##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended March 31, 2005



or



| ̈ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from  to
.



Commission File Number 000-50952



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EDUCATE, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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 an accelerated filer (as defined in Rule
12b-2 of the Act).    Yes ̈.    No  x.



The registrant had 42,586,019 shares of Common Stock outstanding as of May 2,
2005.



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##### Table of Contents

EDUCATE, INC.



INDEX



|                                |  |           |  |                                                                                                        |  |         
|------------------------------- |  | --------- |  | ------------------------------------------------------------------------------------------------------ |  | --------
|                                |  |           |  |                                                                                                        |  | Page No.
|PART I. - FINANCIAL INFORMATION |  |          
|                                |  |           | 
|                                |  | Item 1.   |  | Financial Statements                                                                                   |  |         
|                                |  |           | 
|                                |  |           |  | Consolidated Balance Sheets  March 31, 2005 (Unaudited) and December 31, 2004                         |  | 1       
|                                |  |           | 
|                                |  |           |  | Consolidated Statements of Income (Unaudited)  For the three months ended March 31, 2005 and 2004     |  | 3       
|                                |  |           | 
|                                |  |           |  | Consolidated Statements of Cash Flows (Unaudited)  For the three months ended March 31, 2005 and 2004 |  | 4       
|                                |  |           | 
|                                |  |           |  | Notes to Consolidated Financial Statements (Unaudited)                                                 |  | 5       
|                                |  |           | 
|                                |  | Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                  |  | 15      
|                                |  |           | 
|                                |  | Item 3.   |  | Quantitative and Qualitative Disclosures about Market Risk                                             |  | 21      
|                                |  |           | 
|                                |  | Item 4.   |  | Controls and Procedures                                                                                |  | 22      
|                                | 
|PART II. -
OTHER INFORMATION    |  |          
|                                |  |           | 
|                                |  | Item 1.   |  | Legal Proceedings                                                                                      |  | 22      
|                                |  |           | 
|                                |  | Item 2.   |  | Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 22      
|                                |  |           | 
|                                |  | Item 3.   |  | Defaults Upon Senior Securities                                                                        |  | 22      
|                                |  |           | 
|                                |  | Item 4.   |  | Submission of Matters to a Vote of Security Holders                                                    |  | 22      
|                                |  |           | 
|                                |  | Item 5.   |  | Other Information                                                                                      |  | 22      
|                                |  |           | 
|                                |  | Item 6.   |  | Exhibits                                                                                               |  | 23      
|                                |  |          
|                                |  | SIGNATURE |  | 24                                                                                                    



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##### Table of Contents

Educate, Inc.



Consolidated Balance Sheets



(Dollar amounts in thousands)



|                                          |  |               |         |   |                  |   |         |  
|----------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                          |  | March 31,2005 |         |   | December 31,2004 |  
|                                          |  | (unaudited)   |         |   |                  |  
|Assets                                    |  |               |         |   |                  |   |         |  
|Current assets:                           |  |               |         |   |                  |   |         |  
|Cash and cash equivalents                 |  | $             | 6,042   |   |                  | $ | 14,592  |  
|                                          |  |              
|Receivables:                              |  |               |         |   |                  |   |         |  
|Accounts receivable                       |  |               | 65,458  |   |                  |   | 43,541  |  
|Notes receivable                          |  |               | 125     |   |                  |   | 140     |  
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 65,583  |   |                  |   | 43,681  |  
|Allowance for doubtful accounts           |  |               | (4,858  | ) |                  |   | (3,952  | )
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 60,725  |   |                  |   | 39,729  |  
|                                          |  |              
|Inventory                                 |  |               | 4,480   |   |                  |   | 2,891   |  
|Prepaid expenses and other current assets |  |               | 2,453   |   |                  |   | 2,728   |  
|Deferred income taxes                     |  |               | 501     |   |                  |   | 3,234   |  
|                                          |  |               |         |   |                  |   |         |  
|Total current assets                      |  |               | 74,201  |   |                  |   | 63,174  |  
|                                          |  |              
|Property and equipment:                   |  |               |         |   |                  |   |         |  
|Furniture and fixtures                    |  |               | 4,514   |   |                  |   | 4,392   |  
|Education materials                       |  |               | 5,478   |   |                  |   | 4,225   |  
|Computer equipment and software           |  |               | 9,208   |   |                  |   | 8,282   |  
|Leasehold improvements                    |  |               | 9,506   |   |                  |   | 8,516   |  
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 28,706  |   |                  |   | 25,415  |  
|Accumulated depreciation and amortization |  |               | (11,960 | ) |                  |   | (10,366 | )
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 16,746  |   |                  |   | 15,049  |  
|                                          |  |              
|Intangible assets:                        |  |               |         |   |                  |   |         |  
|Goodwill                                  |  |               | 77,563  |   |                  |   | 69,110  |  
|Tradenames                                |  |               | 139,998 |   |                  |   | 132,425 |  
|Franchise license rights                  |  |               | 85,821  |   |                  |   | 86,000  |  
|Other intangible assets                   |  |               | 6,832   |   |                  |   | 4,898   |  
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 310,214 |   |                  |   | 292,433 |  
|Accumulated amortization                  |  |               | (866    | ) |                  |   | (678    | )
|                                          |  |               |         |   |                  |   |         |  
|                                          |  |               | 309,348 |   |                  |   | 291,755 |  
|Other assets                              |  |               | 10,459  |   |                  |   | 11,404  |  
|                                          |  |               |         |   |                  |   |         |  
|Total assets                              |  | $             | 410,754 |   |                  | $ | 381,382 |  
|                                          |  |               |         |   |                  |   |         |  



See notes to consolidated financial
statements (unaudited).



1



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##### Table of Contents

Educate, Inc.



Consolidated Balance Sheets (continued)



(Dollar amounts in thousands)



|                                                                                                                                                                               |  |               |         |                  |   |        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ------- | ---------------- | - | -------
|                                                                                                                                                                               |  | March 31,2005 |         | December 31,2004
|                                                                                                                                                                               |  | (unaudited)   |         |                 
|Liabilities and stockholders equity                                                                                                                                           |  |               |         |                  |   |        
|Current liabilities:                                                                                                                                                           |  |               |         |                  |   |        
|Accounts payable and accrued expenses                                                                                                                                          |  | $             | 19,276  |                  | $ | 16,193 
|Accrued compensation and related benefits                                                                                                                                      |  |               | 13,971  |                  |   | 13,330 
|Income taxes payable                                                                                                                                                           |  |               | 549     |                  |   | 822    
|Current portion of long-term debt                                                                                                                                              |  |               | 2,128   |                  |   | 2,102  
|Deferred revenue                                                                                                                                                               |  |               | 27,514  |                  |   | 19,925 
|                                                                                                                                                                               |  |               |         |                  |   |        
|Total current liabilities                                                                                                                                                      |  |               | 63,438  |                  |   | 52,372 
|                                                                                                                                                                               |  |              
|Long-term debt, less current portion                                                                                                                                           |  |               | 133,133 |                  |   | 120,411
|Other long-term liabilities                                                                                                                                                    |  |               | 2,587   |                  |   | 2,495  
|Deferred income taxes                                                                                                                                                          |  |               | 7,114   |                  |   | 8,403  
|                                                                                                                                                                               |  |               |         |                  |   |        
|Total liabilities                                                                                                                                                              |  |               | 206,272 |                  |   | 183,681
|Commitments and contingencies                                                                                                                                                  |  |               |        |                  |   |       
|                                                                                                                                                                               |  |              
|Stockholders equity:                                                                                                                                                          |  |               |         |                  |   |        
|Common stock, par value $0.01, 120,000,000 shares authorized, 42,586,019 and 42,585,019 shares issued and outstanding as of March 31, 2005 and
December 31, 2004, respectively |  |               | 426     |                  |   | 426    
|Additional paid-in capital                                                                                                                                                     |  |               | 191,158 |                  |   | 191,002
|Retained earnings                                                                                                                                                              |  |               | 10,300  |                  |   | 2,807  
|Accumulated other comprehensive income                                                                                                                                         |  |               | 2,598   |                  |   | 3,466  
|                                                                                                                                                                               |  |               |         |                  |   |        
|Total stockholders equity                                                                                                                                                     |  |               | 204,482 |                  |   | 197,701
|                                                                                                                                                                               |  |               |         |                  |   |        
|Total liabilities and stockholders equity                                                                                                                                     |  | $             | 410,754 |                  | $ | 381,382
|                                                                                                                                                                               |  |               |         |                  |   |        



See notes to consolidated financial
statements (unaudited).



2



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##### Table of Contents

Educate, Inc.



