**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-K**

 

**ý****  ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31,2003**

 

**or**

 

**o****  TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom            to            **

 

**Commission File Number 000-24289**

 

**CLICK2LEARN, INC.**

(Exact name of registrant asspecified 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)        |
|                                                              |   |                                  |
| Securities  registered pursuant to Section 12(b) of the Act: |
| **None**                                                          |
|                                                              |   |                                  |
| Securities  registered pursuant to Section 12(g) of the Act: |
| Common  Stock, $0.01 par value per share                          |
| (Title of class)                                                  |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities 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.Yes  ý    No  o

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  o   No  ý

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold as of June 30, 2003 was$44,230,166.  For the purposes of thiscalculation, the registrant’s officers, directors, Paul Allen and entitiescontrolled by Paul Allen are assumed to be affiliates.

 

The number of shares outstanding of theregistrant’s common stock as of March 1, 2004 was 33,244,221.

 

 

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**CLICK2LEARN, INC.**

 

**FORM 10-K**

 

**FOR THE YEAR ENDED DECEMBER 31, 2002**

 

**INDEX**

 
| **PART I**     |                                                                                        |
|----------------|---------------------------------------------------------------------------------------------|
| Item 1.        | Business                                                                                    | 3 |
| Item 2.        | Properties                                                                                  | 9 |
| Item 3.        | Legal Proceedings                                                                           | 10 |
| Item 4.        | Submission of Matters to a Vote of Security Holders                                         | 10 |
|           |                                                                                        |   |
| **PART II**    |                                                                                        |
| Item 5.        | Market for Registrant’s Common Stock and Related Stockholder Matters                   | 11 |
| Item 6.        | Selected Consolidated Financial Data                                                        | 12 |
| Item 7.        | Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 13 |
| Item 7A.       | Quantitative and Qualitative Disclosures about Market Risk                                  | 31 |
| Item 8.        | Financial Statements and Supplementary Data                                                 | 33 |
| Item 9.        | Changes in and Disagreements with Accountants on Accounting and  Financial Disclosures      | 57 |
| Item 9A.       | Controls and Procedures                                                                     | 57 |
|           |                                                                                        |   |
| **PART  III**  |                                                                                        |
| Item 10.       | Directors and Executive Officers of the Registrant                                          | 58 |
| Item 11.       | Executive Compensation                                                                      | 62 |
| Item 12.       | Security Ownership of Certain Beneficial Owners and Management                              | 68 |
| Item 13.       | Certain Relationships and Related Transactions                                              | 71 |
| Item 14.       | Principal Accounting Fees and Services                                                      | 71 |
|           |                                                                                        |   |
| **PART IV**    |                                                                                        |
| Item 15.       | Exhibits, Financial Statement Schedules and Reports on Form 8-K                             | 72 |
| Signatures     | 76                                                                                          |
| Certifications |                                                                                        |

 

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**PART I**

 

*This Annual Report includes “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. This Act provides a “safe harbor” for forward-looking statements toencourage companies to provide prospective information about themselves so longas they identify these statements as forward-looking and provide meaningfulcautionary statements identifying important factors that could cause actualresults to differ from the projected results. All statements other thanstatements of historical fact we make in this Annual Report areforward-looking. Such forward-looking statements involve risks anduncertainties, including, among other things, statements regarding ouranticipated costs and expenses and revenue mix. Such forward-looking statementsinclude, among others, those statements including the words “expect”,“anticipate”, “intend”, “believe” and similar language. Our actual results maydiffer significantly from those projected in the forward-looking statements.Factors that might cause or contribute to such differences include, but are notlimited to those discussed in the section ”Management’s Discussion andAnalysis of Financial Condition and Results of Operations — Factors That May AffectFuture Results of Operations.” You are cautioned not to place undue reliance onthe forward-looking statements, which speak only as of the date of this AnnualReport on Form 10-K. We undertake no obligation to publicly release anyrevisions to the forward-looking statements or reflect events or circumstancesafter the date of this document.*

 

**Item 1****.  Business**

 

# **Overview and History**

# ** **

We are a leading developer and provider ofenterprise learning solutions for businesses, government agencies andeducational institutions.  The primarytechnology underlying these solutions is the Aspen Enterprise ProductivitySuite (“Aspen”), which combines collaborative content development,comprehensive learning management and virtual classroom systems into a single,integrated product suite with a unified architecture and user experience.  With the Aspen suite and our relatedsoftware products and professional services, our customers can improveproductivity and increase revenue by creating, managing and delivering timelyinformation and training across their extended enterprise of employees,suppliers, distributors and customers. Our customers can further increase the interactivity and personalizationof the Aspen suite by adding additional Aspen modules such as personalized delivery,collaboration centers and performance management.  The Aspen suite is a web-based system that is designed to beopen, flexible and scalable and easily customized to meet unique customerneeds.  Our customers are in a broadrange of industries including financial services, accounting, healthcare,insurance, technology, manufacturing, telecommunications, transportation,utilities, government and education.

 

We were originally incorporated as AsymetrixCorporation in the State of Washington in 1984 and have developed and marketeda wide range of software products. In 1995 we began to focus our business onthe enterprise learning market and released our first authoring tool focusedspecifically on the creation of online learning content.  We created our first learning managementsystem in 1997 and our first web-based collaborative content development systemin 1999. As a result of our decision to focus on the enterprise learningmarket, we divested several product lines and made a number of acquisitions tostrengthen our position in this market, and we changed our name to AsymetrixLearning Systems, Inc. In connection with our initial public offering inJune 1998, we reincorporated as a Delaware corporation and in 2001 wechanged our name to Click2learn, Inc. In 2001, we acquired IntelliPrep Technologies, Incorporated(“IntelliPrep”) to strengthen our product offerings for the enterprise learningmarket, resulting in the initial release of Aspen in September 2001.

 

In 2002 we limited our services offerings tothose directly related to the implementation and support of the Aspen suite andour other software products and discontinued offering custom contentdevelopment services.  InJanuary 2002 we entered into an agreement to sell the majority of ourcustom content development business to NIIT (USA), Inc. (“NIIT”), the U.S.operation of NIIT Limited, a global custom software development firm.  The sale closed in the first quarter, butdid not include our contract to provide custom content development services forthe Washington Army National Guard.  Wecontinued to provide custom content development services to the Washington ArmyNational Guard until July 2002, when we reached agreement to terminate thecontract and transition the work in process to another contractor.  Upon termination of our contract with theWashington Army National Guard we had discontinued all custom contentdevelopment operations.  Pursuant toStatement of Financial Accounting Standards No. 144, revenue and expensesrelated to our custom content development business have been 

 

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reclassified as Loss from DiscontinuedOperations in our financial statements for 2002 and prior years.  This reclassification is reflected in anydiscussion or description of the results from these periods.

 

In October 2003 we announced the execution of an Agreement andPlan of Reorganization by and among us, Docent, Inc. (“Docent”), Hockey MergerCorporation (“Newco”) and two wholly owned subsidiaries of Newco.  In thattransaction, one wholly owned subsidiary will merge with us and each issued andoutstanding share of our common stock will be exchanged for 0.3188 shares ofNewco common stock.  Concurrently, theother wholly owned subsidiary will merge with and into Docent and each issuedand outstanding share of Docent common stock will be exchanged for 0.7327shares of Newco common stock.  Following the transaction we and Docentwill each become wholly owned subsidiaries of Newco and will thereafter be mergedwith and into Newco and the separate corporate existence of us and Docent willcease.  Special meetings of ourstockholders and the stockholders of Docent to approve the merger are scheduledfor March 18, 2004 at our respective offices.  Newco will announce a new corporate name immediately followingthe approval of the merger.

 

# **Segment Financial Information**

# ** **

Management categorizes revenue in threeseparate categories related to the different components of our business:

 

•                       Platforms revenue includes software licenses, subscription and hostingfees, implementation, customization, consulting, training and support relatedto the Aspen suite, our Ingenium learning management system, which is theprecursor product to the Aspen Learning Management Server, and our e-LearningNetwork, which is no longer offered to new customers.  Platforms revenue contributed 68%, 77% and 83% of our totalrevenue from continuing operations in 2001, 2002 and 2003, respectively.

 

•                       Tools revenue includes software licenses, technical support and trainingrelated to our ToolBook line of products. Tools revenue contributed 22%, 14% and 11% of our total revenue fromcontinuing operations in 2001, 2002 and 2003, respectively.

 

•                       Content Services revenue includes the placement of Click2learn personnelat customer sites on a time and material basis, the resale of third party offthe shelf training content and license and hosting fees for our Rapide-Learning Development System, which is no longer offered to new customers.  Content Services revenue contributed 10%, 9%and 7% of our total revenue from continuing operations in 2001, 2002 and 2003,respectively.

 

We track direct costs of providing the products and services in thesethree segments and the gross margin for each of these segments.  See Item 8, in particular our ConsolidatedStatements of Operations and note 15 thereto, for the revenue from continuingoperations and gross margin for each segment. We do not separately track indirect costs by segment and do not reportprofit or loss on a segment basis.  Wedo not allocate total assets by segment.

 

We have historically reported our revenues and costs separately foreach of these three segments.  We arenow reporting our revenues and costs by licenses and services, rather than byeach of these three segments.  Docenthas historically reported its revenue and costs for licenses and services andwe believe this change will make it easier for investors to compare ourrespective financial results.

 

**Productsand Services**

 

We offer the following products and services:

 

*Aspen Enterprise Productivity Suite. *Aspen is a suite of three software products, eachof which can be implemented on a stand-alone basis or in any combination,together with a set of optional modules to extend the interactivity, personalizationor functionality of the basic Aspen products. The Aspen product suite unifies collaborative content development,comprehensive learning management and virtual classrooms for real-timecollaborative learning sessions in an integrated system designed to be open,flexible, modular, and scalable.  TheAspen suite is available in multiple languages including U.S. and U.K. English,French, German, Italian, European and Latin American Spanish and Japanese.

 

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Each product in the Aspen suite is designedto offer comprehensive support for industry standards such as SCORM and AICCand to work together with other standards-compliant enterprise learningproducts.  Aspen can be integrated withother enterprise applications such as systems for enterprise resource planning,supply chain and customer relationship management, human resources, e-commerceand financial management. We offer Aspen as a behind-the-firewall solution forimplementation on our customers’ information systems or hosted at our datacenter. Aspen can be licensed on a perpetual or subscription basis.

 

The Aspen suite includes the following three basic products, which aregenerally licensed based on the number of individual named users or, for the AspenVirtual Classroom Server, concurrent users of the particular product:

 

•                   *Aspen Learning ContentManagement Server (“Aspen LCMS”). *Aspen LCMS enables customers to collaborativelycreate standards-compliant learning content in the form of reusable learningobjects. Aspen LCMS is designed to provide the instructional design, workflow,collaboration and management capabilities that enable a distributed team ofsubject matter experts, instructional designers and software developers torapidly and cost-effectively develop engaging and flexible enterprise learningcourses. Courses created with Aspen LCMS are designed to integrate with otherstandards-compliant learning management systems.

 

•                   *Aspen Learning ManagementServer (“Aspen LMS”).*  Aspen LMS is designed to allow organizationsto manage learning resources from a central location and provide managersthroughout the organization with access to those resources. Aspen LMS managesonline learning, instructor-led training and other types of learning through asingle interface, enabling organizations to efficiently use learning resourcesfrom a variety of sources, including custom content created with Aspen LCMS andother standards-compliant content authoring programs, as well as commerciallyavailable content offerings.

 

•                   *Aspen Virtual Classroom Server(“Aspen VCS”)*.  Aspen VCS is designed to allow organizationsto provide real-time learning with streaming audio and video over the Internetor intranet in an environment that enables enhanced interactivity amonglearners and between learners and presenters. Aspen VCS enables students to interact through a shareable white board,public and private chat, application sharing, breakout sessions, polling andQ&A.  With Aspen VCS, presenters cancreate interactive training sessions using existing materials or materialscreated for the session. Aspen VCS can capture and categorize virtual classroomsessions, which can then be used to create new learning materials.

 

In addition to the three basic Aspenproducts, there are a number of optional modules to extend the interactivity,personalization or functionality of the basic Aspen products.  The optional modules include:

 

•                   *Collaboration Center*.  TheAspen Collaboration Center module can be used with any of Aspen LCMS, Aspen LMSor Aspen VCS to increase interaction among users and between users andexperts.  The Collaboration Centermodule enables threaded discussion groups, instant messaging, expertcommunities, searchable archives of expert interactions, response tracking andreporting on collaboration activity.

 

•                   *Personalized Delivery*.  TheAspen Personalized Delivery module can be used with Aspen LCMS and Aspen LMS toincrease the personalization of the learning experience.  The Personalized Delivery Module includes supportfor incremental content modifications, adaptive learning, dynamic personalstudy plans, context sensitive searching, collaborative study aids, postassessments and personalized feedback.

 

•                   *Performance Management*.  TheAspen Performance Management module can be used with Aspen LMS to enhance thefunctionality related to skills, performance and employee development.  The Performance Management module includesskill and competency profiles, skill gap analysis, skill certificationmanagement, employee development planning, self and full 360o employeecompetency assessments, competency modeling and assessment analysis andreporting.

 

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•                   *Information Management*.  TheAspen Information Management module can be used with Aspen LCMS and Aspen LMSto enable easy publishing of any type of knowledge document to the Aspenplatform.  The Information Managementmodule includes user defined cataloging for documents and courses, securedocument access, document usage tracking, website management and reporting andanalysis tools.

 

•                   *Auditing*.  TheAspen Auditing module can be used with Aspen LMS to provide an audit trail oftraining taken and other interactions. The Auditing module creates an archive of all transactions within AspenLMS including transaction type, user, date and time.

 

*ToolBook Products. *Inaddition to Aspen, we offer our ToolBook Instructor and ToolBook Assistantenterprise learning content creation products targeted at small teams orindividual authors that do not require the collaborative capabilities andlearning object functionality of Aspen LCMS. These products enable ourcustomers to create their own media-rich interactive learning content fordeployment on the Aspen platform, other standards-compliant learning managementsystems or CD-ROM. ToolBook Instructor is a multimedia development system forcreating sophisticated applications and simulations that is targeted atprofessional software developers. ToolBook Instructor has been incorporated intothe Aspen platform for use with Aspen LCMS as the Aspen Simulation Editor.  ToolBook Assistant is designed to be aneasy-to-use authoring product that automates much of the process of developinglearning applications and is targeted at learning professionals or contentexperts.  Both products are licensed ona per copy basis.

 

*Professional Services. *We complement our Aspen and ToolBook productofferings with a range of professional services to enable our customers toimplement, evaluate and maintain their enterprise learning solutions. Ourprofessional services offerings include:

 

•                       *StrategicConsulting.*  We assist our customers in evaluating theirenterprise learning needs, using enterprise learning to increase effectivenessor add value to current offerings, developing enterprise learning businessmodels, defining a solution that best meets their enterprise learning needs andproviding on-going consulting on the effectiveness of their solution and returnon investment.

 

•                       *SystemsIntegration. *We provide the services necessary to implementand customize our customers’ enterprise learning solutions and to integrateAspen with our customers’ content, information systems and enterpriseapplications.

 

•                       *Training andTechnical Support. *We offer training that helps organizations becomemore self-reliant in the use of our products and in enterprise learninggenerally, and we offer technical support and maintenance packages for ourproducts.

 

**Customers**

 

We provide our enterprise learning productsand services to customers across a broad range of industries includingfinancial services, health care, computer software, manufacturing, media,natural resources, networking, telecommunications, transportation, utilities,government and education. The following is a partial list of our significantcustomers in 2003:

 
| *Technology/Telecommunications* | *Health Care*                          |
|---------------------------------|----------------------------------------|
| AT&T                        | Blue Cross Blue Shield                 |
| Creo Products                   | Medco Health Solutions                 |
| Fujitsu Network Communications  | Medstar Health                         |
| Microsoft                       | Memorial Sloan-Kettering Cancer Center |
| Symantec                        | Wellpoint Health Networks              |
| Vodafone                        |                                   |
| Williams Information Services   | *Other Industries*                     |
|                            | Accenture LLP                          |
| *Financial Services*            | Albertson’s Inc.                  |
| Fidelity Investments            | BBC Worldwide                          |
| Fremont Investment and Loan     | Boise Cascade                          |

 

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| M&T Bank                      | Burlington Northern Santa Fe |
|-----------------------------------|------------------------------|
| New York Mercantile Exchange      | Cendant                      |
| Standard & Poors              | Gillette                     |
|                              | New Horizons                 |
| *Government/Education/Non-profit* | Pfizer                       |
| Commonwealth of Pennsylvania      | SAIC                         |
| Johns Hopkins University          | Southern Company             |
| U.K. Ministry of Defence          | Textron                      |
| University of Michigan            | The Thomson Corporation      |

 

Microsoft accounted for 17.5% of our totalconsolidated revenue from continuing operations during 2003 and 13.7% of ourtotal consolidated revenue from continuing operations during 2002. No othersingle customer accounted for 10% or more of our total consolidated revenuefrom continuing operations in any of the last three fiscal years.

 

**Backlog**

 

As of December 31, 2003 we had firmbacklog orders of approximately $11.4 million, unchanged from firm backlogorders at December 31, 2002. Backlog consists primarily of Aspen implementation services workcontracted but not performed, the unperformed portion of subscription licensesand support contracts for the Aspen platform and the ToolBook products, andpre-purchases of foreign languages or other software modules prior to generalrelease.  We expect most of the currentbacklog will be completed during the current fiscal year, but any changes tooverall backlog will depend on the number of new orders for Aspenimplementations, subscription licenses and product support agreements in placeduring the year.

 

**Competition**

 

The enterprise learning market is evolvingand subject to rapid technological change. The market is also highly fragmented,with no single competitor holding a dominant market position. We facecompetition from a variety of public and private companies in differentsegments of the enterprise learning market. Based on annualrevenue, we are the second largest of three public companies focused on the enterprise learning market.  These competitors are Docent, with whom werecently announced a pending merger and Saba Software, Inc.  We also compete with other public enterprisesoftware companies who have product offerings targeting the enterprise learning market such asPeoplesoft, SAP, and IBM.  However, butthese companies do not separately report revenue from these product offeringsso we cannot quantify our competitive position against them..  We also compete with a number ofprivately-held companies focused on enterpriselearning, such as Plateau Systems, Thinq Learning Solutions, Inc. andPathlore Software Corporation.  Becausethese companies do not publicly report their revenue, we cannot quantify ourcompetitive position against these companies.

 

The Aspen platform faces competition fromvendors of other enterprise learning or learning content management systems, aswell as from other enterprise software vendors who offer enterprise learningsolutions.  Our ToolBook products facecompetition from other web authoring products. Because there are relatively low barriers to entry in this market, newcompetitors may enter this market in the future.

 

The principal competitive factors affectingthe market for enterprise learning include:

 

•                       the features and functionality of enterprise learning solutions;

 

•                       scalabilityand the ability to integrate with a variety of content and other enterpriselearning and enterprise software products;

 

•                       pricing;

 

•                       customer service and support;

 

•                       reputation and financial position of the provider;

 

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•                       the scope and quality of professional services offered; and

 

•                       the effectiveness of sales and marketing efforts.

 

We believe our solutions compete favorablywith respect to most, if not all, of these factors, and that the fullyintegrated, open and scalable nature of the Aspen suite is the most positivecompetitive factor in our favor, while the most significant negative factor islack of features or functionality that is important to the particular customer.

 

**Salesand Marketing**

 

We sell our solutions primarily through adirect sales force consisting of field sales representatives focused on sellinglarger Aspen implementations and related services. We also have inside salesrepresentatives focused on selling the ToolBook authoring products and smallerAspen licenses. Our sales organization also includes sales engineers whoprovide technical expertise, architect the technical aspects of our enterpriselearning solutions, assist in proposal preparation and provide ongoing salessupport. We use resellers primarily to market our enterprise learning solutionsoutside North America and we have established several reseller relationships tobring the Aspen platform to markets in Europe, South Africa, the Middle Eastand the Pacific Rim.

 

We conduct a variety of marketing programs topromote our enterprise learning solutions, including advertising in nationalbusiness and technology magazines and trade publications, major trade shows,direct mail and e-mail campaigns, public seminars, web-based seminars, andpublic relations activities focused on company news and successful applicationsof our enterprise learning solutions. In cooperation with VNU Business Media,the publisher of *Training*magazine, we are founding sponsors of one of thelargest enterprise learning conferences in the industry. We also participate asan exhibitor and speaker at numerous training and enterprise learning tradeshows and we maintain an area on our web site where potential customers canobtain information about enterprise learning and our solutions.

 

**Researchand Development**

 

We believe our long-standing focus ontechnology has attracted qualified engineering and other technical personneland has contributed to our core technology capabilities. Research anddevelopment expenses were $8.8  million, $8.2 million and $6.4 million in 2001, 2002 and 2003,respectively, and represented 28%, 27% and 22% of total revenue from continuingoperations in those periods.

 

We believe our future success will depend onour ability to continue to enhance our enterprise learning solutions to keeppace with competitive product and service offerings, new technologies andindustry standards, and diverse and changing customer requirements.

 

**ProprietaryRights**

 

Our enterprise learning solutions are basedon technology that is primarily internally developed, although some portionsare licensed from third parties. We rely on a combination of copyrights,trademarks, trade secret laws, restrictions on disclosure and other methods toprotect our intellectual property. We also enter confidentiality agreementswith our employees and consultants, and control access to our proprietaryinformation. Despite our precautions, however, unauthorized parties may copy orotherwise obtain or use our intellectual property and other companies mayindependently develop equivalent technology or intellectual property.

 

We use the following trademarks in theconduct of our business: CLICK2LEARN, ASPEN, TOOLBOOK ASSISTANT and TOOLBOOKINSTRUCTOR.

 

From time to time our products may become thesubject of infringement claims asserted by third parties.  Two such claims are currently pendingagainst us.  For more information onthese claims, see Item 3 “Legal Proceedings” on page 10.

 

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**Employees**

 

As of December 31, 2003, we had 308full-time employees, including 96 in research and development, 87 in sales andmarketing and technical support, 84 in professional services and 41 inoperations and administration. None of our employees are represented by a laborunion. We have not experienced any work stoppages and we consider our relationswith our employees to be good.

 

# **International Revenue and Operations**

# ** **

International revenue, based on the countrywhere the customer placing the order is located, accounted for 18%, 15% and 12%of our total revenue from continuing operations for 2001, 2002 and 2003,respectively. See Item 8, specifically note 15 to our consolidated financialstatements, for information on the total revenue from continuing operationsattributable to, and long-lived assets located in, the United States andforeign countries for each of the last three fiscal years.

 

In addition to our direct sales efforts, werely on independent partners in foreign countries to help conduct ourinternational sales and marketing efforts. We intend to continue to expandinternationally by establishing additional reseller relationships to expand thegeographic reach of our enterprise learning solutions.  Our success in international marketsconsequently will depend to a large degree on the success of these independentpartners, over which we have little control. If they are unwilling or unable todedicate sufficient resources to our relationships, our internationaloperations will suffer.

 

In November 2002 we established anoffice in Hyderabad, India to increase our research and development andimplementation services capacity at a lower cost than would be possible byadding this capacity in the United States. We rely on this office to enable us to complete customer implementationprojects and new releases of Aspen on time and within our established budgets.As of March 1, 2004 we had 117 employees in this office, up from 59 onMarch 1, 2003. Should our operations in Hyderabad be disrupted for anysignificant period of time, it could prevent us from completing customerimplementations or new releases of Aspen in a timely manner, which could causeour business to suffer.

 

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

 

•                       diversion of management attention;

 

•                       difficulties and costs of staffing and managing foreign offices;

 

•                       different learning styles and cultures;

 

•                       numerous and potentially conflicting regulatory requirements;

 

•                       export controls, import tariffs and other barriers to trade;

 

•                       changes in laws or governmental policies;

 

•                       reduced protection of intellectual property rights;

 

•                       regional political and economic instability; and

 

•                       fluctuations in currency exchange rates.

 

**Item 2****.  Properties**

 

Our corporate headquarters and executiveoffices are located in Bellevue, Washington in approximately 39,363 square feetof leased office space, with the lease term expiring inDecember 2008.  We also maintainoffices in Fort Worth, Texas; Framingham, Massachusetts; Rochester, New York;London, England and Hyderabad, India. We believe that our current facilities will be adequate to meet ourneeds, or that alternate leased space will be available at reasonable rates tomeet our needs for the foreseeable future.

 

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**Item 3****.  Legal Proceedings**

 

From time to time, we are involved in legalproceedings and litigation arising in the ordinary course of business. We arenot a party to any litigation or other legal proceeding that, in the opinion ofmanagement, could have a material adverse effect on our business, operatingresults and financial condition, except as described below.

 

*Richard B. Grant v. Asymetrix Corporation,* No. CV-96-3635 HLH, Central District ofCalifornia. On May 21, 1996, Richard B. Grant filed a complaint alleging thatour ToolBook and Multimedia ToolBook products infringe a patent owned by himand seeking unspecified damages. We have received an opinion from patentcounsel that the products do not infringe this patent and that the patent isinvalid. This action is still in the discovery stage, and it is not yetpossible to assess the likelihood of its outcome. Currently discovery in thecase has been stayed pending the court’s ruling on the interpretation of thepatent claims.

 

*IpLearn, LLC v.Click2learn.com, Inc.*No. C04 00685 MHP, Northern District of California.  On February 18, 2004 IpLearn LLC fileda complaint alleging that our Aspen product line infringes several patents heldby IpLearn and is seeking an injunction and unspecified monetary damages.  We have retained patent counsel to representus in this case and are currently evaluating IpLearn’s claims.

 

Although we intend to defend these actionsvigorously, the results of litigation cannot be predicted with certainty. Anadverse outcome in either action could have a material adverse effect on ourbusiness, operating results and financial condition. Moreover, defending theaction, regardless of outcome, could be costly, time-consuming, distractmanagement personnel and have a negative effect on our business.

 

# **Item 4**.  Submission of Matters to a Vote ofSecurities Holders

# ** **

Not applicable.

 

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**PART II**

 

**Item 5****.  Market forRegistrant’s Common Stock and Related Stockholder Matters**

 

Since our initial public offering, our common stock has been listed onthe Nasdaq National Market, originally under the symbol ASYM and currentlyunder the symbol CLKS. The following table sets forth the high and low salesprices per share for each fiscal quarter during 2002 and 2003.

 

| **Fiscal Quarter** |   | **High** |   | **Low** |   |
|--------------------|--------|----------|--------|---------|--------|
| 2002               |   |     |   |    |   |
| First Quarter      |   | $        | 5.05   |    | $      | 2.40 |   |
| Second Quarter     |   | 4.90     |   | 1.55    |   |
| Third Quarter      |   | 1.89     |   | 0.23    |   |
| Fourth Quarter     |   | 1.30     |   | 0.52    |   |
| 2003               |   |     |   |    |   |
| First Quarter      |   | $        | 1.55   |    | $      | 0.72 |   |
| Second Quarter     |   | 2.15     |   | 1.08    |   |
| Third Quarter      |   | 2.41     |   | 1.50    |   |
| Fourth Quarter     |   | 2.75     |   | 1.65    |   |

 

As of March 1, 2004, there were 224holders of record of our common stock. Because brokers and other institutionshold many of the shares on behalf of stockholders, we are unable to determinethe actual number of stockholders represented by these record holders.

 

# **Dividends and Distributions**

# ** **

We have never declared or paid any cashdividends on our common stock. We currently intend to retain any futureearnings to finance growth.  We do notanticipate paying any cash dividends in the foreseeable future. Loancovenants in connection with our line of credit with Silicon Valley Bankrestrict us from paying any dividends or making other distributions.

 

# **Recent Sales of Unregistered Securities**

# ** **

On December 11, 2003 we issued 88,120 shares to Silicon ValleyBancshares in connection with the exercise of a warrant originally issued onDecember 6, 2002 in the amount of 181,324 shares.  The warrant was exercised on a “netexercise” basis in which it was fully exercised by canceling the number ofwarrant shares having a fair market value on the exercise date equal to theaggregate exercise price for the number of shares being issued under thewarrant.  The shares were issued to a single accredited investor in reliance onSection 4(2) of the Securities Act of 1933 as amended.

