairment losses will be required to be recognized as thecumulative effect of a change in accounting principle.

**Acquisition ofIntelliPrep Technologies, Inc.**

             InJune 2001, Click2learn completed its acquisition of IntelliPrep Technologies,Inc. (“IntelliPrep”), a provider of technology for personalized learning for1,812,497 shares of common stock and 450,000 options to acquire its commonstock valued at $4,419,688.  Inconnection with the acquisition, Click2learn incurred approximately $600,000 inacquisition-related expenditures of which $301,000 was unpaid as of September30, 2001.  The acquisition was accountedfor under the purchase method of accounting and accordingly, the results ofIntelliPrep’s operations are included in Click2learn’s consolidated financialstatements since the date of acquisition. Goodwill and other identifiable intangible assets of $4,710,061 wasrecorded in connection with the transaction and will be amortized using thestraight-line method over estimated useful lives of to five years up to thedate that Click2learn is required to adopt Statement 142.

**Segment Information**

             Duringmost of 2000, Click2learn had two reportable segments, enterprise andelectronic commerce.  The enterprisesegment included revenues and cost of revenues from software licenses andprofessional services which included consulting, custom development ofe-Learning courses, implementation, training and technical support for Ingeniumand ToolBook II product lines.  Theelectronic commerce segment included revenues and cost of revenues from oure-Learning Network, which included professional services, royalties, andhosting.

             During the fourth quarter of 2000, Click2learnreorganized its internal reporting along similar products and services and nowincludes three reportable segments: Tools, Content Services and Platforms. Tools include software licenses and technical support and training forthe ToolBook II product line and other products.  Content Services includes custom development of e-Learningcourses, consulting, licensing and fees for the Rapid e-Learning DevelopmentSystem, and royalties.  Platformsincludes software licenses, subscription and hosting fees, implementation, andtraining and support for the Ingenium product line and the e-LearningNetwork.  Amounts presented for thethree and nine months ended September 30, 2000 have been restated to conform tocurrent presentation.

             Click2learn’s operating committee, which includes itsChief Executive Officer and Chief Financial Officer, has been identified as theChief Operating Decision Maker (“CODM”) as it assesses the performance of thebusiness units and decides how to allocate resources to the businessunits.  Segment income is the measure ofprofit and loss that the CODM uses to assess performance and makedecisions.  Segment income representsrevenues less cost of revenues incurred within the operating segments aspresented in Click2learn’s consolidated statements of operations.  Click2learn does not allocate operatingexpenses including research and development, sales and marketing, general andadministrative, or amortization of goodwill to its operating segments.  In addition, other income (expense) are alsonot allocated to operating segments.

             Thereare no intersegment revenues. Click2learn’s CODM does not review total assets or depreciation andamortization by operating segment.  Theaccounting policies for reported segments are the same as for Click2learn as awhole.

**Geographic Information**
|                                                 |   | **For  the Three   Months Ended   September 30,** |   | **For  the Nine   Months Ended   September 30,** |   |
|------------------------------------------------------|--------|---------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                 |   | **2001**                                          |   | **2000**                                         |   | **2001** |   | **2000** |   |
| Revenue:                                             |   |                                              |   |                                             |   |   |   |   |   |
| Domestic                                             |   | $                                                 | 8,889  |                                             | $      | 10,468 |   | $ | 29,254 |   | $ | 29,476 |   |
| International – primarily Europe and  Australia |   | 2,347                                             |   | 599                                              |   | 4,333 |   | 1,886 |   |
|                                                 |   | $                                                 | 11,236 |                                             | $      | 11,067 |   | $ | 33,587 |   | $ | 31,362 |   |

Revenuesare attributed to geographic areas based on the location of the customers.
|                                  |     | **September  30,** | ** ** | **December  31,** | ** ** |
|---------------------------------------|----------|--------------------|------------|-------------------|------------|
| **2001**                              | **2000** |
| Long-lived assets                     |     |               |       |              |       |
| Domestic                              |     | $                  | 14,495     |              | $          | 10,979 |   |
| International – primarily Europe |     | 80                 |       | 300               |       |
|                                  |     | $                  | 15,575     |              | $          | 11,279 |   |

 

Long-lived assets represents property,plant and equipment and goodwill, net of accumulated depreciation andamortization.****

**Item 2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

*             The followingdiscussion of the financial condition and results of operations of Click2learnshould be read in conjunction with Click2learn’s Condensed ConsolidatedFinancial Statements and related Notes thereto included elsewhere in thisReport. This Report contains forward-looking statements that involve risks anduncertainties. Click2learn’s actual results may differ significantly from theresults discussed in the forward-looking statements. Factors that may causesuch a difference include, but are not limited to, those discussed in “Factorsthat May Affect Future Results of Operations.”*

**Overview**

             We are a leading developer andprovider of enterprise e–Learning software products and services forGlobal 2000 companies, government agencies and educational institutions.  We design, develop, market, license andsupport an integrated suite of e–Learning software products and relatedservices that allow our customers to cost-effectively create, personalize andmanage the delivery of educational content. We recently introduced our newAspen Enterprise Learning Platform (“Aspen”), a suite of software products thatunifies collaborative content development (Aspen Content Development Server),personalized content delivery (Aspen Learning Experience Server) andcomprehensive learning management (Aspen Learning Management Server) in anintegrated system designed to be open, flexible and scalable.