Consolidated Statements of Income



(Dollar amounts in thousands, except per share data)

(unaudited)



|                                                                             |  |                             |        |   |      |   |        |  
|---------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                             |  | Three months endedMarch 31, |       
|                                                                             |  | 2005                        |        |   | 2004 |  
|Revenues                                                                     |  |                             |        |   |      |   |        |  
|Learning Center:                                                             |  |                             |        |   |      |   |        |  
|Franchise services                                                           |  | $                           | 14,347 |   |      | $ | 12,838 |  
|Company-owned centers                                                        |  |                             | 42,460 |   |      |   | 30,549 |  
|                                                                             |  |                             |        |   |      |   |        |  
|Total Learning Center                                                        |  |                             | 56,807 |   |      |   | 43,387 |  
|                                                                             |  |                            
|Catapult Learning                                                            |  |                             | 41,448 |   |      |   | 38,807 |  
|                                                                             |  |                             |        |   |      |   |        |  
|Total revenues                                                               |  |                             | 98,255 |   |      |   | 82,194 |  
|                                                                             |  |                            
|Costs and expenses                                                           |  |                             |        |   |      |   |        |  
|Instructional and franchise operations costs                                 |  |                             | 70,389 |   |      |   | 59,251 |  
|Marketing and advertising                                                    |  |                             | 8,374  |   |      |   | 6,642  |  
|Depreciation and amortization                                                |  |                             | 2,082  |   |      |   | 1,786  |  
|General and administrative expenses                                          |  |                             | 3,492  |   |      |   | 3,476  |  
|Non-cash stock compensation expense (* see detail below)                     |  |                             | 148    |   |      |   |       |  
|                                                                             |  |                             |        |   |      |   |        |  
|Total costs and expenses                                                     |  |                             | 84,485 |   |      |   | 71,155 |  
|                                                                             |  |                             |        |   |      |   |        |  
|Operating income                                                             |  |                             | 13,770 |   |      |   | 11,039 |  
|                                                                             |  |                            
|Other income (expense)                                                       |  |                             |        |   |      |   |        |  
|Interest income                                                              |  |                             | 93     |   |      |   | 91     |  
|Foreign exchange gains                                                       |  |                             | 114    |   |      |   | 196    |  
|Interest expense                                                             |  |                             | (1,891 | ) |      |   | (3,495 | )
|                                                                             |  |                             |        |   |      |   |        |  
|Income from continuing operations before income taxes                        |  |                             | 12,086 |   |      |   | 7,831  |  
|                                                                             |  |                            
|Income tax expense                                                           |  |                             | (4,593 | ) |      |   | (2,976 | )
|                                                                             |  |                             |        |   |      |   |        |  
|Income from continuing operations                                            |  |                             | 7,493  |   |      |   | 4,855  |  
|Loss from discontinued operations, net of income tax benefit of $410 in 2004 |  |                             |       |   |      |   | (763   | )
|                                                                             |  |                             |        |   |      |   |        |  
|Net income                                                                   |  | $                           | 7,493  |   |      | $ | 4,092  |  
|                                                                             |  |                             |        |   |      |   |        |  
|Earnings per common share - basic                                            |  |                             |        |   |      |   |        |  
|Income from continuing operations                                            |  | $                           | 0.18   |   |      | $ | 0.13   |  
|Loss from discontinued operations                                            |  | $                           |       |   |      | $ | (0.02  | )
|                                                                             |  |                             |        |   |      |   |        |  
|Net income                                                                   |  | $                           | 0.18   |   |      | $ | 0.11   |  
|                                                                             |  |                             |        |   |      |   |        |  
|Earnings per common share - diluted                                          |  |                             |        |   |      |   |        |  
|Income from continuing operations                                            |  | $                           | 0.17   |   |      | $ | 0.13   |  
|Loss from discontinued operations                                            |  | $                           |       |   |      | $ | (0.02  | )
|                                                                             |  |                             |        |   |      |   |        |  
|Net income                                                                   |  | $                           | 0.17   |   |      | $ | 0.11   |  
|                                                                             |  |                             |        |   |      |   |        |  
|                                                                             |  |                             |        |   |      |   |        |  
|*  Composition of stock compensation:                                        |  |                             |        |   |      |   |        |  
|                                                                             |  |                            
|Instructional and franchise operations costs                                 |  | $                           | 94     |   |      |   |        |  
|General and administrative expenses                                          |  | $                           | 54     |   |      |   |        |  
|                                                                             |  |                             |        |   |      |   |        |  
|Total                                                                        |  | $                           | 148    |   |      |   |        |  
|                                                                             |  |                             |        |   |      |   |        |  



See notes to consolidated financial
statements (unaudited).



3



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##### Table of Contents

Educate, Inc.



Consolidated Statements of Cash Flows



(Dollar amounts in thousands)

(unaudited)



|                                                                                                                       |  |                             |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                       |  | Three months endedMarch 31, |        
|                                                                                                                       |  | 2005                        |         |   | 2004 |  
|Operating activities                                                                                                   |  |                             |         |   |      |   |         |  
|Income from continuing operations                                                                                      |  | $                           | 7,493   |   |      | $ | 4,855   |  
|Adjustments to reconcile income from continuing operations to net cash provided by continuing operations               |  |                             |         |   |      |   |         |  
|Depreciation                                                                                                           |  |                             | 1,723   |   |      |   | 1,730   |  
|Amortization                                                                                                           |  |                             | 359     |   |      |   | 56      |  
|Bad debt expense                                                                                                       |  |                             | 416     |   |      |   | 971     |  
|Deferred income taxes                                                                                                  |  |                             | 4,569   |   |      |   | 2,125   |  
|Non-cash stock compensation                                                                                            |  |                             | 148     |   |      |   |        |  
|Gain on foreign currency                                                                                               |  |                             | (114    | ) |      |   | (196    | )
|Other non-cash items                                                                                                   |  |                             | 22      |   |      |   | 209     |  
|Changes in operating assets and liabilities:                                                                           |  |                             |         |   |      |   |         |  
|Receivables                                                                                                            |  |                             | (18,722 | ) |      |   | (15,448 | )
|Prepaid expenses and other current assets                                                                              |  |                             | 560     |   |      |   | 1,106   |  
|Inventory                                                                                                              |  |                             | (217    | ) |      |   | 152     |  
|Accounts payable, accrued expenses, and other current liabilities                                                      |  |                             | (1,466  | ) |      |   | 248     |  
|Income taxes payable                                                                                                   |  |                             | (37     | ) |      |   | 180     |  
|Deferred revenue                                                                                                       |  |                             | 5,049   |   |      |   | 5,292   |  
|Accrued compensation and related benefits                                                                              |  |                             | (49     | ) |      |   | (1,254  | )
|Other assets                                                                                                           |  |                             | 2,280   |   |      |   | 86      |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net cash provided by continuing operations                                                                             |  |                             | 2,014   |   |      |   | 112     |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Loss from discontinued operations                                                                                      |  |                             |        |   |      |   | (763    | )
|Adjustments to reconcile loss from discontinued operations to net cash provided by discontinued operations:            |  |                             |         |   |      |   |         |  
|Changes in operating assets and liabilities                                                                            |  |                             |        |   |      |   | 2,229   |  
|Depreciation and other non-cash items                                                                                  |  |                             |        |   |      |   | 122     |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net cash provided by operations of discontinued operations                                                             |  |                             |        |   |      |   | 1,588   |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net cash provided by operating activities                                                                              |  |                             | 2,014   |   |      |   | 1,700   |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Investing activities                                                                                                   |  |                             |         |   |      |   |         |  
|Cash paid for acquired businesses, net of cash acquired (including acquisition costs of $1,067 in 2005 and $2 in 2004) |  |                             | (14,229 | ) |      |   | (581    | )
|Cash paid for other intangibles                                                                                        |  |                             | (1,315  | ) |      |   |        |  
|Purchase of property and equipment                                                                                     |  |                             | (3,454  | ) |      |   | (2,179  | )
|Change in other assets                                                                                                 |  |                             | (1,021  | ) |      |   | (184    | )
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net cash used in investing activities                                                                                  |  |                             | (20,019 | ) |      |   | (2,944  | )
|Financing activities                                                                                                   |  |                             |         |   |      |   |         |  
|Proceeds from exercise of stock options                                                                                |  |                             | 4       |   |      |   |        |  
|Cash received upon utilization of revolving credit facility                                                            |  |                             | 13,000  |   |      |   |        |  
|Payments on debt                                                                                                       |  |                             | (3,435  | ) |      |   | (1,001  | )
|Change in other long-term liabilities                                                                                  |  |                             | (206    | ) |      |   |        |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                                                                    |  |                             | 9,363   |   |      |   | (1,001  | )
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Effect of exchange rate changes on cash                                                                                |  |                             | 92      |   |      |   | (229    | )
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Net change in cash and cash equivalents                                                                                |  |                             | (8,550  | ) |      |   | (2,474  | )
|Cash and cash equivalents at beginning of period                                                                       |  |                             | 14,592  |   |      |   | 20,259  |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                                             |  | $                           | 6,042   |   |      | $ | 17,785  |  
|                                                                                                                       |  |                             |         |   |      |   |         |  
|Included in balance sheet caption:                                                                                     |  |                             |         |   |      |   |         |  
|                                                                                                                       |  |                            
|Cash and cash equivalents                                                                                              |  | $                           | 6,042   |   |      | $ | 16,264  |  
|Assets of discontinued operations held for sale                                                                        |  | $                           |        |   |      | $ | 1,521   |  
|Supplemental Cash Flow Information                                                                                     |  |                             |         |   |      |   |         |  
|Interest paid                                                                                                          |  | $                           | 1,739   |   |      | $ | 2,136   |  
|Income taxes paid                                                                                                      |  | $                           | 288     |   |      | $ |        |  



See notes to consolidated financial
statements (unaudited).