 

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**Item6****.  Selected Consolidated Financial Data**

 
|                                                           |   | **Years Ended December 31,**         |    |
|----------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                           |   | **1999**                                  |    | **2000** |   | **2001** |   | **2002** |   | **2003** |   |
|                                                           |   | **(In thousands, except per share data)** |    |
| **Statement of  Operations Data:**                             |   |                                      |    |   |   |   |   |   |   |   |   |
| Revenue:                                                       |   |                                      |    |   |   |   |   |   |   |   |   |
| License                                                        |   | $                                         | 14,206  |   | $ | 11,845 |   | $ | 15,508 |   | $ | 12,107 |   | $ | 9,134 |   |
| Services                                                       |   | 9,485                                     |    | 13,650 |   | 15,701 |   | 18,370 |   | 20,353 |   |
| Total revenue                                                  |   | 23,691                                    |    | 25,495 |   | 31,209 |   | 30,477 |   | 29,487 |   |
| Cost of  revenue:                                              |   |                                      |    |   |   |   |   |   |   |   |   |
| License                                                        |   | 1,633                                     |    | 877 |   | 953 |   | 1,002 |   | 1,766 |   |
| Services                                                       |   | 5,530                                     |    | 6,735 |   | 7,125 |   | 8,569 |   | 7,733 |   |
| Total cost of  revenue                                         |   | 7,163                                     |    | 7,612 |   | 8,078 |   | 9,571 |   | 9,499 |   |
| Gross margin                                                   |   | 16,528                                    |    | 17,883 |   | 23,131 |   | 20,906 |   | 19,988 |   |
| Operating  expenses:                                           |   |                                      |    |   |   |   |   |   |   |   |   |
| Research and  development                                      |   | 7,425                                     |    | 9,535 |   | 8,752 |   | 8,153 |   | 6,411 |   |
| Sales and  marketing                                           |   | 15,977                                    |    | 20,530 |   | 18,536 |   | 16,595 |   | 13,942 |   |
| General and  administrative                                    |   | 5,227                                     |    | 6,623 |   | 6,457 |   | 5,997 |   | 5,530 |   |
| Amortization  of goodwill                                      |   | —                                    |    | — |   | 433 |   | — |   | — |   |
| Employee  severance                                            |   | —                                    |    | — |   | — |   | 485 |   | — |   |
| Total  operating expenses                                      |   | 28,629                                    |    | 36,688 |   | 34,178 |   | 31,230 |   | 25,883 |   |
| Loss from  continuing operations                               |   | (12,101                                   | )       | (18,805 | ) | (11,047 | ) | (10,324 | ) | (5,895 | ) |
| Other income  (expense)                                        |   | 856                                       |    | 475 |   | (200 | ) | (190 | ) | (236 | ) |
| Loss from  continuing operations before income taxes           |   | (11,245                                   | )       | (18,330 | ) | (11,247 | ) | (10,514 | ) | (6,131 | ) |
| Provision for  income taxes                                    |   | —                                    |    | — |   | — |   | — |   | 29 |   |
| Loss from  continuing operations                               |   | (11,245                                   | )       | (18,330 | ) | (11,247 | ) | (10,514 | ) | (6,160 | ) |
| Income (loss)  from discontinued operations                    |   | 1,240                                     |    | 1,544 |   | (8,334 | ) | (7,600 | ) | — |   |
| Net loss                                                       |   | (10,005                                   | )       | (16,786 | ) | (19,581 | ) | (18,114 | ) | (6,160 | ) |
| Non cash  dividend associated with preferred stock             |   | (2,754                                    | )       | — |   | — |   | — |   | — |   |
| Net loss  attributable to common stockholders                  |   | $                                         | (12,759 | ) | $ | (16,786 | ) | $ | (19,581 | ) | $ | (18,114 | ) | $ | (6,160 | ) |
| Amounts per  share, basic and diluted:                         |   |                                      |    |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                               |   | $                                         | (0.77   | ) | $ | (1.08 | ) | $ | (0.57 | ) | $ | (0.43 | ) | $ | (0.21 | ) |
| Income (loss)  from discontinued operations                    |   | 0.08                                      |    | 0.09 |   | (0.42 | ) | (0.31 | ) | — |   |
| Net loss                                                       |   | (0.68                                     | )       | (0.99 | ) | (0.99 | ) | (0.74 | ) | (0.21 | ) |
| Non cash  dividend associated with preferred stock             |   | (0.19                                     | )       | — |   | — |   | — |   | — |   |
| Net loss  attributable to common stockholders                  |   | $                                         | (0.87   | ) | $ | (0.99 | ) | $ | (0.99 | ) | $ | (0.74 | ) | $ | (0.21 | ) |
| Weighted  average common shares outstanding, basic and diluted |   | 14,626                                    |    | 16,956 |   | 19,748 |   | 24,393 |   | 28,973 |   |
| **Balance Sheet Data:**                                        |   |                                      |    |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                     |   | $                                         | 19,481  |   | $ | 15,321 |   | $ | 9,553 |   | $ | 3,586 |   | $ | 12,862 |   |
| Working  capital                                               |   | 27,818                                    |    | 21,801 |   | 20,877 |   | 2,900 |   | 9,847 |   |
| Total assets                                                   |   | 49,406                                    |    | 44,880 |   | 39,354 |   | 25,473 |   | 34,570 |   |
| Long-term  obligations                                         |   | 92                                        |    | 4 |   | 417 |   | — |   | — |   |
| Stockholders’  equity                                     |   | 41,355                                    |    | 35,053 |   | 29,560 |   | 12,226 |   | 18,496 |   |

 

(a)          Historical information was restated to reflectthe accounting for discontinued operations.

 

(b)         Historical results of operations are notnecessarily indicative of future results. Refer to the “Factors that May AffectFuture Results of Operations” under Item 7: “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” for the discussionof factors which may impact future results.

 

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# **Item 7**.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

# ** **

*The following discussion of the financialcondition and results of**operationsof Click2learn should be read in conjunction with Click2learn’s**ConsolidatedFinancial Statements and related Notes thereto included**elsewhere inthis Report.*

 

**Overview**

 

We are a leading developer and provider ofenterprise learning solutions for companies, government agencies andeducational institutions. We design, develop, market, license and support anintegrated suite of enterprise software products and related services thatallow our customers to cost-effectively create, personalize and manage thedelivery of learning and knowledge content. Our flagship product, the AspenEnterprise Productivity Suite, combines collaborative content development,comprehensive learning management and virtual classroom systems into a single,integrated product suite with a unified architecture and user experience. Weprovide our products and services to customers across a broad range ofindustries including financial services, health care, computer software,manufacturing, media, natural resources, networking, telecommunications,transportation, utilities, government and education

 

We have three distinct segments that we useto track our operations based on license and service revenue generated by eachsegment.  These three segments are:

 

•                        Platforms segment, which includes software licenses, subscription andhosting fees, implementation, customization, consulting, training and supportrelated to the Aspen suite, our Ingenium learning management system, which isthe precursor product to the Aspen Learning Management Server, and oure-Learning Network, which is no longer offered to new customers.

 

•                        Tools segment, which includes software licenses, technical support andtraining related to our ToolBook line of products.

 

•                        Content Services segment, which includes the placement of Click2learnpersonnel at customer sites on a time and material basis, the resale of thirdparty off the shelf training content and license and hosting fees for our Rapide-Learning Development System, which is no longer offered to newcustomers.  During 2002 we discontinuedour custom content development business, which had been the primary source ofrevenue from Content Services in prior years. Current and prior years’ revenue and expenses for this portion of thebusiness have been reclassified as income or loss from discontinued operations.

 

We track direct costs of providing the products and services in thesethree segments and the gross margin for each of these segments.  See Item 8, in particular our ConsolidatedStatements of Operations and note 15 thereto, for the revenue from continuingoperations and gross margin for each segment. We do not separately track indirect costs by segment and do not reportprofit or loss on a segment basis.  Wedo not allocate total assets by segment.

 

We have historically reported our revenues and costs separately foreach of these three segments.  We arenow reporting our revenues and costs by licenses and services, rather than byeach of these three segments.  Docenthas historically reported its revenue and costs for licenses and services andwe believe this change will make it easier for investors to compare ourrespective financial results.

 

**CriticalAccounting Policies and Estimates**

 

Our critical accounting policies are morefully described in Note 1 to our consolidated financial statements included inthis Annual Report on Form 10-K. Certain of our accounting policies require the application ofsignificant judgment by management in selecting the appropriate assumptions forcalculating financial estimates.  Bytheir nature, these judgments are subject to an inherent degree ofuncertainty.  These judgments arepractices, information provided by our customers and other assumptions that webelieve are reasonable under the circumstances.  Our estimates and assumptions are reviewed periodically and theeffects of revisions are reflected in the consolidated financial statements inthe period in which they are determined to be necessary.  Actual results may differ from theseestimates under different assumptions or conditions.  Our critical accounting policies and estimates include:

 

•                                          Revenue recognition

 

•                                          Estimating allowances for sales returns and theallowance for doubtful accounts

 

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•                                          Valuation of goodwill

 

*Revenue Recognition.*We recognize revenue pursuant to the requirementsof Statement of Position No. 97-2, *Software Revenue Recognition* (“SOP 97-2”),as amended by Statement of Position No. 98-9, *Software Revenue Recognition with Respectto Certain Arrangements.* Under SOP 97-2, revenue attributable to anelement in a customer arrangement is recognized when persuasive evidence of anarrangement exists and delivery has occurred, provided the fee is fixed ordeterminable, collectibility is probable and the arrangement does not requiresignificant customization of the software.

 

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

 

For software license fees in single elementarrangements and multiple element arrangements which do not includecustomization or consulting services, delivery typically is deemed to occurwhen the product is shipped to customers.

 

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

 

We assess the probability of collection basedon a number of factors, including past transaction history with the customerand the current financial condition of the customer. We do not requestcollateral from our customers. If we determine at the time of the transactionthat collection of a fee is not probable, we defer revenue until the timecollection becomes probable, generally when payment is received.

 

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

 

Professional services revenue is recognizedfrom fixed price contracts as services are provided or by using thepercentage-of-completion method of accounting, based on the ratio of costsincurred to the total estimated project cost, for individual fixed-pricecontracts. Provisions for any estimated losses on uncompleted contracts aremade in the period in which such losses become evident. Professional servicesrevenue from time and materials contracts and training services is recognizedas revenue as services are performed.

 

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

 

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Revenue from subscription licenses, hostingagreements and support agreements is recognized on a straight-line basis overthe life of the contract.  We bill thesecontracts either in advance or on a monthly basis.  When we bill these contracts in advance, we record the deferredamounts in deferred revenue.

 

*Allowances for Sales Returns and DoubtfulAccounts.*Thepreparation of financial statements requires us to make estimates andassumptions that affect the reported amount of assets and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reported period.Specifically, we must make estimates of future product returns related tocurrent period product revenue. We analyze historical returns, current economictrends, and changes in customer demand and acceptance of our products whenevaluating the adequacy of the sales returns and other allowances. Significantjudgments and estimates must be made and used in connection with establishingreserves for sales returns and the allowance for doubtful accounts in anyaccounting period. Material differences may result in the amount and timing ofour revenue for any period if we were to make different judgments or utilizedifferent estimates. Similarly, we must make estimates of the uncollectabilityof our accounts receivable. We specifically analyze accounts receivable greaterthan 90 days and analyze historical bad debts, customer concentrations,customer credit-worthiness and current economic trends when evaluating theadequacy of the allowance for doubtful accounts.

 

*Valuation of Goodwill.*We assess the impairment of goodwill on an annualbasis or whenever events or changes in circumstances indicate the fair value ofa reporting unit to which goodwill relates is less than its carrying value.Factors we consider important which could trigger an impairment review includepoor economic performance relative to expected historical or projected futureoperating results, significant negative industry, economic or company specifictrends and changes in the manner of our use of the assets or the plans for ourbusiness. If we were to determine that the fair value of a reporting unit wasless than its carrying value, including goodwill based upon the annual test orthe existence of one or more of the above indicators of impairment, then wewould measure impairment based on a comparison of the implied fair value ofreporting unit goodwill with the carrying amount of goodwill. The implied fairvalue of goodwill is determined by allocating the fair value of a reportingunit to its assets (recognized and unrecognized) and liabilities in a mannersimilar to a purchase price allocation. The residual fair value after thisallocation is the implied fair value of reporting unit goodwill. To the extentthe carrying amount of reporting unit goodwill is greater than the implied fairvalue of reporting unit goodwill, we would record an impairment charge for thedifference.

 

During 2002 we discontinued our custom content developmentbusiness.  Since the discontinuation of our custom content developmentbusiness, the primary focus of our business and source of our revenue has beenthe sale of licenses and services related to the Aspen suite.  This revenue is included in the Platformssegment.  We believe that the currentpublic market value ascribed to Click2learn is entirely based on our continuingoperations, primarily the Aspen suite and the perceived future value that Aspenbrings to Click2learn.  At a minimum weview our market capitalization as our fair value.  The goodwill on our books pertains to the acquisition ofIntelliPrep in 2001.  IntelliPrep’stechnology enabled us to complete Aspen 1.0 and as a result we view the valueascribed to Aspen to be an indication of whether the related goodwill from theIntelliPrep acquisition is impaired. Throughout 2003 our market capitalization has continually exceeded ourcarrying value, therefore we did not undertake further impairment testing.

 

# **Results of Operations**

# ** **

In accordance with Statement of Financial Accounting Standards No. 144,*Accountingfor the Impairment and Disposal of Long-lived Assets*, the financialstatements and management’s discussion and analysis present results fromcontinuing operations with revenue and expenses related to our custom contentdevelopment business for 2003 and prior years presented as loss fromdiscontinued operations.  See “Loss fromDiscontinued Operations” for additional information regarding thediscontinuance of the custom content development business and the amount ofrevenue and costs that have been reclassified to loss from discontinuedoperations.

 

The following table presents our results of continuing operations as apercentage of total revenue for the periods indicated.

 

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| **Statement of Operations Data:**                    |   | **2001** |   | **2002** |   | **2003** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                 |   |     |   |     |   |     |   |
| Revenue:                                             |   |     |   |     |   |     |   |
| Licenses                                             |   | 49.7     | %      | 39.7     | %      | 31.0     | %      |
| Services                                             |   | 50.3     |   | 60.3     |   | 69.0     |   |
| Total revenue                                        |   | 100.0    |   | 100.0    |   | 100.0    |   |
| Cost of revenue:                                     |   |     |   |     |   |     |   |
| Licenses                                             |   | 3.1      |   | 3.3      |   | 6.0      |   |
| Services                                             |   | 22.8     |   | 28.1     |   | 26.2     |   |
| Total cost of revenue                                |   | 25.9     |   | 31.4     |   | 32.2     |   |
| Gross margin                                         |   | 74.1     |   | 68.6     |   | 67.8     |   |
|                                                 |   |     |   |     |   |     |   |
| Operating expenses:                                  |   |     |   |     |   |     |   |
| Research and development                             |   | 28.0     |   | 26.8     |   | 21.7     |   |
| Sales and marketing                                  |   | 59.4     |   | 54.4     |   | 47.3     |   |
| General and administrative                           |   | 20.7     |   | 19.7     |   | 18.8     |   |
| Amortization of goodwill                             |   | 1.4      |   | 0.0      |   | 0.0      |   |
| Employee severance                                   |   | 0.0      |   | 1.6      |   | 0.0      |   |
| Total operating expenses                             |   | 109.5    |   | 102.5    |   | 87.8     |   |
| Loss from continuing operations                      |   | (35.4    | )      | (33.9    | )      | (20.0    | )      |
| Other income (expense)                               |   | (0.6     | )      | (0.6     | )      | (0.8     | )      |
| Loss from continuing operations before  income taxes |   | (36.0    | )%     | (34.5    | )%     | (20.8    | )%     |
| Income taxes                                         |   | 0.0      |   | 0.0      |   | (0.1     | )      |
| Loss from continuing operations                      |   | (36.0    | )      | (34.5    | )      | (20.9    | )      |
| Loss from discontinued operations                    |   | (26.7    | )      | (24.9    | )      | 0.0      |   |
| Net loss                                             |   | (62.7    | )%     | (59.4    | )%     | (20.9    | )%     |

 

# **Year Ended December 31, 2003 Compared To YearEnded December 31, 2002**

# ** **

*Revenue.* Our total revenue from continuing operations decreased 3% from $30.5million in 2002 to $29.5 million in 2003. The decrease was attributable to a 25% decline in license revenue from$12.1 million in 2002 to $9.1 million in 2003, offset by an 11% increase inservices revenue from $18.4 million in 2002 to $20.4 million in 2003.  In general, list pricing and discounting forlicenses and services was unchanged in 2003 as compared to 2002 atapproximately 50%.  Management analyzesour revenue and cost of revenue separately for the three segments of ourbusiness described in the Overview, namely Platforms, Tools and ContentServices.  The following table setsforth the breakout of license and services revenue (in thousands) in 2001, 2002and 2003 for each of the three segments:

 
|             |   | **2001**     |   | **2002**     |   | **2003**     |   |
|------------------|--------|--------------|--------|--------------|--------|--------------|--------|
|             |   | **Licenses** |   | **Services** |   | **Licenses** |   | **Services** |   | **Licenses** |   | **Services** |   |
| Segment Revenue: |   |         |   |         |   |         |   |   |   |   |   |   |   |
| Platforms        |   | $            | 11,302 |         | $      | 9,744        |   | $ | 9,760 |   | $ | 13,585 |   | $ | 7,387 |   | $ | 16,963 |   |
| Tools            |   | 4,206        |   | 2,777        |   | 2,347        |   | 1,943 |   | 1,747 |   | 1,362 |   |
| Content services |   | 0            |   | 3,180        |   | 0            |   | 2,842 |   | 0 |   | 2,028 |   |
| Total            |   | $            | 15,508 |         | $      | 15,701       |   | $ | 12,107 |   | $ | 18,371 |   | $ | 9,134 |   | $ | 20,353 |   |

 

Platform revenue increased 4% from $23.3 million in 2002 to $24.4million in 2003.  The increase was theresult of a 25% increase in Platform services revenue from $13.6 million in2002 to $17.0 million in 2003, offset by a 24% decline in Platform licenserevenue from $ 9.8 million in 2002 to $7.4 million in 2003.  We believe that Platform license salesopportunities in 2003 were equal to or greater than in 2002, but that manypotential clients chose to wait until our proposed merger with Docent iscompleted and the future technology roadmap of the combined company isdisclosed prior to committing to purchases. Platform services increased primarily due to higher support revenue,which increased from $3.0 million in 2002 to $4.8 million in 2003, resultingfrom a higher Platform base from which support revenue is derived.  The remaining $1.6 million in Platformsegment services 

 

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growth was derived from increases in implementation services associatedwith our new and existing clients installing Aspen or upgrading to newversions.

 

Tools revenue declined 28% from $4.3 million in 2002 to $3.1 million in2003.   The overall decline was theresult of a 26% decline in Tools license revenue from $2.3 million in 2002 to $1.7 million in 2003 and a 30%decline in Tools services revenue from $1.9 million in 2002 to $1.4 million in2003.  The decline in Tools licenserevenue resulted from a lack of new versions of the ToolBook products, whichhad not been updated since 2000.  Thedecline in Tools services revenue resulted from the lower Tools license salesin 2003 as compared to 2002, which resulted in lower demand for support andtraining services.

 

Content Services revenue does not include a license revenuecomponent.  Content Services revenuedeclined 29% from $2.8 million in 2002 to $2.0 million in 2003.  Content Service revenue declined due todecreased demand from clients for temporary staff and a decreased focus on thissegment of our business.

 

*Cost of Revenue*.  Cost of revenue from continuing operations declined 1% from $9.6million in 2002 to $9.5 million in 2003. Costs as a percentage of revenue increased slightly from 31% in 2002 to32% in 2003.  Cost of license revenueincreased 76% from $1.0 million in 2002 to $1.8 million in 2003 and increasedas a percentage of license revenue from 8% in 2002 to 19% in 2003.  Cost of service revenue declined 10% from$8.6 million in 2002 to $7.7 million in 2003 and cost as a percentage ofservice revenue declined from 47% in 2002 to 38% in 2003.  The following table sets forth the breakoutof license and services cost of revenue (in thousands) in 2001, 2002 and 2003for each of the three segments used by management to analyze our business: 

 
|                     |   | **2001**     |   | **2002**     |   | **2003**     |   |
|--------------------------|--------|--------------|--------|--------------|--------|--------------|--------|
|                     |   | **Licenses** |   | **Services** |   | **Licenses** |   | **Services** |   | **Licenses** |   | **Services** |   |
| Segment Cost of Revenue: |   |         |   |         |   |         |   |   |   |   |   |   |   |
| Platforms                |   | $            | 308    |         | $      | 3,345        |   | $ | 569 |   | $ | 5,447 |   | $ | 1,413 |   | $ | 5,673 |   |
| Tools                    |   | 645          |   | 901          |   | 433          |   | 650 |   | 353 |   | 210 |   |
| Content services         |   | 0            |   | 2,879        |   | 0            |   | 2,472 |   | 0 |   | 1,850 |   |
| Total                    |   | $            | 953    |         | $      | 7,125        |   | $ | 1,002 |   | $ | 8,569 |   | $ | 1,766 |   | $ | 7,733 |   |

 

Platforms cost of revenue consists primarily of labor costs associatedwith software implementations, amortization of purchased technology and to alesser extent packaging and CD replication costs associated with softwarelicense sales. Costs of Platforms revenue increased 18% from $6.0 million in2002 to $7.1 million in 2003, which was the result of  a 148% increase in Platforms cost of license revenue from$569,000 in 2002 to $1.4 million in 2003 and a 4% increase in cost of Platformsservices revenue from $5.4 million in 2002 to $5.7 million in 2003.  The increase in Platform license cost ofrevenue was primarily due to an increase in amortization of purchasedtechnology related to our virtual classroom product, which was put in serviceduring 2003.  Amortization of purchasedtechnology is recorded under license costs and increased from $467,000 in 2002to $1.2 million in 2003.  The increasein Platforms services cost of revenue resulted from the higher Platformsservices revenue in 2003.  Cost as apercentage of revenue for our Platforms segment increased from 26% in 2002 to29% in 2003.  The increase in cost as apercentage of Platforms revenue resulted from an increase in cost of Platformslicense revenue from 6% in 2002 to 19% in 2003, offset a decrease in costs as apercentage of Platforms services revenue from 40% in 2002 to 33% in 2003.  The increase in cost of Platforms licenserevenue was due to the increase in amortization expense, while the decrease incosts as a percentage of Platforms services revenue was due to the use of lowercost resources based in India to perform these services.

 

Tools cost of revenue consists primarily of labor associated withtraining customers on the use of ToolBook and packaging, royalties and CDreplication costs associated with software license sales.  Tools cost of revenue declined 48% from $1.1million in 2002 to $563,000 which was the result of  an 18% decrease in Tools cost of license revenue from $433,000 in2002 to $353,000 in 2003 and a 68% decrease in cost of Tools services revenuefrom $650,000 in 2002 to $210,000 in 2003. Tools cost of revenue as a percentage of Tools revenue decreased from25% in 2002 to 18% in 2003.  Thedecrease in Tools cost as a percentage of Tools revenue resulted from adecrease in Tools cost of services revenue as a percentage of Tools servicesrevenue from 33% in 2002 to 15% in 2003 primarily due to the use of lessexpensive resources based in India to perform Tools services work, offset by anincrease in Tools license cost of revenue as a percentage of Tools licenserevenue from 18% in 2002 to 20% in 2003.

 

17

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Content Services cost of revenue from continuing operations consistprimarily of labor costs associated with temporary staff.  Content services cost of revenue declined25% from $2.5 million in 2002 to $1.8 million in 2003.  The decline was due to lower segmentrevenue.  Cost as a percentage ofrevenue increased from 87% in 2002 to 91% in 2003 due to the lower revenue withwhich to absorb fixed overhead costs.

 

**Operating Expenses.**

 

*Research and Development*.  Research and development expenses includeexpenses associated with the development of new products and new productversions and consist primarily of salaries, amortization of purchased software,depreciation of development equipment, supplies and overhead allocations.  Research and development expenses decreased21% from $8.2 million in 2002 to $6.4 million in 2003.  This decrease was due primarily to ashifting of payroll to India where individual salaries are lower than in the UnitedStates.  This allowed us to increasetotal research and development staff from 53 at December 31, 2002 to 96 atDecember 31, 2003, while lowering 2003 salary and facility cost $1.5million as compared to 2002.  Researchand development expenses as a percentage of total revenue from continuingoperations declined from 27% in 2002 to 22% in 2003.

 

*Sales and Marketing.* Sales and marketing expenses consist of salesand marketing personnel costs, sales commissions, travel, advertising, publicrelations, seminars, trade shows and other marketing literature and overheadcosts.  Sales and marketing expensesdecreased 16% from $16.6 million in 2002 to $13.9 million in 2003.  The decrease was attributable to a shift instaffing mix from higher compensated sales staff to lower compensated supportstaff as well as lower external marketing expenditures.  Sales staff declined from 56 in 2002 to 49at the end of 2003.  Marketing andsupport staff increased from 26 in 2002 to 38 in 2003 with several of thesepositions shifted to India.  The resultwas a decline in 2003 compensation, travel and facilities costs of $1.9 millionas compared to 2002 levels.  Externalmarketing expenses declined approximately $600,000 in 2003 as compared to 2002levels.  This reduction was planned inorder to reduce cash use.  Sales andmarketing expenses as a percentage of total revenue from continuing operationsdecreased from 54% in 2002 to 47% in 2003.

 

*General and Administrative.* General and administrative expenses consistprimarily of salaries and other personnel-related expenses for administrative,executive and finance personnel as well as outside advisors.  General and administrative expensesdecreased 8% from $6.0 million in 2002 to $5.5 million in 2003.  The primary cause of the reduction was$544,000 of lower compensation and facility related expenses offset by anincrease in bank service charges of $170,000. The increase in bank service charges resulted from higher feesassociated with our line of credit with Silicon Valley Bank, which wasincreased from $5 million during 2002 to $10 million in 2003. General andadministrative expenses as a percentage of total revenue from continuingoperations decreased from 20% in 2002 to 19% in 2003.

 

*Amortization of Goodwill. *Amortizationof goodwill relates to the amortization of excess purchase price over the fairvalue of identifiable tangible and intangible assets acquired in acquisitionsrecorded using the purchase method of accounting.  Goodwill amortization was $0during 2002 and in 2003.  As ofJanuary 1, 2002, we adopted Financial Accounting Standard BoardStatement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets,* which requires that goodwill no longer beamortized, but be subject to an annual impairment test.  Intangible assets with definite useful liveswill continue to be amortized over their respective estimated useful lives. AtDecember 31, 2003 we determined through our annual impairment test thatthe value of our goodwill was greater than our carrying value.  As a result no impairment charges wererecorded.

 

*Other Income (Expense).*  Interest income, net, on cash and cashequivalents in 2003 was $136,000 as compared to $10,000 in 2002.  The increase was due primarily to highercash balances in 2003 resulting from sales of equity.  In April 2000, we established a joint venture with SOFTBANKMedia & Marketing Corp. and SOFTBANK Forums Japan, Inc. creatingClick2learn Japan K.K.  We account forour portion of the joint venture’s operating results under the equitymethod.  In 2003 we recorded a loss of$100,000 as compared to $200,000 in 2002. The remaining value of our investment at December 31, 2003 wasapproximately $169,000.  We do not haveobligations to provide future financing.

 

*Provision for Income Taxes. *We recorded aprovision for foreign income taxes of $29,000 for 2003 and $0 for 2002.

 

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*Loss from Discontinued Operations*.  In thefirst quarter of 2002 we sold certain assets of our custom content developmentbusiness, including equipment and a customer list, to NIIT.  These assets were sold pursuant to an AssetPurchase Agreement for $1 million, resulting in a gain of $927,000 based on thebook value of those assets.  As a partof the transaction, NIIT acted as a subcontractor to complete work in processand will be our primary strategic partner for custom content developmentservices.  In this regard, we will refercustom content development work to NIIT, which will contract directly withcustomers to complete the work.

 

The sale to NIIT did not include any assets related to our contract toprovide custom content development services for the Washington Army NationalGuard (“WANG”).  At the time of the saleto NIIT, we intended to continue to provide these services to the WANG.  However, the WANG contract differed from ourtypical custom content development contract in the following important ways:

 

•                       thecontract did not provide for invoicing upon achievement of defined tasks overthe term of the contract; rather invoicing was subject to acceptance of eachcompleted curriculum;

 

•                       the contentwas simpler to develop, but each curriculum was much longer (generally inexcess of 100 hours, rather than the more typical 30 to 50 hours);

 

•                       we did notcontract with the WANG directly, but rather through a subcontract to agovernment contractor.

 

This contract structure required us to fully fund the developmentthrough completion of the longer curriculum with no interim progress paymentsand further delayed payment once invoiced since payments were made by the WANGto the contractor, which then paid us within 15 days of receiving payment.  Because of the demands this contract placedon our working capital, we negotiated with the WANG to allow us to terminatethe contract and transition the work to the prime contractor.  As a part of these negotiations, we agreedto forfeit our rights to approximately $4.5 million of work performed in returnfor allowing the early contract termination. Upon termination of the WANG contract, we had ceased all operations inconnection with our custom content development business and began presentingthe results of that business as discontinued operations.

 

Results related to our custom contentdevelopment business for the current year and all prior periods have been reclassifiedas loss from discontinued operations. For the year ended December 31, 2002, we reclassified $248,000 ofrevenue, $2.7 million of costs related to revenue, $6.1 million of expenses,and $927,000 of other income as a combined loss from discontinued operations of$7.6 million.  We had no costs fromdiscontinued operations in 2003.  Thebulk of 2002 expenses reflect the termination costs for personnel, facilitiesand the WANG contract during the first and third quarters of 2002.

 

# **Year Ended December 31, 2002 Compared To YearEnded December 31, 2001**

 

*Revenue.* Our total revenue from continuing operations decreased 2% from $31.2million in 2001 to $30.5 million in 2002. The decrease was attributable to a 22% decline in license revenue from$15.5 million in 2001 to $12.1 million in 2002, offset by a 17% increase inservices revenue from $15.7 million in 2001 to $18.4 million in 2001.  In general list pricing for licenses andservices were unchanged in 2001 as compared to 2002, however Platform segment licensediscounting increased to over 50%.

 

Platform revenue increased 11% from $21.0 million in 2001 to $23.3million in 2002.  The increase was theresult of a 39% increase in Platform services revenue from $9.7 million in 2001to $13.6 million in 2002, offset by a 14% decline in Platform license revenuefrom $ 11.3 million to $9.8 million. Platform services revenue increased primarily due to higherimplementation and higher support revenue, which combined increasedapproximately $4 million in 2002.  As mentionedabove license pricing was unchanged from 2001 levels, however due tocompetitive pressure discounting increased to approximately 50% on Platformsegment licenses which, together with a weak economy and decreased spending inthe enterprise software and technology sectors, led to the year over yeardecline.  Unit volumes in 2002 werecomparable to 2001.

 

Tools revenue declined 39% from $7.0 million in 2001 to $4.3 million in2002.  The overall decline was theresult of a 44% decline in Tools license  revenue from $4.2 million in 2001 to $2.3 million in 2002 and a30% decline in Tools services revenue from $2.8 million in 2001 to $1.9 millionin 2002.  The decline in Tools licenserevenue resulted from a lack of new versions of the ToolBook products, whichhad not been updated since 2000.

 

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The decline in Tools services revenue resulted from the lower Toolslicense sales in 2002 as compared to 2001, which lead to in lower demand forsupport and training services.

 

Content Services revenue declined 11% from $3.2 million in 2001 to $2.8million in 2002.  Content Servicerevenue declined due to decreased demand from clients for temporary staffresulting from the weak economy.

 

*Cost of Revenue*.  Cost of revenue increased 18% from $8.1 million in 2001 to $9.6million in 2002, costs as a percentage of revenue increased from 26% in 2001 to31% in 2002.  Cost of license revenueincreased 5% from $953,000 in 2001 to $1.0 million in 2002 and increasedslightly as a percentage of license revenue from 6% in 2001 to 8% in 2002.  Cost of service revenue increased 20% from$7.1 million in 2001 to $8.6 million in 2002 and cost as a percentage ofservice revenue increased slightly from 45% in 2001 to 47% in 2002.

