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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549****Form 10-K/A****(AmendmentNo. 1)**   þ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934******FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005******OR**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE 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 (I.R.S. Employerincorporation or organization) 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****Securities registered pursuant to Section 12(b) of the Act:**   **Title of Each Class** **Name of Each Exchange on Which Registered**   **None****Securities registered pursuant to Section 12(g) of the Act:****Common stock, $0.01 par value**     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes o       No þ     Indicate by check mark if the registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Exchange Act Rule 12b-2 Yes o       No þ     Indicate by check mark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ       No o     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K o     Indicate by check mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act.Large accelerated filer o       Accelerated filer þ       Non-accelerated filer o     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 ofthe Exchange Act). Yes o       No þ     The aggregate market value of registrant’s common stock held by non-affiliates, based upon theclosing price of the common stock on June 30, 2005, as reported by the NASDAQ National Market, wasapproximately $96 million. Shares of common stock held by each executive officer and director andby each person who owns 5% or more of the outstanding common stock, based on Schedule 13G filings,have been excluded since such persons may be deemed affiliates. This determination of affiliatestatus is not necessarily a conclusive determination for other purposes.     Theregistrant had 27,572,172 shares of $0.01 par value common stockoutstanding at March 10,2006.**DOCUMENTS INCORPORATED BY REFERENCE**     Certain information required in Part III of this Form 10-K is incorporated by reference to theProxy Statement for the registrant’s 2006 Meeting of Stockholders to be held on June 15, 2006.  
 

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**EXPLANATORY NOTE**     The Princeton Review, Inc. (“we,” “us,” or the “Company”) is filing this Amendment No. 1(this “Amendment”) to its Annual Report on Form 10-K for the year ended December 31, 2005 torestate its consolidated financial statements and related financial information to correct an errorin the Company’s accounting and disclosures for its Convertible, Redeemable Series B-1 PreferredStock issued on June 4, 2004 (the “Preferred Stock”). On October 24, 2006, the Audit Committee ofthe Board of Directors of the Company, in consultation with the Company’s management and itsindependent registered public accounting firm, Ernst & Young LLP, concluded that the Company’smethod of accounting for the Preferred Stock must be changed. This conclusion was reached followinga thorough evaluation of the Company’s accounting treatment of the Preferred Stock in response to acomment letter from the Staff of the Division of Corporation Finance of the Securities and ExchangeCommission (“SEC”) relating to the Company’s Annual Report on Form 10-K for the year ended December31, 2005. While we have concluded that the Preferred Stock was properly accounted for as “MezzanineEquity” consistent with generally accepted accounting principles (GAAP), the Company did notproperly account for certain derivatives embedded within the Preferred Stock and associated rightsto acquire additional shares of preferred stock that were granted simultaneously with the issuanceof the Preferred Stock. Under GAAP, these embedded derivatives and rights are required to berecorded as liabilities at fair value, and adjusted to their fair values in subsequent periods.Accordingly, we are restating our financial statements to reflect this accounting treatment.     These non-cash adjustments will not have any impact on our previously reported revenue or netcash flows.     This Amendment to our Annual Report on Form 10-K for the year ended December 31, 2005,initially filed with the SEC on March 16, 2006 (the “Original Filing”), is being filed to reflectrestatements of (i) the Company’s consolidated balance sheets at December 31, 2005 and December 31,2004, and (ii) the Company’s consolidated statements of operations, stockholders’ equity and cashflows for the years ended December 31, 2005 and 2004, and the notes related thereto. For a moredetailed description of these restatements, see Note 2, “Restatement of Financial Statements,” tothe accompanying audited consolidated financial statements and the section entitled “Restatement”in Management’s Discussion and Analysis of Financial Condition and Results of Operations in thisAmendment.          The information contained in this Amendment, including the financial statements and the notesthereto, amends only Items 1A, 6, 7, 8 and 9A of the Original Filing, in each case to reflect onlythe restatement discussed herein. No other information in the Original Filing is amended hereby.Currently-dated certifications from our Chief Executive Officer and our Chief Financial Officer andthe consent of our independent registered public accounting firm have been included as exhibits tothis Amendment. As discussed in Item 9A, Controls and Procedures (as restated), managementidentified a control deficiency that relates to the restatement that, under the circumstance constitutes a material weakness.     Theforegoing items have not been updated to reflect other eventsoccurring after the filing date of the OriginalFiling or to modify or update those disclosures affected by subsequent events. Except for theforegoing amended information, this Amendment continues to describe conditions as of the date ofthe Original Filing, and we have not updated the disclosures contained herein to reflect eventsthat occurred at a later date.     We have not amended and do not intend to amend our previously-filed Annual Reports on Form10-K or our Quarterly Reports on Form 10-Q for the periods affected by the restatement describedherein that ended prior to January 1, 2005. For this reason, the consolidated financialstatements, auditors’ reports and related financial information for the affected periods containedin such reports should no longer be relied upon.
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**TABLE OF CONTENTS**     PART I  3      Item 1. Business  3      Item 1A. Risk Factors  12      Item 1B. Unresolved Staff Comments  21      Item 2. Properties  21      Item 3. Legal Proceedings  21      Item 4. Submission of Matters to a Vote of Security Holders  21      PART II  21      Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters  21      Item 6. Selected Consolidated Financial Data  23      Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations  24      Item 7A. Quantitative and Qualitative Disclosures about Market Risk  34      Item 8. Financial Statements and Supplementary Data  35      Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure  65      Item 9A. Controls and Procedures  65      Item 9B. Other Information  67      PART III  67      Item 10. Directors and Executive Officers of the Registrant  67      Item 11. Executive Compensation  68      Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  69      Item 13. Certain Relationships and Related Transactions  69      Item 14. Principal Accountant Fees and Services  69      PART IV  69      Item 15. Exhibits and Financial Statement Schedules  69      SIGNATURES  74      EX-23.1:CONSENT OF ERNST & YOUNG    EX-31.1:CERTIFICATION    EX-31.2:CERTIFICATION    EX-32.1:CERTIFICATION     EX-23.1: CONSENT OF ERNST & YOUNG LLP EX-31.1: CERTIFICATION EX-31.2: CERTIFICATION EX-32.1: CERTIFICATION
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**PART I**     All statements in this Annual Report on Form 10-K that are not historical facts areforward-looking statements within the meaning of Section 21E of the Securities Exchange Act of1934. Such forward-looking statements may be identified by words such as “believe,” “intend,”“expect,” “may,” “could,” “would,” “will,” “should,” “plan,” “project,” “contemplate,” “anticipate”or similar statements. Because these statements reflect our current views concerning future events,these forward-looking statements are subject to risks and uncertainties. Our actual results coulddiffer materially from those anticipated in these forward-looking statements as a result of manyfactors, including, but not limited to, the factors described under the caption “Risk Factors” andelsewhere in this Annual Report on Form 10-K. We undertake no obligation to update publicly anyforward-looking statements for any reason, even if new information becomes available or otherevents occur in the future.     In this Annual Report on Form 10-K, unless the context indicates otherwise, “The PrincetonReview,” “the Company,” “we,” “us” and “our” refer to The Princeton Review, Inc. and itssubsidiaries and predecessors.**Item 1. Business****Overview**     The Princeton Review provides integrated classroom-based, print and online products andservices that address the needs of students, parents, educators and educational institutions. TheCompany was founded in 1981 by our Chairman and Chief Executive Officer, John Katzman, as an SATpreparation course. Today, based on our experience in the test preparation industry, we now believethat we offer the leading SAT preparation course and are among the leading providers of testpreparation courses for most major post-secondary and graduate admissions tests. In 2005, theCompany and its franchisees provided test preparation courses and tutoring services for the SAT,GMAT, MCAT, LSAT, GRE and other standardized admissions tests to more than 129,000 students in over1,500 locations throughout the United States and abroad.     Over the course of several years, beginning in 1998, The Princeton Review has transformeditself from primarily a test preparation company to an integrated provider of standardized testpreparation, K-12-focused products and services and post-secondary admissions services. We launchedour K-12 Services division; complemented our traditional test preparation products with a range ofonline options; invested in and acquired new web-based admissions services capabilities andgenerally broadened our offerings throughout our core markets. While we still derive more than halfof our revenue from standardized test preparation, the percentage of our revenue from our newerproducts and services has increased from 19% in 2001 to 38% in 2005 allowing us to become a morediversified company with clear opportunity for growth.     The Company operates through the following three divisions: **•** *The Test Preparation Services division,*founded in 1981, provides classroom-based aswell as online test preparation courses. The Test Preparation Services division alsoprovides tutoring and No Child Left Behind (NCLB) Supplemental Education Services.Additionally, the division receives monthly royalties from its independent franchisees whoprovide classroom-based test preparation courses under the Princeton Review brand.  **•** *The K-12 Services division,*founded in 1998, provides a range of services to K-12schools and school districts to help primary and secondary school students and teachersmeasurably improve academic performance. With a strong conviction that Every Child CanAchieve TM this division also provides online and print-based assessment,professional development, and materials to support school based intervention programs.  **•** *The Admissions Services division,*founded in 1986, provides marketing services andweb-based admissions products to higher education institutions. Admissions Services alsoprovides post-secondary counseling services and web-based products to secondary schoolsand school districts.     The Company also authors more than 200 print and software titles on test preparation, academicadmissions and related topics under the Princeton Review brand. Books are sold primarily throughRandom House, Inc., from which the Company collects fees for advances, royalties and editing andmarketing arrangements.     The Company was incorporated in Delaware in March 2000. The Company’s Internet address is*www.PrincetonReview.com*. On its Investors web site, located at *www.PrincetonReview.com*, the Companyposts the following filings as soon as reasonably practicable after they are electronically filedwith or furnished to the Securities and Exchange Commission: Annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All suchfilings on the Investors web site are available free of charge.
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**Our Products and Services****Test Preparation Services Division**     The Test Preparation Services division provides test preparation services to students takingthe following major U.S. standardized tests.   SAT LSAT (Law School Admissions Test)GMAT (Graduate Management Admissions Test) MCAT (Medical College Admissions Test)GRE (Graduate Record Examination) ACT (American College Test)TOEFL (Test of English as a Foreign Language) PSATUSMLE (United States Medical Licensing Examination) SAT II     *Our Classroom-Based Course Offerings*     Our test preparation courses focus on customer service and quality instruction. Ourexperienced teachers and tutors generally work with groups of 12 or fewer students in our SATclasses. We have successfully updated all of our SAT products and materials to reflect the changesmade to the SAT as of March 2005. Our GMAT and GRE classes generally have no more than eightstudents in each class to maximize individual attention and grouping by similar ability. We havealso completely redesigned our LSAT course offerings to offer two options — one longer and moreintensive, and one designed to maximize instruction over a shorter time frame. In 2006, our GRE andMCAT courses will be completely updated to reflect significant changes to these tests.     We believe that an important part of our test preparation courses is the high quality studymaterials and the advanced diagnostic analysis that our students receive. We spend significantresources on research and development to enhance the supplemental materials used in our courses. Asa result, each of our students receives in-depth analytical materials, sample questions, testingdrills, model exams and diagnostic analysis of their progress as they take the course.     *Our Private Tutoring Offerings*     The Princeton Review private tutoring program is our most exclusive, customized offering. Weoffer one-to-one, high-end admissions counseling and tutoring services for all of the admissionstests. In addition, we provide individual assistance with academic subjects. Tutoring is chosen bystudents and parents who want customized instruction from our very best instructors on a flexibleschedule.     *Our Online Course Offerings*     Our award-winning online courses are fully interactive and are particularly attractive tostudents who need the flexibility to prepare at any time of the day or night and on short notice.This product line is also very profitable and among our fastest growing. The online courses havebeen remapped for use by all of our classroom-based and tutoring students as well. Students cantake tests, make up classes, or simply do extra work online on their own schedule. Our online toolshave enriched all of our products while providing more flexibility by offering all Princeton Reviewstudents the ability to choose their best and most convenient way of learning as they go throughour programs.     *Our School-Based Offerings*     In addition to offering our standardized test preparation courses to individual students, wealso offer our SAT, SAT II and ACT test preparation services to schools and districts around theUnited States. The Princeton Review works with hundreds of such institutional clients to providetest preparation services to their students. These clients range from remote private schools tolarge urban school districts and other sponsoring non-educational organizations. Our institutionaltest preparation courses are custom designed to meet the needs of these institutional clients andtheir students. Using the same materials and techniques, we train our own teachers and,occasionally, district teachers to deliver test preparation, remediation and enrichment todistricts of all demographics. We also offer extensive testing and professional developmentservices.     Additionally, since 2003, our Test Preparation Services division has teamed up with our K-12Services division to become a major provider of Supplemental Education Services (SES) under NCLB.By combining content and materials developed by our K-12 Services division with our TestPreparation Services division’s teaching professionals we deliver remediation and enrichmentservices directly to thousands of students in school districts throughout the country. Ourcustomized SES services offer students intensive, live instruction related to Math and Englishlanguage arts (including reading) within a small group setting. School-based services provide asignificant growth opportunity in the coming years.     *Our Test Preparation Publications and Software*
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     Examples of the books and educational software products developed by the Test PreparationServices division include the following:     *Cracking the SAT* *Cracking the AP Calculus* *Anatomy Coloring Book**Cracking the GMAT* *Cracking the AP Chemistry* *Human Brain Coloring Book**Cracking the LSAT* *Cracking the AP US History* *Physiology Coloring Book**Cracking the GRE* *Cracking the AP European History* *Cracking the Praxis**WordSmart* *Cracking the GED* *Cracking the ASVAB**MathSmart* *GMAT Math Workbook* *Crash Course for the SAT**GrammarSmart* *GMAT Verbal Workbook* *Crash Course for the GRE*     *The Princeton Review: Inside the SAT and ACT 2003 Edition*(CD ROM software title)**K-12 Services Division**     *Services for Schools*     The accountability movement, which has gained momentum over the past 10 years and has beencodified by new federal laws, including NCLB, places testing at the center of K-12 education.Performance on these tests carries important consequences for students, teachers and administratorsalike. Students who perform poorly can face mandatory summer school, a repeated grade, or denial ofa high school diploma. For teachers and school administrators, these tests exert strong pressure onteaching and learning, and class or school performance increasingly affects the direction of theircareers.     The K-12 Services division partners with schools to help them meet these challenges andmeasurably improve academic performance. Recognizing that schools need a broad range of productsand services, we offer customized solutions that include formative and benchmarking assessments,professional development, and materials to support after school programs. Research indicates thatthe synergy of effective assessments, improvements in teacher quality, and skill-specific,standards-aligned instruction can significantly improve student performance, and our goal is toprovide schools with the right tools to achieve this result. In 2005, we worked with the U.S.Department of Education and a number of states and districts across the country, including:Virginia, and Maryland, the School District of Philadelphia, Los Angeles Unified School District,Chicago City Schools, and The New York City Department of Education.     We provide the following three major solutions to school districts throughout the country.Each solution can be combined into customized programs to meet the specific needs of each schooldistrict.Assessments to Inform Instruction     We offer districts interim, low-stakes assessments aligned to their curriculum and statestandards. These instruments can be delivered in traditional paper and pencil format or onlinethrough our Homeroom.com platform. Homeroom.com is a powerful, web-based tool that enableseducators to quickly assess students’ academic strengths and weaknesses while providing immediatefeedback and tailored educational resources for improving performance. Results are provided in atimely, usable and actionable format for teachers, administrators, parents and students.     These assessments have four important features for school districts: **•** *Quick Turnaround*. Detailed reports are delivered online, soon after test administration.  **•** *Useful Reporting*. Our reports are designed to be maximally useful for teachers toguide instruction and for students and parents to provide meaningful guidance.  **•** *Connection to Learning Resources*. Teachers, students and parents have access tospecific resources based on actual areas of need. These resources include proprietaryPrinceton Review lessons and direct links to web-based resources.  **•** *Ties to Professional Development*. The Princeton Review works with teachers andadministrators to ensure that they understand the solution, and follows up with theinstructional leadership of the schools to review profiles of learning outlined by thedata. In addition, The Princeton Review works with districts to provide “parent nights” tohelp inform the community.     Professional Development
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     We provide ongoing, comprehensive professional development to help teachers ensure theacademic success of their students. Our professional development programs are ongoing in order tocontinually build upon knowledge and to ensure proper implementation of skills and resourcesintroduced throughout our sessions. Programs are flexible and customized.     We offer three main professional development programs: **•** *Ongoing data-differentiated instruction and assessment support.*We implement ongoingprofessional development programs that focus on using data in the classroom to driveindividualized instruction, with the ultimate goal being mastery in the classroom andimprovements on state standardized tests. The Princeton Review works with instructionalleaders to help them learn how to interpret and use reports generated through ThePrinceton Review’s assessments, as well as from their state standards test, to drivestudent instruction.  **•** *Individualized professional development programs.*Using several data streams, fromteacher self-evaluations to low stakes interim assessments, we create individualizedprofessional development for a district’s staff. With this program, teachers work in anongoing manner with a Princeton Review consultant who helps each teacher focus instructionon the area of his or her students’ needs. Our consultants help each teacher evaluate dataand reports gathered from low-stakes assessments administered throughout the program andsubsequently recommend individualized professional development in order to expand eachteachers knowledge of his or her students skill set.  **•** *Product Training.*Training is a crucial component of any successful, comprehensiveprogram. Every program The Princeton Review offers contains some form of training and/orstaff development.Intervention Programs     We offer a comprehensive Math and Reading off-the-shelf intervention program calledSideStreets. SideStreets was designed to meet the needs of struggling students in grades 2 through8. SideStreets provides engaging, guided classroom instruction that reaches students at theirlevels. The program is uniquely designed to build students’ essential skills, step-by-step, sounder-performing students can move quickly towards proficiency.     Aligned to state and national standards, SideStreets is suitable for during school, afterschool, extended day, summer school, and SES programs. Program components include a full set ofstudent and teacher materials that integrate assessment, instruction, and professional development.Prior to and during the program, certified trainers work with clients to provide professionaldevelopment to ensure successful implementation.     We also have the expertise and capacity to build custom intervention programs (instruction,assessment, and professional development) specific to client needs.     *Our K-12 Publications*     The K-12 Services division also authors more than 60 print titles under the Princeton Reviewbrand, including the following:   *Roadmap to the CAHSEE*(California) *North Carolina Roadmap Series**Roadmap to the FCAT*(Florida) *Virginia Roadmap Series**Roadmap to the HSPA*(New Jersey) *Cracking the Virginia SOL Series**Roadmap to the OPT*(Ohio) *Cracking the Texas End-of-Course Series**Roadmap to the MCAS*(Massachusetts), *Smart Junior Series**Roadmap to the Regents*(New York)  **Admissions Services Division**     We sell a range of products and services that help higher education institutions attract newapplicants and manage the student recruitment process more efficiently. Additionally, we workclosely with high schools to aid them in the college and career counseling they deliver. Our goalis to guide students and parents through the challenging transition from high school to college. Wealso guide college students to graduate or professional school programs, and offer career adviceservices through the information available on our free web site, www.PrincetonReview.com.Additionally we offer more than 70 print titles on these topics.     The following are some of the major products, services and tools we offer to higher educationinstitutions, high schools, school districts and individual students and parents.     *Post Secondary Institutions*. We sell academic institutions a broad range of marketing andweb-based products on a subscription and transactional basis.