We provide our e–Learning platform to customersacross a broad range of industries including financial services, accounting,healthcare, insurance, technology, manufacturing, telecommunications,transportation, utilities, government and education.

We group related revenues around the primarycomponents of our solutions: Platforms, Content Services and Tools.  

Platforms include software licenses, subscription andhosting fees, implementation, customization, training and support related to theAspen platform, our Ingenium learning management system, the precursor productto the Aspen Learning Management Server, and our e–Learning Network, anInternet e–Learning ASP offering that is not material to our currentbusiness.

Content Services revenues are derived from thecreation of custom e–Learning courses, consulting, licenses and hostingfees for our Rapid e–Learning Development System (“ReDS”) and sales ofthird-party off–the–shelf content. ReDS is the precursor product to Aspen Content Development Server.  Although revenues from ReDS are included inContent Services, revenues from Aspen Content Development Server are includedin Platforms.

Tools revenues include software licenses, technicalsupport and training related to our ToolBook II line of products.

We recognize revenues for software licenses uponshipment; for technical support, subscription and hosting evenly over the lifeof the contract; and for services such as content development andimplementation based on the percentage of completion method or on a time andmaterials basis.

Costsrelated to revenues consist of media, manuals, royalties, packaging anddistribution for software licenses and primarily salaries and overhead forservice related offerings.  Costs ofrevenues for the Platforms and Tools category are similar due to a relativelyhigh mix of software licenses versus services with cost averaging between 20%to 25% of related revenue. Contrasting the mix for Platforms and Tools, ContentServices consist primarily of relatively high personnel costs associated withproviding professional services compared to the lower materials, packaging andother costs of software.

**Three and Nine months Ended September 30, 2001 Compared toThree and Nine months Ended September 30, 2000**

             *Revenue*.   Our total revenue increased 2% from $11.1million in the three months ended September 30, 2000 to $11.2 million in thethree months ended September 30, 2001. For the nine months ended September 30, revenue grew 7% from $31.4million in 2000 to $33.6 million in 2001. Revenue growth was attributable to an 89% increase in Platforms revenuesfrom $3.2 million for the three months ended September 30, 2000 to $6.1 millionfor the three months ended September 30, 2001. For the nine months ended September 30, Platform revenue increased 56%from $8.8 million in 2000 to $13.7 million in 2001.   Platform growth is attributable to the launch of Aspen as wellas an increased number of customers, size of licenses and scope of integrationprojects currently being performed. Offsetting this growth was a decline in theTools revenue category of 5% from $1.8 million in the three months endedSeptember 30, 2000 versus $1.7 million in the three months ended September 30,2001.  For the nine months endedSeptember 30, Tools revenues declined 15% from $6.5 million in 2000 to $5.5million in 2001.  The Tools categorydecline was anticipated due to the overall decline in the market for authoringtools.   Revenues from Content Servicesdeclined 43% from $6.0 million in the three months ended September 30, 2000compared to $3.5 million in the three months ended September 30, 2001.  For the nine months ended September 30,Content Services declined 11% from $16.1 in 2000 to $14.4 million in 2001.  The decline in the Content Services categorywas anticipated as a result of our focus on Aspen.  Internal Content Services capacity was reduced to approximately$3.5 to $4.0 million of quarterly production during the quarter and we areexpanding the partner network trained to use our tools and methodologies.

*             Cost of Revenue.* Total cost of revenues decreased 7% from $5.6 million in the threemonths ended September 30, 2000 to $5.2 million in the three months endedSeptember 30, 2001.  This decrease is aresult of our emphasis on the higher margin Platforms category ofrevenues.  For the nine months endedSeptember 30, total cost of revenue increased 12% from $15.6 million in 2000 to$17.4 million in 2001.  As a percentageof related revenue costs of Platforms revenues increased from 13% in the threemonths ended September 30, 2000 to 16% in the three months ended September 30,2001.  For the nine months endedSeptember 30, Platform costs as a percentage of revenue increased from 15% in2000 to 17% in 2001.  The fluctuationsare due to the mix of higher margin license revenues and lower margin servicessuch as implementation in the relevant periods.   Costs of Content Services as a percent of related revenueincreases from 78% in the three months ended September 30, 2000 to 110% incomparable period 2001.  For the ninemonths ended September 30, costs as a percent of related revenue increased from80% in 2000 to 95% in 2001.  Theincrease is related to lower utilization of service personnel and employeeseverance costs related to the planned reduction of capacity.   Costs of Tools revenues as a percent ofrelated revenues increased from 24% in the three months ended September 30,2000 to 26% for the three months ended September 30, 2001.  For the nine months costs as a percent ofrelated revenue increased from 22% in 2000 to 25% in 2001.  The increase is attributed to a loweroverall Tools revenue level as compared to 2000.