 

Platforms cost of revenue increased 65% from $3.7 million in 2001 to$6.0 million in 2002, which was the result of an 85% increase in Platforms cost of license revenue from $308,000 in2001 to $569,000 in 2002 and a 63% increase in cost of Platforms services revenuefrom $3.3 million in 2001 to $5.4 million in 2002.  The increase in Platform license cost of revenue was primarilydue to a full year of amortization of technology acquired in connection withIntelliPrep, while the increase in Platform services cost of revenue wasprimarily due to higher Platform services revenue.  Cost as a percentage of revenue for our Platforms segmentincreased from 17% in 2001 to 26% in 2002 due primarily to the largerpercentage of higher cost Platforms services revenue.  Cost as a percentage of Platforms services revenue increased from34 % in 2001 to 40% in 2002 and cost as a percentage of Platforms licenserevenue increased from 3% in 2001 to 6% in 2002.

 

Tools cost of revenue declined 30% from $1.5 million in 2001 to $1.1million which was the result of  a 33%decrease in Tools cost of license revenue from $645,000 in 2001 to $433,000 in2002 and a 28% decrease in cost of Tools services revenue from $901,000 in 2001to $650,000 in 2002.  Tools cost ofrevenue as a percentage of Tools revenue increased  from 22% in 2001 to 25% in 2002. Tools services revenue as a percentage of Tools services revenueincreased slightly from 32% in 2001 to 33% in 2002, and cost as a percentage ofTools license revenue increased from 15% in 2001 to 18% in 2002.

 

Content services revenue cost of revenue declined 14% from $2.9 millionin 2001 to $2.5 million in 2002.  Thedecline was due to lower segment revenue. Cost as a percentage of revenue decreased from 91% in 2001 to 87% in2002.

 

**Operating Expenses.**

 

*Research and Development*.  Research and development expenses decreased7% from $8.8 million in 2001 to $8.2 million in 2002.  This decrease was due primarily to a shifting of payroll to Indiain the second half of 2002 where individual salaries are lower than in theUnited States.  This allowed us toincrease total research and development staff while lowering salary cost$300,000 compared to 2002 costs. Research and development expenses as a percentage of total revenue fromcontinuing operations decreased from 28% in 2001 to 27% in 2002.

 

*Sales and Marketing.* Sales and marketing expenses decreased 10%from $18.5 million in 2001 to $16.6 million in 2002.  The decrease was attributable to headcount reductions of 28% inthe second half of 2002 that reduced 2002 compensation and travel expensesapproximately $1.9 million as compared to 2001.  Sales and marketing expenses as a percentage of total revenuefrom continuing operations decreased from 59% in 2001 to 54% in 2002.

 

*General and Administrative.* General and administrative expenses decreased7% from $6.5 million in 2001 to $6.0 million in 2002.  The reduction was due to 31% lower overall headcount in thecompany as compared to December 31, 2001, which reduced general operatingexpenses $200,000 and compensation expenses $300,000 as compared to 2001.  General and administrative expenses as apercentage of total revenue from continuing operations decreased from 21% in2001 to 20% in 2002.

 

*Amortization of Goodwill. *Goodwill amortization was $0 during 2002 ascompared to $433,000 for 2001. At December 31, 2002 we determinedthrough our annual impairment test that the value of our goodwill was greaterthan our carrying value.  As a result noimpairment charges were recorded.

 

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*Other Income (Expense).*  Interest income, net, on cash and cashequivalents in 2002 was $10,000 as compared to $107,000 in 2001.  The reduction was due primarily to lowercash balances and reduced interest rates in 2002.  Our portion of Click2learn Japan K.K.’s operating loss under theequity method was $200,000 as compared to $400,000 in 2001.

 

**Adoptionof Accounting Standards**

 

No new accounting standards were adopted in 2003.

 

**RecentAccounting Pronouncements**

 

In December 2003, the FASB issued Interpretation No. 46 (“FIN46R”), *Consolidation of Variable InterestEntities.*  FIN 46R addresseshow a business enterprise should evaluate whether it has a controllingfinancial interest in an entity through means other than voting rights andaccordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, *Consolidation of Variable Interest Entities*, which wasissued in January 2003.  we will berequired to apply FIN 46R to variable interests in Variable Interest Entities(“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, FIN46R will be applied beginning on January 1, 2005.  For any VIEs that must be consolidated underFIN 46R that were created before January 1, 2004, the assets, liabilitiesand noncontrolling interests of the VIE initially would be measured at theircarrying amounts with any difference between the net amount added to thebalance sheet and any previously recognized interest being recognized as thecumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value atthe date FIN 46R first applies may be used to measure the assets, liabilitiesand noncontrolling interest of the VIE. We are currently reviewing the potential impact of FIN 46R on ourconsolidated financial statements.

 

In December 2003, the SEC issued Staff Accounting Bulletin No.104, *Revenue Recognition* (“SAB104”) which revises or rescinds certain sections of Staff Accounting BulletinNo. 101, *Revenue Recognition in*Financial *Statements* (“SAB 101”),in order to make this interpretive guidance consistent with currentauthoritative accounting and auditing guidance and SEC rules andregulations.  The changes noted in SAB104 did not have a material effect on our financial position and results ofoperations.

 

#### **Liquidity andCapital Resources**

#### ** **

At December 31, 2003, our principalsource of liquidity was $12.9 million of cash and $12.3 million of accountsreceivable, up from $3.6 million and $10.8 million respectively onDecember 31, 2002.  Cash increasedas a result of our completing a private placement of common stock and warrantswith net proceeds of $11.9 million in June of 2003 offset by uses of cashof $3.5 million.  Accounts receivableincreased $1.5 million primarily due to an increase in billings related todeferred revenue items at year-end, which relate to customers invoiced but forwhich no revenue has been recognized. Included in receivables at December 31, 2003 are approximately $1.9million in receivables from the Washington Army National Guard (WANG) billed inDecember.  These amounts relate toannual technical support already provided as well as licenses for tools that webelieve are being used without licenses. We are currently in negotiations to resolve these items with the WANG,therefore the entire $1.9 million of revenue has been deferred and is reflectedin deferred revenue.  In general, webelieve our risk on current non WANG related receivables is low given thegeneral financial strength of our customers.

 

Cash used in continuing operating activities declined from $13.8million in 2001 to $2.2 million in 2002 to $1.5 million in 2003.  With revenue roughly the same or slightlydown from the previous year in 2001, 2002 and 2003, the primary cause for thedeclines was lower overall expense levels in 2002 as compared to 2001 and in2003 as compared to 2002.  Net cash usedin operating activities includes cash provided by or used in discontinuedoperating activities.  Net cash used inoperating activities declined from $13.4 million in 2001 to $6.2 million in2002 to $1.5 million in 2003.

 

Net cash used in investing activities was $2.8 million, $3.0 millionand $1.9 million in 2001, 2002 and 2003, respectively.  Net cash used in investing activities in2001 was primarily the result of capital expenditures and investments inClick2learn Japan K.K.  Net cash used ininvesting activities in 2002 was primarily the result of capital expendituresand a purchase of technology for $2.7 million, offset by $1.0 million providedby the sale of certain assets used in our custom content development businessto NIIT.  Net cash used in investingactivities in 2003 was primarily the result of expenditures of $1.2 millionassociated with our pending merger with Docent and 

 

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capital expenditures of approximately $700,000 associated with normalpurchases of computers and software. As of December 31, 2003, we had nomaterial commitments for capital expenditures and had commitments undernon-cancelable operating leases with terms in excess of one year of $5.8million through 2008.

 

Based on these trends, we anticipate that our cash and cash equivalentswill be sufficient to meet our working capital needs and capital expendituresfor the next 18 months or longer.

 

Cash provided by financing activities was $10.5 million, $2.3 millionand $12.6 million in 2001, 2002 and 2003, respectively, resulting from:

 

•                  a privateplacement to accredited investors in 2001 in which we sold 3,680,000 shares ofour common stock for an aggregate purchase price of  approximately $9.2 million in cash and issued the investorswarrants for the purchase of an additional 1,840,000 shares of common stock atan exercise price of $4.00 per share, net cash from borrowings of $913,000 andamounts received from exercise of employee stock options and purchases underour Employee Stock Purchase Plan;

 

•                  net borrowingsagainst the Silicon Valley Bank credit facility of $1.7 million in 2002, amountsreceived from exercise of employee stock options and purchases under ourEmployee Stock Purchase Plan; and

 

•                  a privateplacement to accredited investors in 2003 in which we sold 7,460,644 shares ofour common stock and issued investors warrants for the purchase of anadditional 2,611,225 shares of common stock at an exercise price of $1.90 pershare for an aggregate purchase price of approximately $12.8 million, net cashfrom borrowings of $316,000, amounts received from exercise of employee stock optionsand purchases under our Employee Stock Purchase Plan.

 

In connection with the 2001 private placement transaction, Jefferies& Company, Inc. was paid placement agent commissions of $456,750 and issuedwarrants for the purchase of 92,400 common shares at an exercise price of $2.50per share, Commonwealth Associates, L.P. was paid placement agent commissionsof $105,000 and issued warrants for the purchase of 18,000 common shares at anexercise price of $2.50 per share and ComVest Venture Partners, L.P.  was paid placement agent commissions of$70,000 and issued warrants for the purchase of 12,000 common shares, at anexercise price of $2.50 per share. ComVest was also an investor in the 2001 private placement transactionat the same price and on the same terms and conditions as the other investorsin that transaction.  In connection withthe 2003 private placement transaction, Craig-Hallum Capital Group, LLC waspaid placement agent commissions of $702,392 and issued warrants for thepurchase of 373,032 common shares at an exercise price of $1.90 per share.

 

In December 2002 we consolidated our existing $4 million workingcapital line of credit and $1 million term loan facility with Silicon ValleyBank into a new $10 million working capital line.  The working capital line bears interest at the greater of SiliconValley Bank prime rate plus 2.25% or 7.0% and has minimum monthly interest of$8,500 per month regardless of the loan balances.  The credit facility is collateralized by a security interest inall of our assets.  Covenants in theloan agreements include restrictions on our ability to pay dividends or makeother distributions, make acquisitions or investments, merge or consolidatewith others or dispose of assets, as well as financial covenants limiting theamount of net losses during any three-month period to a maximum of $1.6 millionand requiring us to maintain certain levels of minimum tangible net worth asfollows for the fiscal quarters ending:

 

•                  December 31,2002:  $8,400,000;

 

•                  March 31,2003:  $7,100,000;

 

•                  June 30,2003:  $6,000,000;

 

•                  September 30,2003:  $5,000,000; and

 

•                  December 31,2003 and each fiscal quarter ending thereafter:  $4,500,000 plus (i) 100% of all consideration received by us forequity securities and subordinated debt, plus (ii) 50% of our net income ineach fiscal quarter during the loan term.

 

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The failure to meet those covenants could prevent us from accessing theworking capital line and result in the acceleration of any balances under theworking capital line and term loan if not waived.  At December 31, 2003 we were in technical breach of loancovenants due to the fourth quarter’s net loss.  Silicon Valley Bank evaluated the circumstances and provided awaiver for the applicable covenants. If not renewed, the working capital lineterminates and any advances made are due on December 6, 2004.  At December 31, 2003, we had a balanceof $3.6 million on the working capital line.

 

The total amount we can borrow under the line of credit as ofMarch 1, 2004 is 75% of our eligible accounts receivable, or approximatelyequal to our ending loan balance of $3.6 million.  This amount may be adjusted up or down based on a quarterly analysisby the bank of our eligible accounts receivable.  Eligible accounts receivable are those accounts receivable thatthe bank determines in its good faith business judgment to include in theborrowing base.  Certain accounts, suchas accounts that are over 90 days past due, unbilled receivables and foreign orgovernment accounts, are not currently eligible.  Although we may take steps to include foreign and governmentaccounts in our borrowing base, there is additional cost involved and we havenot deemed it necessary to do so to date. As a result of this limitation on eligible accounts, the amountavailable to us under the line of credit may be reduced in the future.  Moreover, because the amount available forborrowing under our agreement is based on our eligible accounts receivable, wemay from time to time become over-advanced under the line of credit if oureligible accounts receivable decrease, either because they have been collectedbut not applied against the existing obligations or because they have becomeineligible under the terms of the agreement. In such a case we may be required to immediately repay a portion of theamount borrowed sufficient to bring the total amount owed to no more than thetotal availability under the loan facility.

 

Our long-term liquidity will be affected by numerous factors, includingdemand for our Aspen platform, the level and timing of revenue, the collectionof our receivables, the availability of our line of credit, the extent to whichwe raise additional funds from investors, the timing and extent to which weinvest in new technology, the expenses of sales and marketing and new productdevelopment, the extent to which competitors are successful in developing theirown products and services and increasing their own market share, acquisitionsof businesses or technologies and other factors.  To the extent that our existing capital resources areinsufficient to fund our activities, we may need to raise additionalfunds.  Such additional funding, ifneeded, may not be available on attractive terms or at all.  If adequate funds are not available onacceptable terms, we may be required tomake further expense reductions, which could significantly restrict ouroperations and limit our ability to enhance our products, fund expansion,respond to competitive pressures or take advantage of business opportunities.

 

Our long-term liquidity could also be affected if our merger withDocent does not conclude.  If terminatedunder certain specified conditions we would be liable for $2.5 million ofbreakup fees and would have to expense all related merger costs.  These items would affect our liquidity.

 

We had the following contractual commitments and obligations atDecember 31, 2003 (in thousands):

 
|                                                                   |   | **Payments  Due by Period** |   |
|------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                   |   | **Total**                   |   | **Less than  1 Year** |   | **1-3  Years** |   | **3-5  Years** |   | **More  than 5  Years** |   |
| Operating Lease Obligations                                            |   | $                           | 5,818  |   | $ | 1,433 |   | $ | 2,384 |   | $ | 2,001 |   | $ | — |   |
| Purchase Obligations                                                   |   | 206                         |   | 108 |   | 30 |   | 68 |   | — |   |
| Other Long Term Liabilities Reflected on  our Balance Sheet under GAAP |   | —                      |   | — |   | — |   | — |   | — |   |
| Total                                                                  |   | $                           | 6,024  |   | $ | 1,541 |   | $ | 2,414 |   | $ | 2,069 |   | $ | — |   |

 

In addition to the contractual commitments listed above we had aliability for deferred revenue of $7.3 million at December 31, 2003 upfrom $4.4 million at December 31, 2002. Deferred revenue is created when we bill clients for product or servicesprior to recognition of the related revenue. Normally, approximately 25% of this amount is reflected in currentaccounts receivable.  Approximately 72%and 85% of deferred revenue in 2003 and 2002, respectively, resulted from contractsto deliver support and maintenance for our software products.  These contracts typically have terms oftwelve months, therefore we recognize the revenue ratably over their life.  When the contracts expire we contact theclient and request renewal, starting the deferred revenue cycle again.  Growth in 

 

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the total deferred revenue liability is primarily dependant on futuresales of our software and the willingness of existing and new clients to contractfor support and maintenance services.

 

**FactorsThat May Affect Future Results of Operations**

 

*Our business andresults of operations are likely to be affected by our announced merger withDocent, Inc.*

 

We believe announcement of the proposed transaction with Docent had anadverse effect on our revenue in the fourth quarter of 2003 as  customers delayed, deferred or canceledpurchases pending consummation of the planned transaction due to potentialuncertainty about the direction of the combined company’s product offerings andits support and service of existing products. To the extent that our announcement of the transaction createsuncertainty among customers such that one or more large customers, or asignificant group of small customers, delays purchase decisions pendingconsummation of the planned transaction, our results of operations in futurequarters could also be negatively affected. Decreased revenue could have a variety of adverse effects, including negativeconsequences to our relationships with, and ongoing obligations to, customers,suppliers, business partners, and others with whom we have businessrelationships.  In addition, ourquarterly operating results and revenue could be substantially below theexpectations of market analysts, which could cause a decline in our stockprice.

 

*We may sufferadditional adverse consequences if the proposed transaction with Docent is notcompleted.*

 

If the planned merger with Docent is not completed, we could suffer anumber of consequences that may adversely affect our business, results ofoperations and stock price, including the following:

 

•                  we would notrealize the benefits we expect from becoming part of a combined company withDocent, including the potentially enhanced financial and competitive position;

 

•                  activitiesrelating to the merger and related uncertainties may divert our management’sattention from our day-to-day business and cause disruptions among ouremployees and to our relationships with customers and business partners, thusdetracting from our ability to increase revenue and minimize costs and possiblyleading to a loss of revenue and market position that we may not be able toregain if the transaction does not occur;

 

•                  the market priceof our common stock could decline following an announcement that the merger hasbeen abandoned, to the extent that the current market price reflects a marketassumption that the merger will be completed;

 

•                  we could berequired to pay Docent a $2.5 million termination fee if the merger agreementis terminated under certain specified conditions;

 

•                  we would berequired to expense approximately $1.1 million of costs currently capitalized.

 

•                  we would remainliable for certain costs related to the transaction, such as legal, accounting,financial advisor and financial printing fees;

 

•                  we may not beable to continue our present level of operations and therefore may have toscale back our present level of business and consider additional reductions inforce; and

 

•                  we may not be able to take advantageof alternative business opportunities or effectively respond to competitivepressures.

 

*Ourquarterly operating results are uncertain and may fluctuate significantly,**which could negatively affect the value of yourinvestment.*

 

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

 

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•                       the size and timing of product orders and the timing and execution ofprofessional services engagements;

 

•                       the mix of revenue from products and services;

 

•                       the mix of products sold;

 

•                       the ability to meet client project milestones;

 

•                       the market acceptance of our products and services;

 

•                       the abilityto develop and market new or enhanced products and services in a timely mannerand the market acceptance of these products and services;

 

•                       the timing of revenue and expense recognition; and

 

•                       recognition of impairment of existing assets.

 

Our future revenue is difficult to predictand we may not be able to adjust spending in response to revenue shortfalls.Our limited operating history with our current enterprise learning solutionsand the rapidly evolving nature of the enterprise learning market makeprediction of future revenue and expenses difficult. Expense levels are based,in part, on expectations as to future revenue and largely are fixed in theshort term.  If we are unable to predictfuture revenue accurately, we may be unable to adjust spending in a timelymanner to compensate for any unexpected revenue shortfall.

 

*Salescycles are lengthy, requiring considerable additional investment with noassurance of generating revenue from our efforts.*

 

The period between our initial contact with apotential customer and that customer’s purchase of our products and services islengthy and may extend over several fiscal quarters.  To sell our products and services successfully, we generally musteducate our potential customers regarding the use and benefits of our productsand services, which can require significant time, capital and otherresources.  The delay or failure tocomplete sales in a particular quarter could reduce our revenue in thatquarter, as well as subsequent quarters over which revenue for the sale wouldlikely be recognized.  If the salescycle unexpectedly lengthens in general or for one or more large orders, itwould negatively affect the timing of our revenue and our revenue growth wouldbe harmed.

 

Although we must expend and allocateresources prior to completing a sales transaction, we may never generate anyrevenue from these activities.  Inaddition, many of our potential customers are large enterprises that generallytake longer than smaller organizations to make significant business decisions.

 

Moreover, our revenue will be subject to fluctuation as a result ofgeneral economic conditions and overall spending in the technology andenterprise software sectors. A weakening economy could result in organizationsfurther delaying, canceling, or reducing capital expenditures generally andspending on enterprise software applications in particular.  A significant portion of our revenue isderived from the sale of products and services to large companies or governmentagencies, which historically have reduced their expenditures for enterprisesoftware applications during economic downturns.

 

Any failure to meet investor expectations for a given quarter as aresult of delayed customer decisions, reduced order sizes or failed salesefforts would likely cause the price of our common stock to decline.

 

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

 

If our business does not generate the cashneeded to finance our operations, we may need to obtain additional financing ortake steps to restrict our operations in order to conserve existing cash.  In addition, poor financial results orunanticipated expenses could give rise to additional financing requirements. Wemay be unable to obtain financing on terms favorable to us, or at all.  If we need to obtain financing and adequatefunds are not

 

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available or are not available on acceptableterms, we may be required to make further expense reductions, which couldsignificantly restrict our operations and limit our ability to enhance ourproducts, fund expansion, respond to competitive pressures or take advantage ofbusiness opportunities.

 

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

 

We incurred a net loss of approximately $6.2million for the year ended December 31, 2003.  As of December 31, 2003, our accumulated deficit was $236million.  We did not generate positivecash flow for the fiscal year.  We havenot yet achieved profitability and may not do so. Even if we do achieveprofitability, we may be unable to sustain or increase profitability on aquarterly or annual basis.

 

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

 

The primary focus of our business is the Aspen suite.  We released the first version of the Aspensuite in September 2001 and released the first major upgrade inSeptember 2002. Accordingly, we have a limited operating history on whichto evaluate our current business and future prospects. Our limited operatinghistory with the Aspen suite makes it difficult to predict our futureperformance and may not provide investors with a meaningful basis forevaluating an investment in our common stock.

 

*Our reliance on Aspen suite means that adecline in the price of or demand for the Aspen suite could seriously harm ourbusiness.*

 

The Aspen suite and related services accounted for the majority of ourrevenue in 2003 and is expected to account for a majority of our revenue forthe foreseeable future.  Consequently, adecline in the price of or demand for the Aspen suite or its failure to achievebroad market acceptance would seriously harm our business.

 

*Theenterprise learning software market may not grow to a sufficient size or at asufficient rate to sustain our**business.*

 

The enterprise learning software market maynot grow to a sufficient size or at a sufficient rate for our business tosucceed. Corporate training and education historically have been conductedprimarily through classroom instruction. Although technology-based trainingapplications have been available for many years, they currently account foronly a small portion of the overall corporate learning market. Accordingly, oursuccess will depend on the extent to which companies implement enterpriselearning software solutions for the design, development, delivery andmanagement of their corporate learning needs.

 

Many companies that have already investedsubstantial resources in traditional training methods may be reluctant to adopta new strategy that may limit or compete with their existing investments. Evenif companies implement enterprise learning software solutions, they may stillchoose to develop such solutions internally. If the use of enterprise learningsoftware does not become widespread or if companies choose to develop suchsoftware internally rather than acquiring it from third parties, then ourenterprise learning software may not be commercially successful.

 

*Weface risks encountered in rapidly evolving markets and may be unsuccessful in**addressing these risks.*

 

We face risks frequently encountered inrapidly evolving markets. Specific risks we face relate to the demand for andmarket acceptance of our enterprise learning solutions. We may fail toadequately address these risks, and therefore our business may suffer. Toaddress these risks, we must:

 

•                       effectively market our enterprise learning software to new and existingcustomers;

 

•                       continue to enhance the technology upon which our enterprise learningsoftware is based;

 

•                       successfully implement our enterprise learning software for our customersand generate continuing revenue from those customers; and

 

•                       address and establish new technologies and technology standards.

 

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

 

The enterprise learning software market ishighly fragmented and competitive, with no single firm accounting for adominant market share. Our competitors vary in size, scope and the breadth ofproducts and services offered. We face competition from:

 

•                       other developers of enterprise learning systems;

 

•                       providers of other enterprise software solutions;

 

•                       large professional consulting firms and in-house IT departments; and

 

•                       developers of web authoring tools.

 

There are relatively low barriers to entry inthe enterprise learning market and new competitors may enter this market in thefuture. Increased competition may result in price reductions, reduced grossmargins and loss of market share. We may not be able to contend effectivelywith such increased competition.  Inparticular, vendors of other enterprise software applications such asenterprise resource planning, human resource management or customerrelationship management have begun to offer learning delivery and managementfunctionality to extend their current product lines.  Although these offerings may not offer the same functionality asour Aspen suite, bundling these offerings with the remainder of their solutionscould diminish our ability to sell our products and services to their customersand announcements by these companies of future products could delay purchasingdecisions by their customers and our prospects, either of which could adverselyaffect our business.

 

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

 

Strategic relationships are important inexpanding the distribution reach of companies in the enterprise learningmarket. If our competitors were to establish strategic relationships to resellor distribute their products through their strategic partners, our ability tomarket and sell products and services successfully may be substantiallydiminished. In addition, the existence or announcement of strategicrelationships involving our competitors could adversely affect our ability toattract and retain customers.

 

*Internationaloperations may impose substantial burdens on our resources, divert**management’s attention or otherwise harm ourbusiness.*

 

We rely on independent partners in manyforeign countries to help conduct our international operations and sales andmarketing efforts. Our success in international markets consequently willdepend to a large degree on the success of these independent partners, overwhich we have little control. If they are unwilling or unable to dedicatesufficient resources to our relationships, our international operations willsuffer.

 

We rely on our operations in Hyderabad, Indiato enable us to complete customer implementation projects and new releases ofthe Aspen suite on time and within our established budgets.  Should our operations in Hyderabad bedisrupted for any significant period of time, it could prevent us fromcompleting customer implementations or new releases of the Aspen suite in atimely manner, which could cause our business to suffer.

 

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

 

•                       diversion of management attention;

 

•                       difficulties and costs of staffing and managing foreign offices;

 

27

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•                       different learning styles and cultures;

 

•                       numerous and potentially conflicting regulatory requirements;

 

•                       export controls, import tariffs and other barriers to trade;

 

•                       changes in laws or governmental policies;

 

•                       reduced protection of intellectual property rights;

 

•                       regional political and economic instability; and

 

•                       fluctuations in currency exchange rates.

 

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

 

Our success depends to a significant degreeon the performance of the senior management team and other key employees. Theloss of any of these individuals could harm our business. We do not haveemployment agreements with several of our executives or with any other keyemployees, and we do not maintain key person life insurance for any officers orkey employees.

 

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

 

*OurAspen suite may contain defects or otherwise**perform improperly.*

 

Our Aspen suite was initially released inSeptember 2001, and the first major version upgrade was released inSeptember 2002.  We anticipatecontinuing to add new features, functionality and components. Complexenterprise software products frequently contain errors or failures, especiallywhen first introduced or when new versions are released. Because the Aspenproducts are complex software packages with new features and functionalitybeing added and new versions being released on a regular basis, there is a greaterlikelihood that they may contain such errors. In addition, since the Aspensuite is targeted at enterprise customers with large numbers of users,customers and potential customers may have a greater sensitivity to productdefects or product integration than the market for software products generally.To date we have experienced errors in the Aspen platform, in particular whennew versions or functionality is first released, although such errors have nothad a material impact on our business and generally have been corrected shortlyafter discovery.  Although we have notexperienced this to date, serious product errors could result in loss ofrevenue or delay in market acceptance, diversion of development resources,damage to our reputation, or increased service and warranty costs.

 

*Wemay not be able to adapt to rapidly changing technology and evolving**industry standards.*

 

The enterprise learning software market ischaracterized by rapidly changing technologies, frequent new product andservice introductions, short development cycles and evolving industrystandards. The introduction of new products and services embodying newtechnologies and the emergence of new industry standards may render ourproducts and services obsolete. Our success depends on our ability to adapt toa rapidly changing landscape and to offer new products and services to addressour customers’ changing demands. We may experience difficulties that delay orprevent the successful design, development, introduction or marketing of our productsand services. To the extent we in fact experience such delays, we mayexperience difficulty in attracting new customers and may lose existingcustomers.

 

*Weface the risk of liability for failures to meet unique customer**requirements, and the risk of cost overruns onfixed-price projects.*

 

The failure or inability to meet a customer’sunique expectations or requirements in the performance of services could impairour reputation or result in a claim for damages, regardless of ourresponsibility for the failure. Although generally we attempt to limitcontractually our liability for damages arising from product defects and other

 

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mistakes in rendering professional services,these contractual protections are not always obtained and may not be enforcedor otherwise may not protect us from liability. Our insurance may not besufficient to cover these claims.  Inaddition, most of our professional services projects are performed on afixed-price basis rather than on a time and materials basis. If we do notcomplete fixed-price engagements within budget, on time and to clients’satisfaction, we bear the risk of cost overruns.

 

*Securityand privacy breaches could subject us to litigation and liability.*

 

We host certain of our customers’ enterpriselearning software implementations at our data center and provide access to thatsoftware using the Internet. The Internet is a public network and data is sentover this network from many sources. Although we take reasonable steps inaccordance with current industry practices to ensure the security of ourhosting systems and customer data, computer viruses could be introduced intoour systems or those of our customers, which could disrupt the operation of ourhosting systems or make them inaccessible to users. We depend on Internetservice providers and telecommunications companies and the efficient operationof their computer networks and other computer equipment to enable customers toaccess and use hosted software implementations. Each of these has experiencedsignificant outages in the past and could experience outages, delays and otherdifficulties due to system failures unrelated to our systems, which could causeour customers to believe we were at fault and withhold payments due to us.

 

We could become subject to litigation andliability if third parties penetrate security for our hosting systems orotherwise misappropriate our users’ confidential information or if customersare unable to access and use hosted software implementations. Advances incomputer capabilities, new discoveries in the field of cryptography or othertechnological events or developments could result in compromises or breaches ofour security systems. Anyone who circumvents our security measures couldmisappropriate proprietary information or cause interruptions in our servicesor operations. We may be required to expend significant capital and otherresources to protect against the threat of security breaches or serviceinterruptions or to alleviate problems caused by breaches or serviceinterruptions.

 

*Acquisitionsor investments may drain capital and equity resources, divert**management’s attention or otherwise harm ourbusiness.*

 

In the future we may acquire or makeinvestments in other businesses, products or technologies. Such acquisitions orinvestments may require that we pay significant cash, issue stock or incursubstantial debt. In addition, such acquisitions or investments may requiresignificant managerial attention, which may be diverted from our otheroperations. These capital, equity and managerial commitments may impair theoperation of our business. Furthermore, acquired businesses may not beeffectively integrated, may be unable to maintain key pre-acquisition businessrelationships, may contribute to increased fixed costs and may expose us tounanticipated liabilities.

 

*Ourintellectual property may become subject to legal challenges, unauthorized**use or infringement, any of which could diminish thevalue of our products and**services.*

 

Our success depends in large part on ourproprietary technology. We rely on a combination of copyrights, trademarks,trade secret laws, restrictions on disclosure and other methods to protect ourproprietary technology.  We do not havepatents for any of the technology underlying our Aspen platform. If we fail tosuccessfully enforce our intellectual property rights, the value of theserights, and consequently the value of our products and services to ourcustomers, could diminish substantially. It may be possible for third partiesto copy or otherwise obtain and use our intellectual property or trade secretswithout our authorization, and it may be possible for third parties toindependently develop substantially equivalent intellectual property.

 

Litigation may be necessary in the future toenforce our intellectual property rights, to protect trade secrets or todetermine the validity and scope of the proprietary rights of others. From timeto time we have received, and may in the future receive, notice of claims ofinfringement of other parties’ proprietary rights. Such claims could result incostly litigation and could divert management and technical resources. Theycould also delay product shipment or require us to develop non-infringingtechnology or enter into royalty or licensing agreements, which agreements maynot be available on reasonable terms, or at all.