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 **•** *Marketing Products and Services*. Colleges and graduate schools may include anin-depth profile about their school in our books and on our web site for which theinstitutions pay us a subscription fee. More importantly, we promote these institutions tostudents who match their profile. The institutions also pay us when these students requestfurther information.  **•** *Embark® Prospect Management Services*. We provide a series of online services forcolleges to help manage the admissions process and maximize their yield with prospectivestudents. These include highly sophisticated online applications, communications tools,interview and recruiting event schedulers, and data integration capabilities.     *Secondary Schools and School Districts*. We sell K-12 school districts support for theirpost-secondary counseling efforts by offering customizable packages of services that includecollege counseling advisors, our college guidance books and a web-based college counseling supportproduct **•** *Post-secondary Counseling Management Tools*. Supported by a combination of online andprint tools, we help districts set interim and outcome goals and track the progress oftheir schools towards those goals.  **•** *Post-Secondary Counseling Support*. We provide teams of specialists who provideprofessional development and counseling services on-line and/or in schools, supporting theefforts of school-based counselors.     *Princetonreview.com visitors.*We attract students to Princetonreview.com by offeringextensive, free useful tools and content. We leverage our high volume of student site usage throughour marketing relationships with post-secondary institutions, as well as by selling testpreparation services to these students. **•** *School Information*. We provide detailed information about colleges and graduateschools, including, in many cases, students’ opinions about faculty, workload, sociallife, sports and more. This information is largely derived from our bestsellingguidebooks.  **•** *Major, Career and Other Searches*. Through a series of “wizards” or matching tools, wehelp students narrow down their list of potential schools, majors, internships,scholarships, and other related educational and career options.  **•** *Discussion Boards and Communication Tools.*We provide a forum for students to discusscollege and graduate school admissions experiences, ask questions of students andadministrators on campus, and obtain advice from Princeton Review moderators.  **•** *Organization*. We help students keep track of information about their prospectiveschools, and try to make the process simpler *and less stressful.*Our Admissions Services Publications   *Complete Book of Colleges* *Complete Book Law Schools**Internship Bible* *Complete Book Medical Schools**Visiting College Campuses* *Paying for College Without Going Broke**Best Value Colleges* *Paying for Graduate School**Guide to Study Abroad* *K&W Guide**Guide to Summer Programs* *145 Things to Do When You Grow Up**Complete Book Business Schools* *Guide to College Majors**Best 361 Colleges*  **Our Franchised Operations**     Our classroom-based test preparation courses and tutoring services are delivered throughcompany-operated locations and through our independent franchisees. Our franchisees provide thesetest preparation courses and tutoring services under the Princeton Review brand within a specifiedterritory, in accordance with franchise agreements with us. The royalties paid to us by ourfranchisees are comprised of a general royalty ranging from 8%–9.5% (starting in 2006) of theircash receipts collected under the Princeton Review name, an additional royalty of 2% of the cashreceipts of our domestic franchisees, which is allocated to an advertising fund that we alsocontribute to, and a 10% fee for use by their students of our online supplemental course tools. Ourfranchisees also purchase our course and marketing materials, which they use in conducting andpromoting their classes. Royalties collected from our independent franchisees and revenue fromtheir purchases of materials together accounted for approximately 5% of our total 2005 revenue.
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     Our franchisees do not provide Princeton Review Online courses. However, to the extent weprovide our Princeton Review Online courses to customers residing within the exclusivejurisdictions of our franchisees, we generally pay those franchisees a royalty of 10% of all of ourrevenue derived from selling Princeton Review Online courses to students residing in theirterritories, net of certain administrative expenses. We have not entered into any such royaltyarrangements with our franchisees for our other web-based products and services.     We have authorized certain of our domestic franchisees to offer SES programs as part of theirPrinceton Review businesses, for which they pay us royalties in the same manner as for otherauthorized courses. These franchisees paid a fee in 2005 to reimburse us for an allocated share ofour SES development expenses. We have also established contract terms with domestic franchiseesrelating to other live K-12 student instruction in their territories. If we offer these programs inthe franchisees’ territories, the terms give us the option to subcontract a customer agreement tothe franchisee and pay the franchisee 85% of the net program receipts or to deliver the programdirectly and pay the franchisee a royalty of 5% of net program receipts.     As of December 31, 2005, the Company had six franchisees operating approximately 18 officesunder the Princeton Review name in the United States and 15 franchises with approximately 38offices in 19 countries.     Our independently-owned domestic franchisees currently provide test preparation courses andtutoring services in the following jurisdictions:       **Number of**   **Counties** California  12 Colorado  8 Connecticut  7 Florida  57 Massachusetts  4 Michigan  4 Nevada  1 New Mexico  33 New York  5 Ohio  4 Pennsylvania  4 Rhode Island  5 Utah  29      Our independently-owned international franchises are located in Egypt, India, Israel, Japan,Jordan, Lebanon, Malaysia, Mexico, Pakistan, People’s Republic of China, the Philippines, SaudiArabia, Singapore, South Korea, Syria, Taiwan, Thailand, Turkey and The United Arab Emirates. Weintend to continue to expand our international presence through the sale, in the next severalyears, of additional franchises, primarily in Asian, Middle Eastern and South American markets.     Over the last several years, we completed a number of acquisitions of businesses operated byour former domestic franchisees, as more fully described below under “Recent Acquisitions.” Themajority of our domestic franchise agreements were renegotiated toward the end of 2005. Weterminated one domestic franchisee for various defaults under its franchise agreement in July 2005.We initiated an arbitration proceeding to confirm the validity of the termination and to recoveramounts owed and seek damages from the former franchisee. We opened a company-owned office toservice that franchisee’s former territory.**Recent Acquisitions**     *Franchise Acquisitions*     In the last several years, we completed acquisitions of the businesses of a number of ourformer domestic franchisees.     In October, 2004, we completed a small acquisition of the independent franchise that providedtest preparation courses in Puerto Rico for a purchase price of approximately $130,000. In July2003, we completed a small acquisition of 77% of Princeton Review of North Carolina, Inc., theindependent franchise that provided test preparation courses in North Carolina, for a purchaseprice of approximately $890,000, of which approximately $760,000 was financed with notes to theseller, including imputed interest. In November 2003 we purchased the remaining 23% forapproximately $248,000, of which approximately $208,000 was financed with notes to the seller,including imputed interest. In October 2002, we completed a small acquisition involving the assetsof Princeton Review of St. Louis, one of our franchisees that provided test preparation courses inMissouri, for a purchase price of approximately $850,000, of which approximately $470,000 wasfinanced with a note to the sellers. In June 2001, we acquired the assets comprising the businessof T.S.T.S., Inc., which offered test preparation courses in Texas, Arizona, Oklahoma, Louisianaand New Mexico under franchise agreements with us, for a purchase price of approximately $6.3million. We financed approximately $4.8 million of the
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purchase price under our then existing line of credit and issued a subordinated promissorynote to the seller for the remaining approximately $1.5 million. In March 2001, we acquired theassets comprising the businesses of Princeton Review of Boston, Inc. and Princeton Review of NewJersey, Inc., at a combined purchase price of $13.8 million. We financed approximately $10.2million of the purchase price under our then existing line of credit and issued two subordinatedpromissory notes for the remaining approximately $3.6 million. In March 2001, we also purchased theassets of another franchisee, Princeton Review Peninsula, Inc., for a purchase price ofapproximately $2.7 million, which was financed through borrowings under our then existing line ofcredit. Princeton Review Peninsula provided test preparation courses in several counties inCalifornia.     *Embark*     In October 2001, we acquired substantially all of the operating assets of Embark.com, Inc., adeveloper of online products and services for the college and graduate school admissions market.The acquired business consisted primarily of Embark’s customer contracts with academic institutionsand its technological platform for submitting electronic applications and related services. Thepurchase price paid by us at closing consisted of 875,000 shares of our common stock valued atapproximately $5.2 million, approximately $3.4 million in assumed indebtedness and approximately$2.1 million in other assumed liabilities of Embark, consisting primarily of deferred revenuerelating to customer contracts assumed by us, net of acquired receivables of approximately $1.0million. In accordance with the earn-out provisions entitling Embark to additional considerationbased on the performance of the acquired business, Embark earned a payment of 9,128 shares of ourcommon stock and approximately $1.5 million in cash, based on the revenue performance of theacquired business through June 30, 2003. In addition to the purchase price, in connection with thetransaction, we made a $1.8 million loan to Embark, which was secured by 300,000 of the shares ofour common stock that Embark received as part of the purchase price. The approximate $1.5 millionearn-out was applied against the loan balance, which was repaid in full as of December 31, 2003.     We intend to continue to pursue strategies to maximize stockholder value, which may continueto include acquisitions that will help us further expand our product offerings or growgeographically or other strategic alternatives, such as dispositions, reorganizations,recapitalizations or other similar transactions. We expect our acquisition focus to be on companieswith complementary products or services, including those businesses operated by our remainingdomestic franchisees that we can acquire on favorable terms. From time to time, we have madeinvestments in businesses with which we wanted to build strategic relationships, and we may do soin the future. We anticipate that future acquisitions or strategic investments, if consummated,would involve some combination of cash, debt and the issuance of our stock.**Sales and Marketing**     The majority of our students and their parents choose our test preparation programs based onthe recommendations of other students, parents, teachers and counselors. We also build awareness ofour brand and promote our products through relationships with other companies that publish anddistribute our products, including Random House, which publishes and distributes the books weauthor. We also utilize an institutional sales force within our K-12 division and engage in somenational and local advertising.     In the last several years, we have substantially increased our sales and marketing efforts inorder to market and support our newer products and services, such as our web-based marketing,application and admissions management products, our K-12 products, our online and institutionaltest preparation offerings and our SES programs. Our sales and marketing activities by division areas follows:     *Test Preparation Services Division.*Nationally, we use mass print media, conferences, directmail and electronic media to market our products and services to students, parents and educators.Locally, we and our franchisees primarily advertise in local and school newspapers, distributeposters and sponsor school activities. We also conduct extensive free information sessions andpractice tests to expose our products to our markets. Virtually everyone in our regional offices ispart of the sales force. They and our regional phone centers counsel students and parents regardingspecific courses. Our Princeton Review one-to-one admissions counseling and tutoring initiative ismarketed to high-end customers utilizing a distinctive message and dedicated marketing resources.Our Princeton Review Online products are marketed through electronic media and e-commercepartnerships, as well as through our classroom course marketing efforts. We recently consolidatedour school sales force into the K-12 Division; but continue to retain a sales staff for our SESbusiness. We expect that marketing to educational institutions will continue to constitute a majorfocus of the marketing activities of the Test Preparation Services division.     *K-12 Services Division.*We are marketing our K-12 services to schools and school districtsthrough a number of channels, including national conferences, direct mail, electronic media andtelemarketing. Our K-12 Services division manages our company-wide sales and marketing force ofapproximately 30 people. Homeroom is also integrated in the offerings of, and sold by, our businesspartners such as Plato Learning, Inc. and SchoolNet.
