##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---



|x | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006

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 Number000-50952



---

EDUCATE, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 37-1465722                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|1001 Fleet Street, Baltimore, Maryland                         |  | 21202                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code: 410-843-8000



---

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 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. (Check one):

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 Act).    Yes ̈No  x

The registrant had 43,013,977 shares of common stock outstanding as of November 3, 2006.



---



---

##### Table of Contents

EDUCATE, INC.

INDEX



|                                |  |                                                                                                            |  |   
|------------------------------- |  | ---------------------------------------------------------------------------------------------------------- |  | --
|                                |  | Page No.                                                                                                  
|PART I.  FINANCIAL INFORMATION |  |                                                                                                           
|                                |  |                                                                                                           
|Item 1.                         |  | Financial Statements.                                                                                      |  |   
|                                |  |                                                                                                           
|                                |  | Consolidated Balance Sheets  September 30, 2006 (Unaudited) and December 31, 2005                         |  | 1 
|                                |  |                                                                                                           
|                                |  | Consolidated Statements of Operations (Unaudited)  For the three months ended September 30, 2006 and 2005 |  | 3 
|                                |  |                                                                                                           
|                                |  | Consolidated Statements of Operations (Unaudited)  For the nine months ended September 30, 2006 and 2005  |  | 4 
|                                |  |                                                                                                           
|                                |  | Consolidated Statements of Cash Flows (Unaudited)  For the nine months ended September 30, 2006 and 2005  |  | 5 
|                                |  |                                                                                                           
|                                |  | Notes to Consolidated Financial Statements (Unaudited)                                                     |  | 7 
|                                |  |                                                                                                           
|Item 2.                         |  | Managements Discussion and Analysis of Financial Condition and Results of Operations.                     |  | 23
|                                |  |                                                                                                           
|Item 3.                         |  | Quantitative and Qualitative Disclosures About Market Risk.                                                |  | 33
|                                |  |                                                                                                           
|Item 4.                         |  | Controls and Procedures.                                                                                   |  | 33
|                                | 
|PART II.  OTHER INFORMATION    |  |                                                                                                           
|                                |  |                                                                                                           
|Item 1.                         |  | Legal Proceedings.                                                                                         |  | 34
|                                |  |                                                                                                           
|Item 1A.                        |  | Risk Factors.                                                                                              |  | 34
|                                |  |                                                                                                           
|Item 2.                         |  | Unregistered Sales of Equity Securities and Use of Proceeds.                                               |  | 34
|                                |  |                                                                                                           
|Item 3.                         |  | Defaults Upon Senior Securities.                                                                           |  | 34
|                                |  |                                                                                                           
|Item 4.                         |  | Submission of Matters to a Vote of Security Holders.                                                       |  | 34
|                                |  |                                                                                                           
|Item 5.                         |  | Other Information.                                                                                         |  | 34
|                                |  |                                                                                                           
|Item 6.                         |  | Exhibits.                                                                                                  |  | 34
|                                | 
|SIGNATURES                      |  | 36                                                                                                        



---

##### Table of Contents

Educate, Inc.

Consolidated Balance Sheets

(Dollar amounts in thousands)



|                                                           |  |                   |         |   |                  |   |         |  
|---------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                           |  | September 30,2006 |         |   | December 31,2005 |  
|                                                           |  | (unaudited)       |         |   |                  |  
|Assets                                                     |  |                   |         |   |                  |   |         |  
|Current assets:                                            |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                  |  | $                 | 7,008   |   |                  | $ | 2,414   |  
|                                                           |  |                  
|Receivables:                                               |  |                   |         |   |                  |   |         |  
|Accounts receivable                                        |  |                   | 46,747  |   |                  |   | 51,883  |  
|Notes receivable                                           |  |                   | 142     |   |                  |   | 140     |  
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 46,889  |   |                  |   | 52,023  |  
|Allowances                                                 |  |                   | (3,839  | ) |                  |   | (4,764  | )
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 43,050  |   |                  |   | 47,259  |  
|                                                           |  |                  
|Finished goods inventory                                   |  |                   | 14,915  |   |                  |   | 11,685  |  
|Prepaid expenses                                           |  |                   | 6,142   |   |                  |   | 3,246   |  
|Other current assets                                       |  |                   | 2,346   |   |                  |   | 1,958   |  
|Other receivables                                          |  |                   | 5,355   |   |                  |   | 5,667   |  
|Deferred income taxes                                      |  |                   | 24      |   |                  |   | 24      |  
|Assets of discontinued operations held for sale            |  |                   |        |   |                  |   | 1,683   |  
|                                                           |  |                   |         |   |                  |   |         |  
|Total current assets                                       |  |                   | 78,840  |   |                  |   | 73,936  |  
|                                                           |  |                  
|Property and equipment:                                    |  |                   |         |   |                  |   |         |  
|Furniture and fixtures                                     |  |                   | 5,925   |   |                  |   | 5,190   |  
|Education materials                                        |  |                   | 4,312   |   |                  |   | 3,950   |  
|Computer equipment and software                            |  |                   | 13,098  |   |                  |   | 10,770  |  
|Leasehold improvements                                     |  |                   | 19,238  |   |                  |   | 14,013  |  
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 42,573  |   |                  |   | 33,923  |  
|Accumulated depreciation and amortization                  |  |                   | (20,712 | ) |                  |   | (14,854 | )
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 21,861  |   |                  |   | 19,069  |  
|                                                           |  |                  
|Intangible assets:                                         |  |                   |         |   |                  |   |         |  
|Goodwill                                                   |  |                   | 94,672  |   |                  |   | 92,077  |  
|Tradenames                                                 |  |                   | 148,640 |   |                  |   | 147,894 |  
|Franchise license rights                                   |  |                   | 91,760  |   |                  |   | 90,590  |  
|Other intangible assets                                    |  |                   | 21,882  |   |                  |   | 11,295  |  
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 356,954 |   |                  |   | 341,856 |  
|Accumulated amortization                                   |  |                   | (5,371  | ) |                  |   | (2,957  | )
|                                                           |  |                   |         |   |                  |   |         |  
|                                                           |  |                   | 351,583 |   |                  |   | 338,899 |  
|Noncurrent assets of discontinued operations held for sale |  |                   |        |   |                  |   | 9,755   |  
|Other assets                                               |  |                   | 12,962  |   |                  |   | 10,229  |  
|                                                           |  |                   |         |   |                  |   |         |  
|Total assets                                               |  | $                 | 465,246 |   |                  | $ | 451,888 |  
|                                                           |  |                   |         |   |                  |   |         |  

See notes to consolidated financial statements (unaudited).



1



---

##### Table of Contents

Educate, Inc.

Consolidated Balance Sheets (continued)

(Dollar amounts in thousands)



|                                                                                                                                                                                   |  |                   |         |                  |   |        
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                                                                                                                                                                                   |  | September 30,2006 |         | December 31,2005
|                                                                                                                                                                                   |  | (unaudited)       |         |                 
|Liabilities and stockholders equity                                                                                                                                               |  |                   |         |                  |   |        
|Current liabilities:                                                                                                                                                               |  |                   |         |                  |   |        
|Accounts payable and accrued expenses                                                                                                                                              |  | $                 | 35,289  |                  | $ | 25,312 
|Accrued compensation and related benefits                                                                                                                                          |  |                   | 9,716   |                  |   | 13,203 
|Income taxes payable                                                                                                                                                               |  |                   | 395     |                  |   | 724    
|Current portion of long-term debt                                                                                                                                                  |  |                   | 160,134 |                  |   | 2,734  
|Deferred revenue                                                                                                                                                                   |  |                   | 23,965  |                  |   | 23,340 
|Other current liabilities                                                                                                                                                          |  |                   | 357     |                  |   | 231    
|                                                                                                                                                                                   |  |                   |         |                  |   |        
|Total current liabilities                                                                                                                                                          |  |                   | 229,856 |                  |   | 65,544 
|                                                                                                                                                                                   |  |                  
|Long-term debt, less current portion                                                                                                                                               |  |                   | 2,091   |                  |   | 160,114
|Other long-term liabilities                                                                                                                                                        |  |                   | 5,400   |                  |   | 4,703  
|Deferred income taxes                                                                                                                                                              |  |                   | 13,465  |                  |   | 9,819  
|                                                                                                                                                                                   |  |                   |         |                  |   |        
|Total liabilities                                                                                                                                                                  |  |                   | 250,812 |                  |   | 240,180
|Commitments and contingencies                                                                                                                                                      |  |                   |        |                  |   |       
|                                                                                                                                                                                   |  |                  
|Stockholders equity:                                                                                                                                                              |  |                   |         |                  |   |        
|Common stock, par value $0.01, 120,000,000 shares authorized, 43,005,178 and 42,731,868 shares issued and outstanding as of September 30,
2006 and December 31, 2005, respectively |  |                   | 430     |                  |   | 427    
|Additional paid-in capital                                                                                                                                                         |  |                   | 194,908 |                  |   | 192,608
|Retained earnings                                                                                                                                                                  |  |                   | 17,342  |                  |   | 18,212 
|Accumulated other comprehensive income                                                                                                                                             |  |                   | 1,754   |                  |   | 461    
|                                                                                                                                                                                   |  |                   |         |                  |   |        
|Total stockholders equity                                                                                                                                                         |  |                   | 214,434 |                  |   | 211,708
|                                                                                                                                                                                   |  |                   |         |                  |   |        
|Total liabilities and stockholders equity                                                                                                                                         |  | $                 | 465,246 |                  | $ | 451,888
|                                                                                                                                                                                   |  |                   |         |                  |   |        

See notes to consolidated financial statements (unaudited).



2



---

##### Table of Contents

Educate, Inc.

Consolidated Statements of Operations

(Dollar amounts in thousands, except per share data)

(unaudited)



|                                                                                                  |  |                                  |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                  |  | Three months ended September 30, |       
|                                                                                                  |  | 2006                             |        |   | 2005 |  
|Revenues                                                                                          |  |                                  |        |   |      |   |        |  
|Learning Center:                                                                                  |  |                                  |        |   |      |   |        |  
|Service revenues:                                                                                 |  |                                  |        |   |      |   |        |  
|Franchise services                                                                                |  | $                                | 8,753  |   |      | $ | 9,447  |  
|Company-owned centers                                                                             |  |                                  | 49,391 |   |      |   | 48,553 |  
|Net product sales                                                                                 |  |                                  | 7,635  |   |      |   | 8,495  |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Total Learning Center                                                                             |  |                                  | 65,779 |   |      |   | 66,495 |  
|                                                                                                  |  |                                 
|Catapult Learning                                                                                 |  |                                  | 15,541 |   |      |   | 12,045 |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Total revenues                                                                                    |  |                                  | 81,320 |   |      |   | 78,540 |  
|                                                                                                  |  |                                 
|Costs and expenses                                                                                |  |                                  |        |   |      |   |        |  
|Instructional and franchise operations costs (* see note below)                                   |  |                                  | 61,043 |   |      |   | 51,948 |  
|Marketing and advertising                                                                         |  |                                  | 9,183  |   |      |   | 7,013  |  
|Cost of goods sold                                                                                |  |                                  | 5,514  |   |      |   | 3,601  |  
|Depreciation and amortization                                                                     |  |                                  | 2,163  |   |      |   | 1,813  |  
|General and administrative expenses (* see note below)                                            |  |                                  | 4,010  |   |      |   | 3,851  |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Total costs and expenses                                                                          |  |                                  | 81,913 |   |      |   | 68,226 |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Operating income (loss)                                                                           |  |                                  | (593   | ) |      |   | 10,314 |  
|                                                                                                  |  |                                 
|Other income (expense)                                                                            |  |                                  |        |   |      |   |        |  
|Interest income                                                                                   |  |                                  | 141    |   |      |   | 105    |  
|Interest expense                                                                                  |  |                                  | (3,426 | ) |      |   | (2,159 | )
|Foreign exchange gains (losses) and other                                                         |  |                                  | (16    | ) |      |   | 134    |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Income (loss) from continuing operations before income taxes                                      |  |                                  | (3,894 | ) |      |   | 8,394  |  
|                                                                                                  |  |                                 
|Income tax expense                                                                                |  |                                  | (1,390 | ) |      |   | (3,190 | )
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Income (loss) from continuing operations                                                          |  |                                  | (5,284 | ) |      |   | 5,204  |  
|Loss from discontinued operations, net of income tax benefit of $1,327 in 2006 and $1,555 in 2005 |  |                                  | (2,260 | ) |      |   | (2,537 | )
|Loss on disposal of discontinued operations, net of income tax benefit of $531                    |  |                                  | (938   | ) |      |   |       |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Net income (loss)                                                                                 |  | $                                | (8,482 | ) |      | $ | 2,667  |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Earnings per common share - basic                                                                 |  |                                  |        |   |      |   |        |  
|Income (loss) from continuing operations                                                          |  | $                                | (0.12  | ) |      | $ | 0.12   |  
|Loss from discontinued operations, net of tax                                                     |  |                                  | (0.08  | ) |      |   | (0.06  | )
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Net income (loss)                                                                                 |  | $                                | (0.20  | ) |      | $ | 0.06   |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Earnings per common share  diluted                                                               |  |                                  |        |   |      |   |        |  
|Income (loss) from continuing operations                                                          |  | $                                | (0.12  | ) |      | $ | 0.12   |  
|Loss from discontinued operations, net of tax                                                     |  |                                  | (0.08  | ) |      |   | (0.06  | )
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Net income (loss)                                                                                 |  | $                                | (0.20  | ) |      | $ | 0.06   |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|*Line item includes non-cash stock compensation as follows:                                       |  |                                  |        |   |      |   |        |  
|Instructional and franchise operations costs                                                      |  | $                                | 167    |   |      | $ | (3     | )
|General and administrative expenses                                                               |  |                                  | 87     |   |      |   | 54     |  
|                                                                                                  |  |                                  |        |   |      |   |        |  
|Total                                                                                             |  | $                                | 254    |   |      | $ | 51     |  
|                                                                                                  |  |                                  |        |   |      |   |        |  

See notes to consolidated financial statements (unaudited).



3



---

##### Table of Contents

Educate, Inc.

