##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended July 31, 2002

Commission File Number 0-20842

PLATO LEARNING, INC.

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|                                                    |  |                       
|--------------------------------------------------- |  | ----------------------
|Delaware                                            |  | 36-3660532            
|                                                    |  |                       
|(State or other jurisdiction                        |  | (I.R.S. Employer      
|of incorporation or organization)                   |  | Identification Number)
|                                                    |  |                       
|10801 Nesbitt Avenue South, Bloomington, MN         |  | 55437                 
|                                                    |  |                       
|(Address of principal executive offices)            |  | (Zip Code)            
|                                                    |  |                       
|Registrants telephone number, including area code: |  | (952) 832-1000        
|                                                    |  |                       

Not Applicable

---

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 the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date.

|                             |  |                                  
|---------------------------- |  | ---------------------------------
|Common stock, $.01 par value |  | 16,422,628 shares                
|                             |  |                                  
|Class                        |  | Outstanding as of August 31, 2002

(This document contains 30 pages)

1



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TABLE OF CONTENTS



|                                           |                                                                                               |                                       |  |  |  |  |  | 
|------------------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION             
|                                           | Item 1. Consolidated Financial Statements                                                    
|                                           |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS
|                                           |                                                                                               | CONSOLIDATED BALANCE SHEETS          
|                                           |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                           | Item 2. Managements Discussion and Analysis of Results of Operations and Financial Condition
|                                           | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                                           | Item 4. Internal Controls                                                                    
|PART II. OTHER INFORMATION                
|                                           | Item 1. Legal Proceedings                                                                    
|                                           | Item 2. Changes in Securities                                                                
|                                           | Item 3. Defaults Upon Senior Securities                                                      
|                                           | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                                           | Item 5. Other Information                                                                    
|                                           | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                
|CERTIFICATIONS                            
|Form 10-Q for Quarter Ending July 31, 2002



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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries

INDEX

|               |  |                                                                                       |  |                                                                                                  |    |        |   | 
|-------------- |  | ------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------ | -- | ------ | - | 
|               |  |                                                                                       |  |                                                                                                  |    | Page  
|               |  |                                                                                       |  |                                                                                                  |    | Number
|               |  |                                                                                       |  |                                                                                                  |    |       
|PART I.        |  | FINANCIAL INFORMATION                                                                 |  |                                                                                                  |    |       
|Item 1.        |  | Consolidated Financial Statements (Unaudited):                                        |  |                                                                                                  |    |       
|               |  |                                                                                       |  | Consolidated Statements of Operations for the
Three and Nine Months Ended July 31, 2002 and 2001 |    |        | 3 | 
|               |  |                                                                                       |  | Consolidated Balance Sheets as of
July 31, 2002 and October 31, 2001                             |    |        | 4 | 
|               |  |                                                                                       |  | Consolidated Statements of Cash Flows for the
Nine Months Ended July 31, 2002 and 2001           |    |        | 5 | 
|               |  |                                                                                       |  | Notes to Consolidated Financial Statements                                                       |    |        | 6 | 
|Item 2.        |  | Managements Discussion and Analysis of
Results of Operations and Financial Condition |  |                                                                                                  | 15 |       
|Item 3.        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |                                                                                                  | 27 |       
|Item 4.        |  | Internal Controls                                                                     |  |                                                                                                  | 27 |       
|PART II.       |  | OTHER INFORMATION                                                                     |  |                                                                                                  |    |       
|Item 1.        |  | Legal Proceedings                                                                     |  |                                                                                                  | 28 |       
|Item 2.        |  | Changes in Securities                                                                 |  |                                                                                                  | 28 |       
|Item 3.        |  | Defaults Upon Senior Securities                                                       |  |                                                                                                  | 28 |       
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                   |  |                                                                                                  | 28 |       
|Item 5.        |  | Other Information                                                                     |  |                                                                                                  | 28 |       
|Item 6.        |  | Exhibits and Reports on Form 8-K                                                      |  |                                                                                                  | 28 |       
|SIGNATURES     |  |                                                                                       |  |                                                                                                  | 29 |       
|CERTIFICATIONS |  |                                                                                       |  |                                                                                                  | 30 |       