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     *Admissions Services Division.*Admissions Services has a dedicated sales and marketing team of12 people that primarily solicits post-secondary institutions to purchase our products andservices.**Product Design and Development**     We believe that successful product design, development and enhancement has been, and willcontinue to be, essential to the success of our business. We believe that the strength of ourreputation and brand name is directly attributable to the quality of our products and services, andexpect to continue to devote significant resources to enhancing our current products and servicesand offering additional high-quality products and services that are responsive to our customers’needs.     *Test Preparation Services Division*. We rely on our development staff, teachers and othereducation experts to create and refine the materials used in our Test Preparation Servicesdivision. Our goal is to design and improve our products in such a way as to offer our students thebest and most productive overall experience, while addressing their preferences and fitting withintheir lifestyles. We seek to accomplish this by: **•** continually updating and enhancing our test preparation materials and our teachingmethods;  **•** ensuring that our designated personnel take virtually every major standardized testfor which we offer courses, so that our techniques and materials remain current;  **•** performing quantitative and qualitative research into the preferences and needs of our customers;  **•** regularly soliciting and reviewing feedback from students taking our courses;  **•** enhancing the services and functionality of our online test preparation tools and content; and  **•** frequently updating our standardized test preparation publications.     Overall, we seek to provide a complementary mix of online and offline offerings that studentscan choose from to best fit their needs and achieve their goals.     *K-12 Services Division*. We rely on a team of teachers, educational experts and developers toresearch, design, enhance and deliver our K-12 educational products and services, which include,live instruction, online and paper-based assessments, professional development and publications.Our programs are designed to provide customized and highly focused resources to improve studentperformance. Our focus in the K-12 Services division is to continue to expand and refine ourofferings to afford schools and school districts the highest degree of flexibility possible in themix of products they choose to purchase from us, while delivering measurable results. In 2005, weintroduced SideStreets, an innovative off-the-shelf intervention program, to supplement ourcustomized programs.     *Admissions Services Division*. Since launching our Review.com (now www.PrincetonReview.com) website in 1994, we have continually expanded the material available and made improvements to itscontent and functionality. The online informational materials and tools are developed and enhancedby our authors and design engineers, through strategic partnerships with third parties and throughfeedback from guidance and admissions counselors. We regularly modify and enhance our web site toprovide students, parents and guidance counselors with additional information and interactive toolsdesigned to assist them with the school selection, admissions and financial aid processes. We alsocontinually strive to provide our educational institution customers with more effective ways toreach potential applicants, and streamline and manage the various facets of the admissions process.To this end, we periodically refine our web-based marketing, admissions and prospect managementsolutions to provide our higher education institution customers with the most technologicallyadvanced and flexible products possible. Finally, our publications are frequently updated by ourstaff and freelance authors and editors to ensure that new editions are up to date and include themost current information available on college and graduate school admissions and related subjects.**Significant Customers**     No single customer exceeded 10% of our revenue in any of the last three years. In the K-12Services division, the top two customers accounted for 56% and 59% of that division’s revenues in2005 and 2004, respectively.**Competition**     The markets for our educational products and services are highly competitive. Following is ourcompetitive landscape, by division:     *Test Preparation Services Division*. Our Test Preparation Services division facescompetition in standardized test preparation primarily from one other established nationalcompany, Kaplan, Inc., a division of The Washington Post Company. We also face competition frommany local and regional companies that provide test preparation, career counseling andapplication assistance to students. In the SES market, national competitors include Edison
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Schools, Platform Learning, Sylvan (a division of Educate, Inc.) and Kaplan, with manysmaller providers competing with us on a local level.     *K-12 Services Division*. Our K-12 Services division faces competition primarily from thefour national textbook companies, Pearson Plc, Harcourt, Inc. (an affiliate of Reed ElsevierGroup Plc), Houghton Mifflin Company and McGraw-Hill Companies, some of which have acquiredonline and supplemental providers.     *Admissions Services Division.*Our Admissions Services division provides a wide variety ofproducts and services that face competition from a variety of companies that, to differentextents, provide products and services similar to ours for the higher education market. Inparticular, The College Board, a non-for-profit membership association, provides a similarrange of products and services to the undergraduate market.     We believe that the principal competitive factors in our markets include the following: **•** brand recognition;  **•** ability to demonstrate measurable results;  **•** availability of integrated online and offline solutions;  **•** overall quality of user experience;  **•** alignment of offerings with specific needs of students, parents and educators; and  **•** value and availability of products and services.     We believe that our primary competitive advantage is our well-known and highly trustedPrinceton Review brand, our extensive experience in test preparation and admissions and ourinnovative, high-quality educational products and services and our employees. We also believe thatour ability to attract students, parents and educators to our Princetonreview.com web site offershigher education institutions access to a large body of potential applicants and offers sponsorsand merchandisers an attractive source of potential consumers. However, some of our competitors mayhave more resources than we do, and they may be able to devote greater resources than we can to thedevelopment, production and sale of their services and respond more quickly than we can to newtechnologies or changes in the education marketplace. As a result, we may not be able to maintainour competitive advantages or otherwise compete effectively with current or future competitors.**Intellectual Property and Property Rights**     Our copyrights, trademarks, service marks, trade secrets, proprietary technology and otherintellectual property rights distinguish our products and services from those of our competitors,and contribute to our competitive advantage in our target markets. To protect our brand, productsand services and the systems that deliver those products and services to our customers we rely on acombination of copyright, trademark and trade secret laws as well as confidentiality agreements andlicensing arrangements with our employees, customers, independent contractors, sponsors and others.     We strategically pursue the registration of our intellectual property rights. However,effective patent, trademark, service mark, copyright and trade secret protection may not always beavailable. Existing laws do not provide complete protection, and monitoring the unauthorized use ofour intellectual property requires significant resources. We cannot be sure that our efforts toprotect our intellectual property rights will be adequate or that third parties will not infringeor misappropriate these rights. In addition, there can be no assurance that competitors will notindependently develop similar intellectual property. If others are able to copy and use ourproducts and delivery systems, we may not be able to maintain our competitive position. Iflitigation is necessary to enforce our intellectual property rights or determine the scope of theproprietary rights of others, we may have to incur substantial costs or divert other resources,which could harm our business.     We have used “The Princeton Review” as our principal service and trademark for testpreparation services and related publications and materials since 1982. In the past, PrincetonUniversity did not object to our use, provided we used an express disclaimer of affiliation withthe University in connection with most of our uses. In February of 2005, we entered into anagreement with Princeton University under which it has agreed not to oppose or contest our use orregistration of these marks anywhere in the world and also to provide us consent and assistancewhere necessary to secure such registration, as long as we include the disclaimer of affiliationwith the University in the size and manner specified in the agreement and annually inform ouremployees and franchisees of the requirement for use of the disclaimer.     In order to develop, improve, market and deliver new products and services, we may be requiredto obtain licenses from others. There can be no assurance that we will be able to obtain licenseson commercially reasonable terms or at all or that rights granted under any licenses will be validand enforceable.
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     In addition, competitors and others may claim that we have infringed their intellectualproperty rights. Defending any such lawsuit, whether with or without merit, could betime-consuming, result in costly litigation or prevent us from offering our products and services,which could harm our business. If a lawsuit against us is successful, we may lose the rights to useour products or be required to modify them, or we may have to pay financial damages. We have beensubject to infringement claims in the past and expect to be subject to legal proceedings and claimsfrom time to time in the ordinary course of business, including claims of alleged infringement ofthe trademarks, patents and other intellectual property rights of third parties.**Government Regulation**     To offer franchises in the U.S., we must comply with regulations adopted by the Federal TradeCommission and with several state laws that regulate the offer and sale of franchises. Federal andstate franchise sales laws may apply to transfers and renewals of existing franchises in somecircumstances. The FTC’s Trade Regulation Rule on Franchising, or the FTC Rule, and various statelaws require that we (1) furnish prospective franchisees with a franchise offering circularcontaining prescribed information; and (2) in some states, register the franchise offering beforean offer is made.     Our existing franchise relationships are subject to a number of state laws that regulatesubstantive aspects of the franchisor-franchisee relationship, including: **•** those governing the termination or non-renewal of a franchise without good cause;  **•** requirements that a franchisor deal with its franchisees in good faith;  **•** prohibitions against interference with the right of free association among franchisees; and  **•** those regulating discrimination among franchisees in charges, royalties or fees.     Some foreign countries also have laws affecting the offer, sale or termination of franchiseswithin their borders and to their citizens. Although unlikely, U.S. federal and state franchiseregulation may be deemed applicable to our efforts to establish franchises abroad. Failure tocomply with these laws could limit or preclude our ability to expand internationally throughfranchising.     To date, these laws have not precluded us from seeking franchisees in any given area and havenot had a material adverse effect on our operations. However, compliance with federal, state andinternational franchise laws can be costly and time consuming, and we cannot be certain that wewill not encounter delays, expenses or other difficulties in this area.**Employees**     As of December 31, 2005, we had 633 full-time employees, including 73 in content andeditorial, 65 in administration, finance, legal and human resources, 74 in information systems, 27in marketing, 36 in sales, 112 in customer support and 246 in our regional offices performingmultiple tasks, including sales, administrative, and teaching functions. In addition, we hadapproximately 2,900 part-time employees, comprised mainly of teachers.     None of our employees are covered by a collective bargaining agreement. We consider ouremployee relations to be good.**Our Restructuring**     The Company recently completed a restructuring in order to recognize certain operationalefficiencies from our corporate structure. Effective January 1, 2005, we merged four of our sixsubsidiaries with and into The Princeton Review, Inc.**Segment Information**     For financial information relating to our operating divisions by business segment, see Note 13to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.**Item 1A. Risk Factors**     You should carefully consider the following risk factors together with all of the otherinformation contained in this Annual Report on Form 10-K before making an investment decision withrespect to our common stock. Any of the following risks, as well as other risks and uncertaintiesdescribed in this Annual Report on Form 10-K, could harm our business, financial condition andresults of operations and could adversely affect the value of our common stock.***Risks Related to Our Business***
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**We have a recent history of significant operating losses and may not be able to achieve sustainedprofitability if we are unable to increase revenue from our newer products and services andsuccessfully implement a number of new initiatives, in which case we could experience an adversechange in the market price of our common stock.**     Over the last few years, the Company has invested heavily in the expansion of existingbusiness lines and the development of new businesses. These investments, combined withSarbanes-Oxley compliance costs and rising overhead expense, have driven losses in two of our lastthree fiscal years. We have incurred net losses of approximately$2.2 million and $29.5 million forthe years ended December 31, 2005 and 2004, respectively. As of December 31, 2005, we had anaccumulated deficit of approximately $65.8 million.     In order to achieve sustained profitability we will need to implement changes to existingbusiness processes, significantly reduce overhead expense and drive profitable revenue growth inour K-12 Services Division. The Company is in the initial stages of a company-wide re-engineeringeffort to reduce our overhead, continue to improve our internal control management process andupgrade or replace certain critical business systems.     If we are unable to achieve these objectives, we may fail to achieve or sustain profitabilityin subsequent periods, in which case the market price of our common stock may be adverselyaffected.**If colleges and universities reduce their reliance on standardized admissions tests or there is asubstantial reduction in the emphasis placed by federal and state governments on assessment andremediation in K-12 education, our business will be materially adversely affected.**     The success of our Test Preparation and K-12 services businesses depends on the continued useof standardized tests. If the use of standardized tests declines or falls out of favor witheducational institutions or state and local governments, the markets for many of our products andservices will deteriorate and our business will be materially adversely affected. Additionally, theSES market, which is serviced by our Test Preparation Services division, is dependent on theavailability of federal funding under NCLB. A substantial reduction in funds available for SESprograms under this Act could have an adverse effect on our operating results.**Our contracts with schools, school districts, municipal agencies and other governmental bodiespresent several risks, including the nature and timing of revenue recognition which combined withfixed expenses puts a strain on our working capital requirements.**     As the Company has grown over the last several years, we have begun to enter into more andmore large, multiple element contracts with schools, school districts, municipal agencies, andother governmental bodies, requiring us to deliver a combination of products and services,including online and print-based assessment, professional development, and face-to-faceinstruction. These contracts present several types of risks and uncertainties.     The approval processes of some of our customers in this area, which are required for formalcontract execution, are lengthy and cumbersome and, in many cases, are not completed prior to thetime we begin performance. This means that we, at times, incur substantial costs prior to theformal execution of these agreements by the customer. While to date we have found that, followingthe award of the contract to us, final approval required for the customer to sign the agreement isusually a formality, our revenue recognition policies preclude us from recognizing revenue fromthese contracts until there is a final agreement binding on the customer. Costs, however, arerecorded as incurred, whether or not the contract is signed. While we do not incur significantcosts until we are awarded a project and we do everything possible to expedite the formal executionof these agreements by the customer, the timing of this final step is outside our control. Until wecomplete our transition over to a school-based fiscal year our current calendar-based fiscal yearmakes it more difficult for us to forecast quarterly revenue streams from these contracts. This maymake it more difficult for us to deliver operating results in line with analysts’ forecasts, andcould therefore adversely affect our stock price.     Because our customers are unable to begin payment for services until formal approval of theagreement, this delay in formal contract execution may also cause our cash balances to fluctuatesignificantly from period to period and may expose us to credit risk. We believe that we may beable to recover monies owed from a customer for which we have performed services but who fails torender payment in the absence of a signed contract based on several legal theories designed toprevent unjust enrichment. However, this basis of recovery may not be available in alljurisdictions where we enter into these contracts, or may limit our recovery with respect toamounts or timing. Accordingly, the absence of a signed agreement may, depending on the laws of theapplicable jurisdiction, make it substantially more difficult or impossible for us to recover sumsdue to us under these agreements. While we have not experienced a default by a customer under suchcircumstances to date, and believe that the nature of the parties with which we are contractingmakes such a default less likely, it is a possibility that such circumstances may arise in thefuture with respect to one or more of these contracts.**We face intense competition that could adversely affect our revenue, profitability and marketshare.**