 

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

 

We use some licensed third-party technologycomponents in our products. Future licenses to this technology may not beavailable to us on commercially reasonable terms, or at all. The loss of orinability to obtain or maintain any of these technology licenses could resultin delays in the introduction of new products or could force us to discontinueoffering portions of our enterprise learning solutions until equivalenttechnology, if available, is identified, licensed and integrated. Furthermore,we may become subject to legal claims related to licensed technology based onproduct liability, infringement of intellectual property or other legaltheories.

 

*Ourdebt covenants may significantly restrict our operations.*

 

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

 

•                       incur debt with parties other than Silicon Valley Bank;

 

•                       pay dividends, redeem or repurchase our stock or make otherdistributions;

 

•                       make acquisitions or investments;

 

•                       engage in new or different businesses;

 

•                       change our capital structure;

 

•                       use assets as security in other transactions;

 

•                       enter into transactions with affiliates or outside the ordinary course ofbusiness;

 

•                       merge or consolidate with others or acquire assets outside the ordinarycourse of business;

 

•                       dispose of assets or use asset sale proceeds;

 

•                       create liens on our assets; and

 

•                       extend  or guaranty credit.

 

In addition, the terms of our indebtednessrequire that we meet certain financial covenants related to maximum net lossesand minimum tangible net worth. The covenants governing our existingindebtedness restrict our operations and those of our subsidiaries, and theselimitations could impair our ability to meet such financial covenants. Inaddition, our ability to meet these financial covenants and to comply withother provisions governing our indebtedness may be affected by changes ineconomic or business conditions or other events beyond our control. Moreover,failure to comply with our debt-related obligations could result in an event ofdefault that, if not cured or waived, could result in an acceleration of ourindebtedness.  We have on occasionviolated certain of the covenants under our loan agreements with Silicon ValleyBank and we cannot assure you that we will not violate these covenants in thefuture.  To date, the bank has waivedthose violations without cost to us. However, we cannot assure you that the bank will waive any futureviolations at no cost to us, or at all.

 

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

 

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*Our stock price hasbeen and may continue to be volatile.*

 

The trading price of our common stock has been and is likely tocontinue to be highly volatile.  Forexample, during the 52-week period ended December 31, 2003, the price ofour common stock ranged from $0.72 to $2.75 per share.  Our stock price is subject to continuedfluctuations in response to a number of factors, including:

 

•                       actual oranticipated variations in quarterly operating results;

 

•                       changes infinancial estimates or recommendations by securities analysts;

 

•                       conditionsor trends in the learning and enterprise software markets;

 

•                       announcementsby us or our competitors of significant customer wins, technologicalinnovations, new products or services;

 

•                       announcementsby us or our competitors of significant acquisitions, strategic partnerships,joint ventures or capital commitments;

 

•                       additionsor departures of key personnel;

 

•                       sales ofour common stock; and

 

•                       generalmarket conditions.

 

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

 

In the past, companies that have experienced volatility in the marketprice of their stock have been subject to securities class actionlitigation.  We may be the targets ofthis type of litigation in the future. Securities litigation against us could result in substantial costs anddivert our management’s attention, which could seriously harm our business.

 

**Item 7a****.  Quantitative andQualitative Disclosures about Market Risk**

 

*Market Rate Risk. *Weare exposed to market risk related to changes in interest rates and foreigncurrency exchange rates. We do not use derivative financial instruments forspeculative or trading purposes.

 

*Interest Rate Risk. *Wehold our assets primarily in cash and cash equivalents, such as short-termmarketable debt securities, money market funds and other cash equivalents. Weminimize risk by investing in financial instruments with maturity of threemonths or less. As a result, if market interest rates were to increaseimmediately and uniformly by 10% from levels at December 31, 2003, thefair value of cash and cash equivalents would not change by a material amount.

 

*Foreign Currency Exchange Risk. *We have foreign currency risk as a result of foreignsubsidiary activities. For the year ended December 31, 2003, internationalrevenue from foreign subsidiaries accounted for approximately 9% of totalrevenue. All foreign subsidiaries use the local currency as their functionalcurrency.

 

Our exposure to foreign exchange ratefluctuations arises in part from intercompany accounts in which costs incurredin the United States are charged to the foreign subsidiaries. Theseintercompany accounts are typically denominated in the functional currency ofthe foreign subsidiary in order to centralize foreign exchange risk with theparent company in the United States. We are also exposed to foreign exchangerate fluctuations as the financial results of foreign subsidiaries aretranslated in U.S. dollars in consolidation. As exchanges rates vary, theseresults, when translated, may vary from expectations and adversely impactoverall expected profitability. The effect of foreign exchange ratefluctuations for the year ended December 31, 2003 was not material. Due tothe substantial 

 

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volatility of currency exchange rates, amongother factors, we cannot predict the effect of exchange rate fluctuations onour future operating results.  We havenot hedged foreign exchange rates.

 

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**Item 8****.  FinancialStatements and Supplementary Data**

 

**Index to Financial Statements, SupplementaryData, and Financial Statement Schedule**

 
| **Consolidated  Financial Statements:**                                                                                                 |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|
| Independent  Auditors’ Report                                                                                                      | 34     |
| Consolidated  Balance Sheets as of December 31, 2002 and 2003                                                                      | 35     |
| Consolidated  Statements of Operations for the Years Ended December 31, 2001, 2002 and  2003                                       | 36     |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Loss for the Years Ended  December 31, 2001, 2002 and 2003 | 37     |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2001, 2002 and  2003                                       | 38     |
| Notes to Consolidated Financial Statements                                                                                              | 39     |
|                                                                                                                                    |   |
| **Supplementary  Data (unaudited):**                                                                                                    |   |
| Quarterly Results (Note 19 of Notes to Consolidated Financial  Statements)                                                              | 56     |
|                                                                                                                                    |   |
| **Financial  Statement Schedule:**                                                                                                      |   |
| Schedule II. Valuation and Qualifying  Accounts                                                                                    | 77     |

 

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**INDEPENDENTAUDITORS’ REPORT**

 

The Board of Directors and Stockholders

Click2learn, Inc.:

 

We have audited the accompanying consolidatedbalance sheets of Click2learn, Inc. and subsidiaries as of December 31,2002 and 2003, and the related consolidated statements of operations,stockholders’ equity and comprehensive loss, and cash flows for each of theyears in the three-year period ended December 31, 2003. In connection withour audit of the consolidated financial statements, we have also audited thefinancial statement schedule as listed in the index at Item 15(a).  These consolidated financial statements andthe financial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements and the financial statement schedule based on ouraudits.

 

We conducted our audits in accordance withauditing standards generally accepted in the United States of America. Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement.An audit includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements. An audit also includes assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Click2learn, Inc. and subsidiaries as ofDecember 31, 2002 and 2003, and the results of their operations and theircash flows for each of the years in the three-year period endedDecember 31, 2003, in conformity with accounting principles generallyaccepted in the United States of America. Also in our opinion, the related financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken asa whole, presents fairly, in all material respects, the information set forththerein.

 

As discussed in note 1 to the consolidatedfinancial statements, the Company changed its method of accounting for goodwilland other intangible assets as of January 1, 2002.

 

KPMG LLP

 

February 6, 2004, except for Notes 14 and 18,which are as of February 18, 2004

Seattle, Washington

 

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**CLICK2LEARN,INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCESHEETS**

**(Inthousands except share data)**

 
|                                                                                                                                           |   | **December 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                                                                                           |   | **2002**              |   | **2003** | ** ** |
| **Assets**                                                                                                                                     |   |                  |   |   |   |
|                                                                                                                                           |   |                  |   |   |   |
| Current assets:                                                                                                                                |   |                  |   |   |   |
| Cash and cash equivalents                                                                                                                      |   | $                     | 3,586  |   | $ | 12,862 |   |
| Accounts receivable, net of allowance for  returns and doubtful accounts of $927 in 2002 and $566 in 2003                                      |   | 10,785                |   | 12,264 |   |
| Inventories                                                                                                                                    |   | 49                    |   | 68 |   |
| Prepaid royalties and licenses                                                                                                                 |   | 157                   |   | 15 |   |
| Other current assets                                                                                                                           |   | 1,570                 |   | 712 |   |
| Total current assets                                                                                                                           |   | 16,147                |   | 25,921 |   |
| Property and equipment, net                                                                                                                    |   | 1,214                 |   | 872 |   |
| Goodwill                                                                                                                                       |   | 2,877                 |   | 2,877 |   |
| Intangible assets, net                                                                                                                         |   | 4,636                 |   | 3,196 |   |
| Other assets                                                                                                                                   |   | 599                   |   | 1,704 |   |
| Total assets                                                                                                                                   |   | $                     | 25,473 |   | $ | 34,570 |   |
|                                                                                                                                           |   |                  |   |   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                  |   |                  |   |   |   |
|                                                                                                                                           |   |                  |   |   |   |
| Current liabilities:                                                                                                                           |   |                  |   |   |   |
| Accounts payable                                                                                                                               |   | $                     | 2,934  |   | $ | 1,786 |   |
| Accrued compensation and benefits                                                                                                              |   | 2,294                 |   | 2,612 |   |
| Deferred revenue                                                                                                                               |   | 4,435                 |   | 7,266 |   |
| Short term debt                                                                                                                                |   | 2,400                 |   | 3,521 |   |
| Other                                                                                                                                          |   | 1,184                 |   | 889 |   |
| Total current liabilities                                                                                                                      |   | 13,247                |   | 16,074 |   |
| Total liabilities                                                                                                                              |   | 13,247                |   | 16,074 |   |
|                                                                                                                                           |   |                  |   |   |   |
| Stockholders’ equity:                                                                                                                     |   |                  |   |   |   |
| Preferred stock, $0.01 par value;  authorized 5,000,000 shares; issued and outstanding no shares in 2002 and  2003                             |   | —                |   | — |   |
| Common stock, $0.01 par value; authorized  100,000,000 shares, issued and outstanding 24,600,114 shares in 2002 and  32,804,816 shares in 2003 |   | 246                   |   | 328 |   |
| Additional paid-in capital                                                                                                                     |   | 242,570               |   | 254,797 |   |
| Accumulated deficit                                                                                                                            |   | (230,008              | )      | (236,168 | ) |
| Accumulated other comprehensive loss                                                                                                           |   | (582                  | )      | (461 | ) |
| Total stockholders’ equity                                                                                                                |   | 12,226                |   | 18,496 |   |
| Total liabilities and stockholders’ equity                                                                                                |   | $                     | 25,473 |   | $ | 34,570 |   |

 

See accompanying notes to ConsolidatedFinancial Statements

 

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**CLICK2LEARN,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Inthousands, except per share data)**

 
|                                                           |   | **Year Ended  December 31,** |    |
|----------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                           |   | **2001**                          |    | **2002** |   | **2003** |   |
|                                                           |   |                              |    |   |   |   |   |
| Revenue:                                                       |   |                              |    |   |   |   |   |
| License                                                        |   | $                                 | 15,508  |   | $ | 12,107 |   | $ | 9,134 |   |
| Services                                                       |   | 15,701                            |    | 18,370 |   | 20,353 |   |
| Total revenue                                                  |   | 31,209                            |    | 30,477 |   | 29,487 |   |
| Cost of revenue:                                               |   |                              |    |   |   |   |   |
| License                                                        |   | 953                               |    | 1,002 |   | 1,766 |   |
| Services                                                       |   | 7,125                             |    | 8,569 |   | 7,733 |   |
| Total cost of revenue                                          |   | 8,078                             |    | 9,571 |   | 9,499 |   |
| Gross margin                                                   |   | 23,131                            |    | 20,906 |   | 19,988 |   |
| Operating expenses:                                            |   |                              |    |   |   |   |   |
| Research and development                                       |   | 8,752                             |    | 8,153 |   | 6,411 |   |
| Sales and marketing                                            |   | 18,536                            |    | 16,595 |   | 13,942 |   |
| General and administrative                                     |   | 6,457                             |    | 5,997 |   | 5,530 |   |
| Amortization of goodwill                                       |   | 433                               |    | — |   | — |   |
| Employee severance                                             |   | —                            |    | 485 |   | — |   |
| Total operating expenses                                       |   | 34,178                            |    | 31,230 |   | 25,883 |   |
| Operating loss from continuing operations                      |   | (11,047                           | )       | (10,324 | ) | (5,895 | ) |
| Other income (expense):                                        |   |                              |    |   |   |   |   |
| Other income, net                                              |   | 93                                |    | — |   | — |   |
| Interest income                                                |   | 126                               |    | 72 |   | 45 |   |
| Interest expense                                               |   | (19                               | )       | (62 | ) | (181 | ) |
| Equity in losses of affiliate                                  |   | (400                              | )       | (200 | ) | (100 | ) |
| Total other income (expense)                                   |   | (200                              | )       | (190 | ) | (236 | ) |
| Loss from continuing operations before  income taxes           |   | (11,247                           | )       | (10,514 | ) | (6,131 | ) |
| Provision for income taxes                                     |   | —                            |    | — |   | (29 | ) |
| Loss from continuing operations                                |   | (11,247                           | )       | (10,514 | ) | (6,160 | ) |
| Loss from discontinued operations                              |   | (8,334                            | )       | (7,600 | ) | — |   |
| Net loss                                                       |   | $                                 | (19,581 | ) | $ | (18,114 | ) | $ | (6,160 | ) |
| Amounts per share, basic and diluted:                          |   |                              |    |   |   |   |   |
| Loss from continuing operations                                |   | $                                 | (0.57   | ) | $ | (0.43 | ) | $ | (0.21 | ) |
| Loss from discontinued operations                              |   | (0.42                             | )       | (0.31 | ) | — |   |
| Net loss                                                       |   | $                                 | (0.99   | ) | $ | (0.74 | ) | $ | (0.21 | ) |
| Weighted average common shares outstanding,  basic and diluted |   | 19,748                            |    | 24,393 |   | 28,973 |   |

 

See accompanying notes to ConsolidatedFinancial Statements

 

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**CLICK2LEARN,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS**

(**In thousands, except share data**)

 
|                                                                   |                           |              |       |       |       | **Additional  Paid-In  Capital** |       | **Deferred  Stock  Compen-  Sation** |       | **Accumulated  Other  Comprehensive  Loss** |       | **Accumulated  Deficit** |       | **Comprehensive  Loss** |   | **Total** |   |
|------------------------------------------------------------------------|--------------------------------|-------------------|------------|------------|------------|----------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|--------------------------|------------|-------------------------|--------|-----------|--------|
|                                                                   | **Preferred  Stock  Series A** | ** **        | ** ** | ** ** | ** ** | ** **                       | ** ** | ** **                           | ** ** |
|                                                                   | ** **                     | **Common  Stock** | ** ** | ** ** | ** ** | ** **                       | ** ** | ** **                           | ** ** |
|                                                                   | **Shares**                     | ** **        | **Amount** | ** ** | **Shares** | ** **                       | **Amount** | ** **                           | ** ** | ** **                                  | ** ** | ** **               | ** ** | ** **              |
| **Balances at December 31, 2000**                                 |                           | —            |       | —     |       | 17,886,563                       |       | $                                    | 180        |                                        | $          | 227,766                  |       | $                       | (72    | )         | $      | (508 | ) | $ | (192,313 | ) | $ | 35,053 |   |   |   |
| Stock options exercised                                                |                           | —            |       | —     |       | 342,101                          |       | 3                                    |       | 560                                         |       | —                   |       | —                  |   | —    |   | — |   | 563 |   |
| Amortization of deferred stock compensation                            |                           | —            |       | —     |       | —                           |       | —                               |       | 62                                          |       | 51                       |       | —                  |   | —    |   | — |   | 113 |   |
| Forfeitures of deferred compensation                                   |                           | —            |       | —     |       | —                           |       | —                               |       | (16                                         | )          | 16                       |       | —                  |   | —    |   | — |   | — |   |
| Common stock issued in business combinations                           |                           | —            |       | —     |       | 1,812,500                        |       | 18                                   |       | 4,402                                       |       | —                   |       | —                  |   | —    |   | — |   | 4,420 |   |
| Sale of common stock and warrants, net of offering  costs of $1,127    |                           | —            |       | —     |       | 3,680,000                        |       | 37                                   |       | 8,036                                       |       | —                   |       | —                  |   | —    |   | — |   | 8,073 |   |
| Exercise of common stock warrants                                      |                           | —            |       | —     |       | 74,759                           |       | 1                                    |       | —                                      |       | —                   |       | —                  |   | —    |   | — |   | 1 |   |
| Common stock sold pursuant to the employee stock  purchase plan        |                           | —            |       | —     |       | 308,086                          |       | 3                                    |       | 959                                         |       | —                   |       | —                  |   | —    |   | — |   | 962 |   |
| Comprehensive loss:                                                    |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   |   |   |   |   |
| Net loss                                                               |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | —                  |   | (19,581   | )      | (19,581 | ) | (19,581 | ) |
| Translation adjustments                                                |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | (44                     | )      | —    |   | (44 | ) | (44 | ) |
| Total comprehensive loss                                               |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   | $ | (19,625 | ) |   |   |
| **Balances at December 31, 2001**                                 |                           | —            |       | —     |       | 24,104,009                       |       | $                                    | 242        |                                        | $          | 241,769                  |       | $                       | (5     | )         | $      | (552 | ) | $ | (211,894 | ) |   |   | $ | 29,560 |   |
| Stock options exercised                                                |                           | —            |       | —     |       | 46,156                           |       | —                               |       | 94                                          |       | —                   |       | —                  |   | —    |   | — |   | 94 |   |
| Amortization of deferred stock compensation                            |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | 5                        |       | —                  |   | —    |   | — |   | 5 |   |
| Issuance of common stock warrants                                      |                           | —            |       | —     |       | —                           |       | —                               |       | 178                                         |       | —                   |       | —                  |   | —    |   | — |   | 178 |   |
| Common stock sold pursuant to the employee stock  purchase plan        |                           | —            |       | —     |       | 449,949                          |       | 4                                    |       | 529                                         |       | —                   |       | —                  |   | —    |   | — |   | 533 |   |
| Comprehensive loss:                                                    |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   |   |   |   |   |
| Net loss                                                               |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | —                  |   | (18,114   | )      | (18,114 | ) | (18,114 | ) |
| Translation adjustments                                                |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | (30                     | )      | —    |   | (30 | ) | (30 | ) |
| Total comprehensive loss                                               |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   | $ | (18,144 | ) |   |   |
| **Balances at December 31, 2002**                                 |                           | —            |       | —     |       | 24,600,114                       |       | $                                    | 246        |                                        | $          | 242,570                  |       | $                       | — |      | $      | (582 | ) | $ | (230,008 | ) |   |   | $ | 12,226 |   |
| Stock options exercised                                                |                           | —            |       | —     |       | 205,984                          |       | 2                                    |       | 105                                         |       | —                   |       | —                  |   | —    |   | — |   | 107 |   |
| Sale of common stock and warrants, net of offering  costs of  843 |                           | —            |       | —     |       | 7,460,644                        |       | 75                                   |       | 11,853                                      |       | —                   |       | —                  |   | —    |   | — |   | 11,928 |   |
| Exercise of common stock warrants                                      |                           | —            |       | —     |       | 88,120                           |       | —                               |       | —                                      |       | —                   |       | —                  |   | —    |   | — |   | — |   |
| Common stock sold pursuant to the employee stock  purchase plan        |                           | —            |       | —     |       | 449,954                          |       | 5                                    |       | 269                                         |       | —                   |       | —                  |   | —    |   | — |   | 274 |   |
| Comprehensive loss:                                                    |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   |   |   |   |   |
| Net loss                                                               |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | —                  |   | (6,160    | )      | (6,160 | ) | (6,160 | ) |
| Translation adjustments                                                |                           | —            |       | —     |       | —                           |       | —                               |       | —                                      |       | —                   |       | 121                     |   | —    |   | 121 |   | 121 |   |
| Total comprehensive loss                                               |                           |              |       |       |       |                             |       |                                 |       |                                        |       |                     |       |                    |   |      |   | $ | (6,039 | ) |   |   |
| **Balances at December 31, 2003**                                 |                           | —            |       | —     |       | 32,804,816                       |       | $                                    | 328        |                                        | $          | 254,797                  |       | $                       | — |      | $      | (461 | ) | $ | (236,168 | ) |   |   | $ | 18,496 |   |

 

See accompanying notes to ConsolidatedFinancial Statements

 

37

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**CLICK2LEARN,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Inthousands)**

 
|                                                                                                  |   | **Year Ended  December 31,** |    |
|-------------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                                                  |   | **2001**                          |    | **2002** |   | **2003** |   |
| Cash flows from operating activities:                                                                 |   |                              |    |   |   |   |   |
| Continuing operations:                                                                                |   |                              |    |   |   |   |   |
| Net loss                                                                                              |   | $                                 | (11,247 | ) | $ | (10,514 | ) | $ | (6,160 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) continuing operating activities: |   |                              |    |   |   |   |   |
| Depreciation and amortization                                                                         |   | 2,505                             |    | 2,252 |   | 2,508 |   |
| Write-off property and equipment                                                                      |   | —                            |    | 270 |   | — |   |
| Provision for returns and doubtful accounts                                                           |   | 1,198                             |    | 1,557 |   | 744 |   |
| Stock compensation expense                                                                            |   | 113                               |    | 5 |   | — |   |
| Amortization of discount on debt                                                                      |   | —                            |    | — |   | 88 |   |
| Equity in loss from affiliate                                                                         |   | 400                               |    | 200 |   | 100 |   |
| Net change in certain operating assets and  liabilities                                               |   | (6,748                            | )       | 4,078 |   | 1,183 |   |
| Net cash used in continuing operating  activities                                                     |   | (13,779                           | )       | (2,152 | ) | (1,537 | ) |
| Discontinued operations:                                                                              |   |                              |    |   |   |   |   |
| Loss from discontinued operations                                                                     |   | (8,334                            | )       | (7,600 | ) | — |   |
| Amortization expense                                                                                  |   | 8,701                             |    | — |   | — |   |
| Accounts receivable forfeited                                                                         |   | —                            |    | 4,475 |   | — |   |
| Gain on sale of assets                                                                                |   | —                            |    | (927 | ) | — |   |
| Net cash provided by (used in) discontinued  operating activities                                     |   | 367                               |    | (4,052 | ) | — |   |
| Net cash used in operating activities                                                                 |   | (13,412                           | )       | (6,204 | ) | (1,537 | ) |
| Cash flows from investing activities:                                                                 |   |                              |    |   |   |   |   |
| Continuing operations:                                                                                |   |                              |    |   |   |   |   |
| Purchase of property and equipment                                                                    |   | (1,935                            | )       | (3,011 | ) | (728 | ) |
| Payments related to acquisitions, net of  cash acquired                                               |   | (247                              | )       | — |   | — |   |
| Payments related to merger                                                                            |   | —                            |    | — |   | (1,156 | ) |
| Investment in affiliate                                                                               |   | (639                              | )       | — |   | — |   |
| Other                                                                                                 |   | (3                                | )       | (10 | ) | (49 | ) |
| Net cash used in continuing investing  activities                                                     |   | (2,824                            | )       | (3,021 | ) | (1,933 | ) |
| Discontinued operations:                                                                              |   |                              |    |   |   |   |   |
| Proceeds from sale of assets                                                                          |   | —                            |    | 1,000 |   | — |   |
| Net cash provided by discontinued  activities                                                         |   | —                            |    | 1,000 |   | — |   |
| Net cash used in investing activities                                                                 |   | (2,824                            | )       | (2,021 | ) | (1,933 | ) |
| Cash flows from financing activities:                                                                 |   |                              |    |   |   |   |   |
| Repayments on debt                                                                                    |   | (87                               | )       | (2,501 | ) | (28,411 | ) |
| Proceeds from borrowings                                                                              |   | 1,000                             |    | 4,162 |   | 28,727 |   |
| Proceeds from exercise of stock options                                                               |   | 563                               |    | 94 |   | 107 |   |
| Net proceeds from sale of common and  preferred stock and common stock warrants                       |   | 9,036                             |    | 533 |   | 12,202 |   |
| Net cash provided by financing activities                                                             |   | 10,512                            |    | 2,288 |   | 12,625 |   |
| Effect of foreign exchange rate changes on  cash                                                      |   | (44                               | )       | (30 | ) | 121 |   |
| Net increase (decrease) in cash and cash  equivalents                                                 |   | (5,768                            | )       | (5,967 | ) | 9,276 |   |
| Cash and cash equivalents at beginning of  year                                                       |   | 15,321                            |    | 9,553 |   | 3,586 |   |
| Cash and cash equivalents at end of year                                                              |   | $                                 | 9,553   |   | $ | 3,586 |   | $ | 12,862 |   |
| Supplemental disclosure of non cash  activities:                                                      |   |                              |    |   |   |   |   |
| Common stock issued in purchase business  combinations                                                |   | $                                 | 4,420   |   | $ | — |   | $ | — |   |
| Issuance of common stock warrants                                                                     |   | $                                 | —  |   | $ | 178 |   | $ | — |   |
| Cash paid for interest                                                                                |   | $                                 | —  |   | $ | — |   | $ | 181 |   |

 

See accompanying notes to ConsolidatedFinancial Statements

 

38

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**(1)****         Summaryof Significant Accounting Policies**

 

*(a)**       Description of Business*

 

Click2learn, Inc. (“Click2learn”) develops, markets, distributes, andsupports an integrated suite of enterprise learning software products andrelated services.  Click2learn’s marketsare worldwide and include a broad range of industries.

 

*(b)**       Principles of Consolidation*

 

The accompanying consolidated financial statements include thefinancial statements of Click2learn and its wholly owned subsidiaries.  All significant intercompany accounts andtransactions have been eliminated in consolidation.  Investments in 20% to 50% owned companies, which has consistedonly of Click2learn Japan K.K.,  areaccounted for using the equity method of accounting.

 

*(c)**        Use of Estimates*

 

The preparation of financial statements in conformity with generallyaccepted accounting principles in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets and liabilitiesand the disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  Examples includedepreciable lives of property and equipment; expense accruals; and allowancesfor returns and doubtful accounts, asset impairments and bad debts.  Such estimates and assumptions are based onhistorical experience, where applicable, and other assumptions.  Estimates and assumptions are reviewedperiodically and the effects of revisions are reflected in the consolidatedfinancial statements in the period they are determined to be necessary.  Actual results could differ from theseestimates.

 

*(d)**       Cash and Cash Equivalents*

 

Cash and cash equivalents of $3,586 and $12,862 at December 31,2002 and 2003, respectively, consist of overnight repurchase agreements andcertificates of deposit with an initial term of less than three months.  All highly liquid financial instrumentspurchased with a remaining maturity of three months or less at the date ofpurchase are reported as cash equivalents.

 

*(e)**        Foreign CurrencyTranslation*

 

The functional currency of Click2learn’s foreign subsidiaries is thelocal currency in the country in which the subsidiary is located.  Assets and liabilities denominated inforeign currencies are translated to U.S. dollars at the exchange rate ineffect on the balance sheet date. Revenues and expenses are translated at the average rates of exchangeprevailing during the year.  Thetranslation adjustment resulting from this process is presented separately as acomponent of accumulated other comprehensive loss in stockholders’ equity.  Gains and losses on foreign currencytransactions are included in the consolidated statement of operations asincurred.  To date, gains and losses onforeign currency transactions have not been significant.

 

*(f)**           Accounts Receivable*

 

Accounts receivable are recorded at the invoiced amount and do not bearinterest.  The allowance for doubtfulaccounts is Click2learn’s best estimate of the amount of probable credit lossesin Click2learn’s existing accounts receivable. Click2learn determines the allowance based on historical write-offexperience by industry and national economic data.  Click2learn reviews its allowance for doubtful accountsmonthly.  Past due balances over 90 daysare reviewed individually for collectibility. Account balances are charged off against the allowance after all means ofcollection have been exhausted and the potential for recovery is considered remote.  Click2learn does not have any off-balancesheet credit exposure related to its customers.

 

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*(g)**       Concentration of Credit andSales Risk*

 

Click2learn has a diverse customer base including customers in numerousindustries and governmental organizations. Click2learn performs ongoing credit evaluations of its customers’financial condition and generally requires no collateral.  For the years ended December 31, 2003and 2002, Microsoft accounted for 17.5% and 13.7%, respectively, of totalrevenues from continuing operations and 10% and 12%, respectively,  of accounts receivable. For the year endedDecember 31, 2001, no customer accounted for 10% or more of total revenuesfrom continuing operations and accounts receivable.

 

*(h)**       Inventories*

 

Inventories are stated at the lower of cost or market.  Cost is determined principally using afirst-in, first-out cost flow assumption.

 

*(i)**          Other Current Assets*

 

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

 
|                       |   | **Year Ended  December 31,** |   |
|----------------------------|--------|-----------------------------------|--------|
|                       |   | **2002**                          |   | **2003** |   |
| Prepaid expense            |   | $                                 | 430    |   | $ | 263 |   |
| Prepaid insurance          |   | 618                               |   | 214 |   |
| Other                      |   | 522                               |   | 235 |   |
| Total other current assets |   | $                                 | 1,570  |   | $ | 712 |   |

 

*(j)**           Financial Instruments*

 

At December 31, 2002 and 2003, the carrying values of financialinstruments, such as cash and cash equivalents, trade receivables and accountspayable approximated their fair values based on the short-term maturities ofthese instruments. The carrying value of the bank term loan outstandingapproximated fair value as the interest rate on the debt instrument is variablein nature and tied to prevailing market rates.

 

*(k)**       Property and Equipment*

 

Property and equipment are stated at cost.  Plant and equipment under capital leases are stated at thepresent value of minimum lease payments.

 

Depreciation is computed using the straight-line method over theestimated useful lives of three to seven years.  Leasehold improvements are amortized over the lesser of the leaseterm or estimated useful life.  Repairsand maintenance that do not improve or extend the lives of the respectiveassets are expensed in the period incurred. Total depreciation for the years ended December 31, 2002 and 2003is $1,085 and $827, respectively, of which 37% was recorded in cost of goodsand services, and 63% was recorded in R&D, selling, general, andadministrative expense.