4



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##### 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 a
national provider of tutoring and other supplemental education services to pre-kindergarten through twelfth grade, or pre-K-12, students. The Company operates through two business segments summarized as follows:



| |  | The Learning Center segment develops and delivers trusted, personalized tutoring programs through a network of 1,083 franchised and company-owned learning centers in 864
geographical territories in North America operated under the Sylvan brand name, and 986 European franchised and company-owned learning centers operated under the Schulerhilfe brand name. The Learning Center segment also develops and sells
educational products and services under the recently-acquired Hooked on Phonics brand name. Sylvan and Hooked on Phonics are two of the most highly recognized brand names in the supplemental education services industry.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Beginning in 2005, the Company began including the operations of its Online Learning Services segment in its Learning Center segment. All segment information has been
restated to conform to the new presentation.



Basis of
Presentation



The unaudited interim financial information as of March
31, 2005 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, 2004.



Due principally to the timing of school semesters and holiday schedules, the Company is
subject to seasonality on 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 in the fourth calendar quarter to evaluate the specific needs of individual students prior to enrolling students into the Companys supplemental education
programs. In addition, a disproportionate amount of costs associated with the Companys Catapult Learning segment are incurred and expensed in periods when reported revenue is seasonally at a low point. As a result of these factors,
quarter-to-quarter comparisons of results of operation may not be indicative of future results of operations.



Certain amounts previously reported for 2004 have been reclassified to conform to the 2005 presentation.



Summary of Significant Accounting Policies



Stock  Based Compensation



The Company accounts for all stock-based compensation plans 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 is generally recognized. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
(Statement 123) encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement 123 requires the disclosure of pro forma data in the notes to the financial statements
if the fair value method is not adopted.



5



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##### Table of Contents

Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



The Company has granted stock options and restricted common stock to employees and directors. These grants are
discussed more fully in Note 10.



Pro forma net income and earnings per share
data have been determined as if the Company had accounted for its stock-based awards using prescribed fair value based methods. For all grants prior to May 14, 2004, the date the Company filed a registration statement with the Securities and
Exchange Commission 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, including the
expected stock price volatility. Because the Companys common stock has been publicly traded only since September 2004, the expected stock price volatility over the expected life of granted options has been based on published volatility
measures of companies in the Companys industry. These estimates of volatility may change in future periods, and the effects could be material.



The following assumptions were used in calculating pro forma stock compensation expense:



|                                |  |                                  |   |  |                                 |  
|------------------------------- |  | -------------------------------- | - |  | ------------------------------- | -
|                                |  | Three monthsended March 31, 2005 |   |  | Three monthsended March 31,2004 |  
|Risk-free interest rate (range) |  | 3.90%-4.08                       | % |  | 2.81                            | %
|Expected dividend yield         |  | 0.00                             | % |  | 0.00                            | %
|Expected life                   |  | 4 years                          |   |  | 4 years                         |  
|Stock price volatility          |  | 46                               | % |  | *                               |  

---

|(*) | Assumption is not applicable to minimum value method
|--- | ----------------------------------------------------



The weighted average estimated fair value of stock-based awards was $5.10 for the three months ended March 31, 2005 and $10.68 for the three months ended March 31, 2004.



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



For the purpose of pro forma disclosures, the estimated fair value of the options is amortized to expense over the
options vesting periods. The Companys pro forma information is as follows:



|                                                                                                |  |                                 |       |   |                                 |   |       |  
|----------------------------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ------------------------------- | - | ----- | -
|                                                                                                |  | Three monthsended March 31,2005 |       |   | Three monthsended March 31,2004 |  
|Net income as reported                                                                          |  | $                               | 7,493 |   |                                 | $ | 4,092 |  
|Stock-based employee compensation expense included in net income as reported, net of tax        |  |                                 | 92    |   |                                 |   |      |  
|Stock-based employee compensation expense using prescribed fair value based methods, net of tax |  |                                 | (197  | ) |                                 |   | (55   | )
|                                                                                                |  |                                 |       |   |                                 |   |       |  
|Pro forma net income                                                                            |  | $                               | 7,388 |   |                                 | $ | 4,037 |  
|                                                                                                |  |                                 |       |   |                                 |   |       |  
|Earnings per common sharebasic                                                                 |  |                                 |       |   |                                 |   |       |  
|As reported                                                                                     |  | $                               | 0.18  |   |                                 | $ | 0.11  |  
|Pro forma                                                                                       |  | $                               | 0.17  |   |                                 | $ | 0.11  |  
|                                                                                                |  |                                
|Earnings per common sharediluted                                                               |  |                                 |       |   |                                 |   |       |  
|As reported                                                                                     |  | $                               | 0.17  |   |                                 | $ | 0.11  |  
|Pro forma                                                                                       |  | $                               | 0.17  |   |                                 | $ | 0.11  |  



New Accounting Pronouncements



In December 2004 the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment, which is a revision of Statement 123. 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.



Statement 123(R) was originally required to be adopted no later than July 1, 2005. On April 14, 2005 the SEC announced that non-small business registrants would not be required to adopt Statement 123(R) until the first fiscal year beginning
after June 15, 2005 which effectively extended the adoption deadline for the Company to January 1, 2006. The Company expects to adopt the standard on January 1, 2006.



2. Acquisitions



On February 8, 2005, the Company acquired all the stock of Gateway Learning Corporation (HOP), the owner of the branded Hooked on Phonics early
reading, math and study skills programs. The results of operations of HOP are included in the Companys consolidated statements of income beginning February 1, 2005.



The initial purchase price totaled approximately $10,699 including acquisition costs of $966. The Company also extinguished $2,982 of
acquired debt at closing. Contingent consideration may be payable to the seller based upon future direct response television advertising spending related to the HOP business. As of March 31, 2005, no amounts are payable under the contingent
consideration provisions of the purchase agreement. Additionally, the purchase price is subject to adjustment upon the completion of a review of the working capital obtained at closing.



The purchase price allocation to assets and liabilities acquired is preliminary pending final resolution of the contingencies related to the
purchase price and final determination of the valuation of the intangible assets acquired. The purchase price was preliminarily allocated to acquired assets totaling $19,274, including identifiable amortizable and indefinite-lived intangible assets
of $727 and $7,994, respectively, and liabilities of $8,575.



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



During the first quarter of 2005, the Company purchased 17 Sylvan Learning Center franchised territories. The
combined purchase of these territories included cash paid of $5,417, acquisition costs of $101 and the assumption of liabilities of $3,749, which were primarily obligations to provide services to customers.



Pro forma financial information has not been included for these acquisitions because they are
not material to the consolidated operations and financial position of the Company.