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     The markets for our products and services are highly competitive, and we expect increasedcompetition in the future that could adversely affect our revenue, profitability and market share.Our current competitors include but are not limited to: **•** providers of online and offline test preparation and tutoring services;  **•** companies that provide SES services;  **•** companies that provide print, software, web-based and other educational assessmentand supplemental products and services to districts and states in the highly competitiveK-12 market; and  **•** companies that offer both face-to-face and web-based products and services to assistindividuals and educational organizations with counseling, marketing and studentapplications.     Some of our competitors may have more resources than we do. These competitors may be able todevote greater resources than we can to the development, promotion and sale of their services andrespond more quickly than we can to new technologies or changes in customer preferences. We may notbe able to maintain our competitive position or otherwise compete effectively with current orfuture competitors, especially those with significantly greater resources.     Some of our competitors that provide K-12 educational products and services may have moreexperience, larger customer bases and greater brand recognition in that market. Further,established companies with high brand recognition and extensive experience providing variouseducational products to the K-12 market may develop products and services that are competitive withours.**Negative developments in school funding could reduce our institutional revenue.**     We expect to derive a growing portion of our revenue from sales of our products and servicesto educational institutions, including our K-12 Services division’s offerings, high schoolcounseling products, SES programs and institutional test preparation offerings. Our ability togenerate revenue from these sources may be adversely affected by decreased government funding ofeducation. Public school funding is heavily dependent on support from federal, state and localgovernments and is sensitive to government budgets. In addition, the government appropriationsprocess is often slow and unpredictable. Funding difficulties also could cause schools to be moreresistant to price increases in our products, compared to other businesses that might be betterable to pass on price increases to their customers.**Theineffectiveness of our internal control over financial reportingcould result in a loss of investor confidence in our financialreports and have an adverse effect on our stock price.**     Pursuantto Section 404 of the Sarbanes-Oxley Act of 2002 (“Section404”), and the rules and regulations promulgated by the SEC toimplement Section 404, we are required to include in our Form 10-K anannual report by our management regarding the effectiveness of ourinternal control over financial reporting. The report includes, amongother things, an assessment of the effectiveness of our internalcontrol over financial reporting as of the end of our fiscal year.This assessment must include disclosure of any material weaknessesin our internal control over financial reporting identified bymanagement.     Asof December 31, 2005, our internal control over financial reportingwas ineffective due to the presence of a material weakness, as morefully described in Item 9A of this Form 10-K. This could result in aloss of investor confidence in the accuracy and completeness of ourfinancial reports, which may have an adverse effect on our stockprice.**Our business is subject to seasonal fluctuations, which may cause our operating results tofluctuate from quarter to quarter. This may result in volatility or adversely affect our stockprice.**     We experience, and expect to continue to experience, seasonal fluctuations in our revenuebecause the markets in which we operate are subject to seasonal fluctuations based on the scheduleddates for standardized admissions tests and the typical school year. These fluctuations couldresult in volatility or adversely affect our stock price. We typically
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generate the largest portion of our test preparation revenue in the third quarter. However, asSES revenues increase, we expect to recognize these revenues primarily in the first and fourthquarters. The electronic application revenue recorded in our Admissions Services division ishighest in the first and fourth quarters, corresponding with the busiest times of year forsubmission of applications to academic institutions. Our K-12 Services division experiencesseasonal fluctuations in revenue, with the first and fourth quarters (corresponding to the schoolyear) expected to have the highest revenue.**Our quarterly operating results are not indicative of future performance and are difficult toforecast.**     Our quarterly operating results may not meet expectations of public market analysts orinvestors, which could cause our stock price to decline. In addition to the seasonal fluctuationsdescribed above, our operating results may vary from quarter to quarter in response to a variety ofother factors beyond our control, including: **•** our customers’ spending patterns, which, in some cases, are difficult to predict;  **•** the timing of school districts’ funding sources and budget cycles;  **•** the timing of signing, expirations and renewals of educational institution contracts;  **•** variations in product mix, particularly in the case of our K-12 Services division;  **•** the timing of corporate sponsorships and advertising; and  **•** non-recurring charges incurred in connection with acquisitions or other extraordinary transactions.     Due to these factors, we believe that quarter-to-quarter comparisons of our operating resultsmay not be indicative of our future performance and you should not rely on them to predict thefuture performance of our stock price. In addition, our past results may not be indicative offuture performance because several of our businesses were introduced or acquired relativelyrecently.**Loss of significant customers could significantly adversely affect our revenue or cause disruptionsin our operations.**     As the business of our K-12 Services division has evolved, the contracts entered into withschool districts have generally increased in size. As a result, two customers accounted for 56% and59% of that division’s revenue in 2005 and 2004, respectively. The loss of one or more suchcustomers could significantly adversely affect our revenue. Additionally, we rely on Random Houseas the publisher and distributor of all of the books we write. Royalties and other fees from booksauthored by us and published and distributed by Random House represented approximately 3% of ourrevenue in each of 2005 and 2004. Accordingly, termination of our relationship with Random Housecould adversely affect our revenue and cause disruption in our operations.**If we are not able to continually enhance our web-based products and services and adapt them tochanges in technology, our future revenue growth could be adversely affected.**     If our improvement and adaptation of our web-based products and services is delayed, resultsin systems interruptions or is not aligned with market expectations or preferences, our revenuegrowth could be adversely affected. The online environment is rapidly evolving, and the technologyused in web-based products changes quickly. We must therefore be able to quickly modify oursolutions to adapt to emerging online standards and practices, technological advances, and changinguser and sponsor preferences. Ongoing enhancement of our web site, web-based products and relatedtechnology will entail significant expense and technical risk. We may use new technologiesineffectively or fail to adapt our web site, web-based products and related technology on a timelyand cost-effective basis.**If our domestic franchisees contest our interpretation of our agreements with them, our ability tooffer our products in the domestic franchisees’ territories could be adversely affected, whichcould adversely affect our revenue.**     If our domestic franchisees contest our interpretation of our rights and obligations under ourexisting agreements with them, then our ability to deliver our products and services within theirfranchise territories could be hindered, and our revenue could be adversely affected. Through aseries of franchise agreements and other agreements, our independent franchisees have variousrights to provide test preparation products and services under the Princeton Review brand withinspecified territories, and to use our trademarks and other intellectual property in connection withproviding these services. Similarly, we have various rights to market and sell our products andservices in the franchisees’ territories. Our agreements have been reviewed and renegotiated toaccommodate our business goals and the goals of our franchisees as they have both developed overthe years.**If we do not adequately protect the intellectual property rights to our products and services, wemay lose these rights and our business may suffer materially.**
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     Failure to protect our intellectual property could materially adversely affect our business.We depend on our ability to protect our brand, our products and services and the systems thatdeliver those products and services to our customers. We rely on a combination of copyright,trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements,to protect these products. These intellectual property rights distinguish our products and servicesfrom those of our competitors. If others are able to copy, use and market these products anddelivery systems, then we may not be able to maintain our competitive position. Despite our bestefforts, we cannot assure you that our intellectual property rights will not be infringed, violatedor legally imitated. Existing laws do not provide complete protection and policing the unauthorizeduse of our products and services requires significant resources.**If our products and services infringe the intellectual property rights of others, this may resultin costly litigation or the loss of our own intellectual property rights, which could materiallyadversely affect our business.**     Competitors and others have claimed and may claim in the future that we have infringed theirintellectual property rights. The defense of any lawsuit, whether with or without merit, could betime-consuming and costly. If a lawsuit against us is successful, we may lose, or be limited in,the rights to offer our products and services. Any proceedings or claims of this type couldmaterially adversely affect our business.**We may be held liable for the content of materials that we author, content available on our website or products sold through our web site.**     We may be subject to claims for defamation, negligence, copyright or trademark infringement orother legal theories based on the content of materials that we author, and content that ispublished on or downloaded from our web sites, accessible from our web sites through links to otherweb sites or posted by our users in chat rooms or bulletin boards. These types of claims have beenbrought, sometimes successfully, against online services as well as print publications in the past.Although we carry general liability insurance, our insurance may not cover potential claims of thistype, such as trademark infringement or defamation, or may not be adequate to cover all costsincurred in defense of potential claims or to indemnify us for all liability that may be imposed.In addition, these claims, with or without merit, would result in diversion of our managementpersonnel and financial resources. Further, if print publications that we author contain materialthat customers find objectionable, these publications may have to be recalled, which could resultin lost revenue and adverse publicity.**Theloss of our senior management could have a material adverse effect onour business.**     Wedepend on the continued service of our senior management. The loss ofany of our Chief Executive Officer, John Katzman, our President and ChiefOperating Officer, Mark Chernis, or our Chief Financial Officer, Andrew Bonanni, could materially adversely affect our business.**Our business may be harmed by actions taken by our franchisees that are outside our control.**     Approximately 5% of our 2005 revenue was derived from royalties paid to us by our franchiseesand from sales of our course and marketing materials to these franchisees. The quality offranchised test preparation operations may be diminished if our franchisees do not successfullyprovide test preparation services in a manner consistent with our standards and requirements, or donot hire and train qualified managers or instructors. As a result, our image and reputation maysuffer and our revenue could decline.**Franchise regulations could limit our ability to terminate or replace unproductive franchises,which could adversely affect our results of operations, and could limit our ability to expandinternationally through franchising.**     Applicable laws may delay or prevent us from terminating an unproductive franchise orwithholding consent to renewal or transfer of a franchise, which could have an adverse effect onfranchise royalties. We are subject to both federal and state laws regulating the offer and sale offranchises. These laws also frequently apply substantive standards to the relationship betweenfranchisor and franchisee and limit the ability of a franchisor to terminate or refuse to renew afranchise. Some foreign countries also have laws affecting the offer and sale of franchises withintheir borders and to their citizens and U.S. federal and state franchise regulation may beapplicable to our efforts to establish franchises abroad. Failure to comply with these laws couldlimit or preclude our ability to expand internationally through franchising.     Compliance with federal, state and international franchise laws can be costly and timeconsuming, and we cannot be certain that we will not encounter delays, expenses or otherdifficulties in this area. Further, the nature and effect of any future legislation or regulationof our franchise operations cannot be predicted.**If we are unable to obtain additional capital, our business may be adversely affected.**
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     We currently expect to secure a revolving line of credit to support our working capitalrequirements. In the future, we may require substantial additional capital to finance ongoingoperations or the growth of our business. To the extent that our existing sources of liquidity,cash flow from operations and anticipated credit line are insufficient to fund our activities, wemay need to raise additional funds.     We cannot be certain that we will be able to obtain needed financing on favorable terms. If wefail to raise additional funds, we may need to sell debt or additional equity securities or toreduce our growth to a level that can be supported by our cash flow. Without additional capital, wemay not be able to: **•** further develop or enhance our services and products;  **•** acquire necessary technologies, products or businesses;  **•** expand operations in the United States or internationally;  **•** hire, train and retain employees;  **•** market our services and products; or  **•** respond to competitive pressures or unanticipated capital requirements.**Charges related to our recent acquisitions could negatively affect our results of operations.**     In connection with our acquisitions of the businesses of Embark.com, Inc. and several of ourfranchisees over the last five years, we recorded a total of approximately $33.4 million ofgoodwill. Statement of Financial Accounting Standards No. 142 (SFAS 142), *Goodwill and OtherIntangible Assets*, requires goodwill and other intangible assets that have an indefinite usefullife to be reviewed at least annually for impairment. To the extent these assets are deemed to beimpaired, they must be written down. At December 31, 2004, we wrote down $8.2 million in goodwillassociated with our acquisition of Embark, due to the Admission Services division’s poorperformance. Any future write down of goodwill, while noncash, would similarly adversely affect ouroperating results. As of December 31, 2005, we had unamortized goodwill of $23.6 million related tothese acquisitions.**We may engage in future acquisitions that could dilute the equity interest of our stockholders,increase our debt or cause us to assume contingent liabilities, all of which may have a detrimentaleffect on the price of our common stock. If any acquisitions are not successfully integrated withour business, our ongoing operations could be negatively affected.**     We may acquire the businesses of our remaining domestic franchisees or other businesses,products or technologies in the future. To facilitate future acquisitions, we may take actions thatcould have a detrimental effect on our financial condition, results of operations or the price ofour common stock, including: **•** issuing equity securities or convertible debt securities, which would dilute currentstockholders’ percentage ownership;  **•** incurring substantial debt; or  **•** assuming contingent liabilities.     Acquisitions also entail numerous business risks, including: **•** difficulties in assimilating acquired operations, technologies or products;  **•** unanticipated costs that could materially adversely affect our results of operations;  **•** negative effects on our reported results of operations from acquisition relatedcharges and amortization of acquired technology and other intangibles;  **•** diversion of management’s attention from other business concerns;  **•** adverse effects on existing business relationships with suppliers and customers;  **•** risks of entering markets in which we have no or limited prior experience; and  **•** the potential inability to retain and motivate key employees of acquired businesses.**If we fail to manage our growth effectively, our business may be harmed.**     Historically we have increased our work force, introduced a number of new products, madesubstantial enhancements to our existing products and consummated several acquisitions. At December31, 2005, we had 633 full time employees, as compared with 335 full time employees at December 31,2001. This recent growth has placed, and our anticipated growth in future operations will continueto place, significant demands on our management, and strain our operational,
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financial and technological resources. We expect that further expansion of our operations willbe required to successfully implement our business strategy, including the continued enhancement ofour product and service offerings. In order to manage our growth effectively, we must drivebusiness process improvement, reduce our overhead costs, replace and or upgrade several significantsystems and continue implementing internal control procedures and controls. If we fail to achievethese objectives our business could be materially and adversely affected.**We may undertake divestitures that may limit our ability to manage and maintain our business andmay adversely affect our business.**     In the future, we may undertake sales or other strategic dispositions of certain businesses oroperations to attempt to maximize stockholder value. These transactions involve a number of risks,including: **•** Diversion of management attention and transaction costs associated with negotiatingand closing the transaction;  **•** Inability to retain customers, management, key personnel and other employees due tothe altered nature of our businesses after such transaction;  **•** Inability to realize the benefits of divestitures and collect monies owed to us; and  **•** Failure to realize the highest value of the divested business because we are sellingit before its full potential has been achieved.**We could be liable for events that occur at facilities that we use to provide our services, and aliability claim against us could adversely affect our reputation and our financial results.**     We could become liable for the actions of instructors and other personnel at the facilities weuse to provide our classroom-based services. In the event of on-site accidents, injuries or otherharm to students, we could face claims alleging that we were negligent, provided inadequatesupervision or were otherwise liable for the injuries. Although we maintain liability insurance,this insurance coverage may not be adequate to protect us fully from these claims. In addition, wemay not be able to obtain liability insurance in the future at reasonable prices or at all. Asuccessful liability claim could adversely affect our reputation and our financial results. Even ifunsuccessful, such a claim could cause unfavorable publicity, entail substantial expense and divertthe time and attention of key management personnel.**If we experience system failures, our reputation may be harmed and users may seek alternate serviceproviders causing us to lose revenue.**     If our primary and backup computer systems were to fail or be disrupted, our services could beinterrupted and we may lose revenue and future business. We depend on the efficient anduninterrupted operation of our computer and communications hardware and software systems. Thesesystems and operations are vulnerable to damage or interruption from floods, fires and power lossand similar events, as well as computer viruses, break-ins, sabotage, intentional acts ofterrorism, vandalism and other misconduct and disruptions or delays occurring throughout theInternet network infrastructure. Although all of our material systems are redundant, short-termservice interruptions may take place if our primary systems were to fail or be disrupted and we areforced to transition to backup systems. All of our computer hardware necessary for our onlineoperations is currently located at a professional datacenter in White Plains, NY. This facility hasredundancy for power, A/C and internet access. Accordingly, our online operations are dependent onour ability to maintain our systems in effective working order and to protect them from disruptiveevents. We do not have a formal disaster recovery plan, and our insurance policies may notadequately compensate us for any losses that may occur due to failures of or interruptions in oursystems.     In addition, the system failures of third party Internet service providers could produceinterruptions in our service for those users who access our services through these third partyproviders. Service interruptions could reduce our revenue and our future revenue will be harmed ifour users believe that our system is unreliable.**If our systems are unable to accommodate a high volume of traffic on our web site, the growth ofour revenue could be reduced or limited.**     If use of our web site infrastructure increases beyond our capacity, customers may experiencedelays and interruptions in service. As a result, they may seek the products and services of ourcompetitors and the growth of our revenue could be reduced or limited. Because we seek to generatea high volume of traffic and accommodate a large number of customers on our web site, thesatisfactory performance, reliability and availability of our web site, processing systems andnetwork infrastructure are critical to our reputation and our ability to serve our customers. Ifuse of our web site continues to increase, we will need to expand and upgrade our technology,transaction processing systems and network infrastructure. While slower response times have not hada material effect on our results of operations to date, our web sites have in the past and may inthe future experience slower response times due to increased traffic.
