UNITED STATES SECURITIES AND EXCHANGE
COMMISSION




WASHINGTON, D.C. 20549




FORM 10-K




[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2005




OR




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




FOR THE TRANSITION PERIOD FROM

TO




COMMISSION FILE NUMBER 000-32469









THE PRINCETON REVIEW, INC.




(Exact name of registrant as specified in its charter)







|Delaware                                                       |  |  |  | 22-3727603                          
|-------------------------------------------------------------- |  |  |  | ------------------------------------
|(State or other
jurisdiction of incorporation or organization) |  |  |  | (I.R.S.
Employer Identification No.)
|                                                              
|2315 Broadway New
York, New York                               |  |  |  | 10024                               
|(Address of principal
executive offices)                       |  |  |  | (Zip
Code)                          



Registrants telephone number, including area code
(212) 874-8282




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 in Rule 405 of the Securities
Act.  Yes [  ] No [X]




Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act Rule
12b-2).  Yes [  ] No [X]




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




Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.  [  ]




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




Large accelerated filer
[  ]    Accelerated filer [X]    Non-accelerated filer [  ]




Indicate by check mark whether
the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ]  No [X]




The aggregate market value of
registrants common stock held by non-affiliates, based upon the closing price of the common stock on June 30, 2005, as reported by the NASDAQ
National Market, was approximately $96 million. Shares of common stock held by each executive officer and director and by 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 affiliate status is not necessarily a conclusive determination for other purposes.




The registrant had 27,572,172
shares of $0.01 par value common stock outstanding at March 10, 2006.




DOCUMENTS INCORPORATED BY REFERENCE




Certain information required in
Part III of this Form 10-K is incorporated by reference to the Proxy Statement for the registrants 2006 Meeting of Stockholders to be held on
June 15, 2006.







---



TABLE OF CONTENTS







|PART I            | 2 
|----------------- | --
|Item
        1.   |   
|Item
        1A.  |   
|Item
        1B.  |   
|Item
        2.   |   
|Item
        3.   |   
|Item
        4.   |   
|                 
|PART II           | 25
|Item
        5.   |   
|Item
        6.   |   
|Item
        7.   |   
|Item
        7A.  |   
|Item
        8.   |   
|Item
        9.   |   
|Item
        9A.  |   
|Item
        9B.  |   
|                 
|PART III          | 74
|Item
        10.  |   
|Item
        11.  |   
|Item
        12.  |   
|Item
        13.  |   
|Item
        14.  |   
|                 
|PART IV           | 76
|Item
        15.  |   
|                 
|SIGNATURES        | 81
|                 
|POWER OF ATTORNEY | 81

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PART I




All statements in this Annual Report on
Form 10-K that are not historical facts are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. 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 could differ materially from those anticipated in these forward-looking
statements as a result of many factors, including, but not limited to, the factors described under the caption Risk Factors and elsewhere
in this Annual Report on Form 10-K. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new
information becomes available or other events occur in the future.




In this Annual Report on Form 10-K,
unless the context indicates otherwise, The Princeton Review, the Company, we, us and our
refer to The Princeton Review, Inc. and its subsidiaries and predecessors.


|Item
1. |  | Business
|------- |  | --------



Overview




The Princeton Review provides
integrated classroom-based, print and online products and services that address the needs of students, parents, educators and educational institutions.
The Company was founded in 1981 by our Chairman and Chief Executive Officer, John Katzman, as an SAT preparation course. Today, based on our experience
in the test preparation industry, we now believe that we offer the leading SAT preparation course and are among the leading providers of test
preparation courses for most major post-secondary and graduate admissions tests. In 2005, the Company 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 over 1,500
locations throughout the United States and abroad.




Over the course of several years,
beginning in 1998, The Princeton Review has transformed itself from primarily a test preparation company to an integrated provider of standardized test
preparation, K-12-focused products and services and post-secondary admissions services. We launched our K-12 Services division; complemented our
traditional test preparation products with a range of online options; invested in and acquired new web-based admissions services capabilities and
generally broadened our offerings throughout our core markets. While we still derive more than half of our revenue from standardized test preparation,
the percentage of our revenue from our newer products and services has increased from 19% in 2001 to 38% in 2005 allowing us to become a more
diversified 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 as well as online test preparation courses. The Test Preparation Services division also provides tutoring and No Child Left
Behind (NCLB) Supplemental Education Services. Additionally, the division receives monthly royalties from its independent franchisees who provide
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-12 schools and school districts to help primary and secondary school students and teachers measurably improve academic
performance. With a strong conviction that Every Child Can Achieve 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 and web-based admissions products to higher education institutions. Admissions Services also provides post-secondary
counseling services and web-based products to secondary schools and school districts.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2


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The Company also authors more than 200
print and software titles on test preparation, academic admissions and related topics under the Princeton Review brand. Books are sold primarily
through Random House, Inc., from which the Company collects fees for advances, royalties and editing and marketing 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 Company posts the following filings as soon as reasonably practicable after they are electronically filed with or
furnished to the Securities and Exchange Commission: Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings on the
Investors web site are available free of charge.




Our Products and Services




Test Preparation Services Division




The Test Preparation Services division
provides test preparation services to students taking the 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)       |  |  |  | PSAT                                  
|USMLE (United
States Medical Licensing Examination) |  |  |  | SAT
II                                



Our Classroom-Based Course
Offerings




Our test preparation courses focus on
customer service and quality instruction. Our experienced teachers and tutors generally work with groups of 12 or fewer students in our SAT classes. We
have successfully updated all of our SAT products and materials to reflect the changes made to the SAT as of March 2005. Our GMAT and GRE classes
generally have no more than eight students in each class to maximize individual attention and grouping by similar ability. We have also completely
redesigned our LSAT course offerings to offer two options  one longer and more intensive, and one designed to maximize instruction over a shorter
time frame. In 2006, our GRE and MCAT 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 study materials and the advanced diagnostic analysis that our students receive. We spend significant
resources on research and development to enhance the supplemental materials used in our courses. As a result, each of our students receives in-depth
analytical materials, sample questions, testing drills, 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. We offer one-to-one, high-end admissions counseling and tutoring services for all of the admissions
tests. In addition, we provide individual assistance with academic subjects. Tutoring is chosen by students and parents who want customized instruction
from our very best instructors on a flexible schedule.




Our Online Course
Offerings




Our award-winning online courses are
fully interactive and are particularly attractive to students 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 have been remapped for use by all of our classroom-based
and tutoring students as well. Students can take tests, make up classes, or simply do extra work online on their own schedule. Our online tools have
enriched all of our products




3


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while providing more flexibility by
offering all Princeton Review students the ability to choose their best and most convenient way of learning as they go through our
programs.




Our School-Based
Offerings




In addition to offering our
standardized test preparation courses to individual students, we also offer our SAT, SAT II and ACT test preparation services to schools and districts
around the United States. The Princeton Review works with hundreds of such institutional clients to provide test preparation services to their
students. These clients range from remote private schools to large urban school districts and other sponsoring non-educational organizations. Our
institutional test preparation courses are custom designed to meet the needs of these institutional clients and their students. Using the same
materials and techniques, we train our own teachers and, occasionally, district teachers to deliver test preparation, remediation and enrichment to
districts of all demographics. We also offer extensive testing and professional development services.




Additionally, since 2003, our Test
Preparation Services division has teamed up with our K-12 Services 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 Test Preparation Services divisions teaching
professionals we deliver remediation and enrichment services directly to thousands of students in school districts throughout the country. Our
customized SES services offer students intensive, live instruction related to Math and English language arts (including reading) within a small group
setting. School-based services provide a significant growth opportunity in the coming years.




Our Test Preparation Publications
and Software




Examples of the books and educational
software products developed by the Test Preparation Services 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 been codified 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 administrators alike. Students who perform poorly can face
mandatory summer school, a repeated grade, or denial of a high school diploma. For teachers and school administrators, these tests exert strong
pressure on teaching and learning, and class or school performance increasingly affects the direction of their careers.




The K-12 Services division partners
with schools to help them meet these challenges and measurably improve academic performance. Recognizing that schools need a broad range of products
and services, we offer customized solutions that include formative and benchmarking assessments, professional development, and materials to support
after school programs. Research indicates that the synergy of effective assessments, improvements in teacher quality, and skill-specific,
standards-aligned instruction can significantly improve student performance, and our goal is to provide 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.




4


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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 school
district.




Assessments to Inform Instruction




We offer districts interim, low-stakes
assessments aligned to their curriculum and state standards. These instruments can be delivered in traditional paper and pencil format or online
through our Homeroom.com platform. Homeroom.com is a powerful, web-based tool that enables educators to quickly assess students academic
strengths and weaknesses while providing immediate feedback and tailored educational resources for improving performance. Results are provided in a
timely, 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 to guide instruction and for students and parents to provide meaningful guidance.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Connection to Learning Resources.  Teachers,
students and parents have access to specific resources based on actual areas of need. These resources include proprietary Princeton Review lessons and
direct links to web-based resources.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ties to Professional Development.  The
Princeton Review works with teachers and administrators to ensure that they understand the solution, and follows up with the instructional leadership
of the schools to review profiles of learning outlined by the data. In addition, The Princeton Review works with districts to provide parent
nights to help inform the community.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Professional Development




We provide ongoing, comprehensive
professional development to help teachers ensure the academic success of their students. Our professional development programs are ongoing in order to
continually build upon knowledge and to ensure proper implementation of skills and resources introduced throughout our sessions. Programs are flexible
and customized.




We offer three main professional
development programs:


| |  | Ongoing data-differentiated instruction and assessment
support.  We implement ongoing professional development programs that focus on using data in the classroom to drive individualized
instruction, with the ultimate goal being mastery in the classroom and improvements on state standardized tests. The Princeton Review works with
instructional leaders to help them learn how to interpret and use reports generated through The Princeton Reviews assessments, as well as from
their state standards test, to drive student instruction.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Individualized professional development
programs.  Using several data streams, from teacher self-evaluations to low stakes interim assessments, we create individualized
professional development for a districts staff. With this program, teachers work in an ongoing manner with a Princeton Review consultant who
helps each teacher focus instruction on the area of his or her students needs. Our consultants help each teacher evaluate data and reports
gathered from low-stakes assessments administered throughout the program and subsequently recommend individualized professional development in order to
expand each teachers knowledge of his or her students skill set.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Product Training.  Training is a crucial
component of any successful, comprehensive program. Every program The Princeton Review offers contains some form of training and/or staff
development.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



5


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Intervention Programs




We offer a comprehensive Math and
Reading off-the-shelf intervention program called SideStreets. SideStreets was designed to meet the needs of struggling students in grades 2 through 8.
SideStreets provides engaging, guided classroom instruction that reaches students at their levels. The program is uniquely designed to build
students essential skills, step-by-step, so under-performing students can move quickly towards proficiency.




Aligned to state and national
standards, SideStreets is suitable for during school, after school, extended day, summer school, and SES programs. Program components include a full
set of student and teacher materials that integrate assessment, instruction, and professional development. Prior to and during the program, certified
trainers work with clients to provide professional development 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 Review brand, 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 new applicants and manage the student recruitment process more efficiently. Additionally, we
work closely with high schools to aid them in the college and career counseling they deliver. Our goal is to guide students and parents through the
challenging transition from high school to college. We also guide college students to graduate or professional school programs, and offer career advice
services 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 education institutions, high schools, school districts and individual students and
parents.




Post Secondary
Institutions.  We sell academic institutions a broad range of marketing and web-based products on a subscription and transactional
basis.


| |  | Marketing Products and Services.  Colleges and
graduate schools may include an in-depth profile about their school in our books and on our web site for which the institutions pay us a subscription
fee. More importantly, we promote these institutions to students who match their profile. The institutions also pay us when these students request
further information.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Embark® Prospect Management Services.  We
provide a series of online services for colleges to help manage the admissions process and maximize their yield with prospective students. 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 their post-secondary counseling efforts by offering customizable packages of
services that include college counseling advisors, our college guidance books and a web-based college counseling support product




6


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| |  | Post-secondary Counseling Management
Tools.  Supported by a combination of online and print tools, we help districts set interim and outcome goals and track the progress of
their schools towards those goals.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Post-Secondary Counseling Support.  We provide
teams of specialists who provide professional development and counseling services on-line and/or in schools, supporting the efforts of school-based
counselors.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Princetonreview.com
visitors.  We attract students to Princetonreview.com by offering extensive, free useful tools and content. We leverage our high volume
of student site usage through our marketing relationships with post-secondary institutions, as well as by selling test preparation services to these
students.


| |  | School Information.  We provide detailed
information about colleges and graduate schools, including, in many cases, students opinions about faculty, workload, social life, sports and
more. This information is largely derived from our bestselling guidebooks.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Major, Career and Other Searches.  Through a
series of wizards or matching tools, we help 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 discuss college and graduate school admissions experiences, ask questions of students and administrators on campus, and
obtain advice from Princeton Review moderators.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Organization.  We help students keep track of
information about their prospective schools, 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 through company-operated locations and through our independent franchisees. Our franchisees provide these
test preparation courses and tutoring services under the Princeton Review brand within a specified territory, in accordance with franchise agreements
with us. The royalties paid to us by our franchisees are comprised of a general royalty ranging from 8%9.5% (starting in 2006) of their cash
receipts collected under the Princeton Review name, an additional royalty of 2% of the cash receipts of our domestic franchisees, which is allocated to
an advertising fund that we also contribute to, and a 10% fee for use by their students of our online supplemental course tools. Our franchisees also
purchase our course and marketing materials, which they use in conducting and promoting their classes. Royalties collected from our independent
franchisees and revenue from their purchases of materials together accounted for approximately 5% of our total 2005 revenue.




Our franchisees do not provide
Princeton Review Online courses. However, to the extent we provide our Princeton Review Online courses to customers residing within the exclusive
jurisdictions of our franchisees, we generally pay those franchisees a royalty of 10% of all of our revenue derived from selling Princeton Review
Online courses to students residing in their territories, net of certain administrative expenses. We have not entered into any such royalty
arrangements with our franchisees for our other web-based products and services.




7


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We have authorized certain of our
domestic franchisees to offer SES programs as part of their Princeton Review businesses, for which they pay us royalties in the same manner as for
other authorized courses. These franchisees paid a fee in 2005 to reimburse us for an allocated share of our SES development expenses. We have also
established contract terms with domestic franchisees relating to other live K-12 student instruction in their territories. If we offer these programs
in the franchisees territories, the terms give us the option to subcontract a customer agreement to the franchisee and pay the franchisee 85% of
the net program receipts or to deliver the program directly 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 offices under the Princeton Review name in the United States and 15 franchises with approximately 38
offices in 19 countries.




Our independently-owned domestic
franchisees currently provide test preparation courses and tutoring services in the following jurisdictions:







|              |  |  |  | Number of Counties |    |  |  | Number of Counties
|------------- |  |  |  | ------------------ | -- |  |  | ------------------
|California    |  |  |  |                    | 12 |  |  | New
Mexico        
|Colorado      |  |  |  |                    | 8  |  |  | New
York          
|Connecticut   |  |  |  |                    | 7  |  |  | Ohio              
|Florida       |  |  |  |                    | 57 |  |  | Pennsylvania      
|Massachusetts |  |  |  |                    | 4  |  |  | Rhode
Island      
|Michigan      |  |  |  |                    | 4  |  |  | Utah              
|Nevada        |  |  |  |                    | 1  |  |  |                   



Our independently-owned international
franchises are located in Egypt, India, Israel, Japan, Jordan, Lebanon, Malaysia, Mexico, Pakistan, Peoples Republic of China, the Philippines,
Saudi Arabia, Singapore, South Korea, Syria, Taiwan, Thailand, Turkey and The United Arab Emirates. We intend to continue to expand our international
presence through the sale, in the next several years, 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 by our former domestic franchisees, as more fully described below under Recent
Acquisitions. The majority of our domestic franchise agreements were renegotiated toward the end of 2005. We terminated 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 recover amounts owed and seek damages from the former franchisee. We opened a company-owned office to service that franchisees former
territory.




Recent Acquisitions




Franchise
Acquisitions




In the last several years, we completed
acquisitions of the businesses of a number of our former domestic franchisees.




In October, 2004, we completed a small
acquisition of the independent franchise that provided test preparation courses in Puerto Rico for a purchase price of approximately $130,000. In July
2003, we completed a small acquisition of 77% of Princeton Review of North Carolina, Inc., the independent franchise that provided test preparation
courses in North Carolina, for a purchase price of approximately $890,000, of which approximately $760,000 was financed with notes to the seller,
including imputed interest. In November 2003 we purchased the remaining 23% for approximately $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 assets of Princeton Review of St.
Louis, one of our franchisees that provided test preparation courses in Missouri, for a purchase price of approximately $850,000, of which
approximately $470,000 was financed with a note to the sellers. In June 2001, we




8


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acquired the assets comprising the
business of T.S.T.S., Inc., which offered test preparation courses in Texas, Arizona, Oklahoma, Louisiana and New Mexico under franchise agreements
with us, for a purchase price of approximately $6.3 million. We financed approximately $4.8 million of the purchase price under our then existing line
of credit and issued a subordinated promissory note to the seller for the remaining approximately $1.5 million. In March 2001, we acquired the assets
comprising the businesses of Princeton Review of Boston, Inc. and Princeton Review of New Jersey, Inc., at a combined purchase price of $13.8 million.
We financed approximately $10.2 million of the purchase price under our then existing line of credit and issued two subordinated promissory notes for
the remaining approximately $3.6 million. In March 2001, we also purchased the assets of another franchisee, Princeton Review Peninsula, Inc., for a
purchase price of approximately $2.7 million, which was financed through borrowings under our then existing line of credit. Princeton Review Peninsula
provided test preparation courses in several counties in California.




Embark




In October 2001, we acquired
substantially all of the operating assets of Embark.com, Inc., a developer 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 institutions and its technological
platform for submitting electronic applications and related services. The purchase price paid by us at closing consisted of 875,000 shares of our
common stock valued at approximately $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 revenue relating to customer contracts assumed by us, net of acquired receivables of
approximately $1.0 million. In accordance with the earn-out provisions entitling Embark to additional consideration based on the performance of the
acquired business, Embark earned a payment of 9,128 shares of our common stock and approximately $1.5 million in cash, based on the revenue performance
of the acquired business through June 30, 2003. In addition to the purchase price, in connection with the transaction, we made a $1.8 million loan to
Embark, which was secured by 300,000 of the shares of our common stock that Embark received as part of the purchase price. The approximate $1.5 million
earn-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 continue to include acquisitions that will help us further expand our product offerings or grow
geographically or other strategic alternatives, such as dispositions, reorganizations, recapitalizations or other similar transactions. We expect our
acquisition focus to be on companies with complementary products or services, including those businesses operated by our remaining domestic franchisees
that we can acquire on favorable terms. From time to time, we have made investments in businesses with which we wanted to build strategic
relationships, and we may do so in 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 on the recommendations of other students, parents, teachers and counselors. We also build awareness
of our brand and promote our products through relationships with other companies that publish and distribute our products, including Random House,
which publishes and distributes the books we author. We also utilize an institutional sales force within our K-12 division and engage in some national
and local advertising.




9


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In the last several years, we have
substantially increased our sales and marketing efforts in order 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 institutional test preparation offerings and our SES
programs. Our sales and marketing activities by division are as follows:




Test Preparation Services
Division.  Nationally, we use mass print media, conferences, direct mail 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, distribute posters and sponsor
school activities. We also conduct extensive free information sessions and practice tests to expose our products to our markets. Virtually everyone in
our regional offices is part of the sales force. They and our regional phone centers counsel students and parents regarding specific courses. Our
Princeton Review one-to-one admissions counseling and tutoring initiative is marketed to high-end customers utilizing a distinctive message and
dedicated marketing resources. Our Princeton Review Online products are marketed through electronic media and e-commerce partnerships, as well as
through our classroom course marketing efforts. We recently consolidated our school sales force into the K-12 Division; but continue to retain a sales
staff for our SES business. We expect that marketing to educational institutions will continue to constitute a major focus 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 districts through a number of channels, including national
conferences, direct mail, electronic media and telemarketing. Our K-12 Services division manages our company-wide sales and marketing force of
approximately 30 people. Homeroom is also integrated in the offerings of, and sold by, our business partners such as Plato Learning, Inc. and
SchoolNet.




Admissions Services
Division.  Admissions Services has a dedicated sales and marketing team of 12 people that primarily solicits post-secondary institutions
to purchase our products and services.




Product Design and Development




We believe that successful product
design, development and enhancement has been, and will continue to be, essential to the success of our business. We believe that the strength of our
reputation and brand name is directly attributable to the quality of our products and services, and expect to continue to devote significant resources
to enhancing our current products and services and 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 other education experts to create and refine the materials used in our Test
Preparation Services division. Our goal is to design and improve our products in such a way as to offer our students the best and most productive
overall experience, while addressing their preferences and fitting within their lifestyles. We seek to accomplish this by:


| |  | continually updating and enhancing our test preparation
materials and our teaching methods;
|- |  | -------------------------------------------------------------------------------------------

| |  | ensuring that our designated personnel take virtually every
major standardized test for 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 students can choose from to best fit their needs and achieve their goals.




10


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K-12 Services
Division.  We rely on a team of teachers, educational experts and developers to research, 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 student performance. Our focus in the K-12 Services division is to
continue to expand and refine our offerings to afford schools and school districts the highest degree of flexibility possible in the mix of products
they choose to purchase from us, while delivering measurable results. In 2005, we introduced SideStreets, an innovative off-the-shelf intervention
program, to supplement our customized programs.




Admissions Services
Division.  Since launching our Review.com (now www.PrincetonReview.com) web site in 1994, we have continually expanded the material
available and made improvements to its content and functionality. The online informational materials and tools are developed and enhanced by our
authors and design engineers, through strategic partnerships with third parties and through feedback from guidance and admissions counselors. We
regularly modify and enhance our web site to provide students, parents and guidance counselors with additional information and interactive tools
designed to assist them with the school selection, admissions and financial aid processes. We also continually strive to provide our educational
institution customers with more effective ways to reach 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 management solutions to provide our higher education institution
customers with the most technologically advanced and flexible products possible. Finally, our publications are frequently updated by our staff and
freelance authors and editors to ensure that new editions are up to date and include the most 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-12 Services division, the top two customers accounted for 56% and 59% of that divisions revenues
in 2005 and 2004, respectively.




Competition




The markets for our educational
products and services are highly competitive. Following is our competitive landscape, by division:




Test Preparation
Services Division.  Our Test Preparation Services division faces competition in standardized test preparation primarily from one other
established national company, Kaplan, Inc., a division of The Washington Post Company. We also face competition from many local and regional companies
that provide test preparation, career counseling and application assistance to students. In the SES market, national competitors include Edison
Schools, Platform Learning, Sylvan (a division of Educate, Inc.) and Kaplan, with many smaller providers competing with us on a local
level.




K-12 Services
Division.  Our K-12 Services division faces competition primarily from the four national textbook companies, Pearson Plc, Harcourt, Inc.
(an affiliate of Reed Elsevier Group Plc), Houghton Mifflin Company and McGraw-Hill Companies, some of which have acquired online and supplemental
providers.