Consolidated Statements of Operations

(Dollar amounts in thousands, except per share data)

(unaudited)



|                                                                                                  |  |                                 |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                  |  | Nine months ended September 30, |        
|                                                                                                  |  | 2006                            |         |   | 2005 |  
|Revenues                                                                                          |  |                                 |         |   |      |   |         |  
|Learning Center:                                                                                  |  |                                 |         |   |      |   |         |  
|Service revenues:                                                                                 |  |                                 |         |   |      |   |         |  
|Franchise services                                                                                |  | $                               | 30,355  |   |      | $ | 32,573  |  
|Company-owned centers                                                                             |  |                                 | 158,614 |   |      |   | 132,265 |  
|Net product sales                                                                                 |  |                                 | 19,407  |   |      |   | 26,650  |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Total Learning Center                                                                             |  |                                 | 208,376 |   |      |   | 191,488 |  
|Catapult Learning                                                                                 |  |                                 | 68,360  |   |      |   | 62,282  |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Total revenues                                                                                    |  |                                 | 276,736 |   |      |   | 253,770 |  
|                                                                                                  |  |                                
|Costs and expenses                                                                                |  |                                 |         |   |      |   |         |  
|Instructional and franchise operations costs (* see note below)                                   |  |                                 | 199,046 |   |      |   | 158,446 |  
|Marketing and advertising                                                                         |  |                                 | 26,720  |   |      |   | 22,590  |  
|Cost of goods sold                                                                                |  |                                 | 13,476  |   |      |   | 11,750  |  
|Depreciation and amortization                                                                     |  |                                 | 6,264   |   |      |   | 5,200   |  
|General and administrative expenses (* see note below)                                            |  |                                 | 12,947  |   |      |   | 10,576  |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Total costs and expenses                                                                          |  |                                 | 258,453 |   |      |   | 208,562 |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Operating income                                                                                  |  |                                 | 18,283  |   |      |   | 45,208  |  
|                                                                                                  |  |                                
|Other income (expense)                                                                            |  |                                 |         |   |      |   |         |  
|Interest income                                                                                   |  |                                 | 281     |   |      |   | 252     |  
|Interest expense                                                                                  |  |                                 | (9,137  | ) |      |   | (5,907  | )
|Other financing costs                                                                             |  |                                 | (1,066  | ) |      |   | (1,506  | )
|Foreign exchange gains (losses) and other                                                         |  |                                 | (207    | ) |      |   | 202     |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Income from continuing operations before income taxes                                             |  |                                 | 8,154   |   |      |   | 38,249  |  
|                                                                                                  |  |                                
|Income tax expense                                                                                |  |                                 | (6,209  | ) |      |   | (14,535 | )
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Income from continuing operations                                                                 |  |                                 | 1,945   |   |      |   | 23,714  |  
|Loss from discontinued operations, net of income tax benefit of $1,064 in 2006 and $2,192 in 2005 |  |                                 | (1,877  | ) |      |   | (3,576  | )
|Loss on disposal of discontinued operations, net of income tax benefit of $531                    |  |                                 | (938    | ) |      |   |        |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Net income (loss)                                                                                 |  | $                               | (870    | ) |      | $ | 20,138  |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Earnings per common share - basic                                                                 |  |                                 |         |   |      |   |         |  
|Income from continuing operations                                                                 |  | $                               | 0.05    |   |      | $ | 0.56    |  
|Loss from discontinued operations, net of tax                                                     |  |                                 | (0.07   | ) |      |   | (0.09   | )
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Net income (loss)                                                                                 |  | $                               | (0.02   | ) |      | $ | 0.47    |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Earnings per common share  diluted                                                               |  |                                 |         |   |      |   |         |  
|Income from continuing operations                                                                 |  | $                               | 0.04    |   |      | $ | 0.54    |  
|Loss from discontinued operations, net of tax                                                     |  |                                 | (0.06   | ) |      |   | (0.08   | )
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Net income (loss)                                                                                 |  | $                               | (0.02   | ) |      | $ | 0.46    |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|*Line item includes non-cash stock compensation as follows:                                       |  |                                 |         |   |      |   |         |  
|Instructional and franchise operations costs                                                      |  | $                               | 406     |   |      | $ | 185     |  
|General and administrative expenses                                                               |  |                                 | 322     |   |      |   | 163     |  
|                                                                                                  |  |                                 |         |   |      |   |         |  
|Total                                                                                             |  | $                               | 728     |   |      | $ | 348     |  
|                                                                                                  |  |                                 |         |   |      |   |         |  

See notes to consolidated financial statements (unaudited).



4



---

##### Table of Contents

Educate, Inc.

Consolidated Statements of Cash Flows

(Dollar amounts in thousands)

(unaudited)



|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                                                        |  | Nine months ended September 30, |       
|                                                                                                                                                        |  | 2006                            |        |   | 2005 |  
|Operating activities                                                                                                                                    |  |                                 |        |   |      |   |        |  
|Net income (loss)                                                                                                                                       |  | $                               | (870   | ) |      | $ | 20,138 |  
|Loss from discontinued operations                                                                                                                       |  |                                 | 1,877  |   |      |   | 3,576  |  
|Loss on disposal of discontinued operations                                                                                                             |  |                                 | 938    |   |      |   |       |  
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Income from continuing operations                                                                                                                       |  |                                 | 1,945  |   |      |   | 23,714 |  
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Adjustments to reconcile income from continuing operations to net cash provided by continuing operations:                                               |  |                                 |        |   |      |   |        |  
|Depreciation                                                                                                                                            |  |                                 | 5,734  |   |      |   | 4,407  |  
|Amortization                                                                                                                                            |  |                                 | 530    |   |      |   | 794    |  
|Bad debt expense                                                                                                                                        |  |                                 | 956    |   |      |   | 688    |  
|Deferred income taxes                                                                                                                                   |  |                                 | 4,309  |   |      |   | 6,353  |  
|Amortization of copyrights and software and media intangible assets                                                                                     |  |                                 | 2,342  |   |      |   | 547    |  
|Non-cash stock compensation                                                                                                                             |  |                                 | 728    |   |      |   | 348    |  
|Other financing costs                                                                                                                                   |  |                                 | 1,066  |   |      |   | 1,506  |  
|Other non-cash items                                                                                                                                    |  |                                 | 958    |   |      |   | (256   | )
|Changes in operating assets and liabilities:                                                                                                            |  |                                 |        |   |      |   |        |  
|Receivables                                                                                                                                             |  |                                 | 3,474  |   |      |   | 10,479 |  
|Prepaid expenses and other current assets                                                                                                               |  |                                 | (3,279 | ) |      |   | (2,325 | )
|Inventory                                                                                                                                               |  |                                 | (2,843 | ) |      |   | (1,466 | )
|Other assets                                                                                                                                            |  |                                 | 249    |   |      |   | (1,074 | )
|Accounts payable, accrued expenses, and other current liabilities                                                                                       |  |                                 | 9,212  |   |      |   | (1,206 | )
|Income taxes payable                                                                                                                                    |  |                                 | 3,239  |   |      |   | (1,388 | )
|Deferred revenue                                                                                                                                        |  |                                 | 628    |   |      |   | (4,656 | )
|Accrued compensation and related benefits                                                                                                               |  |                                 | (3,504 | ) |      |   | (2,175 | )
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Net cash provided by continuing operations                                                                                                              |  |                                 | 25,744 |   |      |   | 34,290 |  
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Adjustments for discontinued operations to reconcile net cash provided by continuing operations to net cash provided by (used in) operating
activities: |  |                                 |        |   |      |   |        |  
|Loss from discontinued operations, including loss on disposal                                                                                           |  |                                 | (2,815 | ) |      |   | (3,576 | )
|Loss on disposal of discontinued operations                                                                                                             |  |                                 | 938    |   |      |   |       |  
|Changes in operating assets and liabilities                                                                                                             |  |                                 | 6,192  |   |      |   | (60    | )
|Depreciation and other non-cash items                                                                                                                   |  |                                 | 40     |   |      |   | 1,020  |  
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Net cash provided by (used in) discontinued operations                                                                                                  |  |                                 | 4,355  |   |      |   | (2,616 | )
|                                                                                                                                                        |  |                                 |        |   |      |   |        |  
|Net cash provided by operating activities                                                                                                               |  |                                 | 30,099 |   |      |   | 31,674 |  

(continued on the following page)

See notes to consolidated financial statements (unaudited).



5



---

##### Table of Contents

Educate, Inc.

Consolidated Statements of Cash Flows (continued)

(Dollar amounts in thousands)

(unaudited)



|                                                                                                                         |  |                                 |         |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                                                         |  | Nine months ended September 30, |        
|                                                                                                                         |  | 2006                            |         |   | 2005 |  
|Investing activities                                                                                                     |  |                                 |         |   |      |   |          |  
|Cash paid for acquired businesses, net of cash acquired (including acquisition costs of $749 in 2006 and $1,417 in 2005) |  | $                               | (6,272  | ) |      | $ | (34,973  | )
|Cash paid for internally developed software and media                                                                    |  |                                 | (6,485  | ) |      |   | (3,556   | )
|Purchases of property and equipment                                                                                      |  |                                 | (9,020  | ) |      |   | (8,299   | )
|Net investing activities of discontinued operations                                                                      |  |                                 | (1,379  | ) |      |   | (2,271   | )
|Change in other assets                                                                                                   |  |                                 | (2,403  | ) |      |   | (1,978   | )
|                                                                                                                         |  |                                 |         |   |      |   |          |  
|Net cash used in investing activities                                                                                    |  |                                 | (25,559 | ) |      |   | (51,077  | )
|                                                                                                                         |  |                                
|Financing activities                                                                                                     |  |                                 |         |   |      |   |          |  
|Proceeds from exercises of stock options                                                                                 |  |                                 | 690     |   |      |   | 992      |  
|Borrowings on revolving credit facility                                                                                  |  |                                 | 13,000  |   |      |   | 13,000   |  
|Payments on revolving credit facility                                                                                    |  |                                 | (33,000 | ) |      |   | (13,000  | )
|Cash received upon issuance of debt                                                                                      |  |                                 | 21,050  |   |      |   | 140,000  |  
|Payments on debt                                                                                                         |  |                                 | (2,012  | ) |      |   | (123,031 | )
|Deferred financing costs                                                                                                 |  |                                 | (922    | ) |      |   | (427     | )
|Change in other long-term liabilities                                                                                    |  |                                 | 631     |   |      |   | 594      |  
|                                                                                                                         |  |                                 |         |   |      |   |          |  
|Net cash provided by (used in) financing activities                                                                      |  |                                 | (563    | ) |      |   | 18,128   |  
|Effect of exchange rate changes on cash                                                                                  |  |                                 | 617     |   |      |   | (615     | )
|                                                                                                                         |  |                                 |         |   |      |   |          |  
|Net change in cash and cash equivalents                                                                                  |  |                                 | 4,594   |   |      |   | (1,890   | )
|Cash and cash equivalents at beginning of period                                                                         |  |                                 | 2,414   |   |      |   | 14,592   |  
|                                                                                                                         |  |                                 |         |   |      |   |          |  
|Cash and cash equivalents at end of period                                                                               |  | $                               | 7,008   |   |      | $ | 12,702   |  
|                                                                                                                         |  |                                 |         |   |      |   |          |  

See notes to consolidated financial statements (unaudited).



6



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share data)

1.
Organization, Basis of Presentation, and Summary of Significant Accounting Policies

Description of Business

Educate, Inc. and subsidiaries (the Company) is an international provider of tutoring, other supplemental education services, and educational products and
services to pre-kindergarten through twelfth grade, or pre-K-12, students. The Company is organized on the basis of educational services provided, and segments are business units that offer distinct services. The segments are managed separately as
they have different customer bases and delivery channels. Reportable segments are as follows:



| |  | The Learning Center segment develops and delivers trusted, personalized tutoring programs through a network of 1,140 franchised and company-owned learning centers in 912
geographical territories in North America operated under the Sylvan brand name, and 1,047 European franchised and company-owned learning centers operated under the Schülerhilfe brand name. In addition, the Learning Center segment offers online
instruction in participating franchised and company-owned territories through Sylvan Online and in participating school districts through NCLB Online. The Learning Center segment also develops and sells educational products and services primarily
under the Hooked on and Reading Rainbow brand names. Sylvan, Hooked on and Reading Rainbow are some of the most highly recognized brand names in the supplemental education services industry.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Catapult Learning segment provides tutoring, other supplemental education services and special-needs services to qualifying students of public and private schools through
government-funded contracts under the Catapult Learning and other brand names.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Basis of Presentation

The unaudited interim financial information as of September 30, 2006, for the three month and nine month periods then ended, and for the comparable periods of the
prior year, has been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information
and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been
included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.

Due principally to the timing of school semesters and holiday schedules, the Company is subject to seasonality of reported revenues and expenses that affect reported
results of operations. The Companys Learning Center segment generally experiences lower revenues in the fourth quarter. Learning Center franchisees pay royalties to the Company based on a percentage of cash receipts. Since customers of these
franchisees frequently make payments for services in advance, royalty revenues earned by the Company are higher in periods of increased enrollment, particularly in the spring months prior to commencement of peak summer service periods. In addition,
the Companys Catapult Learning segment generates a disproportionate amount of revenues during the first six months of the calendar year. This occurs because many school districts are on break during the summer months and use the first semester
which occurs primarily in the fourth calendar quarter to evaluate the specific needs of individual students prior to enrolling students into the Companys supplemental education programs. As a result of these factors, quarter-to-quarter
comparisons of results of operation may not be indicative of future results of operations.

On August 23, 2006, the Company completed the sale of its
Education Station business. The accompanying consolidated financial statements present the results of operations of Education Station as discontinued operations. See also Note 2.

On September 25, 2006 the Company announced that its Board of Directors had received a nonbinding proposal from a management group led by R. Christopher Hoehn-Saric, Chairman and Chief Executive Officer of the
Company, and other investors to acquire all of the outstanding shares of the Company for $8.00 per share in cash.

The Companys Board of Directors
cautions the Companys shareholders and others considering trading in its securities that the Board is reviewing the proposal and no decisions have been made with respect to the Companys response to the proposal. There can be no assurance
that any agreement will be executed or that any transaction will be approved or consummated.

Certain amounts previously reported for 2005 have been
reclassified to conform to the 2006 presentation.



7



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The Company will adopt the provisions of FIN 48 effective January 1, 2007. The provisions of FIN 48 will be applied to all tax positions upon initial adoption. Only tax positions that meet a
more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of
retained earnings (or other appropriate components of equity or net assets in the balance sheet) for fiscal year 2007. The Company is still evaluating the impact of this pronouncement on its financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (Statement 157). Statement 157
defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. Statement 157 emphasizes that fair value is a market-based measurement, not
an entity-specific measurement, and states that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. This Statement applies under other accounting pronouncements
that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value
measurements. Statement 157 is effective for fiscal years beginning after November 15, 2007, which the Company intends to adopt on January 1, 2008. The Company is still evaluating the impact of this pronouncement on its financial
statements.

As more fully described in Note 7, the Company adopted the provisions of FASB Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment (Statement 123(R)) effective January 1, 2006.

2. Discontinued Operations

On October 27, 2005, the Company announced its intention to sell its Education Station business, which delivers site-based No Child Left Behind services to public
schools. Education Station was a component unit within the Catapult Learning operating segment. On August 23, 2006, the Company completed the sale of its Education Station business to Knowledge Learning Corporation (KLC) for cash
payments aggregating up to $6,000.

The aggregate purchase price of $6,000 consists of $3,000 paid into escrow at closing, and $1,000 payable on each of
the first three anniversaries of the closing date. The amount in escrow is payable to the Company on three specific dates during the period beginning ninety days from the closing date and ending on July 31, 2007 upon the renewal by Education
Station of certain contracts applicable to the 2005-2006 school year. The distribution of the escrow amount to the Company is contingent upon the renewal of contracts for the 2006-2007 school year comprising 65% of the revenue from those contracts.
A pro rata portion of the escrow amount is payable to the Company on the three specific dates for the percentage of revenue renewed at each date through contract renewals until the full payout is reached. The fair value of the consideration to be
received from KLC was estimated to be $5,520.