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**Future regulations or the interpretation of existing laws pertaining to the Internet could decreasethe demand for our products or increase the cost of doing business.**     Any new law or regulation pertaining to the Internet, or the application or interpretation ofexisting laws, could increase our cost of doing business, decrease the demand for our products andservices, or otherwise harm our business. We must comply with a variety of federal and state lawsaffecting the content of materials distributed over the Internet, as well as regulations and otherlaws restricting the collection, use and disclosure of personal information that we may obtain inthe course of providing our online services. In particular, we must comply with the Children’sOnline Privacy Protection Act, which, as implemented, mandates that we obtain verifiable, informedparental consent before we collect, use or disclose personal information from children under theage of 13. Future laws or regulations may relate to information retrieved from or transmitted overthe Internet, consumer protection, online content, user privacy, taxation and the quality ofproducts and services. Compliance with future laws and regulations, or existing laws as they may beinterpreted in the future, could be expensive, time consuming, impractical or impossible.**We may be liable for invasion of privacy or misappropriation by others of our users’ information,which could adversely affect our reputation and financial results.**     Some of our services require the disclosure of sensitive information by the user. We rely on anumber of security systems for our services to protect this information from unauthorized use oraccess. If the security measures that we use to protect personal information or credit cardinformation are ineffective, we may be subject to liability, including claims for invasion ofprivacy, impersonation, unauthorized purchases with credit card information or other similarclaims. In addition, the Federal Trade Commission and several states have investigated the use ofpersonal information by certain Internet companies. We could incur significant expenses if newregulations regarding the use of personal information are introduced or if our privacy practicesare investigated.***Risks Related to the Securities Markets and Ownership of Our Common Stock*****Our stock price has been and may continue to be volatile, which could adversely affect ourstockholders.**     Since our initial public offering in 2001, the market price of our common stock has beenvolatile, and it may continue to be volatile as a result of one or more of the following factors,most of which are beyond our control: **•** variations in our quarterly operating results;  **•** changes in securities analysts’ estimates of our financial performance;  **•** loss of a major customer or failure to complete significant transactions;  **•** announcements by us or our competitors of significant contracts, acquisitions,strategic partnerships, joint ventures or capital commitments;  **•** changes in market valuations of similar companies;  **•** the discussion of our company or stock price in online investor communities such as chat rooms;  **•** additions or departures of key personnel  **•** fluctuations in stock market price and volume, and  **•** our continuing operating losses.     In addition, the market prices of the securities of Internet-related companies have beenvolatile, and have experienced fluctuations that often have been unrelated to or disproportionateto the operating performance of these companies. These broad market fluctuations could adverselyaffect the market price of our stock. In the past, securities class action lawsuits alleging fraudhave often been filed against a company following periods of volatility in the market price of itssecurities. In the future, we may be the target of similar lawsuits. If a lawsuit were to be filedagainst us, it could result in substantial costs and the diversion of our management’s attentionand resources, which could seriously harm our financial results or result in a decline in themarket price of our common stock. Declines in the market price of our common stock could also harmemployee morale and retention, our ability to attract qualified employees and our access tocapital.**We have anti-takeover protections, which may discourage or prevent a takeover of us, even if anacquisition would be beneficial to our stockholders.**     Certain provisions of our certificate of incorporation and bylaws, as well as provisions ofDelaware law, could make it more difficult for another company to acquire us, even if a takeoverwould benefit our stockholders. The provisions in our corporate documents:
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 **•** authorize the issuance of “blank check” preferred stock that could be issued by ourboard of directors to increase the number of outstanding shares, making a takeover moredifficult and expensive;  **•** establish a staggered board of directors, so that it would take three successiveannual meetings to replace all directors;  **•** prohibit cumulative voting in the election of directors, which would otherwise allowless than a majority of stockholders to elect director candidates;  **•** prohibit stockholders from calling special meetings of stockholders;  **•** prohibit stockholder action by written consent, thereby requiring all stockholderactions to be taken at a meeting of our stockholders; and  **•** establish advance notice requirements for nominations for election to the board ofdirectors or for proposing matters that can be acted upon by stockholders at stockholdermeetings.     In addition, Section 203 of the Delaware General Corporation Law and the terms of our stockoption plans may discourage, delay or prevent a change in our control, which may depress the marketprice of our common stock.**Concentration of ownership among our existing executive officers and directors may make it moredifficult for other stockholders to influence significant corporate decisions and may hinder achange of control.**     As of March 10, 2006, our present directors and executive officers and their affiliatesbeneficially owned approximately 35% of our outstanding common stock. In particular, John S.Katzman, our Chief Executive Officer, beneficially owned approximately 32% of our outstandingcommon stock. This concentration of ownership may make it more difficult for other stockholders toinfluence matters requiring stockholder approval and may have the effect of delaying, preventing ordeterring a change in control of our company, thereby possibly depriving our stockholders of anopportunity to receive a premium for their common stock as part of any sale or acquisition.**The issuance of our shares of common stock upon conversion or redemption of outstanding preferred stock may cause significant dilution to our stockholders and may have an adverse impact on the market price of our common stock.**     OnJune 4, 2004, we completed a private placement to Fletcher International, Ltd. of 10,000shares of our Series B-1 Cumulative Convertible Preferred Stock (the “Series B-1Preferred Stock”) for $10 million in the aggregate. Dividends on the Series B-1Preferred Stock are payable quarterly, at our option in cash or registered shares of our commonstock, at a minimum rate of 5% per annum. The Series B-1 Preferred Stock is convertible into1,007,303 shares of our common stock at a conversion price of $9.9275 per share, subject toadjustment upon certain events. Fletcher may also redeem its shares of the Series B-1Preferred Stock, in lieu of converting such shares, at any time on or after November 28,2005, for shares of common stock, unless we satisfy the conditions for cash redemption, for anamount of shares of our common stock based upon redemption rate equalto 102.5% of the then prevailing price of our common stock plus thevalue of any accrued and unpaid dividends. Fletcher also has theright, for a period of twenty-four months, beginning on July 1,2005, to purchase up to $20 million in newly created series ofpreferred stock having, except as set forth in our agreement withFletcher, similar terms, conditions, rights, preferences andprivileges as the Series B-1 Preferred Stock (the “AdditionalPreferred Stock”). The Additional Preferred Stock will beconvertible into shares of our common stock at a conversion priceequal to 108.3% of the then prevailing price of our common stock,subject to a minimum of $9.9275 per share.     The issuance of our shares of common stock to Fletcher upon conversion or redemption of the Series B-1 Preferred Stock and the Additional Preferred Stock and their resale by Fletcher will increase our publicly traded shares. These resales could also depress the market price of our common stock. We will not control whether or when Fletcher elects to convert its securities for common stock. The perceived risk of dilution may cause our stockholders to sell their shares, which would contribute to a downward movement in the stock price of our common stock. Moreover, the perceived risk of dilution and the resulting downward pressure on our stock price could encourage investors to engage in short sales of our common stock. By increasing the number of shares offered for sale, material amounts of short selling could further contribute to progressive price declines in our common stock.**In connection with the private placement of Series B-1 Preferred Stock, we may be responsible for having the resale of shares issued or issuable to Fletcher registered with the SEC and may be subject to penalties if the shares are not registered with the SEC.**     Pursuant to our agreement with Fletcher, we are obligated to file a registration statement with the SEC at any time that the number of shares of common stock issued or issuable under the agreement exceeds 80% of the number of shares then registered. If we fail to file any such required registration statement and have it declared effective by the SEC, we must (i) issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was based on the actual conversion price reduced by five percent for each month in which we fail to satisfy our obligations and (ii) adjust the conversion price for the additional investment rights to such lower price. In addition, such failure will result in an extension of the investment term for each day we fail to satisfy our registration obligations.
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**Item 1B.Unresolved Staff Comments**     None.**Item 2.Properties**     Our headquarters are located in New York, New York, where we lease approximately 30,000 squarefeet of office space under a lease that expires on December 31, 2014. As of December 31, 2005, wealso leased an aggregate of approximately 229,000 square feet of office space for additionaloperations in New York, New York and our 55 regional offices or classroom locations located inAlabama, Arizona, California, Colorado, Georgia, Illinois, Kansas, Louisiana, Maryland,Massachusetts, Minnesota, Missouri, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon,Pennsylvania, South Carolina, Texas, Virginia, Washington, Washington D.C., Canada and Puerto Rico.**Item 3.Legal Proceedings**     On September 10, 2003, CollegeNet, Inc. filed suit in Federal District Court in Oregon,alleging that the Company infringed a patent owned by CollegeNet related to the processing ofon-line applications. CollegeNet never served the Company and no discovery was ever conducted.However, based on adverse rulings in other lawsuits concerning the same patent, CollegeNetdismissed the 2003 case without prejudice on January 9, 2004 against the Company. Thereafter, onAugust 2, 2005, the Federal Circuit Court of Appeals issued an opinion favorable to CollegeNet fromits appeal from the adverse rulings. Then on August 3, 2005, CollegeNet filed suit again againstthe Company alleging an infringement of the same CollegeNet patent related to processing on-lineapplications. The Company was served on November 22, 2005 and filed its answer and counterclaim onJanuary 13, 2006. CollegeNet seeks injunctive relief and unspecified monetary damages. Because thisproceeding is at a very preliminary stage, we are unable to predict its outcome with any degree ofcertainty. However, the Company believes that it has meritorious defenses to CollegeNet’s claims ofinfringement and intends to vigorously defend. In a related matter, the Company filed a requestwith the United Stated Patent and Trademark Office (“PTO”) for ex parte reexaminations of theCollegeNet No. 6,460,042 (‘042) patent on September 1, 2005 and the CollegeNet No. 6,910,045 (‘045)patent on December 12, 2005. The PTO granted the Company’s request and ordered reexamination of allclaims of the CollegeNet ‘042 patent on October 31, 2005 and the CollegeNet ‘045 patent on January27, 2006.     On August 29, 2005, Test Services, Inc. (“TSI”), a franchisee of the Company under tenseparate franchise agreements, six of which expired on December 31, 2005, filed suit against us inthe United States District Court for the District of Colorado. TSI alleged that the terms weoffered for renewal of the franchise relationship did not comply with TSI’s contractual renewalrights. TSI sought declaratory relief and specific performance and unspecified damages as to thealleged breaches of the renewal provisions. TSI’s complaint also included claims that we hadbreached the existing franchise agreements with TSI in ways unrelated to the core renewal dispute.On November 29, 2005, the court granted our motion to dismiss all of TSI’s claims relating to thecore renewal dispute. On December 31, 2005, we entered into a settlement in which: (1) TSI agreedto execute a new franchise agreement for each of its ten franchise territories with certainnegotiated changes; (2) TSI paid us $1 million in cash; (3) we, TSI and TSI’s parent company agreedon certain terms regarding competitive activities by the parent company, a potential spin-off ofTSI, and a TPR option to acquire TSI at a formula value in certain circumstances; TSI agreed toincrease royalty payments to us from 8% to 91⁄2% (beginning January 1, 2006); and (4) alllitigation was dismissed with prejudice and the parties exchanged releases as to all matters exceptamounts payable in the ordinary course of business under the superseded franchise agreements.     In addition to the foregoing, from time to time, we are involved in legal proceedingsincidental to the conduct of our business, none of which is likely to have a material adverseeffect on us.**Item 4.Submission of Matters to a Vote of Security Holders**     No matters were submitted to a vote of security holders during the fourth quarter of thefiscal year covered by this Annual Report on Form 10-K.**PART II****Item 5.Market for Registrant’s Common Stock and Related Stockholder Matters**     *Price Range of Common Stock*
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     Our common stock trades on the NASDAQ National Market under the symbol “REVU.” The followingtable sets forth, for the periods indicated, the high and low sales prices per share of our commonstock as reported on the NASDAQ National Market.                   **2005** **2004****Fiscal Quarter** **High** **Low** **High** **Low** First $6.14  $5.25  $10.56  $7.57 Second  5.95   5.46   9.21   6.81 Third  6.25   5.70   7.96   6.52 Fourth  6.03   5.05   8.26   5.41      As of March 10, 2006, the last reported sale price of our common stock on the NASDAQ NationalMarket was $5.50 per share. As of March 10, 2006, there were 71 stockholders of record of ourcommon stock. This does not include the number of persons whose stock is in nominee or “streetname” accounts through brokers.     *Dividend Policy*     We have never declared or paid any cash dividends on our common stock and we do not intend topay any cash dividends with respect to our common stock in the foreseeable future. We currentlyintend to retain any earnings for use in the operation of our business and to fund future growth.Any future determination to pay cash dividends on our common stock will be at the discretion of ourboard of directors and will depend upon our financial condition, operating results, capitalrequirements and such other factors as the board of directors deems relevant.     *Securities Authorized for Issuance under Equity Compensation Plans*     As of December 31, 2005, the following securities were authorized for issuance under our 2000Stock Incentive Plan:               **Number of**      **securities to be**      **issued upon**      **exercise of** **Weighted-average**    **outstanding** **exercise price of** **Number of securities**  **options, warrants** **outstanding options,** **remaining available****Plan category** **and rights** **warrants and rights** **for future issuance** Stock Incentive Plan  3,299,881  $7.00   702,525 