**OperatingExpenses**

*             Research and Development.*  Research and development expenses include expenses associated with thedevelopment of new products and new product versions and consist primarily ofsalaries, depreciation of development equipment, supplies and overheadallocations.  Research and developmentexpenses were unchanged at $2.2 million in the three months ended September 30,2000  and  2001. For the nine months ended September 30, costs declined 5%from $7.0 million in 2000 to $6.7 million in 2001. The decrease is related tocompletion of the development efforts for the e-Learning Network.

*             Sales and Marketing.* Sales and marketing expenses consist primarily of sales and marketingpersonnel costs, including sales commissions, travel, advertising, publicrelations, seminars, trade shows and other marketing literature and overheadallocations.  Sales and marketingexpenses decreased 35% from $7.0 million in the three months ended September30, 2000 to $4.5 million in the three months ended September 30, 2001.  Included in the three months ended September30, 2000 was a charge of $2.2 million related to acceleration of costs under amarketing agreement.  Excluding thischarge expenses decreased approximately 5%. For the nine months ended September 30, costs decreased 11% from $16.0million in 2000 to $14.2 million in 2001. The decrease was related to the acceleration of costs under themarketing agreement in 2000.  Withoutthe accelerated charges, costs increased 3% due to increased size of our salesorganization.

*             Generaland Administrative. * General and administrative expenses consistprimarily of salaries and other personnel-related expenses for administrative,executive and finance personnel as well as outside advisors.  For the three-month period ended September30, general and administrative expense was unchanged at $1.6 million in 2000and 2001.  For the nine-months endedSeptember 30, general and administrative expenses increased 4% from $4.6million in 2000 to $4.8 million in 2001. This increase was to support ourexpanded operations group in Europe.

*             Amortization of Goodwill.*** **Amortization expense relates to theamortization of excess purchase price over the fair value of identifiabletangible and intangible assets acquired in acquisitions recorded using thepurchase method of accounting. Amortization of goodwill expense increased 101% from $235,000 in thethree months ended September 30, 2000 to $473,000 during the three months endedSeptember 30, 2001.  For the nine monthsended September 30, amortization of expense increased 45% from $705,000 in 2000to $1.0 million in 2001.  The increasesare attributed to additional amortization resulting from goodwill created bythe acquisition of IntelliPrep.

*             Other Income.*** **Interest income on cash and cashequivalents in the three months ended September 30, 2000 was $240,000 ascompared to $33,000 in the three months ended September 30, 2001 due primarilyto higher interest rates and cash balances in 2000.  In April 2000, we established a joint venture with SOFTBANKCorporation subsidiaries creating Click2learn Japan K.K.  We account for our portion of the jointventure’s operating results under the equity method, and in the three monthsended September 30, 2000 and 2001, we recorded $170,000 and $100,000,respectively, related to our equity share of net losses.  For the nine months ended September 30, 2000and 2001, our portion of the net losses of the joint venture were $340,000 and$300,000.

**Recent Accounting Pronouncements**

             InJuly 2001, the Financial Accounting Standards Board issues Statement No. 141"Business Combinations" and Statement No. 142 "Goodwill andOther Intangible Assets." Statement No. 141 requires business combinationsinitiated after September 30, 2001 to be accounted for using the purchasemethod of accounting, and specifies criteria for recognizing intangible assetsacquired in a business combination. Statement No. 142 requires that goodwilland intangible assets with indefinite useful lives no longer be amortized, butinstead be tested for impairment at least annually. Intangible assets withdefinite useful lives will continue to be amortized over their respectiveestimated useful lives. Click2Learn plans to adopt the provisions of StatementNo. 141 and 142 effective January 1, 2002. Because of the extensive effortneeded to comply with adopting these Statements 141 and 142, it is notpracticable to reasonably estimate the impact of adopting these Statements onClick2Learn's financial statements at the date of this report, includingwhether any transitional impairment losses will be required to be recognized asthe cumulative effect of a change in accounting principle.

**Acquisition ofIntelliPrep Technologies, Inc.**

             InJune 2001, Click2learn completed its acquisition of IntelliPrep Technologies,Inc. (“IntelliPrep”), a provider of technology for personalized learning for1,812,497 shares of common stock and 450,000 options to acquire its commonstock valued at $4,419,688.  Inconnection with the acquisition, Click2learn incurred approximately $600,000 inacquisition-related expenditures of which $301,000 was unpaid as of September30, 2001.  The acquisition was accountedfor under the purchase method of accounting and accordingly, the results ofIntelliPrep’s operations are included in Click2learn’s consolidated financialstatements since the date of acquisition. Goodwill and other identifiable intangible assets of $4,710,061 wasrecorded in connection with the transaction and will be amortized using thestraight-line method over estimated useful lives of to five years up to thedate that Click2learn is required to adopt Statement 142.