2



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##### Table of Contents












PART I. FINANCIAL INFORMATION

PLATO LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)

|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |        |        |       | 
|------------------------------------------- | --------------------------------------------- | ------------------------ | ----------------------------------- | ------ | ------------------ | ---- | ----- | ----------------- | ------ | ----- | ---- | ------ | ------ | ------ | ----- | ------ | ------ | ----- | 
|                                            |                                               |                          |                                     |        | Three Months Ended |      |       | Nine Months Ended |       
|                                            |                                               |                          |                                     |        | July 31,           |      |       | July 31,          |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |       
|                                            |                                               |                          |                                     |        | 2002               |      |       | 2001              |        |       | 2002 |        |        | 2001   |      
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |      
|Revenues:                                   |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |       
|                                            | License fees                                  |                          | $                                   | 15,509 |                    |      | $     | 19,903            |        |       | $    | 39,509 |        |        | $     | 39,572 |       
|                                            | Services                                      |                          |                                     | 2,880  |                    |      |       | 1,896             |        |       |      | 8,067  |        |        |       | 5,517  |       
|                                            | Other                                         |                          |                                     | 1,217  |                    |      |       | 1,004             |        |       |      | 3,289  |        |        |       | 2,832  |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               | Total revenues           |                                     |        | 19,606             |      |       |                   | 22,803 |       |      |        | 50,865 |        |       |        | 47,921 |      
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|Cost of revenues:                           |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |       
|                                            | License fees                                  |                          |                                     | 854    |                    |      |       | 624               |        |       |      | 2,637  |        |        |       | 1,319  |       
|                                            | Services                                      |                          |                                     | 481    |                    |      |       | 233               |        |       |      | 1,058  |        |        |       | 743    |       
|                                            | Other                                         |                          |                                     | 954    |                    |      |       | 810               |        |       |      | 2,717  |        |        |       | 2,553  |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               | Total cost of revenues   |                                     |        | 2,289              |      |       |                   | 1,667  |       |      |        | 6,412  |        |       |        | 4,615  |      
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               | Gross profit             |                                     |        | 17,317             |      |       |                   | 21,136 |       |      |        | 44,453 |        |       |        | 43,306 |      
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|Operating expenses:                         |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |       
|                                            | Selling, general and administrative           |                          |                                     | 13,372 |                    |      |       | 11,950            |        |       |      | 36,848 |        |        |       | 30,844 |       
|                                            | Product development and customer support      |                          |                                     | 3,899  |                    |      |       | 2,238             |        |       |      | 9,257  |        |        |       | 6,070  |       
|                                            | Amortization of intangibles                   |                          |                                     | 343    |                    |      |       | 818               |        |       |      | 705    |        |        |       | 1,412  |       
|                                            | Purchased in-process research and development |                          |                                     | 360    |                    |      |       |                  |        |       |      | 360    |        |        |       |       |       
|                                            | Special charges                               |                          |                                     |       |                    |      |       |                  |        |       |      |       |        |        |       | 1,260  |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               | Total operating expenses |                                     |        | 17,974             |      |       |                   | 15,006 |       |      |        | 47,170 |        |       |        | 39,586 |      
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               |                          | Operating profit (loss)             |        |                    | (657 | )     |                   |        | 6,130 |      |        |        | (2,717 | )     |        |        | 3,720 | 
|Interest income                             |                                               |                          | 171                                 |        |                    |      | 313   |                   |        |       | 728  |        |        |        | 344   |       
|Interest expense                            |                                               |                          | (34                                 | )      |                    |      | (273  | )                 |        |       | (107 | )      |        |        | (428  | )     
|Other expense, net                          |                                               |                          | (30                                 | )      |                    |      | (10   | )                 |        |       | (139 | )      |        |        | (107  | )     
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               |                          | Earnings (loss) before income taxes |        |                    | (550 | )     |                   |        | 6,160 |      |        |        | (2,235 | )     |        |        | 3,529 | 
|Income tax expense (benefit)                |                                               |                          | (350                                | )      |                    |      | 2,587 |                   |        |       | (975 | )      |        |        | 1,482 |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            |                                               |                          | Net earnings (loss)                 |        | $                  | (200 | )     |                   | $      | 3,573 |      |        | $      | (1,260 | )     |        | $      | 2,047 | 
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|Earnings (loss) per share:                  |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |       
|                                            | Basic                                         |                          | $                                   | (0.01  | )                  |      | $     | 0.24              |        |       | $    | (0.08  | )      |        | $     | 0.17   |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            | Diluted                                       |                          | $                                   | (0.01  | )                  |      | $     | 0.22              |        |       | $    | (0.08  | )      |        | $     | 0.15   |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|Weighted average common shares outstanding: |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |        |        |        |       |       
|                                            | Basic                                         |                          |                                     | 16,676 |                    |      |       | 14,758            |        |       |      | 16,512 |        |        |       | 12,390 |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       
|                                            | Diluted                                       |                          |                                     | 16,676 |                    |      |       | 15,953            |        |       |      | 16,512 |        |        |       | 13,416 |       
|                                            |                                               |                          |                                     |        |                    |      |       |                   |        |       |      |       