Admissions
Services Division.  Our Admissions Services division provides a wide variety of products and services that face competition from a
variety of companies that, to different extents, provide products and services similar to ours for the higher education market. In particular, The
College Board, a non-for-profit membership association, provides a similar range 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;
|- |  | ------------------------------------------



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| |  | 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 trusted Princeton Review brand, our extensive experience in test preparation and admissions and our innovative,
high-quality educational products and services and our employees. We also believe that our ability to attract students, parents and educators to our
Princetonreview.com web site offers higher education institutions access to a large body of potential applicants and offers sponsors and merchandisers
an attractive source of potential consumers. However, some of our competitors may have more resources than we do, and they may be able to devote
greater resources than we can to the development, production and sale of their services and respond more quickly than we can to new technologies or
changes in the education marketplace. As a result, we may not be able to maintain our 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 other intellectual 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, products and services and the systems that
deliver 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 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 be available. Existing laws do not provide complete protection, and monitoring the unauthorized use of our intellectual property requires
significant resources. We cannot be sure that our efforts to protect our intellectual property rights will be adequate or that third parties will not
infringe or misappropriate these rights. In addition, there can be no assurance that competitors will not independently develop similar intellectual
property. If others are able to copy and use our products and delivery systems, we may not be able to maintain our competitive position. If litigation
is necessary to enforce our intellectual property rights or determine the scope of the proprietary 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 test preparation services and related publications and materials since 1982. In the past,
Princeton University did not object to our use, provided we used an express disclaimer of affiliation with the University in connection with most of
our uses. In February of 2005, we entered into an agreement with Princeton University under which it has agreed not to oppose or contest our use or
registration of these marks anywhere in the world and also to provide us consent and assistance where necessary to secure such registration, as long as
we include the disclaimer of affiliation with the University in the size and manner specified in the agreement and annually inform our employees 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 required to obtain licenses from others. There can be no assurance that we will be able to obtain
licenses on commercially reasonable terms or at all or that rights granted under any licenses will be valid and enforceable.




In addition, competitors and others may
claim that we have infringed their intellectual property rights. Defending any such lawsuit, whether with or without merit, could be time-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 use our products or be required to modify them, or we may have to pay financial damages. We have been subject to
infringement claims in the past and expect to be subject to legal proceedings and claims from time to time in the ordinary course of




12


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business, including claims of
alleged infringement of the 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 Trade Commission and with several state laws that regulate the offer and sale of franchises.
Federal and state franchise sales laws may apply to transfers and renewals of existing franchises in some circumstances. The FTCs Trade
Regulation Rule on Franchising, or the FTC Rule, and various state laws require that we (1) furnish prospective franchisees with a franchise offering
circular containing prescribed information; and (2) in some states, register the franchise offering before an offer is made.




Our existing franchise relationships
are subject to a number of state laws that regulate substantive 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 franchises within their borders and to their citizens. Although unlikely, U.S. federal and state franchise
regulation may be deemed applicable to our efforts to establish franchises abroad. Failure to comply with these laws could limit or preclude our
ability to expand internationally through franchising.




To date, these laws have not precluded
us from seeking franchisees in any given area and have not had a material adverse effect on our operations. However, compliance with federal, state and
international franchise laws can be costly and time consuming, and we cannot be certain that we will 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 and editorial, 65 in administration, finance, legal and human resources, 74 in information systems, 27 in
marketing, 36 in sales, 112 in customer support and 246 in our regional offices performing multiple tasks, including sales, administrative, and
teaching functions. In addition, we had approximately 2,900 part-time employees, comprised mainly of teachers.




None of our employees are covered by a
collective bargaining agreement. We consider our employee relations to be good.




Our Restructuring




The Company recently completed a
restructuring in order to recognize certain operational efficiencies from our corporate structure. Effective January 1, 2005, we merged four of our six
subsidiaries with and into The Princeton Review, Inc.




Segment Information




For financial information relating to
our operating divisions by business segment, see Note 13 to 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 other information contained in this Annual Report on Form 10-K before making an investment decision
with respect to our common stock. Any of the following risks, as well as other risks and uncertainties described in this




13


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Annual Report on Form 10-K, could
harm our business, financial condition and results of operations and could adversely affect the value of our common stock.




Risks Related to Our Business




We have a recent history of significant operating losses and
may not be able to achieve sustained profitability if we are unable to increase revenue from our newer products and services and successfully implement
a number of new initiatives, in which case we could experience an adverse change in the market price of our common stock.




Over the last few years, the Company
has invested heavily in the expansion of existing business lines and the development of new businesses. These investments, combined with Sarbanes-Oxley
compliance costs and rising overhead expense, have driven losses in two of our last three fiscal years. We have incurred net losses of approximately
$3.5 million and $30.4 million for the years ended December 31, 2005 and 2004, respectively. As of December 31, 2005, we had an accumulated deficit of
approximately $65.4 million.




In order to achieve sustained
profitability we will need to implement changes to existing business processes, significantly reduce overhead expense and drive profitable revenue
growth in our K-12 Services Division. The Company is in the initial stages of a company-wide re-engineering effort to reduce our overhead, continue to
improve our internal control management process and upgrade or replace certain critical business systems.




If we are unable to achieve these
objectives, we may fail to achieve or sustain profitability in subsequent periods, in which case the market price of our common stock may be adversely
affected.




If colleges and universities reduce their reliance on
standardized admissions tests or there is a substantial reduction in the emphasis placed by federal and state governments on assessment and remediation
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 use of standardized tests. If the use of standardized tests declines or falls out of favor with
educational institutions or state and local governments, the markets for many of our products and services will deteriorate and our business will be
materially adversely affected. Additionally, the SES market, which is serviced by our Test Preparation Services division, is dependent on the
availability of federal funding under NCLB. A substantial reduction in funds available for SES programs under this Act could have an adverse effect on
our operating results.




Our contracts with schools, school districts, municipal
agencies and other governmental bodies present several risks, including the nature and timing of revenue recognition which combined with fixed 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 and more large, multiple element contracts with schools, school districts, municipal agencies, and
other governmental bodies, requiring us to deliver a combination of products and services, including online and print-based assessment, professional
development, and face-to-face instruction. These contracts present several types of risks and uncertainties.




The approval processes of some of our
customers in this area, which are required for formal contract execution, are lengthy and cumbersome and, in many cases, are not completed prior to the
time we begin performance. This means that we, at times, incur substantial costs prior to the formal execution of these agreements by the customer.
While to date we have found that, following the award of the contract to us, final approval required for the customer to sign the agreement is usually
a formality, our revenue recognition policies preclude us from recognizing revenue from these contracts until there is a final agreement binding on the
customer. Costs, however, are recorded as incurred, whether or not the contract is signed. While we do not incur significant costs until we are awarded
a project and we do




14


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everything possible to expedite the
formal execution of these agreements by the customer, the timing of this final step is outside our control. Until we complete our transition over to a
school-based fiscal year our current calendar-based fiscal year makes it more difficult for us to forecast quarterly revenue streams from these
contracts. This may make it more difficult for us to deliver operating results in line with analysts forecasts, and could therefore adversely
affect our stock price.




Because our customers are unable to
begin payment for services until formal approval of the agreement, this delay in formal contract execution may also cause our cash balances to
fluctuate significantly from period to period and may expose us to credit risk. We believe that we may be able to recover monies owed from a customer
for which we have performed services but who fails to render payment in the absence of a signed contract based on several legal theories designed to
prevent unjust enrichment. However, this basis of recovery may not be available in all jurisdictions where we enter into these contracts, or may limit
our recovery with respect to amounts or timing. Accordingly, the absence of a signed agreement may, depending on the laws of the applicable
jurisdiction, make it substantially more difficult or impossible for us to recover sums due to us under these agreements. While we have not experienced
a default by a customer under such circumstances to date, and believe that the nature of the parties with which we are contracting makes such a default
less likely, it is a possibility that such circumstances may arise in the future with respect to one or more of these contracts.




We face intense competition that could adversely affect our
revenue, profitability and market share.




The markets for our products and
services are highly competitive, and we expect increased competition 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 assessment and supplemental products and services to districts and states in the highly competitive K-12 market; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | companies that offer both face-to-face and web-based products
and services to assist individuals and educational organizations with counseling, marketing and student applications.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Some of our competitors may have more
resources than we do. These competitors may be able to devote greater resources than we can to the development, promotion and sale of their services
and respond more quickly than we can to new technologies or changes in customer preferences. We may not be able to maintain our competitive position or
otherwise compete effectively with current or future competitors, especially those with significantly greater resources.




Some of our competitors that provide
K-12 educational products and services may have more experience, larger customer bases and greater brand recognition in that market. Further,
established companies with high brand recognition and extensive experience providing various educational products to the K-12 market may develop
products and services that are competitive with ours.




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 services to educational institutions, including our K-12 Services divisions offerings, high school
counseling products, SES programs and institutional test preparation offerings. Our ability to generate revenue from these sources may be adversely
affected by decreased government funding of education. Public school funding is heavily dependent on support from federal, state and local governments
and is sensitive to government budgets. In addition, the government appropriations process is often slow and unpredictable. Funding difficulties also
could cause schools to be more resistant to price increases in our products, compared to other businesses that might be better able to pass on price
increases to their customers.




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While we believe we currently have
adequate internal control over financial reporting, we are required to assess our internal control over financial reporting on an annual basis and any
future adverse results from such assessment could result in a loss of investor confidence in our financial reports and have an adverse effect on our
stock price.




Pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002 (Section 404), and the rules and regulations promulgated by the SEC to implement Section 404, we are required to
include in our Form 10-K an annual report by our management regarding the effectiveness of our internal control over financial reporting. The report
includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year.
This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by
management.




Managements assessment of
internal control over financial reporting requires management to make subjective judgments and our auditors, who are required to issue an audit report
covering our internal control over financial reporting, may not agree with managements assessment. As of December 31, 2004, our internal control
over financial reporting was ineffective due to the presence of material weaknesses. We invested significant resources to help drive process
improvements and strengthen internal control. As a result, as more fully described in Section 9.A of this Annual Report on Form 10-K, we currently
believe our internal control over financial reporting is effective as of December 31, 2005. However, the effectiveness of our internal control over
financial reporting in future periods is subject to the risk that our controls may again become inadequate or may otherwise
deteriorate.




If we are unable to assert that our
internal control over financial reporting is effective in any future period (or if our auditors disagree with us or are unable to express an opinion on
the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which may
have an adverse effect on our stock price.




Our business is subject to seasonal fluctuations, which may
cause our operating results to fluctuate from quarter to quarter. This may result in volatility or adversely affect our stock
price.




We experience, and expect to continue
to experience, seasonal fluctuations in our revenue because the markets in which we operate are subject to seasonal fluctuations based on the scheduled
dates for standardized admissions tests and the typical school year. These fluctuations could result in volatility or adversely affect our stock price.
We typically generate the largest portion of our test preparation revenue in the third quarter. However, as SES revenues increase, we expect to
recognize these revenues primarily in the first and fourth quarters. The electronic application revenue 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 academic institutions. Our
K-12 Services division experiences seasonal fluctuations in revenue, with the first and fourth quarters (corresponding to the school year) expected to
have the highest revenue.




Our quarterly operating results are not indicative of future
performance and are difficult to forecast.




Our quarterly operating results may not
meet expectations of public market analysts or investors, which could cause our stock price to decline. In addition to the seasonal fluctuations
described above, our operating results may vary from quarter to quarter in response to a variety of other 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
|- |  | ---------------------------------------------------------



16


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| |  | 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 results may not be indicative of our future performance and you should not rely on them to predict the
future performance of our stock price. In addition, our past results may not be indicative of future performance because several of our businesses were
introduced or acquired relatively recently.




Loss of significant customers could significantly adversely
affect our revenue or cause disruptions in our operations.




As the business of our K-12 Services
division has evolved, the contracts entered into with school districts have generally increased in size. As a result, two customers accounted for 56%
and 59% of that divisions revenue in 2005 and 2004, respectively. The loss of one or more such customers could significantly adversely affect our
revenue. Additionally, we rely on Random House as the publisher and distributor of all of the books we write. Royalties and other fees from books
authored by us and published and distributed by Random House represented approximately 3% of our revenue in each of 2005 and 2004. Accordingly,
termination of our relationship with Random House could 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 to changes in technology, our future revenue growth could be adversely affected.




If our improvement and adaptation of
our web-based products and services is delayed, results in systems interruptions or is not aligned with market expectations or preferences, our revenue
growth could be adversely affected. The online environment is rapidly evolving, and the technology used in web-based products changes quickly. We must
therefore be able to quickly modify our solutions to adapt to emerging online standards and practices, technological advances, and changing user and
sponsor preferences. Ongoing enhancement of our web site, web-based products and related technology will entail significant expense and technical risk.
We may use new technologies ineffectively or fail to adapt our web site, web-based products and related technology on a timely and cost-effective
basis.




If our domestic franchisees contest our interpretation of our
agreements with them, our ability to offer our products in the domestic franchisees territories could be adversely affected, which could
adversely affect our revenue.




If our domestic franchisees contest our
interpretation of our rights and obligations under our existing agreements with them, then our ability to deliver our products and services within
their franchise territories could be hindered, and our revenue could be adversely affected. Through a series of franchise agreements and other
agreements, our independent franchisees have various rights to provide test preparation products and services under the Princeton Review brand within
specified territories, and to use our trademarks and other intellectual property in connection with providing these services. Similarly, we have
various rights to market and sell our products and services in the franchisees territories. Our agreements have been reviewed and renegotiated to
accommodate our business goals and the goals of our franchisees as they have both developed over the years.




If we do not adequately protect the intellectual property
rights to our products and services, we may lose these rights and our business may suffer materially.




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 that
deliver 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
services from those of our competitors. If others are able to copy, use and market these products and delivery systems, then we may not be able to
maintain our competitive position. Despite our best efforts, we cannot assure you that our intellectual




17


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property rights will not be
infringed, violated or legally imitated. Existing laws do not provide complete protection and policing the unauthorized use of our products and
services requires significant resources.




If our products and services infringe the intellectual
property rights of others, this may result in costly litigation or the loss of our own intellectual property rights, which could materially adversely
affect our business.




Competitors and others have claimed and
may claim in the future that we have infringed their intellectual property rights. The defense of any lawsuit, whether with or without merit, could be
time-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 could materially adversely affect our business.




We may be held liable for the content of materials that we
author, content available on our web site or products sold through our web site.




We may be subject to claims for
defamation, negligence, copyright or trademark infringement or other legal theories based on the content of materials that we author, and content that
is published on or downloaded from our web sites, accessible from our web sites through links to other web sites or posted by our users in chat rooms
or bulletin boards. These types of claims have been brought, 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 this type, such as trademark infringement or defamation,
or may not be adequate to cover all costs incurred 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 management personnel and financial resources. Further, if print
publications that we author contain material that customers find objectionable, these publications may have to be recalled, which could result in lost
revenue and adverse publicity.




The loss of our senior management could have a material
adverse effect on our business.




We depend on the continued service of
our senior management. The loss of any of our Chief Executive Officer, John Katzman, our President and Chief Operating 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 franchisees and from sales of our course and marketing materials to these franchisees. The quality of
franchised test preparation operations may be diminished if our franchisees do not successfully provide test preparation services in a manner
consistent with our standards and requirements, or do not hire and train qualified managers or instructors. As a result, our image and reputation may
suffer 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 expand internationally through
franchising.




Applicable laws may delay or prevent us
from terminating an unproductive franchise or withholding consent to renewal or transfer of a franchise, which could have an adverse effect on
franchise royalties. We are subject to both federal and state laws regulating the offer and sale of franchises. These laws also frequently apply
substantive standards to the relationship between franchisor and franchisee and limit the ability of a franchisor to terminate or refuse to renew a
franchise. Some foreign countries also have laws affecting the offer and sale of franchises within their borders and to their citizens and U.S. federal
and state franchise regulation may be applicable to our efforts to establish franchises abroad. Failure to comply with these laws could limit or
preclude our ability to expand internationally through franchising.




Compliance with federal, state and
international franchise laws can be costly and time consuming, and we cannot be certain that we will not encounter delays, expenses or other
difficulties in this area. Further, the nature and effect of any future legislation or regulation of our franchise operations cannot be
predicted.




18


---



If we are unable to obtain additional capital, our business
may be adversely affected.




We currently expect to secure a
revolving line of credit to support our working capital requirements. In the future, we may require substantial additional capital to finance ongoing
operations 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, we may need to raise additional funds.




We cannot be certain that we will be
able to obtain needed financing on favorable terms. If we fail to raise additional funds, we may need to sell debt or additional equity securities or
to reduce our growth to a level that can be supported by our cash flow. Without additional capital, we may 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 our franchisees over the last five years, we recorded a total of approximately $33.4 million of
goodwill. Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets, requires goodwill and other
intangible assets that have an indefinite useful life to be reviewed at least annually for impairment. To the extent these assets are deemed to be
impaired, they must be written down. At December 31, 2004, we wrote down $8.2 million in goodwill associated with our acquisition of Embark, due to the
Admission Services divisions poor performance. Any future write down of goodwill, while noncash, would similarly adversely affect our operating
results. As of December 31, 2005, we had unamortized goodwill of $23.6 million related to these 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 detrimental effect on the
price of our common stock. If any acquisitions are not successfully integrated with our 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 that
could have a detrimental effect on our financial condition, results of operations or the price of our common stock, including:


| |  | issuing equity securities or convertible debt securities, which
would dilute current stockholders 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 related charges 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;
|- |  | --------------------------------------------------------------------------------



19


---

| |  | 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, made substantial enhancements to our existing products and consummated several acquisitions. At December
31, 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 continue to place, significant demands on our management, and strain our operational, financial and
technological resources. We expect that further expansion of our operations will be required to successfully implement our business strategy, including
the continued enhancement of our product and service offerings. In order to manage our growth effectively, we must drive business process improvement,
reduce our overhead costs, replace and or upgrade several significant systems and continue implementing internal control procedures and controls. If we
fail to achieve these objectives our business could be materially and adversely affected.




We may undertake divestitures that may limit our ability to
manage and maintain our business and may adversely affect our business.




In the future, we may undertake sales
or other strategic dispositions of certain businesses or operations to attempt to maximize stockholder value. These transactions involve a number of
risks, including:


| |  | Diversion of management attention and transaction costs
associated with negotiating and closing the transaction;
|- |  | ----------------------------------------------------------------------------------------------------------------

| |  | Inability to retain customers, management, key personnel and
other employees due to the 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 selling it 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 a liability 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 we use to provide our classroom-based services. In the event of on-site accidents, injuries or
other harm to students, we could face claims alleging that we were negligent, provided inadequate supervision 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, we
may not be able to obtain liability insurance in the future at reasonable prices or at all. A successful liability claim could adversely affect our
reputation and our financial results. Even if unsuccessful, such a claim could cause unfavorable publicity, entail substantial expense and divert the
time and attention of key management personnel.




If we experience system failures, our reputation may be harmed
and users may seek alternate service providers causing us to lose revenue.




If our primary and backup computer
systems were to fail or be disrupted, our services could be interrupted and we may lose revenue and future business. We depend on the efficient and
uninterrupted operation of our computer and communications hardware and software systems. These systems and operations are vulnerable to damage or
interruption from floods, fires and power loss and similar events, as well as computer viruses, break-ins, sabotage, intentional acts of terrorism,
vandalism and other misconduct and disruptions or delays occurring throughout the Internet network infrastructure. Although all of our material systems
are redundant, short-term service interruptions may take place if our primary systems were to fail or be disrupted and we are forced to transition to
backup systems. All of




20


---



our computer hardware necessary for
our online operations is currently located at a professional datacenter in White Plains, NY. This facility has redundancy for power, A/C and internet
access. Accordingly, our online operations are dependent on our ability to maintain our systems in effective working order and to protect them from
disruptive events. We do not have a formal disaster recovery plan, and our insurance policies may not adequately compensate us for any losses that may
occur due to failures of or interruptions in our systems.




In addition, the system failures of
third party Internet service providers could produce interruptions in our service for those users who access our services through these third party
providers. Service interruptions could reduce our revenue and our future revenue will be harmed if our 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 of our revenue could be reduced or limited.




If use of our web site infrastructure
increases beyond our capacity, customers may experience delays and interruptions in service. As a result, they may seek the products and services of
our competitors and the growth of our revenue could be reduced or limited. Because we seek to generate a high volume of traffic and accommodate a large
number of customers on our web site, the satisfactory performance, reliability and availability of our web site, processing systems and network
infrastructure are critical to our reputation and our ability to serve our customers. If use 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 had a material
effect on our results of operations to date, our web sites have in the past and may in the future experience slower response times due to increased
traffic.




Future regulations or the interpretation of existing laws
pertaining to the Internet could decrease the 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 of existing laws, could increase our cost of doing business, decrease the demand for our products
and services, or otherwise harm our business. We must comply with a variety of federal and state laws affecting the content of materials distributed
over the Internet, as well as regulations and other laws restricting the collection, use and disclosure of personal information that we may obtain in
the course of providing our online services. In particular, we must comply with the Childrens Online Privacy Protection Act, which, as
implemented, mandates that we obtain verifiable, informed parental consent before we collect, use or disclose personal information from children under
the age of 13. Future laws or regulations may relate to information retrieved from or transmitted over the Internet, consumer protection, online
content, user privacy, taxation and the quality of products and services. Compliance with future laws and regulations, or existing laws as they may be
interpreted 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 a number of security systems for our services to protect this information from unauthorized
use or access. If the security measures that we use to protect personal information or credit card information are ineffective, we may be subject to
liability, including claims for invasion of privacy, impersonation, unauthorized purchases with credit card information or other similar claims. In
addition, the Federal Trade Commission and several states have investigated the use of personal information by certain Internet companies. We could
incur significant expenses if new regulations regarding the use of personal information are introduced or if our privacy practices are
investigated.




21


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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 our stockholders.




Since our initial public offering in
2001, the market price of our common stock has been volatile, 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 been volatile, and have experienced fluctuations that often have been unrelated to or disproportionate to
the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our stock. In the past,
securities class action lawsuits alleging fraud have often been filed against a company following periods of volatility in the market price of its
securities. In the future, we may be the target of similar lawsuits. If a lawsuit were to be filed against us, it could result in substantial costs and
the diversion of our managements attention and resources, which could seriously harm our financial results or result in a decline in the market
price of our common stock. Declines in the market price of our common stock could also harm employee morale and retention, our ability to attract
qualified employees and our access to capital.




We have anti-takeover protections, which may discourage or
prevent a takeover of us, even if an acquisition would be beneficial to our stockholders.




Certain provisions of our certificate
of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for another company to acquire us, even if a takeover
would benefit our stockholders. The provisions in our corporate documents:


| |  | authorize the issuance of blank check preferred
stock that could be issued by our board of directors to increase the number of outstanding shares, making a takeover more difficult and
expensive;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | establish a staggered board of directors, so that it would take
three successive annual meetings to replace all directors;
|- |  | --------------------------------------------------------------------------------------------------------------------------

| |  | prohibit cumulative voting in the election of directors, which
would otherwise allow less 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 stockholder actions to be taken at a meeting of our stockholders; and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------

| |  | establish advance notice requirements for nominations for
election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



22


---



In addition, Section 203 of the
Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in our control, which may depress
the market price of our common stock.




