----

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C.  20549**

**FORM 10-Q**

| x                                                                | **Quarterly   Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|------------------------------------------------------------------|------------------------------------------------------------------------------------------------|
|                                                             |                                                                                           |
| **For the quarterly period ended March 31, 2006**                |
|                                                             |                                                                                           |
| **OR**                                                           |
|                                                             |                                                                                           |
| o                                                                | **Transition   Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|                                                             |                                                                                           |
| **For the transition period from______________to______________** |
|                                                             |                                                                                           |
| **Commission File Number 000-32469**                             |
|                                                             |                                                                                           |
| **THE   PRINCETON REVIEW, INC.**                                 |
| **(Exact   name of registrant as specified in its charter)**     |

| **Delaware**                                                                |   | **22-3727603**                             |
|-----------------------------------------------------------------------------|--------|--------------------------------------------|
| **(State or   other jurisdiction of incorporation or organization)**        |   | **(I.R.S.   Employer Identification No.)** |
|                                                                        |   |                                       |
| **2315 Broadway New York, New York**                                        |   | **10024**                                  |
| **(Address   of principal executive offices)**                              |   | **(Zip Code)**                             |
|                                                                        |   |                                       |
| **Registrant’s telephone number, including area code: (212) 874-8282** |

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

| Yes  x | No  o |
|------------------|-----------------|

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

| Large   accelerated filer  o | Accelerated   filer  x | Non-accelerated   filer  o |
|----------------------------------------|----------------------------------|--------------------------------------|

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

| Yes  o | No  x |
|------------------|-----------------|

          The Companyhad 27,574,512 shares of $0.01 par value common stock outstanding at May 8,2006.

----

**TABLE OF CONTENTS**

| PART I.  FINANCIAL   INFORMATION | 3                                                                                                    |
|---------------------------------------|------------------------------------------------------------------------------------------------------|
|                                  | Item 1.  Condensed Consolidated Financial   Statements                                          | 3 |
|                                  |                                                                                                 | Condensed Consolidated Balance Sheets | 3 |
|                                  |                                                                                                 | Condensed Consolidated   Statements of Operations | 4 |
|                                  |                                                                                                 | Condensed Consolidated   Statements of Cash Flows | 5 |
|                                  |                                                                                                 | Notes to Condensed Consolidated Financial Statements | 6 |
|                                  | Item 2. Management’s Discussion and Analysis of Financial Condition   and Results of Operations | 13 |
|                                  | Item 3.  Quantitative and   Qualitative Disclosures about Market Risk                           | 17 |
|                                  | Item 4.  Controls and   Procedures                                                              | 17 |
| PART II.  OTHER INFORMATION      | 18                                                                                                   |
|                                  | Item 1.  Legal Proceedings                                                                      | 18 |
|                                  | Item 1A. Risk Factors                                                                                | 18 |
|                                  | Item 2.  Unregistered Sales of   Equity Securities and Use of Proceeds                          | 18 |
|                                  | Item 3.  Defaults Upon Senior   Securities                                                      | 18 |
|                                  | Item 4.  Submission of Matters   to a Vote of Security Holders                                  | 19 |
|                                  | Item 5.  Other Information                                                                      | 19 |
|                                  | Item 6.  Exhibits                                                                               | 21 |
| SIGNATURES                            | 22                                                                                                   |

2

**PART I.  FINANCIAL INFORMATIONItem 1.  Condensed Consolidated Financial Statements**

**THE PRINCETON REVIEW, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets**

|   |   | **March 31,2006**                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | **December 31,2005** |   |
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|   |   |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                 |        |  |   |
|   |   | **(in   thousands, except share data)** |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   | **(unaudited)**                         |  

 

 

**ASSETS**

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash   and cash equivalents

 

$

3,143

 

$

8,002

 

Accounts   receivable, net of allowance of $2,126 in 2006 and $1,601 in 2005

 

 

24,518

 

 

22,493

 

Accounts   receivable-related parties

 

 

542

 

 

1,591

 