The Purchase Agreement includes a non-competition provision whereby the Company has agreed, for a period of
five years after the closing date, not to engage in the site-based business conducted by Education Station. However, the Company is permitted to provide NCLB services online, and the Companys franchisees within the Sylvan Learning Center
business may also provide NCLB services in their current and future territories.

On the closing date, the Company and KLC also entered into a Technology
License Agreement (License Agreement) whereby the Company granted a non-exclusive, non-transferable license to KLC of certain proprietary software used in providing real-time online NCLB services. The term of the License Agreement is
four years, and provides for a license fee of $10,000, payable in three



8



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

installments of $3,000 within 30 days following each of the first three anniversaries of the closing date, and a final installment of
$1,000 within 30 days following the fourth anniversary. KLC has the right to terminate the License Agreement if the Company fails to deliver the licensed technology within 30 days following the closing date, if KLC makes a warranty claim during the
first year that cannot be timely remedied and results in a material impairment to KLCs use of the licensed technology, or if the federal government terminates funding for NCLB services without replacing NCLB with, or approving, similar
legislation.

On the closing date, the Company and KLC also entered into a Transition Services Agreement for the Company to provide certain information
technology, finance, and human resources and benefits services to KLC for an initial term of one year for $2,000. The Transition Services Agreement may be terminated by KLC upon 30 days written notice, or by either party for default. The agreement
also provides for possible renewal for two additional one-year terms.

As a result of the sale, the Company recorded a loss of $938 (or $0.02 per diluted
common share), net of tax benefit of $531, which represented the difference between the fair value of the net proceeds received and the net assets sold. Goodwill in the amount of $353, representing a portion of the Catapult reporting unit goodwill,
was assigned to Education Station and was included in the net assets sold in determining the loss on disposal. The Company incurred $750 in transaction costs in connection with the sale.

The sale of Education Station will allow management to focus greater attention and resources on the opportunities available in the Learning Center and remaining Catapult Learning businesses.

In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets, the operations of
Education Station are reported as discontinued operations for all periods presented. In addition, the net assets of Education Station were classified as assets held for sale at December 31, 2005.

Summarized operating results from the discontinued operations included in the Companys consolidated statements of operations were as follows:



|                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|                                                      |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005   |  
|Revenues                                              |  | $                               | 3      |   |                                | $ | 365    |      |  | $ | 27,469 |   |  | $ | 26,441 |  
|                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from discontinued operations before income taxes |  |                                 | (3,587 | ) |                                |   | (4,092 | )    |  |   | (2,941 | ) |  |   | (5,768 | )
|Income tax benefit                                    |  |                                 | 1,327  |   |                                |   | 1,555  |      |  |   | 1,064  |   |  |   | 2,192  |  
|                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from discontinued operations                     |  | $                               | (2,260 | ) |                                | $ | (2,537 | )    |  | $ | (1,877 | ) |  | $ | (3,576 | )
|                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  

Assets and liabilities of the discontinued operations of Education Station as of the date of sale and as of
December 31, 2005 were as follows:



|                                      |  |                |       |                  |   |       
|------------------------------------- |  | -------------- | ----- | ---------------- | - | ------
|                                      |  | August 23,2006 |       | December 31,2005
|Current assets                        |  | $              | 771   |                  | $ | 1,683 
|Property and equipment, net           |  |                | 5,105 |                  |   | 3,797 
|Other long-term assets                |  |                | 363   |                  |   | 5,958 
|Long-term liabilities                 |  |                | 531   |                  |   |      
|                                      |  |                |       |                  |   |       
|Net assets of discontinued operations |  | $              | 5,708 |                  | $ | 11,438
|                                      |  |                |       |                  |   |       

3. Acquisitions

On April 10, 2006, the Company closed on a co-production agreement for Reading Rainbow and the acquisition of the assets of Great Plains National Instructional Library (GPN) for $4,900 in cash with contingent payments based
upon future revenues. Reading



9



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

Rainbow, a PBS television series, has garnered more than 250 awards including the Peabody, 9 Parents Choice Awards and 24 Emmy
Awards. In this transaction, the Company acquired the rights to a library of 148 programs and rights to all Reading Rainbow programs to be produced in the future. GPN is the largest non-profit educators source for classroom-use video and
interactive media learning packages. The results of operations of the acquired business are included in the Companys consolidated statements of income beginning April 10, 2006.

The initial purchase price totaled approximately $5,608 including acquisition costs of $708. Contingent consideration may be payable to the seller based upon future
revenues exceeding a threshold in any of the five annual periods commencing on the closing date. No amounts are currently payable nor are amounts expected to be paid under the contingent consideration provisions of the purchase agreement.

The final purchase price allocation is pending determination of the fair value of the intangible assets acquired. The purchase price was preliminarily
allocated to acquired assets, excluding goodwill, of $4,315, including inventory of $376 and identifiable amortizable and indefinite-lived intangible assets of $529 and $3,410, respectively. The Company recognized $1,293 of goodwill, all of which is
expected to be deductible for tax purposes.

During the first quarter of 2006, the Company purchased two Sylvan Learning Center franchised territories
comprising three centers. The combined purchase price of these territories was $902, consisting of cash and short term notes payable to the sellers, including acquisition costs of $15. The combined purchase price was preliminarily allocated to
acquired assets, including accounts receivable of $2 and identifiable indefinite-lived intangible assets of $1,047, and liabilities assumed of $147, which consisted primarily of obligations to provide services to customers.

4. Intangible Assets Other Than Goodwill

A summary of other
intangible assets at September 30, 2006 and December 31, 2005 is as follows:



|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|----------------------------------------------------------------- |  | ------------------- |  | ------------------- | ------- | ----------------------- | - | ----------------- |  | - | -------
|                                                                  |  | September 30, 2006 
|                                                                  |  | Useful LifeIn Years |  | GrossCarryingAmount |         | AccumulatedAmortization |   | NetCarryingAmount
|Intangible assets subject to amortization:                        |  |                     |  |                     |         |                         |   |                   |  |   |        
|Acquired backlog (Learning Center segment)                        |  | 0.5                 |  | $                   | 115     |                         | $ | 115               |  | $ |       
|Contract rights (Catapult Learning segment)                       |  | 5                   |  |                     | 1,084   |                         |   | 701               |  |   | 383    
|Schülerhilfe franchise license rights (Learning Center segment)   |  | 25                  |  |                     | 3,738   |                         |   | 720               |  |   | 3,018  
|Customer list (Learning Center segment)                           |  | 1                   |  |                     | 243     |                         |   | 235               |  |   | 8      
|Copyrights (Learning Center segment)                              |  | 3                   |  |                     | 1,272   |                         |   | 1,014             |  |   | 258    
|Distribution agreements (Learning Center segment)                 |  | 5                   |  |                     | 435     |                         |   | 43                |  |   | 392    
|Internet domain names (primarily Learning Center segment)         |  | 10                  |  |                     | 108     |                         |   | 4                 |  |   | 104    
|Internally developed software and media (Learning Center segment) |  | 5-7                 |  |                     | 15,215  |                         |   | 2,539             |  |   | 12,676 
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total intangible assets subject to amortization                   |  |                     |  |                     | 22,210  |                         |   | 5,371             |  |   | 16,839 
|                                                                  |  |                     |  |                    
|Indefinite-lived intangible assets not subject to amortization:   |  |                     |  |                     |         |                         |   |                   |  |   |        
|Tradenames (Learning Center segment)                              |  | N/A                 |  |                     | 148,640 |                         |   |                  |  |   | 148,640
|Learning Center franchise license rights                          |  | N/A                 |  |                     | 88,022  |                         |   |                  |  |   | 88,022 
|Licensing agreements (Learning Center segment)                    |  | N/A                 |  |                     | 3,410   |                         |   |                  |  |   | 3,410  
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total indefinite-lived intangible assets                          |  |                     |  |                     | 240,072 |                         |   |                  |  |   | 240,072
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total intangible assets other than goodwill                       |  |                     |  | $                   | 262,282 |                         | $ | 5,371             |  | $ | 256,911
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        



10



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)



|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|----------------------------------------------------------------- |  | ------------------- |  | ------------------- | ------- | ----------------------- | - | ----------------- |  | - | -------
|                                                                  |  | December 31, 2005  
|                                                                  |  | Useful LifeIn Years |  | GrossCarryingAmount |         | AccumulatedAmortization |   | NetCarryingAmount
|Intangible assets subject to amortization:                        |  |                     |  |                     |         |                         |   |                   |  |   |        
|Acquired backlog (Learning Center segment)                        |  | 0.5                 |  | $                   | 115     |                         | $ | 115               |  | $ |       
|Contract rights (Catapult Learning segment)                       |  | 5                   |  |                     | 1,084   |                         |   | 539               |  |   | 545    
|Schülerhilfe franchise license rights (Learning Center segment)   |  | 25                  |  |                     | 3,491   |                         |   | 478               |  |   | 3,013  
|Customer list (Learning Center segment)                           |  | 1                   |  |                     | 228     |                         |   | 209               |  |   | 19     
|Copyrights (Learning Center segment)                              |  | 3                   |  |                     | 1,137   |                         |   | 672               |  |   | 465    
|Internally developed software and media (Learning Center segment) |  | 5-7                 |  |                     | 8,731   |                         |   | 944               |  |   | 7,787  
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total intangible assets subject to amortization                   |  |                     |  |                     | 14,786  |                         |   | 2,957             |  |   | 11,829 
|                                                                  |  |                     |  |                    
|Indefinite-lived intangible assets not subject to amortization:   |  |                     |  |                     |         |                         |   |                   |  |   |        
|Tradenames (Learning Center segment)                              |  | N/A                 |  |                     | 147,894 |                         |   |                  |  |   | 147,894
|Learning Center franchise license rights                          |  | N/A                 |  |                     | 87,099  |                         |   |                  |  |   | 87,099 
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total indefinite-lived intangible assets                          |  |                     |  |                     | 234,993 |                         |   |                  |  |   | 234,993
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        
|Total intangible assets other than goodwill                       |  |                     |  | $                   | 249,779 |                         | $ | 2,957             |  | $ | 246,822
|                                                                  |  |                     |  |                     |         |                         |   |                   |  |   |        

As of September 30, 2006, estimated future amortization expense of intangible assets subject to amortization
is as follows:



|                         |  |   |       
|------------------------ |  | - | ------
|Year ending December 31, |  |   |       
|2006                     |  | $ | 916   
|2007                     |  |   | 4,364 
|2008                     |  |   | 3,767 
|2009                     |  |   | 3,233 
|2010                     |  |   | 1,794 
|Thereafter               |  |   | 2,765 
|                         |  |   |       
|Total                    |  | $ | 16,839
|                         |  |   |       



11



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

5. Long-Term Debt

Long-term debt
consists of the following:



|                                                                                                                                                                                                                                                                                                                                     |  |                   |          |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | -------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                                                                                                                                                     |  | September 30,2006 |          |   | December 31,2005 |  
|Senior term loan payable to a bank (2005 Term Loan) in quarterly installments through March 2012. The loan bears interest at
the banks prime rate or the Eurodollar rate, plus specified margins, as elected by the Company (aggregating to 8.75% and 6.03% per annum at September 30, 2006 and December 31, 2005, respectively). |  | $                 | 159,247  |   |                  | $ | 138,950 |  
|Revolving loan payable to a bank (under the 2005 Term Loan) maturing April 27, 2009. The loan bears interest at the
banks prime rate or the Eurodollar rate, plus specified margins, as elected by the Company.                                                                                                                   |  |                   |         |   |                  |   | 20,000  |  
|Note payable, due in semi-annual installments through June 30, 2009. The note does not bear interest, and is recorded net of a discount
of $145 and $221 at September 30, 2006 and December 31, 2005, respectively.                                                                                                                  |  |                   | 1,308    |   |                  |   | 1,656   |  
|Various notes payable bearing interest at fixed rates ranging from 5.00% to 8.25% per annum.                                                                                                                                                                                                                                         |  |                   | 1,670    |   |                  |   | 2,242   |  
|                                                                                                                                                                                                                                                                                                                                     |  |                   |          |   |                  |   |         |  
|                                                                                                                                                                                                                                                                                                                                     |  |                   | 162,225  |   |                  |   | 162,848 |  
|Less: current portion of long-term debt                                                                                                                                                                                                                                                                                              |  |                   | (160,134 | ) |                  |   | (2,734  | )
|                                                                                                                                                                                                                                                                                                                                     |  |                   |          |   |                  |   |         |  
|Total long-term debt                                                                                                                                                                                                                                                                                                                 |  | $                 | 2,091    |   |                  | $ | 160,114 |  
|                                                                                                                                                                                                                                                                                                                                     |  |                   |          |   |                  |   |         |  

On March 31, 2006, the Company amended the 2005 Term Loan with a bank syndicate (the Amendment),
which increased the term loan facility to $160,000, increased the interest rate spread over a base rate and the quarterly maturities over the existing term of the loan, and provided for increased flexibility in certain other terms and conditions of
the term loan facility, including covenants concerning financial condition, certain capital expenditures and required interest rate protection coverage. The Amendment also provides consent for the sale of the Companys Education Station
business, and modifies the required prepayments of amounts outstanding under the facility to 50% of the net cash proceeds from such sale. No changes were made to the agreement concerning the $30,000 revolving credit facility. The Company paid down
$21,050 of the revolving loan with the proceeds from the Amendment. Of the $30,000 revolving credit facility, $28,570 was available to the Company due to outstanding standby letters of credit totaling $1,430 as of September 30, 2006.

At the Companys election, the 2005 Term Loan and Amendment bears interest at the base rate or Eurodollar rate plus a margin, which was 325 basis
points at September 30, 2006. Pursuant to the 2005 Term Loan and Amendment, quarterly principal payments based upon a 100-year amortization schedule are due through September 30, 2011 with two balloon payments in equal amounts due at the
end of each of the following quarters. The obligations under the 2005 Term Loan are guaranteed by the Company and certain direct and indirect subsidiaries of the Company. These obligations are secured by a senior interest in substantially all of the
assets of the consolidated subsidiaries of the Company.

The Amendment constituted a substantial modification of the terms of the prior agreement according
to Emerging Issues Task Force Issue No. 96-19: Debtors Accounting for a Modification or Exchange of Debt Instruments, and as a result, the Company wrote-off unamortized deferred financing costs of approximately $144 related to the
prior term loan facility and expensed an additional $922 related to the modification during the quarter ended March 31, 2006.

The 2005 Term Loan and
Amendment includes customary covenants for transactions of this type, including covenants limiting liens on assets of certain of the Companys subsidiaries, certain asset sales, payment of dividends, incurrence of additional indebtedness, and
mergers or fundamental business changes. On August 8, 2006 the Company amended certain financial covenants within the 2005 Term Loan and Amendment for the June 30, 2006 and subsequent quarterly reporting periods to provide additional
flexibility to achieve these covenants (Second Amendment).

As of September 30, 2006, the Company was not in compliance with certain
financial covenants within the 2005 Term Loan, as amended and therefore is subject to the demand repayment provisions of that credit facility. As a result, the Company classified all outstanding debt under the 2005 Term Loan as a current liability
in the balance sheet as of September 30, 2006. Management is



12



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

currently working with the lenders under the 2005 Term Loan to obtain covenant amendments for current and future quarterly reporting
periods to return to compliance with the 2005 Term Loan agreement. The Company believes that its relations with the lenders under the 2005 Term Loan are good, and management believes that the appropriate amendments will be obtained in the near
future.