Concentration of ownership among our existing executive
officers and directors may make it more difficult for other stockholders to influence significant corporate decisions and may hinder a change of
control.




As of March 10, 2006, our present
directors and executive officers and their affiliates beneficially owned approximately 35% of our outstanding common stock. In particular, John S.
Katzman, our Chief Executive Officer, beneficially owned approximately 32% of our outstanding common stock. This concentration of ownership may make it
more difficult for other stockholders to influence matters requiring stockholder approval and may have the effect of delaying, preventing or deterring
a change in control of our company, thereby possibly depriving our stockholders of an opportunity 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.




On June 4, 2004, we completed a private
placement to Fletcher International, Ltd. of 10,000 shares of our Series B-1 Cumulative Convertible Preferred Stock (the Series B-1 Preferred
Stock) for $10 million in the aggregate. Dividends on the Series B-1 Preferred Stock are payable quarterly, at our option in cash or registered
shares of our common stock, at a minimum rate of 5% per annum. The Series B-1 Preferred Stock is convertible into 1,007,303 shares of our common stock
at a conversion price of $9.9275 per share, subject to adjustment upon certain events. Fletcher may also redeem its shares of the Series B-1 Preferred
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 an amount of shares of our common stock based upon a redemption rate equal to 102.5% of the then prevailing price of our common
stock plus the value of any accrued and unpaid dividends. Fletcher also has the right, for a period of twenty-four months, beginning on July 1, 2005,
to purchase up to $20 million in newly created series of preferred stock having, except as set forth in our agreement with Fletcher, similar terms,
conditions, rights, preferences and privileges as the Series B-1 Preferred Stock (the Additional Preferred Stock). The Additional Preferred
Stock will be convertible into shares of our common stock at a conversion price equal 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 resales 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




23


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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.


|Item
1B. |  | Unresolved Staff Comments
|-------- |  | -------------------------



None.


|Item
2. |  | Properties
|------- |  | ----------



Our headquarters are located in New
York, New York, where we lease approximately 30,000 square feet of office space under a lease that expires on December 31, 2014. As of December 31,
2005, we also leased an aggregate of approximately 229,000 square feet of office space for additional operations in New York, New York and our 55
regional offices or classroom locations located in Alabama, 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 of on-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, CollegeNet dismissed the 2003 case without prejudice on January 9, 2004 against the Company. Thereafter, on August 2, 2005, the
Federal Circuit Court of Appeals issued an opinion favorable to CollegeNet from its appeal from the adverse rulings. Then on August 3, 2005, CollegeNet
filed suit again against the Company alleging an infringement of the same CollegeNet patent related to processing on-line applications. The Company was
served on November 22, 2005 and filed its answer and counterclaim on January 13, 2006. CollegeNet seeks injunctive relief and unspecified monetary
damages. Because this proceeding is at a very preliminary stage, we are unable to predict its outcome with any degree of certainty. However, the
Company believes that it has meritorious defenses to CollegeNets claims of infringement and intends to vigorously defend. In a related matter,
the Company filed a request with the United Stated Patent and Trademark Office (PTO) for ex parte reexaminations of the CollegeNet 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 all claims of the CollegeNet ‘042 patent on October 31, 2005 and the CollegeNet ‘045
patent on January 27, 2006.




On August 29, 2005, Test Services, Inc.
(TSI), a franchisee of the Company under ten separate franchise agreements, six of which expired on December 31, 2005, filed suit against
us in the United States District Court for the District of Colorado. TSI alleged that the terms we offered for renewal of the franchise relationship
did not comply with TSIs contractual renewal rights. TSI sought declaratory relief and specific performance and unspecified damages as to the
alleged breaches of the renewal provisions. TSIs complaint also included claims that we had breached 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 the
core renewal dispute. On December 31, 2005, we entered into a settlement in which: (1) TSI agreed to execute a new franchise agreement for each of its
ten franchise territories with certain negotiated changes; (2) TSI paid us $1 million in cash; (3) we, TSI and TSIs parent company agreed on
certain terms regarding competitive activities by the parent company, a potential spin-off of TSI, and a TPR option to acquire TSI at a formula value
in certain circumstances; TSI agreed to increase royalty payments to us from 8% to 9-1/2% (beginning January 1, 2006); and (4) all litigation was
dismissed with prejudice and the parties exchanged releases as to all matters except amounts payable in the ordinary course of business under the
superseded franchise agreements.




24


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In addition to the foregoing, from time
to time, we are involved in legal proceedings incidental to the conduct of our business, none of which is likely to have a material adverse effect 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 the fiscal 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




Our common stock trades on the NASDAQ
National Market under the symbol REVU. The following table sets forth, for the periods indicated, the high and low sales prices per share
of our common stock as reported on the NASDAQ National Market.







|       |  |  |  | 2005 |      | 2004 | 
|------ |  |  |  | ---- | ---- | ---- | 
|
|First  |  |  |  | $    | 6.14 |      | 
|Second |  |  |  |      | 5.95 |      | 
|Third  |  |  |  |      | 6.25 |      | 
|Fourth |  |  |  |      | 6.03 |      | 



As of March 10, 2006, the last reported
sale price of our common stock on the NASDAQ National Market was $5.50 per share. As of March 10, 2006, there were 71 stockholders of record of our
common stock. This does not include the number of persons whose stock is in nominee or street name accounts through
brokers.




Dividend Policy




We have never declared or paid any cash
dividends on our common stock and we do not intend to pay any cash dividends with respect to our common stock in the foreseeable future. We currently
intend 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 our board of directors and will depend upon our financial condition, operating results, capital requirements
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 2000 Stock Incentive Plan:







|Plan category        |  |  |  | Number of securities to be issued upon
exercise of outstanding options, warrants and rights |           | Weighted-average exercise price of outstanding
options, warrants and rights |  | Number of securities remaining available for
future issuance
|-------------------- |  |  |  | ------------------------------------------------------------------------------------------- | --------- | --------------------------------------------------------------------------- |  | ------------------------------------------------------------
|Stock Incentive
Plan |  |  |  |                                                                                             | 3,299,881 |                                                                             |  | $                                                           

|Item
6. |  | Selected Consolidated Financial Data
|------- |  | ------------------------------------



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 been derived from our audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. 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 has
been derived




25


---



from our audited consolidated
financial statements which are not included in this Annual Report on Form 10-K. The information shown below is qualified by reference to and should be
read together with our consolidated financial statements and their notes and Managements Discussion and Analysis of Financial Condition and
Results of Operations included elsewhere in this Annual Report on Form 10-K. We have calculated the weighted average shares used in computing net
income (loss) per share as described in Note 1 to our consolidated financial statements.







|                                                                      |  |  |  | Years Ended December 31, |        
|--------------------------------------------------------------------- |  |  |  | ------------------------ | -------
|
|
|Statement
of Operations Data:                                         |  |  |  |                          |        
|Revenue                                                               |  |  |  |                          |        
|Test
Preparation Services                                             |  |  |  | $                        | 87,310 
|K-12
Services                                                         |  |  |  |                          | 31,931 
|Admissions
Services                                                   |  |  |  |                          | 11,252 
|Total
Revenue                                                         |  |  |  |                          | 130,493
|Cost of
revenue                                                       |  |  |  |                          |        
|Test
Preparation Services                                             |  |  |  |                          | 28,144 
|K-12
Services                                                         |  |  |  |                          | 16,838 
|Admissions
Services                                                   |  |  |  |                          | 4,615  
|Total cost of
revenue                                                 |  |  |  |                          | 49,597 
|Gross
profit                                                          |  |  |  |                          | 80,896 
|Operating
expenses                                                    |  |  |  |                          |        
|Selling,
general and administrative                                   |  |  |  |                          | 85,144 
|Impairment of
goodwill                                                |  |  |  |                          |       
|Loss on early
extinguishment of debt                                  |  |  |  |                          |       
|Impairment of
investment                                              |  |  |  |                          |       
|Total
operating expenses                                              |  |  |  |                          | 85,144 
|Income (loss)
from operations                                         |  |  |  |                          | (4,248 
|Net income
(loss)                                                     |  |  |  |                          | (3,474 
|Accreted
dividends on Series A redeemable preferred stock             |  |  |  |                          |       
|Accreted
dividends on Class B non-voting common stock                 |  |  |  |                          |       
|Dividend and
accretion on Series-B preferred stock                    |  |  |  |                          | (854   
|Net income
(loss) attributed to common stockholders                   |  |  |  | $                        | (4,328 
|Basic income
(loss) per share                                         |  |  |  | $                        | (0.16  
|Diluted
income (loss) per share                                       |  |  |  | $                        | (0.16  
|Weighted
average shares used in computing net income (loss) per share |  |  |  |                          |        
|Basic                                                                 |  |  |  |                          | 27,570 
|Diluted                                                               |  |  |  |                          | 27,570 



26


---






|                                       |  |  |  | As of December 31, |        
|-------------------------------------- |  |  |  | ------------------ | -------
|
|
|Balance
Sheet Data:                    |  |  |  |                    |        
|Cash and cash
equivalents              |  |  |  | $                  | 8,002  
|Total
assets                           |  |  |  |                    | 105,371
|Long-term
debt, net of current portion |  |  |  |                    | 2,845  
|Series B-1
preferred stock             |  |  |  |                    | 10,000 
|Stockholders equity                   |  |  |  |                    | 50,846 








Period-to-period comparability of the
above Selected Consolidated Financial Data is affected by the following:




In 2005, as part of the franchise
renewal process, four of our franchisees licensed the right to 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 related to Embark, and recorded a reserve against our deferred tax asset, in the form of a valuation
allowance, 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, Princeton Review 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 operations should be read in conjunction with our consolidated financial statements and the related notes
included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially 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 Annual Report 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 integrated
classroom-based and online instruction, professional development for teachers and educators, print and online materials and lessons, and higher
education marketing and admissions management. We operate our businesses through three divisions, which correspond to our business
segments.




The Test Preparation Services division
derives the majority of its revenue from classroom-based and Princeton Review Online test preparation courses and tutoring services. Additionally, Test
Preparation Services receives royalties from its independent franchises who provide classroom-based courses under the Princeton Review brand. Since
2004, this division has also been providing SES programs to students in public school districts. This division has historically 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 in response to the increased emphasis on state assessments, and institutional sales, which is partially attributed to
the




27


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new SAT test introduced in 2005.
Tutoring and retail classroom revenues also 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 related
products) and face-to-face instruction. As a result of the increased emphasis on accountability and the measurement of student performance in public
schools in this country and the centralization of school districts purchasing of assessment, professional development and supplemental
educational products and services, this division continues to see growing demand by the public school market for its products. During 2005 K-12
Services introduced its SideStreets after-school intervention materials. We believe this material will allow us to be more responsive to school
districts needs and less reliant on providing custom made content.




The K-12 Services division experienced
revenue growth of 14%, as compared to 2004 levels. As this division has grown over the last several years, we have begun to enter into more and more
large, multiple element contracts with schools, school districts, municipal agencies, and other governmental bodies, requiring us to deliver a
combination of products and services, including online and print-based assessment, professional development, and face-to-face instruction. The approval
processes of some of our customers in this area, which are required for formal contract execution, are lengthy and cumbersome. These contracts
therefore present several types of risks and uncertainties, including reducing our ability to effectively predict our operating performance, increasing
variability in our cash balances and increasing credit risk. These risks and uncertainties 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 difficult to predict accurately, due to the foregoing factors and the fact that each contract entered
into by this division has its own, unique product mix. Because our various products in this division have different gross margins (professional
development and live course instruction products typically have lower gross margins than fees for assessment products and printed materials), contracts
with varying product mix could significantly alter this divisions operating results from period to period. 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 of web-based admissions and application management products and marketing services to educational
institutions. In 2005, this division represented 9% of our overall revenue.




In 2005, the divisions
performance was again below managements expectations, primarily due to a lack of increase in demand for subscription-based admissions and
application management services. For the third consecutive year, revenue in this division did not grow appreciably over the prior
year.




We are currently in the process of
refocusing this divisions overall direction, with the goal of changing the way we charge post-secondary academic institutions for our marketing
services. We are moving from a model of pricing for various bundles of marketing services, to a model where payment is based upon actual leads we
generate. We believe this model will allow us to better capitalize on the popularity of our web site with college and graduate school-bound students.
To support this change in our marketing services model, we re-launched our web site with a view to optimizing our ability to match the right prospects
with the post-secondary institutions looking to attract them. Additionally, we expanded our counseling services in this division by signing a
multi-year contract with several schools in Texas. We believe that we will need to further increase revenues before this division will show sustainable
operating profits, and it is managements hope that this new direction of providing lead generation and college counseling services will provide
the needed momentum to do so.




Revenue




Test Preparation
Services.  The Test Preparation Services division derives revenue primarily from:


| |  | classroom-based and online test preparation courses and tutoring
services, which consists of tuition and fees paid to our company-operated sites. We recognize revenue from tuition paid for our
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | courses over the life of the course, which is usually from five
to 10 weeks depending on the course type. Tutoring revenue is based on an hourly fee and is recognized as the services are delivered. Course and
tutoring revenue represented approximately 49% of our total revenue in 2005.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SES programs, which consist of after school courses taught
primarily in the K-12 grades. We are typically paid for these courses on a per-student basis, and recognize the revenue over the life of the courses.
SES revenue represented approximately 3% of our total revenue in 2005.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | royalty fees paid to us by our independent franchisees. These
royalties in 2005 are 8% of all cash receipts collected by our franchisees for all test preparation and tutoring services performed by them under the
Princeton Review name. Royalties received from franchisees also include a 10% fee for use by their students of our online supplemental course tools.
Royalties also include a fee of 2% of the domestic franchisees cash receipts for contribution to a national advertising fund. For a description
of the advertising fund, see Note 8 to our consolidated financial statements. We recognize revenue from franchise royalties on a monthly basis. This
revenue represented approximately 4% of our total revenue in 2005.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | sales of course and marketing materials and other products to
our independent franchisees. This revenue is recognized upon the transfer of title to our customers, which occurs 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. This revenue consists of performance-based fees, including royalties and marketing fees from sales of books and software. We recognize
these fees based on sales of the books and software when reported to us by the publishers. Additionally, we earn delivery-based fees from 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 represented
approximately 2% of our total revenue in 2005.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



K-12 Services.  The
K-12 Services division derives revenue from the services we provide to primary and secondary schools and school districts, from authoring books
published by Random House and 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, which we recognize when the courses are delivered;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------

| |  | fees for paper-based and online benchmark testing, which we
recognize over the period the services 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 us ratably 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 districts represented 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
sales of the books when reported to us by the publisher. Additionally, we earn delivery-based fees from 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 represented less than 1% of our total revenue
in 2005.




Revenue from McGraw-Hill is derived
from royalties under an agreement that expired in September, 2003 for Princeton Review branded content that we provided for their textbooks, which
we




29


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recognize based on sales reported
by McGraw-Hill. Revenue from our contract with McGraw-Hill represented 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 annual subscription fees and application processing fees paid to us by academic institutions for our online application and management
products, annual subscription fees paid to us by secondary schools for our ECOS product, and annual marketing fees paid to us by academic institutions
to promote their programs on our web site and in our publications. We recognize the subscription and marketing fees over the contract period, which is
typically one or two years. We recognize the application processing fees in the month that the relevant applications are submitted. This revenue
represented approximately 5% of our total revenue in 2005.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | college counseling fees paid by high schools. This revenue
consists of annual subscription fees paid to us by secondary schools. We recognize these fees over the contract period, which is typically one to three
years. This revenue represented approximately 1% of our total revenue in 2005.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | marketing fees paid to us by academic institutions based upon
the number of student inquiries we generate. This revenue is recognized as leads are generated based on the price per lead in the applicable contracts,
and represented 1% of our total revenue in 2005.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | authoring books published by Random House. This revenue consists
of performance-based fees, including royalties and marketing fees from sales of books. We recognize these fees based on sales of the books when
reported to us by the publisher. Additionally, we earn delivery-based fees from 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 represented less than 1% of our total revenue in 2005.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | sales of advertising and sponsorships to businesses and schools
wishing to promote their products, services and programs on our web site. Advertising and sponsorship revenue is recognized each month based on
contractual terms. This revenue represented approximately 1% of our total revenue in 2005.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Cost of Revenue




Test Preparation
Services.  Cost of revenue consists of course expenses of our company-owned operations, cost of course materials sold and the costs to
author, develop, edit and produce content for books and software. Course expenses consist of costs incurred to deliver test preparation courses, SES
programs, tutoring and admissions counseling services, including rent of classroom space, teacher salaries, credit card fees, and costs of course
materials. The largest components of cost of revenue in our Test Preparation Services division are rent for classroom spaces and teacher salaries,
which together accounted for approximately 66% of the cost of revenue of this division in 2005. Also included in cost of revenue is a royalty we pay to
our franchisees in 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. These fees are for Princeton Review Online courses provided to students residing within our
franchisees territories, net of certain administrative expenses.




K-12 Services.  Cost
of revenue primarily consists of the costs related to providing training, professional development, after school programs, authoring and producing
workbooks, developing content for textbooks, our Homeroom subscription service and book development. Additionally, cost of revenue includes
amortization expense related to our capitalized K-12 content, which are the direct costs we incur to write questions and lessons that are used across
our various product categories in this division. These costs, primarily comprised of internal compensation costs of dedicated employees, are
capitalized and amortized over a seven-year period, on a straight-line basis (see Note 1 to our Consolidated Financial Statements).




30


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Admissions
Services.  Cost of revenue includes the costs to author, develop and edit our books and the admissions services section of our web site.
Cost of revenue also includes the costs to build and maintain our web-based products, primarily comprised of internal compensation costs of dedicated
employees, and the commissions related to the sale of those products, which are recognized over the contract period, and credit card fees incurred in
connection with processing student applications, which are recognized in the month the applications are processed. Additionally, cost of revenue
includes the costs to provide counseling services to high schools contracting 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 and
miscellaneous expenditures, which collectively represented approximately 65% of our total selling, general and administrative expenses in 2005.
Selling, general and administrative expenses also include costs associated with national advertising campaigns that benefit our company-owned locations
as well as our independent franchisees. Finally, the remaining components of selling, general and administrative expenses include professional fees,
travel and entertainment, health insurance and depreciation and amortization.




Income Taxes




As a result of the effect under SFAS
No. 109, Accounting for Income Taxes, on the recoverability of our net deferred tax assets, we decided to record a 100% valuation allowance
against any deferred tax benefits. In 2005, a deferred tax benefit of $1.5 million was offset by a further valuation allowance of the same amount,
resulting in no net tax expense in 2005. During 2004, as a result of the establishment of a valuation allowance for net deferred tax assets we recorded
an income tax expense of $16.7 million for 2004. Income tax expense was $3.2 million for 2003. 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
in future years. Our loss in 2005 and 2004 and the emphasis placed on cumulative losses under generally 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 full valuation
allowance against net deferred tax assets. Although management expects these assets will ultimately be fully utilized, future performance cannot be
assured. The Company will continue to evaluate the need for the valuation allowance in future periods.




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 $4.5 million, 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 in 2004 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 and an 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 $11.6 million in 2005. This increase is primarily driven by $2.0 million of growth in assessment
services and the receipt of $400,000 in prior year license fees. Reductions are driven primarily by the recognition of a certain professional
development contract which combined both third and fourth quarter 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 be approximately 22%.




31


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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 counseling
contracts 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 increased by $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 $5.1 million in 2004 to $6.6 million in 2005. This increase is driven by a $1.4 million volume
increase related to retail enrollments which caused variable costs such as teacher salaries, site rent and course 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 in support 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 2004 to $6.5 million in 2005. This increase is primarily related to an increase in content
development and professional development costs of approximately $2.0 million. Gross margin declined by 17.5% from 61.7% to 44.2%. Adjusting for the
additional $1.7 million 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 higher content development, production and distribution costs.




Admissions Services cost of revenue
increased by $320,000, or 29.8%, from $1.1 million in 2004 to $1.4 million in 2005. This increase is primarily driven by an increase of $378,000
related to counseling labor and related costs. Gross margin declined by 2.4% from 64.3% to 61.9%. This decrease is primarily related to ongoing
expenses in support of the new counseling services contracts.




Selling, General &
Administration Expenses




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:
increased rent and related costs of $450,000 and $400,000 of advertising expense primarily related to the SES business.




Impairment of
goodwill




Our results for the fourth quarter of
2004 included a write-down of approximately $8.2 million of 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 in 2004 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 MCAT courses, 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 in 2004 to approximately $32 million in 2005. This increase is driven by $2.4 million in
assessment services, $1.8 million in workbook intervention materials (primarily SideStreets) and $943,000 of professional development
services.




For the year, Admissions Services
revenue increased by $168,000, or 1.5%, from $11.1 million in 2004 to $11.3 million in 2005. This increase is driven by an increase of approximately
$700,000 in revenue from




32


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counseling services, and a $1.4
million increase in higher education marketing fees. Reductions to revenue include a decrease in higher education technology fees and book related
revenues related to timing.




Cost of Revenue




For the year ended December 31, 2005
total cost of revenue for the Company increased by $8.9 million, 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 $23.6 million in 2004 to $28.1 million in 2005. This increase is primarily driven by the variable
expense increase related to higher retail enrollments, and higher tutoring and institutional revenue. Gross margin 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 2004 to $16.8 million in 2005. This increase is driven by variable expense of approximately $2.1
million on $4.0 million of incremental revenue growth. In addition, there is an increase of $300,000 of web content amortization and approximately
$889,000 increase related to incremental content production and labor related expense. Gross margin declined by 3.8% from 51.1% to 47.3% due to revenue
timing and 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 in 2004 to $4.6 million in 2005. This increase is driven by an increase of $500,000 in
counseling expense and $700,000 of other related expense in support of both the technology and marketing business. Gross margins declined by 10.5% from
69.5% to 59.0%. The key drivers of this reduction relate to $700,000 in revenue credits driving approximately 6% of the decline, as well as
approximately 2% in consulting mix and another 1.5% attributed to the cost base.




Selling, General &
Administrative Expenses




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
expense of $2.1 million, office rent and related expense of $730,000, professional fees primarily related to Sarbanes-Oxley of $2.8 million, $400,000
in advertising and recruitment expense and workers compensation fees of $300,000.




Impairment of
goodwill




Our 2004 results included a write-down
of approximately $8.2 million of goodwill related to the acquisition of Embark.




Sale of Rights to
Franchises




During the third quarter of 2005, we
sold the right to provide SES programs to four of our independent franchisees for $990,000.