 

*(l)**          Goodwill and OtherIntangible Assets*

 

Goodwill represents the excess of costs over fair value of assets ofbusinesses acquired. Click2learn adopted the provisions of Statement ofFinancial Accounting Standards No. 142 (“SFAS 142”), *Goodwill and Other Intangible Assets,*as of January 1, 2002. Goodwill and intangible assets acquired in apurchase business combination and determined to have an indefinite useful lifeare not amortized, but instead tested for impairment at least annually inaccordance with the provisions of SFAS 142. SFAS 142 also requires thatintangible assets with estimable useful lives be amortized over their respectiveestimated useful lives to their estimated residual values, and reviewed forimpairment in accordance with Statement of Financial Accounting StandardsNo. 144 (“SFAS 144”), *Accounting for Impairment or Disposal of Long-LivedAssets*.

 

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In connection with SFAS 142’s transitional goodwill impairmentevaluation, Click2learn performed an assessment of whether there was anindication that goodwill is impaired as of the date of adoption. To accomplishthis, Click2learn was required to identify its reporting units and determinethe carrying value of each reporting unit by assigning the assets andliabilities, including the existing goodwill and intangible assets, to thosereporting units as of January 1, 2002. To the extent the carrying amountof a reporting unit exceeded the fair value of the reporting unit, Click2learnwould be required to perform the second step of the transitional impairmenttest.  The second step, which requires acomparison of the implied fair value of the reporting unit goodwill with thecarrying amount of the reporting unit goodwill was not required because thecarrying amount of the reporting unit did not exceed its respective fair value.

 

Prior to the adoption of SFAS 142, goodwill was amortized on astraight-line basis over the expected periods to be benefited, generally15 years, and assessed for recoverability by determining whether theamortization of the goodwill balance over its remaining life could be recoveredthrough undiscounted future operating cash flows of the acquired operation.Goodwill amortization in 2001, prior to the adoption of SFAS 142, was$1,494.  All other intangible assetswere amortized on a straight-line basis from 3 to 5 years. The amount ofgoodwill and other intangible asset impairment, if any, was measured based onprojected discounted future operating cash flows using a discount ratereflecting Click2learn’s average cost of funds.

 

*(m)**     Other assets*

 

The following table sets forth the componentsof other assets (in thousands):                                            

 
|                       |   | **Year Ended  December 31,** |   |
|----------------------------|--------|-----------------------------------|--------|
|                       |   | **2002**                          |   | **2003** |   |
| Deposits                   |   | $                                 | 280    |   | $ | 329 |   |
| Prepaid merger costs       |   | —                            |   | 1,156 |   |
| Other                      |   | 319                               |   | 219 |   |
| Total other current assets |   | $                                 | 599    |   | $ | 1,704 |   |

 

*(n)**       Impairment of Long-LivedAssets*

 

SFAS 144 provides a single accounting model for disposal of long-livedassets. SFAS 144 also changes the criteria for classifying an asset as held forsale and broadens the scope of businesses to be disposed of that qualify forreporting as discontinued operations and changes the timing of recognizinglosses on such operations. Click2learn adopted SFAS 144 on January 1,2002.  The adoption of SFAS 144 did notaffect our consolidated financial position or results of operations as ofJanuary 1, 2002.  The broadeneddefinition of discontinued operations with SFAS 144 has affected thepresentation and disclosure of our results of operations for the year ended2002 and prior years presented for comparison. In accordance with SFAS 144,long-lived assets, such as property, plant, and equipment, and purchasedintangibles subject to amortization, are reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of an asset to estimatedundiscounted future cash flows expected to be generated by the asset. If thecarrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized by the amount by which the carrying amount ofthe asset exceeds the fair value of the asset. Assets to be disposed of wouldbe separately presented in the balance sheet and reported at the lower of thecarrying amount or fair value less costs to sell, and are no longer depreciated.  The assets and liabilities of a disposalgroup classified as held for sale would be presented separately in theappropriate asset and liability sections of the balance sheet.

 

Goodwill and intangible assets not subject to amortization are testedannually for impairment, and are tested for impairment more frequently ifevents and circumstances indicate that the asset might be impaired.  An impairment loss is recognized to theextent that the carrying amount exceeds the asset’s fair value.

 

Prior to the adoption of SFAS 144, Click2learn accounted forlong-lived assets in accordance with SFAS No. 121 (“SFAS 121”), *Accountingfor Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of*.

 

41

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*(o)**       Revenue Recognition*

 

Click2learn recognizes revenue pursuant tothe requirements of Statement of Position No. 97-2, *Software Revenue Recognition*(“SOP 97-2”), as amended by Statement of Position No. 98-9, *SoftwareRevenue Recognition with Respect to Certain Arrangements.* Under SOP97-2, revenue attributable to an element in a customer arrangement isrecognized when persuasive evidence of an arrangement exists and delivery hasoccurred, provided the fee is fixed or determinable, collectibility is probableand the arrangement does not require significant customization of the software.

 

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

 

For software license fees in single elementarrangements and multiple element arrangements, which do not includecustomization or consulting services, delivery typically is deemed to occurwhen the product is shipped to customers.

 

At the time of each transaction, Click2learnassesses whether the fee associated with its revenue is fixed and determinableand whether or not collection is reasonably assured. Click2learn assesseswhether the fee is fixed and determinable based on the payment terms associatedwith the transaction. If a significant portion of a fee is due afterClick2learn’s normal payment terms, based upon a variable matrix such as aminimum level of distribution or subject to refund (other than refunds forwarranty claims or its uncured defaults), Click2learn accounts for the fee asnot being fixed and determinable. In these cases, Click2learn defers revenueand recognize it when it becomes due and payable.

 

Click2learn assesses the probability ofcollection based on a number of factors, including past transaction historywith the customer and the current financial condition of the customer.Click2learn does not request collateral from its customers. If Click2learndetermines at the time of the transaction that collection of a fee is notreasonably assured, it defers revenue until the time collection becomesreasonably assured, generally when payment is received.

 

For multiple element arrangements, whencompany-specific objective evidence of fair value exists for all of theundelivered elements of the arrangement, but does not exist for one or more ofthe delivered elements in the arrangement, Click2learn recognizes revenue underthe residual method. Under the residual method, at the outset of thearrangement with a customer, Click2learn defers revenue for the fair value ofits undelivered elements such as consulting services and product support andupgrades, and recognizes the revenue for the remainder of the arrangement feeattributable to the elements initially delivered, such as software licenses,when the criteria in SOP 97-2 have been met. Company-specific objectiveevidence is established for support and upgrades of standard products for whichno installation or customization is required based upon the amounts Click2learncharges when support and upgrades are sold separately. For multiple elementarrangements involving installation or customization, company-specificobjective evidence is established for support and maintenance arrangements ifits customers have an optional annual renewal rate specified in the arrangementand the rate is substantive. Company-specific objective evidence is establishedfor consulting and installation services based on the hourly rates Click2learncharges for its employees when they are performing these services providedClick2learn has the ability to accurately estimate the hours required tocomplete a project based upon its experience with similar projects.

 

Professional services revenue is recognizedfrom fixed price contracts as services are provided or by using thepercentage-of-completion method of accounting, based on the ratio of costsincurred to the total estimated project cost, for individual fixed-price contracts.Provisions for any estimated losses on uncompleted contracts are made in theperiod in which such losses become evident. Professional services revenue fromtime and materials contracts and training services is recognized as revenue asservices are performed.

 

Click2learn recognizes revenue fromnon-refundable minimum royalty agreements from distributors or resellers upondelivery of product to the distributor or reseller, provided no significantobligations remain outstanding and the conditions of SOP 97-2 have beenmet.  If minimum royalties are exceeded,the additional royalties are recognized as revenue when earned, based on thecontractual reporting obligations.

 

42

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Revenue from subscription licenses, hosting agreements and supportagreements is recognized on a straight-line basis over the life of thecontract.

 

*(p)**       Research and Development*

 

Research and development costs, which consist primarily of softwaredevelopment costs, are expensed as incurred. Financial accounting standards provide for the capitalization of certainsoftware development costs after technological feasibility of software isestablished.  Under Click2learn’scurrent practice of developing new products and enhancements, the technologicalfeasibility of the underlying software is not established until the completionof a working model at which time all product development is substantiallycomplete.  Accordingly, no such costshave been capitalized because the impact would not be material.

 

*(q)**       Income Taxes*

 

Income taxes are accounted for under the asset and liabilitymethod.  Deferred tax assets andliabilities are recognized for the future tax consequences attributable to thedifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating loss and taxcredit carryforwards.  Deferred taxassets and liabilities are measured using enacted tax rates expected to apply totaxable income in the years in which those temporary differences are expectedto be recovered or settled.  The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin results of operations in the period that includes the enactment date.

 

(r)            *Stock-Based Compensation*

 

Click2learn applies the intrinsic-value-based method of accountingprescribed by Accounting Principles Board Opinion No. 25 (“APB 25”), *Accountingfor Stock Issued to Employees,*and related interpretations includingFASB Interpretation No. 44 (“FIN 44”),*Accounting for Certain Transactions Involving StockCompensation, an interpretation of APB 25*, issued inMarch 2000, to account for its fixed-plan stock options.  Under this method, compensation expense isrecorded only if the current market price of the underlying stock exceeded theexercise price on the date of the grant. Statement of Financial Accounting Standards No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*, established accounting and disclosurerequirements using a fair-value-based method of accounting for stock-basedemployee compensation plans.  As allowedby SFAS 123, Click2learn has elected to continue to apply theintrinsic-value-based method of accounting described above, and has adoptedonly the disclosure requirements of SFAS 123 as amended by Statement ofFinancial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation–Transition and Disclosure, Amendment of SFAS 123*(“SFAS148”).  The following tableillustrates the effect on net income if the fair-value-based method had beenapplied to all outstanding and unvested awards in each period.

 
|                                                                                                                          |   | **Year Ended  December 31,**          |    |
|-------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|---------|
|                                                                                                                          |   | **2001**                                   |    | **2002** |   | **2003** |   |
|                                                                                                                          |   | **(In  thousands, except per share data)** |    |
|                                                                                                                          |   |                                       |    |   |   |   |   |
| Net loss, as reported                                                                                                         |   | $                                          | (19,581 | ) | $ | (18,114 | ) | $ | (6,160 | ) |
| Add stock-based employee compensation  expenses included in reported net loss, net of tax                                     |   | 113                                        |    | 5 |   | — |   |
| Deduct total stock-based employee  compensation expense determined under fair-value-based method for all  rewards, net of tax |   | (6,498                                     | )       | (5,460 | ) | (3,836 | ) |
| Pro forma net loss                                                                                                            |   | $                                          | (25,966 | ) | $ | (23,569 | ) | $ | (9,996 | ) |
| Basic and diluted net loss per share:                                                                                         |   |                                       |    |   |   |   |   |
| As reported                                                                                                                   |   | $                                          | (0.99   | ) | $ | (0.74 | ) | $ | (0.21 | ) |
| Pro forma                                                                                                                     |   | $                                          | (1.31   | ) | $ | (0.97 | ) | $ | (0.35 | ) |

 

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The fair value for the options granted was estimated using theBlack-Scholes option pricing model with the following assumptions:

 
|                    |   | **Years  ended December 31,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   | **2001**                           |   | **2002** |   | **2003** |   |
| Expected dividend yield |   | 0                                  | %      | 0 | % | 0 | % |
| Risk-free interest rate |   | 4.4                                | %      | 2.8 | % | 3.3 | % |
| Expected life (years)   |   | 5                                  |   | 5 |   | 5 |   |
| Volatility              |   | 130                                | %      | 124 | % | 99 | % |

 

*(s)**         Advertising*

 

Advertising costs are expensed as incurred and are included in salesand marketing expenses.  Advertisingexpense was $555, $318, and $5, respectively, during the years endedDecember 31, 2001, 2002, and 2003.

 

*(t)**          Net Loss Per Share*

 

Basic net loss per share is computed by dividing the sum of net loss bythe weighted average number of common shares outstanding during theperiod.  Diluted share amounts reflectthe weighted average number of common and dilutive shares outstanding duringthe period. As Click2learn had a net loss attributable to common stockholdersin each of the periods presented, basic and diluted net losses per share arethe same.

 

Excluded from the computation of diluted loss per share for the yearended December 31, 2003 are options to acquire approximately 6,060,652shares of common stock with a weighted average share price of $7.47 andwarrants to purchase 6,755,732 shares of common stock with a weighted averageshare price of $3.40 because their effects would be anti-dilutive. Excludedfrom the computation of diluted earnings per share for the years endedDecember 31, 2001 and 2002 are options to acquire approximately 5,669,125and 6,239,354 shares, respectively, of common stock with a weighted averageexercise price of $6.49 and $4.19, respectively, and warrants to purchase3,633,686 and 3,825,010 shares, respectively, of common stock with a weightedaverage share price of $5.75 and $5.33, respectively, because their effectswould be anti-dilutive.

 

*(u)**       Comprehensive Loss*

 

Click2learn’s total comprehensive loss for the years endedDecember 31, 2001, 2002, and 2003 consisted of net loss and foreigncurrency translation adjustments. Accumulated other comprehensive loss as of December 31, 2001, 2002,and 2003 consists of foreign currency translation adjustments.  The tax effects on the foreign currencytranslation adjustments were not significant.

 

*(v)**        Derivative FinancialInstruments*

 

Statement of Financial Accounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities* (“SFAS 133”), asamended, requires that all derivative instruments be recorded on the balancesheet at fair value.  Changes in thefair value of derivatives are recorded each period in current results ofoperations or other comprehensive income (loss) depending on whether aderivative is designated as part of a hedge transaction, and if so, the type ofrisk being hedged.

 

For a derivative designated as a fair value hedge, the gain or loss ofthe derivative in the period of change and the offsetting loss or gain of thehedged item attributed to the hedged risk are recognized in results ofoperations.  For a derivative designatedas a cash flow hedge, the effective portion of the derivative’s gain or loss isinitially reported as a component of other comprehensive income (loss) andsubsequently reclassified into results of operations when the hedged exposureaffects results of operations.  The ineffectiveportion of the

 

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gain or loss of a cash flow hedge is recognized immediately in resultsof operations.  For a derivative notdesignated as a hedging instrument, the gain or loss is recognized in resultsof operations in the period of change.

 

Click2learn had no derivative financial instruments outstanding as ofDecember 31, 2002 and 2003.

 

*(w)**     Recent AccountingPronouncements*

 

In December 2003, the FASB issued Interpretation No. 46 (“FIN46R”), *Consolidation of Variable InterestEntities.*  FIN 46R addresseshow a business enterprise should evaluate whether it has a controllingfinancial interest in an entity through means other than voting rights andaccordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, *Consolidation of Variable Interest Entities*, which wasissued in January 2003. Click2learn will be required to apply FIN 46R to variable interests inVariable Interest Entities (“VIEs”) created after December 31, 2003.  For variable interests in VIEs createdbefore January 1, 2004, FIN 46R will be applied beginning onJanuary 1, 2005.  For any VIEs thatmust be consolidated under FIN 46R that were created before January 1,2004, the assets, liabilities and noncontrolling interests of the VIE initiallywould be measured at their carrying amounts with any difference between the netamount added to the balance sheet and any previously recognized interest beingrecognized as the cumulative effect of an accounting change.  If determining the carrying amounts is notpracticable, fair value at the date FIN 46R first applies may be used tomeasure the assets, liabilities and noncontrolling interest of the VIE.  Click2learn is currently reviewing thepotential impact of FIN 46R on Click2learn’s consolidated financial statements.

 

In December 2003, the SEC issued Staff Accounting Bulletin No.104, *Revenue Recognition* (“SAB104”) which revises or rescinds certain sections of Staff Accounting BulletinNo. 101, *Revenue Recognition in*Financial *Statements* (“SAB 101”),in order to make this interpretive guidance consistent with currentauthoritative accounting and auditing guidance and SEC rules andregulations.  The changes noted in SAB104 did not have a material effect on Click2learn’s financial position andresults of operations.

 

*(x)**        Reclassifications*

 

Amortization of purchased technology has beenreclassified, as follows, from research and development costs to license costof revenue since it relates to products currently being sold by Click2learn (inthousands):

 
|                                 |   | **Year Ended  December 31,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
|                                 |   | **2001**                          |   | **2002** |   |
|                                 |   |                              |   |   |   |
| Amortization of purchased technology |   | $                                 | 117    |   | $ | 466 |   |
|                                      |        |                                   |        |  |  |  |  |

 

**(2)****          Inventories**

 

Inventories consist of the following (in thousands):

 
|           |   | **December 31,** |   |
|----------------|--------|-----------------------|--------|
|           |   | **2002**              |   | **2003** |   |
| Raw materials  |   | $                     | 23     |   | $ | 37 |   |
| Finished goods |   | 26                    |   | 31 |   |
|           |   | $                     | 49     |   | $ | 68 |   |

 

45

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**(3)****          Propertyand Equipment**

 

Property and equipment consists of the following (in thousands):

 
|                                            |   | **December 31,** |   |
|-------------------------------------------------|--------|-----------------------|--------|
|                                            |   | **2002**              |   | **2003** |   |
| Leasehold improvements                          |   | $                     | 657    |   | $ | 675 |   |
| Computer equipment and software                 |   | 8,913                 |   | 9,353 |   |
| Furniture and fixtures                          |   | 1,100                 |   | 1,127 |   |
|                                            |   | 10,670                |   | 11,155 |   |
| Less accumulated depreciation and  amortization |   | 9,456                 |   | 10,283 |   |
|                                            |   | $                     | 1,214  |   | $ | 872 |   |

 

**(4)****          Goodwilland Other Intangible Assets**

 

Click2learn adopted the provisions of Statement of Financial AccountingStandards No. 142 (“SFAS 142”), *Goodwill and Other Intangible Assets,* asof January 1, 2002.  Based uponClick2learn’s analysis, there was no impairment of goodwill upon completion ofthe transitional goodwill impairment test. Click2learn’s identifiable intangible assets as of January 1, 2002consisted of acquired technology. Click2learn has reviewed the useful lives of identifiable intangibleassets and determined that the original useful lives of 3 to 5 years wereappropriate. In the fourth quarter of 2003, Click2learn performed its annualevaluation of goodwill and other intangibles and no impairment wasindicated.  Click2learn will reassessthe carrying value of its goodwill assets in the fourth quarter of each year,unless indicators of impairment become apparent earlier.

 

Net loss and net loss per share for the year ended 2001adjusted toexclude goodwill amortization (in thousands, except per share data):

 
|                                       |   | **2001** |    |
|--------------------------------------------|--------|----------|---------|
| Net loss:                                  |   |     |    |
| Loss from continuing operations            |   | $        | (11,247 | ) |
| Goodwill amortization                      |   | 433      |    |
| Adjusted loss from continuing operations   |   | (10,814  | )       |
| Loss from discontinued operations          |   | (8,334   | )       |
| Goodwill amortization                      |   | 1,061    |    |
| Adjusted loss from discontinued operations |   | (7,273   | )       |
| Adjusted net loss                          |   | $        | (18,087 | ) |
| Basic and diluted loss per share:          |   |     |    |
| Loss from continuing operations            |   | $        | (0.57   | ) |
| Goodwill amortization                      |   | 0.02     |    |
| Adjusted loss from continuing operations   |   | (0.55    | )       |
| Loss from discontinued operations          |   | (0.42    | )       |
| Goodwill amortization                      |   | 0.05     |    |
| Adjusted loss from discontinued operations |   | (0.37    | )       |
| Adjusted net loss                          |   | $        | (0.92   | ) |

 

46

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Goodwill and other intangibles are as follows (in thousands): 

 
|                |   | **December 31,  2002** |   | **December 31,  2003**         |   |
|---------------------|--------|-----------------------------|--------|-------------------------------------|--------|
|                |   | **Gross  Carrying  Amount** |   | **Accumu-  lated  Amort-  ization** |   | **Net  Carrying  Amount** |   | **Gross  Carrying  Amount** |   | **Accumu-  lated  Amort-  ization** |   | **Net  Carrying  Amount** |   |
| Goodwill            |   | $                           | 3,310  |                                | $      | 433 |   | $ | 2,877 |   | $ | 3,310 |   | $ | 433 |   | $ | 2,877 |   |
| Acquired technology |   | 8,807                       |   | 4,171                               |   | 4,636 |   | 9,048 |   | 5,852 |   | 3,196 |   |
|                     |        |                             |        |                                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Expected future amortization expense relatedto acquired technology through 2006 is $1,556 in 2004, $1,150 in 2005 and $490in 2006.

 

 

**(5)****         Click2learnJapan K.K.**

 

In 2000, Click2learn Japan K.K., a Japanese corporation, owned 36% byClick2learn, was formed to promote Click2learn’s products in Japan.  Click2learn recognized losses of $400, $200and $100 in the years ending December 31, 2001, 2002 and 2003,respectively, representing its equity share in the losses of Click2learn JapanK.K.  No sales were made to Click2learnJapan K.K. in 2001, 2002 or 2003. Click2learn does not have contractual commitments to provide financingto Click2learn Japan K.K. as of December 31, 2003.

 

In June 2001, Click2learn Japan K.K. became an exclusivedistributor of Click2learn’s ToolBook products in Japan and will payClick2learn royalties on the ToolBook products sold.  The royalties paid were $0, $91, and $58 for the years endedDecember 31, 2001, 2002, and 2003, respectively.

 

**(6)****         BankCredit Facility**

 

In December 2002, Click2learn consolidated its existing $4 millionworking capital line of credit and $1 million term loan facility with SiliconValley Bank into a new $10 million working capital line.  The term loan and the working capital lineis bearing interest at the greater of Silicon Valley Bank prime rate plus 2.25%or 7.0% and has a minimum monthly interest of $8,500 per month regardless ofthe loan balances.

 

The credit facility is collateralized by a security interest in all ofClick2learn’s assets.  Covenants in theloan agreements include restrictions on Click2learn’s ability to pay dividendsor make other distributions, make acquisitions or investments, merge orconsolidate with others or dispose of assets, as well as financial covenantslimiting the amount of net losses during any three month period and requiringClick2learn to maintain certain levels of minimum tangible net worth.  If not renewed the working capital lineterminates and any advances made are due on December 6, 2004.

 

Under the revolving credit line, the principal amount of $3.6 millionwas outstanding as of December 31, 2003 all of which was repaid in thefirst quarter of 2004.  Borrowingsoutstanding under the term loan were $0 at December 31, 2003.  Aggregate short-term debt of $3.5 million atDecember 31, 2003 is presented net of debt discount of $89,000attributable to warrants.  As ofDecember 31, 2003, Click2learn was not in compliance with the loan’scovenants.  However, Silicon Valley Bankissued a limited waiver and the loan agreement was amended to modify theminimum tangible net worth covenant which requires Click2learn to maintain atangible net worth of not less than $11.0 million for 2004.  The failure to meet the covenant could preventus from accessing the working capital line and result in the acceleration ofany balances under the working capital line if not waived.

 

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**(7)****         Guarantees**

 

In November 2002, the Financial Accounting Standards Board(“FASB”) issued FASB Interpretation No. 45 (“FIN 45”), *Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers*.  FIN 45 providesexpanded accounting guidance surrounding liability recognition and disclosurerequirements related to guarantees, as defined by this Interpretation.Click2learn adopted FIN 45 during the quarter ended December 31,2002.  In the ordinary course ofbusiness, Click2learn is not subject to potential obligations under guaranteesthat fall within the scope of FIN 45 except for standard indemnification andwarranty provisions that are contained within many of our customer license andservice agreements, and give rise only to the disclosure requirementsprescribed by FIN 45*.*

 

Indemnification and warranty provisions contained within our customerlicense and service agreements are generally consistent with those prevalent inour industry.  The duration of ourproduct warranties generally does not exceed 90 days following delivery of ourproducts.  We have not incurredsignificant obligations under customer indemnification or warranty provisionshistorically and do not expect to incur significant obligations in thefuture.  Accordingly, we do not maintainaccruals for potential customer indemnification or warranty-relatedobligations.

 

**(8)****         Leases**

 

Click2learn leases office space under noncancelable operating leasesexpiring through 2008.  Future minimumlease payments under noncancelable operating leases with terms in excess of oneyear are as follows (in thousands):

 

Years ending December 31 (in thousands):

 
| 2004                         |   | $     | 1,431  |   |
|------------------------------|--------|-------|--------|--------|
| 2005                         |   | 1,293 |   |
| 2006                         |   | 1,091 |   |
| 2007                         |   | 1,001 |   |
| 2008                         |   | 1,001 |   |
| Total minimum lease payments |   | $     | 5,817  |   |

 

Rent expense under operating leases approximated $2,425, $1,767 and$1,724 during the years ended December 31, 2001, 2002, and 2003,respectively.

 

**(9)****         IncomeTaxes**

 

Net loss before income taxes consists of the following (in thousands):

 
|                               |   | **Year Ended  December 31,** |    |
|------------------------------------|--------|-----------------------------------|---------|
|                               |   | **2001**                          |    | **2002** |   | **2003** |   |
| U.S                                |   | $                                 | (18,086 | ) | $ | (18,028 | ) | $ | (6,239 | ) |
| Foreign                            |   | (1,495                            | )       | (86 | ) | 108 |   |
| Total net loss before income taxes |   | $                                 | (19,581 | ) | $ | (18,114 | ) | $ | (6,131 | ) |

 

Click2learn’s income tax benefit differs from the expected income taxbenefit computed by applying the U.S. federal statutory rate of 34% to net lossbefore income taxes as follows (in thousands):

 
|                                        |   | **Year Ended  December 31,** |   |
|---------------------------------------------|--------|-----------------------------------|--------|
|                                        |   | **2001**                          |   | **2002** |   | **2003** |   |
| Income tax benefit at statutory rate of 34% |   | $                                 | (6,658 | ) | $ | (6,159 | ) | $ | (2,085 | ) |
| Losses producing no current tax benefit     |   | 3,514                             |   | 6,057 |   | 2,160 |   |
| Non-deductible goodwill amortization        |   | 3,106                             |   | 0 |   | 0 |   |
| Other                                       |   | 38                                |   | 102 |   | (46 | ) |
| Total provision for income taxes            |   | $                                 | — |   | $ | — |   | $ | 29 |   |

 

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As of December 31, 2003, Click2learn had net operating losscarryforwards (NOL) and research and development tax credit carryforwards(R&D), substantially all of which relate to the U.S., available to offsetfuture taxable income, whose expiration dates approximated the following (inthousands):

 
|                   |   | **NOL** |    | **R&D** |   |
|------------------------|--------|---------|---------|-------------|--------|
| 2004                   |   | $       | 6,621   |        | $      | — |   |
| From 2005 through 2010 |   | 89,197  |    | 1,833       |   |
| From 2011 through 2024 |   | 117,548 |    | 1,805       |   |
|                   |   | $       | 213,366 |        | $      | 3,638 |   |

 

Click2learn’s ability to utilize NOL carryforwards is limited due tothe change in ownership, as defined in the Internal Revenue CodeSection 382, which occurred at the time of Click2learn’s initial publicoffering of securities (IPO). Approximately $17.2 million of NOLs were acquired in businesscombinations.  If these NOLs become recoverablein the future, they will first be used to reduce to zero any goodwill associatedwith the business combinations prior to being used to reduce any income taxexpense.

 

Deferred income tax assets consist of the following (in thousands):

 
|                                                    |   | **December 31,** |       |
|---------------------------------------------------------|--------|-----------------------|------------|
|                                                    |   | **2002**              |       | **2003** |   |
| Assets:                                                 |   |                  | ** ** |   | ** ** |
| U.S. net operating loss carryforwards                   |   | $                     | 84,801     |   | $ | 72,545 |   |
| Foreign net operating loss carryforwards                |   | 1,665                 |       | 1,628 |   |
| Research and development tax credit  carryforwards      |   | 3,871                 |       | 3,638 |   |
| Allowance for doubtful accounts and sales  returns      |   | 315                   |       | 177 |   |
| Other provisions and expenses not currently  deductible |   | 240                   |       | 1,530 |   |
|                                                    |   | 90,892                |       | 79,518 |   |
| Valuation allowance for deferred tax assets             |   | (90,892               | )          | (79,518 | ) |
| Net deferred tax assets                                 |   | $                     | —     |   | $ | — |   |

 

For financial reporting purposes, a valuation allowance has beenestablished due to the uncertainty of the realization of the deferred taxassets.  The valuation allowance fordeferred tax assets increased $3,780 and $14,730 in the years endedDecember 31, 2001 and 2002, respectively, and decreased $11,374 in the yearended December 31, 2003.  At suchtime as it is determined that it is more likely than not that the deferred taxassets are realizable, the valuation allowance will be reduced.

 

**(10)****  Acquisitions**

 

The following transaction was accounted for as a purchase andaccordingly, the results of operations are included from the acquisition date:

 

*IntelliPrep Technologies, Incorporated. (“IntelliPrep”)*

 

In May 2001, Click2learn acquired IntelliPrep, a provider of technologyfor personalized learning.  Click2learnissued 1,812,500 shares of common stock and options to acquire 450,000 sharesof its common stock valued at $4.4 million. Goodwill of $3.3 million and other identifiable intangible assets of$1.4 million representing acquired software were recorded in connection withthe acquisition.  No elements of in-processresearch and development were identified as part of the acquisition.  Goodwill is amortized over 5 years throughDecember 31, 2001 and other intangible assets are amortized over 3 years.

 

The following table presents unaudited proforma results of operationsas if the acquisition of IntelliPrep had occurred as of January 1, 2001(in thousands, except per share data):

 
|                                |   | **Year ended  December 31,** |   |
|-------------------------------------|--------|-----------------------------------|--------|
|                                |   | **2001**                          |   |
| Revenue                             |   | $                                 | 31,646 |   |
| Net loss from continuing operations |   | (20,115                           | )      |
| Net loss per share                  |   | (1.02                             | )      |
|                                     |        |                                   |        |  |

 

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**(11)****  Impairmentof Goodwill**

 

During the fourth quarter of 2001, Click2learn identified indicators ofpossible impairment of its recorded goodwill related to its custom contentdevelopment business. Such indicators included the general slowdown in thecustom content development business evidenced by general declines in demand,utilization rates of related personnel and profit margins.  In addition, significant declines invaluations of similar businesses in comparison with the market valuations atthe time Click2learn invested in the acquired businesses and changes inClick2learn’s plans for content development services.  Based on the results of its discounted cash flow analyses,Click2learn recognized impairment charges in connection with the followingacquisitions made primarily in 1997 through 1999, Oakes Interactive, Inc.,TopShelf Multimedia, Inc., Acorn Consulting, Inc., Communication Strategies,Inc., Strategic Systems Associates, Inc., Graham-Wright Interactive, Inc.,Pixelmedia Ltd. and 3 Dog Multimedia, Inc. Accordingly, Click2learn recorded animpairment loss of $7.6 million during the fourth quarter of 2001 included inloss from discontinued operations in the consolidated statements of operations.  There was no impairment of goodwill in theyears ended December 31, 2002 and 2003.