**Liquidityand Capital Resources**

             At September 30, 2001, we had cash and cash equivalentstotaling $2.9 million, a decrease of $12.4 million from December 31, 2000.  The decrease in cash during 2001 was due touses of cash for operating expenses, payments to Go2Net of $750,000 related toa co-marketing agreement terminated in the third quarter of 2000, as well asinvestments of approximately $700,000 in Click2learn Japan KK and $1.0 millionfor the purchase of a CRM system.  Cashflows from financing activities in 2001 are primarily related to our employeestock purchase plan and our credit facility with Silicon Valley Bank, which wascompleted on September 4, 2001.  TheSilicon Valley Bank credit facility line includes a $4.0 million revolving creditline with a term of 12 months and a $1.0 million 24 month term loan intended tofinance the purchase of a customer relationship management system.  We have not made any draws against therevolving line, but the term loan was drawn during the quarter.  Both elements of the credit facility bearinterest at the Silicon Valley Bank prime rate plus 1.5%.  This credit facility is secured by a generallien against our assets other than intellectual property, which is subject to anegative pledge.

             Accounts receivable at September 30, 2001 increased ascompared to December 31, 2000 due primarily to a large multi-year contract tocreate content for the Washington National Guard.  Amounts related to this agreement at September 30, 2001 wereapproximately $6.3 million. At September 30, 2001, our principal source ofliquidity was $13.3 million of working capital and the Silicon Valley Bankcredit facility of $5 million.

             Weanticipate that our cash and cash equivalents and our credit facility will besufficient to meet our working capital needs and capital expenditures for atleast the next 12 months.  Our long-termliquidity will be affected by numerous factors, including acquisitions ofbusinesses or technologies, demand for our e-Learning solutions, the extent towhich our e-Learning solutions achieve market acceptance, the timing and extentto which we invest in new technology, the expenses of sales and marketing andnew product development, the extent to which competitors are successful indeveloping their own products and services and increasing their own marketshare, the level and timing of revenues and other factors.  To the extent that resources areinsufficient to fund our activities, we may need additional funds to financeour operations in the future as well as to enhance our products and services,fund our expansion, respond to competitive pressures or acquire complementarybusinesses or technologies.  We may beunable to obtain financing on terms favorable to us, or at all.  If adequate funds are not available or arenot available on acceptable terms, we may be unable to finance our operations,enhance our services, fund our expansion, respond to competitive pressures ortake advantage of business opportunities and we may need to significantlyrestrict our operations.

**Factors That May Affect FutureResults of Operations**

*             We have alimited operating history in our current markets, which makes it difficult topredict our future performance. *Ourlimited operating history in our current markets makes it difficult to predictour future performance and may not provide investors with a meaningful basisfor evaluating an investment in our common stock.  From our inception until early 1995, we were engaged in variousresearch and development activities and in developing and marketing multimediaauthoring products, database and Internet tools, web publishing products andother ancillary products, most of which we do not currently sell.  In 1995, we began to focus our developmentand marketing efforts on products and services for the enterprise learning market.  We released the Aspen platform in September2001. Accordingly, we have a limited operating history on which to evaluate ourcurrent business and future prospects.

*             Ourquarterly operating results are uncertain and may fluctuate significantly,which could negatively affect the value of your investment. *Ouroperating results have varied significantly from quarter to quarter and arelikely to continue to fluctuate as a result of a variety of factors, many ofwhich we cannot control.  Factors thatmay adversely affect our quarterly operating results include:
| • |   | the size and timing of product orders  and the timing and execution of professional services engagements;                                              |   |
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| • |   | 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 revenues and expenses;                                                                                                                   |   |
|   |   |                                                                                                                                                   |   |
| • |   | recognition of impairment of existing  assets; and                                                                                                     |   |
|   |   |                                                                                                                                                   |   |
| • |   | the timing of revenue recognition.                                                                                                                     |   |

 

             Our future revenues are difficult to predict and we maynot be able to adjust spending in response to revenue shortfalls.  Our limited operating history with ourcurrent e-Learning solutions, possible acquisitions and the emerging nature ofthe e-Learning market make prediction of future revenue and expensesdifficult.  Expense levels are based, inpart, on expectations as to future revenue and largely are fixed in the shortterm.  We will likely be unable to, ormay elect not to, reduce spending quickly enough to offset any unexpectedrevenue shortfall.  If we are unable topredict future revenue accurately, we may be unable to adjust spending in atimely manner to compensate for any unexpected revenue shortfall.

             *Ourbusiness currently does 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. *Ourbusiness currently does not generate the cash needed to finance ouroperations.  As a result, we may needadditional funds to finance our operations in the future as well as to enhanceour products and services, fund our expansion, respond to competitive pressuresor acquire complementary businesses or technologies.  In addition, poor financial results, additional expenses orunanticipated opportunities that require capital commitments could give rise toadditional financing requirements sooner than we expect.  We may be unable to obtain financing onterms favorable to us, or at all.  Ifadequate funds are not available or are not available on acceptable terms, we maybe unable to finance our operations, enhance our services, fund our expansion,respond to competitive pressures or take advantage of business opportunitiesand we may need to significantly restrict our operations.

*             We have ahistory of losses and anticipate continued losses in the future.* We incurred net losses of approximately $16.8million and $10.5 million in the year ended December 31, 2000 and for the ninemonths ended September 30, 2001, respectively. As of September 30, 2001, our accumulated deficit was $202.8million.  We have not achievedprofitability and expect to continue to incur operating losses at least throughthe year ending December 31, 2001.  Evenif we do achieve profitability, we may be unable to sustain or increaseprofitability on a quarterly or annual basis.