Comparison of Years Ended December 31, 2004 and
2003




Overall, results for 2004 were below
expectations in all three divisions. After returning to profitability in 2003, we incurred a net loss of $30.4 million in 2004. In the Test Preparation
Services division, weakness in enrollments in LSAT and GMAT courses offset growth in online courses, SES programs and tutoring, resulting in annual
revenue growth of only 4%. Despite revenue growth for the year of 30%, the K-12 Services division experienced a longer sales cycle in closing on
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 for subscription-based services from its post-secondary institution customers. Gross margins for the company as a whole
slipped from 69.4% in 2003 to 64.3% in 2004, due primarily to higher costs combined with lower enrollment in test preparation services and a less
profitable product mix in K-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
aged accounts




33


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receivable in the Admissions
Services and K-12 Services divisions further hurt our bottom line. Additionally, we recorded a valuation allowance relating to our net deferred tax
assets as of December 31, 2004, of approximately $22.1 million, resulting in a tax charge of $16.7 million in 2004, 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 in 2004, representing a 4% increase, comprised primarily of an increase of approximately $2.9
million in revenue from our company-owned operations. The increased revenue from company-owned operations resulted from an increase of approximately
$488,000 in revenue attributable to the operations acquired from our former franchisee, Princeton Review of North Carolina, Inc., and an increase of
approximately $2.5 million in course and tutoring revenue at our other locations. This $2.5 million increase 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, professional development and Homeroom subscriptions, due to additional
contracts signed in 2004, as well as increased revenue from contracts signed in 2003 which were in effect for the full year in 2004. The increase 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 to
high schools, a new product offering in 2004 by this division, was offset by a decrease in revenues from 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 $23.6 million in 2004, representing a 13% increase, primarily as a result of increasing the number of
tutoring sessions and SES programs delivered. Cost of revenue as a percentage of revenue increased due to reduction in the average class size due to
reduced enrollment, primarily in our LSAT courses, as well as an increase in the relative cost of teachers and course materials.




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 costs
incurred to service increasing numbers and increasingly complex contracts with school-based customers. The percentage increase in cost of revenue was
significantly higher than the increase in revenue in this division primarily because of the increased revenues from the lower margin professional
development services.




Admissions Services cost of revenue
increased from $2.8 million in 2003 to $3.4 million in 2004, representing a 21% increase, primarily due to increased customer support costs, including
the new high school counseling product.




Operating
Expenses




Selling, general and administrative
expenses increased from $65.6 million in 2003 to $86.6 million 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 $8.2 million;
|- |  | --------------------------------------------------------------------------------------------



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| |  | an increase of approximately $4.7 million in salaries and
payroll taxes, resulting primarily from increased headcount;
|- |  | ----------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately $2.6 million attributable primarily
to personnel related costs, including office rent and expenses, travel and entertainment, employee benefits and recruiting fees;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately $2.4 million in professional fees,
comprised primarily of legal, accounting and consultant fees, relating to Sarbanes-Oxley compliance, an internal corporate reorganization and other
miscellaneous matters;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately $2.2 million in web site technology
and development expenses;
|- |  | ------------------------------------------------------------------------------------------

| |  | an increase of approximately $1.1 million in bad debt allowance
expense primarily due to an increase in aged accounts receivable in the Admissions Services and K-12 Services divisions; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately $725,000 in depreciation and
amortization expenses, due primarily to increased amortization expense relating to the K-12 Services divisions web site development
costs.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Liquidity and Capital Resources




Our primary sources of liquidity are
cash and cash equivalents on hand and collections from customers. At December 31, 2005, we had $8.0 million of cash and cash equivalents. The $11.2
million decrease in cash from the December 31, 2004 balance is primarily attributed to investing activities of $13.6 million ($8.3 million in
furniture, fixtures, equipment and software development and $5.6 million in capitalized content) along with $5.1 million related to financing activity
that more than offset the $7.5 million cash increase provided by operating activities. Our Test Preparation Services division has historically
generated, and continues to generate, the largest portion of our cash flow from its retail classroom and tutoring courses. These customers usually pay
us in advance or contemporaneously with the services we provide, thereby supporting our short-term liquidity needs. Increasingly, however, across all
of our divisions, we are generating a greater percentage of our cash from contracts with institutions such as the schools and school districts serviced
by our K-12 Services division and the post-secondary institutions serviced by our Admissions Services division, all of which pay us in arrears. Typical
payment performance for these institutional customers, once invoiced, ranges from 60 to 90 days. Additionally, the long contract approval cycles and/or
delays in purchase order generation with some of our contracts with large institutions or school districts can contribute to the level of variability
in the timing of our cash receipts.




Cash provided by operating activities
is our net income (loss) adjusted for certain non-cash items and changes in operating assets and liabilities. During 2005, cash provided by operating
activities was $7.5 million, compared to $4.0 million for 2004, an increase of $3.5 million. The increase is primarily attributed to the year-over-year
increase in accounts payable and accrued expenses of $5.6 million and an increase in net income adjusted for non cash items of $4.8 million. These
increases were partially offset by a decrease in deferred income of $1.1 million and an increase in inventory, primarily SideStreets instruction books,
of $1.7 million




During 2005, we used $13.6 million in
cash for investing activities as compared to $8.3 million used during 2004. This increase is driven by increases of $2.5 million in capital
expenditures due primarily to the Oracle implementation, an increase of $4.1 million in content expenditures related to the development of SideStreets
content and an increase of $1.8 million in leasehold improvements.




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Financing cash flows consist primarily
of transactions related to our debt and equity structure. We used approximately $5.1 million in 2005 compared to net proceeds of $9.6 million during
2004. During 2005, we repaid approximately $2.0 million of the debt we had borrowed in 2004 under a bank credit facility, and we repaid approximately
$2.0 million in other debt. In 2004, we raised approximately $9.7 million net of issuance costs, from the sale of Series B-1 Preferred Stock and repaid
approximately $2.3 million of other debt.




Our current cash balances and operating
cash flow, will be sufficient to cover our normal operating requirements for the next 12 months as we implement a number of restructuring initiatives
designed to significantly improve operating cash flow. We also expect to shortly secure a revolving line of credit in an amount of $5 million to $10
million to support any further working capital requirements.




Contractual Obligations and Commercial
Commitments




As of December 31, 2005, our principal
contractual obligations and commercial commitments consisted of obligations outstanding under our long-term office and classroom leases, obligations
under promissory notes entered into in connection with acquisitions, employment agreements and several capital leases of computer equipment. As of
December 31, 2005, we operated from leased premises 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 commitments set forth therein as of December 31, 2005.







|                            |  |  |  | Payments due by period |     
|--------------------------- |  |  |  | ---------------------- | ----
|
|
|Long-term
debt obligations  |  |  |  | $                      | 3.1 
|Capital lease
obligations   |  |  |  |                        | 1.2 
|Operating
lease obligations |  |  |  |                        | 28.5
|Purchase
obligations (1)    |  |  |  |                        | 6.5 
|Total                       |  |  |  | $                      | 39.3






|(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 for transactions 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 in share-based payment transactions. SFAS 123(R) requires that
the fair value of such equity instruments be recognized as expense in the financial statements as services are performed. Prior to SFAS 123(R), only
the pro forma disclosures of fair value were required. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, TOPIC 14: Share-Based
Payment which addresses the interaction between SFAS 123(R) and certain SEC rules and regulations and provides views regarding the valuation
of share-based payment arrangements for public companies. SFAS 123(R) is effective for our first quarter of 2006 and the adoption of this new
accounting pronouncement is expected to result in pre-tax stock-based compensation expense of between $0.3 million and $0.5 million in our fiscal year
2006.




In December 2004, the FASB issued SFAS
No. 153, Exchanges of Nonmonetary Assets  An Amendment of APB Opinion No. 29 (SFAS 153). This new standard is the
result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles
(GAAP) in the U.S. and GAAP developed by the International Accounting




36


---



Standards Board (IASB).
As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between
their existing accounting standards. SFAS 153 amends Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary
Transactions (APB 29), that was issued in 1973. The amendments made by SFAS 153 are based on the principle that exchanges of
nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for
nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have
commercial substance. Previously, APB 29 required that the accounting for an exchange of a productive asset for 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 were effective 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  a Replacement of APB Opinion No. 20 and FASB Statement No. 3 (SFAS
154). SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines restatement
as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005 (our 2006 fiscal year) and is not expected to have a significant impact on
our consolidated financial statements.




Critical Accounting Policies




The estimates, methods and judgments we
use in applying our accounting policies significantly impact the results we report in our financial statements. Some of our accounting policies require
us to make subjective and difficult judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our most
critical accounting estimates include the assessment of the collectability of our accounts receivable balances, which impacts bad debt write-offs;
recoverability of goodwill, which impacts goodwill impairment expense; assessment of recoverability of long-lived assets, which primarily impacts
operating margins when we record the impairment of assets or accelerate their depreciation; recognition and measurement of current and deferred income
tax assets and liabilities, which impacts our tax provision and, to a lesser extent, revenue recognition requirements, which impacts how and when we
recognize revenue from our goods and services. Below, we discuss these policies further, as well as the estimates and judgments
involved.




We also have other policies that we
consider to be key accounting policies. However, these policies do not meet the definition of critical accounting estimates because they do not
generally require us to make estimates or judgments that are difficult or subjective.




Accounts
Receivable.  We maintain allowances for doubtful accounts for losses resulting from the inability of our customers to make required
payments. If the financial condition of our customers 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 receivables monthly. This review includes discussions with our customers and
their account representatives, the customers payment history and other factors. Based on these reviews we may increase or decrease our allowance
for uncollectible accounts if we determine there is a change in the collectability of our accounts receivable.




Goodwill and Territorial Marketing
Rights.  We perform an annual goodwill impairment review during the fourth quarter, or more frequently if indicators of potential
impairment exist. No impairment was indicated in 2003 or 2005. In 2004, we recorded an impairment expense of $8.2 million against goodwill in our
Admissions Services division due to the continued poor performance of this division. Our impairment review process is based on a discounted future cash
flow approach that uses our estimates of revenue for the reporting units, driven by assumed market growth rates as well as appropriate discount rates.
These estimates are consistent with the plans and estimates that we use to manage the underlying businesses.




37


---



Long-Lived Assets.  We
assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping
may not be recoverable. Factors we consider in deciding when to perform an impairment review include significant 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 our use of the
assets. Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying amount of the asset grouping to
the related total future undiscounted net cash flows. If an asset groupings carrying value is not recoverable through those cash flows, the asset
grouping is considered to be impaired. The impairment is measured by the difference between the assets carrying amount and their fair value,
based on the best information available, including market prices or discounted cash flow analysis.




Income Taxes.  In
determining income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments occur in the
calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary
differences between 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. If recovery is not likely, we must increase our provision for taxes by recording a reserve, in the
form of a valuation allowance, for the deferred tax assets that we estimate will not ultimately be recoverable. At December 31, 2005, we had a net
deferred tax asset of approximately $23.7 million, primarily relating to our net operating loss carryforwards of $53.7 million, which expire in varying
amounts between 2021 and 2025.




Realization of our deferred tax asset
is dependent on generating sufficient taxable income in the United States prior to expiration of these loss carryforwards. As of December 31, 2004, we
recorded a valuation allowance for the entire net deferred tax asset because our loss in 2004 and the emphasis placed on cumulative losses under
generally accepted accounting principles represented sufficient evidence under SFAS No. 109 Accounting for Income Taxes for us to
determine that it was appropriate to establish a full valuation allowance. If, in the future, an appropriate level and consistency of profitability is
attained, we would reduce the valuation allowance, which could have a significant impact on our consolidated financial statements.




Revenue
Recognition.  In general our revenue recognition policies do not require us to make estimates or judgments that are difficult or
subjective, with the possible exception being the recognition of revenue for separate units of accounting in accordance with EITF No. 00-21,
Revenue Arrangements with Multiple Deliverables. In accounting for multiple-element arrangements, one of the key judgments to be
made is the accounting value that is attributable to the different contractual elements. The appropriate allocation of value not only impacts which
segment is credited with the revenue, it also impacts the amount and timing of revenue recorded in the consolidated statement of operations during a
given period due to the differing methods of recognizing revenue for each product or service by each of the segments. Revenue is allocated to each
element based on the accounting determination of the relative fair value of that element to the aggregate fair value of all elements. The fair values
must be reliable, verifiable and objectively determinable. When available, such determination is based principally on the pricing of similar
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 revenue because the markets in which we operate are subject to seasonal fluctuations based on the
scheduled dates for standardized admissions tests and the typical school year. These fluctuations could result in volatility or adversely affect our
stock price. We typically generate the largest portion of our test preparation revenue in the third quarter. However, as SES revenues increase, we
expect to recognize these revenues primarily in the first and fourth quarters. The electronic application revenue recorded in




38


---



our Admissions Services division is
highest in the first and fourth quarters, corresponding with the busiest times of year for submission of applications to academic institutions. Our
K-12 Services division experiences seasonal fluctuations in revenue, with the first 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. The fair value of our portfolio of marketable securities would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due primarily to the short-term nature of the portfolio. All of our currently
outstanding long-term debt bears interest at fixed rates. Our Series 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 the Series B-1 Preferred Stock in an aggregate
amount of $534,000 and $374,000, at an average rate of 5.3% and 7.5% in 2005 and 2004, respectively. A 100 basis point increase in the dividend rate
would have resulted in a $100,000 increase in dividends paid during this period.




We repaid and terminated our line of
credit in February 2005. We do not currently hold or issue derivative financial instruments.




Revenue from our international
operations and royalty payments from our international franchisees constitute an insignificant percentage of our revenue. Accordingly, our exposure to
exchange rate fluctuations is minimal.




39


---

|Item
8. |  | Financial Statements and Supplementary Data
|------- |  | -------------------------------------------



Index to Consolidated Financial Statements and Financial
Statement Schedule







|                                                        |  |  |  | Page
|------------------------------------------------------- |  |  |  | ----
|Consolidated
Financial Statements:                      |  |  |  |     
|Report of
Independent Registered Public Accounting Firm |  |  |  |     
|Consolidated
Balance Sheets                             |  |  |  |     
|Consolidated
Statements of Operations                   |  |  |  |     
|Consolidated
Statements of Stockholders Equity         |  |  |  |     
|Consolidated
Statements of Cash Flows                   |  |  |  |     
|Notes to
Consolidated Financial Statements              |  |  |  |     
|Financial
Statement Schedule:                           |  |  |  |     
|Schedule II
 Valuation And Qualifying Accounts         |  |  |  |     



40


---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




To the Board of Directors and Stockholders of The Princeton
Review, Inc. and Subsidiaries




We have audited the accompanying
consolidated balance sheets of The Princeton Review, Inc. and Subsidiaries (the Company) as of December 31, 2005 and 2004, and the related
consolidated statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2005. Our
audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and schedule are the responsibility of
the Companys management. Our responsibility is to express an opinion on these financial statements and schedule based on our
audits.




We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Princeton Review, Inc. and
Subsidiaries as of December 31, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the three years in the
period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles. Also, in our opinion the related financial statement
schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information
set forth therein.




We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of The Princeton Review, Inc.s internal
control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2006 expressed an unqualified opinion
thereon.




/s/ ERNST & YOUNG LLP




New York, NY March 13, 2006




41


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THE PRINCETON REVIEW, INC. AND
SUBSIDIARIES




Consolidated Balance Sheets







|                                                                                                                                                                |  |  |  | December 31, |        
|--------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------ | -------
|
|
|A S S E T S                                                                                                                                                    
|Current
assets:                                                                                                                                                 |  |  |  |              |        
|Cash and cash
equivalents (including $255 restricted cash in 2005)                                                                                              |  |  |  | $            | 8,002  
|Accounts
receivable, net of allowance of $1,601 in 2005 and $1,290 in 2004                                                                                      |  |  |  |              | 22,493 
|Accounts
receivable-related parties                                                                                                                             |  |  |  |              | 1,591  
|Other
receivables ($789 in 2005 and $1,049 in 2004 from related parties)                                                                                        |  |  |  |              | 813    
|Inventories                                                                                                                                                     |  |  |  |              | 2,798  
|Prepaid
expenses                                                                                                                                                |  |  |  |              | 2,229  
|Other current
assets                                                                                                                                            |  |  |  |              | 1,307  
|Total current
assets                                                                                                                                            |  |  |  |              | 39,233 
|Furniture,
fixtures equipment and software development, net                                                                                                     |  |  |  |              | 16,155 
|Goodwill,
net                                                                                                                                                   |  |  |  |              | 31,506 
|Investment in
affiliates                                                                                                                                        |  |  |  |              | 1,938  
|Other
intangibles, net                                                                                                                                          |  |  |  |              | 13,371 
|Other
assets                                                                                                                                                    |  |  |  |              | 3,168  
|Total
assets                                                                                                                                                    |  |  |  | $            | 105,371
|                                                                                                                                                               
|L I A B I L I T I E S  A N D S T O C K H O L D E R S E Q U I T Y                                                                                              
|Current
liabilities:                                                                                                                                            |  |  |  |              |        
|Accounts
payable                                                                                                                                                |  |  |  | $            | 10,449 
|Accrued
expenses                                                                                                                                                |  |  |  |              | 10,826 
|Current
maturities of long-term debt                                                                                                                            |  |  |  |              | 1,530  
|Deferred
income                                                                                                                                                 |  |  |  |              | 16,548 
|Total current
liabilities                                                                                                                                       |  |  |  |              | 39,353 
|Deferred
rent                                                                                                                                                   |  |  |  |              | 2,327  
|Long-term
debt                                                                                                                                                  |  |  |  |              | 2,845  
|Series B-1
Preferred stock, $.01 par value; 10,000 authorized, issued and outstanding at December 31, 2005 and 2004 respectively (liquidation value of
$10,000) |  |  |  |              | 10,000 
|Stockholders equity                                                                                                                                            |  |  |  |              |        
|Preferred
stock, $.01 par value; 4,990,000 shares authorized; none issued and outstanding at December 31, 2005 and 2004                                         |  |  |  |              |       
|Common stock,
$.01 par value; 100,000,000 shares authorized; 27,572,172 and 27,569,764 issued and outstanding at December 31, 2005 and 2004,
respectively       |  |  |  |              | 276    
|Additional
paid-in capital                                                                                                                                      |  |  |  |              | 116,279
|Accumulated
deficit                                                                                                                                             |  |  |  |              | (65,430
|Accumulated
other comprehensive (loss)                                                                                                                          |  |  |  |              | (279   
|Total
stockholders equity                                                                                                                                      |  |  |  |              | 50,846 
|Total
liabilities and stockholders equity                                                                                                                      |  |  |  |              | 105,371



See accompanying notes.




42


---



THE PRINCETON REVIEW, INC. AND
SUBSIDIARIES




Consolidated Statements of Operations







|                                                                      |  |  |  | Years Ended December 31, |        
|--------------------------------------------------------------------- |  |  |  | ------------------------ | -------
|
|
|Revenue                                                               |  |  |  |                          |        
|Test
Preparation Services                                             |  |  |  | $                        | 87,310 
|K-12
Services                                                         |  |  |  |                          | 31,931 
|Admissions
Services                                                   |  |  |  |                          | 11,252 
|Total
revenue                                                         |  |  |  |                          | 130,493
|Cost of
revenue                                                       |  |  |  |                          |        
|Test
Preparation Services                                             |  |  |  |                          | 28,144 
|K-12
Services                                                         |  |  |  |                          | 16,838 
|Admissions
Services                                                   |  |  |  |                          | 4,615  
|Total cost of
revenue                                                 |  |  |  |                          | 49,597 
|Gross
profit                                                          |  |  |  |                          | 80,896 
|Operating
expenses                                                    |  |  |  |                          |        
|Selling,
general and administrative                                   |  |  |  |                          | 85,144 
|Impairment of
goodwill                                                |  |  |  |                          |       
|Total
operating expenses                                              |  |  |  |                          | 85,144 
|Income
(loss) from operations                                         |  |  |  |                          | (4,248 
|Interest
expense                                                      |  |  |  |                          | (354   
|Sale of rights
to franchisees                                         |  |  |  |                          | 990    
|Other income
(loss), net                                              |  |  |  |                          | 138    
|Income
(loss) before provision from income taxes                      |  |  |  |                          | (3,474 
|(Provision)
for income taxes                                          |  |  |  |                          |       
|Net income
(loss)                                                     |  |  |  |                          | (3,474 
|Dividends
and accretion on Series B-1 Preferred Stock                 |  |  |  |                          | (854   
|Net income
(loss) attributed to common stockholders                   |  |  |  | $                        | (4,328 
|Basic
income (loss) per share                                         |  |  |  | $                        | (0.16  
|Diluted
income (loss) per share                                       |  |  |  | $                        | (0.16  
|Weighted
average shares used in computing net income (loss) per share |  |  |  |                          |        
|Basic                                                                 |  |  |  |                          | 27,570 
|Diluted                                                               |  |  |  |                          | 27,570 



See accompanying notes.




43


---



THE PRINCETON REVIEW, INC. AND
SUBSIDIARIES




Consolidated Statements of Stockholders Equity
(in thousands)







|                                                                           |  |  |  | Stockholders Equity (Deficit) |       
|-------------------------------------------------------------------------- |  |  |  | ------------------------------ | ------
|
|
|Balance at
January 1, 2003                                                 |  |  |  |                                | 27,261
|Exercise of
stock options                                                  |  |  |  |                                | 124   
|Issuance of
non-employee options                                           |  |  |  |                                |      
|Comprehensive
income                                                       |  |  |  |                                |       
|Net
income                                                                 |  |  |  |                                |      
|Foreign
currency gain (loss)                                               |  |  |  |                                |      
|Unrealized
loss on securities, net of applicable income tax expense of $10 |  |  |  |                                |      
|Comprehensive
income                                                       |  |  |  |                                |      
|Balance at
December 31, 2003                                               |  |  |  |                                | 27,385
|Exercise of
stock options                                                  |  |  |  |                                | 121   
|Shares issued
in connection with an equity investment                      |  |  |  |                                | 64    
|Stock based
compensation                                                   |  |  |  |                                |      
|Dividends and
accretion on Series B-1 Preferred Stock                      |  |  |  |                                |      
|Comprehensive
loss                                                         |  |  |  |                                |      
|Net
loss                                                                   |  |  |  |                                |      
|Foreign
currency gain (loss)                                               |  |  |  |                                |      
|Comprehensive
loss                                                         |  |  |  |                                |      
|Balance at
December 31, 2004                                               |  |  |  |                                | 27,570
|Exercise of
stock options                                                  |  |  |  |                                | 2     
|Dividends and
accretion on Series B-1 Preferred Stock                      |  |  |  |                                |       
|Comprehensive
loss                                                         |  |  |  |                                |       
|Net
loss                                                                   |  |  |  |                                |      
|Foreign
currency gain (loss)                                               |  |  |  |                                |      
|Comprehensive
loss                                                         |  |  |  |                                |      
|Balance at
December 31, 2005                                               |  |  |  |                                | 27,572



See accompanying notes.