See Notes to Consolidated Financial Statements

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PLATO LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)

|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |             |       |         |             |  |  | 
|--------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------ | ------- | ------- | ----------- | ----- | ------- | ----------- |  |  | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         | July 31,    |       |         | October 31, | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         | 2002        |       |         | 2001        | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |             |       |         |             | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         | (Unaudited) |       |         | (See Note)  | 
|                      |                                                                                                                                                                                                     |                                            |                                      | ASSETS  |         |             |       |         |             |  |  | 
|Current assets:       |                                                                                                                                                                                                     |                                            |                                      |         |         |             |       |        
|                      | Cash and cash equivalents                                                                                                                                                                           |                                            | $                                    | 32,827  |         |             | $     | 61,568  |            
|                      | Accounts receivable, less allowance of $2,877
and $2,545, respectively                                                                                                                              |                                            |                                      | 30,212  |         |             |       | 28,739  |            
|                      | Prepaid expenses and other current assets                                                                                                                                                           |                                            |                                      | 2,611   |         |             |       | 1,317   |            
|                      | Deferred income taxes                                                                                                                                                                               |                                            |                                      | 2,468   |         |             |       | 2,468   |            
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total current assets                       |                                      |         | 68,118  |             |       |         | 94,092      | 
|                      | Equipment and leasehold improvements, less accumulated
depreciation and amortization of $4,954 and $3,829, respectively                                                                             |                                            |                                      | 5,119   |         |             |       | 2,803   |            
|                      | Product development costs, less accumulated amortization
of $15,115 and $12,094, respectively                                                                                                       |                                            |                                      | 11,992  |         |             |       | 9,949   |            
|                      | Deferred income taxes                                                                                                                                                                               |                                            |                                      | 8,375   |         |             |       | 6,832   |            
|                      | Goodwill                                                                                                                                                                                            |                                            |                                      | 38,486  |         |             |       | 16,152  |            
|                      | Identified intangible assets, less accumulated amortization of $1,531
and $601, respectively                                                                                                        |                                            |                                      | 7,904   |         |             |       | 3,634   |            
|                      | Other assets                                                                                                                                                                                        |                                            |                                      | 1,968   |         |             |       | 2,449   |            
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total assets                               |                                      | $       | 141,962 |             |       | $       | 135,911     | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     |                                            | LIABILITIES AND STOCKHOLDERS EQUITY |         |         |             |       |         |             |  | 
|Current liabilities:  |                                                                                                                                                                                                     |                                            |                                      |         |         |             |       |        
|                      | Current portion of long-term debt                                                                                                                                                                   |                                            | $                                    | 316     |         |             | $     | 242     |            
|                      | Accounts payable                                                                                                                                                                                    |                                            |                                      | 2,115   |         |             |       | 2,216   |            
|                      | Accrued employee salaries and benefits                                                                                                                                                              |                                            |                                      | 4,836   |         |             |       | 4,539   |            
|                      | Accrued liabilities                                                                                                                                                                                 |                                            |                                      | 4,184   |         |             |       | 3,883   |            
|                      | Deferred revenue                                                                                                                                                                                    |                                            |                                      | 12,944  |         |             |       | 9,163   |            
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total current liabilities                  |                                      |         | 24,395  |             |       |         | 20,043      | 
|Long-term debt        |                                                                                                                                                                                                     |                                            | 638                                  |         |         |             | 720   |        
|Deferred revenue      |                                                                                                                                                                                                     |                                            | 1,794                                |         |         |             | 1,170 |        
|Other liabilities     |                                                                                                                                                                                                     |                                            | 25                                   |         |         |             | 79    |        
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total liabilities                          |                                      |         | 26,852  |             |       |         | 22,012      | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|Stockholders equity: |                                                                                                                                                                                                     |                                            |                                      |         |         |             |       |        
|                      | Common stock, $.01 par value, 50,000 shares
authorized; 17,649 shares issued and 16,418 shares
outstanding at July 31, 2002; 16,689 shares issued
and 16,411 shares outstanding at October 31, 2001 |                                            |                                      | 164     |         |             |       | 164     |            
|                      | Paid-in capital                                                                                                                                                                                     |                                            |                                      | 127,086 |         |             |       | 113,767 |            
|                      | Treasury stock at cost, 1,231 and 278 shares, respectively                                                                                                                                          |                                            |                                      | (15,993 | )       |             |       | (4,914  | )          
|                      | Retained earnings                                                                                                                                                                                   |                                            |                                      | 4,526   |         |             |       | 5,786   |            
|                      | Accumulated other comprehensive loss                                                                                                                                                                |                                            |                                      | (673    | )       |             |       | (904    | )          
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total stockholders equity                 |                                      |         | 115,110 |             |       |         | 113,899     | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            
|                      |                                                                                                                                                                                                     | Total liabilities and stockholders equity |                                      | $       | 141,962 |             |       | $       | 135,911     | 
|                      |                                                                                                                                                                                                     |                                            |                                      |         |         |            