*             We facerisks encountered by early-stage companies in emerging markets and may beunsuccessful in addressing these risks. *We face risks frequentlyencountered by early-stage companies in new and rapidly evolving markets.  Specific risks we face relate to the demandfor and market acceptance of our e-Learning solutions.  We mayfail to adequately address these risks, and therefore our business maysuffer.  To address these risks, wemust:
| • |   | effectively market our e-Learning solutions  to new and existing customers;                                                    |
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|   |   |                                                                                                                           |
| • |   | continue to enhance the technology upon  which our e-Learning solutions are based;                                             |
|   |   |                                                                                                                           |
| • |   | successfully implement our e-Learning  solutions for our customers and generate continuing revenues from those  customers; and |
|   |   |                                                                                                                           |
| • |   | address and establish new technologies  and technology standards.                                                              |

 

*             Thee-Learning market is in the early stages of development and may not grow to asufficient size or at a sufficient rate to sustain our business. *Thee-Learning market is in the early stages of development, and may not grow to asufficient size or at a sufficient rate for our business to succeed.  Corporate training and educationhistorically have been conducted primarily through classroom instruction andtraditionally have been performed by internal personnel.  Although technology-based trainingapplications have been available for several years, they currently account foronly a small portion of the overall training market.  Accordingly, our success will depend on the extent to whichcompanies migrate from traditional training methods to technology-basedsolutions in connection with their training activities.  In addition, our success will depend uponthe extent to which companies utilize the products or services of third-partyproviders and whether companies adopt hosted e-Learning solutions.

             Weprovide a hosted solution for some of our customers through our datacenter.  Those users may access oure-Learning solutions over the Internet. Any factors that adversely affect Internet usage could disrupt theability of those users to access our e-Learning solutions, which couldadversely affect customer satisfaction and therefore our business.  Factors which could disrupt Internet usageinclude slow access and download times, security concerns, network problems orservice disruptions that prevent users from accessing an Internet server anddelays in, or disputes concerning, the development of industry wide Internetstandards and protocols.

             Manycompanies that have already invested substantial resources in traditionaltraining methods may be reluctant to adopt a new strategy that may limit orcompete with their existing investments. Even if companies implement technology-based training or e-Learningsolutions, they may still choose to design, develop, deliver or manage all or apart of their education and training internally.  If e-Learning does not become widespread, or if companies do notuse the products and services of third parties to develop, deliver or managetheir training needs, then our e-Learning solutions may not be commerciallysuccessful.

*             Ourpricing, expense and revenue model for our Aspen platform is unproven, and maynot yield results sufficient for our business to succeed. *OurAspen platform was commercially released in September 2001.  The pricing, expense and revenue models forour Aspen platform have not been tested in the marketplace and may not yieldresults sufficient for our business to succeed.  If the pricing is not acceptable to our customers, the Aspenplatform may not be commercially successful.

*             We faceintense competition from other e-Learning providers and may be unable tocompete successfully. *Thee-Learning market is highly fragmented and competitive, with no single firmaccounting for a dominant market share. Our competitors vary in size, scope and the breadth of products andservices offered.  We face competitionfrom:
| • |   | other developers of learning management  systems, such as Saba, Docent, Thinq and Knowledge Planet, as well as  publishers of e-Learning courses that sell management systems with their  titles such as SmartForce or DigitalThink; |
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|   |   |                                                                                                                                                                                                                                 |
| • |   | large professional consulting firms and  in-house training departments;                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                 |
| • |   | many small, regional e-Learning and  technology-based training services businesses; and                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                 |
| • |   | developers of web authoring tools.                                                                                                                                                                                                   |

 

             Many of our existing and potential competitors havelonger operating histories and significantly greater financial, technical,marketing and other resources and therefore may be able to respond more quicklyto new or changing opportunities, technologies, standards and customerrequirements.  Many of these competitorsalso have broader and more established distribution channels that may be usedto establish strategic alliances or deliver competing products or servicesdirectly to customers.  If thesecompetitors were to bundle competing products or services with the products andservices of their strategic partners, the demand for our products and servicesmight be substantially reduced and our ability to market and sell products andservices successfully may be substantially diminished.  In addition, the existence or announcementof strategic relationships involving our competitors could adversely affect ourability to attract and retain customers.

             Because of the lack of significant barriers to entry inthe e-Learning market, new competitors are likely to enter this market in thefuture.  Increased competition is likelyto result in price reductions, reduced gross margins and loss of market share.  We may not be able to contend effectivelywith such increased competition.

*             Adeterioration of general economic conditions may materially and adverselyaffect our business.* Our revenues are subject to fluctuation as aresult of general economic conditions. A significant portion of our revenues is derived from the sale ofproducts and services to Global 2000 companies or government agencies, whichhistorically have reduced their expenditures for education and training duringeconomic downturns.  In recent months,our sales force has experienced increased delays, cancellations or reductionsin scope of sales opportunities as a result of the down turn in theeconomy.  Recent incidents of terrorismcould cause the economy to weaken further. Should the economy weaken in any future period, these organizations mayfurther delay, cancel, or reduce their expenditures on education and training,which could adversely affect our business.