44


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THE PRINCETON REVIEW, INC. AND
SUBSIDIARIES




Consolidated Statements of Cash Flows







|                                                                                         |  |  |  | Years Ended December 31, |        
|---------------------------------------------------------------------------------------- |  |  |  | ------------------------ | -------
|
|
|Cash
flows from operating activities:                                                    |  |  |  |                          |        
|Net income
(loss)                                                                        |  |  |  | $                        | (3,474 
|Adjustments
to reconcile net income (loss) to net cash provided by operating activities: |  |  |  |                          |        
|Depreciation                                                                             |  |  |  |                          | 1,776  
|Amortization                                                                             |  |  |  |                          | 5,897  
|Impairment
of goodwill                                                                   |  |  |  |                          |       
|Bad debt
expense                                                                         |  |  |  |                          | 1,328  
|Write-off of
deferred financing costs                                                    |  |  |  |                          | 117    
|Deferred
income taxes                                                                    |  |  |  |                          | (1,520 
|Valuation
allowance for deferred tax assets                                              |  |  |  |                          | 1,520  
|Stock based
compensation                                                                 |  |  |  |                          |       
|Other,
net                                                                               |  |  |  |                          | 1,241  
|Net change
in operating assets and liabilities:                                          |  |  |  |                          |        
|Accounts
receivable                                                                      |  |  |  |                          | (2,785 
|Inventory                                                                                |  |  |  |                          | (1,744 
|Prepaid
expenses                                                                         |  |  |  |                          | (211   
|Other
assets                                                                             |  |  |  |                          | 880    
|Accounts
payable and accrued expenses                                                    |  |  |  |                          | 5,574  
|Deferred
income                                                                          |  |  |  |                          | (1,089 
|Net cash
provided by operating activities                                                |  |  |  |                          | 7,510  
|Cash
flows from investing activities:                                                    |  |  |  |                          |        
|Purchases of
furniture, fixtures, equipment and software development                     |  |  |  |                          | (8,258 
|Investment
in affiliates                                                                 |  |  |  |                          |       
|Purchases of
franchises and other businesses, net of cash acquired                       |  |  |  |                          |       
|Payment of
related party loan                                                            |  |  |  |                          | 33     
|Note
receivable                                                                          |  |  |  |                          | 250    
|Additions to
capitalized K-12 content, capitalized course costs                          |  |  |  |                          | (5,595 
|Net cash
used in investing activities                                                    |  |  |  |                          | (13,570
|Cash
flows from financing activities:                                                    |  |  |  |                          |        
|Proceeds
from the sale of Series B-1 Preferred Stock, net of issuance cost               |  |  |  |                          |       
|Proceeds
(payments) from revolving credit facility                                       |  |  |  |                          | (2,000 
|Notes issued
in connection with sale of rights to franchisees                            |  |  |  |                          | (956   
|Long-term
debt borrowings                                                                |  |  |  |                          | 367    
|Capital
lease payments                                                                   |  |  |  |                          | (717   
|Dividends on
Series B-1 Preferred Stock                                                  |  |  |  |                          | (591   
|Notes
payable related to acquisitions                                                    |  |  |  |                          | (1,257 
|Proceeds
from exercise of options                                                        |  |  |  |                          | 19     
|Payment of
credit facility financing costs                                               |  |  |  |                          |       
|Net cash
(used in) provided by financing activities                                      |  |  |  |                          | (5,135 
|Net
(decrease) increase in cash and cash equivalents                                     |  |  |  |                          | (11,195
|Cash and
cash equivalents, beginning of period                                           |  |  |  |                          | 19,197 
|Cash and
cash equivalents, end of period                                                 |  |  |  | $                        | 8,002  
|Supplemental
cash flow disclosures:                                                      |  |  |  |                          |        
|Cash paid
during the year for interest                                                   |  |  |  | $                        | 580    
|Supplemental
schedule of noncash financing activities:                                   |  |  |  |                          |        
|Equipment
acquired through capital leases                                                |  |  |  | $                        | 316    



See accompanying notes.




45


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THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements


|1. |  | Nature of Business and Significant Accounting
Policies
|-- |  | ------------------------------------------------------



Business




The Princeton Review, Inc. and its
wholly owned subsidiaries (together, the Company), are engaged in the business of providing courses that prepare students for college,
graduate school and other admissions tests. The Company, through Princeton Review Operations, LLC, provides these courses in various locations
throughout the United States and Canada and over the Internet. As of December 31, 2005, the Company had six franchisees operating approximately 18
offices under the Princeton Review name in the United States and 15 franchises with approximately 38 offices in 19 countries. The Company also sells
support materials and equipment to its franchisees, authors content for various books and software products published by third parties, sells
marketing and web-based products to higher education institutions, operates a Web site providing education-related content and provides a number of
services to K-12 schools and school districts to help them measurably improve academic performance.




Principles of Consolidation




The accompanying consolidated financial
statements include the accounts of The Princeton Review, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances
are eliminated in consolidation.




Use of Estimates




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




Reclassifications




Certain prior period balance sheet and
cash flow amounts have been reclassified to conform with the current year presentation.




Cash and Cash Equivalents




As of December 31, 2005 and 2004, cash
and cash equivalents consist of investments in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, which have
maturities of 90 days or less at the date of purchase. As of December 31, 2005 approximately 90% of the Companys cash and cash equivalents was on
hand at one financial institution. As of December 31, 2004 approximately 90% of the Companys cash and cash equivalents were on hand at two
financial institutions.




Accounts Receivable and Allowance for Doubtful
Accounts




The Company provides credit, in the
normal course of business, to its customers. The Company maintains an allowance for doubtful customer accounts for estimated losses that may result
from the inability of the Companys customers to make required payments. That estimate is based on a variety of factors, including historical
collection experience, current economic and market conditions, and a review of the current status of each customers trade accounts receivable.
The Company charges actual losses when incurred to this allowance.




46


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Inventories




Inventories consist of program support
equipment, course materials and supplies. All inventories are valued at the lower of cost (first-in, first-out basis) or market.




Furniture, Fixtures and Equipment




Furniture, fixtures and equipment are
stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives
of the assets principally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the lesser of the
lease term or its estimated economic useful life. Lease terms used are based upon the initial lease agreement and do not consider potential renewals or
extensions until such time that the renewals or extensions are contracted.




Software and Web Site Development




The Company accounts for internal use
software development in accordance with the provisions of the American Institute of Certified Public Accountants Statement of Position
(SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use and Emerging Issues Task Force
(EITF) 00-2, Accounting for Web site Development Costs.




For the years ended December 31, 2005,
2004 and 2003, the Company expensed approximately $2.7 million, $3.8 million and $2.3 million, respectively, of product development costs that were
incurred in the preliminary project stage under SOP 98-1. For the years ended December 31, 2005 and 2004, the Company capitalized approximately $5.0
million and $3.2 million, respectively, in product and web site development costs under SOP 98-1 and EITF 00-2. For the years ended December 31, 2005,
2004 and 2003, the Company recorded related amortization expense of approximately $3.1 million, $2.8 million and $2.4 million, respectively. As of
December 31, 2005 and 2004, the net book value of these capitalized product and web site development costs were $7.2 million and $5.3 million,
respectively. These capitalized costs are amortized using the straight-line method over the estimated useful life of the assets ranging from 12 to 60
months.




Goodwill, Capitalized Course Costs, Capitalized K-12 Content
and Other Intangible Assets.




Goodwill represents the excess purchase
price of acquired businesses over the estimated fair value of net assets acquired.




Territorial marketing rights represent
rights contributed by our independent franchisees to our former subsidiary, Princeton Review Publishing, L.L.C., in 1995 in exchange for membership
units of Princeton Review Publishing, L.L.C. to allow the marketing of the Companys products on a contractually agreed-upon basis within the
franchisee territories. Without these rights, the Company would be prohibited from selling its products in these territories due to the exclusivity
granted to the franchisees within their territories. Should a franchisee decide not to renew its franchise agreement, which is unlikely unless there is
a sale of the franchise back to the Company, these rights would remain with the Company. Since no legal, regulatory, contractual, competitive, or other
factors limit the useful life of territorial marketing rights, the Company has deemed these intangible assets to have indefinite lives. Goodwill and
territorial marketing rights were amortized on a straight-line basis until December 31, 2001, after which such amortization ceased upon the adoption of
Statement of Financial Accounting Standards (SFAS) 142. Accordingly, the Companys goodwill and territorial marketing rights that are
deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests.




Capitalized course costs include
certain expenditures incurred by our Test Preparation Services division to develop test preparation courses and consist primarily of amounts paid to
consultants and




47


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THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




salaries of employees hired to
develop course materials and curriculum. Course costs are capitalized only when a course is first developed or there is a major revision to a course or
significant re-write of the course materials or curriculum, for example, when the related test changes. The amortization period for these costs is five
years, based upon the average life cycle of the related standardized tests. Amortization of these capitalized course costs commences with the
realization of course revenues. The cost of minor enhancements or annual updates to the curriculum and materials is expensed as
incurred.




Capitalized K-12 content includes
certain expenditures incurred by our K-12 Services division to produce questions and lessons primarily for math, reading and language arts subjects
typically taught in grades one through 11 and consist primarily of amounts paid to consultants and salaries of employees hired to produce these
questions or lessons. These questions or lessons are used in numerous products sold by the K-12 Services division, including the Homeroom subscription
service, printed materials and live instruction products. Only expenditures for questions or lessons that allow the Company to enter into new markets,
such as new geographic areas or grades, or that significantly enhance the marketability of the Companys products, such as a new subject area, are
capitalized. The amortization period for these costs is seven years, based on numerous factors, including the average lives of similar products and the
cycle of major changes in educational philosophies and methodologies as reflected by the adoption cycles of state tests and textbooks. Amortization of
these capitalized K-12 content costs commences when the questions or lessons are available for use. The cost of planning, marketing and maintenance
related to this content is expensed as incurred, as is the cost of design and feasibility work.




Publishing rights primarily consist of
amounts paid in 1995 to certain co-authors to purchase their rights to future royalties on certain books, including Cracking the SAT/PSAT, Cracking
the LSAT, Cracking the GRE, Cracking the GMAT, The Best 361 Colleges and Word Smart. These books are primarily current reference materials
that are updated every one or two years. In 2005, the Company collected approximately $1.0 million in royalties from the publisher of these books.
Publishing rights are being amortized on a straight-line basis over 25 years.




Franchise costs represent the cost of
franchise rights purchased by the Company from third parties and are amortized using the straight-line method over the remaining useful life of the
applicable franchise agreement.




Customer lists were purchased by the
Company from Embark.com, Inc. (Embark) in 2001 and consist primarily of academic institution customers of the Companys Admissions
Service division. At the time of the acquisition, an independent party completed a valuation of the customer list using a discounted cash flow analysis
and assumed an eight percent annual loss of customer revenues. Customer lists are amortized on a straight-line basis over 10 years.




Other intangible assets are amortized
on a straight-line basis over their useful lives: three to 20 years for trademarks/tradenames and for non-compete agreements.




See Note 5 for further information with
respect to the Companys goodwill and other intangible assets.




Impairment




Goodwill and Territorial Marketing
Rights




As noted above, the Company adopted
SFAS 142, Goodwill and Other Intangible Assets, under which goodwill and territorial marketing rights are no longer amortized but
instead goodwill and territorial marketing rights are assessed for impairment annually. In making this assessment, management relies on a number of
factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and market place data.
Goodwill is assigned to specific reporting units and is reviewed for possible impairment at least annually or more frequently upon the occurrence of an
event or when circumstances indicate that a reporting units carrying amount




48


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THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




is greater than its fair value.
During the fourth quarter of 2005, the Company completed its annual assessment for impairment and determined that there was no such impairment against
the current carrying amount. During 2004, the carrying amount of goodwill for one of its reporting units exceeded its fair value. As a result of the
second step analysis, a goodwill impairment of approximately $8.2 million was recognized.




Long-Lived
Assets




The Company reviews its long-lived
assets, which excludes goodwill and territorial marketing rights, for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. If such review indicates that an asset may not be recoverable, an impairment loss is recognized for the
excess of the carrying amount over the fair value of an asset to be held and used or over the fair value less cost to sell an asset to be disposed.
During 2005 and 2004, no impairment charge was required.




Investments in Affiliates




The Company values its investments in
affiliate companies in which it has a less than 50% ownership interest and can exercise significant influence using the equity method of accounting.
Investments in affiliate companies in which the Company has a less than 20% ownership interest and does not have the ability to exercise significant
influence are accounted for using the cost method of accounting. The Company has evaluated its investment under FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, and concluded that consolidation is not required.




Deferred Income




Deferred income represents tuition and
customer deposits (which are refundable prior to the commencement of the program), college marketing fees and subscription services, professional
development fees and fees for printed materials. Tuition is applied to income ratably over the periods in which it is earned, generally the term of the
program. College marketing fees and subscription fees are applied to income ratably over the life of the agreements, which typically range from one to
two years. Fees for professional development and printed materials are recognized as the services and products are delivered.




Revenue Recognition




The Company recognizes revenue from the
sale of products and services as follows:




Course and Tutoring
Income




Tuition and tutoring fees are paid to
the Company and recognized over the life of the course.




Book, Software and Publication
Income and Expenses




The Company recognizes revenue from
both performance-based fees such as marketing fees and royalties and delivery-based fees such as advances, copy editing fees, workbook development and
test booklet fees and books sold directly to schools. Performance-based fees, which represent royalties on books and software sold, are recognized when
sales reports are received from the publishers. Delivery-based fees are recognized upon the completion and acceptance of the product by the publishers
and/or customers. Until such time, all costs and revenues related to such delivery-based fees are deferred. Book advances are recorded as liabilities
and deferred book expenses are included in other current assets.




49


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THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Royalty Service
Fees




As consideration of the rights and
entitlements granted under franchise agreements, which entitle the franchisees to provide test preparation services utilizing the Princeton Review
method in their licensed territories, the franchisees are required to pay to the Company a monthly royalty service fee equal to 8% (9.5% beginning in
2006) of the franchises gross receipts collected during the preceding month. In addition, these fees include a 10% fee charged to the
Companys franchisees for use by their students of the Companys supplemental online course tools. The Companys franchisees
contributions to the advertising fund are also recognized by the Company as royalty revenue (see Note 8). Under the terms of the franchise agreements,
the Company has the right to perform audits of royalty service fees reported by the franchisees. Any differences resulting from an audit, including
related interest and penalties, if any, are recorded upon the completion of the audit when such amounts are determinable.




Course Materials and Other
Products




The Company recognizes revenue from the
sale of course materials and other products to the independently owned franchises upon shipment.




Lead Generation
Fees




The Company recognizes revenue from
lead generation fees as the service is delivered to these institutions.




College Marketing and Subscription
Fees




The Company recognizes revenue from
subscription fees for web-based services over the life of the contract, which is typically one to two years.




Transaction Processing
Fees




The Company recognizes revenue from
transaction processing fees, such as web-based school application fees, as the transactions are completed.




Multiple-deliverable
contracts




Certain of the Companys customer
contracts represent multiple-element arrangements, which may include several of the Companys products and services. Multiple-element arrangements
are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more
than one unit of accounting if all of the criteria in EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables are met. If
there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the
separate units of accounting based on each units relative fair value and the revenue policies described above are then applied to each unit of
accounting.




Other Revenue




Other revenue consists of miscellaneous
fees for other services provided to third parties primarily for assessment tests, authoring questions, advertising, training and professional
development fees, which are recognized as the products or services are delivered. Other revenue also includes college marketing fees, such as
newsletter or banner ads, which are recognized ratably over the period in which the marketing services are provided, which is typically one
year.




50


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Revenue Components




The following table summarizes the
Companys revenue and cost of revenue for the years ended December 31, 2005, 2004 and 2003:







|                      |  |  |  | Years Ended December 31, |        
|--------------------- |  |  |  | ------------------------ | -------
|
|
|Revenue               |  |  |  |                          |        
|Services              |  |  |  | $                        | 104,283
|Products              |  |  |  |                          | 18,214 
|Other                 |  |  |  |                          | 7,996  
|Total
Revenue         |  |  |  | $                        | 130,493
|Cost of
Revenue       |  |  |  |                          |        
|Services              |  |  |  | $                        | 40,354 
|Products              |  |  |  |                          | 8,719  
|Other                 |  |  |  |                          | 524    
|Total Cost of
Revenue |  |  |  | $                        | 49,597 



Foreign Currency Translation




Balance sheet accounts of the
Companys Canadian subsidiary, with the exception of certain historical rate-based assets, are translated using year-end exchange rates. Statement
of operations accounts, with the exception of depreciation and amortization, are translated at monthly average exchange rates. The resulting
translation adjustment is recorded as a separate component of stockholders equity. Foreign exchange gains and losses for all the years presented
were not significant. The accumulated balance as a component of comprehensive income, comprised entirely of foreign exchange differences, was
approximately $262,000 and $221,000 at December 31, 2005 and 2004, respectively.




Advertising and Promotion




Advertising and promotion costs are
expensed in the year incurred. Costs related to producing mailers and other pamphlets are expensed when mailed. Due to the seasonal nature of the
business, most advertising costs related to mailers and pamphlets are expensed by the end of the year. Total advertising and promotion expense was
approximately $6.8 million, $6.4 million, and $7.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.




Fair Value of Financial Instruments




For financial instruments including
cash and cash equivalents, accounts receivable, other receivables and accounts payable, the carrying amount approximated fair value because of their
short maturity. The carrying value of the Companys debt approximated fair value as the interest rates for the debt approximated market rates of
interest available to the Company for similar instruments.




Concentration of Credit Risk




Financial instruments that potentially
subject the Company to concentration of credit risk include cash and cash equivalents and accounts receivable arising from its normal business
activities. The Company places its cash and cash equivalents with high credit quality financial institutions.




Concentrations of credit risks with
respect to accounts receivable are limited due to the large number of entities comprising the payor base, and their dispersion across different states.
The Company




51


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




does not require collateral. At
December 31, 2004, two customers accounted for approximately 18% and 10% of gross accounts receivable.




Income Taxes




The Company accounts for income taxes
based upon the provisions of SFAS No. 109, Accounting for Income Taxes. Under SFAS 109, the liability method is used for accounting for income
taxes, and deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities.
A valuation allowance is recorded when it is more likely than not that some or all of the deferred tax assets will not be realized.




Income (Loss) Per Share




Basic and diluted net income (loss) per
share information for all periods is presented under the requirements of SFAS No. 128, Earnings per Share. Basic net income (loss) per share is
computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the period.
Diluted net income (loss) per share is determined in the same manner as basic net income (loss) per share, except that the number of shares is
increased assuming exercise of dilutive stock options, warrants and convertible securities. The calculation of diluted net income (loss) per share
excludes potential common shares if the effect is antidilutive.




During certain of the periods
presented, stock options and securities convertible into or exercisable for common stock were outstanding that would be dilutive but were excluded
because to include them would have been antidilutive (see Note 15).




Stock options




The Company accounts for the issuance
of stock options using the intrinsic value method in accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock
Issued to Employees, and related interpretations. Generally for the Companys stock option plans, no compensation cost is recognized in the
Consolidated Statements of Operations because the exercise price of the Companys stock options equals the market price of the underlying stock on
the date of grant. Had the Company accounted for its employee stock options under the fair-value method of that statement, the Companys net
income per share would have been decreased and net loss per share would have been increased to the pro forma amounts indicated:







|                                                                                                                                    |  |  |  | Year Ended December 31, |       
|----------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ----------------------- | ------
|
|
|Net income
(loss) attributed to common stockholders, as reported                                                                    |  |  |  | $                       | (4,328
|Total
stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects |  |  |  |                         | (3,467
|Pro forma net
income (loss) attributed to common stockholders                                                                       |  |  |  | $                       | (7,795
|Basic and
diluted income (loss) per share:                                                                                          |  |  |  |                         |       
|As
reported                                                                                                                         |  |  |  | $                       | (0.16 
|Pro
forma                                                                                                                           |  |  |  | $                       | (0.28 



52


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




After the Companys initial public
offering, these options were valued using a Black-Scholes option pricing model. The following weighted-average assumptions were used under this
method:







|                        |  |  |  | Year Ended December 31, |     
|----------------------- |  |  |  | ----------------------- | ----
|
|Expected life
(years)   |  |  |  |                         | 5.0 
|Risk-free
interest rate |  |  |  |                         | 4.25
|Dividend
yield          |  |  |  |                         | 0   
|Volatility
factor       |  |  |  |                         | 41  



This option-valuation method requires
input of highly subjective assumptions. Because the Companys employee stock options have characteristics significantly different from those of
traded options, and because change in the subjective input assumptions can materially affect the fair value estimate, in managements opinion, the
existing methods do not necessarily provide a reliable single measure of the fair value of its employee stock options. The effects of applying SFAS 123
in this pro forma disclosure are not indicative of future amounts and additional awards in future years are anticipated. For purposes of pro forma
disclosure, the estimated fair value of the equity awards is amortized to expense, on a straight-line basis, over the options vesting period. The
weighted average fair value of options granted during the years ended December 31, 2005, 2004 and 2003 was $5.77, $4.42, and $2.75, respectively. As of
December 31, 2005, there were approximately 2,461,000 options exercisable with a weighted average remaining contractual life of approximately 6.4
years.




As of December 23, 2005, the
Compensation Committee of the Board of Directors of the Company approved the acceleration of vesting of unvested stock options granted to employees of
the Company outstanding as of December 31, 2005 that have an exercise price at or greater than $7.00 and which are scheduled to vest in the 24-month
period following December 31, 2005. Options held by the Companys Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and
the Board of Directors are excluded from the vesting acceleration. There are approximately 360,000 options to purchase the Companys common stock
that were accelerated. Options accelerated on behalf of the Companys Executive Officers are as follows:







|Officer                |  |  |  | Title                                                   |  | Number of Accelerated Options |        | Weighted Average Exercise Price Per Share
|---------------------- |  |  |  | ------------------------------------------------------- |  | ----------------------------- | ------ | -----------------------------------------
|Margot
Lebenberg       |  |  |  | Executive Vice President, Secretary and General Counsel |  |                               | 27,500 |                                          
|Stephen
Quattrociocchi |  |  |  | Executive Vice President                                |  |                               | 23,019 |                                          
|Young J.
Shin          |  |  |  | Executive Vice President                                |  |                               | 10,000 |                                          



The decision to accelerate vesting of
these out-of-the-money stock options was made primarily to minimize future compensation expense that the Company would otherwise have been
required to recognize in its consolidated statements of operations pursuant to Financial Accounting Standards Board Statement No. 123(R) (revised
2004), Share-Based Payment, which becomes effective as to the Company beginning in the first fiscal quarter of 2006. The Company
believes that the aggregate future expense that will not be included in future consolidated statements of operations as a result of this acceleration
of vesting is approximately $1.6 million.




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 for transactions in which an entity exchanges its equity instruments for goods or services. SFAS
123(R)




53


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity
instruments be recognized as expense in the financial statements as services are performed. Prior to SFAS 123(R), only the pro forma disclosures of
fair value were required. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, TOPIC 14: Share-Based Payment which addresses
the interaction between SFAS 123(R) and certain SEC rules and regulations and provides views regarding the valuation of share-based payment
arrangements for public companies. SFAS 123(R) is effective for our first quarter of 2006 and the adoption of this new accounting pronouncement is
expected to result in pre-tax stock-based compensation expense of between $0.3 million and $0.5 million in 2006.