Other   receivables ($697 in 2006 and $789 in 2005 from related parties)

 

 

728

 

 

813

 

Inventories

 

 

2,828

 

 

2,798

 

Prepaid   expenses

 

 

2,467

 

 

2,229

 

Other   current assets

 

 

1,310

 

 

1,307

 

 

 

 

 

Total   current assets

 

 

35,536

 

 

39,233

 

Furniture, fixtures,   equipment and software development, net

 

 

16,074

 

 

16,155

 

Goodwill, net

 

 

31,506

 

 

31,506

 

Investment in affiliates

 

 

1,873

 

 

1,938

 

Other intangibles, net

 

 

13,717

 

 

13,371

 

Other assets

 

 

3,753

 

 

3,168

 

 

 

 

 

**Total assets**

 

$

102,459

 

$

105,371

 

 

 

 

 

**LIABILITIES   AND STOCKHOLDERS’ EQUITY**

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts   payable

 

$

8,931

 

$

10,449

 

Accrued   expenses

 

 

9,634

 

 

10,826

 

Current   maturities of long-term debt

 

 

1,469

 

 

1,530

 

Deferred   income

 

 

18,438

 

 

16,548

 

 

 

 

 

Total   current liabilities

 

 

38,472

 

 

39,353

 

Deferred rent

 

 

2,408

 

 

2,327

 

Long-term debt

 

 

2,681

 

 

2,845

 

Series B-1 Preferred   stock, $.01 par value; 10,000 authorized, issued and outstanding at March 31,   2006 and December 31, 2005 (liquidation value of $11,018)

 

 

10,000

 

 

10,000

 

Stockholders’ equity

 

 

 

 

 

 

 

Preferred   stock, $.01 par value; 4,990,000 shares authorized; none issued and   outstanding at March 31, 2006 and December 31, 2005

 

 

—  

 

 

—  

 

Common   stock, $.01 par value; 100,000,000 shares authorized;  27,572,172 issued and outstanding at March   31, 2006 and December 31, 2005

 

 

276

 

 

276

 

Additional   paid-in capital

 

 

116,449

 

 

116,279

 

Accumulated   deficit

 

 

(67,555

)

 

(65,430

)

Accumulated   other comprehensive (loss)

 

 

(272

)

 

(279

)

 

 

 

 

Total   stockholders’ equity

 

 

48,898

 

 

50,846

 

 

 

 

 

**Total liabilities and stockholders’ equity**

 

$

102,459

 

$

105,371

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

3

**THE PRINCETON REVIEW, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations (unaudited)**

 

 

**Three   Months Ended March 31,**

 

 

 

 

 

 

**2006**

 

**2005**

 

 

 

 

 

 

 

**(in   thousands, except per share data)**

 

**Revenue**

 

 

 

 

 

 

 

Test   Preparation Services

 

$

25,033

 

$

22,885

 

K-12   Services

 

 

6,873

 

 

7,919

 

Admissions   Services

 

 

3,174

 

 

2,794

 

 

 

 

 

Total   revenue

 

 

35,080

 

 

33,598

 

**Cost of   revenue**

 

 

 

 

 

 

 

Test   Preparation Services

 

 

7,845

 

 

7,037

 

K-12   Services

 

 

4,726

 

 

4,023

 

Admissions   Services

 

 

1,290

 

 

773

 

 

 

 

 

Total   cost of revenue

 

 

13,861

 

 

11,833

 

 

 

 

 

Gross   profit

 

 

21,219

 

 

21,765

 

**Operating   expenses**

 

 

23,089

 

 

21,575

 

 

 

 

 

**Income   (loss) from operations**

 

 

(1,870

)

 

190

 

Interest   expense

 

 

(31

)

 

(309

)

Equity   in the income (loss) of affiliates

 

 

(67

)

 

(67

)

Other   income

 

 

—  

 

 

41

 

 

 

 

 

**Loss   before provision for income taxes**

 

 

(1,968

)

 

(145

)

(Provision)   benefit for income taxes

 

 

—  

 