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**Item 6.** **Selected Consolidated Financial Data (Restated – See Note 2 of the Notes to theConsolidated Financial Statements)**     The consolidated statement of operations data for each of the years ended December 31, 2005,2004 and 2003, and the consolidated balance sheet data as of December 31, 2005 and 2004 has beenderived from our audited consolidated financial statements appearing elsewhere in this AnnualReport on Form 10-K/A. The consolidated statement of operations data for the years ended December 31,2002 and 2001 and the consolidated balance sheet data as of December 31, 2003, 2002 and 2001 hasbeen derived from our audited consolidated financial statements which are not included in thisAnnual Report on Form 10-K/A. The information shown below is qualified by reference to and should beread together with our consolidated financial statements and their notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” included elsewhere inthis Annual Report on Form 10-K/A. We have calculated the weighted average shares used in computingnet income (loss) per share as described in Note 1 to our consolidated financial statements.                       **Years Ended December 31,**   **2005**  **2004**  **2003**  **2002**  **2001**   **(in thousands, except per share data)**   As restated  As restated             **Statement of Operations Data:**                    Revenue                    Test Preparation Services $87,310  $74,744  $71,719  $67,930  $55,340 K-12 Services  31,931   27,957   21,525   10,066   6,885 Admissions Services  11,252   11,084   11,218   11,240   6,890                 Total Revenue  130,493   113,785   104,462   89,236   69,115                                      Cost of revenue                    Test Preparation Services  28,144   23,584   20,809   18,516   17,608 K-12 Services  16,838   13,684   8,328   3,533   2,482 Admissions Services  4,615   3,385   2,836   2,888   1,653                 Total cost of revenue  49,597   40,653   31,973   24,937   21,743                                      Gross profit  80,896   73,132   72,489   64,299   47,372                      Operating expenses                    Selling, general and administrative  85,144   78,381   65,634   65,482   60,993 Impairment of goodwill  —   8,199   —   —   — Loss on early extinguishment of debt  —   —   —   —   3,130 Impairment of investment  —   —   —   344   —                 Total operating expenses  85,144   86,580   65,634   65,826   64,123                 Income (loss) from operations  (4,248)  (13,448)  6,855   (1,527)  (16,751)                Net income (loss)  (2,182)  (29,495)  4,309   (1,090)  (10,334)                     Accreted dividends on Series A redeemablepreferred stock  —   —   —   —   (2,309)Accreted dividends on Class B non-votingcommon stock  —   —   —   —   (1,956)Dividends and accretion on Series B-1preferred stock  (2,446)  (1,439)  —   —   —                                      Net income (loss) attributed to commonstockholders $(4,628) $(30,934) $4,309  $(1,090) $(14,599)                Basic income (loss) per share $(0.17) $(1.13) $0.16  $(0.04) $(0.68)                Diluted income (loss) per share $(0.17) $(1.13) $0.16  $(0.04) $(0.68)                                     Weighted average shares used in computingnet income (loss) per share                    Basic  27,570   27,468   27,306   27,239   21,383                 Diluted  27,570   27,468   27,467   27,239   21,383                 
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                       **As of December 31,**  **2005** **2004** **2003** **2002** **2001**  **(in thousands)**  As restated As restated            **Balance Sheet Data:**                    Cash and cash equivalents $8,002  $19,197  $13,937  $11,963  $21,935 Total assets  105,371   107,641   121,697   112,116   111,833 Long-term debt, net of current portion  2,845   4,213   5,710   5,656   6,830 Series B-1 preferred stock  10,000   8,147   —   —   — Stockholders’ equity  50,453   55,104   84,467   79,298   80,233 __________________    Period-to-period comparability of the above SelectedConsolidated Financial Data is affected by the following:     In 2005, as part of the franchise renewal process, four of our franchisees licensed the rightto sell, under The Princeton Review brand, SES in their franchised territories for approximately$1.0 million.     In 2004, we incurred an $8.2 million impairment charge for the write-down of goodwill relatedto Embark, and recorded a reserve against our deferred tax asset, in the form of a valuationallowance, in the amount of $22.1 million.     In 2004, we sold our Series B-1 Preferred Stock for gross proceeds of $10.0 million.     In 2003, we acquired the Princeton Review of North Carolina.     In 2002, we acquired The Princeton Review of St. Louis.     In 2001, we acquired Princeton Review of Boston, Princeton Review of New Jersey, PrincetonReview Peninsula, T.S.T.S., and Embark.     In 2001, we completed our initial public offering, resulting in net proceeds of $51.8 million.**Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations**     The following discussion and analysis of our financial condition and results of operationsshould be read in conjunction with our consolidated financial statements and the related notesincluded elsewhere in this Annual Report on Form 10-K. This discussion and analysis containsforward-looking statements that involve risks and uncertainties. Our actual results may differmaterially from those anticipated in these forward-looking statements as a result of many factors,including, but not limited to, those described under “Risk Factors” and elsewhere in this AnnualReport on Form 10-K.**Overview**     The Princeton Review provides educational products and services to students, parents,educators and educational institutions. These products and services include integratedclassroom-based and online instruction, professional development for teachers and educators, printand online materials and lessons, and higher education marketing and admissions management. Weoperate our businesses through three divisions, which correspond to our business segments.     The Test Preparation Services division derives the majority of its revenue fromclassroom-based and Princeton Review Online test preparation courses and tutoring services.Additionally, Test Preparation Services receives royalties from its independent franchises whoprovide classroom-based courses under the Princeton Review brand. Since 2004, this division hasalso been providing SES programs to students in public school districts. This division hashistorically accounted for the majority of our overall revenue and accounted for approximately 66%of our overall revenue in 2005.     The Test Preparation Services division’s revenue increased 17% from 2004 levels. During 2005,the fastest growing areas for this division were its SES courses, sales of which have increased inresponse to the increased emphasis on state assessments, and institutional sales, which ispartially attributed to the new SAT test introduced in 2005. Tutoring and retail classroom revenuesalso contributed to the overall growth in this division.     The K-12 Services division provides a number of services to K-12 schools and school districts,including assessment, professional development, intervention materials (workbooks and relatedproducts) and face-to-face instruction. As a result of the increased emphasis on accountability andthe measurement of student performance in public schools in thiscountry and the centralization of school districts’ purchasing of assessment, professionaldevelopment and supplemental educational products and services, this division continues to seegrowing demand by the public school market for its products. During 2005 K-12 Services introducedits SideStreets after-school intervention materials. We believe this material will allow us to bemore responsive to school districts needs and less reliant on providing custom made content.
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     The K-12 Services division experienced revenue growth of 14%, as compared to 2004 levels. Asthis division has grown over the last several years, we have begun to enter into more and morelarge, multiple element contracts with schools, school districts, municipal agencies, and othergovernmental bodies, requiring us to deliver a combination of products and services, includingonline and print-based assessment, professional development, and face-to-face instruction. Theapproval processes of some of our customers in this area, which are required for formal contractexecution, are lengthy and cumbersome. These contracts therefore present several types of risks anduncertainties, including reducing our ability to effectively predict our operating performance,increasing variability in our cash balances and increasing credit risk. These risks anduncertainties are discussed in detail under the heading “Risk Factors” in this Form 10-K.     While we see continued strong revenue growth in this division, operating results are difficultto predict accurately, due to the foregoing factors and the fact that each contract entered into bythis division has its own, unique product mix. Because our various products in this division havedifferent gross margins (professional development and live course instruction products typicallyhave lower gross margins than fees for assessment products and printed materials), contracts withvarying product mix could significantly alter this division’s operating results from period toperiod. Primarily due to changes in product mix, gross margins in this division declined from 51%in 2004 to 47% in 2005.     Our Admissions Services division currently derives most of its revenue from the sale ofweb-based admissions and application management products and marketing services to educationalinstitutions. In 2005, this division represented 9% of our overall revenue.     In 2005, the division’s performance was again below management’s expectations, primarily dueto a lack of increase in demand for subscription-based admissions and application managementservices. For the third consecutive year, revenue in this division did not grow appreciably overthe prior year.     We are currently in the process of refocusing this division’s overall direction, with the goalof changing the way we charge post-secondary academic institutions for our marketing services. Weare moving from a model of pricing for various bundles of marketing services, to a model wherepayment is based upon actual leads we generate. We believe this model will allow us to bettercapitalize on the popularity of our web site with college and graduate school-bound students. Tosupport this change in our marketing services model, we re-launched our web site with a view tooptimizing our ability to match the right prospects with the post-secondary institutions looking toattract them. Additionally, we expanded our counseling services in this division by signing amulti-year contract with several schools in Texas. We believe that we will need to further increaserevenues before this division will show sustainable operating profits, and it is management’s hopethat this new direction of providing lead generation and college counseling services will providethe needed momentum to do so.*Revenue*     *Test Preparation Services*. The Test Preparation Services division derives revenue primarilyfrom: **•** classroom-based and online test preparation courses and tutoring services, whichconsists of tuition and fees paid to our company-operated sites. We recognize revenue fromtuition paid for our courses over the life of the course, which is usually from five to 10weeks depending on the course type. Tutoring revenue is based on an hourly fee and isrecognized as the services are delivered. Course and tutoring revenue representedapproximately 49% of our total revenue in 2005.  **•** SES programs, which consist of after school courses taught primarily in the K-12grades. We are typically paid for these courses on a per-student basis, and recognize therevenue over the life of the courses. SES revenue represented approximately 3% of ourtotal revenue in 2005.  **•** royalty fees paid to us by our independent franchisees. These royalties in 2005 are8% of all cash receipts collected by our franchisees for all test preparation and tutoringservices performed by them under the Princeton Review name. Royalties received fromfranchisees also include a 10% fee for use by their students of our online supplementalcourse tools. Royalties also include a fee of 2% of the domestic franchisees’ cashreceipts for contribution to a national advertising fund. For a description of theadvertising fund, see Note 8 to our consolidated financial statements. We recognizerevenue from franchise royalties on a monthly basis. This revenue representedapproximately 4% of our total revenue in 2005.  **•** sales of course and marketing materials and other products to our independentfranchisees. This revenue is recognized upon the transfer of title to our customers, whichoccurs on the shipment dates of these materials. This revenue represented approximately 1%of our total revenue in 2005.  **•** authoring books published by Random House and providing content for software. Thisrevenue consists of performance-based fees, including royalties and marketing fees fromsales of books and software. We recognize
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   these fees based on sales of the books andsoftware when reported to us by the publishers. Additionally, we earn delivery-based feesfrom Random House in the form of advances and copy editing fees for books written by us.We recognize these fees as the products are delivered. This revenue representedapproximately 2% of our total revenue in 2005.     *K-12 Services*.The K-12 Services division derives revenue from the services we provide toprimary and secondary schools and school districts, from authoring books published by Random Houseand from our work with McGraw-Hill.     Revenue from the services we provide to schools and school districts is derived from: **•** fees for training and professional development for schoolteachers and administrators,which we recognize over the period that the services are provided;  **•** fees for classroom instruction, principally during after school K-12 programs, whichwe recognize when the courses are delivered;  **•** fees for paper-based and online benchmark testing, which we recognize over the period theservices are delivered;  **•** sales of printed materials, which we recognize when the materials are delivered; and  **•** annual subscription fees for the Homeroom subscription service, recognized by usratably over the life of the subscription period, which is typically one or two years.     The revenue we earned from the above services we provided to schools and school districtsrepresented approximately 24% of our total revenue in 2005.     Revenue from authoring books published by Random House is derived from performance-based fees,including royalties and marketing fees from sales of books. We recognize these fees based on salesof the books when reported to us by the publisher. Additionally, we earn delivery-based fees fromRandom House in the form of advances and copy editing fees for books written by us. We recognizethese fees as the products are delivered. This revenue represented less than 1% of our totalrevenue in 2005.     Revenue from McGraw-Hill is derived from royalties under an agreement that expired inSeptember, 2003 for Princeton Review branded content that we provided for their textbooks, which werecognize based on sales reported by McGraw-Hill. Revenue from our contract with McGraw-Hillrepresented approximately 1% of our total revenue in 2005.     *Admissions Services*.The Admissions Services division derives revenue from: **•** web-based subscription, application and marketing fees. These fees consist of annualsubscription fees and application processing fees paid to us by academic institutions forour online application and management products, annual subscription fees paid to us bysecondary schools for our ECOS product, and annual marketing fees paid to us by academicinstitutions to promote their programs on our web site and in our publications. Werecognize the subscription and marketing fees over the contract period, which is typicallyone or two years. We recognize the application processing fees in the month that therelevant applications are submitted. This revenue represented approximately 5% of ourtotal revenue in 2005.  **•** college counseling fees paid by high schools. This revenue consists of annualsubscription fees paid to us by secondary schools. We recognize these fees over thecontract period, which is typically one to three years. This revenue representedapproximately 1% of our total revenue in 2005.  **•** marketing fees paid to us by academic institutions based upon the number of studentinquiries we generate. This revenue is recognized as leads are generated based on theprice per lead in the applicable contracts, and represented 1% of our total revenue in2005.  **•** authoring books published by Random House. This revenue consists of performance-basedfees, including royalties and marketing fees from sales of books. We recognize these feesbased on sales of the books when reported to us by the publisher. Additionally, we earndelivery-based fees from Random House in the form of advances and copy editing fees forbooks written by us. We recognize these fees as the products are delivered. This revenuerepresented less than 1% of our total revenue in 2005.  **•** sales of advertising and sponsorships to businesses and schools wishing to promotetheir products, services and programs on our web site. Advertising and sponsorship revenueis recognized each month based on contractual terms. This revenue representedapproximately 1% of our total revenue in 2005.*Cost of Revenue*     *Test Preparation Services*. Cost of revenue consists of course expenses of our company-ownedoperations, cost of course materials sold and the costs to author, develop, edit and producecontent for books and software. Course expenses