3. Goodwill



Changes in the carrying amount of goodwill during
the period from December 31, 2004 through March 31, 2005 are summarized as follows:



|                                           |  |                |        |   |                  |   |       |  |   |        |  
|------------------------------------------ |  | -------------- | ------ | - | ---------------- | - | ----- |  | - | ------ | -
|                                           |  | LearningCenter |        |   | CatapultLearning |   | Total | 
|Goodwill at December 31, 2004              |  | $              | 59,559 |   |                  | $ | 9,551 |  | $ | 69,110 |  
|Acquisition of franchised learning centers |  |                | 9,130  |   |                  |   |      |  |   | 9,130  |  
|Foreign currency translation adjustment    |  |                | (677   | ) |                  |   |      |  |   | (677   | )
|                                           |  |                |        |   |                  |   |       |  |   |        |  
|Goodwill at March 31, 2005                 |  | $              | 68,012 |   |                  | $ | 9,551 |  | $ | 77,563 |  
|                                           |  |                |        |   |                  |   |       |  |   |        |  



4. Intangible Assets Other Than
Goodwill



A summary of other intangible assets at March
31, 2005 and December 31, 2004 is as follows:



|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|--------------------------------------------------------------- |  | ------------------- |  | ------------------- | ------- | ------------------------ | - | ----------------- |  | - | -------
|                                                                |  | March 31, 2005     
|                                                                |  | Usefullife in Years |  | GrossCarryingAmount |         | Accumulated Amortization |   | NetCarryingAmount
|Intangible assets subject to amortization:                      |  |                     |  |                     |         |                          |   |                   |  |   |        
|Acquired backlog (Learning Center Segment)                      |  | 0.5                 |  | $                   | 115     |                          | $ | 115               |  | $ |       
|Contract rights (Catapult Learning Segment)                     |  | 5                   |  |                     | 1,084   |                          |   | 361               |  |   | 723    
|Schulerhilfe franchise license rights (Learning Center Segment) |  | 25                  |  |                     | 3,821   |                          |   | 302               |  |   | 3,519  
|Customer list (Learning Center Segment)                         |  | 1                   |  |                     | 122     |                          |   | 38                |  |   | 84     
|Internally developed software (Learning Center Segment)         |  | 5                   |  |                     | 5,511   |                          |   | 50                |  |   | 5,461  
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total intangible assets subject to amortization                 |  |                     |  |                     | 10,653  |                          |   | 866               |  |   | 9,787  
|                                                                |  |                     |  |                    
|Indefinite-lived intangible assets not subject to amortization: |  |                     |  |                     |         |                          |   |                   |  |   |        
|Tradenames                                                      |  | N/A                 |  |                     | 139,998 |                          |   |                  |  |   | 139,998
|Learning Center franchise license rights                        |  | N/A                 |  |                     | 82,000  |                          |   |                  |  |   | 82,000 
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total indefinite-lived intangible assets                        |  |                     |  |                     | 221,998 |                          |   |                  |  |   | 221,998
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total intangible assets excluding goodwill                      |  |                     |  | $                   | 232,651 |                          | $ | 866               |  | $ | 231,785
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|--------------------------------------------------------------- |  | ------------------- |  | ------------------- | ------- | ------------------------ | - | ----------------- |  | - | -------
|                                                                |  | December 31, 2004  
|                                                                |  | Usefullife in Years |  | GrossCarryingAmount |         | Accumulated Amortization |   | NetCarryingAmount
|Intangible assets subject to amortization:                      |  |                     |  |                     |         |                          |   |                   |  |   |        
|Acquired backlog (Learning Center Segment)                      |  | 0.5                 |  | $                   | 115     |                          | $ | 115               |  | $ |       
|Contract rights (Catapult Learning Segment)                     |  | 5                   |  |                     | 1,084   |                          |   | 323               |  |   | 761    
|Schulerhilfe franchise license rights (Learning Center Segment) |  | 25                  |  |                     | 4,000   |                          |   | 240               |  |   | 3,760  
|Internally developed software (Learning Center Segment)         |  | 5                   |  |                     | 3,699   |                          |   |                  |  |   | 3,699  
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total intangible assets subject to amortization                 |  |                     |  |                     | 8,898   |                          |   | 678               |  |   | 8,220  
|                                                                |  |                     |  |                    
|Indefinite-lived intangible assets not subject to amortization: |  |                     |  |                     |         |                          |   |                   |  |   |        
|Tradenames                                                      |  | N/A                 |  |                     | 132,425 |                          |   |                  |  |   | 132,425
|Learning Center franchise license rights                        |  | N/A                 |  |                     | 82,000  |                          |   |                  |  |   | 82,000 
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total indefinite-lived intangible assets                        |  |                     |  |                     | 214,425 |                          |   |                  |  |   | 214,425
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        
|Total intangible assets excluding goodwill                      |  |                     |  | $                   | 223,323 |                          | $ | 678               |  | $ | 222,645
|                                                                |  |                     |  |                     |         |                          |   |                   |  |   |        



As of March 31, 2005, estimated future
amortization expense of intangible assets subject to amortization is as follows:



|                        |  |   |      
|----------------------- |  | - | -----
|Year ended December 31: |  |   |      
|2005                    |  | $ | 1,511
|2006                    |  |   | 1,740
|2007                    |  |   | 1,575
|2008                    |  |   | 1,375
|2009                    |  |   | 1,197
|Thereafter              |  |   | 2,389
|                        |  |   |      
|                        |  | $ | 9,787
|                        |  |   |      



5. Long-Term Debt



Long-term debt consists of the following:



|                                                                                                                                                                                                                                                                                                                  |  |                |         |   |                  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                                                                                                                                  |  | March 31, 2005 |         |   | December 31,2004 |  
|Senior term loan payable to a bank (2004 Term Loan) in quarterly installments through March 2011. The loan bears interest at the
banks prime rate or the Eurodollar rate, plus specified margins, as elected by the Company (aggregating to 5.06% per annum at March 31, 2005 and 4.475% at December 31, 2004) |  | $              | 118,551 |   |                  | $ | 118,851 |  
|Borrowings under revolving credit facility maturing April 27, 2009. The borrowings bear interest at the banks Eurodollar rate, plus
specified margins, as elected by the Company (ranging from 5.33% to 5.38% per annum at March 31, 2005)                                                                       |  |                | 13,000  |   |                  |   |        |  
|Note payable to Laureate, due in semi-annual installments through June 30, 2009. The note does not bear interest, and is recorded net of a
discount of $314 at March 31, 2005 and $348 at December 31, 2004                                                                                                       |  |                | 1,865   |   |                  |   | 1,831   |  
|Various notes payable bearing interest at fixed rates ranging from 5.00% to 8.00% per annum                                                                                                                                                                                                                       |  |                | 1,845   |   |                  |   | 1,831   |  
|                                                                                                                                                                                                                                                                                                                  |  |                |         |   |                  |   |         |  
|                                                                                                                                                                                                                                                                                                                  |  |                | 135,261 |   |                  |   | 122,513 |  
|Less: current portion of long-term debt                                                                                                                                                                                                                                                                           |  |                | (2,128  | ) |                  |   | (2,102  | )
|                                                                                                                                                                                                                                                                                                                  |  |                |         |   |                  |   |         |  
|Total long-term debt                                                                                                                                                                                                                                                                                              |  | $              | 133,133 |   |                  | $ | 120,411 |  
|                                                                                                                                                                                                                                                                                                                  |  |                |         |   |                  |   |         |  



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



In order to manage interest rate exposure and to comply with certain covenants of the Companys credit
agreement, the Company has entered into three interest rate swap agreements. A notional amount of $40,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 2.58% per annum. A second
agreement with a notional amount of $10,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 3.44% per annum. These agreements will terminate on July 1, 2006. A third agreement effective
from July 1, 2006 through May 1, 2007 with a notional amount of $50,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 4.03% per annum. Interest paid under these agreements is recorded
as interest expense in the period in which it is incurred.



On April 28, 2005,
one of the Companys consolidated subsidiaries entered into an Amended and Restated Credit Agreement (the Agreement) with a bank syndicate, replacing the existing 2004 Term Loan facility. The Agreement provides for an increase in
the term loan facility to $140 million and other amendments to lower the interest rate spread over a variable rate, extend the maturities, and provide for increased flexibility in certain other terms and conditions of the term loan facility. No
amendments were made to the agreement concerning the revolving credit facility.



At the Companys election the modified term loan will bear interest at the base rate or Eurodollar rate plus a margin, currently at 200 basis points. Pursuant to the Agreement, quarterly principal payments based upon a 100-year
amortization schedule are due until the seventh year, when the remaining balance is due. The obligations under the Agreement 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 certain of the consolidated subsidiaries of the Company.



The Agreement includes usual and 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 making fundamental changes to the business.



The Agreement is expected to constitute a substantial modification of the terms of the prior agreement in accordance with generally accepted accounting principles.
Accordingly, the Company currently expects to write off financing costs of approximately $1.5 million related to the prior term facility during the three-month period ending June 30, 2005.



6. Income Taxes



The Companys income tax provisions for all periods consist of federal, state, and foreign income taxes. The tax provision for the
three-month period ended March 31, 2005 is based on the estimated effective tax rate applicable for the full year. Currently, the effective tax rate for the Company for the year ending December 31, 2005 is expected to be 38%. Due to potential
changes in the mix of earnings between tax jurisdictions, the Companys consolidated effective tax rate may fluctuate during 2005.