6. Commitments and Contingencies

In
connection with the acquisition of the pre-K-12 business from Laureate Education, Inc. (Laureate), the Company and Laureate entered into a three-year shared services agreement that expired June 30, 2006. Under the terms of the
shared service agreement, the Company provided certain support services including, but not limited to, specified accounting, benefits, information technology, human resources, purchasing and payroll services to Laureate. Conversely, Laureate
provided certain support services, primarily in the areas of tax, treasury, and facilities administration to the Company. Laureate and the Company are considered related parties because two individuals, one of whom is the Companys CEO, serve
on the Board of Directors of both companies.

On July 1, 2006, the Company and Laureate extended its shared service agreement through
December 31, 2007 for a portion of the originally contracted services. Under the extended agreement, the Company will continue to provide specified accounting, benefits, human resources, purchasing and payroll services to Laureate through the
end of 2007. Laureate will continue to provide to the Company certain facilities administration functions through the remainder of 2006.

The shared
services agreement provides for the Company to receive net payments consisting of a base fee plus specified volume-based increases to the fees attributable to the services. The net base fees to be received by the Company under the extended agreement
are approximately $127 each quarter. These payments are accounted for as a reduction of general and administrative expenses.

The Company is subject to
legal actions arising in the ordinary course of its business. In managements opinion, the Company has adequate legal defenses and/or insurance coverage with respect to the eventuality of such actions and does not believe any settlement would
materially affect the Companys financial position.

The Company maintains a number of standby letters of credit totaling $1,430 as of
September 30, 2006 to guarantee certain of its insurance programs and the potential payment under a franchisee acquisition through 2008.

The Company
has guaranteed certain bank loans of franchisees related to financing the purchase of educational programs and other purchased instructional material. Of the $680 of available credit under this program, $155 was outstanding at September 30,
2006. These guarantees are secured by the assets of the business of the individual franchisee utilizing this financing arrangement.

The Company has
guaranteed a bank loan of the Sylvan National Advertising Fund (Fund) in the amount of $2.0 million, which expires in November 2006. All Sylvan Learning Centers pay advertising fees into the Fund, which coordinates national advertising
campaigns for the benefit of the Learning Center network. The Fund is a separate legal entity, which the Company does not control. Provision of the guarantee allowed the Fund to obtain external financing at more favorable terms. The Company would be
required to perform under the guarantee in the event of default on the loan by the Fund. An event of default under the 2005 Term Loan would be an event of default under this loan to the Fund.

7. Share-Based Payment

In December 2004, the FASB issued Statement
123(R), Share-Based Payment, which is a revision of Statement 123, Accounting for Stock-Based Compensation. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized
in the income statement based on their estimated fair values. Pro forma disclosure is no longer an alternative.

Prior to January 1, 2006, the Company
accounted for all stock-based awards under the intrinsic value recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations (Opinion 25), as permitted by
Statement 123. On January 1, 2006, the Company adopted the provisions of Statement 123(R) using the modified prospective



13



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

method. Under the modified prospective method, compensation cost is recognized beginning with the effective date for
(a) all new share-based payments granted after the effective date; (b) all awards modified, repurchased, or cancelled after the effective date; and (c) the remaining portion of the requisite service under previously-granted unvested
awards outstanding as of the effective date. For options that vest ratably, the Company recognizes compensation cost on a straight-line basis over the requisite service period for the entire award.

Unvested stock-based awards issued prior to May 14, 2004, the date the Company filed a registration statement with the SEC to sell its common stock in a public
offering, and disclosed in the financial statements using the minimum value method (rather than the estimated fair value using an option-pricing model) were accounted for at the date of adoption using the intrinsic value method originally applied to
those awards. Awards issued after May 14, 2004 and through December 31, 2005 that have not vested were accounted for at the date of adoption using the same estimate of the grant-date fair value disclosed in the historical financial
statements and estimated in accordance with the provisions of Statement 123. As a result of adopting Statement 123(R), no future expense will be recognized for unvested options granted prior to May 14, 2004 that had no intrinsic value at the
grant date.

As a result of adopting Statement 123(R), the Companys income before income taxes, income from continuing operations, and net income for
the three months ended September 30, 2006 are $163, $73 and $73 lower, respectively, and $426, $191 and $197 lower, respectively, for the nine months ended September 30, 2006 than if the Company had continued to account for share-based
compensation under Opinion 25. There was no impact on diluted net income per share for the nine months ended September 30, 2006 as a result of adopting Statement 123(R). Results for prior periods have not been restated.

Prior to the adoption of Statement 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in
the statement of cash flows. Statement 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing
cash flows.

Prior to adoption of Statement 123(R), the Company accounted for all stock-based compensation awards using the intrinsic value method. Under
the intrinsic value method, if the exercise price of the employee stock option equals the estimated fair value of the underlying stock on the date of grant, no compensation expense was generally recognized. Statement 123(R) requires the disclosure
of pro forma data based on the original provisions of Statement 123 in the notes to the financial statements for periods prior to the date of adoption for companies adopting using the modified prospective method.

Pro forma net income and earnings per share data have been determined as if the Company had accounted for its stock-based awards using the prescribed fair value based
method. For all grants prior to May 14, 2004, the date the Company filed a registration statement with the SEC to sell its common stock in a public offering, the Company used the minimum value method. The minimum value method assumes that the
fair value of an award is equal to the excess of the fair value of the underlying common stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the
expected life of the option.

For all stock options granted after May 14, 2004, the Company used the Black-Scholes option-pricing model. The
Black-Scholes option-pricing model was developed for estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Black-Scholes and other option valuation models require the input of highly subjective
assumptions. These assumptions may change in future periods, and the effects could be material. Significant assumptions used during the year to estimate the fair value of stock options are described below:



| |  |  | Expected Term. Because the Company was formed in June 2003, it has limited historical experience regarding its employees exercise and post-vesting employment
termination behavior. The Companys options have the characteristics of plain vanilla options described in Staff Accounting Bulletin No. 107 (SAB 107), and as such, the expected term is calculated using SAB
107s simplified method.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expected Volatility. Because the Companys common stock has only been publicly traded since September 2004, the expected stock price volatility over the expected life of
granted options has been based on published volatility measures of companies with similar characteristics.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expected Dividend Yield. The Company does not anticipate paying dividends in the foreseeable future.
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | Risk-Free Interest Rates. The risk-free interest rates for stock options are based on the U.S. Treasury yield curve rates in effect at the time of grant for maturities
similar to the expected term of the stock options.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

The weighted average assumptions used in the 2006 valuation model are presented in the table below.



|                                |  |                                     |  
|------------------------------- |  | ----------------------------------- | -
|                                |  | Nine months endedSeptember 30, 2006 |  
|Expected term (in years)        |  | 6.02                                |  
|Expected volatility             |  | 40                                  | %
|Expected dividend yield         |  | 0                                   | %
|Risk-free interest rate (range) |  | 4.92  5.13                         | %

The following assumptions (weighted averages) were used in calculating 2005 pro
forma stock compensation expense:



|                                |  |                                     |  
|------------------------------- |  | ----------------------------------- | -
|                                |  | Nine months endedSeptember 30, 2005 |  
|Expected life (in years)        |  | 4                                   |  
|Expected volatility             |  | 45                                  | %
|Expected dividend yield         |  | 0                                   | %
|Risk-free interest rate (range) |  | 3.81  4.18                         | %

The weighted average estimated fair value of stock-based awards granted during the three months ended
September 30, 2005 was $5.60, and $3.85 and $5.36 during the nine months ended September 30, 2006 and 2005, respectively. The Company did not grant any share-based awards during the three month period ended September 30, 2006.

For the purpose of pro forma disclosures, the estimated fair value of the options in periods prior to adoption of Statement 123(R) was expensed over the
options vesting periods. The Companys pro forma information is as follows:



|                                                                                                      |  |                                      |       |   |                                     |   |        |  
|----------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ----- | - | ----------------------------------- | - | ------ | -
|                                                                                                      |  | Three months endedSeptember 30, 2005 |       |   | Nine months endedSeptember 30, 2005 |  
|Net income, as reported                                                                               |  | $                                    | 2,667 |   |                                     | $ | 20,138 |  
|Add: Stock-based employee compensation expense included in net income as reported, net of tax         |  |                                      | 32    |   |                                     |   | 216    |  
|Less: Stock-based employee compensation expense using prescribed fair value based methods, net of tax |  |                                      | (194  | ) |                                     |   | (548   | )
|                                                                                                      |  |                                      |       |   |                                     |   |        |  
|Pro forma net income                                                                                  |  | $                                    | 2,505 |   |                                     | $ | 19,806 |  
|                                                                                                      |  |                                      |       |   |                                     |   |        |  
|Earnings per common sharebasic                                                                       |  |                                      |       |   |                                     |   |        |  
|As reported                                                                                           |  | $                                    | 0.06  |   |                                     | $ | 0.47   |  
|Pro forma                                                                                             |  | $                                    | 0.06  |   |                                     | $ | 0.46   |  
|                                                                                                      |  |                                     
|Earnings per common sharediluted                                                                     |  |                                      |       |   |                                     |   |        |  
|As reported                                                                                           |  | $                                    | 0.06  |   |                                     | $ | 0.46   |  
|Pro forma                                                                                             |  | $                                    | 0.06  |   |                                     | $ | 0.45   |  

Description of Stock Option Plans

2003 Omnibus Stock Incentive Plan

During 2003, the Company adopted a stock option plan that provides for the
granting of options to purchase up to 4,360,000 shares of common stock to selected employees and directors of the Company. Options to purchase 3,898,800 shares of common stock were



15



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

granted under this plan. Of this amount, 104,000 shares immediately vested with the remainder vesting ratably over thirty-six or
forty-eight months. Options under this plan expire 10 years after the grant date. Options to purchase 374,000 shares of common stock were granted in 2004 under this plan with an exercise price less than the estimated fair value of the Companys
common stock at the grant date. The Company can no longer grant options under this plan.

2004 Omnibus Stock Incentive Plan

During 2004, the Company adopted a stock option plan that provides for the granting to selected employees and directors of the Company of options to purchase up to
700,000 shares of common stock plus an annual increase added automatically on the first day of the fiscal year equal to the lesser of (i) 400,000 shares or (ii) one percent of the number of outstanding shares on the last day of the
immediately preceding fiscal year. Options under this plan expire 10 years after the grant date.

The annual automatic increases on January 1, 2006
and 2005 each resulted in 400,000 additional shares of common stock available for issuance under the 2004 stock option plan, and after taking into account shares already granted, 875,979 shares of common stock are available for issuance as of
September 30, 2006. Options vest ratably over a forty-eight month period.

The following tables summarize the Companys stock option activity
(options in thousands):



|                                                 |  |         |   |  |                              |      |                                        |     |                         |   |       
|------------------------------------------------ |  | ------- | - |  | ---------------------------- | ---- | -------------------------------------- | --- | ----------------------- | - | ------
|                                                 |  | Options |   |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingLife (inYears) |     | AggregateIntrinsicValue
|Outstanding  December 31, 2005                  |  | 3,586   |   |  | $                            | 4.78 |                                        |     |                         |   |       
|Granted                                          |  | 388     |   |  |                              | 8.19 |                                        |     |                         |   |       
|Exercised                                        |  | (170    | ) |  |                              | 4.03 |                                        |     |                         |   |       
|Forfeited                                        |  | (248    | ) |  |                              | 9.08 |                                        |     |                         |   |       
|                                                 |  |         |   |  |                              |      |                                        |     |                         |   |       
|Outstanding  September 30, 2006                 |  | 3,556   |   |  | $                            | 4.87 |                                        | 7.2 |                         | $ | 12,246
|                                                 |  |         |   |  |                              |      |                                        |     |                         |   |       
|Vested and expected to vest  September 30, 2006 |  | 3,437   |   |  | $                            | 4.78 |                                        | 7.1 |                         | $ | 12,073
|                                                 |  |         |   |  |                              |      |                                        |     |                         |   |       
|Exercisable  September 30, 2006                 |  | 2,784   |   |  | $                            | 4.21 |                                        | 6.9 |                         | $ | 10,999
|                                                 |  |         |   |  |                              |      |                                        |     |                         |   |       

The aggregate intrinsic value in the table above represents the difference between the Companys closing
stock price on the last trading day of the third quarter of 2006 (September 29, 2006) and the exercise price, multiplied by the number of in-the-money options outstanding, whether vested or not vested.

The total intrinsic value of stock options exercised, based on the difference between the Companys stock price at the time of exercise and the related exercise
price, was $132 and $1,128 during the three month periods ended September 30, 2006 and 2005, respectively, and $748 and $1,299 during the nine month periods ended September 30, 2006 and 2005, respectively.

The total fair value of stock options vested was $258 and $222 during the three month periods ended September 30, 2006 and 2005, respectively, and $762 and $617
during the nine months ended September 30, 2006 and 2005, respectively. At September 30, 2006, unrecognized compensation cost related to stock options outstanding as of September 30, 2006 was $2,470 ($1,482 after income taxes), which
is expected to be recognized over a weighted average remaining vesting period of 3.1 years.

8. Income Taxes

At the end of each interim period the Company makes its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined
is used in providing for income taxes on a current year-to-date basis. The effective tax rate reflects anticipated investment tax credits, foreign tax rates, capital gains rates, and other available tax-planning alternatives. It also includes the
effect of any valuation allowance expected to be necessary at the end of the year for deferred tax assets related to originating deductible temporary differences and carryforwards during the year. Estimates of the annual effective tax rate at the
end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision.



16



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

In arriving at this effective tax rate, no effect is included for the tax related to significant, unusual, or extraordinary items that
will be separately reported or reported net of their related tax effect in financial statements for the interim period or for the year. The effective tax rate excludes the effects of changes in judgment about beginning-of-year valuation allowances
and reversals of a prior-year reserve related to a tax loss contingency. Rather, these items are recorded as adjustments to tax expense in the interim period they are determined, and are not allocated to future interim periods.

During the three month period ended September 30, 2006, the Company recorded approximately $1,745 of additional tax expense as a result of increasing its valuation
allowances related to certain state deferred tax assets, which reduced income from continuing operations and net income by that same amount in the three and nine month periods ended September 30, 2006. As a result, diluted net income per share
was $0.04 lower for the three and nine months ended September 30, 2006.

Currently, the Companys effective tax rate for the year ending
December 31, 2006 is expected to be 55% excluding the impact of the valuation allowance for prior year state deferred tax assets. The estimated rate increased from the 40% rate estimated as of June 30, 2006 due to a decline in estimated
book income for the full year and the effect of recording valuation allowances on certain current year state net operating losses. The Company concluded that unexpected current year operating losses has created uncertainties surrounding the
realization of certain state deferred tax assets.

This rate change reduced income from continuing operations and net income by $1,202 and $1,338,
respectively, or $0.03 per diluted common share, in the nine month period ended September 30, 2006.