 

**(12)****  Stockholder’sEquity**

 

*(a)**       Common Stock*

 

On August 18, 1999, Click2learn sold 428,571 shares of commonstock and warrants to purchase 428,571 shares of common stock with an exerciseprice of $7 per share to Go2Net, Inc. for an aggregate purchase price of $3million, which includes the cost of warrants allocated to services providedunder the Marketing Agreement.  Aportion of the fair value of the warrants was allocated to the MarketingAgreement and was being amortized over the term of the Agreement.  The fair value of these warrants wasdetermined using the Black-Scholes option pricing model with the followingassumptions: (1) the stock price at the date of the securities purchaseagreement, (2) a five-year contractual life of the warrants, (3) no dividends,(4) risk-free interest rate of 5.0%, and (5) a volatility of approximately60%.  The anti-dilution clause wastriggered by the private placement transactions closing on November 20,2001, December 10, 2001 and June 20, 2004 resulting in aggregateadjustments to the number of shares of common stock from 428,571 to 615,997 andaggregate adjustments to the exercise price from $7 per share to $4.87.  The warrants were all outstanding atDecember 31, 2003 and expire on August 18, 2004.

 

On October 6, 1999, in connection with the purchase of the SeriesA Stock, Click2learn issued Marshall Capital Management, Inc. (“MarshallCapital”) warrants for the purchase of 580,646 shares of common stock andVulcan Ventures warrants for the purchase of 387,096 shares of common stock atan exercise price of $9.30 per share. Click2learn allocated approximately $3.4million of the proceeds to the warrants using the Black-Scholes option pricingmodel and substantially the same assumptions as discussed in the precedingparagraph. Because the fair value of the preferred stock and common stockwarrants issued exceeded the proceeds received, Click2learn recorded a non-cashdividend associated with the preferred stock of $2.8 million. An anti-dilutionclause was triggered by the private placement transactions closing in 2001 and2003 resulting in aggregate adjustments to the exercise price of the warrantsfrom $9.30 per share to $6.11.  The warrantswere all outstanding at December 31, 2002 and expire on October 6,2004.  Alpine Capital Partners, Inc.received warrants for the purchase of 30,000 shares of common stock at anexercise price of $9.30 as a finder’s fee. An anti-dilution clause was triggered by the private placementtransactions closing in 2001 and 2003 resulting in aggregate adjustments to theexercise price of the warrants from $9.30 per share to $6.11.  Warrants for 20,000 shares of common stock,which expire on October 6, 2004, were outstanding at December 31,2003.

 

On December 12, 2000, Click2learn sold 410,678 shares of commonstock to Marshall Capital for an aggregate purchase price of $5 million.  In connection with the purchase of commonstock, Click2learn issued warrants for the purchase of 205,339 shares of commonstock at an exercise price of $14.61 per share.  An anti-dilution clause was triggered by the private placementtransactions closing in 2001 and 2003 resulting in aggregate adjustments to theexercise price of the warrants from $14.61 per share to $9.05.  The warrants were all outstanding as ofDecember 31, 2002 and expire on December 12, 2005.  In addition, Click2learn issued MarshallCapital warrants for the purchase of up to 176,177 shares of common stock at anexercise price of

 

50

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$.01, which would be exercisable if the price of Click2learn’s commonstock declined between the closing of the purchase and the effective date of arelated registration statement. The number of shares with respect to which thiswarrant would become exercisable was determined by the change in Click2learn’sstock price.  On January 19, 2001,Marshall Capital exercised the warrants for nominal additional considerationand received 74,759 additional shares. Warrants for the remaining 101,418shares expired on January 20, 2001.

 

In transactions closing on November 20, 2001 and December 10,2001, Click2learn sold 3,680,000 shares of common stock to several accreditedinvestors for an aggregate purchase price of $9.2 million.  In connection withthe purchase of the common stock, Click2learn issued the investors warrants forthe purchase of an additional 1,840,000 shares of common stock at an exerciseprice of $4.00 per share.  Ananti-dilution clause was triggered by the private placement transaction closingin 2003 resulting in an adjustment to the exercise price of the warrants from$4.00 per share to $3.34.  Jefferies& Company, Inc. acted as placement agent in connection with these transactionsand was issued warrants for the purchase of 64,200 common shares onNovember 20, 2001 which expire on November 20, 2006 and for thepurchase of 28,200 common shares on December 10, 2001 which expire onDecember 10, 2006, both at an exercise price of $2.50 per share.  An anti-dilution clause was triggered by theprivate placement transaction closing in 2003 resulting in an adjustment to theexercise price of the warrants from $2.50 per share to $2.28.  On November 20, 2001, Click2learnissued warrants to ComVest Venture Partners, L.P. for the purchase of 12,000shares and to Commonwealth Associates, L.P. for the purchase of 18,000 shares,both at an exercise price of $2.50 per share. An anti-dilution clause was triggered by the private placement transactionclosing in 2003 resulting in an adjustment to the exercise price of thewarrants from $2.50 per share to $2.28. The warrants expire on November 20, 2006.  Both ComVest Venture Partners, L.P. and Commonwealth Associates,L.P. acted as placement agents in connection with a portion of the privateplacement closing on November 20, 2001. The warrants were all outstanding at December 31, 2003.

 

In connection with the establishment of our line of credit with SiliconValley Bank, on December 6, 2002 we issued Silicon Valley Bank a warrantfor the purchase of 181,324 shares of common stock at an exercise price of$1.10 per share, which expires on December 6, 2009.  On December 11, 2003 we issued 88,120shares to Silicon Valley Bancshares in connection with the exercise of thewarrant.  The warrant was exercised on a“net exercise” basis in which it was fully exercised by canceling the number ofwarrant shares having a fair market value on the exercise date equal to theaggregate exercise price for the number of shares being issued under thewarrant.

 

On June 20, 2003, Click2learn sold tocertain accredited investors a total of 7,460,644 shares of our common stock ata price of $1.668 per share in a private placement transaction.  Click2learn also sold warrants to purchase2,611,222 shares of common stock at an exercise price of $1.90 per share.  The purchase price for the warrants was$0.125 per warrant.  Craig-HallumCapital Group, LLC acted as placement agent in the transaction.  The aggregate offering price for the sharesand warrants was approximately $12,771,000 and the placement agent was issuedwarrants for the purchase of an additional 373,032 shares on the same terms asthe warrants issued to investors.  Thewarrants expire on June 20, 2008.

 

The terms of the warrants are summarized inthe following table:

 
| **Original  Warrant Holder(s)**    |   | **Total No. of****Common Shares** |   | **Exercise****Price** |   | **Expiration Date** |                   |
|------------------------------------|--------|-----------------------------------|--------|-----------------------|--------|---------------------|------------------------|
| Go2Net, Inc.                       |   | 488,205                           |   | $                     | 4.87   |                | August 18, 2004   |   |
| Marshall  Capital Management, Inc. |   | 580,646                           |   | $                     | 6.11   |                | October 6, 2004   |   |
| Vulcan  Ventures Inc.              |   | 387,096                           |   | $                     | 6.11   |                | October 6, 2004   |   |
| Alpine Capital  Partners           |   | 20,000                            |   | $                     | 6.11   |                | October 6, 2004   |   |
| Marshall  Capital Management, Inc. |   | 205,339                           |   | $                     | 9.05   |                | December 12, 2005 |   |
| November 20,  2001 Investors  |   | 1,370,000                         |   | $                     | 3.34   |                | November 20, 2008 |   |
| December 10,  2001 Investors  |   | 470,000                           |   | $                     | 3.34   |                | December 10, 2008 |   |
| Jefferies                          |   | 64,200                            |   | $                     | 2.28   |                | November 20, 2006 |   |
| Jefferies                          |   | 28,200                            |   | $                     | 2.28   |                | December 10, 2006 |   |
| ComVest                            |   | 12,000                            |   | $                     | 2.28   |                | November 20, 2006 |   |
| Commonwealth                       |   | 18,000                            |   | $                     | 2.28   |                | December 10, 2006 |   |
| June 20,  2003 Investors      |   | 2,611,222                         |   | $                     | 1.90   |                | June 20, 2008     |   |
| Craig-Hallum Capital Group, LLC    |   | 373,032                           |   | $                     | 1.90   |                | June 20, 2008     |   |

 

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*(b)**       Stock Option Plans*

 

Click2learn has adopted stock option plans and assumed stock optionplans from acquisitions (the “Plans”) that provide for the issuance ofnonqualified and incentive stock options to officers, employees, consultants,and directors to acquire up to 11,227,073 shares of common stock.  The Compensation Committee determines theterms and conditions of options granted under the Plans, including the exerciseprice.  The exercise price for incentivestock options shall not be less than the fair market value at the date ofgrant, and the options expire ten years from the date of grant. Option grantsgenerally vest at 25% after the first year and ratably each month for the nextthree years, or 50% at the first and second anniversary of the grant.  When options are issued at less than fairmarket value, compensation expense is recorded.  All canceled options revert back to the option pool, other thanoptions assumed under the 2000 IntelliPrep Equity Incentive Plan.

 

The weighted-average fair value of stock options granted in 2001, 2002and 2003 was $2.42, $1.02 and $1.54 per option, respectively.

 

A summary of Click2learn’s stock option activity is as follows:

 
|                                                        |   |                             |   | **Outstanding  Options** |   |
|-------------------------------------------------------------|--------|----------------------------------|--------|--------------------------|--------|
|                                                        |   | **Shares  available for  grant** |   | **Number of  shares**    |   | **Weighted  average  exercise price** |   |
| Balances at December 31, 2000                          |   | 838,320                          |   | 5,196,433                |   | $ | 9.64 |   |
| Increase in shares available for grant                      |   | 2,750,000                        |   | —                   |   | — |   |
| Options granted and assumption of plan  in acquisition |   | (3,058,685                       | )      | 3,058,685                |   | 2.71 |   |
| Options exercised                                           |   | —                           |   | (342,101                 | )      | 1.65 |   |
| Options canceled                                            |   | 2,243,892                        |   | (2,243,892               | )      | 9.08 |   |
| Balances at December 31, 2001                          |   | 2,773,527                        |   | 5,669,125                |   | 6.49 |   |
| Options granted                                             |   | (2,725,971                       | )      | 2,725,971                |   | 1.03 |   |
| Options exercised                                           |   | —                           |   | (46,156                  | )      | 2.07 |   |
| Options canceled – IntelliPrep Plan                    |   | —                           |   | (109,146                 | )      | 3.06 |   |
| Options canceled all other plans                            |   | 2,000,440                        |   | (2,000,440               | )      | 6.34 |   |
| Balances at December 31, 2002                          |   | 2,047,996                        |   | 6,239,354                |   | 4.19 |   |
| Options granted                                             |   | (1,380,622                       | )      | 1,380,622                |   | 1.54 |   |
| Options exercised                                           |   | (205,984                         | )      | 0.52                     |   |   |   |
| Options canceled                                            |   | 1,353,340                        |   | (1,353,340               | )      | 4.36 |   |
| Balances at December 31, 2003                          |   | 2,020,714                        |   | 6,060,652                |   | 3.67 |   |
|                                                             |        |                                  |        |                          |        |  |  |  |

 

Canceled IntelliPrep options are not available for new grants.

 

The following table summarizes information concerning currentlyoutstanding and exercisable options at December 31, 2003:

 
| **Range of  Exercise  Prices** |   | **Number of  shares**                                    |   | **Options  Outstanding**                |   | **Options  Exercisable**                 |   |
|--------------------------------|--------|----------------------------------------------------------|--------|-----------------------------------------|--------|------------------------------------------|--------|
|                           |   | **Weighted-  average  remaining**

**contractual  life** |   | **Weighted  -average  exercise  price** |   |                                     |
|                           |   |                                                     |   | **Number of   shares**                  |   | **Weighted-  average  exercise  prices** |   |
|                           |   |                                                     |   |                                    |   |
|                           |   |                                                     |   |                                    |   |
|                           |   |                                                     |   |                                    |   |
| $0.34-0.80                     |   | 1,326,361                                                |   | 9.68 years                              |   | $                                        | 0.34   |   | 562,761 |   | $ | 0.56 |   |
| 0.83-1.55                      |   | 1,062,854                                                |   | 8.27 years                              |   | 0.95                                     |   | 314,509 |   | 1.44 |   |
| 1.56-2.21                      |   | 1,252,339                                                |   | 8.56 years                              |   | 2.09                                     |   | 549,810 |   | 2.00 |   |
| 2.26-4.75                      |   | 1,135,128                                                |   | 8.04 years                              |   | 3.50                                     |   | 769,784 |   | 3.57 |   |
| 4.93-13.63                     |   | 1,020,295                                                |   | 6.30 years                              |   | 9.31                                     |   | 963,768 |   | 9.27 |   |
| 14.38-19.94                    |   | 263,675                                                  |   | 7.41 years                              |   | 16.05                                    |   | 245,682 |   | 16.44 |   |
|                           |   | 6,060,652                                                |   | 7.47 years                              |   | 3.67                                     |   | 3,406,274 |   | 5.16 |   |
|                                |        |                                                          |        |                                         |        |                                          |        |  |  |  |  |  |  |

 

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**(c)****          EmployeeStock Purchase Plan**

 

Effective March 1999, Click2learn adopted an Employee StockPurchase Plan (ESPP) that authorizes the issuance of a maximum of 450,000shares of common stock annually for a term of ten years expiring 2009 and isadministered by Click2learn’s Compensation Committee.  Under the ESPP, an eligible employee may purchase shares ofcommon stock, based on certain limitations, at a price equal to the lesser of85 percent of the fair market value of the common stock at the beginning orend of the respective semi-annual offering periods. There were 308,086,449,949, and 449,954 shares purchased under the ESPP during 2001, 2002 and2003, respectively. The weighted average fair value of the employee stockpurchase rights was $1.1 million in 2001, approximately $1.4 million in 2002,and approximately $896,000 in 2003. The following assumptions were used toperform the calculation:

 
|                    |   | **Years  ended December 31,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   | **2001**                           |   | **2002** |   | **2003** |   |
| Expected dividend yield |   | 0                                  | %      | 0 | % | 0 | % |
| Risk-free interest rate |   | 4.4                                | %      | 2.8 | % | 3.3 | % |
| Expected life (years)   |   | 1.25                               |   | 1.25 |   | 1.25 |   |
| Volatility              |   | 130                                | %      | 124 | % | 99 | % |

 

**(13)****  BenefitPlans**

 

Click2learn has a Retirement Savings Plan to provide for voluntarysalary deferral contributions on a pretax basis in accordance with Section 401(k)of the Internal Revenue Code of 1986, as amended.  To date, Click2learn has made no contributions.

 

**(14)****  Litigation**

 

In 1996, a complaint seeking unspecified damages was filed againstClick2learn alleging that Click2learn’s ToolBook and Multimedia ToolBookproducts infringe a patent.  Click2learnhas received an opinion from counsel that the products do not infringe thispatent and that the patent is invalid. The action is still in the discovery stage.  Although Click2learn does not believe that the resolution of thislitigation will have a material impact on its financial position and results ofoperations, it is possible that the outcome will result in a loss toClick2learn. Click2learn intends to vigorously defend this action.  No amounts have been accrued for thismatter.

 

On February 18, 2004, a complaint wasfiled against Click2learn alleging that Click2learn’s Aspen product lineinfringes several patents held by IpLearn and is seeking an injunction andunspecified monetary damages.  Click2learnhas retained patent counsel to represent it in this case and is currentlyevaluating IpLearn’s claims.  AlthoughClick2learn does not believe that the resolution of this litigation will have amaterial impact on its financial position and results of operations, it ispossible that the outcome will result in a loss to Click2learn. Click2learnintends to vigorously defend this action. No amounts have been accrued for this matter.

 

Certain other lawsuits and claims are pending against Click2learn.  Although the outcome of such lawsuits andclaims cannot be predicted with certainty, the expected disposition thereofwill not, in the opinion of management both individually and in the aggregate,result in a material adverse effect on Click2learn’s operations and financialposition and liquidity.

 

**(15)****  SegmentInformation**

 

Click2learn’s internal reporting includes the three reportablesegments:  Platforms, Tools, and ContentServices.  Platforms include softwarelicenses, subscription and hosting fees, implementation, customization,consulting, training and support for the Aspen suite as well as Ingenium andthe e-Learning Network, which is no longer offered to new customers. Toolsinclude software licenses, technical support and training related to the ToolBookline of products.  Content Servicesincludes the placement of Click2learn personnel at customer sites 

 

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on a time and material basis, the resale of third party off the shelftraining content and license and hosting fees for our Rapid e-LearningDevelopment System, which is no longer offered to new customers.

 

Click2learn’s operating committee, which includes its Chief ExecutiveOfficer and Chief Financial Officer, has been identified as the Chief OperatingDecision Maker (CODM) as it assesses the performance of the business units anddecides how to allocate resources to the business units.  Segment income is the measure of profit andloss that the CODM uses to assess performance and make decisions.  Segment income represents revenue less costof revenue incurred within the operating segments as presented in Click2learn’sconsolidated statements of operations. Click2learn does not allocate operating expenses including research anddevelopment, sales and marketing, general and administrative, or amortizationof goodwill to its operating segments. In addition, other income (expense) are also not allocated to operatingsegments.

 

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

 

Revenue, cost of revenue, and gross margin by segment (in thousands):

 
|                  |   | **Year Ended  December 31,** |   |
|-----------------------|--------|-----------------------------------|--------|
|                  |   | **2001**                          |   | **2002** |   | **2003** |   |
|                  |   |                              |   |   |   |   |   |
| Revenue:              |   |                              |   |   |   |   |   |
| Platforms             |   | $                                 | 21,046 |   | $ | 23,345 |   | $ | 24,350 |   |
| Tools                 |   | 6,983                             |   | 4,290 |   | 3,109 |   |
| Content services      |   | 3,180                             |   | 2,842 |   | 2,028 |   |
| Total revenue         |   | $                                 | 31,209 |   | $ | 30,477 |   | $ | 29,487 |   |
| Cost of revenue:      |   |                              |   |   |   |   |   |
| Platforms             |   | $                                 | 3,653  |   | $ | 6,016 |   | $ | 7,086 |   |
| Tools                 |   | 1,546                             |   | 1,083 |   | 563 |   |
| Content services      |   | 2,879                             |   | 2,472 |   | 1,850 |   |
| Total cost of revenue |   | $                                 | 8,078  |   | $ | 9,571 |   | $ | 9,499 |   |
| Gross Margin          |   |                              |   |   |   |   |   |
| Platforms             |   | $                                 | 17,393 |   | $ | 17,329 |   | $ | 17,264 |   |
| Tools                 |   | 5,437                             |   | 3,207 |   | 2,546 |   |
| Content services      |   | 301                               |   | 370 |   | 178 |   |
| Total gross margin    |   | $                                 | 23,131 |   | $ | 20,906 |   | $ | 19,988 |   |

 

Geographic Information (in thousands): 

 
|          |   | **Year Ended  December 31,** |   |
|---------------|--------|-----------------------------------|--------|
|          |   | **2001**                          |   | **2002** |   | **2003** |   |
| Revenue:      |   |                              |   |   |   |   |   |
|          |   |                              |   |   |   |   |   |
| Domestic      |   | $                                 | 25,536 |   | $ | 25,759 |   | $ | 25,973 |   |
| International |   | 5,673                             |   | 4,718 |   | 3,514 |   |
|          |   | $                                 | 31,209 |   | $ | 30,477 |   | $ | 29,487 |   |

 

Revenues are attributed to geographic areas based on the location ofthe customers.

 

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|                     |   | **December 31,** |   |
|--------------------------|--------|-----------------------|--------|
|                     |   | **2002**              |   | **2003** |   |
| Long-lived assets:       |   |                  |   |   |   |
| Domestic operations      |   | $                     | 8,596  |   | $ | 6,704 |   |
| International operations |   | 131                   |   | 241 |   |
|                     |   | $                     | 8,727  |   | $ | 6,945 |   |

 

Long-lived assets represent property, plant and equipment, goodwill andother intangible assets, net of accumulated depreciation and amortization.  The total goodwill of $2.9 million relatesto the Platforms segment.

 

**(16)****  DiscontinuedOperations**

 

During January 2002, Click2learn sold certain assets of itscontent development business, including equipment and a customer list to NIITunder an Asset Purchase agreement for $1 million, resulting in a gain of$927,000 based on the book value of those assets. As a result of thetransaction with NIIT, Click2learn significantly reduced its headcount of itscustom content development business and closed certain facilities.  During the third quarter of 2002,Click2learn completed the discontinuation of its remaining custom contentdevelopment business by early termination of its contract to develop content forthe Washington Army National Guard. As part of the negotiation to terminate thecontract, Click2learn agreed to forego the collection of $4.5 million inaccounts receivable.   Results relatedto its custom content development business for the year ended December 31,2002 and prior years have been reclassified as loss from discontinuedoperations. For the year ended December 31, 2001, Click2learn reclassified$13.9 million of revenues, $13.5 million of costs related to revenue, and $8.7million of expenses as a loss from discontinued operations of $8.3 million. Forthe year ended December 31, 2002, Click2learn reclassified $248,000 ofrevenue, $2.7 million of costs related to revenue, $6.1 million of expenses,and $927,000 of other income as a loss from discontinued operations of $7.6million.

 

Summarized operating results of the discontinued operations for theyears ended December 31, 2001 and 2002 are as follows (in thousands):

 
|                              |   | **2001** |   | **2002** |   |
|-----------------------------------|--------|----------|--------|----------|--------|
| Revenues                          |   | $        | 13,882 |     | $      | 248 |   |
|                              |   |     |   |     |   |
| Gross margin                      |   | $        | 367    |     | $      | (2,468 | ) |
|                              |   |     |   |     |   |
| Operating loss                    |   | $        | (8,701 | )        | $      | (8,526 | ) |
|                              |   |     |   |     |   |
| Loss from discontinued operations |   | $        | (8,334 | )        | $      | (7,600 | ) |

 

**(17)****  Liquidity**

 

Click2learn has incurred significant operating losses since itsinception.  During 2003, steps weretaken to significantly reduce sales and marketing expenditures and Click2learncompleted a private placement of common stock and warrants with net proceeds of$11.9 million.  Click2learn’s cash andcash equivalents as of December 31, 2003 were $12.9 million, which managementbelieves, based on 2003 operating results and irrespective of whether themerger agreement discussed in note 18 is consummated, is sufficient to fundoperations through the next 18 months or longer.  Should Click2learn’s 2004 operating results fall significantlybelow that experienced in 2003, Click2learn’s management expects that it wouldfurther restructure its operations to preserve its cash and that such actionswould primarily consist of reducing headcount.

 

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**(18)****  Merger**

 

On October 20, 2003, Click2learn enteredinto an Agreement and Plan of Reorganization with Docent, Inc, which wasapproved by Click2learn’s board of directors. Under the terms of the agreement, Click2learn and Docent will be acquiredby a new corporate entity.  Click2learnhas been identified as the acquirer under Generally Accepted AccountingPrinciples (“GAAP”).  Stockholders ofClick2learn will receive 0.3188 shares in the new company for each common shareheld on the closing date.  Stockholdersof Docent will receive 0.7327 shares of common stock in the new company foreach common share held on the closing date. Outstanding options and warrants will be converted into options andwarrants for the purchase of shares in the new corporation in accordance withthe same exchange ratio.  Thetransaction is anticipated to be a tax-free reorganization and/or a tax-freeexchange for income tax purposes.  Theconsummation of the merger is subject to the approval of Click2learn’sstockholders and the stockholders of Docent and other customary closingconditions.  Meetings of thestockholders of each company to vote on the merger are scheduled forMarch 18, 2004.

 

**(19)****         Unaudited Quarterly Financial Information(in thousands, except per share data)**

 
|                                          |   | **For the  Quarter Ended** |   |
|-----------------------------------------------|--------|----------------------------|--------|
|                                          |   | **March 31,  2002**   |   | **June 30,  2002** |   | **Sept. 30,  2002** |   | **Dec. 31,  2002** |   |
| Total revenue                                 |   | $                          | 7,310  |   | $ | 7,602 |   | $ | 6,939 |   | $ | 8,626 |   |
| Gross margin                                  |   | 4,569                      |   | 5,165 |   | 4,788 |   | 6,484 |   |
| Operating loss from continuing operations     |   | (3,630                     | )      | (3,487 | ) | (2,493 | ) | (714 | ) |
| Net loss                                      |   | (5,684                     | )      | (4,221 | ) | (7,452 | ) | (757 | ) |
| Net loss per common share, basic and  diluted |   | (0.23                      | )      | (0.17 | ) | (0.30 | ) | (0.04 | ) |
|                                               |        |                            |        |  |  |  |  |  |  |  |  |  |  |

 
|                                          |   | **For the  Quarter Ended** | ** ** |
|-----------------------------------------------|--------|----------------------------|------------|
|                                          |   | **March 31,  2003**   |       | **June 30,  2003** | ** ** | **Sept. 30,  2003** | ** ** | **Dec. 31,  2003** | ** ** |
| Total revenue                                 |   | $                          | 8,000      |   | $ | 8,129 |   | $ | 7,513 |   | $ | 5,845 |   |
| Gross margin                                  |   | 5,612                      |       | 5,722 |   | 5,178 |   | 3,476 |   |
| Operating loss from continuing operations     |   | (773                       | )          | (748 | ) | (1,328 | ) | (3,046 | ) |
| Net loss                                      |   | (855                       | )          | (826 | ) | (1,369 | ) | (3,110 | ) |
| Net loss per common share, basic and  diluted |   | (0.03                      | )          | (0.03 | ) | (0.04 | ) | (0.10 | ) |
|                                               |        |                            |            |  |  |  |  |  |  |  |  |  |  |

 

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**Item 9****.   Changes in and Disagreements withAccountants on Accounting and Financial Disclosures**

 

Not applicable.

 

**Item 9A****. Controls and Procedures**

 

Click2learn maintains a set ofdisclosure controls and procedures and internal controls designed to ensurethat information required to be disclosed in filings made pursuant to theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’srules and forms. Our principal executive and financial officers have evaluatedour disclosure controls and procedures within 90 days prior to the filing ofthis Annual Report on Form 10-K and have determined that such disclosure controlsand procedures are effective.

 

Subsequent to our evaluation, there were no significant changes ininternal controls or other factors that could significantly affect internalcontrols, including any corrective actions with regard to significant deficienciesand material weaknesses.

 

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**PART III**

 

#### **Item10**.  Directors andExecutive Officers of the Registrant.

#### ** **

The Board of Directors consists of threeclasses of directors serving staggered three-year terms expiring at the annualmeeting of stockholders in the year specified. Executive officers do not serve for fixed terms, but rather at thepleasure of the Board.  The following tablesets forth our directors and executive officers, their ages, the principalpositions held by each director and executive officer with Click2learn,  the year such director or executive officerwas first elected or appointed as a director or executive officer, the class ofeach director, the year each director’s term will expire, and the year suchdirectors term, and certain additional biographical information regarding thenominees and continuing directors.

 
| **Name**                    |   | **Age** |   | **Position  with Click2learn**                                |   | **Director  or  Officer  Since** |   | **Class** |   | **Term  Expires** |   |
|-----------------------------|--------|---------|--------|---------------------------------------------------------------|--------|----------------------------------|--------|-----------|--------|-------------------|--------|
| *Directors:*                |   |    |   |                                                          |   |                             |   |      |   |              |   |
| Sally Narodick (3)          |   | 58      |   | Lead Director                                                 |   | 1999                             |   | I         |   | 2005              |   |
| John W. Coné (1)(2)(3) |   | 53      |   | Director                                                      |   | 2002                             |   | I         |   | 2005              |   |
| Kevin M. Oakes              |   | 40      |   | Chairman of the Board, Chief Executive  Officer and President |   | 1997                             |   | II        |   | 2006              |   |
| Ronald S. Posner            |   | 61      |   | Director                                                      |   | 1998                             |   | II        |   | 2006              |   |
| Jonathan Morgan (1)         |   | 50      |   | Director                                                      |   | 2002                             |   | II        |   | 2006              |   |
| Bert Kolde (2)              |   | 49      |   | Director                                                      |   | 1984                             |   | III       |   | 2004              |   |
| Edward Harris (2)           |   | 46      |   | Director                                                      |   | 2001                             |   | III       |   | 2004              |   |
| Vijay Vashee (1)            |   | 52      |   | Director                                                      |   | 2001                             |   | III       |   | 2004              |   |
|                        |   |    |   |                                                          |   |                             |   |      |   |              |   |
| *Executive Officers:*       |   |    |   |                                                          |   |                             |   |      |   |              |   |
| John D. Atherly             |   | 45      |   | Chief Financial Officer                                       |   | 1995                             |   | —    |   | —            |   |
| Sudheer Koneru              |   | 34      |   | Chief Strategy Officer                                        |   | 2001                             |   | —    |   | —            |   |
| Srinivasan Chandrasekar     |   | 34      |   | Chief Technology Officer                                      |   | 2001                             |   | —    |   | —            |   |
| Gary Millrood               |   | 44      |   | Executive Vice President, Worldwide Sales                     |   | 2002                             |   | —    |   | —            |   |
| Steven Esau                 |   | 40      |   | Senior Vice President, General Counsel and  Secretary         |   | 1995                             |   | —    |   | —            |   |
| Anthony J. Federico         |   | 32      |   | Senior Vice President, Technology                             |   | 2003                             |   | —    |   | —            |   |
| Richard Collins             |   | 44      |   | Vice President, Business Development                          |   | 2001                             |   | —    |   | —            |   |
| Ray Pitts                   |   | 39      |   | Vice President, Professional Services                         |   | 2003                             |   | —    |   | —            |   |

 

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(1)  Member of the AuditCommittee

(2)  Member of the CompensationCommittee

(3)  Member of the CorporateGovernance Committee

 

Ms. Narodick has served as Lead Director since December 2002 andas a director since May 1999.  Ms. Narodickis currently an independent consultant in the e-Learning industry.  From September 2000 to March 2001,she worked with Click2learn’s management team advising on mergers andacquisitions, in addition to working with other non-competitive e-Learning companies.  From October 1998 toSeptember 2000, she was President and CEO of Apex Learning Inc., whichprovides e-Learning courses to high school students.  Prior to that, she was Chairman and CEO of Edmark Corporation, apublicly held educational software company, from 1989 untilSeptember 1996.  FromDecember 1996 through October 1998, she was an educational technologyconsultant working primarily for the Consumer Software Division of IBM.  Ms. Narodick is a director of PenfordCorporation, a publicly held complex carbohydrate company, Solutia, Inc., apublicly held specialty chemical company, and Puget Energy, a publicly held gasand electric utility.