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



7. Stockholders Equity



Changes in the Companys stockholders equity during the period December 31, 2004 through March 31, 2005 are summarized as
follows:



|                                                                                                    |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------- |  | ------------ | --- | ------------------------ | - | ---------------- |  | ----------------------------------- | ------ |  | ------------------------ | ------ | - |  | - | ------- | -
|                                                                                                    |  | Common Stock |     | AdditionalPaid-inCapital |   | RetainedEarnings |  | AccumulatedOtherComprehensiveIncome |        |  | TotalStockholdersEquity |       
|Balance at December 31, 2004                                                                        |  | $            | 426 |                          | $ | 191,002          |  | $                                   | 2,807  |  | $                        | 3,466  |   |  | $ | 197,701 |  
|Options exercised for purchase of 1,000 shares of common stock (including income tax benefit of $3) |  |              |     |                          |   | 8                |  |                                     |        |  |                          |        |   |  |   | 8       |  
|Non-cash compensation expense                                                                       |  |              |     |                          |   | 148              |  |                                     |        |  |                          |        |   |  |   | 148     |  
|Comprehensive income:                                                                               |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  
|Net income for the three months ended March 31, 2005                                                |  |              |     |                          |   |                  |  |                                     | 7,493  |  |                          |        |   |  |   | 7,493   |  
|Other comprehensive income:                                                                         |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  
|Change in fair value of derivative financial instrument, net of tax of $222                         |  |              |     |                          |   |                  |  |                                     |        |  |                          | 363    |   |  |   | 363     |  
|Foreign currency translation adjustment                                                             |  |              |     |                          |   |                  |  |                                     |        |  |                          | (1,231 | ) |  |   | (1,231  | )
|                                                                                                    |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  
|Total comprehensive income                                                                          |  |              |     |                          |   |                  |  |                                     | 7,493  |  |                          | (868   | ) |  |   | 6,625   |  
|                                                                                                    |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  
|Balance at March 31, 2005                                                                           |  | $            | 426 |                          | $ | 191,158          |  | $                                   | 10,300 |  | $                        | 2,598  |   |  | $ | 204,482 |  
|                                                                                                    |  |              |     |                          |   |                  |  |                                     |        |  |                          |        |   |  |   |         |  



8. Comprehensive Income



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



|                                                                                                                      |  |                                 |        |   |                                 |   |        |  
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------- | - | ------ | -
|                                                                                                                      |  | Three monthsended March 31,2005 |        |   | Three monthsended March 31,2004 |  
|Net income                                                                                                            |  | $                               | 7,493  |   |                                 | $ | 4,092  |  
|Foreign currency translation adjustment, net of tax of $(269) in 2005                                                 |  |                                 | (1,231 | ) |                                 |   | (1,005 | )
|Change in fair value of derivative financial instrument, net of tax of $222 and $(182) in 2005 and 2004, respectively |  |                                 | 363    |   |                                 |   | (297   | )
|                                                                                                                      |  |                                 |        |   |                                 |   |        |  
|Comprehensive income                                                                                                  |  | $                               | 6,625  |   |                                 | $ | 2,790  |  
|                                                                                                                      |  |                                 |        |   |                                 |   |        |  



9. Earnings Per Share



Basic earnings per common share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted earnings 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.



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



A reconciliation of the numerators and denominators for basic and diluted earnings per common share are as follows:



|                                    |  |                                 |        |                                 |   |        |  
|----------------------------------- |  | ------------------------------- | ------ | ------------------------------- | - | ------ | -
|                                    |  | Three monthsended March 31,2005 |        | Three monthsended March 31,2004 |  
|Numerator                           |  |                                 |        |                                 |   |        |  
|Income from continuing operations   |  | $                               | 7,493  |                                 | $ | 4,855  |  
|Loss from discontinued operations   |  |                                 |       |                                 |   | (763   | )
|                                    |  |                                 |        |                                 |   |        |  
|Net income                          |  | $                               | 7,493  |                                 | $ | 4,092  |  
|                                    |  |                                 |        |                                 |   |        |  
|Denominator (shares in 000s)       |  |                                 |        |                                 |   |        |  
|Basic:                              |  |                                 |        |                                 |   |        |  
|Weighted-average shares outstanding |  |                                 | 42,586 |                                 |   | 36,800 |  
|                                    |  |                                 |        |                                 |   |        |  
|Diluted:                            |  |                                 |        |                                 |   |        |  
|Weighted-average shares outstanding |  |                                 | 42,586 |                                 |   | 36,800 |  
|Dilutive effect of stock options    |  |                                 | 1,436  |                                 |   | 542    |  
|                                    |  |                                 |        |                                 |   |        |  
|Total                               |  |                                 | 44,022 |                                 |   | 37,342 |  
|                                    |  |                                 |        |                                 |   |        |  
|Earnings per common sharebasic     |  |                                 |        |                                 |   |        |  
|Income from continuing operations   |  | $                               | 0.18   |                                 | $ | 0.13   |  
|Loss from discontinued operations   |  |                                 |       |                                 |   | (0.02  | )
|                                    |  |                                 |        |                                 |   |        |  
|Net income                          |  | $                               | 0.18   |                                 | $ | 0.11   |  
|                                    |  |                                 |        |                                 |   |        |  
|Earnings per common sharediluted   |  |                                 |        |                                 |   |        |  
|Income from continuing operations   |  | $                               | 0.17   |                                 | $ | 0.13   |  
|Loss from discontinued operations   |  |                                 |       |                                 |   | (0.02  | )
|                                    |  |                                 |        |                                 |   |        |  
|Net income                          |  | $                               | 0.17   |                                 | $ | 0.11   |  
|                                    |  |                                 |        |                                 |   |        |  



10. Stock Option Plan



During 2003, the Company adopted a stock option plan that provides for
the granting of options to purchase up to 3,680,000 shares of common stock to selected employees and directors of the Company. All options granted during 2003 were issued with an exercise price of $3.71 per share, which is equal to the estimated
fair value of the common stock at the date of the grant, vest over a four-year period, and expire 10 years after the date of the grant.



During 2004, the Company adopted a stock option plan that provides for the granting of options to purchase up to 700,000 shares of common stock to selected employees and
directors of the Company. At December 31, 2004 options to purchase 194,000 shares of common stock had been granted under this plan with a weighted average exercise price of $11.76 per share. Of this amount, 16,000 shares immediately vested with the
balance vesting ratably over four years. Options under this plan expire 10 years after the grant date.



During the period from January 1, 2005 through March 31, 2005 the Company issued options to purchase 83,000 shares of common stock to employees of the Company with a weighted average exercise price of $12.60 per
share. Options will vest ratably over a four-year period.



At March 31, 2005
the Company had outstanding options to purchase 3,830,409 shares of common stock at a weighted average exercise price of $4.62 per share.



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



11. 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. Beginning in 2005, the Company began to manage the operations of its previous Online Learning Services segment within its Learning Center segment, and accordingly now has two operating segments. All
segment information has been restated to conform to the new presentation. The segments are managed separately as they have different customer bases and delivery channels. Reportable segments are as follows:



| |  |  | Learning Center segment develops and delivers trusted, personalized tutoring programs primarily through a network of 1,083 franchised and company-owned learning centers in 864
geographical territories in North America operated under the Sylvan brand name, and 986 European franchised and company-owned learning centers operated under the Schulerhilfe brand name. The Learning Center segment also develops and sells
educational products and services under the recently-acquired Hooked on Phonics brand name. Sylvan and Hooked on Phonics are two of the most highly recognized brand names in the supplemental education services industry.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Catapult Learning segment, formerly Institutional Services, provides tutoring, as well as other supplemental education services and special-needs services, to public and private
schools through government-funded contracts under the Catapult Learning and other brand names.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company evaluates performance and allocates resources based on operating income. There are no significant intercompany sales or transfers.



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



|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|----------------------------------------------------- |  | -------------- | ------- | - | ---------------- | - | ------ | ----- |  | - | ------- | -
|Three months ended March 31, 2005                     |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                              |  | $              | 56,807  |   |                  | $ | 41,448 |       |  | $ | 98,255  |  
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization   |  |                | 12,382  |   |                  |   | 7,110  |       |  |   | 19,492  |  
|Depreciation and amortization                         |  |                | (1,235  | ) |                  |   | (438   | )     |  |   | (1,673  | )
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit                                        |  | $              | 11,147  |   |                  | $ | 6,672  |       |  | $ | 17,819  |  
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment assets                                        |  | $              | 342,400 |   |                  | $ | 61,097 |       |  | $ | 403,497 |  
|Total expenditures for additions to long-lived assets |  |                | 4,919   |   |                  |   | 1,297  |       |  |   | 6,216   |  
|                                                      |  |                |        
|Three months ended March 31, 2004                     |  | LearningCenter |         |   | CatapultLearning |   |        | Total | 
|Revenues                                              |  | $              | 43,387  |   |                  | $ | 38,807 |       |  | $ | 82,194  |  
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit before depreciation and amortization   |  |                | 10,394  |   |                  |   | 5,907  |       |  |   | 16,301  |  
|Depreciation and amortization                         |  |                | (929    | ) |                  |   | (466   | )     |  |   | (1,395  | )
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment profit                                        |  | $              | 9,465   |   |                  | $ | 5,441  |       |  | $ | 14,906  |  
|                                                      |  |                |         |   |                  |   |        |       |  |   |         |  
|Segment assets                                        |  | $              | 285,934 |   |                  | $ | 60,129 |       |  | $ | 346,063 |  
|Total expenditures for additions to long-lived assets |  |                | 2,674   |   |                  |   | 422    |       |  |   | 3,096   |  



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Educate, Inc.



Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)



The following tables reconcile the reported information on segment profit to income from continuing operations before
income taxes reported in the consolidated statements of income:



|                                                      |  |                                 |        |   |                                  |   |        |  
|----------------------------------------------------- |  | ------------------------------- | ------ | - | -------------------------------- | - | ------ | -
|                                                      |  | Three monthsended March 31,2005 |        |   | Three monthsended March 31, 2004 |  
|Segment profit                                        |  | $                               | 17,819 |   |                                  | $ | 14,906 |  
|Corporate depreciation and amortization               |  |                                 | (409   | ) |                                  |   | (391   | )
|General and administrative costs                      |  |                                 | (3,492 | ) |                                  |   | (3,476 | )
|Non-cash stock compensation expense                   |  |                                 | (148   | ) |                                  |   |       |  
|Other income (expense)                                |  |                                 | (1,684 | ) |                                  |   | (3,208 | )
|                                                      |  |                                 |        |   |                                  |   |        |  
|Income from continuing operations before income taxes |  | $                               | 12,086 |   |                                  | $ | 7,831  |  
|                                                      |  |                                 |        |   |                                  |   |        |  



Revenues by geographic
area are as follows:



|                   |  |                                 |        |                                 |   |       
|------------------ |  | ------------------------------- | ------ | ------------------------------- | - | ------
|                   |  | Three monthsended March 31,2005 |        | Three monthsended March 31,2004
|United States      |  | $                               | 89,296 |                                 | $ | 74,894
|Other              |  |                                 | 8,959  |                                 |   | 7,300 
|                   |  |                                 |        |                                 |   |       
|Consolidated total |  | $                               | 98,255 |                                 | $ | 82,194
|                   |  |                                 |        |                                 |   |       



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. Substantially all long-lived assets are located in the United States.



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Educate, Inc.



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 consolidated financial statements and related notes to those statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and 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, 2004.



Information Regarding Forward-Looking Statements



The statements contained herein 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 might cause such a difference: the development and expansion of the Sylvan Learning Center franchise system; changes in the relationships among Sylvan Learning Center 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 by institutional customers and consumers; changes in customer relationships; the seasonality of operating results; global economic conditions,
including interest and currency rate fluctuations; and inflation rates. 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 national 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 served more than 320,000 students in 2004.



Our Learning Center segment develops and delivers trusted diagnostic, prescriptive tutoring
programs primarily through a network of franchised and company-owned learning centers located primarily in North America operating under the Sylvan brand name. The Learning Center segment also develops and sells educational products and services
under the recently-acquired Hooked on Phonics brand name. Sylvan and Hooked on Phonics are two of the most highly recognized brand names in the supplemental education services industry.



Our Catapult Learning segment, formerly referred to as Institutional Services, provides tutoring, as well as other supplemental education
services and special needs services, to eligible students in public and private schools through government-funded contracts under the Catapult Learning and other brand names.



We have experienced significant growth over the last five years. We expect that both of our business segments will continue to benefit from
economic and government policy trends in the education marketplace. Parents have become more proactive in seeking education services that supplement their childrens education and are increasingly willing to pay for these services largely due
to the increase in economic value of a college degree relative to a high school diploma. In addition, increased education spending by government authorities has also opened the market for services provided by the Company. The passage of the No Child
Left Behind Act in 2002 created a federally funded program serving students in poor performing schools. Through the provision of education services to school districts under the No Child Left Behind, or NCLB, program, the Catapult Learning segment
has achieved significant revenue growth during the current and prior school years. We continue to see strong growth opportunities for NCLB services as more states adopt programs and testing standards to address federal requirements.



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Educate, Inc.



Seasonality and Other Quarterly Fluctuations



|                                  |  |               |      |                       |   |      |                |  |   |               |   |  |                |      |   |  |   |      |  
|--------------------------------- |  | ------------- | ---- | --------------------- | - | ---- | -------------- |  | - | ------------- | - |  | -------------- | ---- | - |  | - | ---- | -
|                                  |  | 2005          |      | 2004                  |  
|                                  |  | First Quarter |      | First Quarter         |   |      | Second Quarter |  |   | Third Quarter |   |  | Fourth Quarter |     
|                                  |  |               |      | (Dollars in Millions) |   |      |                |  |   |               |  
|Revenues:                         |  |               |      |                       |   |      |                |  |   |               |   |  |                |      |   |  |   |      |  
|Learning Center                   |  | $             | 56.8 |                       | $ | 43.4 |                |  | $ | 50.0          |   |  | $              | 48.6 |   |  | $ | 39.3 |  
|Catapult Learning                 |  |               | 41.5 |                       |   | 38.8 |                |  |   | 37.3          |   |  |                | 13.8 |   |  |   | 29.1 |  
|                                  |  |               |      |                       |   |      |                |  |   |               |   |  |                |      |   |  |   |      |  
|Total revenues                    |  | $             | 98.3 |                       | $ | 82.2 |                |  | $ | 87.3          |   |  | $              | 62.4 |   |  | $ | 68.4 |  
|Percentage of revenues (1)        |  |               | N/A  |                       |   | 27   | %              |  |   | 29            | % |  |                | 21   | % |  |   | 23   | %
|Operating income                  |  | $             | 13.8 |                       | $ | 11.0 |                |  | $ | 8.1           |   |  | $              | 7.6  |   |  | $ | 4.6  |  
|Income from continuing operations |  | $             | 7.5  |                       | $ | 4.9  |                |  | $ | 0.5           |   |  | $              | 1.9  |   |  | $ | 1.9  |  

---

|(1) | Represents percentage of total annual revenues.
|--- | -----------------------------------------------



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 also have been 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 franchises more than a month in the future.



First Quarter. In our Learning Center segment, we 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 in the summer time period. In our Catapult Learning segment, we deliver services under NCLB and other programs during this quarter.



Second Quarter. In our Learning Center segment, we 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. In our Catapult Learning segment, we complete delivery of our NCLB and other institutional
services in conjunction with the ending of the school year.



Third
Quarter. The third quarter marks the peak delivery of services 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. Due to summer vacation, we provide limited services in our Catapult Learning segment during this period, which results in the lowest
segment revenue for the year. However, we gain significant visibility for the upcoming year because the majority of our institutional contracts are renewed during the third quarter.



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 Catapult Learning segment, we incur significant start-up costs in connection with preparation of
our NCLB programs.



Other. The timing of school year contracts,
advertising spending and critical enrollment periods 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.



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Educate, Inc.



Results of Operations



Comparison of results for the quarter ended March 31, 2005 and 2004.