In December 2004, the FASB issued SFAS
No. 153, Exchanges of Nonmonetary Assets  An Amendment of APB Opinion No. 29 (SFAS 153). This new standard is the
result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles
(GAAP) in the U.S. and GAAP developed by the International Accounting Standards Board (IASB). As part of this effort, the FASB
and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting
standards. SFAS 153 amends Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions (APB 29),
that was issued in 1973. The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on
the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets
and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, APB 29
required that the accounting for an exchange of a productive asset for 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 were effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005, and there was no impact on the Companys consolidated financial
statements.




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




54


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THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)


|2. |  | Other Assets
|-- |  | ------------



Other assets (current) consists of the
following:







|                                   |  |  |  | December 31, |      
|---------------------------------- |  |  |  | ------------ | -----
|
|
|Deferred book
costs                |  |  |  | $            | 297  
|Deferred
financing expenses        |  |  |  |              |     
|Loans to
officers, current portion |  |  |  |              | 168  
|Loan
receivable                    |  |  |  |              | 781  
|Other                              |  |  |  |              | 61   
|                                   |  |  |  | $            | 1,307



Other assets (non-current) consists of
the following:







|                                             |  |  |  | December 31, |      
|-------------------------------------------- |  |  |  | ------------ | -----
|
|
|Security
deposits                            |  |  |  | $            | 655  
|Content and
software development in progress |  |  |  |              | 910  
|Loans to
officers                            |  |  |  |              | 457  
|Loan
receivable                              |  |  |  |              | 1,146
|Other                                        |  |  |  |              |     
|                                             |  |  |  | $            | 3,168

|3. |  | Furniture, Fixtures, Equipment and Software
Development
|-- |  | -------------------------------------------------------






|                                                                                                                                                        |  |  |  | December 31, |       
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------ | ------
|
|
|Computer
equipment                                                                                                                                      |  |  |  | $            | 7,019 
|Furniture,
fixtures and equipment                                                                                                                       |  |  |  |              | 2,054 
|Computer and
phone equipment under capital lease                                                                                                        |  |  |  |              | 3,258 
|Automobiles                                                                                                                                             |  |  |  |              |      
|Software and
web site development  third party                                                                                                         |  |  |  |              | 4,648 
|Software and
web site development  internally developed                                                                                                |  |  |  |              | 10,374
|Leasehold
improvements                                                                                                                                  |  |  |  |              | 6,732 
|                                                                                                                                                        |  |  |  |              | 34,085
|Less
accumulated depreciation and amortization, including $1,719 in 2005 and $1,182 in 2004 of accumulated depreciation for assets under capital
leases |  |  |  |              | 17,930
|                                                                                                                                                        |  |  |  | $            | 16,155

|4. |  | Investment in Affiliates
|-- |  | ------------------------



On June 25, 2004, the Company invested
$625,000 and issued 63,562 shares of the Companys common stock, with an approximate value of $500,000 at the time of issuance, and incurred
approximately $162,000 of acquisition costs for an approximate 25% equity interest in Oasis Childrens Services, LLC (Oasis), a
privately held company. Under the agreement, the Company guaranteed a minimum market value of the shares issued. Oasis sold all of the shares in the
open market in December,




55


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




2005. The proceeds from the sale of
the shares fell short of the guaranteed amount, requiring the Company to pay an additional $117,000 in cash.




Oasis works with schools, school
systems and communities to operate summer and after-school programs. In conjunction with the investment, Oasis and the Company have agreed to, from
time to time, jointly develop, market and sell summer programs for the K-12 market that combine recreational and enrichment programs and activities
provided by Oasis with educational programs and activities provided by the Company. The Company accounts for its investment in Oasis using the equity
method. This investment is carried as a corporate asset.




The Company has an ownership interest
of approximately 20% in Student Monitor, LLC, a privately held company. At December 31, 2005 and 2004, as a result of recording its shares of losses,
the Companys investment in this company was recorded as $0.




At December 31, 2005 and 2004, the
Companys net investment in Tutor.com was recorded as $0, as a result of recording its share of Tutor.com losses. Pursuant to an agreement entered
into on December 31, 2003, the Company terminated its strategic relationship with Tutor.com and sold preferred stock it held in Tutor.com for $300,000
in cash. As consideration for the termination of certain strategic agreements and the restructuring of certain rights, the Company received an
additional $200,000 in cash and $500,000 in notes. The Company retains a common stock position in Tutor.com, representing approximately 2.5% of its
outstanding equity, which was recorded as $0 as of December 31, 2005.




During 2001 and 2002, the Company
invested $700,000 in SchoolNet, Inc.(SchoolNet), a privately held education technology solutions company. The Company currently owns
approximately 5% of SchoolNet. The Company maintains a strategic marketing relationship with SchoolNet, through which SchoolNet markets and distributes
a version of the Companys Homeroom product called Homeroom Inside. As of December 31, 2005 and 2004, the value of the Companys
investment in SchoolNet was approximately $356,000, net of an impairment writedown of approximately $344,000 in 2002. This investment is carried in the
K-12 Services Segment. The Company has also contracted with SchoolNet to provide Enterprise Resource Planning software that monitors the use of the
Homeroom.com Web site.


|5. |  | Goodwill and Other Intangible Assets
|-- |  | ------------------------------------



The following table summarizes the
components of goodwill which is no longer subject to amortization:







|                              |  |  |  | December 31, |       
|----------------------------- |  |  |  | ------------ | ------
|
|
|Gross
carrying amount         |  |  |  | $            | 33,065
|Less
accumulated amortization |  |  |  |              | 1,559 
|                              |  |  |  | $            | 31,506



56


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




The following table summarizes the
change in the carrying amount of segment goodwill for the periods indicated:







|                                |  |  |  | Test Preparation Services |        | K-12 Services |  | Admissions Services |   | Total
|------------------------------- |  |  |  | ------------------------- | ------ | ------------- |  | ------------------- | - | -----
|
|Balance as of
January 1, 2004   |  |  |  | $                         | 30,881 |               |  |                     |  |      
|Net change
from acquisitions    |  |  |  |                           | 130    |               |  |                     |  |      
|Impairments                     |  |  |  |                           |       |               |  |                     |  |      
|Balance as of
December 31, 2004 |  |  |  |                           | 31,011 |               |  |                     |  |      
|Other                           |  |  |  |                           | (5     | )             |  |                     |   |      
|Balance as of
December 31, 2005 |  |  |  | $                         | 31,006 |               |  |                     |  |      



As a result of the Companys
annual evaluation of the impairment of intangible assets, the Company recorded an $8.2 million charge for the impairment of goodwill related to the
2001 acquisition of Embark. This impairment resulted from the Admission Services divisions operating results in 2004, and while this division
continues to operate and expects to generate future cash flows from the sale of its new marketing services, these future cash flows are still
uncertain.




The following is a summary of other
intangible assets:







|                                     |  |  |  | December
      31, 2005 |        | December
      31, 2004
|------------------------------------ |  |  |  | ----------------------- | ------ | -----------------------
|
|
|Franchise
        costs              |  |  |  | $                       | 283    |                        
|Publishing
        rights            |  |  |  |                         | 1,761  |                        
|Capitalized
        K-12 content     |  |  |  |                         | 12,867 |                        
|Trademark
        / tradename        |  |  |  |                         | 338    |                        
|Non-compete
        agreements       |  |  |  |                         | 1,244  |                        
|Customer
        lists               |  |  |  |                         | 2,700  |                        
|Capitalized
        course costs     |  |  |  |                         | 1,610  |                        
|                                     |  |  |  | $                       | 20,803 |                        
|Not
        Subject to Amortization  |  |  |  |                         |        |                        
|Territorial
        marketing rights |  |  |  |                         |        |                        
|                                     |  |  |  |                         |        |                        






|                                |  |  |  | (in thousands)
|------------------------------- |  |  |  | --------------
|Aggregate
amortization expense: |  |  |  |               
|Actual:                         |  |  |  |               
|2003                            |  |  |  |               
|2004                            |  |  |  |               
|2005                            |  |  |  |               
|Estimate for
fiscal year:       |  |  |  |               
|2006                            |  |  |  |               
|2007                            |  |  |  |               
|2008                            |  |  |  |               
|2009                            |  |  |  |               
|2010                            |  |  |  |               



57


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)


|6. |  | Line of Credit and Long-Term Debt
|-- |  | ---------------------------------



Line of Credit




On May 21, 2004, the Company entered
into a credit agreement with Commerce Bank, N.A. for a three-year revolving credit facility with a maximum aggregate principal amount of $5.0 million.
As of December 31, 2004, the effective interest rate was 3.9% and $2.0 million was outstanding. In February 2005, the Company repaid the entire
outstanding balance and terminated the facility. The outstanding balance at the time of payment was $2.0 million. Additionally, the Company wrote off
unamortized deferred financing costs of approximately $0.1 million.




Notes Payable




On March 2, 2001, the Company completed
its acquisition of Princeton Review of New Jersey, Inc. and Princeton Review of Boston, Inc. The Company financed part of this acquisition with notes
to the sellers totaling $3,625,000. This balance was comprised of two notes. The first promissory note of $3,125,000 is payable as to principal in 20
equal quarterly installments beginning with the 17th calendar quarter following the closing date of the acquisition and bears interest at the rate of
8.25% per year, payable quarterly. The second promissory note for $500,000 bears interest at the rate of 8.25% per year, payable on a quarterly basis,
and is payable as to the entire principal amount four years from its date of issuance. At December 31, 2005 and 2004, $2,500,000 and $3,625,000 was
outstanding, respectively.




On July 11, 2003, the Company acquired
77% of Princeton Review of North Carolina, Inc with the balance acquired from the minority shareholders on November 13, 2003. The Company financed part
of this acquisition with two notes to the sellers in the amount of $609,000 and $740,000, including imputed interest at 5% per year, which were
outstanding as of December 31, 2005 and 2004. The notes are payable in annual installments, including interest, of approximately $121,000 per year in
years 2006 through 2010 when the loans are due.




The annual maturities of notes payable
as of December 31, 2005 are approximately as follows:







|As of December 31, |  |  |  | Amount Maturing
|------------------ |  |  |  | ---------------
|
|2006               |  |  |  | $              
|2007               |  |  |  |                
|2008               |  |  |  |                
|2009               |  |  |  |                
|2010               |  |  |  |                
|                   |  |  |  | $              



Capital Lease Obligations




At December 31, 2005, the Company has
leased approximately $3.3 million of computer and phone equipment under capital leases, all of which are included in fixed assets




58


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




The following is a schedule of the
future minimum capital lease obligation payments together with the present value of the minimum lease payments at December 31, 2005:







|Year ending December 31,                                                            |  |  |  | (in thousands)
|----------------------------------------------------------------------------------- |  |  |  | --------------
|2006                                                                                |  |  |  | $             
|2007                                                                                |  |  |  |               
|2008                                                                                |  |  |  |               
|Total                                                                               |  |  |  |               
|Less: amounts
representing interest (effective interest rate ranges from 6% to 11%) |  |  |  |               
|Present value
of minimum lease payments                                             |  |  |  |               
|Less: current
portion of capital lease obligations                                  |  |  |  |               
|Long-term
portion of capital lease obligations                                      |  |  |  | $             



Total Long-Term Debt




Long-term debt consists of the
following:







|                          |  |  |  | December 31, |      
|------------------------- |  |  |  | ------------ | -----
|
|
|Notes
payable             |  |  |  | $            | 3,161
|Capital lease
obligations |  |  |  |              | 1,214
|Auto
loan                 |  |  |  |              |     
|                          |  |  |  |              | 4,375
|Less current
portion      |  |  |  |              | 1,530
|                          |  |  |  | $            | 2,845

|7. |  | Series B-1 Preferred Stock
|-- |  | --------------------------



On June 4, 2004, the Company sold
10,000 shares of its Series B-1 Preferred Stock to Fletcher International, Ltd. (Fletcher) for proceeds of $10,000,000. These shares are
convertible into common stock at any time. Prior to conversion, each share accrues dividends at an annual rate of the greater of 5% and the 90-day
London Interbank Offered Rate (LIBOR) plus 1.5% (4.4% at December 31, 2005), subject to adjustment. Dividends are payable, at the Companys
option, in cash or registered shares of common stock. At the time of issuance of the Series B-1 Preferred Stock to Fletcher, each share of Series B-1
Preferred Stock was convertible into a number of shares of common stock equal to: (1) the stated value of one share of Series B-1 Preferred Stock plus
accrued and unpaid dividends, divided by (2) the conversion price of $11.00, subject to adjustment. In accordance with the terms of the agreement with
Fletcher, the conversion price was decreased to $9.9275 per share because effectiveness of the registration statement relating to the Fletcher shares
was delayed until December 28, 2004.




Fletcher may redeem its shares of the
Series B-1 Preferred Stock, in lieu of converting such shares, at any time on or after November 28, 2005, for shares of common stock unless the Company
satisfies the conditions for cash redemption. If Fletcher elects to redeem its shares and the Company does not elect to make such redemption in cash,
then each share of Series B-1 Preferred Stock will be redeemed for a number of shares of common stock equal to: (1) the stated value of $1,000 per
share of Series B-1 Preferred Stock plus accrued and unpaid dividends, divided by (2) 102.5% of the prevailing price of common stock at the time of
delivery of a redemption notice (based on an average daily trading price formula). If Fletcher elects to redeem its shares and the Company elects to
make such redemption in cash, then Fletcher will receive funds equal to the product of: (1) the number of shares of common stock




59


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




that would have been issuable if
Fletcher redeemed its shares of Series B-1 Preferred Stock for shares of common stock; and (2) the closing price of the common stock on the NASDAQ
National Market on the date notice of redemption was delivered. As of June 4, 2014 the Company may redeem any shares of Series B-1 Preferred Stock then
outstanding. If the Company elects to redeem such outstanding shares, Fletcher will receive funds equal to the product of: (1) the number of shares of
Series B-1 Preferred Stock so redeemed, and (2) the stated value of $1,000 per share of Series B-1 Preferred Stock, plus accrued and unpaid
dividends.




In addition, the Company granted
Fletcher certain rights entitling Fletcher to purchase up to 20,000 shares of additional preferred stock, at a price of $1,000 per share, for an
aggregate additional consideration of $20,000,000. The agreement with Fletcher provides that any shares of additional preferred stock will have the
same conversion ratio as the Series B-1 Preferred Stock, except that the conversion price will be the greater of (1) $11.00, or (2) 120% of the
prevailing price of common stock at the time of exercise of the rights (based on an average daily trading price formula), subject to adjustment upon
the occurrence of certain events. Due to the delay in the effectiveness of the registration statement relating to the Series B-1 Preferred Stock, the
conversion price for any such additional series of preferred stock was reduced to the greater of (1) $9.9275, or (2) 108.3% of the prevailing price of
common stock at the time of exercise of the rights. These rights may be exercised by Fletcher on one or more occasions commencing July 1, 2005, and for
the 24-month period thereafter, which period may be extended under certain circumstances. The Agreement with Fletcher also provides that shares of
additional preferred stock will also be redeemable upon terms substantially similar to those of the Series B-1 Preferred Stock.




During 2005 and 2004, cash dividends in
the amount of $534,200 and $373,600, respectively were paid to the Series B-1 Preferred stockholder.


|8. |  | Commitments and Contingencies
|-- |  | -----------------------------



Advertising Fund




All domestic franchisees are required
to pay a monthly advertising fee to the Company, for contribution to an advertising fund, equal to 2% of their franchises gross receipts, as
defined, for the preceding month. In accordance with the terms of the franchise agreements, the Company is required to use all advertising fees it
receives for the development, placement and distribution of regional and national consumer advertising, designed at its discretion to promote consumer
demand for services and products available from the franchises.




The Company is required to keep
separate advertising fund accounting records and to maintain the advertising funds collected from the franchisees in a separate bank account.
Franchisee payments to the Company for the advertising fund are recorded in the Companys revenue and advertising expenses of the advertising fund
are recorded in the Companys selling, general and administrative expenses.




60


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Office and Classroom Leases




The Company has entered into various
operating leases in excess of one year, primarily office and classroom site locations. Minimum rental commitments under these leases, including fixed
escalation clauses, which are in excess of one year, as of December 31, 2005, are approximately as follows:







|Years Ending December 31, |  |  |  | (in thousands)
|------------------------- |  |  |  | --------------
|2006                      |  |  |  | $             
|2007                      |  |  |  |               
|2008                      |  |  |  |               
|2009                      |  |  |  |               
|2010                      |  |  |  |               
|Thereafter                |  |  |  |               
|                          |  |  |  | $             



Rent expense for the years ended
December 31, 2005, 2004 and 2003 was approximately $9.5 million, $8.6 million, and $7.7 million, respectively. These amounts include rent expense for
the rental of space on a month-to-month basis, as well as those amounts incurred under operating leases for longer periods. Certain leases provide for
early termination without penalty.




Legal Matters




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 of on-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, CollegeNet dismissed the 2003 case without prejudice on January 9, 2004 against the Company. Thereafter, on August 2, 2005, the
Federal Circuit Court of Appeals issued an opinion favorable to CollegeNet from its appeal from the adverse rulings. Then on August 3, 2005, CollegeNet
filed suit again against the Company alleging an infringement of the same CollegeNet patent related to processing on-line applications. The Company was
served on November 22, 2005 and filed its answer and counterclaim on January 13, 2006. CollegeNet seeks injunctive relief and unspecified monetary
damages. Because this proceeding is at a very preliminary stage, we are unable to predict its outcome with any degree of certainty. However, the
Company believes that it has meritorious defenses to CollegeNets claims of infringement and intends to vigorously defend. In a related matter,
the Company filed a request with the United Stated Patent and Trademark Office (PTO) for ex parte reexaminations of the CollegeNet 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 all claims of the CollegeNet ‘042 patent on October 31, 2005 and the CollegeNet ‘045
patent on January 27, 2006.




On August 29, 2005, Test Services, Inc.
(TSI), a franchisee of the Company under ten separate franchise agreements, six of which expired on December 31, 2005, filed suit against
the Company in the United States District Court for the District of Colorado. TSI alleged that the terms the Company offered for renewal of the
franchise relationship did not comply with TSIs contractual renewal rights. TSI sought declaratory relief and specific performance and
unspecified damages as to the alleged breaches of the renewal provisions. TSIs complaint also included claims that the Company had breached the
existing franchise agreements with TSI in ways unrelated to the core renewal dispute. On November 29, 2005, the court granted the Companys motion
to dismiss all of TSIs claims relating to the core renewal dispute. On December 31, 2005, the Company entered into a settlement in which: (1) TSI
agreed to execute a new franchise agreement for each of its ten franchise territories with certain negotiated changes; (2) TSI paid the Company $1
million in cash; (3) the Company, TSI and TSIs parent company agreed on certain terms regarding competitive activities by the parent company, a
potential spin-off of TSI, and a Company option




61


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




to acquire TSI at a formula value
in certain circumstances; TSI agreed to increase royalty payments to the Company from 8% to 9-1/2% (beginning January 1, 2006); and (4) all litigation
was dismissed with prejudice and the parties exchanged releases as to all matters except amounts payable in the ordinary course of business under the
superseded franchise agreements.




In addition to the foregoing, from time
to time, the Company is involved in legal proceedings incidental to the conduct of the Companys business, none of which is likely to have a
material adverse effect on the Company.




Co-authorship Agreements




In connection with its publishing
agreements, the Company has entered into various co-authorship agreements for the preparation of manuscripts. These agreements require payment of
nonrecourse advances for services rendered at various established milestones. The Company did not have any future contractual commitments under the
co-authorship agreements for manuscripts not yet delivered for the years ended December 31, 2005 and 2004, however there were approximately $30,000 in
commitments as of December 31, 2003. In addition, the co-authors are entitled to a percentage of the future royalties earned by the Company, which are
first to be offset against such advances. The total costs incurred under these co-authorship agreements by the Company for advances and royalties were
approximately $524,000, $585,000, and $528,000 for the years ended December 31, 2005, 2004 and 2003, respectively.




The expense related to co-author
payments is accrued monthly. This expense is adjusted based upon actual expenditures paid to the co-authors. These expenditures are a percentage of the
royalties paid to the Company by the publisher. Royalties from the publisher are recorded as revenue with the co-author expenditures recorded as
expense.


|9. |  | Income Taxes
|-- |  | ------------



The (provision) benefit for income
taxes consists of the following:







|                                           |  |  |  | Year Ended December 31, |  
|------------------------------------------ |  |  |  | ----------------------- | -
|
|
|Current tax
(provision) benefit:           |  |  |  |                         |  
|U.S.
Federal                               |  |  |  | $                       | 
|State                                      |  |  |  |                         | 
|Foreign                                    |  |  |  |                         | 
|                                           |  |  |  |                         | 
|Deferred tax
(provision) benefit:          |  |  |  |                         |  
|U.S.
Federal                               |  |  |  |                         | 
|State                                      |  |  |  |                         | 
|Foreign                                    |  |  |  |                         | 
|                                           |  |  |  |                         | 
|Total
(provision) benefit for income taxes |  |  |  | $                       | 



62


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Significant components of the
Companys deferred tax assets and liabilities are as follows at:







|                                                             |  |  |  | December 31, |        
|------------------------------------------------------------ |  |  |  | ------------ | -------
|
|
|Deferred tax
assets:                                         |  |  |  |              |        
|Net operating
loss carryforwards                             |  |  |  | $            | 22,281 
|Tax credit
carryforwards                                     |  |  |  |              | 85     
|Allowance for
doubtful accounts                              |  |  |  |              | 663    
|Equity
compensation                                          |  |  |  |              | 188    
|Capitalized
inventory costs                                  |  |  |  |              | 168    
|Deferred
rent                                                |  |  |  |              | 911    
|Unrealized
losses                                            |  |  |  |              | 147    
|Accumulated
amortization including write down of intangibles |  |  |  |              | 621    
|Other                                                        |  |  |  |              | 464    
|Total
deferred tax assets                                    |  |  |  |              | 25,528 
|Deferred tax
liabilities:                                    |  |  |  |              |        
|Software
development costs                                   |  |  |  |              | (1,133 
|Accumulated
depreciation                                     |  |  |  |              | (743   
|Total
deferred tax liabilities                               |  |  |  |              | (1,876 
|Net deferred
tax before valuation allowance                  |  |  |  |              | 23,652 
|Valuation
allowance                                          |  |  |  |              | (23,652
|                                                             |  |  |  | $            |       



The net deferred income tax asset
decreased from an asset of $16.7 million at December 31, 2003, to $0 at December 31, 2004 and 2005. The $16.7 million change in the net deferred tax
balance is primarily attributable to the establishment of a valuation allowance on the net deferred tax asset. The net deferred tax asset at December
31, 2003 was included in the Companys consolidated balance sheet as other current assets of approximately $852,000, and noncurrent deferred tax
assets of approximately $15.8 million. As of December 31, 2005 the Company has a net operating loss carryforward totaling approximately $53.7 million
which expires in the years 2021 through 2025, and other timing differences which will be available to offset regular taxable income during the
carryforward period.