Note: The balance sheet at October 31, 2001 has been derived from the audited financial
statements at that date. See Notes to Consolidated Financial Statements.

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PLATO LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |        |        |        |       | 
|---------------------------------------------------- | ------------------------------------------------------------------------------------------ | ----------------------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------- | ------- | ----------------- | ------ | ------ | ------ | ------ | ----- | 
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         | Nine Months Ended |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         | July 31,          |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         | 2002              |        |        | 2001   |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |        |        |       
|Operating activities:                                |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |       
|                                                     | Net earnings (loss)                                                                        |                                                                   | $                                                                                 | (1,260                                    | )       |                   | $      | 2,047  |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|                                                     | Adjustments to reconcile net earnings (loss) to net cash provided by
operating activities: |                                                                   |                                                                                   |                                           |         |                   |        |        |       
|                                                     |                                                                                            | Depreciation and amortization                                     |                                                                                   |                                           | 5,119   |                   |        |        | 4,394  |       
|                                                     |                                                                                            | Deferred income taxes                                             |                                                                                   |                                           | (975    | )                 |        |        | 1,482  |       
|                                                     |                                                                                            | Provision for doubtful accounts                                   |                                                                                   |                                           | 1,501   |                   |        |        | 1,035  |       
|                                                     |                                                                                            | Purchased in-process research and development                     |                                                                                   |                                           | 360     |                   |        |        |       |       
|                                                     |                                                                                            | Stock-based compensation                                          |                                                                                   |                                           | 45      |                   |        |        | 556    |       
|                                                     |                                                                                            | Loss on disposal of equipment                                     |                                                                                   |                                           | 100     |                   |        |        | 29     |       
|                                                     |                                                                                            | Changes in assets and liabilities, net of effect of acquisitions: |                                                                                   |                                           |         |                   |        |        |        |       
|                                                     |                                                                                            |                                                                   | Accounts receivable                                                               |                                           |         | (2,655            | )      |        |        | (6,878 | )    
|                                                     |                                                                                            |                                                                   | Prepaid expenses and other current and noncurrent assets                          |                                           |         | 58                |        |        |        | (972   | )    
|                                                     |                                                                                            |                                                                   | Accounts payable                                                                  |                                           |         | (2,578            | )      |        |        | (276   | )    
|                                                     |                                                                                            |                                                                   | Accrued liabilities, accrued employee salaries and benefits
and other liabilities |                                           |         | 109               |        |        |        | (1,433 | )    
|                                                     |                                                                                            |                                                                   | Deferred revenue                                                                  |                                           |         | 624               |        |        |        | 2,655  |      
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|                                                     |                                                                                            |                                                                   |                                                                                   | Total adjustments                         |         |                   | 1,708  |        |        |        | 592   | 
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|                                                     |                                                                                            |                                                                   |                                                                                   | Net cash provided by operating activities |         |                   | 448    |        |        |        | 2,639 | 
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Investing activities:                                |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |       
|                                                     | Acquisitions,
net of cash acquired of $153 and $279                                        |                                                                   |                                                                                   | (9,310                                    | )       |                   |        | (4,327 | )     
|                                                     | Capitalization of product development costs                                                |                                                                   |                                                                                   | (5,014                                    | )       |                   |        | (3,541 | )     
|                                                     | Capital expenditures                                                                       |                                                                   |                                                                                   | (2,592                                    | )       |                   |        | (811   | )     
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|                                                     |                                                                                            |                                                                   | Net cash used in investing activities                                             |                                           |         | (16,916           | )      |        |        | (8,679 | )    
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Financing activities:                                |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |       
|                                                     | Net proceeds from issuance of common stock                                                 |                                                                   |                                                                                   | 1,277                                     |         |                   |        | 57,603 |       
|                                                     | Repurchase of common stock                                                                 |                                                                   |                                                                                   | (11,089                                   | )       |                   |        |       |       
|                                                     | Repayments of bank debt                                                                    |                                                                   |                                                                                   | (2,366                                    | )       |                   |        |       |       
|                                                     | Repayments of capital lease obligations                                                    |                                                                   |                                                                                   | (233                                      | )       |                   |        | (138   | )     
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|                                                     |                                                                                            | Net cash provided by (used in) financing activities               |                                                                                   |                                           | (12,411 | )                 |        |        | 57,465 |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Effect of foreign currency on cash                   |                                                                                            |                                                                   | 138                                                                               |                                           |         |                   | (99    | )     
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Net increase (decrease) in cash and cash equivalents |                                                                                            |                                                                   | (28,741                                                                           | )                                         |         |                   | 51,326 |       
|Cash and cash equivalents at beginning of period     |                                                                                            |                                                                   | 61,568                                                                            |                                           |         |                   | 6,415  |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Cash and cash equivalents at end of period           |                                                                                            | $                                                                 | 32,827                                                                            |                                           |         | $                 | 57,741 |       
|                                                     |                                                                                            |                                                                   |                                                                                   |                                           |         |                  
|Cash paid for interest                               |                                                                                            | $                                                                 | 138                                                                               |                                           |         | $                 | 240    |       
|Cash paid for income taxes                           |                                                                                            |                                                                   | 58                                                                                |                                           |         |                   | 418    |       
|Non-cash investing and financing activities:         |                                                                                            |                                                                   |                                                                                   |                                           |         |                   |        |       
|                                                     | Common stock and warrants issued for acquisition                                           |                                                                   |                                                                                   | 11,497                                    |         |                   |        | 12,000 |       
|                                                     | Assets acquired in acquisition                                                             |                                                                   |                                                                                   | 2,480                                     |         |                   |        | 595    |       
|                                                     | Liabilities assumed in acquisition                                                         |                                                                   |                                                                                   | 9,232                                     |         |                   |        | 557    |       
|                                                     | Capital lease obligations incurred                                                         |                                                                   |                                                                                   | 85                                        |         |                   |        | 733    |       
|                                                     | Debt converted to common stock                                                             |                                                                   |                                                                                   |                                          |         |                   |        | 600    |       
|                                                     | Stock option exercises using common stock                                                  |                                                                   |                                                                                   |                                          |         |                   |        | 3,620  |       