 

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Mr. Coné has served as a director since May2002.  He currently is a consultant andauthor in the field of organizational learning.  From September 15, 2003 until February 13, 2004 heserved as Interim President of the American Society of Training and Development.  From July 1995 until his retirement inAugust 2001 he served as Vice President of Learning & Development forDell Computer.  Prior to Dell, he servedas Chief Learning Officer and Vice President of Human Resources for SequentComputer Systems Inc. a computer hardware and software company, from June 1991to June 1995.  Prior to Sequent, heserved as Director of Corporate Educational Services for Motorola fromFebruary 1988 to May 1991, where he was a founder and creator of MotorolaUniversity in 1990.  In 2002, Mr. Conéserved as the Chairman of the American Society of Training and Development andon the Board of Storied Learning, a privately-held e-Learning content company.

 

Mr. Oakes has served as a director since September 1997.  Mr. Oakes has served as Chief ExecutiveOfficer since January 2000 and as Chairman of the Board since May2001.  Mr. Oakes has served as Presidentsince he joined Click2learn in September 1997.  Prior to that time, Mr. Oakes was the President of each of OakesInteractive, a custom content development company, Acorn Associates, ane-Learning consulting firm and TopShelf Multimedia, a reseller of e-Learningtitles (the “Oakes Companies”) which he founded in March 1993,January 1996 and March 1997, respectively, and each of whichClick2learn acquired in September 1997. Prior to forming the Oakes Companies, Mr. Oakes held positions at TheMinnesota Mutual Life Insurance Company and Fidelity Investments.  Mr. Oakes also serves on the Board ofDirectors of the American Society of Training & Development (ASTD) andDevelopment Dimensions International (DDI), a privately-held HR training firm.

 

Mr. Posner has served as a director since September 1998.  Mr. Posner is Chairman of NetCatalyst, ahigh technology mergers and acquisitions firm, and a founding general partnerof PS Capital LLC, an angel venture capital firm.  Mr. Posner has over 25 years experience in the technologyindustry, having held CEO positions with a number of high technology companies,including Peter Norton Computing, a PC utilities software company.  He has been an active investor and advisorto a number of Internet companies including PrizeCentral.com (now calledFlipside.com and part of Vivendi-Universal Net Group), tunes.com (now part ofUniversal Music Group), Spinner.com (now part of AOL Time Warner), STV.com (nowpart of Sonic Foundry), Match.com (now part of TicketMaster City Search, Inc.),and Novatel Wireless.

 

Mr. Morgan has served as a director sinceDecember 2002.  He is the Presidentand Chief Executive Officer of First Virtual Communications, Inc,a real-time rich media communications company. Mr. Morgan was a director of CUseeMe Networks when it was acquired byFirst Virtual Communications in June 2001 and he continues to serve as adirector of First Virtual Communications. From 1993 to 2001, Mr. Morgan was a Managing Director at PrudentialSecurities and a Managing Director at Prudential Volpe Technology Group, adivision of Prudential Securities.

 

Mr. Kolde has served as a director since December 1984.  Mr. Kolde is Chief Operating Officer atDigeo, Inc., an interactive media company, and has served as Vice Chairman ofthe Seattle Seahawks and Portland Trail Blazers.  Mr. Kolde served as Executive Vice President of Click2learn fromDecember 1984 until April 1993, and thereafter as President untilNovember 1994.  Prior to joiningClick2learn, Mr. Kolde was the Vice President of Management Reporting ofSeafirst Corporation.

 

Mr. Harris has served as a director since May 2001.  Mr. Harris is currently CEO of RazorCapital LLC, a financial advisory firm. Previously, Mr. Harris was a SeniorInvestment Analyst for Vulcan Ventures Inc. from December 1998 toDecember 2002.  Prior to that Mr.Harris served as Chief Financial Officer for three early stage companies:Claircom Communications Group, L.P., an affiliate of McCaw CellularIncorporated,  and provider of wirelesscommunications services; Starwave Incorporated, an Internet company; and MirrorSoftware, Inc., a provider of medical imaging software.  From 1985 to 1992, Mr. Harris was aninvestment banker, for Salomon Brothers Inc from 1985 to 1990, and for SumishinCapital from 1990 to 1992.  Mr. Harrisis a director of Edison Schools, Inc., First Virtual Communications, Inc. andRCN Corporation.

 

Mr. Vashee has served as a director since July 2001.  From 1982 to until October 2001,Mr. Vashee served in various seniormarketing, product management and executive positions at Microsoft, includingas General Manager for Microsoft Project from 1988 to 1992 and as GeneralManager for Power Point from 1992 to 1997. Mr. Vashee holds a B.Tech EE from IIT Bombay, an MSEE from CornellUniversity and MBA from the University of Chicago.  Mr. Vashee is the Chairman and was founding President of TheIndus Entrepreneurs, Seattle and previously served as a board member of IntelliPrepTechnologies, Incorporated prior to its acquisition by Click2learn in May 2001.

 

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Mr. Atherly has served as Chief Financial Officer sinceFebruary 1995, and prior to that as Director of Finance and Operations,Treasurer and Secretary from February 1993.  Mr. Atherly held various other positions since he joinedClick2learn in June 1990, including Controller from February 1991until February 1993.  Prior tojoining Click2learn, Mr. Atherly was a Finance and Operations Manager atMicroDisk Services, a software manufacturing services company.

 

Mr. Koneru has served as Chief StrategyOfficer since June 1993, as Chief Operating Officer from January 2003until June 2003, as Executive Vice President, Customer Services fromJanuary 2002 until January 2003 and as Executive Vice President,Products and Strategy from May 2001 until January 2002.  Prior to joining Click2learn, he co-foundedIntelliPrep, an enterprise learning software company, in 2000 and served asIntelliPrep’s Chief Executive Officer until IntelliPrep was acquired byClick2learn in May 2001.  Prior toIntelliPrep, Mr. Koneru served in various positions at Microsoft Corporationsince 1992, most recently as Director/Product Unit Manager for the consumerWindows division from 1998 to 2000.

 

Mr. Chandrasekar has served asChief Technology Officer since June 1993, as Executive Vice President,Products and Strategy from January 2003 until June 2003 and as SeniorVice President, Technology from May 2001 until January 2003.  Mr. Chandrasekar was a co-founder ofIntelliPrep and served as its Chief Technology Officer from March 2000until IntelliPrep was acquired by Click2learn in May 2001.  From 1993 to March 2000, he served invarious positions at Microsoft in both managerial and technical leadership,including as head of Microsoft’s Metadirectory product development group fromSeptember 1999 to March 2000.

 

Mr. Millrood has served as Executive Vice President, World Wide Salessince June 2003 and as Senior Vice President, North American Sales fromDecember 2002 until June 2003. From December 2001 to December 2002 he was Executive VicePresident of Corporate Development at Playback Media.  From November 2000 until November 2001 he was CEO andPresident of iGeneration, a developer of training performance technology andservices for the IT marketplace.  Priorto iGeneration, he was a founder and Executive Vice President of BusinessDevelopment, Sales and Marketing for Hungry Minds, a provider of e-Learning solutions,from May of 1999 until its acquisition by IDG Books in October 2000. Priorto that, he was Vice President of Business Development and Sales for the ZDStudios division of Ziff-Davis, a provider of marketing and training solutions,from April 1996 until April 1999.

 

Mr. Esau has served as General Counsel since October 1995, as VicePresident and Secretary of Click2learn since January 1997 and as SeniorVice President since February 2002. Prior to that time, Mr. Esau served as Director of Legal Affairs fromFebruary 1995 until October 1995 and as counsel since joiningClick2learn in February 1994.  From1988 until February 1994, he was in private law practice, first with StoelRives LLP in Seattle and then with his own law firm, where he focused on advisingsoftware and technology startup companies.

 

Mr. Federico has served as Senior Vice President, Technology sinceJune 2003.  Since joiningClick2learn in connection with its acquisition of Meliora Systems, Inc. inJuly 1998, Mr. Federico has held a number of senior positions withinClick2learn’s engineering organization, including Vice President, Development;Vice President,  Learning Platforms;Vice President, Engineering for LMS and LXS; and Director of Engineering.

 

Mr. Collins has served as Vice President, Business Development sinceMay 2001 after serving as Senior Director, Business Development sinceAugust 1999.  FromSeptember 1998 to August 1999, Mr. Collins served as Vice Presidentof Media at Crisp Publications, Inc., a publisher of educational content.  Prior to that, he served as Business Managerat Crisp Publications from September 1995 to September 1998.

 

Mr. Pitts has served as Vice President, Services sinceJune 2003.  Prior to joiningClick2learn, he served as Manager and Sr. Manager with Deloitte Consulting inthe Global Learning and Global Outsourcing practices from April 1997 toJune 2003.  From August 1993to April 1997, he held a positions as Regional Manager, Operations Managerand Project Manager with DA Consulting Group.

 

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# **Audit Committee and Financial Expert**

# ** **

We have a separately-designated standing Audit Committee.  Mr. Vashee, Mr. Coné and Mr. Morgan are thecurrent members of the Audit Committee, with Mr. Morgan serving as thechair.  Each member of the AuditCommittee is independent in accordance with Nasdaq current listingstandards.  The Audit Committee’sprimary function is to assist the Board in its oversight of  (1) the integrity of our financialstatements, (2) our independent auditors’ qualifications and independence,(3) the performance of our independent auditors and (4) compliancewith the code of ethics for senior financial officers.  The Board has determined that Mr. Morgan isindependent and an audit committee financial expert within the meaning ofapplicable regulations of the U.S. Securities and Exchange Commission.

 

**Section 16(a) Beneficial OwnershipReporting Compliance**

 

Section 16 of the Exchange Act requires directors and officers,and persons who own more than 10% of Click2learn’s common stock, to fileinitial reports of ownership and reports of changes in ownership with the SECand the Nasdaq National Market.  Suchpersons are required by SEC regulation to furnish us with copies of allSection 16(a) forms they file. Based solely on our review of the copies ofsuch forms provided to us, we believe that Ray Pitts was late filing a Form 3,WM Advisors Inc. did not file a Form 4 with respect to any transactions duringthe year, Sudheer Koneru was late filing a Form 4 for an option to purchase100,000 shares granted on January 10, 2003, Srinivasan Chandrasekar waslate filing a Form 4 for an option to purchase 100,000 shares granted onJanuary 10, 2003, Bert Kolde was late filing a Form 4 for an option topurchase 15,000 shares granted on June 11, 2003 and Jonathan Morgan didnot file a Form 4 for an option to purchase 15,000 shares granted onDecember 15, 2003, but reported the grant on an early Form 5.

 

**Code of Ethics**

 

We have adopted a code of ethics that appliesto our executive officers and directors, including our principal executiveofficer, principal financial officer and controller.  A copy of our code of ethics has been  posted to our internet web site at www.click2learn.com.  We will provide any person a copy of thecode of ethics without charge upon request. Requests for a copy of the code of ethics should be addressed to theOffice of the General Counsel, Click2learn, Inc., 110 — 110th AvenueNE, Bellevue, Washington 98004.

 

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**Item 11****.  ExecutiveCompensation.**

 

**Summary CompensationTable**

 

The following table sets forth certain summary information concerningthe compensation awarded to, earned by, or paid for services rendered toClick2learn in all capacities the three fiscal years ended December 31,2003 by each of our Chief Executive Officer and four most highly compensatedexecutive officers, other than the Chief Executive Officer, who were serving asexecutive officers at the end of 2003 (collectively, the “Named ExecutiveOfficers”).

 
|                            |   | **Annual  Compensation** |   | **Long Term  Compensation Awards** |    |
|---------------------------------|--------|--------------------------|--------|------------------------------------|---------|
| **Name and Principal Position** |   | **Year**                 |   | **Salary($)**                      |    | **Bonus($)** |   | **Other  Annual  Compensation** |   | **Securities  Underlying  Options (#)** |   |
| Kevin M. Oakes                  |   | 2003                     |   | $                                  | 250,000 |   | — |   | — |   | — |   |
| Chairman of the Board, Chief    |   | 2002                     |   | 228,846                            |    | — |   | — |   | 191,125 |   |
| Executive Officer and President |   | 2001                     |   | 245,192                            |    | — |   | — |   | 225,000 |   |
|                            |   |                     |   |                               |    |   |   |   |   |   |   |
| Gary Millrood (1)               |   | 2003                     |   | $                                  | 174,327 |   | $ | 101,677 |   | $ | 34,094 |   | 50,000 |   |
|                            |   | 2002                     |   | 3,365                              |    | — |   | — |   | 100,000 |   |
|                            |   |                     |   |                               |    |   |   |   |   |   |   |
| Sudheer Koneru (2)              |   | 2003                     |   | $                                  | 190,000 |   | — |   | — |   | 100,000 |   |
| Chief Operating Officer         |   | 2002                     |   | 176,558                            |    | — |   | — |   | 63,750 |   |
|                            |   | 2001                     |   | 72,500                             |    | — |   | — |   | 52,363 |   |
|                            |   |                     |   |                               |    |   |   |   |   |   |   |
| John D. Atherly                 |   | 2003                     |   | $                                  | 175,000 |   | — |   | — |   | — |   |
| Chief Financial Officer         |   | 2002                     |   | 163,894                            |    | — |   | — |   | 82,500 |   |
|                            |   | 2001                     |   | 171,635                            |    | — |   | — |   | 70,000 |   |
|                            |   |                     |   |                               |    |   |   |   |   |   |   |
| Steven Esau                     |   | 2003                     |   | $                                  | 150,000 |   | — |   | — |   | — |   |
| Senior Vice President, General  |   | 2002                     |   | 139,038                            |    | — |   | — |   | 97,187 |   |
| Counsel and Secretary           |   | 2001                     |   | 132,404                            |    | — |   | — |   | 39,375 |   |
|                                 |        |                          |        |                                    |         |  |  |  |  |  |  |  |  |  |

 

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(1)          Mr. Millrood joined Click2learn inDecember 2002.  Bonus consists ofsales commissions actually paid in 2003 and excludes commissions earned in 2003but not paid until 2004.  Other annualcompensation consists of reimbursement of relocation expenses.

 

(2)          Mr. Koneru joined Click2learn in May 2001 inconnection with the acquisition of IntelliPrep.

 

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**Optionand SAR Grants in Fiscal 2003**

 

The following table sets forth certain information regarding stockoptions granted to Named Executive Officers during the year endedDecember 31, 2003.  No options weregranted to Mr. Oakes, Mr. Atherly or Mr. Esau and no stock appreciation rightswere granted in the year ended December 31, 2003.
|           |                                                        | **Individual  Grants (1)** | ** **                                                          |       |                                                |
|----------------|-------------------------------------------------------------|----------------------------|---------------------------------------------------------------------|------------|-----------------------------------------------------|
| **Name**       | **Number of  Securities  Underlying  Options   Granted(#)** |                       | **% of Total  Options  Granted to  Employees  in Fiscal  Year (2)** | ** ** | **Exercise  or Base  Price Per  Share   ($/Sh)(3)** | ** ** | **Expiration  Date** | **Potential  Realizable Value at  Assumed Annual Rates of  Stock Price Appreciation  for Option Term (4)** |   |
| **5%($)**      | ** **                                                  | **10%($)**                 | ** **                                                          |
| Kevin Oakes    |                                                        | —                     |                                                                | —     |                                                | — |   | — |   | — |   | — |   |
| Gary Millrood  |                                                        | 50,000                     |                                                                | 3.95       | %                                                   | $ | 1.50 |   | 5/16/13 |   | $ | 47,167 |   | $ | 119,531 |   |
| Sudheer Koneru |                                                        | 100,000                    |                                                                | 7.90       | %                                                   | $ | 0.99 |   | 1/10/13 |   | $ | 62,261 |   | $ | 157,781 |   |
| John Atherly   |                                                        | —                     |                                                                | —     |                                                | — |   | — |   | — |   | — |   |
| Steven Esau    |                                                        | —                     |                                                                | —     |                                                | — |   | — |   | — |   | — |   |

 

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(1)          Options were granted under the Click2learn1998 Equity Incentive Plan (the “Incentive Plan”). The options becomeexercisable with respect to 25% of the shares covered by the option on thefirst anniversary of the date of grant and with respect to an additional 2.083%of the total number of shares each month thereafter.  The Incentive Plan provides that upon a change in controltransaction or sale of substantially all of Click2learn’s assets, the optionsmay be assumed, converted or replaced by substantially equivalent awards andthat if the acquiring entity fails to do, the options become fully exercisableimmediately prior to such transaction. However, under the Change in ControlSeverance Plan adopted in 2002, vesting is accelerated if the Named ExecutiveOfficer is terminated without cause or terminates with good reason (as definedin the Change of Control Plan) within 12 months following a change of controltransaction.  The completion of the mergerwith Docent with constitute a change in control for these purposes.  All options have a term of ten years.

 

(2)          We granted options to purchase an aggregateof 1,265,622 shares of common stock to all employees during 2003.

 

(3)          Options were granted at an exercise priceequal to the fair market value of our common stock as determined by its closingprice on the Nasdaq National Market on the date of grant, to the nearest wholecent.

 

(4)          Potential realizable value is based on theassumption that common stock appreciates at the annual rate shown (compoundedannually) from the date of grant until the expiration of the ten-yearterm.  These numbers are calculatedbased on SEC requirements and do not reflect our projection or estimate offuture stock price growth.

 

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**OptionExercises and Fiscal Year End Option Values**

 

The following table sets forth for each of the Named Executive Officersthe number and year-end value of exercisable and unexercisable options for theyear ended December 31, 2003.  Noneof the Named Executive Officers exercised options in 2003.

 
|                |   | **Number of  Securities Underlying  Unexercised Options at 12/31/03(1)** |   | **Value of  Unexercised In-the-Money  Options at 12/31/03 (2)** |   |
|---------------------|--------|--------------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|
| **Name**            |   | **Exercisable**                                                          |   | **Unexercisable**                                               |   | **Exercisable** |   | **Unexercisable** |   |
| Kevin M. Oakes (3)  |   | 386,666                                                                  |   | 186,709                                                         |   | $ | 124,231 |   | $ | 124,232 |   |
| Gary Millrood       |   | 25,000                                                                   |   | 125,000                                                         |   | $ | 31,750 |   | $ | 125,250 |   |
| Sudheer Koneru      |   | 72,805                                                                   |   | 143,308                                                         |   | $ | 27,619 |   | $ | 128,613 |   |
| John D. Atherly (4) |   | 225,951                                                                  |   | 73,125                                                          |   | $ | 81,992 |   | $ | 53,625 |   |
| Steven Esau (5)     |   | 185,468                                                                  |   | 65,626                                                          |   | $ | 65,914 |   | $ | 46,922 |   |

 

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(1)          Options shown were granted under both theIncentive Plan and the 1995 Combined Incentive and Non-qualified Stock OptionPlan.  All options have a term of tenyears.

 

(2)          Based on the closing price of our commonstock on the Nasdaq National Market on December 31, 2003 of $2.10 pershare, net of exercise price.

 

(3)          Pursuant to his Employment Agreement, alloptions held by Mr. Oakes will accelerate and become exercisable uponcompletion of the merger with Docent.

 

(4)          Mr. Atherly’s employment will terminatefollowing the merger with Docent. Pursuant to the Change ofControl Executive Severance Plan, all options held by Mr. Atherly will accelerateand become exercisable on March 31, 2003.

 

(5)          Mr. Esau’s employment will terminatefollowing the merger with Docent. Pursuant to the Change ofControl Executive Severance Plan, all options held by Mr. Esau will accelerateand become exercisable on March 31, 2003.

 

##### ***Director Compensation***

##### * *

We do not pay directors any cash fees for their service on the Board orany committee, but we reimburse all reasonable out-of-pocket expenses incurredin connection with their attendance at Board and committee meetings.

 

Board members who are not our employees or employees of a parent,subsidiary or affiliate of ours are eligible to participate in the 1998Directors Stock Option Plan (the “Directors Plan”). Option grants under theDirectors Plan are automatic and non-discretionary, and the exercise price pershare of such options is the fair market value of a share of common stock onthe date of grant.  Non-employeedirectors receive annual grants of 15,000 options on either June 11 (ifsuch director was serving on the Board when the Directors Plan first becameeffective) or on the date he or she first became a director and eachanniversary thereof, if the director has served continuously as a member of theBoard since the date of the initial grant.

 

The term of these options is ten years, but they will terminate sevenmonths following the date such director ceases to be a member of the Board or aconsultant or twelve months if the termination is due to death or disability.All options granted under the Directors Plan will vest as to 2.78% of theshares each month after the date of grant for so long as the recipientcontinues as a director or a consultant. Additionally, immediately prior to ourdissolution or liquidation or a change in control transaction, all optionsgranted pursuant to the Directors Plan will accelerate and will be exercisablefor a period of up to six months following the transaction, after which anyunexercised options will expire.  OnJuly 28, 2003 the Board approved the grant of an additional 10,000 sharesto Jonathan Morgan in consideration of his service as Chair of the AuditCommittee.  Although this option wasgranted 

 

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under the Incentive Plan, the vesting, exercisability and terminationprovisions are identical to options granted under the Directors Plan.

 

In addition, on January 23, 2004, the Board approved themodification of certain options originally granted on October 29, 2002pursuant to the Incentive Plan to directors who will not continue to serve onthe Board of the combined company following the merger with Docent.  As modified, these options will become fullyexercisable upon the completion of the merger with Docent and will terminate 12months following the date of that merger.

 

**EmploymentAgreements**

 

On  March 20, 2002, weentered into a two-year Employment Agreement with Mr. Oakes.  Pursuant to this agreement, Mr. Oakes willreceive an annual salary of $250,000, have a target bonus of 40% of his annualsalary, and be eligible to receive a maximum bonus of 100% of his annualsalary.  Payment of the bonus is basedon achievement of corporate performance goals set by the Board.  If Mr. Oakes is terminated without cause(including termination resulting from a merger, change in control oracquisition of Click2learn or sale of substantially all of its assets) prior tothe end of the agreement term, Mr. Oakes will be entitled to receive severancepay equal to his salary for the greater of the remaining term of the EmploymentAgreement or six months.  In the eventof  certain transactions that result ina change in control of Click2learn or the sale of substantially all of itsassets (including the completion of the merger with Docent), all of Mr. Oakesunvested options will accelerate and become exercisable immediately prior tothe closing of such a transaction.

 

On January 1, 2003 we entered into a one-year Employment Agreementwith Mr. Millrood.  This agreementautomatically renews for additional one-year terms unless terminated by eitherparty.  Pursuant to this agreement, Mr.Millrood will receive an annual salary of $175,000, and will have a commissionplan approved by the Compensation Committee with target commissions of $100,000per year.  He was also reimbursed forexpenses in connection with relocating the Bellevue, Washington area.  If Mr. Millrood is terminated without causeprior to the end of the agreement term, Mr. Millrood would be entitled toreceive severance pay equal to his salary for three months, plus allcommissions earned prior to his termination date. The Agreement provides thatMr. Millrood will be entitled to the benefits of the Change of ControlExecutive Severance Plan.

 

On June 26, 2003 we entered into a one-year Employment Agreementwith Mr. Koneru.  Pursuant to thisagreement, Mr. Koneru will receive an annual salary of $190,000, and iseligible to participate in any executive bonus plan adopted by the CompensationCommittee.  If Mr. Koneru is terminatedwithout cause prior to the end of the agreement term, Mr. Koneru would beentitled to receive severance pay equal to his salary for the greater of theremaining term of the Employment Agreement or six months, all of his unvestedoptions will accelerate and become exercisable and we will pay the costs tomaintain his health insurance for the shorter of 12 months or until he has foundother employment.

 

**Termination of Employment and Change inControl Arrangements**

 

On July 16, 2002 the Board adopted theChange of Control Executive Severance Plan (the “Change of Control Plan”),which provides benefits to each of the Named Executive Officers and each of theother executive officers listed in Item 10 if they are terminated in connectionwith a change in control of Click2learn. These benefits become available to an executive officer who isterminated without cause or who terminates his employment with good reasonprior to or within 12 months following a change in control transaction.  In the event of such a termination, thevesting of any stock options held by the executive officer would be acceleratedand the executive officer would be entitled to severance pay based on hislength of continuous employment with Click2learn and/or the acquiring companyas follows:

 

| **Length of Employment** |   | **Severance Period** |
|--------------------------|--------|----------------------|
| Less than 2 years        |   | 3 months             |
| 2 – 4 years         |   | 6 months             |
| 4 – 6 years         |   | 9 months             |
| 6 or more years          |   | 12 months            |

 

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Such severance is payable either on regular payroll dates over theseverance term or in a lump sum at the option of the acquiring company.  If an executive officer is also entitled toseverance payments on a change in control pursuant to his employment agreementor because a severance plan is made available to employees generally, suchbenefits will not be cumulative, but the executive officer will be entitled toreceive the greater of the amounts due under the Change of Control Plan orunder the employment agreement or generally available severance plan.

 

The Incentive Plan contains certain additional provisions relating tothe acceleration of option vesting in the event of a change in control.  These provisions are described on page 63 innote (1) to the table Options and SAR Grants in Fiscal 2003.

 

**CompensationCommittee Interlocks and Insider Participation**

 

Mr. Kolde, Mr. Harris and Mr. Coné served on the Compensation Committeeduring the last completed fiscal year. Neither Mr. Kolde, Mr. Harris nor Mr. Coné was an officer or employee ofClick2learn or any of our subsidiaries during the fiscal year, although Mr.Kolde was an officer from December 1984 until November 1994.  Neither Mr. Kolde, Mr. Harris nor Mr. Conéengaged in any transaction or had any relationship with us other than as adirector.  During our last completedfiscal year none of our executive officers served as a director or member of thecompensation committee of any entity, any of whose executive officers served asa director of Click2learn or a member of our Compensation Committee.

 

**CompensationCommittee Report on Executive Compensation**

 

This report of the Compensation Committee is required by the SEC andshall not be deemed to be incorporated by reference by any general statementincorporating this Annual Report on Form 10-K into any filing under theSecurities Act of 1933, as amended (the “Securities Act”), or under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”) except to theextent that we specifically incorporate this information by reference, andshall not otherwise be deemed soliciting material or filed under such acts.

 

##### *GeneralCompensation Policy*

##### * *

The Compensation Committee acts on behalf of the Board to establish thegeneral compensation policy for executive officers of Click2learn.  Executive compensation generally consists ofbase salary, bonus or revenue-based incentive compensation (for executives withdirect revenue generating responsibility), stock options and participation inbenefit plans generally available to Click2learn employees.  The Compensation Committee reviews thegeneral executive bonus plan and individual incentive compensation plans forcertain executive officers who do not participate in the general executivebonus plan at or about the beginning of each year.  The Compensation Committee also designates the persons eligibleto participate in Click2learn’s Change of Control Executive Severance Plan.

 

The Compensation Committee’s general philosophy in compensatingexecutive officers, including the Chief Executive Officer, is to relatecompensation to corporate performance. Long-term equity incentives for executive officers are accomplishedthrough grants of stock options under the Incentive Plan.  Stock options generally have value for theexecutive only if the price of Click2learn’s stock increases above the fairmarket value on the grant date and the executive remains employed by Click2learnfor the period required for the shares to vest, except that vesting mayaccelerated pursuant to the Change of Control Executive Severance Plan or anindividual employment agreement.

 

In the past, bonuses or incentive compensation plans have accounted fora significant portion of the target compensation for executive officers.  Bonuses have been tied to the achievement ofcorporate performance targets set by the Board, while incentive compensationplans have been tied to the revenue for which the particular executive isresponsible.

 

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*Executive Compensation *

 

The Board determined that there would be no increases in basecompensation for executives in 2003 and that no executive bonus plan would beadopted for 2003 unless Click2learn achieved positive cash flow from operationsfor the fiscal year.

 

*Base Compensation.*  In 2003 the base salary level for each executive officer was notincreased from 2002 base salary levels, without taking into account voluntarypay reductions taken by executives in the second half of 2002.  The CEO’s base compensation was paid inaccordance with his Employment Agreement originally approved by theCompensation Committee 2002.

 

*Incentive Compensation.*  No executive bonus plan was adopted for 2003and no other individual executive bonuses were approved by the CompensationCommittee in 2003.  The Executive VicePresident, Worldwide Sales and Alliances does not participate in the executivebonus plan, but during 2003 had an incentive compensation plan tied to therevenue he was responsible for generating.

 

*Stock Options.* Stock options are granted toexecutive officers as incentives to become employees or to aid in the retentionof executive officers and to align their interests with those of thestockholders.  The number of sharessubject to each stock option granted is within the discretion of theCompensation Committee and is based on anticipated future contribution andability to impact corporate and/or business unit results, past performance,consistency within the executive’s peer group or to provide a greater incentiveto continue employment with Click2learn and strive to increase the value of itscommon stock.

 

*Company Performance and CEO Compensation.*  CEO compensation during 2003 was fixed by anEmployment Agreement approved in March 2002.  In determining the CEO’s base salary under the Employment Agreement, the Compensation Committeeconsidered his  performance in movingClick2learn from primarily a service business to an enterprise softwarecompany, revenue growth related to Click2learn’s Aspen Enterprise ProductivitySuite and progress toward generating positive cash flow and profitableoperations.  No changes were made to theCEO’s base salary in 2003 from that established in 2002.  The CEO did not receive bonus compensationand was not granted any additional options in 2003.

 
|   | THE COMPENSATION COMMITTEE |
|--------|----------------------------|
|   | Bert Kolde, Chairman       |
|   | Edward Harris              |
|   | John Coné             |

 

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**CompanyStock Price Performance Graph**

 

The stock price performance graph below is required by the SEC andshall not be deemed to be incorporated by reference by any general statementincorporating this Annual Report on Form 10-K into any filing under theSecurities Act or under the Exchange Act, except to the extent that wespecifically incorporate this information by reference, and shall not otherwisebe deemed soliciting material or filed under such Acts.

 

The graph below compares the cumulative total stockholder return as ofDecember 31 of each year on (1) the common stock of Click2learn with (2)the Nasdaq U.S Stocks Index and (3) the Nasdaq Computer and Data ProcessingServices Index from December 31, 1998 to December 31, 2003 (assumingthe investment of $100 in Click2learn’s common stock and in each of the otherindices on December 31, 1998, and reinvestment of all dividends).