9. Stockholders Equity and Comprehensive
Income

Changes in the Companys stockholders equity are summarized as follows:



|                                                                 |  |             |     |                          |   |                  |  |   |                                     |   |  |                          |       |   |  |   |         |  
|---------------------------------------------------------------- |  | ----------- | --- | ------------------------ | - | ---------------- |  | - | ----------------------------------- | - |  | ------------------------ | ----- | - |  | - | ------- | -
|                                                                 |  | CommonStock |     | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome |   |  | TotalStockholdersEquity |      
|Balance at December 31, 2005                                     |  | $           | 427 |                          | $ | 192,608          |  | $ | 18,212                              |   |  | $                        | 461   |   |  | $ | 211,708 |  
|Options exercised for purchase of 170,661 shares of common stock |  |             | 1   |                          |   | 687              |  |   |                                    |   |  |                          |      |   |  |   | 688     |  
|Issuance of 102,649 shares of common stock for 401(k) match      |  |             | 2   |                          |   | 845              |  |   |                                    |   |  |                          |      |   |  |   | 847     |  
|Non-cash stock compensation expense                              |  |             |    |                          |   | 768              |  |   |                                    |   |  |                          |      |   |  |   | 768     |  
|Comprehensive income:                                            |  |             |     |                          |   |                  |  |   |                                     |   |  |                          |       |   |  |   |         |  
|Net loss for 2006                                                |  |             |    |                          |   |                 |  |   | (870                                | ) |  |                          |      |   |  |   | (870    | )
|Other comprehensive income:                                      |  |             |     |                          |   |                  |  |   |                                     |   |  |                          |       |   |  |   |         |  
|Change in fair value of derivative financial instrument          |  |             |    |                          |   |                 |  |   |                                    |   |  |                          | (260  | ) |  |   | (260    | )
|Foreign currency translation adjustment                          |  |             |    |                          |   |                 |  |   |                                    |   |  |                          | 1,553 |   |  |   | 1,553   |  
|                                                                 |  |             |     |                          |   |                  |  |   |                                     |   |  |                          |       |   |  |   |         |  
|Balance at September 30, 2006                                    |  | $           | 430 |                          | $ | 194,908          |  | $ | 17,342                              |   |  | $                        | 1,754 |   |  | $ | 214,434 |  
|                                                                 |  |             |     |                          |   |                  |  |   |                                     |   |  |                          |       |   |  |   |         |  



17



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

The components of comprehensive income, net of related taxes, are as follows:



|                                                         |  |                                  |        |   |                                 |   |       |      |  |   |       |   |  |   |        |  
|-------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ------ | -
|                                                         |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|                                                         |  | 2006                             |        |   | 2005                            |   |       | 2006 |  |   | 2005  |  
|Net income (loss)                                        |  | $                                | (8,482 | ) |                                 | $ | 2,667 |      |  | $ | (870  | ) |  | $ | 20,138 |  
|Change in fair value of derivative financial instruments |  |                                  | (213   | ) |                                 |   | 208   |      |  |   | (260  | ) |  |   | 386    |  
|Foreign currency translation adjustment                  |  |                                  | (217   | ) |                                 |   | (772  | )    |  |   | 1,553 |   |  |   | (3,566 | )
|                                                         |  |                                  |        |   |                                 |   |       |      |  |   |       |   |  |   |        |  
|Comprehensive income (loss)                              |  | $                                | (8,912 | ) |                                 | $ | 2,103 |      |  | $ | 423   |   |  | $ | 16,958 |  
|                                                         |  |                                  |        |   |                                 |   |       |      |  |   |       |   |  |   |        |  

Income tax expense (benefit) related to the derivative financial instrument in the table above was $(134) and $128
for the three months ended September 30, 2006 and 2005, respectively, and $(132) and $237 for the nine months ended September 30, 2006 and 2005, respectively. Income tax expense (benefit) related to the foreign currency translation
adjustment in the table above was $(123) and $(364) for the three and nine months ended September 30, 2005, respectively.

The components of
accumulated other comprehensive income are summarized as follows:



|                                                                  |  |                                       |       |   |                                |   |      |       |  |   |      
|----------------------------------------------------------------- |  | ------------------------------------- | ----- | - | ------------------------------ | - | ---- | ----- |  | - | -----
|                                                                  |  | Foreign CurrencyTranslationAdjustment |       |   | DerivativeFinancialInstruments |   |      | Total
|Balance at December 31, 2005                                      |  | $                                     | (128  | ) |                                | $ | 589  |       |  | $ | 461  
|Gains (losses) recorded in other comprehensive income, net of tax |  |                                       | 1,553 |   |                                |   | (260 | )     |  |   | 1,293
|                                                                  |  |                                       |       |   |                                |   |      |       |  |   |      
|Balance at September 30, 2006                                     |  | $                                     | 1,425 |   |                                | $ | 329  |       |  | $ | 1,754
|                                                                  |  |                                       |       |   |                                |   |      |       |  |   |      

10. Earnings Per Share

Basic earnings (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per common share include the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or converted into common stock.



18



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

A reconciliation of the numerators and denominators for basic and diluted earnings (loss) per common share is as follows:



|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                              |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|                                              |  | 2006                             |        |   | 2005                            |   |        | 2006 |  |   | 2005   |  
|Numerator                                     |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from continuing operations      |  | $                                | (5,284 | ) |                                 | $ | 5,204  |      |  | $ | 1,945  |   |  | $ | 23,714 |  
|Loss from discontinued operations, net of tax |  |                                  | (3,198 | ) |                                 |   | (2,537 | )    |  |   | (2,815 | ) |  |   | (3,576 | )
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                             |  | $                                | (8,482 | ) |                                 | $ | 2,667  |      |  | $ | (870   | ) |  | $ | 20,138 |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Denominator (shares in thousands)             |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Basic:                                        |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares outstanding           |  |                                  | 42,981 |   |                                 |   | 42,672 |      |  |   | 42,884 |   |  |   | 42,619 |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Diluted:                                      |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares outstanding           |  |                                  | 42,981 |   |                                 |   | 42,672 |      |  |   | 42,884 |   |  |   | 42,619 |  
|Dilutive effect of stock options              |  |                                  |       |   |                                 |   | 1,494  |      |  |   | 807    |   |  |   | 1,448  |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total                                         |  |                                  | 42,981 |   |                                 |   | 44,166 |      |  |   | 43,691 |   |  |   | 44,067 |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Earnings (loss) per common share - basic      |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from continuing operations      |  | $                                | (0.12  | ) |                                 | $ | 0.12   |      |  | $ | 0.05   |   |  | $ | 0.56   |  
|Loss from discontinued operations, net of tax |  |                                  | (0.08  | ) |                                 |   | (0.06  | )    |  |   | (0.07  | ) |  |   | (0.09  | )
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                             |  | $                                | (0.20  | ) |                                 | $ | 0.06   |      |  | $ | (0.02  | ) |  | $ | 0.47   |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Earnings (loss) per common share - diluted    |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from continuing operations      |  | $                                | (0.12  | ) |                                 | $ | 0.12   |      |  | $ | 0.04   |   |  | $ | 0.54   |  
|Loss from discontinued operations, net of tax |  |                                  | (0.08  | ) |                                 |   | (0.06  | )    |  |   | (0.06  | ) |  |   | (0.08  | )
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                             |  | $                                | (0.20  | ) |                                 | $ | 0.06   |      |  | $ | (0.02  | ) |  | $ | 0.46   |  
|                                              |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  

Since their exercise price exceeded the market value of the Companys common stock, options to purchase
623,021 shares of common stock were excluded from the 2006 computations because the effect was antidilutive. In accordance with FASB Statement No. 128, Earnings per Share, the Company uses income from continuing operations as the
control number in determining whether potential common shares are dilutive.

11. Employee Benefit Plan

The Company sponsors a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. The provisions of this plan allow for voluntary employee
contributions of up to 20% of salary, subject to certain annual limitations. All employees are eligible after meeting certain minimum service requirements.

The Company may at its discretion make matching contributions, which are allocated to eligible participants. The Company made discretionary contributions to this plan of 102,649 shares of Educate, Inc. common stock valued at $847 during the
nine months ended September 30, 2006 and $741 in cash during the year ended December 31, 2005.



19



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

12. Businesses and Geographic Segment Information

The Company is organized on the basis of educational services provided, and segments are business units that offer distinct services. The segments are managed separately as they have different customer bases and
delivery channels. Reportable segments are as follows:



| |  | The Learning Center segment develops and delivers trusted, personalized tutoring programs and online instruction, including Sylvan Online, through a network of franchised and
company-owned learning centers located primarily in North America and Europe. The Learning Center segment also provides online NCLB supplemental education services to qualifying students through NCLB Online. The Learning Center segment also develops
and sells educational products and services primarily under the Hooked on brand name.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Catapult Learning segment provides tutoring, other supplemental education services and special-needs services to public and private schools.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

The Company evaluates performance and allocates resources based on operating income. Any significant intercompany sales or transfers are eliminated.



20



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

The following tables set forth information on the Companys reportable segments:



|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|--------------------------------------------------- |  | -------------- | ------- | - | ---------------- | - | ------ | ----- |  | - | ------- | -
|Three months ended September 30, 2006               |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                            |  | $              | 65,779  |   |                  | $ | 15,541 |       |  | $ | 81,320  |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization |  |                | 4,698   |   |                  |   | 882    |       |  |   | 5,580   |  
|Depreciation and amortization                       |  |                | (1,586  | ) |                  |   | (207   | )     |  |   | (1,793  | )
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit                                      |  | $              | 3,112   |   |                  | $ | 675    |       |  | $ | 3,787   |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|                                                    |  |                |        
|Three months ended September 30, 2005               |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                            |  | $              | 66,495  |   |                  | $ | 12,045 |       |  | $ | 78,540  |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization |  |                | 15,965  |   |                  |   | 13     |       |  |   | 15,978  |  
|Depreciation and amortization                       |  |                | (1,208  | ) |                  |   | (201   | )     |  |   | (1,409  | )
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit (loss)                               |  | $              | 14,757  |   |                  | $ | (188   | )     |  | $ | 14,569  |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|                                                    |  |                |        
|Nine months ended September 30, 2006                |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                            |  | $              | 208,376 |   |                  | $ | 68,360 |       |  | $ | 276,736 |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization |  |                | 26,390  |   |                  |   | 11,104 |       |  |   | 37,494  |  
|Depreciation and amortization                       |  |                | (4,422  | ) |                  |   | (602   | )     |  |   | (5,024  | )
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit                                      |  | $              | 21,968  |   |                  | $ | 10,502 |       |  | $ | 32,470  |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|                                                    |  |                |        
|Nine months ended September 30, 2005                |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                            |  | $              | 191,488 |   |                  | $ | 62,282 |       |  | $ | 253,770 |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization |  |                | 48,733  |   |                  |   | 12,251 |       |  |   | 60,984  |  
|Depreciation and amortization                       |  |                | (3,474  | ) |                  |   | (512   | )     |  |   | (3,986  | )
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit                                      |  | $              | 45,259  |   |                  | $ | 11,739 |       |  | $ | 56,998  |  
|                                                    |  |                |         |   |                  |   |        |       |  |   |         |  



21



---

##### Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, continued)

(Dollars in thousands, except
per share data)

The following tables reconcile segment profit to income (loss) from continuing operations before income taxes reported in the
consolidated statements of income and segment assets to total assets reported on the consolidated balance sheet:



|                                                             |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                             |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|                                                             |  | 2006                             |        |   | 2005                            |   |        | 2006 |  |   | 2005    |  
|Segment profit                                               |  | $                                | 3,787  |   |                                 | $ | 14,569 |      |  | $ | 32,470  |   |  | $ | 56,998  |  
|Corporate depreciation and amortization                      |  |                                  | (370   | ) |                                 |   | (404   | )    |  |   | (1,240  | ) |  |   | (1,214  | )
|General and administrative costs                             |  |                                  | (4,010 | ) |                                 |   | (3,851 | )    |  |   | (12,947 | ) |  |   | (10,576 | )
|Other expense                                                |  |                                  | (3,301 | ) |                                 |   | (1,920 | )    |  |   | (10,129 | ) |  |   | (6,959  | )
|                                                             |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations before income taxes |  | $                                | (3,894 | ) |                                 | $ | 8,394  |      |  | $ | 8,154   |   |  | $ | 38,249  |  
|                                                             |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  



|                                                |  |                    |        
|----------------------------------------------- |  | ------------------ | -------
|                                                |  | September 30, 2006
|Learning Center segment assets                  |  | $                  | 417,856
|Catapult Learning segment assets                |  |                    | 32,573 
|                                                |  |                    |        
|Total assets for reportable segments            |  |                    | 450,429
|Unallocated corporate assets                    |  |                    | 14,817 
|Assets of discontinued operations held for sale |  |                    |       
|                                                |  |                    |        
|Total assets                                    |  | $                  | 465,246
|                                                |  |                    |        

Revenues by geographic area are as follows:



|                   |  |                                  |        |                                 |   |        |  |      |         |  |   |        
|------------------ |  | -------------------------------- | ------ | ------------------------------- | - | ------ |  | ---- | ------- |  | - | -------
|                   |  | Three months ended September 30, |        | Nine months ended September 30,
|                   |  | 2006                             |        | 2005                            |   | 2006   |  | 2005
|United States      |  | $                                | 71,021 |                                 | $ | 70,643 |  | $    | 245,548 |  | $ | 227,635
|Other              |  |                                  | 10,299 |                                 |   | 7,897  |  |      | 31,188  |  |   | 26,135 
|                   |  |                                  |        |                                 |   |        |  |      |         |  |   |        
|Consolidated total |  | $                                | 81,320 |                                 | $ | 78,540 |  | $    | 276,736 |  | $ | 253,770
|                   |  |                                  |        |                                 |   |        |  |      |         |  |   |        

Revenues are attributed to countries based on the location of the customer. No country other than the United
States represents more than 10% of consolidated revenues for any period presented. Substantially all long-lived assets are located in the United States.



22



---

##### Table of Contents

Educate, Inc.

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.

The following
discussion of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements and related notes to those statements included in Part I, Item 1 of this Quarterly Report on Form
10-Q, the consolidated financial statements and related notes to those statements in the Companys Annual Report on Form 10-K for the year ended December 31, 2005, and the managements discussion and analysis of financial condition
and results of operations contained in Part II, Item 7 of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.

Information Regarding Forward-Looking Statements

The statements contained in this Quarterly Report on Form 10-Q include forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include information about possible or assumed results of operations, business strategies, financing plans, competitive
position and potential growth opportunities. Forward-looking statements include all statements that are not historical facts and are generally accompanied by words such as may, will, intend,
anticipate, believe, estimate, expect, should or similar expressions or the negative of such words or expressions. These statements also relate to the Companys contingent payment
obligations relating to acquisitions, future capital requirements, potential acquisitions and the Companys future development plans and are based on current expectations. Forward-looking statements involve various risks, uncertainties and
assumptions. The Companys actual results may differ materially from those expressed in these forward-looking statements.