Deferred Tax Valuation Allowance




SFAS No. 109, Accounting for
Income Taxes, requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax
asset will not be realized. The cumulative pre-tax loss of $9.7 million incurred in the most recent three years represents sufficient negative evidence
under the provisions of SFAS No. 109 for the Company to determine that the establishment of a full valuation allowance against the deferred tax asset
is appropriate. This valuation allowance will offset assets associated with future tax deductions as well as carryforward items. Although management
expects that these assets will ultimately be fully utilized, future performance cannot be assured.




63


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




A reconciliation setting forth the
differences between the effective tax rate of the Company for the years ended December 31, 2005, 2004 and 2003 and the U.S. federal statutory tax rate
is as follows:







|                                                                       |  |  |  | Years ended December 31, |       
|---------------------------------------------------------------------- |  |  |  | ------------------------ | ------
|
|
|U.S. Federal
income tax benefit (provision) expenses at statutory rate |  |  |  | $                        | 1,181 
|Effect of
permanent differences and other                              |  |  |  |                          | 15    
|Effect of state
taxes                                                  |  |  |  |                          | 324   
|Valuation
allowance                                                    |  |  |  |                          | (1,520
|                                                                       |  |  |  | $                        |      

|10. |  | Employee Benefits and Contracts
|--- |  | -------------------------------



Retirement Plan




The Company has a defined contribution
plan (the Plan) under Section 401(k) of the Internal Revenue Code, which provides that eligible employees may make contributions subject to
Internal Revenue Code limitations. Employees become eligible to participate in the Plan on the first day of the quarter following the beginning of
their full-time employment, but company matching contributions do not begin until one year after full-time employment. Under the provisions of the
Plan, contributions made by the Company are discretionary and are determined annually by the trustees of the Plan. The Companys contributions to
the Plan for the years ended December 31, 2005, 2004 and 2003 were $342,000, $230,000, and $200,000, respectively.




Stock Incentive Plan




On April 1, 2000, the Company adopted
its 2000 Stock Incentive Plan (the Stock Incentive Plan) providing for the authorization and issuance of up to 2,538,000 shares of common
stock, as adjusted. On various date, beginning in June 2000 and extending through December 2005, an additional 2,675,744 shares were authorized. The
Stock Incentive Plan provides for the granting of incentive stock options, non-qualified stock options, restricted stock and deferred stock to eligible
participants. Options granted under the Stock Incentive Plan are for periods not to exceed ten years. Other than for options to purchase 133,445 shares
granted in 2000 to certain employees which were vested immediately, options outstanding under the Stock Incentive Plan generally vest quarterly over
two to four years. As of December 31, 2005, there were approximately 703,000 shares available for grant.




64


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




A summary of the activity of the Stock
Incentive Plan is as follows:







|                                 |  |  |  | Options |           | Weighted-Average Exercise Price
|-------------------------------- |  |  |  | ------- | --------- | -------------------------------
|Outstanding at
December 31, 2002 |  |  |  |         | 2,413,362 |                                
|Granted at
Market                |  |  |  |         | 429,236   |                                
|Forfeited                        |  |  |  |         | (170,330  | )                              
|Excercised                       |  |  |  |         | (124,205  | )                              
|Outstanding at
December 31, 2003 |  |  |  |         | 2,548,063 |                                
|Granted at
Market                |  |  |  |         | 1,098,473 |                                
|Forfeited                        |  |  |  |         | (167,107  | )                              
|Excercised                       |  |  |  |         | (120,926  | )                              
|Outstanding at
December 31, 2004 |  |  |  |         | 3,358,503 |                                
|Granted at
Market                |  |  |  |         | 224,900   |                                
|Forfeited                        |  |  |  |         | (282,503  | )                              
|Excercised                       |  |  |  |         | (2,406    | )                              
|Outstanding at
December 31, 2005 |  |  |  |         | 3,298,494 |                                
|Exercisable at
December 31, 2003 |  |  |  |         | 1,790,513 |                                
|Exercisable at
December 31, 2004 |  |  |  |         | 2,134,059 |                                
|Exercisable at
December 31, 2005 |  |  |  |         | 2,461,129 |                                



Stock options
outstanding at December 31, 2005 are summarized as follows:







|Options Outstanding |  | Options Exercisable | 
|------------------- |  | ------------------- | 
|
|$1.73$2.29         |  |                     | 
|$2.30$7.31         |  |                     | 
|$7.31$7.39         |  |                     | 
|$7.45$8.30         |  |                     | 
|$8.31$11.00        |  |                     | 
|                    |  |                     | 



During 2001, the Company granted
116,500 stock options to non-employee advisors and, using the fair value method, recorded expense of approximately $98,000, and $151,000 for the years
ended December 31, 2004 and 2003, respectively. Prior to 2005, these options were fully vested, therefore no expense was recorded in
2005.


|11. |  | Related Parties
|--- |  | ---------------



Publisher




Random House, Inc., a holder of
1,515,353 shares of the Companys common stock at December 31, 2005, is also the publisher and distributor of substantially all of the
Companys books. For the years ended December 31, 2005, 2004 and 2003, the Company earned $3.3 million, $3.7 million and $3.6 million
respectively, of book and publication income from Random House, Inc. Total receivables at December 31, 2005 and 2004 included $2.5 million and $2.8
million, respectively, due from Random House, Inc. for royalties, book advances, copy editing and marketing fees.




65


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




Loans to Officers




As of December 31, 2005 the Company had
a loan to one executive officer in the amount of $625,000, while in 2004 the Company had loans to two executive officers of approximately $1.3 million.
No loans were made to executive officers after February 2002, although interest continues to accrue. Such amounts and accrued interest are included in
Other Current Assets and Other assets at December 31, 2005 and December 31, 2004. Both loans are payable in four consecutive,
equal annual installments with the first payment to be made on the earlier of the fourth anniversary of the loan or 60 days after termination of
employment, accrue interest at 7.3% per year and. These loans are secured by shares of the Companys common stock owned by each of these
individuals. At December 31, 2005, the loan was secured by 178,316 shares of the Companys common stock. At December 31, 2004 the loans were
secured by 299,066 shares of the Companys common stock.


|12. |  | Acquisitions
|--- |  | ------------



On July 11, 2003, the Company acquired
a 77% interest in Princeton Review of North Carolina, Inc. and the remaining 23% was acquired on November 13, 2003. The total purchase price including
both transactions was approximately $1,138,000, including imputed interest. The purchase price exceeded the fair value of the net assets acquired
resulting in goodwill of approximately $938,000. Princeton Review of North Carolina, Inc. provided test preparation courses in North Carolina under the
Princeton Review name through a franchise agreement with the Company. This acquisition has been accounted for as a purchase and has been included in
the Companys operations from the date of the purchase.




Approximately $170,000 of the purchase
price was paid in cash at the time of closings. The remaining approximately $968,000 of the purchase price was paid by delivery to the sellers of
subordinated promissory notes (see Note 6).




The pro forma effect of the purchase of
the Princeton Review of North Carolina, Inc. is not presented in 2003 because its results are not significant.


|13. |  | Segment Reporting
|--- |  | -----------------



The operating segments reported below
are the segments of the Company for which separate financial information is available and for which operating results as measured by EBITDA are
evaluated regularly by executive management in deciding how to allocate resources and in assessing performance. The accounting policies of the business
segments are the same as those described in the summary of significant accounting policies (see Note 1).




The following segment results include
the allocation of certain information technology costs, accounting services, executive management costs, office facilities expenses, human resources
expenses and other shared services which are allocated based on consumption. Corporate consists of unallocated administrative support functions. The
Company operates its business through three divisions. The majority of the Companys revenue is earned by the Test Preparation Services division,
which sells a range of services including test preparation, tutoring and academic counseling. Test Preparation Services derives its revenue from
Company operated locations and from royalties from and product sales to independently owned franchises. The Admissions Services division earns revenue
from subscription, transaction and marketing fees from higher education institutions and from selling advertising and sponsorships. The K-12 Services
division earns fees from assessment, remediation and professional development services it renders to K-12 schools and from its content development
work. Additionally, each division earns royalties and other fees from sales of its books published by Random House.




The segment results include EBITDA for
the periods indicated. As used in this report, EBITDA means earnings before interest, income taxes, depreciation and amortization. The Company believes
that EBITDA, a non-GAAP financial measure, represents a useful measure of evaluating its financial




66


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)




performance because it reflects
earnings trends without the impact of certain non-cash and non-operations-related charges or income. The Companys management uses EBITDA to
measure the operating profits or losses of the business. Analysts, investors and rating agencies frequently use EBITDA in the evaluation of companies,
but the Companys presentation of EBITDA is not necessarily comparable to other similarly titled measures of other companies because of potential
inconsistencies in the method of calculation. EBITDA is not intended as an alternative to net income as an indicator of the Companys operating
performance, nor as an alternative to any other measure of performance calculated in conformity with GAAP.







|                                                             |  |  |  | Year Ended December 31, 2005 |       
|------------------------------------------------------------ |  |  |  | ---------------------------- | ------
|
|
|Revenue                                                      |  |  |  | $                            | 87,310
|Operating
expenses (including depreciation and amortization) |  |  |  | $                            | 48,457
|Segment
operating income (loss)                              |  |  |  |                              | 10,708
|Depreciation
& amortization                                  |  |  |  |                              | 1,853 
|Other                                                        |  |  |  |                              |      
|Segment
EBITDA                                               |  |  |  | $                            | 12,561
|Total segment
assets                                         |  |  |  | $                            | 50,355
|Segment
goodwill                                             |  |  |  | $                            | 31,006
|Expenditures
for long lived assets                           |  |  |  | $                            | 1,275 






|                                                             |  |  |  | Year Ended December 31, 2004 |       
|------------------------------------------------------------ |  |  |  | ---------------------------- | ------
|
|
|Revenue                                                      |  |  |  | $                            | 74,744
|Operating
expenses (including depreciation and amortization) |  |  |  | $                            | 42,858
|Segment
operating income (loss)                              |  |  |  |                              | 8,301 
|Depreciation
& amortization                                  |  |  |  |                              | 1,804 
|Other                                                        |  |  |  |                              |      
|Segment
EBITDA                                               |  |  |  | $                            | 10,105
|Total segment
assets                                         |  |  |  | $                            | 37,419
|Segment
goodwill                                             |  |  |  | $                            | 31,011
|Expenditures
for long lived assets                           |  |  |  | $                            | 2,551 



67


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)







|                                                             |  |  |  | Year Ended December 31, 2003 |       
|------------------------------------------------------------ |  |  |  | ---------------------------- | ------
|
|
|Revenue                                                      |  |  |  | $                            | 71,719
|Operating
expenses (including depreciation and amortization) |  |  |  | $                            | 39,123
|Segment
operating income (loss)                              |  |  |  |                              | 11,787
|Depreciation
& amortization                                  |  |  |  |                              | 1,522 
|Other                                                        |  |  |  |                              |      
|Segment
EBITDA                                               |  |  |  | $                            | 13,309
|Total segment
assets                                         |  |  |  | $                            | 41,798
|Segment
goodwill                                             |  |  |  | $                            | 30,881
|Expenditures
for long lived assets                           |  |  |  | $                            | 2,103 



Reconciliation of operating income (loss) to net income
(loss)







|                                            |  |  |  | Years Ended December 31, |       
|------------------------------------------- |  |  |  | ------------------------ | ------
|
|
|Total income
(loss) for reportable segments |  |  |  | $                        | (4,248
|Unallocated
amounts:                        |  |  |  |                          |       
|Interest
expense, net                       |  |  |  |                          | (354  
|Other
income                                |  |  |  |                          | 1,128 
|(Provision)
benefit for income taxes        |  |  |  |                          |      
|Net income
(loss)                           |  |  |  | $                        | (3,474



68


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)


|14. |  | Quarterly Results of Operations (Unaudited)
|--- |  | -------------------------------------------



The following table presents unaudited
statement of operations data for each of the eight quarters in the two-year period ended December 31, 2005. This information has been derived from the
Companys historical consolidated financial statements and should be read in conjunction with the Companys historical consolidated financial
statements and related notes appearing in this Annual Report on Form 10-K.







|                                                                      |  |  |  | Quarter Ended |       
|--------------------------------------------------------------------- |  |  |  | ------------- | ------
|
|
|Revenue                                                               |  |  |  |               |       
|Test
Preparation Services                                             |  |  |  | $             | 22,885
|K-12
Services                                                         |  |  |  |               | 7,919 
|Admissions
Services                                                   |  |  |  |               | 2,794 
|Total
revenue                                                         |  |  |  |               | 33,598
|Cost of
revenue                                                       |  |  |  |               |       
|Test
Preparation Services                                             |  |  |  |               | 7,037 
|K-12
Services                                                         |  |  |  |               | 4,245 
|Admissions
Services                                                   |  |  |  |               | 861   
|Total cost of
revenue                                                 |  |  |  |               | 12,143
|Gross
profit                                                          |  |  |  |               | 21,455
|Operating
expenses                                                    |  |  |  |               |       
|Selling,
general and administrative                                   |  |  |  |               | 21,265
|Impairment of
investment                                              |  |  |  |               |      
|Total operating
expenses                                              |  |  |  |               | 21,265
|Income (loss)
from operations                                         |  |  |  |               | 190   
|Net income
(loss) attributed to common shareholders                   |  |  |  | $             | (340  
|Basic income
(loss) per share (1)                                     |  |  |  | $             | (0.01 
|Diluted income
(loss) per share                                       |  |  |  | $             | (0.01 
|Weighted
average shares used in computing net income (loss) per share |  |  |  |               |       
|Basic                                                                 |  |  |  |               | 27,570
|Diluted                                                               |  |  |  |               | 27,570






|(1) |  | The sum of quarterly earnings (loss) per share does not equal
the annual loss per share due to changes in average shares outstanding.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------



69


---



THE PRINCETON REVIEW, INC. AND SUBSIDIARIESNotes to
Consolidated Financial Statements(Continued)


|15. |  | Earnings (Loss) Per Share
|--- |  | -------------------------



The following table sets forth the
denominators used in computing basic and diluted earnings (loss) per common share for the periods indicated:







|                                                                        |  |  |  | Year Ended December 31, |       
|----------------------------------------------------------------------- |  |  |  | ----------------------- | ------
|
|
|Weighted
Average common shares outstanding                              |  |  |  |                         |       
|Basic                                                                   |  |  |  |                         | 27,570
|Net effect of
dilutive stock options-based on the treasury stock method |  |  |  |                         |      
|Other                                                                   |  |  |  |                         |      
|Diluted                                                                 |  |  |  |                         | 27,570



For the year ended December 31, 2005
and 2004, the following were excluded from the computation of diluted earnings per common share because of their antidilutive effect.







|                                                                           |  |  |  | Year Ended December 31, |      
|-------------------------------------------------------------------------- |  |  |  | ----------------------- | -----
|
|
|Net effect of
dilutive stock options-based on the treasury stock method    |  |  |  |                         | 132  
|Net effect of
convertible preferred stock-based on the if converted method |  |  |  |                         | 1,007
|Other                                                                      |  |  |  |                         | 9    
|                                                                           |  |  |  |                         | 1,148



70


---





THE PRINCETON REVIEW, INC. AND
SUBSIDIARIES




Schedule II Valuation and Qualifying Accounts For
the years ended December 31, 2005, 2004 and 2003







|                                            |  |  |  | Balance at Beginning of Period |        | Additions Charged to Expense |  | Deductions From Allowance(1) |        | Balance at End of Period
|------------------------------------------- |  |  |  | ------------------------------ | ------ | ---------------------------- |  | ---------------------------- | ------ | ------------------------
|
|Allowance
for Doubtful Accounts             |  |  |  |                                |        |                              |  |                              |        |                         
|Year Ended
December 31, 2005                |  |  |  | $                              | 1,290  |                              |  | $                            | 1,328  |                         
|Year Ended
December 31, 2004                |  |  |  | $                              | 302    |                              |  | $                            | 1,521  |                         
|Year Ended
December 31, 2003                |  |  |  | $                              | 527    |                              |  | $                            | 380    |                         
|Valuation
allowance for deferred tax assets |  |  |  |                                |        |                              |  |                              |        |                         
|Year Ended
December 31, 2005                |  |  |  | $                              | 22,132 |                              |  | $                            | 1,520  |                         
|Year Ended
December 31, 2004                |  |  |  |                                |       |                              |  | $                            | 22,132 |                         
|Year Ended
December 31, 2003                |  |  |  |                                |       |                              |  |                              |       |                         






|(1) |  | Consists primarily of amounts written off during the
period.
|--- |  | ------------------------------------------------------------



71


---

|Item
9. |  | Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
|------- |  | ------------------------------------------------------------------------------------



None.


|Item
9A. |  | Controls and Procedures
|-------- |  | -----------------------



Disclosure Controls and
Procedures




We conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and procedures (Disclosure Controls), as defined in Rule 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934 (Exchange Act) as of December 31, 2005. The evaluation was done under the supervision and
with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), and
included a review of the controls objectives, design and operating effectiveness with respect to the information generated for use in this Annual
Report. In the course of the evaluation, we sought to identify data errors, control problems or acts of fraud and confirm that appropriate corrective
actions, including process improvements, were being undertaken. This type of Disclosure Controls evaluation is performed on a quarterly basis so that
the conclusions of management, including the CEO and CFO, concerning the effectiveness of controls can be reported in our Quarterly Reports on Form
10-Q and in our Annual Reports on Form 10-K. Many of the components of our Disclosure Controls are also evaluated on an ongoing basis by other
personnel in our accounting, finance and legal functions. The overall goals of these various evaluation activities are to monitor our Disclosure
Controls and to modify them on an ongoing basis as necessary.




Based upon the evaluation of our
Disclosure Controls, our CEO and CFO concluded that the Companys Disclosure Controls were effective as of December 31, 2005 to ensure that
information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commissions rules and forms.




Managements Report on Internal
Control over Financial Reporting




Management of the Company is
responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of
financial reporting and preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting
principles.




The Companys management assessed
the effectiveness of the Companys internal control over financial reporting as of December 31, 2005. In making this assessment, management used
the criteria set forth in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).




Based on that evaluation, our
management concluded that our internal control over financial reporting was effective as of December 31, 2005.




Managements assessment of the
effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent
registered public accounting firm, as stated in their report which is included elsewhere herein.




Changes in Internal Control over
Financial Reporting




As described in Item 9A of the
Companys Form 10-K/A, dated May 2, 2005, the Companys management assessed the effectiveness of the Companys internal control over
financial reporting and identified three material weaknesses in internal control over financial reporting as of December 31, 2004. These material
weaknesses were identified in the areas of capitalized software development costs, the financial statement close process and revenue recognition.
During the period covered by this report,




72


---



including the most recent quarter,
the Company continued its remediation efforts which included the following:


| |  | reorganized the accounting and finance department, with the
focus on simplifying our business workflow processes;
|- |  | -----------------------------------------------------------------------------------------------------------------

| |  | hired more qualified and experienced accounting personnel to
perform the month-end review and closing processes as well as provide additional oversight and supervision within the accounting
department;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | established written policies and procedures along with control
matrices to ensure that account reconciliation and amounts recorded, as well as the review of these areas, are substantiated by detailed and
contemporaneous documentary support and that reconciling items are investigated, resolved and recorded in a timely manner; and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | established programs providing ongoing training and professional
education and development plans for the accounting department and improving internal communications procedures through the Company.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As a result of these efforts, the
previously identified material weaknesses in internal control over financial reporting have been remediated as of December 31, 2005. We are continuing
to actively assess and evaluate our most critical business and accounting processing to identify further enhancements and improvement
opportunities.




Attestation Report of Independent
Registered Public Accounting Firm




Report of Independent Registered Public Accounting
Firm




The Board of Directors and Stockholders of The Princeton
Review, Inc. and Subsidiaries




We have audited managements
assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that The Princeton Review, Inc. and
Subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an
opinion on the effectiveness of the companys internal control over financial reporting based on our audit.




We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.




A companys internal control over
financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures
of the company are being made only




73


---



in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the companys assets that could have a material effect on the financial statements.




Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.




In our opinion, managements
assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on the COSO criteria.




We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2005 and 2004,
and the related consolidated statements of income, stockholders equity, and cash flows for each of the three years in the period ended December
31, 2005 of The Princeton Review, Inc. and Subsidiaries and our report dated March 13, 2006 expressed an unqualified opinion thereon.




/s/ Ernst & Young LLP




New York, NY March 13, 2006


|Item
9B. |  | Other Information
|-------- |  | -----------------



None




PART III


|Item
10. |  | Directors and Executive Officers of the
Registrant
|-------- |  | --------------------------------------------------



Executive Officers




The following table sets forth
information with respect to our executive officers as of March 10, 2006.







|Name                   |  |  |  | Age |  | Position                                                              
|---------------------- |  |  |  | --- |  | ----------------------------------------------------------------------
|John S.
Katzman        |  |  |  | 46  |  | Chairman and Chief Executive Officer                                  
|Mark
Chernis           |  |  |  | 39  |  | President, Chief Operating Officer                                    
|Andrew
Bonanni         |  |  |  | 40  |  | Chief Financial Officer and Treasurer                                 
|Kevin A.
Howell        |  |  |  | 47  |  | Executive Vice President, General Manager K-12 Services Division      
|Margot
Lebenberg       |  |  |  | 38  |  | Executive Vice President, General Counsel and Secretary               
|Stephen
Quattrociocchi |  |  |  | 43  |  | Executive Vice President, Test Preparation Services Division          
|Young J.
Shin          |  |  |  | 39  |  | Executive Vice President, General Manager Admissions Services Division



John S. Katzman, Chairman and
Chief Executive Officer, founded our company in 1981. Mr. Katzman has served as our Chief Executive Officer and director since our formation. Mr.
Katzman served as our President from 1981 until August 2000. Mr. Katzman is the brother of Richard Katzman, one of the other members of the board of
directors. Mr. Katzman received a BA from Princeton University.




Mark Chernis, President, Chief
Operating Officer and Secretary, joined us in 1984. Mr. Chernis has served as Chief Operating Officer and Secretary since 1995 and became President in
August 2000. From 1989 to 1995, Mr. Chernis served as our Vice President, Operations. From 1984 to 1989, Mr. Chernis served as a systems analyst. Mr.
Chernis received a BA from Vassar College.




74


---



Andrew J. Bonanni, Chief
Financial Officer and Treasurer joined us in September 2005. From 2002 to 2005, he served as Senior Vice President & Chief Financial Officer of
Bowne Business Solutions where he was responsible for overseeing all financial and IT management functions and presided over several key acquisitions
and strategic joint ventures. From 2001 to 2002, Mr. Bonanni was Managing Vice President, Worldwide Business Planning & Corporate Reporting for
Gartner, Inc. He began his career in 1992 with Xerox, where he held a series of finance and strategy positions with increasing responsibilities. Mr.
Bonanni received a B.S. in Finance and Marketing from Le Moyne College and a M.B.A. in Accounting from Rochester Institute of
Technology.




Kevin A. Howell, Executive Vice
President, General Manager K-12 Services Division, joined us in October 2005. From 2001 to 2005, Mr. Howell was with the National Education
Associations (NEA) Portal Company, where he served as interim CEO for a subsidiary providing online training for K-12 educators. From 1995 to
2000, Mr. Howell worked for McGraw Hill, rising to the position of Senior Vice President, Technology and New Media. He began his career with Digital
Equipment Corporation, where he held various managerial positions of increasing responsibility. He received a B.A. in Economics from Vassar
College.