 

—  

 

 

 

 

 

**Net loss**

 

 

(1,968

)

 

(145

)

**Dividends   and accretion on Series B-1 Preferred Stock**

 

 

(157

)

 

(195

)

 

 

 

 

**Net loss   attributed to common stockholders**

 

$

(2,125

)

$

(340

)

 

 

 

 

**Net loss   per share - basic and diluted**

 

$

(0.08

)

$

(0.01

)

 

 

 

 

**Weighted   average shares used in computing net loss per share**

 

 

27,572

 

 

27,570

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

4

**THE PRINCETON REVIEW, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (unaudited)**

 

 

**Three   Months Ended March 31,**

 

 

 

 

 

 

**2006**

 

**2005**

 

 

 

 

 

 

 

**(in   thousands)**

 

**Cash flows   from operating activities:**

 

 

 

 

 

 

 

Net income (loss)

 

$

(1,968

)

$

(145

)

Adjustments to reconcile   net income (loss) to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

451

 

 

400

 

Amortization

 

 

1,661

 

 

1,336

 

Bad   debt expense

 

 

762

 

 

165

 

Write-off   of inventory

 

 

166

 

 

 

 

Stock   based compensation

 

 

170

 

 

—  

 

Other,   net

 

 

101

 

 

(185

)

Net   change in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts   receivable

 

 

(1,654

)

 

(2,202

)

Inventory

 

 

(196

)

 

131

 

Prepaid   expenses

 

 

(238

)

 

342

 

Deferred   book and software development costs

 

 

(846

)

 

515

 

Other   assets

 

 

(74

)

 

326

 

Accounts   payable and accrued expenses

 

 

(2,711

)

 

(659

)

Deferred   income

 

 

1,890

 

 

(3,145

)

 

 

 

 

Net cash used by operating   activities

 

 

(2,486

)

 

(3,121

)

 

 

 

 

**Cash flows   from investing activities:**

 

 

 

 

 

 

 

Purchases of furniture,   fixtures, equipment and software development

 

 

(1,366

)

 

(1,931

)

Payment of related party   loan

 

 

133

 

 

—  

 

Note receivable

 

 

250

 

 

250

 

Additions to capitalized   K-12 content, capitalized course costs

 

 

(1,010

)

 

(587

)

 

 

 

 

Net cash used in investing   activities

 

 

(1,993

)

 

(2,268

)

 

 

 

 

**Cash flows   from financing activities:**

 

 

 

 

 

 

 

Proceeds (payments) from revolving   credit facility

 

 

—  

 

 

(2,000

)

Capital lease payments

 

 

(223

)

 

(168

)

Dividends on Series B-1   Preferred Stock

 

 

(157

)

 

(125

)

Proceeds from exercise of   options

 

 

—  

 

 

7

 

 

 

 

 

Net cash used in financing   activities

 

 

(380

)

 

(2,286

)

 

 

 

 

Net decrease in cash and   cash equivalents

 

 

(4,859

)

 

(7,675

)

Cash and cash equivalents,   beginning of period

 

 

8,002

 

 

19,197

 

 

 

 

 

Cash and cash equivalents,   end of period

 

$

3,143

 

$

11,522

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

5

**THE PRINCETON REVIEW, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (unaudited)**

**1. Basis of Presentation**

          The accompanying unaudited interim consolidated financial statements include the accounts of The Princeton Review, Inc. and its wholly-owned subsidiaries, The Princeton Review Canada Inc. and Princeton Review Operations L.L.C., as well as the Company’s national advertising fund (together, the “Company”).

          These financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and reflect all adjustments, consisting only of normal recurring accruals, that are, in the opinion of management, necessary for a fair presentation of the interim financial statements. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission. The results of operations for the three-month period ended March 31, 2006 are not necessarily indicative of the results to be expected for the entire fiscal year or any future period.