Future events and
actual results could differ materially from those set forth in the forward-looking statements as a result of many factors. The following factors are some of the factors that might cause such a difference: the development and expansion of the Sylvan
Learning franchise system; changes in the relationships among Sylvan Learning and its franchisees; the Companys ability to effectively manage business growth; changes in the Companys ability to effectively integrate recently acquired
companies; increased competition from other educational service providers; changes in laws and government policies and programs; changes in the acceptance of the Companys services and products by institutional customers and consumers; changes
in customer relationships; acceptance of new programs, services and products by institutional customers and consumers; changes in the expected seasonality of operating results; global economic conditions, including interest and currency rate
fluctuations and inflation rates; fluctuations in the Companys consolidated effective tax rate due to potential changes in the mix of earnings; and the other factors described in this Form 10-Q. Additional information regarding these and other
risk factors and uncertainties are set forth from time to time in the Companys filings with the Securities and Exchange Commission, available for viewing on the Companys website www.educate-inc.com. These forward-looking statements are
based on estimates, projections, beliefs and assumptions of management and speak only as of the date made and are not guarantees of future performance. We do not undertake any obligation to release publicly any revisions to these forward-looking
statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable securities law.

Overview

We are a leading international provider of tutoring and
other supplemental education services to pre-kindergarten through twelfth grade, or pre-K-12, students. We operate through two business segments that offer distinct supplemental education programs and services from which we earn revenues. Through
our Learning Center segment, we deliver diagnostic, prescriptive tutoring programs, principally through a network of 912 territories supporting 1,140 Sylvan branded franchised and company-owned learning centers primarily in North America. In
addition, the Learning Center segment offers online instruction in participating franchised and company-owned territories through Sylvan Online and in participating school districts through NCLB Online. Our Learning Center segment also provides
tutoring services in Europe under the Schülerhilfe brand name and delivers educational products including the highly regarded Hooked on early reading, math and study skills programs and Reading Rainbow television programs. We also
provide tutoring, other supplemental education services and special needs services to public and private schools through government-funded contracts in our Catapult Learning segment under Catapult Learning and other brand names.

On August 23, 2006, we completed the sale of our Education Station business, which delivered site-based No Child Left Behind services to public schools. Education
Station was a component unit within the Catapult Learning operating segment. On the closing date we also entered into a Technology License Agreement and a Transition Services Agreement with the buyer of Education Station. See Note 2 to our unaudited
consolidated financial statements in this Form 10-Q for further information regarding these transactions. The operations of Education Station are classified as discontinued operations for all periods presented.



23



---

##### Table of Contents

Educate, Inc.

On September 25, 2006 we announced that our Board of Directors had received a nonbinding proposal from a management group led by R. Christopher Hoehn-Saric, Chairman and Chief Executive Officer of the Company, and other investors to
acquire all of the outstanding shares of the Company for $8.00 per share in cash.

Our Board of Directors cautions the Companys shareholders and
others considering trading in its securities that the Board is reviewing the proposal and no decisions have been made with respect to the Companys response to the proposal. There can be no assurance that any agreement will be executed or that
any transaction will be approved or consummated.

Our revenues and operating income are characterized by significant seasonal fluctuations as described
below.

Seasonality and Other Quarterly Fluctuations

The following table sets forth selected information related to seasonality and other quarterly fluctuations:



|                                         |  |              |      |               |   |              |      |   |      |   |              |  |  |               |      |   |              |   |      |                |  |   |      |   |  |   |      |  
|---------------------------------------- |  | ------------ | ---- | ------------- | - | ------------ | ---- | - | ---- | - | ------------ |  |  | ------------- | ---- | - | ------------ | - | ---- | -------------- |  | - | ---- | - |  | - | ---- | -
|                                         |  | 2006         |      |               |   |              | 2005 |  
|(Dollars in millions)                    |  | FirstQuarter |      | SecondQuarter |   | ThirdQuarter |      |   |      |   | FirstQuarter |  |  | SecondQuarter |      |   | ThirdQuarter |   |      | Fourth Quarter | 
|Revenues:                                |  |              |      |               |   |              |      |   |      |   |              |  |  |               |      |   |              |   |      |                |  |   |      |   |  |   |      |  
|Learning Center                          |  | $            | 66.7 |               | $ | 75.9         |      | $ | 65.8 |   |              |  |  | $             | 57.5 |   |              | $ | 67.5 |                |  | $ | 66.5 |   |  | $ | 52.8 |  
|Catapult Learning                        |  |              | 26.2 |               |   | 26.6         |      |   | 15.5 |   |              |  |  |               | 25.0 |   |              |   | 25.2 |                |  |   | 12.0 |   |  |   | 23.8 |  
|                                         |  |              |      |               |   |              |      |   |      |   |              |  |  |               |      |   |              |   |      |                |  |   |      |   |  |   |      |  
|Total revenues                           |  | $            | 92.9 |               | $ | 102.5        |      | $ | 81.3 |   |              |  |  | $             | 82.5 |   |              | $ | 92.7 |                |  | $ | 78.5 |   |  | $ | 76.6 |  
|Percentage of annual revenues            |  |              | N/A  |               |   | N/A          |      |   | N/A  |   |              |  |  |               | 25   | % |              |   | 28   | %              |  |   | 24   | % |  |   | 23   | %
|Operating income (loss)                  |  | $            | 5.9  |               | $ | 9.8          |      | $ | (0.6 | ) |              |  |  | $             | 12.6 |   |              | $ | 22.3 |                |  | $ | 10.3 |   |  | $ | 0.4  |  
|Income (loss) from continuing operations |  | $            | 1.4  |               | $ | 5.9          |      | $ | (5.3 | ) |              |  |  | $             | 6.8  |   |              | $ | 11.7 |                |  | $ | 5.2  |   |  | $ | (1.7 | )

Like other companies that provide tutoring and other supplemental education services, we are subject to
seasonality in our revenue streams that can affect our results of operations. This seasonality arises from a number of factors, primarily driven by the timing of school semester cycles. Our quarterly results are also affected by our license
agreements with franchisees that require the payment of royalties to us based on a percentage of their cash receipts, a significant portion of which consist of prepayments by customers for services to be provided by our franchisees more than a month
in the future.

First Quarter. In our Learning Center segment, we generally experience increased enrollments as a result of the initiation of
advertising and increased parental focus on their childrens performance associated with the receipt of academic results from the first part of the school year. Our royalties increase as our franchisees begin to receive advance payment for
services to be provided during the summer. Our products business experiences a slowdown in revenue due to softness in retailers sales in the post holiday period. In our Catapult Learning segment, we deliver services under school-based programs
during this quarter.

Second Quarter. In our Learning Center segment, we generally experience a higher level of revenues as we benefit from our
continued investment in advertising, delivery of services in our company-owned territories and increased receipts of franchise royalties due to prepayment for summer programs. As our revenue mix has shifted more towards company-owned revenues and
away from franchise royalties, more revenues have shifted from the second quarter to the third quarter, our peak service delivery period in the Learning Center segment. In our Catapult Learning segment, we complete delivery of our institutional
services in conjunction with the ending of the school year.

Third Quarter. The third quarter is a significant service delivery period in
company-owned centers in our Learning Center segment. We recognize revenue as we deliver these services in our company-owned territories. However, with respect to our franchised territories, our royalties decline as the cash receipts our franchisees
receive from their customers decline from peak second quarter levels. Our product sales are expected to modestly increase in this quarter as retailers purchase more educational products in preparation for back to school sales. Due to summer recess,
we provide limited summer school services in our Catapult Learning segment during this period, which results in the lowest segment revenue for the year. However, we gain visibility for the upcoming year because the majority of our institutional
contracts are renewed during the third quarter.



24



---

##### Table of Contents

Educate, Inc.

Fourth Quarter. In our Learning Center segment, enrollments are at their lowest levels of the year as a result of lower advertising expenditures, students taking a greater number of vacations during the holiday season and
parental optimism towards their childrens improved school performance associated with the beginning of a new school year. In addition, we experience lower revenues from franchise royalties in the fourth quarter as a result of prepayments by
our franchisees customers in earlier quarters. In our products business, we believe that we may experience relatively higher revenues in this quarter due to new product introductions and as retailers restock in expectation of higher sales
during the holiday period. The period reflects increased revenues in Catapult Learning as schools are back in session and programs begin.

Other. The timing of school year services, advertising spending, critical enrollment periods, changes in consumer behavior, and new product introductions can affect our revenues at any time during the year.

As a result of the foregoing factors, we believe that quarter-to-quarter comparisons of our results of operations may not be a fair indicator and should not be relied
upon as a measure of our future performance.

Results of Operations

Comparison of results for the three months ended September 30, 2006 and 2005.



|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|--------------------------------------------------------- |  | -------------------------------- | ----- | -- | ---- | - | ----- | -------------------- |  | --- | --
|                                                          |  | Three months ended September 30, |       |    |      |  
|                                                          |  | 2006                             |       |    | 2005 |   |       | % Increase(Decrease) | 
|                                                          |  | (Dollars in millions)            |       |    |      |  
|Revenues                                                  |  |                                  |       |    |      |   |       |                      |  |     |   
|Learning Center:                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Franchise services-North American                         |  | $                                | 7.1   |    |      | $ | 8.1   |                      |  | (12 | )%
|Company-owned centers-North American                      |  |                                  | 43.0  |    |      |   | 43.1  |                      |  | 0   | % 
|European                                                  |  |                                  | 8.1   |    |      |   | 6.8   |                      |  | 19  | % 
|Net product sales                                         |  |                                  | 7.6   |    |      |   | 8.5   |                      |  | (11 | )%
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|                                                          |  |                                  | 65.8  |    |      |   | 66.5  |                      |  | (1  | )%
|Catapult Learning                                         |  |                                  | 15.5  |    |      |   | 12.0  |                      |  | 29  | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Total                                                     |  | $                                | 81.3  |    |      | $ | 78.5  |                      |  | 4   | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Business Metrics                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Sylvan Learning same territory revenue growth: (1)        |  |                                  | (9    | )% |      |   | 1     | %                    |  |     |   
|                                                          |  |                                  |      
|Number of Sylvan Learning Territories as of September 30: |  |                                  |       |    |      |   |       |                      |  |     |   
|Franchisee-owned                                          |  |                                  | 737   |    |      |   | 723   |                      |  | 2   | % 
|Company-owned                                             |  |                                  | 175   |    |      |   | 163   |                      |  | 7   | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Total                                                     |  |                                  | 912   |    |      |   | 886   |                      |  | 3   | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Number of Sylvan Learning Centers as of September 30:     |  |                                  |       |    |      |   |       |                      |  |     |   
|Franchisee-owned                                          |  |                                  | 888   |    |      |   | 877   |                      |  | 1   | % 
|Company-owned                                             |  |                                  | 252   |    |      |   | 234   |                      |  | 8   | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   
|Total                                                     |  |                                  | 1,140 |    |      |   | 1,111 |                      |  | 3   | % 
|                                                          |  |                                  |       |    |      |   |       |                      |  |     |   

---

|(1) | Same Territory amounts include the results of territories for the identical months for each period presented in the comparison, commencing with the 13thfull month each territory has been operating. Same territory growth is presented as the aggregate revenue growth (as adjusted
for franchise acquisitions) for franchised and company-owned territories during the period. A territory reflects the geographically-specified area where an operator controls rights to provision of services under the Sylvan license agreement. Same
territory amounts include revenue from additional centers opened in existing territories and online revenues, including NCLB Online revenues.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues. The increase in revenue during the quarter ended September 30, 2006 of $2.8 million compared to the same period of the prior year was due to growth of $3.5 million in the Catapult Learning segment partially offset
by a decrease in the Learning Center segment of $0.7 million.



25



---

##### Table of Contents

Educate, Inc.

Learning CenterEuropean revenues increased $1.3 million primarily due to increased enrollment across the Schülerhilfe network resulting in an increase of $0.9 million combined with a favorable exchange rate impact of $0.4
million. The enrollment gains were reflected in increased franchised and company-owned territory revenues of 18% and 12%, respectively.

Revenues from
North American company-owned territories decreased by $0.1 million as an increase in the number of company-owned territories as a result of acquisitions and openings was offset by a decrease in same territory revenue of 9%. Same territory revenue
declines were driven by a decline in inquiries which was partially offset by improved conversions but at a shorter average length of stay. Inexperienced center management as a result of company-owned centers acquired during 2005 and newly opened
company-owned centers were also a major contributor to declines in the length of stay and revenues per enrollment, which negatively impacted revenues. Increased center management turnover and challenges faced by rapidly expanding the company-owned
center management team strained our ability to smoothly transition new centers and to staff centers to generate expected levels of revenue growth.

North
American franchise services revenues declined by $1.0 million due to the decline in inquiries during the period as well as a decrease in the number of mature franchisee-owned territories resulting from our acquisitions since September 30, 2005.
Although new franchise territory openings have exceeded the number of acquisitions during the past year, newly opened franchises generate lower average revenues during the period of initial operation than the more mature territories acquired by the
Company.

Net product sales decreased by $0.9 million primarily because we introduced fewer new Sylvan Learning franchisee educational programs in 2006
compared to 2005.

Revenues for the Learning Center segment represented 81% of our total revenues for the quarter ended September 30, 2006, compared
to 85% in the comparable 2005 period.

Catapult LearningOur school services and special needs revenues increased $3.5 million in this
seasonally slower period due to success in obtaining new summer school contracts. Results of the Catapult Learning segment do not include the results of the Education Station unit, which was sold during the quarter and is reported as discontinued
operations for all periods presented. See Note 2 to the unaudited consolidated financial statements in this Form 10-Q. Revenues for the Catapult Learning segment accounted for 19% of our total revenues for the quarter ended September 30, 2006,
compared to 15% in the comparable 2005 period.



|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|------------------------------------------------ |  | -------------------------------- | ---- | - | ---- | - | ---- | -------------------- |  | ---- | --
|                                                 |  | Three months ended September 30, |      |   |      |  
|                                                 |  | 2006                             |      |   | 2005 |   |      | % Increase(Decrease) | 
|                                                 |  | (Dollars in millions)            |      |   |      |  
|Segment Operating Costs                          |  |                                  |      |   |      |   |      |                      |  |      |   
|Learning Center                                  |  | $                                | 62.7 |   |      | $ | 51.7 |                      |  | 21   | % 
|Catapult Learning                                |  |                                  | 14.8 |   |      |   | 12.2 |                      |  | 21   | % 
|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|Total Segment Operating Costs                    |  | $                                | 77.5 |   |      | $ | 63.9 |                      |  | 21   | % 
|                                                 |  |                                  |     
|Segment Profit (Loss)                            |  |                                  |      |   |      |   |      |                      |  |      |   
|Learning Center                                  |  | $                                | 3.1  |   |      | $ | 14.8 |                      |  | (79  | )%
|Catapult Learning                                |  |                                  | 0.7  |   |      |   | (0.2 | )                    |  | (450 | )%
|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|Total Segment Profit (Loss)                      |  | $                                | 3.8  |   |      | $ | 14.6 |                      |  | (74  | )%
|                                                 |  |                                  |     
|Corporate Expenses                               |  |                                  |      |   |      |   |      |                      |  |      |   
|Corporate depreciation and amortization expenses |  | $                                | 0.4  |   |      | $ | 0.4  |                      |  | 0    | % 
|General and administrative expenses              |  |                                  | 4.0  |   |      |   | 3.9  |                      |  | 3    | % 
|Interest expense, net                            |  |                                  | 3.3  |   |      |   | 2.0  |                      |  | 65   | % 
|Foreign exchange gains and other                 |  |                                  |     |   |      |   | (0.1 | )                    |  |     |   
|Income tax expense                               |  |                                  | 1.4  |   |      |   | 3.2  |                      |  | (56  | )%
|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|Total Corporate Expenses                         |  |                                  | 9.1  |   |      |   | 9.4  |                      |  | (3   | )%
|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|Income (loss) from continuing operations         |  | $                                | (5.3 | ) |      | $ | 5.2  |                      |  | (202 | )%
|                                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|                                                 |  |                                  |     
|Business Metrics                                 |  |                                  |      |   |      |   |      |                      |  |      |   
|Segment Operating Margin (1)                     |  |                                  |      |   |      |   |      |                      |  |      |   
|Learning Center                                  |  |                                  | 5    | % |      |   | 22   | %                    |  |      |   
|Catapult Learning                                |  |                                  | 4    | % |      |   | (2   | )%                   |  |      |   



26



---

##### Table of Contents

Educate, Inc.