 

The comparisons in the graph below are based on historical data and arenot intended to forecast the possible future performance of Click2learn’scommon stock.

 

 

The stock price performance shown on thegraph above is not necessarily indicative of future price performance.  Information used in the graph was obtainedfrom the Nasdaq National Market, a source believed to be reliable, but we are notresponsible for any errors or omissions in such information.

 

**Item 12****.  Security Ownershipof Certain Beneficial Owners and Management.**

 

The following table sets forth certain information known to us withrespect to the beneficial ownership of our common stock as of March 1,2003, by (1) each person who is known to us to own beneficially more than 5% ofour common stock, (2) each director, (3) the Named Executive Officers and (4)all directors and executive officers as a group. Unless otherwise indicated inthe notes to the table, the persons and entities named in the table have solevoting and sole investment power with respect to all shares beneficially owned,subject to community property laws where applicable.

 
| **Name of Beneficial Owner**                             |   | **Number of  Shares  Beneficially Owned** |   | **Percentage  of Common Stock  Beneficially Owned (1)** |   |
|----------------------------------------------------------|--------|-------------------------------------------|--------|---------------------------------------------------------|--------|
| Paul G. Allen (2)                                        |   | 6,928,216                                 |   | 20.84                                                   | %      |
| WM Advisors (3)                                          |   | 3,613,537                                 |   | 10.87                                                   |   |
| Burquette Investement Partnership, L.P. (4)              |   | 2,114,936                                 |   | 6.36                                                    |   |
| Gruber & McBaine Capital Management,  LLC (5)        |   | 1,888,684                                 |   | 5.68                                                    |   |
| Kevin M. Oakes (6)                                       |   | 1,018,451                                 |   | 3.06                                                    |   |
| Sudheer Koneru(7)                                        |   | 277,994                                   |   | *                                                       |   |
| John D. Atherly (8)                                      |   | 253,121                                   |   | *                                                       |   |
| Steven Esau (9)                                          |   | 197,302                                   |   | *                                                       |   |
| Bert Kolde (10)                                          |   | 128,748                                   |   | *                                                       |   |
| Ronald S. Posner (11)                                    |   | 84,998                                    |   | *                                                       |   |
| Sally Narodick (10)                                      |   | 71,039                                    |   | *                                                       |   |
| Vijay Vashee (13)                                        |   | 52,819                                    |   | *                                                       |   |
| Edward Harris (10)                                       |   | 35,499                                    |   | *                                                       |   |
| Gary Millrood (10)                                       |   | 33,333                                    |   | *                                                       |   |
| John Coné (10)                                      |   | 17,196                                    |   | *                                                       |   |
| Jonathan Morgan (10)                                     |   | 10,832                                    |   | *                                                       |   |
| All officers and directors as a group (16  persons) (14) |   | 2,675,644                                 |   | 8.05                                                    | %      |

 

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*Less than 1% of outstanding common stock

 

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(1)                                  Percentage ownershipis based on 33,244,221 shares outstanding as of March 1, 2004.  Shares of common stock subject to options orwarrants currently exercisable or exercisable within 60 days of March 1,2004 are deemed outstanding for the purpose of computing the percentageownership of the person holding such options or warrants but are not deemedoutstanding for computing the percentage ownership of any other person.  Options or warrants that may be acceleratedand become exercisable as a result of the merger with Docent or the terminationof a director or officer following the merger are not deemed outstanding eventhough we expect the merger to close within 60 days of March 1, 2004.

 

(2)                                  Principal address is505 Union Station, 505 Fifth Avenue South, Suite 900, Seattle, Washington98104. Includes 616,120 shares held of record by Vulcan Ventures, Inc. and387,096 shares issuable upon exercise of a warrant issued to Vulcan Ventures.Mr. Allen is the sole shareholder of Vulcan Ventures and may be deemed to haveshared voting and investment power with respect to such shares. Mr. Allen isthe founder of Click2learn.

 

(3)                                  Principaladdress is 1201 Third Avenue, 22nd Floor, Seattle, Washington 98101. Based onpublicly available information filed with the SEC on Form 13G filed onOctober 31, 2003.

 

(4)           Principal address isP.O. Box 3439, Blaine Washington. Based on publicly available information filedwith the SEC on Form 13G on November 24, 2003. Includes 471,317 sharesissuable upon exercise of warrants held by Burquette Investment Partnership,L.P.

 

(5)           Principal address is50 Osgood Place, Penthouse, San Francisco, California 94113. Based on publiclyavailable information filed with the SEC on Form 13F filed on October 30,2003.

 

(6)           Includes 407,499shares subject to stock options exercisable within 60 days of March 1,2004.

 

(7)           108,013 sharessubject to stock options exercisable within 60 days of March 1, 2004 and169,981 shares held of record by his spouse.

 

(8)           Includes 231,784shares subject to stock options exercisable within 60 days of March 1,2004.

 

(9)                                  Includes190,259 shares subject to stock options exercisable within 60 days ofMarch 1, 2004.

 

(10)         Represents sharessubject to stock options exercisable within 60 days of March 1, 2004.

 

(11)         Includes 64,998shares subject to stock options exercisable within 60 days of March 1,2004 and 20,000 shares held of record by PS Capital LLC. Mr. Posner is aprincipal of PS Capital LLC and may be deemed to have shared voting andinvestment power with respect to such shares. Mr. Posner disclaims beneficialownership of shares held by PS Capital LLC except to the extent of hispecuniary interest therein.

 

(12)         Includes 26,250shares subject to stock options exercisable within 60 days of March 1,2004.

 

(13)         Includes 32,499shares subject to stock options exercisable within 60 days of March 1,2004.

 

(14)         Represents the sharesdescribed in the table, plus an additional 494,332 shares beneficially owned bythree other executive officers, of which 338,272 are shares subject to stockoptions exercisable within 60 days of March 1, 2004 and 75,226 are ownedby the spouses of certain such executive officers.

 

69

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The following table sets forth certain information regarding equitycompensation plans under which shares of our common stock are authorized forissuance.  No class of securities otherthan common stock or options to purchase common stock is authorized forissuance under any of our equity compensation plans.

 
| **Plan Category**                                               |   | **Number of Securities to be  Issued Upon Exercise of  Outstanding Options,  Warrants and Rights (a)** |   | **Weighted Average  Exercise Price of   Outstanding Options,  Warrants and Rights (b)** |   | **Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (Excluding  Securities Reflected in   Column (a)) (c)** |      |
|-----------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
|                                                            |   |                                                                                                   |   |                                                                                    |   |                                                                                                                                                       |      |
| Equity  Compensation Plans Approved by Security Holders         |   | 5,762,440                                                                                              |   | $                                                                                       | 3.75   |                                                                                                                                                       | 2,001,842 |   |
|                                                            |   |                                                                                                   |   |                                                                                    |   |                                                                                                                                                       |      |
| Equity  Compensation Plans Not Approved by Security Holders (1) |   | 0                                                                                                      |   | —                                                                                  |   | 0                                                                                                                                                          |      |
|                                                            |   |                                                                                                   |   |                                                                                    |   |                                                                                                                                                       |      |
| Total                                                           |   | 6,060,652                                                                                              |   | $                                                                                       | 3.67   |                                                                                                                                                       | 0         |   |

 

----

(1)                            Doesnot include stock options issued under the IntelliPrep 2000 Equity IncentivePlan (the “IntelliPrep Plan”) that were assumed in connection with ouracquisition of IntelliPrep.  As ofDecember 31, 2003 there were assumed options for the purchase of 298,212shares of our common stock outstanding with a weighted-average exercise priceof $2.15 per share.  If any assumedoption expires or is canceled without being exercised, the shares subject tosuch expired or canceled option are not available for issuance of other optionsunder the IntelliPrep Plan or any other equity compensation plan and no furtheroptions to purchase shares of our common stock can be issued under theIntelliPrep Plan.

 

**Changes in Control**

 

OnOctober 20, 2003, we executed an Agreement and Plan of Reorganization,dated as of October 20, 2003 (as amended to date, the “Merger Agreement”),by and among us, Docent, Newco, Canuck Acquisition Corporation, a wholly ownedsubsidiary of Newco (“Click2learn Merger Sub”) and Devil AcquisitionCorporation, a wholly owned subsidiary of Newco (“Docent Merger Sub”).  Inaccordance with the Merger Agreement, Click2learn Merger Sub will merge withand into Click2learn and each issued and outstanding share of Click2learncommon stock will be exchanged for 0.3188 shares of Newco common stock (the“Click2learn Exchange Ratio”), Docent Merger Sub will merge with and intoDocent and each issued and outstanding share of Docent common stock will beexchanged for 0.7327 shares of Newco common stock (the “Docent ExchangeRatio”).

 

Inconnection with the merger:

 

•                  each outstanding option and warrant topurchase shares of Click2learn common stock will be assumed by Newco and willthereafter represent the right to purchase a number of shares of Newco commonstock based on the Click2learn Exchange Ratio, and the exercise price per sharewill be adjusted accordingly, and

 

•                  each outstanding option and warrant topurchase Docent common stock will be assumed by Newco and will thereafterrepresent the right to purchase a number of shares of Newco common stock basedon the Click2learn Exchange Ratio, and the exercise price per share will beadjusted accordingly.

 

Theseparate corporate existences of Click2learn Merger Sub and Docent Merger Subwill thereupon cease and we and Docent will each become wholly-ownedsubsidiaries of Newco.  Thereafter, weand Docent will each merge with and into Newco and the separate corporateexistence of each company will cease.

 

Theconsummation of the merger is subject to the approval of our stockholders andthe stockholders of Docent and other customary closing conditions.  Meetings of the stockholders of each companyto vote on the merger are scheduled for March 18, 2004.  The merger is intended to be a tax-freereorganization under Section 368

 

70

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ofthe Internal Revenue Code of 1986, as amended (the “Code”) and/or qualify as atax-free exchange under Section 351 of the Code, and is expected to betreated as a purchase for financial accounting purposes, in accordance withgenerally accepted accounting principles.

 

In connection with the Merger Agreement, certain of our stockholders,including executive officers and members of the Board, having beneficialownership of approximately 7.13% of the outstanding Click2learn stock as ofOctober 15, 2003 entered into voting agreements with Docent in which,among other things, each stockholder agreed, until the earlier of theconsummation of the merger or the termination of the Merger Agreement, to voteits shares of Click2learn Common Stock:

 

•                  in favor of theadoption of the Merger Agreement and approval of the merger,

 

•                  against theapproval of any proposal that would result in a breach by Click2learn of theMerger Agreement, and

 

•                  against anyproposal made in opposition to, or incompetition with, consummation of the merger and the other transactionscontemplated by the Merger Agreement.

 

Certain Docent stockholders, including executive officers and membersof the board of directors of Docent, having beneficial ownership ofapproximately 6.84% of the outstanding stock of Docent as of October 15,2003 entered into a reciprocal voting agreement with Click2learn.

 

**Item 13.**** Certain Relationshipsand Related Transactions.**

 

Since January 1, 2003 there has not been, nor is there currentlyproposed, any transaction or series of similar transactions to which we or anyof our subsidiaries was or is to be a party in which the amount involvedexceeded or will exceed $60,000 and in which any director, executive officer,holder of more than 5% of our common stock or any member of the immediatefamily of any of the foregoing persons had or will have a direct or indirectmaterial interest other than compensation agreements and other arrangements,which are described where required in Item 11 “Executive Compensation.”

 

**Item 14.****  Principal AccountingFees and Services.**

 
|                                                                                                                                                                                                                                                                                                     |   | **Fiscal Year** |    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|---------|
|                                                                                                                                                                                                                                                                                                     |   | **2002**        |    | **2003** |   |
| **Audit Fees—**the aggregate fees  billed for the audit of annual financial statements, review of quarterly  financial statements and services normally provided in connection statutory  and regulatory filings or engagements.                                                                    |   | $               | 178,000 |   | $ | 320,000 |   |
|                                                                                                                                                                                                                                                                                                     |   |            |    |   |   |
| **Audit Related Fees—**the aggregate fees billed for assurance and related  services that are reasonably related to the performance of the audit or  review of our financial statements, including conducting accounting due  diligence in connection with our proposed merger with Docent in 2003. |   | $               | 5,000   |   | $ | 76,500 |   |
|                                                                                                                                                                                                                                                                                                     |   |            |    |   |   |
| **Tax Fees—**the  aggregate fees billed for tax compliance, tax advice and tax planning.                                                                                                                                                                                                            |   | —          |    | — |   |
|                                                                                                                                                                                                                                                                                                     |   |            |    |   |   |
| **All  Other Fees—**the aggregate fees billed for other  products and services.                                                                                                                                                                                                                     |   | —          |    | — |   |

 

The AuditCommittee’s has no pre-determined policies for pre-approval of non-audit feesthe principal auditor, rather it evaluates each potential engagementindividually to determine whether such engagement might impact the independenceof the potential auditor.  The processfor such evaluation is to discuss the potential engagement with the principalauditors and management at an Audit Committee meeting and determine whethersuch engagement might impact the independence of the potential auditor.  The Audit Committee considers all of therelevant facts and circumstances in making its determination, including thenature of the services to be provided, the 

 

71

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estimatedfees for the engagement and the principal auditor’s personnel that will beperforming the services.  All suchservices described above were pre-approved by the Audit Committee.

 

**Item 15****.****     Exhibits, Financial Statement Schedules, andReports on Form 8-K.**

 

**(a)(1)****                   Financial Statements**

 

Financial statements filed as part of thisreport are listed in the index on page 33.

 

**(a)(2)****                   Financial Statement Schedules**

 

Financial statement schedules filed as partof this report are listed in the index on page 33.

 

All other schedules are omitted because theyare not applicable, not required or the information required is shown in theconsolidated financial statements or notes thereto.

 

**(a)(3)****                   Exhibits**

 

See Index to Exhibits.

 

**(b)****                                  Reports on Form 8-K**

 

A report was filed on Form 8-K datedOctober 20, 2003 reporting the execution of the Agreementand Plan of Reorganization, dated October 20, 2003 by and amongClick2learn, Docent, Inc., Hockey Merger Corporation, Canuck AcquisitionCorporation, and Devil Acquisition Corporation.  No financial statements werefiled with the report.

 

A report on Form 8-K dated October 20,2003 was filed announcing results of operations for the six months endedSeptember 30, 2003.  No financialstatements were filed with the report.

 

**(c)****                                  Index to Exhibits**

 

The following Exhibits are attached to thisAnnual Report on Form 10-K:

 
| **Exhibit****Number** |   | **Exhibit Title**                                                                                                                                                                                                                  |
|-----------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |                                                                                                                                                                                                                               |
| 2.1                   |   | Asset Purchase Agreement dated  January 15, 2002, between Click2learn and NIIT (USA), Inc. (1)                                                                                                                                |
|                  |   |                                                                                                                                                                                                                               |
| 2.2                   |   | Agreement and Plan of Reorganization, dated October 20, 2003 by  and among Click2learn, Docent, Inc., Hockey Merger Corporation, Canuck  Acquisition Corporation, and Devil Acquisition Corporation. (2)                      |
|                  |   |                                                                                                                                                                                                                               |
| 2.3                   |   | Amendment No. 1 to Agreement  and Plan of Reorganization, dated November 13, 2003 by and among  Click2learn, Docent, Inc., Hockey Merger Corporation, Canuck Acquisition  Corporation, and Devil Acquisition Corporation. (2) |
|                  |   |                                                                                                                                                                                                                               |
| 2.4                   |   | Amendment No. 2 to Agreement  and Plan of Reorganization, dated January 26, 2004 by and among  Click2learn, Docent, Inc., Hockey Merger Corporation, Canuck Acquisition  Corporation, and Devil Acquisition Corporation. (2)  |
|                  |   |                                                                                                                                                                                                                               |
| 3.1                   |   | Amended and Restated Certificate of  Incorporation of Click2learn.(3)                                                                                                                                                              |
|                  |   |                                                                                                                                                                                                                               |
| 3.2                   |   | Certificate of Amendment of Amended and  Restated Certificate of Incorporation of Click2learn filed on  November 23, 1999.(4)                                                                                                 |
|                  |   |                                                                                                                                                                                                                               |
| 3.3                   |   | Certificate of Amendment of Amended and  Restated Certificate of Incorporation of Click2learn filed on June 11,  2001.(5)                                                                                                     |
|                  |   |                                                                                                                                                                                                                               |
| 3.4                   |   | Certificate of Amendment of Amended and  Restated Certificate of Incorporation of Click2learn filed on May 31, 2002.  (6)                                                                                                          |

 

72

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| **Exhibit****Number** |   | **Exhibit Title**                                                                                                                                                                             |
|-----------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |                                                                                                                                                                                          |
| 3.5                   |   | Bylaws of Click2learn.(2)                                                                                                                                                                     |
|                  |   |                                                                                                                                                                                          |
| 4.1                   |   | Form of Specimen Stock Certificate for  Click2learn’s Common Stock.(4)                                                                                                                   |
|                  |   |                                                                                                                                                                                          |
| 4.2                   |   | Securities Purchase Agreement dated as of  August 18, 1999 by and between Click2learn and Go2Net, Inc.(7)                                                                                |
|                  |   |                                                                                                                                                                                          |
| 4.3                   |   | Common Stock Purchase Warrant dated as of  August 16, 1999 from Click2learn to Go2Net, Inc.(7)                                                                                           |
|                  |   |                                                                                                                                                                                          |
| 4.4                   |   | Securities Purchase Agreement dated as of  October 6, 1999 by and between Click2learn, Marshall Capital Management,  Inc. and Vulcan Ventures, Inc.(8)                                   |
|                  |   |                                                                                                                                                                                          |
| 4.5                   |   | Registration Rights Agreement dated as of  October 6, 1999 by and between Click2learn, Marshall Capital Management,  Inc. and Vulcan Ventures, Inc.(8)                                   |
|                  |   |                                                                                                                                                                                          |
| 4.6                   |   | Form of Warrant to Purchase Common Stock  dated as of October 6, 1999 from Click2learn to Marshall Capital  Management, Inc., Vulcan Ventures, Inc. and Alpine Capital Partners, Inc.(8) |
|                  |   |                                                                                                                                                                                          |
| 4.7                   |   | Securities Purchase Agreement dated as of  December 8, 2000 by and between Click2learn and Marshall Capital  Management, Inc.(9)                                                         |
|                  |   |                                                                                                                                                                                          |
| 4.8                   |   | Registration Rights Agreement dated as of  December 8, 2000 by and between Click2learn and Marshall Capital  Management, Inc.(9)                                                         |
|                  |   |                                                                                                                                                                                          |
| 4.9                   |   | Series A Warrant to Purchase Common Stock  dated as of December 12, 2000 by and between Click2learn and Marshall  Capital Management, Inc.(9)                                            |
|                  |   |                                                                                                                                                                                          |
| 4.10                  |   | Purchase Agreement dated as of November 15, 2001 by and between  Click2learn and various investors. (10)                                                                                 |
|                  |   |                                                                                                                                                                                          |
| 4.11                  |   | Registration Rights Agreement dated as of  November 15, 2001 by and between Click2learn and various investors.(10)                                                                       |
|                  |   |                                                                                                                                                                                          |
| 4.12                  |   | Form of Warrant to Purchase Common Stock  dated as of November 20, 2001 from Click2learn to various investors.(10)                                                                       |
|                  |   |                                                                                                                                                                                          |
| 4.13                  |   | Addendum to Purchase Agreement and  Registration Rights Agreement dated as of December 10, 2001 by and  between Click2learn and various investors.(11)                                   |
|                  |   |                                                                                                                                                                                          |
| 4.14                  |   | Warrant to Purchase Stock dated  December 6, 2001 by and between Click2learn and Silicon Valley Bank.(12)                                                                                |
|                  |   |                                                                                                                                                                                          |
| 4.15                  |   | Purchase Agreement dated as of June 20, 2003 by and between  Click2learn and various investors. (13)                                                                                     |
|                  |   |                                                                                                                                                                                          |
| 4.16                  |   | Registration Rights Agreement dated as of June 20,  2003 by and between Click2learn and  various investors.(13)                                                                          |
|                  |   |                                                                                                                                                                                          |
| 4.17                  |   | Form of Warrant to Purchase Common Stock  dated as June 20, 2003 from  Click2learn to various investors.(13)                                                                             |
|                  |   |                                                                                                                                                                                          |
| 9.01                  |   | Form of Voting Agreement entered into on  October 20, 2003 by and between Docent, Inc. and executive officers and  directors of Click2learn. (2)                                         |
|                  |   |                                                                                                                                                                                          |
| 10.1                  |   | Form of Indemnification Agreement entered  into by Click2learn with each of its directors and executive officers.(2)                                                                          |
|                  |   |                                                                                                                                                                                          |
| 10.2                  |   | Click2learn’s 1995 Combined Incentive and  Nonqualified Stock option Plan and related documents. (3)(20)                                                                                 |
|                  |   |                                                                                                                                                                                          |
| 10.3                  |   | Click2learn’s 1998 Directors Stock Option  Plan, as amended to date. (12)(20)                                                                                                            |

 

73

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| **Exhibit****Number** |   | **Exhibit Title**                                                                                                                                                                          |
|-----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |                                                                                                                                                                                       |
| 10.4                  |   | Click2learn’s 1998 Equity Incentive Plan,  as amended to date. (12)(20)                                                                                                               |
|                  |   |                                                                                                                                                                                       |
| 10.5                  |   | Click2learn’s 1999 Employee Stock Purchase  Plan and related documents.(14)(20)                                                                                                       |
|                  |   |                                                                                                                                                                                       |
| 10.6                  |   | IntelliPrep Technologies, Incorporated 2001  Equity Incentive Plan.(15)(20)                                                                                                                |
|                  |   |                                                                                                                                                                                       |
| 10.7                  |   | Lease Agreement, dated as of May 24. 1991,  by and between Click2learn and EOP-110 Atrium Place, L.L.C. and first through  eighth amendments thereto.(3)(16)                               |
|                  |   |                                                                                                                                                                                       |
| 10.8                  |   | Ninth Amendment to Lease Agreement dated as  of April 16, 2002 by and between Click2learn and EOP-110 Atrium Place,  L.L.C.(12)                                                       |
|                  |   |                                                                                                                                                                                       |
| 10.9                  |   | Tenth Amendment to Lease Agreement dated as  of March 3, 2003 by and between Click2learn and EOP-110 Atrium Place,  L.L.C.(17)                                                             |
|                  |   |                                                                                                                                                                                       |
| 10.10                 |   | Employment Agreement dated as of  March 21, 2002 by and between Click2learn and Kevin Oakes.(1)(20)                                                                                   |
|                  |   |                                                                                                                                                                                       |
| 10.11                 |   | Employment Agreement dated as of  January 1, 2003 by and between Click2learn and Gary Millrood.(20)                                                                                   |
|                  |   |                                                                                                                                                                                       |
| 10.12                 |   | Employment Agreement dated as of  June 26, 2003 by and between Click2learn and Sudheer Koneru.(11)(20)                                                                                |
|                  |   |                                                                                                                                                                                       |
| 10.13                 |   | Loan and Security Agreement dated as of  December 6, 2002 by and between Click2learn and Silicon Valley Bank.  (12)                                                                   |
|                  |   |                                                                                                                                                                                       |
| 10.14                 |   | Amendment to Loan Documents dated as of  December 6, 2002 by and between Click2learn and Silicon Valley Bank.  (12)                                                                   |
|                  |   |                                                                                                                                                                                       |
| 10.15                 |   | Custom Software Development Agreement.(1)                                                                                                                                                  |
|                  |   |                                                                                                                                                                                       |
| 10.16                 |   | Click2learn Change of Control Severance  Plan. (19)(20)                                                                                                                                    |
|                  |   |                                                                                                                                                                                       |
|                  |   |                                                                                                                                                                                       |
| 21.1                  |   | Subsidiaries of Click2learn.                                                                                                                                                               |
|                  |   |                                                                                                                                                                                       |
| 23.1                  |   | Consent of KPMG LLP, Independent Auditors.                                                                                                                                                 |
|                  |   |                                                                                                                                                                                       |
| 31.1                  |   | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
|                  |   |                                                                                                                                                                                       |
| 31.2                  |   | Certification of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
|                  |   |                                                                                                                                                                                       |
| 32.1                  |   | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

**Notesto Exhibit List:**

 

(1)                                  Incorporated by reference to Click2learn’sQuarterly Report on Form 10-Q for the fiscal quarter ended January 31,2002.

 

(2)                                  Incorporated herein by reference to Hockey MergerCorporation’s Registration Statement on Form S-4, as amended (Registration no. 333-110535).

 

(3)                                  Incorporated herein by reference to Click2learn’sRegistration Statement on Form S-1 (Registration no. 333-49037), as amended.

 

(4)                                  Incorporated herein by reference to Click2learn’sAnnual Report on Form 10-K for the fiscal year ended December 31, 1999.

 

(5)                                  Incorporated by reference to Click2learn’sQuarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2001.

 

74

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(6)                                  Incorporated herein by reference to Click2learn’sDescription of Capital Stock on Amendment No. 1 to Form 8-A filed onAugust 8, 2002.

 

(7)                                  Incorporated herein by reference to Click2learn’sRegistration Statement on Form S-3 (Registration no. 333-87425).

 

(8)                                  Incorporated herein by reference to Click2learn’sRegistration Statement on Form S-3 (Registration no. 333-89615).

 

(9)                                  Incorporated herein by reference to Click2learn’sCurrent Report filed with the Securities and Exchange Commission on Form 8-Kdated December 12, 2000.

 

(10)                            Incorporated herein by reference to Click2learn’sCurrent Report filed with the Securities and Exchange Commission on Form 8-Kdated November 15, 2001.

 

(11)                            Incorporated herein by reference to Click2learn’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2001.

 

(12)                            Incorporated herein by reference to Click2learn’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2002.

 

(13)                            Incorporated herein by reference to Click2learn’sCurrent Report filed with the Securities and Exchange Commission on Form 8-Kdated June 20, 2003.

 

(14)                            Incorporated herein by reference to Click2learn’sRegistration Statement on Form S-8 (Registration no. 333-83759).

 

(15)                            Incorporated herein by reference to Click2learn’sRegistration Statement on Form S-8 (Registration no. 333-63916).

 

(16)                            Incorporated herein by reference to Click2learn’sAnnual Report on Form 10-K for the fiscal year ended December 31, 1998.

 

(17)                            Incorporated by reference to Click2learn’sQuarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003.

 

(18)                            Incorporated by reference to Click2learn’sQuarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2003.

 

(19)                            Incorporated by reference to Click2learn’sQuarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2002.

 

(20)                            Management contract or compensatory plan orarrangement.

 

75

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, Click2learn has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                |   | **CLICK2LEARN, INC.**                                                                                                                             |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                              |
|                |   |                                                                                                                                              |
| March 17, 2004 |   | /s/ John D. Atherly                                                                                                                               |
| Date                |   | John D. Atherly  Vice President, Finance and Administration  and Chief Financial Officer  (Duly Authorized Officer and Chief Accounting  Officer) |

 

**POWER OFATTORNEY**

 

Each individual whose signature appears below constitutes and appointsKevin Oakes and John D. Atherly, and each of them, his true lawfulattorneys-in-fact and agents, with full power of substitution, for him and inhis name, place and stead, in any and all capacities, to sign any and allamendments to this Annual Report on Form 10-K and to file the same, with allexhibits thereto and all documents in connection therewith, with the Securitiesand Exchange Commission, granted unto said attorneys-in-fact and agents, andeach of them, full power and authority to do and perform each and every act andthing requisite and necessary to be done in and about the premises, as fully toall intents and purposes as he might or could do in person, hereby ratifyingand confirming all that said attorneys-in-fact and agents or any of them, ortheir substitute or substitutes, may lawfully do or cause to be done by virtuehereof.

 

In accordance with the requirements of theSecurities Exchange Act of 1934,this report has been signed by the followingpersons on behalf of the Registrant in the capacities and on the datesindicated.

 
| March 17,  2004 |   | /s/ Kevin Oakes                                          |
|----------------------|--------|----------------------------------------------------------|
| Date                 |   | Kevin Oakes, President, Chief Executive  Officer         |
|                 |   | and Chairman of the Board (Principal  Executive Officer) |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Sally Narodick                                       |
| Date                 |   | Sally Narodick, Lead Director                            |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ John Coné                                       |
| Date                 |   | John Coné, Director                                 |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Edward Harris                                        |
| Date                 |   | Edward Harris, Director                                  |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Bert Kolde                                           |
| Date                 |   | Bert Kolde, Director                                     |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Jonathan Morgan                                      |
| Date                 |   | Jonathan Morgan, Director                                |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Ronald S. Posner                                     |
| Date                 |   | Ronald S. Posner, Director                               |
|                 |   |                                                     |
| March 17,  2004 |   | /s/ Vijay Vashee                                         |
| Date                 |   | Vijay Vashee, Director                                   |

 

76

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**SCHEDULE II.**

 

**CLICK2LEARN, INC. AND SUBSIDIARIES**

**SCHEDULE OF VALUATION AND QUALIFYINGACCOUNTS**

**Years Ended December 31, 2003, 2002, and2001**

**(In thousands)**

 
|                                                  |   | **Balance at****Beginning  of Year** |   | **Charge to****Other    Costs and  Expenses** |   | **Deductions** |   | **Balance at****End of  Year** |   |
|-------------------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------------|--------|----------------|--------|--------------------------------|--------|
| Year ended  December 31, 2003:                   |   |                                 |   |                                          |   |           |   |                           |   |
| Valuation  accounts deducted from assets:             |   |                                 |   |                                          |   |           |   |                           |   |
| Allowance for  doubtful receivables and sales returns |   | $                                    | 927    |                                          | $      | 744            |   | $                              | 1,104  |   | $ | 566 |   |
| Year ended  December 31, 2002:                   |   |                                 |   |                                          |   |           |   |                           |   |
| Valuation  accounts deducted from assets:             |   |                                 |   |                                          |   |           |   |                           |   |
| Allowance for  doubtful receivables and sales returns |   | $                                    | 1,430  |                                          | $      | 1,557          |   | $                              | 2,060  |   | $ | 927 |   |
| Year ended  December 31, 2001:                   |   |                                 |   |                                          |   |           |   |                           |   |
| Valuation  accounts deducted from assets:             |   |                                 |   |                                          |   |           |   |                           |   |
| Allowance for  doubtful receivables and sales returns |   | $                                    | 962    |                                          | $      | 1,198          |   | $                              | 730    |   | $ | 1,430 |   |

 

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