|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|----------------------------------------- |  | ---------------------- | ----- | - | --------------------- | - | ----- | - |  | -- | --
|                                          |  | Quarter Ended March 31 |       |   | % Increase (Decrease) |  
|                                          |  | 2005                   |       |   | 2004                  |   |      
|                                          |  | (Dollars in Millions)  |       |   |                       |  
|Revenues                                  |  |                        |       |   |                       |   |       |   |  |    |   
|Learning Center:                          |  |                        |       |   |                       |   |       |   |  |    |   
|Franchise services                        |  | $                      | 12.9  |   |                       | $ | 11.7  |   |  | 10 | % 
|Company-owned centers                     |  |                        | 35.7  |   |                       |   | 24.8  |   |  | 44 | % 
|European                                  |  |                        | 8.2   |   |                       |   | 6.9   |   |  | 19 | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|                                          |  |                        | 56.8  |   |                       |   | 43.4  |   |  | 31 | % 
|Catapult Learning:                        |  |                        |       |   |                       |   |       |   |  |    |   
|School Services and Special Needs         |  |                        | 25.1  |   |                       |   | 27.1  |   |  | (7 | )%
|NCLB                                      |  |                        | 16.4  |   |                       |   | 11.7  |   |  | 40 | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|                                          |  |                        | 41.5  |   |                       |   | 38.8  |   |  | 7  | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|Total                                     |  | $                      | 98.3  |   |                       | $ | 82.2  |   |  | 20 | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|Business Metrics                          |  |                        |       |   |                       |   |       |   |  |    |   
|Sylvan Learning revenue growth:           |  |                        |       |   |                       |   |       |   |  |    |   
|Same territory (1)                        |  |                        | 5     | % |                       |   | 3     | % |  |    |   
|Same center (2)                           |  |                        | 4     | % |                       |   | 2     | % |  |    |   
|                                          |  |                        |      
|Number of Sylvan Learning Territories (3) |  |                        |       |   |                       |   |       |   |  |    |   
|Franchise                                 |  |                        | 736   |   |                       |   | 739   |   |  | 0  | % 
|Company-owned                             |  |                        | 128   |   |                       |   | 86    |   |  | 49 | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|Total                                     |  |                        | 864   |   |                       |   | 825   |   |  | 5  | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|Number of Sylvan Learning Centers (4)     |  |                        |       |   |                       |   |       |   |  |    |   
|Franchise                                 |  |                        | 898   |   |                       |   | 878   |   |  | 2  | % 
|Company-owned                             |  |                        | 185   |   |                       |   | 138   |   |  | 34 | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   
|Total                                     |  |                        | 1,083 |   |                       |   | 1,016 |   |  | 7  | % 
|                                          |  |                        |       |   |                       |   |       |   |  |    |   

---

|(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 Educate revenue growth for
franchise or company-owned territories during the period. A territory reflects the geographically specified area where an operator has the right to provide services under a Sylvan franchise agreement. Same territory amounts include revenue from
additional centers opened in existing territories.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Same Center amounts include the results of centers for the identical months for each period presented in the comparison, commencing with the 13th full month each center
has been operating. Same center growth is presented as the aggregate Educate revenue growth for franchise or company-owned centers during the period.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Number of Sylvan Learning territories at period end.
|--- | ----------------------------------------------------

|(4) | Number of Sylvan Learning centers at period end.
|--- | ------------------------------------------------



Revenues. The increase in revenue during the first quarter of 2005 of $16.1 million compared to the same quarter of the prior year was primarily due to the
acquisition of Gateway Learning Corporation and the Hooked on Phonics product line as well as acquisitions of Sylvan Learning Centers from franchisees and growth in revenue of existing company-owned centers of $10.9 million. European revenues
increased $1.3 million and franchise services revenues grew by $1.2 million compared to the same period of 2004. In the Catapult Learning segment, there was a 40% increase in NCLB service revenues, or $4.7 million, partially offset by decreases in
revenues of the school services and special needs businesses compared to the same period of 2004.



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Educate, Inc.



Learning CenterRevenues from company-owned territories increased primarily as a result of the
acquisition of 46 company-owned territories after March 31, 2004. Our combined same territory revenue growth increased 5% in the quarter ended March 31, 2005 compared to the same period of 2004. Franchise services revenues increased $1.2 million as
a result of same territory royalty growth and increased educational program sales to franchisees during the quarter.



European revenues, reflecting both company-owned territory and franchise results, increased $1.3 million due to company-owned territory growth of $0.8 million and the
effects of a $0.5 million benefit from a favorable foreign currency exchange environment. Revenues for the Learning Center segment represented 58% of our total revenues for the quarter ended March 31, 2005.



Catapult LearningRevenues increased as a result of the continued growth in our
NCLB supplemental service program of $4.7 million, which began during the 2002-2003 school year. Our school services business experienced a decrease in revenue of $1.1 million due to planned reductions in several non-strategic contracts primarily in
our CareerStarters programs. In addition, our special needs business has experienced a $0.9 million decrease in revenues due to reduced staffing availability of speech therapists. Revenues for the Catapult Learning segment accounted for 42% of our
total revenues for the quarter ended March 31, 2005.



|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|------------------------------------------------ |  | ---------------------- | ---- | - | --------------------- | - | ---- | - |  | --- | --
|                                                 |  | Quarter Ended March 31 |      |   | % Increase (Decrease) |  
|                                                 |  | 2005                   |      |   | 2004                  |   |     
|                                                 |  | (Dollars in millions)  |      |   |                       |  
|Segment Operating Costs                          |  |                        |      |   |                       |   |      |   |  |     |   
|Learning Center                                  |  | $                      | 45.7 |   |                       | $ | 34.0 |   |  | 34  | % 
|Catapult Learning                                |  |                        | 34.8 |   |                       |   | 33.3 |   |  | 4   | % 
|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|Total Segment Operating Costs                    |  |                        | 80.5 |   |                       |   | 67.3 |   |  | 20  | % 
|Segment Profit                                   |  |                        |      |   |                       |   |      |   |  |     |   
|Learning Center                                  |  |                        | 11.1 |   |                       |   | 9.5  |   |  | 17  | % 
|Catapult Learning                                |  |                        | 6.7  |   |                       |   | 5.4  |   |  | 24  | % 
|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|Total Segment Profit                             |  |                        | 17.8 |   |                       |   | 14.9 |   |  | 19  | % 
|Corporate Expenses                               |  |                        |      |   |                       |   |      |   |  |     |   
|Corporate depreciation and amortization expenses |  |                        | .4   |   |                       |   | .4   |   |  | 0   | % 
|General administrative expenses                  |  |                        | 3.5  |   |                       |   | 3.5  |   |  | 0   | % 
|Non-cash stock compensation expense              |  |                        | .1   |   |                       |   |     |   |  | 100 | % 
|Interest expense (net)                           |  |                        | 1.8  |   |                       |   | 3.4  |   |  | (47 | )%
|Foreign exchange gains                           |  |                        | (0.1 | ) |                       |   | (0.2 | ) |  | (50 | )%
|Income tax expense                               |  |                        | 4.6  |   |                       |   | 2.9  |   |  | 59  | % 
|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|Total Corporate Expenses                         |  |                        | 10.3 |   |                       |   | 10.0 |   |  | 3   | % 
|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|Income from continuing operations                |  | $                      | 7.5  |   |                       | $ | 4.9  |   |  | 53  | % 
|                                                 |  |                        |      |   |                       |   |      |   |  |     |   
|Segment Profit Margin                            |  |                        |      |   |                       |   |      |   |  |     |   
|                                                 |  |                        |     
|Learning Center                                  |  |                        | 20   | % |                       |   | 22   | % |  |     |   
|Catapult Learning                                |  |                        | 16   | % |                       |   | 14   | % |  |     |   



Segment Operating Costs.
Segment operating costs increased primarily due to the expansion of company-owned Learning Center territories, the delivery of NCLB services, and the acquisition of Gateway Learning Corporation.



Learning CenterSegment operating costs increased to 80% of operating revenue for
the quarter ended March 31, 2005 compared to 78% in the first quarter of 2004. Reduced labor costs in our existing company-owned territories were offset by the additional costs associated with operating and integrating company-owned territories
acquired in the first quarter of 2005 and the last nine months of 2004. Segment costs also increased due to the acquisition of Gateway Learning Corporation and the launch of online tutorial services to customers during the first quarter of 2005.
Company-owned territory expenses increased primarily as a result of instructional costs associated with 46 additional company-owned territories. European expenses related to Schülerhilfe increased by $0.9 million, related to $0.5 million in
higher costs to support revenue growth and an unfavorable impact of $0.4 million from foreign currency exchange rate movements.



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Catapult LearningCosts increased by $1.5 million, or 4% primarily due to the expansion of our new NCLB
business. Segment operating costs as a percentage of segment revenue decreased 2% from 86% for the quarter ended March 31, 2004 to 84% for the first quarter of 2005.



Segment Profit Margin. Learning Center segment profit margins decreased in the first quarter of 2005 to 20% compared to the prior
year period at 22%. The decreased margin is primarily related to additional costs associated with operating and integrating additional company-owned territories acquired and the related shift in revenue mix from franchise revenues to company-owned
territory revenues. Catapult Learning segment profit margins were 16% for the three months ended March 31, 2005, up 2% from the prior year at 14% due primarily to the focus on contracts with higher margins.



Corporate Expenses. Corporate expenses before interest expense and income taxes were
$3.9 million in the first quarter of 2005 and $3.7 million in the first quarter of 2004, but declined as a percentage of revenue from 4.5% in the first quarter of 2004 to 4.0% in the first quarter of 2005. Net interest expense in the first quarter
of 2005 declined $1.6 million, primarily as a result of refinancing the senior term loan and repayment of the subordinated note payable to Laureate. Income from continuing operations increased in the 2005 period due to increased segment profits. Our
income tax expense increased to $4.6 million for the three months ended March 31, 2005 from $2.9 million for the three months ended March 31, 2004. This was due to increased income before income taxes. Our effective income tax rate was 38% for both
periods.