(1) Segment operating margin is calculated by dividing segment profit by segment revenue.

Segment Operating Costs. Segment operating
costs increased primarily due to the expansion, integration and operation of company-owned Learning Center territories and the investment in developing new products and services. Cost of goods sold increased due to higher initial production costs
incurred on newly developed products.

Learning CenterSegment operating costs increased to 95% of operating revenue for the quarter ended
September 30, 2006 compared to 78% in 2005. Segment operating costs increased by $11.0 million in 2006 compared to the prior year primarily as a result of the additional costs associated with operating and integrating the company-owned
territories acquired and opened during the past year as well as program development and product-related costs. These increased company-owned territory costs consisted primarily of instructional and advertising costs and also included additional
regional and overall network management costs to ensure consistent and effective service delivery. Additional expenses were incurred to develop new premium service offerings and a program for homework support. Product-related expenses increased due
to the incurrence of higher cost of goods sold for newly developed Hooked on programs in initial production runs and due to expenses for building an operating infrastructure to develop, produce and distribute new product offerings to an
expanded distribution channel. Marketing costs also increased during the quarter as a result of new product introductions and development of channel partners. European expenses related to Schülerhilfe increased by $1.4 million, primarily due to
higher costs to support revenue growth.

Catapult LearningCosts increased by $2.6 million in 2006 compared to 2005, primarily due to increased
service delivery and sales and marketing costs associated with the higher revenues earned during the current period.

Segment Operating Margin.
Learning Center segment operating margins decreased in 2006 to 5% compared to 22% in 2005. The decreased margin is primarily the result of reduced revenues associated with the integration delays of the company-owned territories acquired during the
past year, combined with the additional costs associated with operating and integrating additional company-owned territories, and greater expenditures for new program and product development as well as on the development of an infrastructure capable
of developing, producing and distributing new products in the future. The decrease in operating margin is also due to increased cost of goods sold on new products in initial production runs, as well as the addition of some less expensive products
sold at lower margins. The margin decline is also due to the related shift in revenue mix from franchise revenues to company-owned territory revenues. Absent the factors noted above, management expects the operating income from an acquired territory
in the year after acquisition to be comparable to the royalty income earned from the franchisee in the prior year; but both the revenue and related expense increase substantially, resulting in a lower margin percentage. Catapult Learning segment
operating margins were 4% in 2006 compared to (2)% in 2005. Operating margins increased over the prior year due to service expansion during this summer break period.

Corporate Expenses. Corporate general and administrative and depreciation and amortization expenses increased to $4.4 million for the quarter ended September 30, 2006 from $4.3 million in 2005 in order to
support the expansion of the business. Net interest expense increased by $1.3 million, primarily as a result of higher debt levels and short-term interest rates on the credit facility. Our income tax expense decreased to $1.4 million for the quarter
ended September 30, 2006 from $3.2 million in 2005, due to higher pretax earnings in 2005, partially offset by a higher effective tax rate in 2006. Also, during the third quarter we recorded a valuation allowance of approximately $1.7 million
to fully reserve certain historical net state deferred tax assets due to uncertainty surrounding the future realization of these state tax benefits because of declines in operating results. Excluding this discrete tax charge our annual effective tax
rate increased to 55% in the quarter ended September 30, 2006 compared to 38% for the quarter ended September 30, 2005. The increase is primarily due to not recording the tax benefit of pretax losses in certain states due to the uncertain
realization of those benefits, the effect of permanent tax differences on lower pretax earnings, the mix of domestic and international pretax income, and state tax law changes.



27



---

##### Table of Contents

Educate, Inc.

Results of Operations

Comparison of results for the nine months ended September 30, 2006 and 2005.



|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|--------------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ----- | -------------------- |  | --- | --
|                                                          |  | Nine months ended September 30, |       |   |      |  
|                                                          |  | 2006                            |       |   | 2005 |   |       | % Increase(Decrease) | 
|                                                          |  | (Dollars in millions)           |       |   |      |  
|Revenues                                                  |  |                                 |       |   |      |   |       |                      |  |     |   
|Learning Center:                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Franchise services-North American                         |  | $                               | 25.9  |   |      | $ | 28.7  |                      |  | (10 | )%
|Company-owned centers-North American                      |  |                                 | 136.9 |   |      |   | 113.2 |                      |  | 21  | % 
|European                                                  |  |                                 | 26.2  |   |      |   | 23.0  |                      |  | 14  | % 
|Net product sales                                         |  |                                 | 19.4  |   |      |   | 26.6  |                      |  | (27 | )%
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|                                                          |  |                                 | 208.4 |   |      |   | 191.5 |                      |  | 9   | % 
|Catapult Learning                                         |  |                                 | 68.3  |   |      |   | 62.3  |                      |  | 10  | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Total                                                     |  | $                               | 276.7 |   |      | $ | 253.8 |                      |  | 9   | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Business Metrics                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Sylvan Learning same territory revenue growth: (1)        |  |                                 | 0     | % |      |   | 3     | %                    |  |     |   
|                                                          |  |                                 |      
|Number of Sylvan Learning Territories as of September 30: |  |                                 |       |   |      |   |       |                      |  |     |   
|Franchisee-owned                                          |  |                                 | 737   |   |      |   | 723   |                      |  | 2   | % 
|Company-owned                                             |  |                                 | 175   |   |      |   | 163   |                      |  | 7   | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Total                                                     |  |                                 | 912   |   |      |   | 886   |                      |  | 3   | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|                                                          |  |                                 |      
|Number of Sylvan Learning Centers as of September 30:     |  |                                 |       |   |      |   |       |                      |  |     |   
|Franchisee-owned                                          |  |                                 | 888   |   |      |   | 877   |                      |  | 1   | % 
|Company-owned                                             |  |                                 | 252   |   |      |   | 234   |                      |  | 8   | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   
|Total                                                     |  |                                 | 1,140 |   |      |   | 1,111 |                      |  | 3   | % 
|                                                          |  |                                 |       |   |      |   |       |                      |  |     |   

---

|(1) | Same Territory amounts include the results of territories for the identical months for each period presented in the comparison, commencing with the 13thfull month each territory has been operating. Same territory growth is presented as the aggregate revenue growth (as adjusted
for franchise acquisitions) for franchised and company-owned territories during the period. A territory reflects the geographically-specified area where an operator controls rights to provision of services under the Sylvan license agreement. Same
territory amounts include revenue from additional centers opened in existing territories and online revenues, including NCLB Online revenues.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues. The increase in revenue during the nine months ended September 30, 2006 of $22.9 million compared to the same period of the prior year was due to growth in the Learning Center segment of $16.9 million and growth
of $6.0 million in the Catapult Learning segment.

Learning CenterRevenues from North American company-owned territories increased
approximately $23.7 million, primarily as a result of the addition of company-owned territories during 2005 through acquisitions and openings which were in operation during the entire nine months of 2006. Excluding online services, company-owned
revenue on a same territory basis declined compared to the prior year. Inexperienced center management in the 2005 acquired and newly opened company-owned centers was a major contributor to declines in the length of stay and revenues per enrollment,
which negatively impacted revenues. Increased center management turnover and challenges faced by rapidly expanding the center management team strained our ability to smoothly transition new centers and to staff centers to generate expected levels of
revenue growth. European revenues, which include both company-owned and franchise territory results, increased $3.2 million, primarily due to increased enrollment, net of an unfavorable foreign currency exchange rate impact of $0.4 million.

North American franchise services revenues declined by $2.8 million due to a decline in inquiries which led to fewer students served in the third quarter
as well as a decrease in the number of mature franchisee-owned territories resulting from our acquisitions of franchise territories during 2005. Although new franchise territory openings have exceeded the number of acquisitions during the past year,
newly opened franchises generate lower average revenues during the period of initial operation than the more mature territories acquired by the Company.



28



---

##### Table of Contents

Educate, Inc.

Net product sales decreased by $7.2 million primarily because we introduced fewer new Sylvan Learning franchisee educational programs in 2006 compared to 2005. Additionally, we experienced significant initial orders in the 2005 comparison
period as we opened new distribution channels in our newly acquired Hooked on Phonics business and because the 2005 period included revenue from runoff of the prior owners direct marketing business, a channel we elected not to pursue.

Revenues for the Learning Center segment represented 75% of our total revenues for the nine months ended September 30, 2006 and 2005.

Catapult LearningOur school services and special needs revenues increased $6.0 million due to new contract sales in the public and non-public school
businesses, including new summer school contracts, as well as growth in the therapy services business. These increases were partially offset by the loss of some Gulf Coast contracts due to school closures following the hurricanes in that region in
2005. Results of the Catapult Learning segment do not include the results of the Education Station unit, which was sold during the quarter and is reported as discontinued operations for all periods presented. See Note 2 to the unaudited consolidated
financial statements in this Form 10-Q. Revenues for the Catapult Learning segment accounted for 25% of our total revenues for the nine months ended September 30, 2006.



|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|------------------------------------------------ |  | ------------------------------- | ----- | - | ---- | - | ----- | -------------------- |  | ---- | --
|                                                 |  | Nine months ended September 30, |       |   |      |  
|                                                 |  | 2006                            |       |   | 2005 |   |       | % Increase(Decrease) | 
|                                                 |  | (Dollars in millions)           |       |   |      |  
|Segment Operating Costs                          |  |                                 |       |   |      |   |       |                      |  |      |   
|Learning Center                                  |  | $                               | 186.4 |   |      | $ | 146.2 |                      |  | 27   | % 
|Catapult Learning                                |  |                                 | 57.8  |   |      |   | 50.6  |                      |  | 14   | % 
|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Total Segment Operating Costs                    |  | $                               | 244.2 |   |      | $ | 196.8 |                      |  | 24   | % 
|                                                 |  |                                 |      
|Segment Profit                                   |  |                                 |       |   |      |   |       |                      |  |      |   
|Learning Center                                  |  | $                               | 22.0  |   |      | $ | 45.3  |                      |  | (51  | )%
|Catapult Learning                                |  |                                 | 10.5  |   |      |   | 11.7  |                      |  | (10  | )%
|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Total Segment Profit                             |  | $                               | 32.5  |   |      | $ | 57.0  |                      |  | (43  | )%
|                                                 |  |                                 |      
|Corporate Expenses                               |  |                                 |       |   |      |   |       |                      |  |      |   
|Corporate depreciation and amortization expenses |  | $                               | 1.2   |   |      | $ | 1.2   |                      |  | 0    | % 
|General and administrative expenses              |  |                                 | 13.0  |   |      |   | 10.6  |                      |  | 23   | % 
|Interest expense, net                            |  |                                 | 8.9   |   |      |   | 5.7   |                      |  | 56   | % 
|Other financing costs                            |  |                                 | 1.1   |   |      |   | 1.5   |                      |  | (27  | )%
|Foreign exchange (gains) and other               |  |                                 | 0.2   |   |      |   | (0.2  | )                    |  | (200 | )%
|Income tax expense                               |  |                                 | 6.2   |   |      |   | 14.5  |                      |  | (57  | )%
|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Total Corporate Expenses                         |  |                                 | 30.6  |   |      |   | 33.3  |                      |  | (8   | )%
|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Income from continuing operations                |  | $                               | 1.9   |   |      | $ | 23.7  |                      |  | (92  | )%
|                                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Business Metrics                                 |  |                                 |       |   |      |   |       |                      |  |      |   
|Segment Operating Margin (1)                     |  |                                 |       |   |      |   |       |                      |  |      |   
|Learning Center                                  |  |                                 | 11    | % |      |   | 24    | %                    |  |      |   
|Catapult Learning                                |  |                                 | 15    | % |      |   | 19    | %                    |  |      |   

---

|(1) | Segment operating margin is calculated by dividing segment profit by segment revenue.
|--- | -------------------------------------------------------------------------------------

Segment Operating Costs. Segment operating costs increased primarily due to the expansion, integration and operation of company-owned Learning Center territories including delivery of online services and
the investment in developing new products and services as well as programs to identify best practices in Learning Center operations. Cost of goods sold increased due to higher initial production costs incurred on newly developed products.

Learning CenterSegment operating costs increased to 89% of operating revenue for the nine months ended September 30, 2006 compared to
76% in 2005. Segment operating costs increased by $40.2 million in 2006 compared to the prior year primarily as a



29



---

##### Table of Contents

Educate, Inc.

result of the additional costs associated with operating and integrating the company-owned territories acquired and opened during the past year, increased program development and product-related costs, and servicing the increase in online
tutoring sessions during this period. The increased company-owned territory costs consist primarily of instructional and advertising costs and also include additional regional and overall network management costs to ensure consistent and effective
service delivery. Additional expenses were incurred to develop new premium service offerings and a program for homework support. Product-related expenses increased due to the incurrence of higher cost of goods sold for newly developed Hooked
on programs in initial production runs and due to expenses for building an operating infrastructure to develop, produce and distribute new product offerings to an expanded distribution channel. Marketing costs also increased during the period
as a result of new product introductions and development of channel partners. Additional investments were made in identifying and implementing operational best practices to improve conversions of inquiries into enrollments and to improve the
efficiency of our advertising expenditures. European expenses related to Schülerhilfe increased by $2.9 million, primarily due to higher costs to support revenue growth, net of a favorable foreign currency exchange rate impact of $0.3
million.

Catapult LearningCosts increased by $7.2 million in 2006 compared to 2005, primarily due to increased service delivery costs
associated with the higher revenue and increased business development costs as we sold new contracts to offset the contract losses in the Gulf Coast region and new summer school contracts.

Segment Operating Margin. Learning Center segment operating margins decreased in 2006 to 11% compared to 24% in 2005. The decreased margin is primarily the result
of reduced same territory revenues associated with integration delays of company-owned territories acquired during 2005, combined with the additional costs associated with operating and integrating additional company-owned territories, and greater
expenditures for new program and product development as well as on the development of an infrastructure capable of developing, producing and distributing new products in the future. The decrease in operating margin is also due to increased cost of
goods sold on new products in initial production runs, as well as the addition of some less expensive products sold at lower margins. The margin decline is also due to the related shift in revenue mix from franchise revenues to company-owned
territory revenues. Absent the factors noted above, management expects the operating income from an acquired territory in the year after acquisition to be comparable to the royalty income earned from the franchisee in the prior year; but both the
revenue and related expense increase substantially, resulting in a lower margin percentage. Catapult Learning segment operating margins were 15% in 2006 compared to 19% in 2005. This margin decline is primarily due to the negative impact of the
contract losses in the Gulf Coast region, including the increased business development costs and lower operating margins on the replacement contracts.