See Notes to Consolidated Financial Statements

5



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                                                                  
|-- |  | -----------------------------------------------------------------
|1. |  | NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

PLATO Learning, Inc. and its subsidiaries provide computer-based and e-learning
instruction software and related services, offering basic to advanced level
courseware in reading, writing, math, science, social studies and life and job
skills. Our PLATO® Learning System and PLATO® Web Learning Network provide more
than 3,500 hours of objective-based, problem solving courseware and include
assessment, alignment and management tools to create standards-based curricula
and facilitate the learning process. PLATO courseware is delivered via
networks, CD-ROM, private intranets and the Internet. In addition, single
topic PLATO courseware is available through our e-commerce Web site and
distributors. We market our courseware products and services to K-12 schools,
colleges, job training programs, correctional institutions, military education
programs, corporations and individuals.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States of America for interim financial information and with the instructions
to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. We have included all normal recurring adjustments considered
necessary to give a fair presentation of our operating results for the interim
periods shown. Operating results for these interim periods are not necessarily
indicative of the results to be expected for the full fiscal year. For further
information, refer to the consolidated financial statements and accompanying
notes included in our Annual Report on Form 10-K for the fiscal year ended
October 31, 2001.

Certain reclassifications of previously reported amounts have been made to
conform to the current year presentation and had no impact on net earnings
(loss), cash flows or stockholders equity.

Revenue Recognition

We recognize revenue in accordance with the provisions of Statement of Position
No. 97-2, Software Revenue Recognition, as amended and modified, as well as
Technical Practice Aids issued from time to time by the American Institute of
Certified Public Accountants, and Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements.