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consist of costs incurred to deliver testpreparation courses, SES programs, tutoring and admissions counseling services, including rent ofclassroom space, teacher salaries, credit card fees, and costs of course materials. The largestcomponents of cost of revenue in our Test Preparation Services division are rent for classroomspaces and teacher salaries, which together accounted for approximately 66% of the cost of revenueof this division in 2005. Also included in cost of revenue is a royalty we pay to our franchiseesin exchange for allowing us to offer our Princeton Review Online courses within their territories.This royalty is calculated based on a fee per student which varies depending on the course. Thesefees are for Princeton Review Online courses provided to students residing within our franchisees’territories, net of certain administrative expenses.     *K-12Services*. Cost of revenue primarily consists of the costs related to providing training,professional development, after school programs, authoring and producing workbooks, developingcontent for textbooks, our Homeroom subscription service and book development. Additionally, costof revenue includes amortization expense related to our capitalized K-12 content, which are thedirect costs we incur to write questions and lessons that are used across our various productcategories in this division. These costs, primarily comprised of internal compensation costs ofdedicated employees, are capitalized and amortized over a seven-year period, on a straight-linebasis (see Note 1 to our Consolidated Financial Statements).     *AdmissionsServices*. Cost of revenue includes the costs to author, develop and edit our booksand the admissions services section of our web site. Cost of revenue also includes the costs tobuild and maintain our web-based products, primarily comprised of internal compensation costs ofdedicated employees, and the commissions related to the sale of those products, which arerecognized over the contract period, and credit card fees incurred in connection with processingstudent applications, which are recognized in the month the applications are processed.Additionally, cost of revenue includes the costs to provide counseling services to high schoolscontracting for this service.     *Selling, General and Administrative Expenses*     Selling, general and administrative expenses include payroll and payroll related expenses,advertising expenses and office facility expenses, including rent, utilities, telephone andmiscellaneous expenditures, which collectively represented approximately 65% of our total selling,general and administrative expenses in 2005. Selling, general and administrative expenses alsoinclude costs associated with national advertising campaigns that benefit our company-ownedlocations as well as our independent franchisees. Finally, the remaining components of selling,general and administrative expenses include professional fees, travel and entertainment, healthinsurance and depreciation and amortization.     *Income Taxes*     As a result of the effect under SFAS No. 109, *Accounting for Income Taxes*, on therecoverability of our net deferred tax assets, we decided to record a 100% valuation allowanceagainst any deferred tax benefits. In 2005, a deferred tax benefit of $1.5 million was offset by afurther valuation allowance of the same amount, resulting in no net tax expense in 2005. During2004, as a result of the establishment of a valuation allowance for net deferred tax assets werecorded an income tax expense of $16.7 million for 2004. Income tax expense was $3.2 million for2003. Our effective income tax rate was 0% for 2005, 122% for 2004, and 42% for 2003.     We currently have significant deferred tax assets related to net operating loss carryforwards,tax credit carryforwards and deductible temporary differences that will reduce taxable income infuture years. Our loss in 2005 and 2004 and the emphasis placed on cumulative losses undergenerally accepted accounting principles represents sufficient evidence under SFAS No. 109,*Accounting for Income Taxes,*for us to determine that it was appropriate to establish a fullvaluation allowance against net deferred tax assets. Although management expects these assets willultimately be fully utilized, future performance cannot be assured. The Company will continue toevaluate the need for the valuation allowance in future periods.     *Restatement of Financial Statements*     On October 24, 2006, the Audit Committee of the Board of Directors of the Company, inconsultation with the Company’s management and its independent registered public accounting firm,Ernst & Young LLP, concluded that the Company’s method of accounting for the Preferred Stock mustbe changed. This conclusion was reached following athorough evaluation of the Company’s accounting treatment of the Preferred Stock in responseto a comment letter from the Staff of the Division of CorporationFinance of the SEC relating to the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005. While we have concluded that the Preferred Stock was properly accounted for as“Mezzanine Equity” consistent with GAAP, the Company didnot properly account for certain derivatives embedded within the Preferred Stock and associatedrights to acquire additional shares of preferred stock that weregranted simultaneously with theissuance of the Preferred Stock. Under GAAP these embedded derivatives and rights are required tobe recorded as liabilities at fair
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value, andadjusted to their fair values in subsequent periods. Accordingly,we are restating our financial statements to reflect this accounting treatment.     The cumulative effect of the restatement through fiscal 2005 is an increase in the non-currentliability related to derivative instruments of $393,000 , anincrease in the non-cashaccretion on Preferred Stock of $2.6 million and a non-cash gain on the derivativeinstrument of $2.2 million. As a result, retained earnings at the end of fiscal 2005 decreased by$393,000. The gain on derivative instruments for fiscal years ended2005 and 2004 was $1.3 million and $918,000, respectively. Dividends dueto accretion on Preferred Stockfor fiscal years ended 2005 and 2004 increased by $1.6 million and$1.0 million, respectively. Therestatement increased reported net loss per common share by $0.01 ineach of the fiscal yearsended 2005 and 2004.     Thesenon-cash adjustments will not have any impact on our previouslyreported net cash flows,sales, operating income or our compliance with any financial covenant under our revolving creditfacility.          Management’s Discussion and Analysis of Financial Condition and Results of Operations has beenrevised for the effects of the restatement. Further information on the nature and impact of theseadjustments is provided in Note 2, “Restatement of FinancialStatements” and Note 15, “ Quarterly Results of Operations(unaudited)” under Notes toConsolidated Financial Statements included in Item 8, “Financial Statements and SupplementaryData” of this Form 10-K/A.**Results of Operations****Three Months Ended December 31, 2005 Compared to Three Months Ended December 31, 2004**     *Revenue*     For the three months ended December 31, 2005 total revenue for the Company increased by $4.5million, or 16.2%, from $27.8 million in 2004 to $32.3 million in 2005.     Test Preparation Services revenue increased by $3.5 million, or 25.7%, from $13.6 million in2004 to $17.1 million in 2005. This increase is driven by an increase of $2.1 million in retail,institutional and tutoring revenue, reflecting strong enrollment in SAT, LSAT, and MCAT courses andan increase of $1.0 million in SES revenue.     K-12 Services revenue increased by $385,000, or 3.4%, from $11.2 million in 2004 to $11.6million in 2005. This increase is primarily driven by $2.0 million of growth in assessment servicesand the receipt of $400,000 in prior year license fees. Reductions are driven primarily by therecognition of a certain professional development contract which combined both third and fourthquarter revenue into the fourth quarter of 2004 driving a year-over-year reduction of $1.7 million.After adjusting for this $1.7 million contract, revenue growth for the quarter would beapproximately 22%.     Admissions Services revenues increased by $648,000, or 21.6%, from $3.0 million in 2004 to$3.6 million in 2005. This increase was driven primarily by an increase of $643,000 in counselingcontracts entered into during the third quarter of 2005.     *Cost of Revenue*     For the three months ended December 31, 2005 total cost of revenue for the Company increasedby $4.0 million, or 38.1%, from $10.5 million in 2004 to $14.5 million in 2005.     Test Preparation Services cost of revenue increased by $1.5 million, or 29.5%, from $5.1million in 2004 to $6.6 million in 2005. This increase is driven by a $1.4 million volume increaserelated to retail enrollments which caused variable costs such as teacher salaries, site rent andcourse materials to increase. Costs associated with SES also increased by approximately $300,000.Gross margin declined by 1.1% from 62.1% to 61.0% due to higher costs of labor and materials insupport of SES institutional based contracts and year end delays.     K-12 Services cost of revenues increased by $2.2 million, or 50.5%, from $4.3 million in 2004to $6.5 million in 2005. This increase is primarily related to an increase in content developmentand professional development costs of approximately $2.0 million. Gross margin declined by 17.5%from 61.7% to 44.2%. Adjusting for the additional $1.7million of revenue during the fourth quarter of 2004 gross margin declines by 10.4% from 54.6%to 44.2% related to higher fourth quarter mix of professional development services and highercontent development, production and distribution costs.     Admissions Services cost of revenue increased by $320,000, or 29.8%, from $1.1 million in 2004to $1.4 million in 2005. This increase is primarily driven by an increase of $378,000 related tocounseling labor and related costs. Gross
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margin declined by 2.4% from 64.3% to 61.9%. Thisdecrease is primarily related to ongoing expenses in support of the new counseling servicescontracts.     *Selling,general and administrative*     Selling, general and administrative expense increased by approximately $890,000 or 4.1%, from$21.6 million in 2004 to $22.5 million in 2005. Primary components of this increase are: increasedrent and related costs of $450,000 and $400,000 of advertising expense primarily related to the SESbusiness.     *Impairment of goodwill*     Our results for the fourth quarter of 2004 included a write-down of approximately $8.2 millionof goodwill related to the Embark acquisition.**Comparison of Years Ended December 31, 2005 and 2004**     *Revenue*     For the year ended December 31, 2005 total revenue for the Company increased by $16.7 million,or 14.7%, from $113.8 million in 2004 to $130.5 million in 2005.     Test Preparation Services revenue increased by $12.6 million, or 16.8%, from $74.7 million in2004 to $87.3 million in 2005. This increase is driven by an increase of $9.3 million in retail,institutional and tutoring revenue, once again reflecting strong enrollment in SAT, LSAT and MCATcourses, and $2.1 million in SES revenue.     For the year, K-12 services revenue increased by $4.0 million or 14.2%, from $28 million in2004 to approximately $32 million in 2005. This increase is driven by $2.4 million in assessmentservices, $1.8 million in workbook intervention materials (primarily SideStreets) and $943,000 ofprofessional development services.     For the year, Admissions Services revenue increased by $168,000, or 1.5%, from $11.1 millionin 2004 to $11.3 million in 2005. This increase is driven by an increase of approximately $700,000in revenue from counseling services, and a $1.4 million increase in higher education marketingfees. Reductions to revenue include a decrease in higher education technology fees and book relatedrevenues related to timing.     *Cost of Revenue*     For the year ended December 31, 2005 total cost of revenue for the Company increased by $8.9million, or 22%, from $40.7 million in 2004 to $49.6 million in 2005.     Test Preparation Services cost of revenue increased by $4.6 million, or 19.3%, from $23.6million in 2004 to $28.1 million in 2005. This increase is primarily driven by the variable expenseincrease related to higher retail enrollments, and higher tutoring and institutional revenue. Grossmargin declined slightly by 0.6% from 68.4% to 67.8%.     K-12 Services cost of revenue increased by $3.1 million, or 23.0%, from $13.7 million in 2004to $16.8 million in 2005. This increase is driven by variable expense of approximately $2.1 millionon $4.0 million of incremental revenue growth. In addition, there is an increase of $300,000 of webcontent amortization and approximately $889,000 increase related to incremental content productionand labor related expense. Gross margin declined by 3.8% from 51.1% to 47.3% due to revenue timingand content production related costs. The Company expects margins to improve in 2006.     Admissions Services cost of revenue increased by $1.2 million, or 36.3%, from $3.4 million in2004 to $4.6 million in 2005. This increase is driven by an increase of $500,000 in counselingexpense and $700,000 of other related expense in support of both the technology and marketingbusiness. Gross margins declined by 10.5% from 69.5% to 59.0%. The key drivers of this reductionrelate to $700,000 in revenue credits driving approximately 6% of the decline, as well asapproximately 2% in consulting mix and another 1.5% attributed to the cost base.     *Selling,general and administrative*     Selling, general and administrative expense increased by approximately $6.7 million or 8.6%,from $78.4 million in 2004 to $85.1 million in 2005. This increase is attributed to: salary expenseof $2.1 million, office rent and related expense of $730,000, professional fees primarily relatedto Sarbanes-Oxley of $2.8 million, $400,000 in advertising and recruitment expense and workerscompensation fees of $300,000.     *Impairment of goodwill*     Our 2004 results included a write-down of approximately $8.2 million of goodwill related tothe acquisition of Embark.
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     *Sale of Rights to Franchises*     During the third quarter of 2005, we sold the right to provide SES programs to four of ourindependent franchisees for $990,000.     *OtherIncome (Expense), net*     Otherincome of $1.4 million in 2005 and $1.0 million in 2004,increased by approximately $400,000. This was principally due tothe change in the fair value of derivatives andwarrant.     *Dividends and Accretion on Series B-1 Preferred Stock*     As a result of the dividends accruing for the entire year 2005 compared with approximately sixmonths in 2004, cash paid to the Series B-1 preferredstockholders in 2005 increased by $217,000.In addition, for the same reason, the accretion related to the Series B-1 Preferred Stockincreased by $578,000.**Comparison of Years Ended December 31, 2004 and 2003**     Overall, results for 2004 were below expectations in all three divisions. After returning toprofitability in 2003, we incurred a net loss of $30.4 million in 2004. In the Test PreparationServices division, weakness in enrollments in LSAT and GMAT courses offset growth in onlinecourses, SES programs and tutoring, resulting in annual revenue growth of only 4%. Despite revenuegrowth for the year of 30%, the K-12 Services division experienced a longer sales cycle in closingon contracts. The Admissions Services division, despite rolling out a new counseling product,failed to grow revenue for the second year in a row, primarily due to weak demand forsubscription-based services from its post-secondary institution customers. Gross margins for thecompany as a whole slipped from 69.4% in 2003 to 64.3% in 2004, due primarily to higher costscombined with lower enrollment in test preparation services and a less profitable product mix inK-12 services.     On the expense side, professional fees, including those relating to Sarbanes Oxley compliance,were significantly higher than expected, and a bad debt expense relating to the write-off of agedaccounts receivable in the Admissions Services and K-12 Services divisions further hurt our bottomline. Additionally, we recorded a valuation allowance relating to our net deferred tax assets as ofDecember 31, 2004, of approximately $22.1 million, resulting in a tax charge of $16.7 million in2004, and incurred an $8.2 million impairment charge relating to the write-down of goodwill.     *Revenue*     Our total revenue increased from $104.5 million in 2003 to $113.8 million in 2004,representing a 9% increase.     Test Preparation Services revenue increased from $71.7 million in 2003 to $74.7 million in2004, representing a 4% increase, comprised primarily of an increase of approximately $2.9 millionin revenue from our company-owned operations. The increased revenue from company-owned operationsresulted from an increase of approximately $488,000 in revenue attributable to the operationsacquired from our former franchisee, Princeton Review of North Carolina, Inc., and an increase ofapproximately $2.5 million in course and tutoring revenue at our other locations. This $2.5 millionincrease is attributable to an increase in our tutoring, online course and SES revenue totaling$4.2 million, which was partially offset by a decrease in retail classroom revenue of approximately$2.3 million, primarily due to a drop in LSAT and GMAT course fees.     K-12 Services revenue increased from $21.5 million in 2003 to $28.0 million in 2004,representing a 30% increase. This increase resulted primarily from an increase of approximately$6.8 million in revenue from schools for assessment tests, printed materials, professionaldevelopment and Homeroom subscriptions, due to additional contracts signed in 2004, as well asincreased revenue from contracts signed in 2003 which were in effect for the full year in 2004. Theincrease in revenue from schools was partially offset by a decrease in fees from McGraw-Hill.     Admissions Services revenue decreased from $11.2 million in 2003 to $11.1 million in 2004,representing a 1% decrease. The approximate $750,000 in sales of college counseling services tohigh schools, a new product offering in 2004 by this division, was offset by a decrease in revenuesfrom post-secondary institutions.     *Cost of Revenue*     Our total cost of revenue increased from $32.0 million in 2003 to $40.7 million in 2004,representing a 27% increase.     Test Preparation Services cost of revenue increased from $20.8 million in 2003 to $23.6million in 2004, representing a 13% increase, primarily as a result of increasing the number oftutoring sessions and SES programs delivered. Cost of revenue as a percentage of revenue increaseddue to reduction in the average class size due to reduced enrollment, primarily in our LSATcourses, as well as an increase in the relative cost of teachers and course materials.