*             If we areunable to build the Click2learn and Aspen brands, we may be unable to grow ourbusiness.*  We believe that establishing and maintainingthe Click2learn and Aspen brands will be critical to the success of oure-Learning strategy and that the importance of brand recognition will increasedue to the growing number of enterprise learning software products.  We intend to increase our marketing andbranding expenditures in our effort to increase our brand awareness.  If our brand building strategy isunsuccessful, these expenses may never be recovered, and our business could bematerially harmed.

*             Acquisitionsor investments may drain capital and equity resources, divert management’sattention or otherwise harm our business.* In the future, we may acquire or makeinvestments in other businesses, products or technologies.  Such acquisitions or investments may requirethat we pay significant cash, issue stock or incur substantial debt.  In addition, such acquisitions orinvestments may require significant managerial attention, which may be divertedfrom our other operations.  Thesecapital, equity and managerial commitments may impair the operation of ourbusiness.  Furthermore, acquiredbusinesses may not be effectively integrated, may be unable to maintain keypre-acquisition business relationships, may contribute to increased fixed costsand may expose us to unanticipated liabilities.

*             Internationalexpansion may impose substantial burdens on our resources, divert management’sattention or otherwise harm our business. *Our current and plannedexpansion into international markets will require extensive managementattention and resources.  In addition,we will need to rely extensively on third-parties in foreign countries to helpconduct our international operations and conduct sales and marketingefforts.  Our success in internationalmarkets consequently will depend to a large degree on the success of thesethird parties, over which we have little control.  If they are unwilling or unable to dedicate sufficient resourcesto our relationships, our international operations will suffer.  Furthermore, our efforts abroad are subjectto a number of additional risks inherent in international operations,including:
| • |   | difficulties and costs of staffing and  managing foreign offices; |
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|   |   |                                                              |
| • |   | different learning styles and cultures;                           |
|   |   |                                                              |
| • |   | numerous and potentially conflicting  regulatory requirements;    |
|   |   |                                                              |
| • |   | export controls, import tariffs and  other barriers to trade;     |
|   |   |                                                              |
| • |   | reduced protection of intellectual  property rights;              |
|   |   |                                                              |
| • |   | regional political and economic  instability; and                 |
|   |   |                                                              |
| • |   | fluctuations in currency exchange  rates.                         |

             *The loss ofthe services of our senior executives and key personnel would likely cause ourbusiness to suffer.* Oursuccess depends to a significant degree on the performance of the seniormanagement team and other key employees. The loss of any of these individuals could harm our business.  We do not have employment agreements withseveral of our executives or with any other key employees, and we do notmaintain key person life insurance for any officers or key employees.

             Oursuccess also depends on our ability to attract, integrate, motivate and retainadditional highly skilled technical, sales and marketing, and professionalservices personnel.  Competition forqualified personnel in the e-Learning and enterprise software industries isintense.  To the extent we are unable toattract and retain a sufficient number of additional skilled personnel, ourbusiness will suffer.

*             Oursoftware may contain defects or otherwise perform improperly.*  Our Aspenplatform was released in September 2001. Software productsfrequently contain errors or failures, especially when first introduced or whennew versions are released.  In the past,we have discovered errors in our products after their initial release.  Because our e-Learning products are complexsoftware packages targeted at enterprise customers in an emerging market,customers and potential customers may have a greater sensitivity to productdefects or product integration than the market for software products generally.  Product defects could result in loss ofrevenue or delay in market acceptance, diversion of development resources,damage to our reputation, or increased service and warranty costs.

*             Ourintellectual property may become subject to legal challenges, unauthorized useor infringement, any of which could diminish the value of our products andservices.* Our success depends in large part on ourproprietary technology.  We rely on acombination of copyrights, trademarks, trade secret laws, restrictions on disclosureand other methods to protect our proprietary technology.  While we have patent applications pending,we do not have issued patents for any of the technology underlying our Aspenplatform.  If we fail to successfullyenforce our intellectual property rights, the value of these rights, andconsequently the value of our products and services to our customers, coulddiminish substantially.  It may bepossible for third parties to copy or otherwise obtain and use our intellectualproperty or trade secrets without our authorization, and it may be possible forthird parties to independently develop substantially equivalent intellectualproperty.

             Litigationmay be necessary in the future to enforce our intellectual property rights, toprotect trade secrets or to determine the validity and scope of the proprietaryrights of others.  From time to time wehave received, and may in the future receive, notice of claims of infringementof other parties’ proprietary rights. Such claims could result in costly litigation and could divertmanagement and technical resources. They could also delay product shipment or require us to developnon-infringing technology or enter into royalty or licensing agreements, whichagreements may not be available on reasonable terms, or at all.