Liquidity and Capital Resources



|                                               |  |                              |       |   |                              |   |      |  
|---------------------------------------------- |  | ---------------------------- | ----- | - | ---------------------------- | - | ---- | -
|                                               |  | Quarter ended March 31, 2005 |       |   | Quarter ended March 31, 2004 |  
|                                               |  | (Dollars in Millions)        |      
|Beginning cash balance                         |  | $                            | 14.6  |   |                              | $ | 20.3 |  
|Operating activities  continuing operations   |  |                              | 2.0   |   |                              |   | 0.1  |  
|Operating activities  discontinued operations |  |                              |      |   |                              |   | 1.6  |  
|Investing activities                           |  |                              | (20.0 | ) |                              |   | (2.9 | )
|Financing activities                           |  |                              | 9.3   |   |                              |   | (1.0 | )
|Effect of exchange rates                       |  |                              | .1    |   |                              |   | (0.3 | )
|                                               |  |                              |       |   |                              |   |      |  
|Ending cash balance                            |  | $                            | 6.0   |   |                              | $ | 17.8 |  
|                                               |  |                              |       |   |                              |   |      |  



Historically, we have generated
significant cash flows from our operations which have allowed us to meet our working capital needs and fund the cash we require to make investments in property and equipment, open new company-owned territories, and acquire franchised learning
territories and other businesses. More recently, the cash flows we have generated from operations and our recent common stock offering have also been used to service debt we incurred in June 2003 and refinanced in April 2004.



Our working capital requirements are favorably impacted by the fact that in our largest
segment, the Learning Center segment, our operations generate positive working capital even during growth periods. The learning center business has the favorable working capital attribute that parents must pay in advance of service. Therefore,
company-owned territories have the benefit of customer prepayment and, in connection with franchise territories, we receive royalty payments from franchisees based upon net cash collected in the prior month. 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. As our revenues in the Catapult Learning segment increase as a result of the
expected expansion of our NCLB business, our working capital requirements will also increase to fund the seasonal growth of accounts receivable.



For the quarters ended March 31, 2005 and March 31, 2004, our cash flows from continuing operations were $2.0 million and $0.1 million, respectively. The increase of $1.9
million was attributed primarily to an increase in income from continuing operations before non-cash charges of $4.9 million for the quarter ended March 31, 2005. The increase was offset by an increase in working capital. The reported income from
continuing operations for the quarter ended March 31, 2005 included significant non-cash elements such as deferred income taxes of $4.5 million and depreciation and amortization of $2.1 million. The working capital increase consisted primarily of
seasonal increases in accounts receivable of $18.7 million and a decrease in accounts payable and accrued expenses of $1.5 million.



Our investing activities have historically consisted of investments in property and equipment and acquisitions of franchised learning territories and other businesses.
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.



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During the three-month period ended March 31, 2005, we used $8.7 million of cash to acquire Gateway Learning
Corporation net of cash acquired. We invested an additional $5.5 million in learning center acquisitions and $4.7 million in property and equipment and other intangible assets.



During the first quarter of 2005, we borrowed $13.0 million under our revolving credit facility to finance the acquisition of Gateway
Learning Corporation and repay debt assumed in the acquisition.



As described
more fully in the unaudited Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on April 28, 2005 the Company amended their term loan facility, increasing the term loans outstanding from $118.6 million at
March 31, 2005 to $140.0 million. The revolving credit borrowings of $13.0 million were immediately repaid, and the remaining $8.4 million was available for use in operations, acquisitions or other investments. As a result of the repayment of the
borrowings under the revolving credit facility, the Company has $30 million of available credit through that facility as of April 28, 2005.



We believe that cash flow from operations, available cash and existing credit facilities will be sufficient to meet our operating requirements, including expansion of our
existing business, acquisition of centers, funding of program and software development and operating costs through at least the end of 2006. Our future capital requirements will depend on many factors, including our rate of revenue growth, center
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. 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.



Contingent Matters



We have guaranteed certain bank loans of franchisees related to financing the purchase of educational programs and other purchased instructional material. Of the $.75 million of available credit under this program,
$.24 million was outstanding at March 31, 2005. These guarantees are secured by the assets of the business of the individual franchisee utilizing this financing arrangement.



International Exposure



Our Learning Center segment has operations outside the United States, primarily in Germany. 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 our Annual Report on Form
10-K for the year ended December 31, 2004.



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New Accounting Pronouncements



In December 2004 the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, which is a
revision of Statement 123. 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.



Statement 123(R) was originally required to be adopted no
later than July 1, 2005. On April 14, 2005 the SEC announced that non-small business registrants would not be required to adopt Statement 123(R) until the first fiscal year beginning after June 15, 2005 which effectively extended the adoption
deadline for the Company to January 1, 2006. The Company expects to adopt the standard on January 1, 2006. Statement 123(R) permits public companies to adopt its requirements using one of two methods:



A modified prospective method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective
date of Statement 123(R) that remain unvested on the effective date.



A
modified retrospective method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of
proforma disclosures for either (a) all prior periods presented or (b) prior interim periods of the year of adoption.



The Company will adopt the provisions of Statement 123(R) on January 1, 2006, using the modified prospective method. Unvested stock-based awards issued prior to May 14,
2004 and disclosed in the financial statements using the minimum value method (rather than the estimated fair value using the Black-Sholes option pricing model) will be 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 June 30, 2005 that have not vested will be accounted for at the date of adoption using the same estimate of the grant-date fair value disclosed in the historical
financial statements. See also Note 1, Stock-Based Compensation.



As
permitted by Statement 123, the Company currently accounts for share-based payments to employees using the intrinsic value method and, as such, recognizes no compensation cost when employee stock options are granted with exercise prices equal to the
market price of the shares on the date of grant. Accordingly, the adoption of Statement 123(R)s fair value method may have a significant impact on the Companys results of operations, although it will have no impact on our financial
position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend significantly on levels of share-based payments granted in the future.



Cash retained as a result of excess tax benefits relating to share-based payments will be presented in the statement of cash flows as
financing cash inflows. Previously, the cash retained from excess tax benefits was presented in operating cash flows along with other tax cash flows.



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. Refer to Note 1 within Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2004 for further information on accounting policies related to
derivative financial instruments.



Foreign Currency Risk



In the first quarter of 2005, approximately 9% 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 our exchange rate exposure to operating margins. A hypothetical 10% adverse change in average annual foreign currency movements would have decreased both net income and cash flows for the three months
ended March 31, 2005 by $0.1 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 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 $2.1 million at March 31, 2005.



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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 of the Notes to Consolidated Financial Statements (Unaudited) of
Educate, Inc. in this Quarterly report on Form 10-Q, provides information on our significant indebtedness. The total notional amount of interest rate swaps at March 31, 2005 was $50.0 million, representing a settlement asset of $0.9 million.
Assuming average variable rate debt levels, a one percentage point increase in interest rates would have increased interest expense by approximately $0.2 million in the three months ended March 31, 2005.



All the potential impacts noted above are based on sensitivity analysis performed on our
financial position at March 31, 2005. 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(c) and 15d-15e of the Securities
Exchange Act of 1934, as amended) as of March 31, 2005. 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. 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 March
31, 2005, and has concluded that there was no change that occurred during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, the Companys internal controls over financial reporting.



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 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



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ITEM 6. EXHIBITS



|            |  |                                                                                                                                                                                                                                                                                                                                                                                 
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|IndexNumber |  |                                                                                                                                                                                                                                                                                                                                                                                 
|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)                                                                                                                                                                                                                                                                                                       
|            | 
|10.1        |  | $170,000,000 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.                                                                                   
|            | 
|10.2        |  | First Amendment, dated as of April 28, 2005, to the Guarantee and Collateral Agreement, dated as of April 27, 2004, among Educate, Inc., Educate Operating Company, LLC and the other
guarantors party thereto in favor of JP Morgan Chase Bank, N.A. as administrative agent for the banks and other financial institutions party to the Amended and Restated Credit Agreement.
|            | 
|31.1        |  | Certification of R. Christopher Hoehn-Saric pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                           
|            | 
|31.2        |  | Certification of Kevin 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 Shaffer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                        

---

|(1) | Incorporated by reference to the Registrants Registration Statement on Form 8-A filed on September 22, 2004.
|--- | -------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the Registrants Registration Statement originally filed on May 14, 2004 and declared effective on September 22, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------



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Educate, Inc.



SIGNATURE



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.                            
|                   | 
|Date: May 16, 2005 |  | /s/ Kevin E. Shaffer                     
|                   |  | Kevin E. Shaffer, Chief Financial Officer



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