Corporate Expenses. Corporate general and administrative and depreciation and amortization expenses increased to $14.2 million for the nine months ended September 30, 2006 from $11.8 million in 2005, primarily to support the
expansion of the business. Net interest expense increased by $3.2 million, primarily as a result of higher debt levels and short-term interest rates on the credit facility. Other financing costs decreased by $0.4 million due to lesser costs
attributable to the credit facility debt refinanced in 2006 compared to debt refinanced in 2005. Our income tax expense decreased to $6.2 million for the nine months ended September 30, 2006 from $14.5 million in 2005, due to higher pretax
earnings in 2005, partially offset by a higher effective tax rate in 2006. Also, during the third quarter we recorded a valuation allowance of approximately $1.7 million to fully reserve certain historical net state deferred tax assets due to
uncertainty surrounding the future realization of these state tax benefits because of declines in operating results. Excluding this discrete tax charge, our annual effective tax rate increased to 55% for the nine months ended September 30, 2006
compared to 38% for the nine months ended September 30, 2005. The increase is primarily due to not recording the tax benefit of pretax losses in certain states due to the uncertain realization of those benefits, the effect of permanent tax
differences on lower pretax earnings, the mix of domestic and international pretax income, and state tax law changes.

Liquidity and Capital
Resources

The following table summarizes major changes in our cash position during the nine months ended:



|                                               |  |                       |       |   |                   |   |       |  
|---------------------------------------------- |  | --------------------- | ----- | - | ----------------- | - | ----- | -
|                                               |  | September 30,2006     |       |   | September 30,2005 |  
|                                               |  | (Dollars in millions) |      
|Beginning cash balance                         |  | $                     | 2.4   |   |                   | $ | 14.6  |  
|Operating activities  continuing operations   |  |                       | 25.7  |   |                   |   | 34.3  |  
|Operating activities  discontinued operations |  |                       | 4.4   |   |                   |   | (2.6  | )
|Investing activities                           |  |                       | (25.5 | ) |                   |   | (51.1 | )
|Financing activities                           |  |                       | (0.6  | ) |                   |   | 18.1  |  
|Effect of exchange rates                       |  |                       | 0.6   |   |                   |   | (0.6  | )
|                                               |  |                       |       |   |                   |   |       |  
|Ending cash balance                            |  | $                     | 7.0   |   |                   | $ | 12.7  |  
|                                               |  |                       |       |   |                   |   |       |  



30



---

##### Table of Contents

Educate, Inc.

Historically, we have generated significant cash flows from our operations which have allowed us to meet our working capital needs and provide the cash we require to make investments in property and equipment, open new company-owned
Learning Center territories, and acquire franchised territories and other businesses.

Our working capital requirements are favorably impacted by the fact
that in our largest segment, the Learning Center segment, learning center operations generate positive working capital even during growth periods. In our Learning Center business, customers must pay in advance of services, which contributes to our
cash position. Company-owned territories benefit from customer prepayment and, in connection with franchised territories, we receive royalty payments from franchisees based upon net cash collected in the prior month. Customers in our products
business are granted payment terms customary in the industry. The products business has also used cash to develop new products and to finance production and growth in inventory levels during the current and prior years.

Our working capital needs are greater in our Catapult Learning segment because our customers are primarily public school districts that pay us in arrears, often 60 days
or longer after we perform our services.

For the nine months ended September 30, 2006 and 2005, our cash flows from continuing operations were $25.7
million and $34.3 million, respectively. The decrease of $8.6 million was attributed primarily to a decrease in income from continuing operations before non-cash charges of $19.6 million, partially offset by an increase in working capital and other
assets of $11.0 million. Cash provided by (used in) operating activities of discontinued operations was $4.4 million in 2006 compared to $(2.6) million in 2005.

Our investing activities have historically consisted of acquisitions of franchised territories and other businesses, investments in property and equipment and internally developed software and media. Our ability to make future acquisitions
and investments in property and equipment will be dependent on the cash flows we generate from our operations and our ability to obtain additional capital.

During the nine months ended September 30, 2006, we invested $0.7 million in Learning Center acquisitions, $5.6 million to acquire Reading Rainbow and GPN, and $15.5 million in property and equipment and internally developed software
and media. See Note 3 to our unaudited consolidated financial statements in this Form 10-Q for more information regarding these acquisitions.

As described
more fully in the Note 5 to our unaudited consolidated financial statements in this Form 10-Q, we amended our term loan facility during the first quarter of 2006, increasing the term loan outstanding from $139.0 million to $159.7 million at
March 31, 2006. Using proceeds from the term loan amendment, $21.1 million of revolving credit borrowings were repaid. As of September 30, 2006, the Company was not in compliance with certain financial covenants within the 2005 Term Loan,
as amended and therefore is subject to the demand repayment provisions of that credit facility. As a result, the Company classified all outstanding debt under the 2005 Term Loan as a current liability in the balance sheet as of September 30,
2006. Management is currently working with the lenders under the 2005 Term Loan to obtain covenant amendments for current and future quarterly reporting periods to return to compliance with the 2005 Term Loan agreement. The Company believes that its
relations with the lenders under the 2005 Term Loan are good, and management believes that the appropriate amendments will be obtained in the near future. In July 2006, we repaid all outstanding borrowings under our revolving credit facility.

Assuming we are successful in obtaining the appropriate amendments with regard to our 2005 Term Loan, we believe that cash flows from operations,
available cash and credit facilities will be sufficient to meet our operating requirements, including expansion of our existing business, funding of program and software development and operating costs for the next year. Our future capital
requirements will depend on many factors, including our rate of revenue growth, territory and other acquisitions and new company-owned center development, the expansion of sales and marketing activities, the timing of introductions of new services
and enhancements to existing programs and products. We expect that we will, from time to time, continue to consider opportunities in the educational services industry for potential acquisitions of companies that complement our overall business
strategy.

Contractual Obligations

As noted above, we
amended our term loan during the quarter ended March 31, 2006, which increased the quarterly principal maturities and interest payments over the existing term of the loan. Our total debt decreased to $162.2 million at September 30, 2006
from $162.8 million at December 31, 2005. As discussed more fully above in Liquidity and Capital Resources, our $159.2 million term loan with a bank syndicate is currently in default as a result of covenant violations and therefore is subject
to the demand repayment provisions of the loan agreement.

The Company also has other obligations recorded within long-term liabilities of $3.5 million
that have no specified payment dates.



31



---

##### Table of Contents

Educate, Inc.

International Exposure

Our Learning Center segment has operations outside the United States, primarily in Germany and Canada. These
international operations subject us to political uncertainties, currency devaluations and national regulations affecting the provision of educational services. Accordingly, our revenues and income in any period may be impacted by international
developments outside our control.

Critical Accounting Policies and Estimates

Managements Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted
accounting principles. The preparation of these financial statements 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
revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue, intangible assets and contingencies. Management bases its estimates and judgments on
historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies and
estimates are described in Managements Discussion and Analysis of Financial Condition and Results of Operations and our significant accounting policies are described in Note 1 to our consolidated financial statements, both in our Annual Report
on Form 10-K for the year ended December 31, 2005.

New Accounting Pronouncements

As more fully described in Note 7 to our unaudited consolidated financial statements in this Form 10-Q, we adopted the provisions of Financial Accounting Standards Board (FASB) Statement No. 123(R),
Share-Based Payment (Statement 123(R)), effective January 1, 2006 using the modified prospective transition method. Accordingly, we have not restated results for prior periods. Under this transition method,
compensation cost is recognized beginning with the effective date for (a) all new share-based payments granted after the effective date; (b) all awards modified, repurchased, or cancelled after the effective date; and (c) the
remaining portion of the requisite service under previously-granted unvested awards outstanding as of the effective date. For options that vest ratably, we recognize compensation cost on a straight line basis over the requisite service period for
the entire award.

We did not grant any stock-based compensation awards during the third quarter of 2006. Accordingly, stock-based compensation expense for
the third quarter of 2006 consists of awards granted during the first and second quarters of 2006 estimated in accordance with the provisions of Statement 123(R) and awards granted prior to, and unvested as of, January 1, 2006 that were granted
under the 2003 Omnibus Stock Incentive Plan and the 2004 Omnibus Stock Incentive Plan, based on the grant date fair value estimated in accordance with the original provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation (Statement 123). The option vesting period is typically thirty-six or forty-eight months under these plans. Unvested stock-based awards issued prior to May 14, 2004, the date the Company filed a registration
statement with the SEC to sell its common stock in a public offering, and disclosed in the financial statements using the minimum value method (rather than the estimated fair value using an option-pricing model) were accounted for at the date of
adoption using the intrinsic value method originally applied to those awards. As a result of adopting Statement 123(R), no future expense will be recognized for unvested options granted prior to May 14, 2004 that had no intrinsic value at the
grant date.

Prior to the adoption of Statement 123(R), we recognized stock-based compensation expense in accordance with Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) regarding the SECs interpretation of
Statement 123(R) and the valuation of share-based payments for public companies. We applied the provisions of SAB 107 in our adoption of Statement 123(R).

As more fully described in Note 1 to our unaudited consolidated financial statements in this Form 10-Q, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109 (FIN 48) in June 2006 and Statement of Financial Accounting Standards No. 157, Fair Value Measurements (Statement 157) in September 2006. We are still evaluating the impact of these pronouncements
on our financial statements.



32



---

##### Table of Contents

Educate, Inc.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to certain market risks, which exist
as part of our ongoing business operations. We use derivative financial instruments, where appropriate, to manage these risks. As a matter of policy, we do not engage in trading or speculative transactions. See Note 1 to our consolidated financial
statements in our Annual Report on Form 10-K for the year ended December 31, 2005 for further information on accounting policies related to derivative financial instruments.

Foreign Currency Risk

During the quarter ended September 30, 2006, approximately 13% of our revenues were
derived from customers outside the United States. Most of this business is transacted through international subsidiaries, generally in the local currency that is considered the functional currency of that foreign subsidiary. Expenses are also
incurred in the foreign currencies to match revenues earned and minimize the exchange rate exposure of our operating margins. A hypothetical 10% adverse change in average annual foreign currency movements would have decreased both net income and
cash flows for the nine months ended September 30, 2006 by approximately $0.3 million. We are also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments.
We generally view our equity investment in foreign subsidiaries as long-term. The effects of a change in foreign currency exchange rates on our net investment in foreign subsidiaries are reflected in other comprehensive income (loss). A hypothetical
10% average change in depreciation in functional currencies relative to the U.S. dollar would have resulted in a decrease in our net investment in foreign subsidiaries of approximately $2.5 million at September 30, 2006.

Interest Rate Risk

We hold cash and cash equivalents in high
quality, short-term, fixed income securities. Consequently, the fair value of our cash and cash equivalents would not be significantly impacted by either a 100 basis point increase or decrease in interest rates.

We are exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing and future issuance of variable rate debt. Primary exposures
include movements in U.S. Treasury rates, London Interbank Offered Rates (LIBOR) and commercial paper. We currently have interest rate swaps in place to reduce interest rate volatility associated with our secured credit facility, and to achieve a
desired proportion of variable versus fixed rate debt.

Note 5 to our unaudited consolidated financial statements in this Form 10-Q provides information on
our significant indebtedness. Note 6 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2005 provides information on our interest rate swap agreements. The total notional amount of
interest rate swaps at September 30, 2006 was $50.0 million, representing a settlement asset of $0.6 million. Assuming average variable rate debt levels, a one percentage point increase in interest rates would have increased interest expense by
approximately $0.9 million for the nine months ended September 30, 2006.

All the potential impacts noted above are based on sensitivity analysis
performed on our financial position at September 30, 2006. Actual results may differ materially.

Item 4. Controls and Procedures.

The Companys management, with the participation of our principal executive and
principal financial officers, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of
September 30, 2006. Disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in reports that the Company files or submits under the Exchange Act has been appropriately
recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to the Companys management, including its principal executive and
principal financial officers, to allow timely decisions regarding required disclosure. Based on such evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are
effective at the reasonable assurance level.

The Companys management, including the principal executive and principal financial officers, has
evaluated any changes in the internal controls over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act that occurred during the quarter ended September 30, 2006, and has concluded that there was no change
that occurred during the quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Companys internal controls over financial reporting.



33



---

##### Table of Contents

Educate, Inc.

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is involved in various lawsuits in the ordinary course of business, usually
related to employment matters or commercial disputes. The Company maintains liability insurance to cover claims over a deductible amount. In the opinion of management, amounts accrued for exposure relating to legal proceedings are adequate and,
accordingly, the ultimate resolution of these matters is not expected to have a material adverse effect on the Companys consolidated financial statements.

Item 1A. Risk Factors.

There has been no material change in the information provided in Part I, Item 1A of our
Annual Report on Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

Item 5. Other Information.

None.

Item 6. Exhibits.



|              |  |                                                                                                                                                                                                                                                                                                                                                      
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                                                          
|3.1           |  | Amended and Restated Certificate of Incorporation of Educate, Inc., a Delaware corporation. (1)                                                                                                                                                                                                                                                      
|              | 
|3.2           |  | Amended and Restated By-Laws of Educate Inc., a Delaware corporation. (2)                                                                                                                                                                                                                                                                            
|              | 
|4.1           |  | Form of Registration Rights Agreement, by and among Educate, Inc., and certain of its stockholders. (2)                                                                                                                                                                                                                                              
|              | 
|10.17         |  | First Amendment and Consent, dated as of March 31, 2006, to the Amended and Restated Credit Agreement, dated as of April 28, 2005, among Educate Operating Company, LLC, the several banks and
other financial institutions party thereto, Merrill Lynch Capital, as documentation agent, and JPMorgan Chase Bank, N.A., as administrative agent. (3)
|              | 
|10.18         |  | Second Amendment, dated as of August 8, 2006, to the Amended and Restated Credit Agreement, dated as of April 28, 2005, among Educate Operating Company, LLC, the several banks and other
financial institutions party thereto, Merrill Lynch Capital, as documentation agent, and JPMorgan Chase Bank, N.A., as administrative agent. (4)           
|              | 
|31(i).1       |  | Certification of R. Christopher Hoehn-Saric pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                               
|              | 
|31(i).2       |  | Certification of Kevin E. Shaffer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                         
|              | 
|32.1          |  | Certification of R. Christopher Hoehn-Saric pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                               
|              | 
|32.2          |  | Certification of Kevin E. Shaffer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                         



34



---

##### Table of Contents

Educate, Inc.



|   |   |  |                                                                                                     
|-- | - |  | ----------------------------------------------------------------------------------------------------
|(1 | ) |  | Incorporated by reference to our Registration Statement on Form 8-A filed on September 22, 2004.    
|   |  
|(2 | ) |  | Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-115496).          
|   |  
|(3 | ) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006.
|   |  
|(4 | ) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006. 



35



---

##### Table of Contents

SIGNATURES

Pursuant to the requirements 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.



EDUCATE, INC.By:



/s/ Kevin E. ShafferName:



Kevin E. ShafferTitle:



Chief Financial OfficerDate:



November 8, 2006




36