Margot Lebenberg, Executive Vice
President, General Counsel and Secretary, joined us in June 2004. From 2003 to 2004, Ms. Lebenberg served as the Executive Vice President and General
Counsel and Secretary for SoundView Technology Group, Inc., a research driven securities firm, through its sale to Charles Schwab. From 2001 to 2003,
she served as Vice President and Assistant General Counsel of Cantor Fitzgerald, a leading financial services provider, and its subsidiary eSpeed,
Inc., a leader in developing and deploying electronic trading. From 1996 to 2000, she served as Senior Vice President, General Counsel and Secretary of
SOURCECORP, Incorporated (formerly known as F.Y.I. Incorporated), a business process outsourcing and consulting firm, in Dallas, Texas. Ms. Lebenberg
began her career at Morgan, Lewis & Bockius LLP in New York and founded and served as President of Living Mountain Capital LLC, a business advisory
consulting firm specializing in corporate development, strategic alliances and restructurings. Ms. Lebenberg received her JD from Fordham University
School of Law and her BA from SUNY Binghamton.




Stephen Quattrociocchi,
Executive Vice President, Test Preparation Services Division, joined us in 1988. Since 1997, he has served as Executive Vice President of our Test
Preparation Services division. From 1991 to 1997, Mr. Quattrociocchi served as Vice President of Course Operations. Mr. Quattrociocchi received a BS
from the Massachusetts Institute of Technology and an MBA from the Wharton School.




Young J. Shin, Executive Vice
President, General Manager Admissions Services Division, joined us in February 2003. From October 2002 to February 2003, Mr. Shin served as the Chief
Executive Officer of eduAdvisors, LLC, an education marketing company. In 1995, Mr. Shin co-founded Embark.com, Inc., a provider of online college and
graduate school information and application services, the assets of which we acquired in October 2001. Mr. Shin served as Embarks Chairman of the
Board from 1995 until February 2003, as Embarks Chief Technology Officer from 2000 to 2001 and its President and Chief Executive Officer from
1995 to 2000. From 1991 to 1994, Mr. Shin was a Technical Specialist and Consulting Practice Manager at Seer Technologies, Inc. a computer aided
software company. Mr. Shin received a BS from Massachusetts Institute of Technology and a BS from Massachusetts Institute of Technologys Sloan
School of Management.




The information required by this Item
10, other than information with respect to our executive officers, which is contained above, is incorporated by reference from our definitive proxy
statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.


|Item
11. |  | Executive Compensation
|-------- |  | ----------------------



The information required by this Item
11 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15,
2006.




75


---

|Item
12. |  | Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
|-------- |  | ----------------------------------------------------------------------------------------------



Information required by this Item 12 is
incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15,
2006.


|Item
13. |  | Certain Relationships and Related Transactions
|-------- |  | ----------------------------------------------



The information required by this Item
13 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15,
2006.


|Item
14. |  | Principal Accountant Fees and Services
|-------- |  | --------------------------------------



The information required by this Item
14 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15,
2006.




PART IV


|Item
15. |  | Exhibits and Financial Statement Schedules
|-------- |  | ------------------------------------------



(a)  The following documents
are filed as part of this Report:




1.  Financial
StatementsSee Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 40 of this Annual Report on Form
10-K.




2.  Financial Statement
SchedulesSee Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 40 of this Annual Report on Form 10-K.
All other schedules are omitted because they are not applicable or not required.




3.  ExhibitsThe
following exhibits are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K:




76


---






|Exhibit
      Number |  |   | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------------------- |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1                  |  |  | Conversion and Contribution Agreement, dated as of March 31, 2000, by
        and among The Princeton Review, Inc., the Non-Voting Members of Princeton
        Review Publishing L.L.C., John S. Katzman and TPR Holdings, Inc. (1)                                                                                                                                                                                                                                         
|2.2                  |  |  | RH
        Contribution Agreement, dated as of March 31, 2000, by and among Random
        House TPR, Inc., Random House, Inc., The Princeton Review, Inc., John
        S. Katzman, and TPR Holdings, Inc. (1)                                                                                                                                                                                                                                                              
|2.3                  |  |  | TPR
        Contribution Agreement, dated as of March 31, 2000, by and among The Princeton
        Review, Inc., each of the persons listed on Schedule I attached to the
        agreement and TPR Holdings, Inc. (1)                                                                                                                                                                                                                                                       
|2.4                  |  |  | Option Agreement, dated as of May 30, 2000, by and among Princeton Review
        Operations, L.L.C., Princeton Review of Boston, Inc. and Princeton Review
        of New Jersey, Inc. (1)                                                                                                                                                                                                                                                                                  
|2.5                  |  |  | Option Agreement Amendment, dated as of December 14, 2000, by and between
        Princeton Review Operations, L.L.C., Princeton Review of Boston, Inc.
        and Princeton Review of New Jersey, Inc. (1)                                                                                                                                                                                                                                                                 
|2.6                  |  |  | Option Agreement, dated as of October 18, 2000, by and among Princeton
        Review Operations, L.L.C., T.S.T.S., Inc., Robert O. Case and Kevin D.
        Campbell. (1)                                                                                                                                                                                                                                                                                                  
|2.7                  |  |  | Option Agreement, dated as of December 15, 2000, by and between Princeton
        Review Operations, L.L.C. and The Princeton Review Peninsula, Inc. (1)                                                                                                                                                                                                                                                                                                                     
|2.8                  |  |  | Asset Purchase Agreement, dated as of January 18, 2001, by and among
        Princeton Review Boston, Inc., Princeton Review New Jersey, Inc., Robert
        L. Cohen, Matthew Rosenthal, Princeton Review Operations, L.L.C., and
        Princeton Review Management, L.L.C. (1)                                                                                                                                                                                          
|2.9                  |  |  | Closing Agreement, dated as of March 2, 2001, by and among Princeton
        Review of Boston, Inc., Princeton Review of New Jersey, Inc., Robert L.
        Cohen, Matthew Rosenthal, Princeton Review Operations, L.L.C. and Princeton
        Review Management, L.L.C. (incorporated herein by reference to Exhibit
        2.8.1 to our Registration Statement on Form S-1 (File No. 333-43874) which
        was declared effective on June 18, 2001 (the Form S-1)).
|2.10                 |  |  | Promissory Note, dated as of March 2, 2001, made by Princeton Review
        Operations, L.L.C. in favor of Princeton Review of Boston, Inc., in the
        principal amount of $3,125,000 (incorporated herein by reference to Exhibit
        2.9 to our Form S-1).                                                                                                                                                                                                       
|2.11                 |  |  | Promissory Note, dated as of March 2, 2001, made by Princeton Review
        Operations, L.L.C. in favor of Princeton Review of Boston, Inc., in the
        principal amount of $500,000 (incorporated herein by reference to Exhibit
        2.10 to our Form S-1).                                                                                                                                                                                                        
|2.12                 |  |  | Asset Purchase Agreement, dated as of March 6, 2001, by and among The
        Princeton Review Peninsula, Inc., the Hirsch Living Trust, Pamela N. Hirsch,
        Myles E. Hirsch, Frederick Sliter, Princeton Review Operations, L.L.C.
        and Princeton Review Management, L.L.C. (incorporated herein by reference
        to Exhibit 2.11 to our Form S-1).                                                                                                        
|2.13                 |  |  | Asset Purchase Agreement, dated June 18, 2001, among Princeton Review
        Operations, L.L.C., Princeton Review Management, L.L.C., T.S.T.S., Inc.,
        Robert O. Case and Kevin D. Campbell (incorporated herein by reference
        to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 000-32469),
        filed with the Securities and Exchange Commission on August 8, 2001 (the
        2001 Second Quarter Form 10-Q)).                         
|2.14                 |  |  | Subordinated Promissory Note, dated June 18, 2001, made by Princeton
        Review Operations, L.L.C. in favor of T.S.T.S., Inc., in the principal
        amount of $1,475,000 (incorporated herein by reference to Exhibit 10.2
        to our 2001 Second Quarter Form 10-Q).                                                                                                                                                                                            
|2.15                 |  |  | Asset Purchase Agreement, dated as of October 1, 2001, by and among The
        Princeton Review, Inc., Princeton Review Publishing, L.L.C. and Embark.com,
        Inc. (incorporated herein by reference to Exhibit 2.1 to our Current Report
        on Form 8-K (File No. 000-32469), filed with the Securities and Exchange
        Commission on October 9, 2001 (the Form 8-K)).                                                                                    



77


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|Exhibit
      Number |  |   | Description                                                                                                                                                                                                                                                                                                                                               
|-------------------- |  | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1                  |  |  | Amended and Restated Certificate of Incorporation (incorporated herein
        by reference to Exhibit 3.1.2 to our Form S-1).                                                                                                                                                                                                                            
|3.2                  |  |  | Amended and Restated By-laws (incorporated herein by reference to Exhibit
        3.3.1 to our Form S-1).                                                                                                                                                                                                                                                 
|4.1                  |  |  | Form
        of Specimen Common Stock Certificate (1).                                                                                                                                                                                                                                                                                                    
|4.2                  |  |  | Certificate of Designation of Series B-1 Cumulative Convertible Preferred
        Stock of The Princeton Review, Inc. (incorporated herein by reference
        to Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-32469),
        filed with the Securities and Exchange Commission on June 9, 2004)                                         
|10.1                 |  |  | Stockholders Agreement, dated as of April 1, 2000, by and among The Princeton
        Review, Inc., and its stockholders (1).                                                                                                                                                                                                                             
|10.2                 |  |  | Stock Purchase Agreement, dated April 18, 2000, by and among The Princeton
        Review, Inc., SG Capital Partners LLC, Olympus Growth Fund III, L.P. and
        Olympus Executive Fund, L.P. (1).                                                                                                                                                     
|10.3                 |  |  | Joinder Agreement, dated April 18, 2000, to the Stockholders Agreement
        dated April 1, 2000, among stockholders of The Princeton Review, Inc.
        (1).                                                                                                                                                                                         
|10.4                 |  |  | Investor Rights Agreement, dated April 18, 2000, by and among The Princeton
        Review, Inc., SG Capital Partners LLC, Olympus Growth Fund III, L.P. and
        Olympus Executive Fund, L.P. (1).                                                                                                                                                    
|10.5                 |  |  | The
        Princeton Review, Inc. 2000 Stock Incentive Plan, March 2000 (1).                                                                                                                                                                                                                                                                             
|10.6                 |  |  | Amendment to The Princeton Review, Inc. 2000 Stock Incentive Plan (incorporated
        herein by reference to Exhibit 10.5.1 to our Form S-1).                                                                                                                                                                                                           
|10.7                 |  |  | Form
        of Incentive Stock Option Agreement (incorporated herein by reference
        to Exhibit 10.6 to our Form S-1).                                                                                                                                                                                                                              
|10.8                 |  |  | Software Purchase Agreement, dated as of June 23, 1998, by and between
        Learning Company Properties and Princeton Review Publishing, L.L.C. (incorporated
        herein by reference to Exhibit 10.10 to our Form S-1).                                                                                                                           
|10.9                 |  |  | The
        Princeton Review Executive Compensation Policy Statement, as amended (incorporated
        by reference to Exhibit 10.12 of our Annual Report on Form 10-K for the
        year ended December 31, 2001).                                                                                                                                     
|10.10                |  |  | Office Lease, dated as of April 23, 1992, as amended, by and between
        The Princeton Review, Inc. and 2316 Broadway Realty Co. (incorporated
        herein by reference to Exhibit 10.12 to our Form S-1).                                                                                                                                         
|10.11                |  |  | Amendment to Office Lease, dated December 9, 1993 (incorporated herein
        by reference to Exhibit 10.13 to our Form S-1).                                                                                                                                                                                                                            
|10.12                |  |  | Second Amendment to Office Lease, dated February 6, 1995 (incorporated
        herein by reference to Exhibit 10.14 to our Form S-1).                                                                                                                                                                                                                     
|10.13                |  |  | Third Amendment to Office Lease, dated April 2, 1996 (incorporated herein
        by reference to Exhibit 10.15 to our Form S-1).                                                                                                                                                                                                                         
|10.14                |  |  | Fourth Amendment to Office Lease, dated July 10, 1998 (incorporated herein
        by reference to Exhibit 10.16 to our Form S-1).                                                                                                                                                                                                                        
|10.15                |  |  | Employment Agreement, dated as of April 11, 2002, by and between The
        Princeton Review, Inc. and John Katzman (incorporated by reference to
        Exhibit 10.1 to our Quarterly Report on Form 10-Q (file No. 000-32469),
        filed with the Securities and Exchange Commission on May 14, 2002 (the
        2002 First Quarter Form 10-Q).
|10.16                |  |  | Employment Agreement, dated as of April 10, 2002, by and between The
        Princeton Review, Inc. and Mark Chernis (incorporated by reference to
        Exhibit 10.2 to our 2002 First Quarter Form 10-Q).                                                                                                                                             
|10.17                |  |  | Employment Agreement, dated as of April 10, 2002, by and between The
        Princeton Review, Inc. and Steve Quattrociocchi (incorporated by reference
        to Exhibit 10.3 to our 2002 First Quarter Form 10-Q).                                                                                                                                     



78


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|Exhibit
                  Number |  |   | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------------------------------- |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.18                            |  |  | Employment Agreement, dated as of April 10, 2002, by and between The
                        Princeton Review, Inc. and Bruce Task (incorporated by reference to Exhibit
                        10.4 to our 2002 First Quarter Form 10-Q).                                                                                                                                                                                                                            
|10.19                            |  |  | Employment Agreement, dated as of October 15, 2001, by and between The
                        Princeton Review, Inc. and Stephen Melvin (incorporated by reference to
                        Exhibit 10.61 of our Annual Report on Form 10-K for the year ended December
                        31, 2001).                                                                                                                                                          
|10.20                            |  |  | Office Lease by and between The Rector, Church-Wardens and Vestrymen
                        of Trinity Church in the City of New York, as Landlord, and Princeton
                        Review Publishing, L.L.C., as Tenant (incorporated herein by reference
                        to Exhibit 10.35 to our Form S-1).                                                                                                                                           
|10.21                            |  |  | Agreement, dated September 1, 1998, by and between The Educational and
                        Professional Publishing Group, a unit of the McGraw-Hill Companies, Inc.,
                        and Princeton Review Publishing, L.L.C. (incorporated herein by reference
                        to Exhibit 10.36 to our Form S-1).(2)                                                                                                                               
|10.22                            |  |  | Franchise Agreement, dated as of July 1, 1986, by and between The Princeton
                        Review Management Corp. and Lloyd Eric Cotsen (Lecomp Company, Inc.) (incorporated
                        herein by reference to Exhibit 10.39 to our Form S-1).                                                                                                                                                                                                  
|10.23                            |  |  | Franchise Agreement, dated as of September 13, 1986, by and between The
                        Princeton Review Management Corp. and Robert Case, Richard McDugald and
                        Kevin Campbell (Test Services, Inc.) (incorporated herein by reference
                        to Exhibit 10.40 to our Form S-1).                                                                                                                                      
|10.24                            |  |  | Addendum to the Franchise Agreement, dated as of May 31, 1995, by and
                        between The Princeton Review Management Corp. and the persons and entities
                        listed on the Franchisee Joinders (incorporated herein by reference to
                        Exhibit 10.41 to our Form S-1).                                                                                                                                        
|10.25                            |  |  | Formation Agreement, dated as of May 31, 1995, by and among The Princeton
                        Review Publishing Company, L.L.C., The Princeton Review Publishing Co.,
                        Inc., the Princeton Review Management Corp. and the independent franchisees
                        (incorporated herein by reference to Exhibit 10.42 to our Form S-1).                                                                                             
|10.26                            |  |  | Distance Learning Waiver, dated as of June 21, 2000, by and between Princeton
                        Review Management, L.L.C. and Lecomp, Inc. (incorporated herein by reference
                        to Exhibit 10.44 to our Form S-1).                                                                                                                                                                                                                          
|10.27                            |  |  | Pledge and Security Agreement, dated as of September 19, 2000, by and
                        between Steven Hodas and The Princeton Review, Inc. (incorporated herein
                        by reference to Exhibit 10.45 to our Form S-1)                                                                                                                                                                                                                          
|10.28                            |  |  | Promissory Note, dated as of September 19, 2000, made by Steven Hodas
                        in favor of The Princeton Review, Inc. (incorporated herein by reference
                        to Exhibit 10.46 to our Form S-1).                                                                                                                                                                                                                                      
|10.29                            |  |  | Non-Recourse Promissory Note, dated August 15, 2001, made by Bruce Task
                        in favor of The Princeton Review, Inc. (incorporated herein by reference
                        to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 000-32469)
                        for the third quarter of 2001, filed with the Securities and Exchange
                        Commission on November 13, 2001 (the 2001 Third Quarter Form 10-Q)).
|10.30                            |  |  | Pledge and Security Agreement, dated as of August 15, 2001, by and between
                        Bruce Task and The Princeton Review, Inc. (incorporated herein by reference
                        to Exhibit 10.2 to our 2001 Third Quarter Form 10-Q).                                                                                                                                                                                                           
|10.31                            |  |  | Non-Recourse Promissory Note, dated November 27, 2001, made by Mark Chernis
                        in favor of The Princeton Review, Inc. (incorporated by reference to Exhibit
                        10.53 of our Annual Report on Form 10-K for the year ended December 31,
                        2001).                                                                                                                                                        
|10.32                            |  |  | Pledge and Security Agreement, dated as of November 27, 2001, by and
                        between Mark Chernis and The Princeton Review, Inc. (incorporated by reference
                        to Exhibit 10.54 of our Annual Report on Form 10-K for the year ended
                        December 31, 2001).                                                                                                                                                  



79


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|Exhibit Number |  |  |  |   |  | Description                                                                                                                                                                                                                                                                                                                                                                                                    
|-------------- |  |  |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.33          |  |  |  |  |  | Non-Recourse Promissory Note, dated March 7, 2002, made by Mark Chernis in favor of The Princeton Review, Inc. (incorporated by reference to
Exhibit 10.55 of our Annual Report on Form 10-K for the year ended December 31, 2001).                                                                                                                                                                            
|10.34          |  |  |  |  |  | Agreement, dated as of May 28, 2004, by and between The Princeton Review, Inc. and Fletcher International, Ltd. (incorporated herein by
reference to Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-32469), filed with the Securities and Exchange Commission on June 9,
2004).                                                                                                                   
|10.35          |  |  |  |  |  | Lease, dated as of August 1, 2004, by and between The Rector, Church-Wardens and Vestrymen of Trinity Church in the City of New York, as
Landlord and The Princeton Review, Inc., as Tenant. (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No.
000-32469) for the third quarter of 2004, filed with the Securities and Exchange Commission on November 9, 2004).
|10.36          |  |  |  |  |  | Amendment to Employment Agreement, dated September 12, 2005, between The Princeton Review, Inc. and Stephen Melvin (incorporated by reference
to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 0000-32469) for the third quarter of 2005, filed with the Securities and Exchange
Commission on November 9, 2006).                                                                                
|10.37          |  |  |  |  |  | Employment Agreement, dated September 9, 2005, between The Princeton Review, Inc. and Andrew Bonanni (incorporated by reference to Exhibit
10.2 to our Quarterly Report on Form 10-Q (File No. 0000-32469) for the third quarter of 2005, filed with the Securities and Exchange Commission on
November 9, 2006).                                                                                              
|10.38          |  |  |  |  |  | Office Lease Extension, dated November 18, 2005, as amended, by and between The Princeton Review, Inc. and 2315 Broadway Realty
Co.                                                                                                                                                                                                                                                                            
|21.1           |  |  |  |  |  | Subsidiaries of the Registrant. (Incorporated by reference to Exhibit 21.1 of our Annual Report on Form 10-K for the year ended December 31,
2004)                                                                                                                                                                                                                                                             
|23.1           |  |  |  |  |  | Consent of Ernst & Young LLP.                                                                                                                                                                                                                                                                                                                                                                                  
|24.1           |  |  |  |  |  | Powers of Attorney (included on the signature pages hereto).                                                                                                                                                                                                                                                                                                                                                   
|31.1           |  |  |  |  |  | Certification of CEO Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                         
|31.2           |  |  |  |  |  | Certification of CFO Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                         
|32.1           |  |  |  |  |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                        






|(1) |  | Incorporated herein by reference to the exhibit with the same
number to our Registration Statement on Form S-1 (File No. 333-43874), which was declared effective on June 18, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Confidential portions of this document are omitted pursuant to a
request for confidential treatment that has been granted by the Commission, and have been filed separately with the Commission.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



80


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SIGNATURES




Pursuant to the requirements of Section
13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on March 16, 2006.







| |  |  |  | THE PRINCETON REVIEW, INC.                                         
| |  |  |  | -------------------------------------------------------------------
| |  |  |  | By:   /s/ ANDREW J. BONANNI                                        
| |  |  |  | Andrew J. Bonanni
      Chief Financial Officer and
      Treasurer



POWER OF ATTORNEY




Each individual whose signature appears
below constitutes and appoints each of John S. Katzman, Mark Chernis and Andrew Bonanni, such persons true and lawful attorney-in-fact and agent
with full power of substitution and resubstitution, for such person and in such persons name, place and stead, in any and all capacities, to sign
any and all amendments to this report on Form 10-K, and to file the same, with all exhibits thereto, and all documents in connection therewith, with
the Securities and Exchange Commission, granting unto each said attorney-in-fact and agent full power and authority to do and perform each and every
act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as such person might or could do in
person, hereby ratifying and confirming all that any said attorney-in-fact and agent, or any substitute or substitutes of any of them, may lawfully do
or cause to be done by virtue hereof.




Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.


|Signature                                  |  |  |  | Title                                                                |  | Date          
|------------------------------------------ |  |  |  | -------------------------------------------------------------------- |  | --------------
|/s/
JOHN S. KATZMAN(John S. Katzman)       |  |  |  | Chairman and Chief Executive Officer (Principal Executive Officer)   |  | March
16, 2006
|                                          
|/s/
ANDREW J. BONANNI(Andrew J. Bonanni)   |  |  |  | Chief Financial Officer (Principal Financial and Accounting Officer) |  | March
16, 2006
|                                          
|/s/
ROBERT E. EVANSON(Robert E. Evanson)   |  |  |  | Director                                                             |  | March
16, 2006
|                                          
|/s/
RICHARD KATZMAN(Richard Katzman)       |  |  |  | Director                                                             |  | March
16, 2006
|                                          
|/s/
JOHN C. REID(John C. Reid)             |  |  |  | Director                                                             |  | March
16, 2006
|                                          
|/s/
RICHARD SARNOFF(Richard Sarnoff)       |  |  |  | Director                                                             |  | March
16, 2006
|                                          
|/s/
SHEREE T. SPEAKMAN(Sheree T. Speakman) |  |  |  | Director                                                             |  | March
16, 2006
|                                          
|/s/
HOWARD A. TULLMAN(Howard A. Tullman)   |  |  |  | Director                                                             |  | March
16, 2006



81


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