*             Anincrease in traffic may strain our hosted e-Learning systems, and our hostede-Learning systems are vulnerable to other technical malfunction. *Thesystems that support our hosted e-Learning solutions may be unable toaccommodate an increased volume of traffic. Internet sites and service providers have been subject to denial ofservice attacks, in which unauthorized persons intentionally overload systemswith a heavy volume of traffic. Consequently, our hosted e-Learning systems may experience slowerresponse times or other problems.  Inaddition, we depend on Internet service providers and telecommunicationscompanies and the efficient operation of their computer networks and othercomputer equipment for the operation and delivery of our hosted e-Learningsolutions.  Each of these hasexperienced significant outages in the past and could experience outages,delays and other difficulties due to system failures unrelated to our systems.  Any delays in response time or performanceproblems could cause users to perceive our systems as not functioning properlyand therefore not use our hosted e-Learning solutions for their training needs.

             *Security andprivacy breaches could subject us to litigation and liability and deterconsumers from using our hosted e-Learning solutions*.  Our hosted e-Learning solutions are oftendelivered over the Internet.  TheInternet is a public network and data is sent over this network from manysources.  Although we take reasonablesteps to ensure the security of our hosted solutions, computer viruses could beintroduced into our systems or those of our customers, which could disrupt ourhosted e-Learning solutions or make them inaccessible to users.  In addition, well-publicized Internetsecurity breaches could deter customers from using the Internet to conducttransactions that involve the transmission of confidential information.  We cannot predict the extent to whichtransactions over the Internet will be, or will be perceived to be, secureagainst breaches by third parties.  As aresult, we cannot be certain the Internet ultimately will become widelyaccepted for the delivery of e-Learning solutions.

             Wecould become subject to litigation and liability if third parties penetratesecurity for our hosted e-Learning solutions or otherwise misappropriate ourusers’ confidential information. Advances in computer capabilities, new discoveries in the field ofcryptography or other technological events or developments could result incompromises or breaches of our security systems.  Anyone who circumvents our security measures could misappropriateproprietary information or cause interruptions in our services oroperations.  We may be required toexpend significant capital and other resources to protect against the threat ofsecurity breaches or to alleviate problems caused by breaches.  Furthermore, to the extent that our hostede-Learning solutions may involve the storage and transmission of proprietaryinformation, security breaches could expose us to a risk of loss or litigationand possible liability.

*             We dependon third-party technology, the loss of which could materially harm ourbusiness. *Weuse licensed third-party technology in our e-Learning solutions.  Future licenses to this technology may notbe available to us on commercially reasonable terms, or at all.  The loss of or inability to obtain ormaintain any of these technology licenses could result in delays in theintroduction of new products or could force us to discontinue offering portionsof our e-Learning solutions until equivalent technology, if available, isidentified, licensed and integrated. Furthermore, we may become subjected to legal claims related to licensedtechnology based on defamation, negligence, product liability, infringement ofintellectual property or other legal theories.

             *We may not be able to adapt to the rapidly changingtechnology and evolving industry standards.* The e-Learning market is characterized byrapidly changing technologies, frequent new product and service introductions,short development cycles and evolving industry standards.  The introduction of new products andservices embodying new technologies and the emergence of new industry standardsmay render our products and services obsolete. Our success depends on our ability to adapt to a rapidly changinglandscape and to offer new products and services to address our customers’changing demands.  We may experiencedifficulties that delay or prevent the successful design, development, introductionor marketing of our products and services. To the extent we in fact experience such delays, we may experiencedifficulty in attracting new customers and may lose existing customers.

*             We facethe risk of liability for failures to meet unique customer requirements, andthe risk of cost overruns on fixed-price projects. *The failure or inabilityto meet a customer’s unique expectations or requirements in the performance ofservices could impair our reputation or result in a claim for damages,regardless of our responsibility for the failure.  Although we generally attempt to contractually limit ourliability for damages arising from product defects and other mistakes inrendering professional services, these contractual protections are not always obtainedand may not be enforced or otherwise may not protect us from liability.  Our insurance may not be sufficient to coverany of these claims.

             *Our debt covenants may significantly restrict ouroperations.*  We are subject to numerous covenants in ouragreement with Silicon Valley Bank that impose financial and operatingrestrictions on our business.  Theserestrictions may affect our ability to operate our business, may limit ourability 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 ourability to, among other things:
| • |   | incur more debt;                                                            |
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|   |   |                                                                        |
| • |   | pay dividends, redeem or repurchase our  stock or make other distributions; |
|   |   |                                                                        |
| • |   | make acquisitions or investments;                                           |
|   |   |                                                                        |
| • |   | use assets as security in other  transactions;                              |
|   |   |                                                                        |
| • |   | enter into transactions with  affilitates;                                  |
|   |   |                                                                        |
| • |   | merge or consolidate with others;                                           |
|   |   |                                                                        |
| • |   | dispose of assets or use asset sale  proceeds;                              |
|   |   |                                                                        |
| • |   | create liens on our assets; and                                             |
|   |   |                                                                        |
| • |   | extend credit.                                                              |

             Inaddition, the terms of our indebtedness require that we meet certain financialratios and tests.  The covenantsgoverning our existing indebtedness restrict our operations and those of oursubsidiaries, and these limitations could impair our ability to meet suchfinancial ratios and tests.  Inaddition, our ability to meet these ratios and tests and to comply with otherprovisions governing our indebtedness may be affected by changes in economic orbusiness conditions or other events beyond our control.  Moreover, our failure to comply with ourdebt-related obligations could result in an event of default which, if notcured or waived, could result in an acceleration of our indebtedness.