*Products and Services*

          The following table summarizes the Company’s revenue and cost of revenue for the three-month periods ended March 31, 2006 and 2005:

 

 

**Three   Months Ended March 31,**

 

 

 

 

 

 

 

**2006**

 

 

**2005**

 

 

 

 

 

 

 

**(in   thousands)**

 

**Revenue**

 

 

 

 

 

 

 

Services

 

$

31,158

 

$

30,186

 

Products

 

 

1,837

 

 

1,708

 

Other

 

 

2,085

 

 

1,704

 

 

 

 

 

Total   Revenue

 

$

35,080

 

$

33,598

 

 

 

 

 

**Cost of   Revenue**

 

 

 

 

 

 

 

Services

 

$

12,080

 

$

10,861

 

Products

 

 

1,646

 

 

793

 

Other

 

 

135

 

 

179

 

 

 

 

 

Total   Cost of Revenue

 

$

13,861

 

$

11,833

 

 

 

 

 

          Services revenue includes course fees, professional development, subscription fees and marketing services fees. Products revenue includes sales of workbooks, test booklets and printed tests, sales of course material to independently owned franchisees and fees from a publisher for manuscripts delivered.  Other revenue includes royalties from independently owned franchisees and royalties and marketing fees received from publishers.

*Stock-Based Compensation*

          Prior to January 1, 2006, the Company accounted for the issuance of stock options under the recognition and measurement provisions of Accounting Principles Board (“APB”) No. 25, *Accounting for Stock Issued to Employees*, and related interpretations, as permitted by FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  No stock-based employee compensation cost was recognized in the Statement of Operations for the three months ended March 31, 2005, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  Effective January 1, 2006, the Company adopted the fair value recognition provision of FASB Statement No. 123(R), *Share-Based Payment*, using the modified-prospective transition method.  Under that transition method, compensation cost recognized in the quarterended

6

March 31, 2006 includes: (a) compensation cost of all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost of all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results of prior periods have not been restated. 

          As a result of adopting Statement 123(R) on January 1, 2006, the Company’s loss before taxes and net loss for the three months ended March 31, 2006, is $170,000 lower than if it had continued to account for share-based compensation under Opinion 25.  Basic and diluted loss per share for the three months ended March 31, 2006 would have been $0.08, if the company had not adopted Statement 123(R), compared to reported basic and diluted loss per share of $0.08.

          Prior to the adoption of Statement 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows.  Statement 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.  Because of the Company’s historical net losses, and the uncertainty as to the realizability of its tax benefits, no tax benefits have been recorded.

          The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of Statement 123(R) to options granted under the Company’s stock option plan for the three months ended March 31, 2005.  For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing formula and amortized to expense over the options vesting periods.

 

 

**Three   Months   EndedMarch 31, 2005**

 

 

 

 

 

 

**(In   thousands,except per   share amounts)**

 

Net loss attributed to   common stockholders, as reported

 

$

(340

)

Total stock-based employee   compensation expense detemined under fair-value based method for all award,   net of related tax effects

 

 

(513

)

 

 

 

Pro forma net loss   attributed to common stockholders

 

$

(853

)

 

 

 

Net loss per share:

 

 

 

 

Basic and diluted, as   reported

 

$

(0.01

)

 

 

 

Basic and diluted, pro   forma

 

$

(0.03

)

 

 

 

*Adoption of New Accounting Pronouncements*

          In May 2005, the FASB issued SFAS No.154, “*Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No. 3”* (“SFAS 154”). SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines “restatement” as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and does not have a significant impact on the Company’s consolidated financial statements.

 

Other   recently issued accounting pronouncements include the following:

 

 

 

•

Financial Accounting   Standards Board (“FASB”) Staff Position FAS 13-1, “*Accounting for Rental   Costs Incurred during a Construction Period*” (October 2005);

 

 

 

 

•

FASB Staff Position FAS   115-1, “*The Meaning of Other-Than-Temporary Impairment and Its Application to   Certain Investments*” (November 2005);

7

 

•

FASB Staff Position FIN   45-3, “*Application of FASB Interpretation No. 45 to Minimum Revenue   Guarantees Granted to a Business or Its Owners*” (November 2005); and,

 

 

 

 

•

FASB SFAS No. 155,   “*Accounting for Certain Hybrid Financial Instruments – an amendment of FASB   Statements No. 133 and 140*” (February 2006).