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     K-12 Services cost of revenue increased from $8.3 million in 2003 to $13.7 million in 2004,representing a 65% increase. This increase is primarily attributable to an increase in costsincurred to service increasing numbers and increasingly complex contracts with school-basedcustomers. The percentage increase in cost of revenue was significantly higher than the increase inrevenue in this division primarily because of the increased revenues from the lower marginprofessional development services.     Admissions Services cost of revenue increased from $2.8 million in 2003 to $3.4 million in2004, representing a 21% increase, primarily due to increased customer support costs, including thenew high school counseling product.     *Operating Expenses*     Selling, general and administrative expenses increased from $65.6 million in 2003 to $86.6million in 2004, representing a 32% increase. This increase resulted from the following: **•** a write-down of goodwill related to the acquisition of Embark of approximately $8.2million;  **•** an increase of approximately $4.7 million in salaries and payroll taxes, resultingprimarily from increased headcount;  **•** an increase of approximately $2.6 million attributable primarily to personnel relatedcosts, including office rent and expenses, travel and entertainment, employee benefits andrecruiting fees;  **•** an increase of approximately $2.4 million in professional fees, comprised primarilyof legal, accounting and consultant fees, relating to Sarbanes-Oxley compliance, aninternal corporate reorganization and other miscellaneous matters;  **•** an increase of approximately $2.2 million in web site technology and developmentexpenses;  **•** an increase of approximately $1.1 million in bad debt allowance expense primarily dueto an increase in aged accounts receivable in the Admissions Services and K-12 Servicesdivisions; and  **•** an increase of approximately $725,000 in depreciation and amortization expenses, dueprimarily to increased amortization expense relating to the K-12 Services division’s website development costs.     *OtherIncome (Expense), net*     Otherincome decreased by approximately $200,000. In 2003, other incomeresulted primarily from our sale of preferredstock in, and certain contractual rights with, Tutor.com for$1.0 million. In 2004, other income represented primarily the changein the fair value of derivatives and warrant of approximately$918,000.     *Dividends and Accretion on Series B-1 Preferred Stock*     Cashdividends paid during 2004, together with the accretion related tothe issuance of Series B-1 Preferred Stock in June 2004 totaled$1.4 million.**Liquidity and Capital Resources**     Our primary sources of liquidity are cash and cash equivalents on hand and collections fromcustomers. At December 31, 2005, we had $8.0 million of cash and cash equivalents. The $11.2million decrease in cash from the December 31, 2004 balance is primarily attributed to investingactivities of $13.6 million ($8.3 million in furniture, fixtures, equipment and softwaredevelopment and $5.6 million in capitalized content) along with$5.1 million related to financingactivity that more than offset the $7.5 million cash increase provided by operating activities. OurTest Preparation Services division has historically generated, and continues to generate, thelargest portion of our cash flow from its retail classroom and tutoring courses. These customersusually pay us in advance or contemporaneously with the services we provide, thereby supporting ourshort-term liquidity needs. Increasingly, however, across all of our divisions, we are generating agreater percentage of our cash from contracts with institutions such as the schools and schooldistricts serviced by our K-12 Services division and the post-secondary institutions serviced byour Admissions Services division, all of which pay us in arrears. Typical payment performance forthese institutional customers, once invoiced, ranges from 60 to 90 days. Additionally, the longcontract approval cycles and/or delays in purchase order generation with some of our contracts withlarge institutions or school districts can contribute to the level of variability in the timing ofour cash receipts.     Cash provided by operating activities is our net income (loss) adjusted for certain non-cashitems and changes in operating assets and liabilities. During 2005, cash provided by operatingactivities was $7.5 million, compared to $4.0 million for2004, an increase of $3.5 million. Theincrease is primarily attributed to the year-over-year increase in accountspayable and accrued expenses of $5.9 million and an increase in net income adjusted for noncash items of $3.3 million. These increases were partially offset by a decrease in deferred incomeof $1.1 million and an increase in inventory, primarily SideStreets instruction books, of $1.7million
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     During 2005, we used $13.6 million in cash for investing activities as compared to $8.3million used during 2004. This increase is driven by increases of $2.5 million in capitalexpenditures due primarily to the Oracle implementation, an increase of $4.1 million in contentexpenditures related to the development of SideStreets content and an increase of $1.8 million inleasehold improvements.     Financing cash flows consist primarily of transactions related to our debt and equitystructure. We used approximately $5.1 million in 2005 comparedto net proceeds of $9.6 millionduring 2004. During 2005, we repaid approximately $2.0 million of the debt we had borrowed in 2004under a bank credit facility, and we repaid approximately $2.0 million in other debt. In 2004, weraised approximately $9.7 million net of issuance costs from the saleof Series B-1 Preferred Stock and repaid approximately $2.0 million of other debt.     Our current cash balances and operating cash flow, will be sufficient to cover our normaloperating requirements for the next 12 months as we implement a number of restructuring initiativesdesigned to significantly improve operating cash flow. We also expect to shortly secure a revolvingline of credit in an amount of $5 million to $10 million to support any further working capitalrequirements.**Contractual Obligations and Commercial Commitments**     As of December 31, 2005, our principal contractual obligations and commercial commitmentsconsisted of obligations outstanding under our long-term office and classroom leases, obligationsunder promissory notes entered into in connection with acquisitions, employment agreements andseveral capital leases of computer equipment. As of December 31, 2005, we operated from leasedpremises in New York, Alabama, Arizona, California, Colorado, Georgia, Illinois, Kansas, Louisiana,Maryland, Massachusetts, Minnesota, Missouri, New Jersey, North Carolina, Ohio, Oklahoma, Oregon,Pennsylvania, South Carolina, Texas, Virginia, Washington, Washington D.C., and Canada.     The following table summarizes our contractual obligations and other commercial commitmentsset forth therein as of December 31, 2005.                       **Payments due by period**  **($ in millions)**      **Less than**         **More than****Contractual Obligations** **Total** **1 year** **1–3 years** **3–5 years** **5 years** Long-term debt obligations $3.1  $0.7  $2.3  $0.1  $— Capital lease obligations  1.2   0.8   0.4   —   — Operating lease obligations  28.5   5.1   9.2   6.8   7.4 Purchase obligations (1)  6.5   3.0   3.5   —   —    Total $39.3  $9.6  $15.4  $6.9  $7.4     (1) Purchase obligations consist of payments required under employment agreements.**Adoption of New Accounting Pronouncements**     In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R),*“Share-Based Payment”*(“SFAS 123(R)”). SFAS 123(R) establishes standards for accounting fortransactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R)focuses primarily on accounting for transactions in which an entity obtains employee services inshare-based payment transactions. SFAS 123(R) requires that the fair value of such equityinstruments be recognized as expense in the financial statements as services are performed. Priorto SFAS 123(R), only the pro forma disclosures of fair value were required. In March 2005, the SECissued Staff Accounting Bulletin No. 107, *“TOPIC 14: Share-Based Payment”*which addresses theinteraction between SFAS 123(R) and certain SEC rules and regulations and provides views regardingthe valuation of share-based payment arrangements for public companies. SFAS 123(R) is effectivefor our first quarter of 2006 and the adoption of this new accounting pronouncement is expected toresult in pre-tax stock-based compensation expense of between $0.3 million and $0.5 million in ourfiscal year 2006.     In December 2004, the FASB issued SFAS No. 153, *“Exchanges of Nonmonetary Assets — AnAmendment of APB Opinion No. 29”*(“SFAS 153”). This new standard is the result of a broader effortby the FASB to improve financial reporting by eliminating differences between generally acceptedaccounting principles (“GAAP”) in the U.S. and GAAP developed by the International AccountingStandards Board (“IASB”). As part of this effort, the FASB and the IASBidentified opportunities to improve financial reporting by eliminating certain narrowdifferences between their existing accounting standards. SFAS 153 amends Accounting PrinciplesBoard Opinion No. 29, *“Accounting for Nonmonetary Transactions”*(“APB 29”), that was issued in1973. The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetaryassets should be measured based on the fair value of the assets exchanged. Further, the
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amendmentseliminate the narrow exception for nonmonetary exchanges of similar productive assets and replaceit with a broader exception for exchanges of nonmonetary assets that do not have “commercialsubstance.” Previously, APB 29 required that the accounting for an exchange of a productive assetfor a similar productive asset, or an equivalent interest in the same or similar productive asset,should be based on the recorded amount of the asset relinquished. The provisions of SFAS 153 wereeffective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005, and there was no impact on our consolidated financial statements.     In May 2005, the FASB issued SFAS No. 154, *“Accounting Changes and Error Corrections — aReplacement of APB Opinion No. 20 and FASB Statement No. 3”*(“SFAS 154”). SFAS 154 requiresretrospective 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 effectof the change. SFAS 154 also redefines “restatement” as the revising of previously issued financialstatements to reflect the correction of an error. This statement is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15, 2005 (our 2006fiscal year) and is not expected to have a significant impact on our consolidated financialstatements.**Critical Accounting Policies**     The estimates, methods and judgments we use in applying our accounting policies significantlyimpact the results we report in our financial statements. Some of our accounting policies requireus to make subjective and difficult judgments, often as a result of the need to make estimates ofmatters that are inherently uncertain. Our most critical accounting estimates include theassessment of the collectability of our accounts receivable balances, which impacts bad debtwrite-offs; recoverability of goodwill, which impacts goodwill impairment expense; assessment ofrecoverability of long-lived assets, which primarily impacts operating margins when we record theimpairment of assets or accelerate their depreciation; valuation ofembedded derivatives and warrant, which impacts gain or loss onderivative instruments; recognition and measurement of current anddeferred income tax assets and liabilities, which impacts our tax provision and, to a lesserextent, revenue recognition requirements, which impacts how and when we recognize revenue from ourgoods and services. Below, we discuss these policies further, as well as the estimates andjudgments involved.     We also have other policies that we consider to be key accounting policies. However, thesepolicies do not meet the definition of critical accounting estimates because they do not generallyrequire us to make estimates or judgments that are difficult or subjective.     *Accounts Receivable*. We maintain allowances for doubtful accounts for losses resulting fromthe inability of our customers to make required payments. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability to make payments,additional allowances for uncollectible accounts may be required. We review our aged receivablesmonthly. This review includes discussions with our customers and their account representatives, thecustomers’ payment history and other factors. Based on these reviews we may increase or decreaseour allowance for uncollectible accounts if we determine there is a change in the collectability ofour accounts receivable.     *Goodwill and Territorial Marketing Rights*. We perform an annual goodwill impairment reviewduring the fourth quarter, or more frequently if indicators of potential impairment exist. Noimpairment was indicated in 2003 or 2005. In 2004, we recorded an impairment expense of $8.2million against goodwill in our Admissions Services division due to the continued poor performanceof this division. Our impairment review process is based on a discounted future cash flow approachthat uses our estimates of revenue for the reporting units, driven by assumed market growth ratesas well as appropriate discount rates. These estimates are consistent with the plans and estimatesthat we use to manage the underlying businesses.     *Long-Lived Assets.*We assess the impairment of long-lived assets when events or changes incircumstances indicate that the carrying value of the assets or the asset grouping may not berecoverable. Factors we consider in deciding when to perform an impairment review includesignificant under-performance of a business or product line in relation to expectations,significant negative industry or economic trends and significant changes or planned changes in ouruse of the assets. Recoverability of assets that will continue to be used in our operations ismeasured by comparing the carrying amount of the asset grouping to the related total futureundiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through thosecash flows, the asset grouping is considered to be impaired. The impairment is measured by thedifference between the assets’ carrying amount and their fair value, based on the best informationavailable, including market prices or discounted cash flow analysis.     *EmbeddedDerivatives and Warrant.* Our Series B-1 Preferred Stock contains two embeddedderivatives that, consistent with the requirements of Statement ofFinancial Accounting Standards No. 133, *“Accounting forDerivative Instruments and Hedging Activities”* are accountedfor separately from the Preferred Stock. The two embeddedderivatives, the “holder’s conversion option” and the“make whole” provision are accounted for on a combinedbasis and, along with the warrant, reported at fair value(See Notes 2 and 8 to our consolidated financial statements). Any changes tofair value are reflected in “Other Income (Expense)” andtotaled $1.3 million and $918,000 forthe years ended December 31, 2005 and 2004, respectively. Wemust calculate the fair value of these embedded derivatives andwarrant at the end of each quarter. In making these calculations, thekey estimates and assumptions that we use includethe estimated life of the Preferred Stock and the warrant, the volatility rates applicable to the trading price of our commonstock and the probability of events that would trigger the operationof the “make whole”. Factors considered in thedetermination of the key assumptions include likelihood of theholder's exercise of conversion or redemption based upon currentstock prices and interest rates, as well as the historical stockprices to determine volatility. The Company’s use of derivatives is limitedto the embedded features within its Preferred Stock.     *Income Taxes*. In determining income for financial statement purposes, we must make certainestimates and judgments. These estimates and judgments occur in the calculation of certain taxliabilities and in the determination of therecoverability of certain of the deferred tax assets, which arise from temporary differencesbetween the tax and financial statement recognition of revenue and expense.     We must assess the likelihood that we will be able to recover our deferred tax assets. Ifrecovery is not likely, we must increase our provision for taxes by recording a reserve, in theform of a valuation allowance, for the deferred tax assets that we estimate will not ultimately berecoverable. At December 31, 2005, we had a net deferred tax asset of
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approximately $23.7 million,primarily relating to our net operating loss carryforwards of $53.7 million, which expire invarying amounts between 2021 and 2025.     Realization of our deferred tax asset is dependent on generating sufficient taxable income inthe United States prior to expiration of these loss carryforwards. As of December 31, 2004, werecorded a valuation allowance for the entire net deferred tax asset because our loss in 2004 andthe emphasis placed on cumulative losses under generally accepted accounting principles representedsufficient evidence under SFAS No. 109 “*Accounting for Income Taxes*” for us to determine that itwas appropriate to establish a full valuation allowance. If, in the future, an appropriate leveland consistency of profitability is attained, we would reduce the valuation allowance, which couldhave a significant impact on our consolidated financial statements.     *Revenue Recognition*. In general our revenue recognition policies do not require us to makeestimates or judgments that are difficult or subjective, with the possible exception being therecognition of revenue for separate units of accounting in accordance with EITF No. 00-21, “*RevenueArrangements with Multiple Deliverables*.” In accounting for multiple-element arrangements, one ofthe key judgments to be made is the accounting value that is attributable to the differentcontractual elements. The appropriate allocation of value not only impacts which segment iscredited with the revenue, it also impacts the amount and timing of revenue recorded in theconsolidated statement of operations during a given period due to the differing methods ofrecognizing revenue for each product or service by each of the segments. Revenue is allocated toeach element based on the accounting determination of the relative fair value of that element tothe aggregate fair value of all elements. The fair values must be reliable, verifiable andobjectively determinable. When available, such determination is based principally on the pricing ofsimilar arrangements with unrelated parties that are not part of a multiple-element arrangement.**Impact of Inflation**     Inflation has not had a significant impact on our historical operations.**Seasonality in Results of Operations**     We experience, and we expect to continue to experience, seasonal fluctuations in our revenuebecause the markets in which we operate are subject to seasonal fluctuations based on the scheduleddates for standardized admissions tests and the typical school year. These fluctuations couldresult in volatility or adversely affect our stock price. We typically generate the largest portionof our test preparation revenue in the third quarter. However, as SES revenues increase, we expectto recognize these revenues primarily in the first and fourth quarters. The electronic applicationrevenue recorded in our Admissions Services division is highest in the first and fourth quarters,corresponding with the busiest times of year for submission of applications to academicinstitutions. Our K-12 Services division experiences seasonal fluctuations in revenue, with thefirst and fourth quarters (corresponding to the school year) expected to have the highest revenue.**Item 7A.Quantitative and Qualitative Disclosures about Market Risk**     Our portfolio of marketable securities includes primarily short-term money market funds. Thefair value of our portfolio of marketable securities would not be significantly impacted by eithera 100 basis point increase or decrease in interest rates due primarily to the short-term nature ofthe portfolio. All of our currently outstanding long-term debt bears interest at fixed rates. OurSeries B-1 Preferred Stock requires the payment of quarterly dividends at the greater of 5% or 1.5%above 90-day LIBOR (4.4% at December 31, 2005). During 2005 and 2004, we paid dividends on theSeries B-1 Preferred Stock in an aggregate amount of $534,000 and $374,000, at an average rate of5.3% and 7.5% in 2005 and 2004, respectively. A 100 basis point increase in the dividend rate wouldhave resulted in a $100,000 increase in dividends paid during this period.     We repaid and terminated our line of credit in February 2005. Our Series B-1 Preferred Stock contains embedded derivatives and a warrant to purchase additional preferred stockwhich are adjusted to fair value and remeasured quarterly.     Revenue from our international operations and royalty payments from our internationalfranchisees constitute an insignificant percentage of our revenue. Accordingly, our exposure toexchange rate fluctuations is minimal.
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**Item 8. Financial Statements and Supplementary Data**     **Index to Consolidated Financial Statements and Financial Statement Schedule**       **Page**ConsolidatedFinancial Statements:    Report of Independent Registered Public Accounting Firm  41 Consolidated Balance Sheets  42 Consolidated Statements of Operations  43 Consolidated Statements of Stockholders’ Equity  44 Consolidated Statements of Cash Flows  45 Notes to Consolidated Financial Statements  46 FinancialStatement Schedule:    Schedule II — Valuation And Qualifying Accounts  71 
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**To the Board of Directors and Stockholders of