**Item 3. Quantitative and Qualitative Disclosures about MarketRisk**

*             Market Rate Risk. *The following discussion about our market rate risk involvesforward-looking statements.  Actualresults could differ materially from those projected in the forward-lookingstatements.  We are exposed to marketrisk related to changes in interest rates and foreign currency exchangerates.  We do not use derivativefinancial instruments for speculative or trading purposes.

*             Interest Rate Risk.* We hold our assets primarily in cash and cash equivalents, such asshort-term marketable debt securities, money market funds and other cashequivalents.   We minimize risk byinvesting in financial instruments with a maturity of three months orless.  Therefore, if market interestrates were to increase immediately and uniformly by 10% from levels at December31, 2000, the fair values of cash and cash equivalents would not change by amaterial amount.

*             ForeignCurrency Exchange Risk.* We have foreign currency risk because offoreign subsidiary activities.  For thethree months ended September 30, 2001, revenues from foreign subsidiariesaccounted for approximately 4% of total revenues. All foreign subsidiaries usethe local currency as their functional currency.

             Our exposure to foreign exchangerate fluctuations arises in part from intercompany accounts in which costsincurred in the United States are charged to the foreign subsidiaries.  These intercompany accounts are typicallydenominated in the functional currency of the foreign subsidiary in order tocentralize foreign exchange risk with the parent company in the UnitedStates.  We are also exposed to foreignexchange rate fluctuations as the financial results of foreign subsidiaries aretranslated in U.S. dollars in consolidation. As exchanges rates vary, these results, when translated, may vary fromexpectations and adversely impact overall expected profitability.  The effect of foreign exchange ratefluctuations for the three and nine months ended September 30, 2001 was notsignificant.  Due to the substantialvolatility of currency exchange rates, among other factors, we cannot predictthe effect of exchange rate fluctuations on our future operating results.

**PART II—OTHER INFORMATION**

**Item 1.   Legal Proceedings**

             *ComVest Venture Partners, L.P. v, Click2learn, Inc.,*SupremeCourt of the State of New York, County of New York, No. 01604817.  On October 10, 2001, ComVest VenturePartners, L.P. (“ComVest”) filed suit against us alleging that we breached ourobligations under a term sheet to allow them to purchase shares of our commonstock and warrants for the purchase of additional shares.   ComVest is seeking damages in the amount of$2.5 million plus unspecified punitive damages.  The parties are currently involved in settlement discussions.
| **Item 2****.** | **Changes In Securities and Use of  Proceeds**              |
|-----------------|-------------------------------------------------------------|
|            | Not Applicable.                                             |
| **Item 3****.** | **Defaults Upon Senior Securities.**                        |
|            | Not Applicable.                                             |
| **Item 4****.** | **Submission of Matters to a Vote of  Securities Holders.** |
|            | Not Applicable.                                             |
| **Item 5****.** | **Other Information.**                                      |

             *Management Changes. *In October 2001, we appointed Dennis Worsley as ExecutiveVice President, Worldwide Sales and Marketing. Prior to joining Click2learn, Mr. Worsley was with Saba Software, Inc.since April 1999, where he held a number of sales management positions and wasmost recently responsible for managing Saba’s worldwide salesorganization.  From April 1997 to April1999 he was Senior Territory Manager with PeopleSoft, Inc. and fromSeptember  1995 to April 1997 he was aTerritory Manager with Oracle Corporation. Prior to that Mr. Worsley held a number of sales positions in thepharmaceutical industry.  Mr. Worsleyholds bachelors degrees in cellular and molecular biology and biochemistry fromCalifornia State University at Northridge. 

*CreditFacility. *On September 4,2001, we completed a $5.0 million credit facility with Silicon Valley Bankconsisting of a $1.0 million term loan and a $4.0 million revolving line ofcredit.

**Item 6.    Exhibits and Reports on Form 8-K.**
| (a)    | Exhibits.             |
|--------|-----------------------|
|   |                  |
|   | 2.1                   | Employment Agreement dated as of October 1, 2001  by and between Click2learn and Dennis Worsley. |
|   |                  |   |
|   | 2.2                   | Loan  and Security Agreement dated as of September 2, 2001 by and between  Click2learn and Silicon Valley Bank. |
|   |                  |   |
|   | 3.1                   | Articles  of Incorporation |
|   |                  |   |
| (b)    | Reports on Form  8-K. |
|   |                  |
|   |                  | Not applicable. |

 

 

**SIGNATURES**

             Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|              |   | **CLICK2LEARN, INC.**                                                    |
|-------------------|--------|--------------------------------------------------------------------------|
|              |   |                                                                     |
| November 14, 2001 |   | /s/John D. Atherly                                                       |
|              |   |                                                                     |
| Date              |   | John D. Atherly                                                          |
|              |   | Vice President, Finance and Administration   and Chief Financial Officer |
|              |   | (Duly Authorized Officer and Chief Accounting Officer)                   |

 

 

 

** **