 

 

 

 

The Company does not expect these   pronouncements to have a significant impact on its consolidated financial   statements.

*Use of Estimates*

          The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant accounting estimates used include estimates for uncollectible accounts receivable, deferred tax valuation allowances, impairment write-downs, amortization lives assigned to intangible assets and money back guarantees. Actual results could differ from those estimated.

*Reclassifications*

          Certain balances have been reclassified to conform to the current quarter’s presentation.

**2. Stock-Based Compensation**

          As of  March 31, 2006, the Company has a stock-based compensation plan more fully described below.  The compensation cost charged against income for this plan was $170,000 for the three months ended March 31, 2006.  Due to the Company’s historical net losses, and the uncertainty as to the realizability of its tax benefits, no income tax benefit has been recognized in the statement of operations for this share-based compensation arrangement.

          The Company’s 2000 Stock Incentive Plan (as amended and restated on March 24, 2003) (“the Plan”), which is shareholder-approved, initially permitted grants of incentive stock options, non-qualified stock options, restricted stock and deferred stock to eligible participants for up to 2,538,000 shares of common stock, as adjusted.  On various dates, beginning in June 2000 through March 2006, an additional 2,675,744 shares were authorized.  The Company believes that such awards better align the interest of its employees with those of its shareholders.   Options granted under the Plan are for periods not to exceed ten years. Other than for options to purchase 133,445 shares granted in 2000 to certain employees which were vested immediately, options outstanding under the Plan generally vest quarterly over twoto four years. As of March 31, 2006, there were approximately 1,012,700 shares available for grant.

          The fair value of each option award is estimated on the date of grant using a Black-Scholes option pricing model that uses assumptions noted in the following table.  Expected volatilities are based on implied volatilities from traded options on the Company’s stock, historical volatility of the Company’s stock, and other factors.  The Company uses historical data to estimate option exercise and forfeiture within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes.  The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding,  The risk-free rate for periods within the expected term of the option is based on the U.S. Treasury yield curve in effect at thetime of grant.

8

 

 

**Three   Months Ended March 31,**

 

 

 

 

 

 

**2006**

 

**2005**

 

 

 

 

 

**Assumptions**

 

 

 

 

 

 

 

Expected volatility

 

 

44

%

 

59

%

Expected dividends

 

 

0

%

 

0

%

Expected term (in years)

 

 

5.0

 

 

5.0

 

Risk-free rate

 

 

5.00

%

 

4.25

%

A summary of option activity under the Plan as of March 31, 2006, and changes during the period then ended is presented below:

 

 

**Options**

 

**Weighted-   Average   Exercise Price**

 

**Weighted-   Average   Remaining   Contractual   Term**

 

**Aggregate   Intrinsic   Value   ($000)**

 

 

 

 

 

 

 

**Outstanding   at January 1, 2006**

 

 

3,298,494

 

$

7.00

 

 

 

 

 

 

 

Granted

 

 

10,500

 

$

5.18

 

 

 

 

 

 

 

Forfeited

 

 

(47,774

)

$

7.41

 

 

 

 

 

 

 

Exercised

 

 

—  

 

$

0.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Outstanding   at March 31 2006**

 

 

3,261,220

 

$

6.99

 

 

6.06

 

$

1,055

 

 

 

 

 

 

 

 

 

Exercisable   at March 31, 2006

 

 

2,134,059

 

$

6.99

 

 

4.53

 

$

870

 

 

 

 

 

 

 

 

 

The weighted average fair value of options granted during the three months ended March 31, 2006 was $3.89. No options were exercised during the three months ended March 31, 2006.

A summary of the status of the Company’s nonvested options as of March 31, 2006 and changes during the period ended March 31, 2006, is presented below:

**Nonvested Options**

 

**Options**

 

**Weighted-   Average** |