Revenue from the sale of courseware licenses and computer hardware is
recognized upon meeting the following criteria: (i) a written customer order
is executed, (ii) courseware and hardware are delivered, (iii) the license fee
is fixed or determinable and (iv) collectibility of the

6Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                                                                             
|-- |  | ----------------------------------------------------------------------------
|1. |  | NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued

Revenue Recognition, Continued

proceeds is probable. For software arrangements that include more than one
element, we allocate the total arrangement fee among each deliverable based on
vendor-specific objective evidence of the relative fair value of each
deliverable. Vendor-specific objective evidence of fair value is determined
using the price charged when that element is sold separately. Upon delivery,
future service costs, if any, are accrued. Future service costs represent our
problem resolution and support hotline services for a one-year period.
Service revenue includes software support, which is deferred and recognized
ratably over the support period, and revenue from installation and training
services, which is recognized as services are performed. Installation and
training services are customarily billed at a fixed daily rate. Deferred
revenue represents the portion of billings made or payments received in advance
of services being performed or products being delivered.

Product Development, Enhancement and Maintenance Costs

Costs incurred in the development, enhancement and routine maintenance of our
current generation courseware products are expensed as incurred. Costs
incurred in establishing the technological feasibility of new courseware
products are expensed as incurred. Once technological feasibility has been
established, costs incurred in the development of new generation courseware
products are capitalized. Technological feasibility is established when we
have completed all planning, designing, coding and testing activities necessary
to establish that a product can be produced to meet its design specifications.

Capitalized costs are amortized to product development and customer support
expense over the estimated useful life of the new courseware products, which is
generally three years. Amortization begins when the product is available for
general release to our customers. Unamortized costs determined to be in excess
of the net realizable value of the product, if any, are expensed at the date of
such determination.

Amortization expense related to capitalized product development costs was
$1,066 and $863 for the three months and $3,006 and $2,114 for the nine months
ended July 31, 2002 and 2001, respectively.

Earnings (Loss) Per Share

Basic earnings (loss) per share is calculated by dividing net earnings (loss)
by the weighted average number of common shares outstanding during the period.
Diluted earnings (loss) per share is calculated by dividing net earnings (loss)
by the weighted average number of common and, where dilutive, potential common
shares outstanding during the period. Potential common shares include options
and warrants.

7



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |             
|-- |  | ------------
|2. |  | ACQUISITIONS

NetSchools Corporation

In May 2002, we acquired NetSchools Corporation (NetSchools), a provider of
Internet-based e-learning software and services solutions for the K-12 market.
NetSchools offers a web-based curriculum and instructional management delivery
platform that facilitates delivery of school curriculum aligned to local, state
and national standards and facilitates online assessment, lesson planning and
content delivery. This acquisition will enhance our ability to provide
enterprise-wide solutions that align classroom education across all standards
and deliver compelling and effective content through NetSchools instructional
management platform.

We acquired all the shares of NetSchools for $6,050 in cash; 800,000 shares of
our common stock; 200,000 warrants to purchase shares of our common stock at
$17.00 per share through May 9, 2007; assumed liabilities and transaction
expenses; and additional consideration of up to approximately $6,000,
contingent on the NetSchools product and services revenues generated through
October 2004. If earned, any additional consideration will be recorded as
additional goodwill.

The purchase price consisted of the following components:

|                             |  |   |        | 
|---------------------------- |  | - | ------ | 
|Common stock issued          |  | $ | 10,528 | 
|Cash paid                    |  |   | 6,050  | 
|Direct acquisition fees      |  |   | 3,575  | 
|Liabilities assumed          |  |   | 9,232  | 
|Common stock warrants issued |  |   | 969    | 
|                             |  |   |       
|                             |  | $ | 30,354 | 
|                             |  |   |       

The allocation of the total purchase price, including acquisition fees, was as
follows:

|                                                     |  |   |        | 
|---------------------------------------------------- |  | - | ------ | 
|Estimated fair value of tangible assets acquired     |  | $ | 2,480  | 
|Estimated fair value of identified intangible assets |  |   | 5,200  | 
|Goodwill                                             |  |   | 22,314 | 
|Purchased in-process research and development        |  |   | 360    | 
|                                                     |  |   |       
|                                                     |  | $ | 30,354 | 
|                                                     |  |   |       

The NetSchools acquisition was accounted for under SFAS 141 using the purchase
method of accounting and, accordingly, the assets and liabilities acquired were
recorded at their estimated fair values on the acquisition date.

Direct acquisition fees consisted of $1,700 for investment banking, legal and
professional fees, $1,125 for NetSchools change-in-control and management
incentive payments, and $750 for lease termination costs. Substantially all of
these fees have been paid as of July 31, 2002.

8



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                        
|-- |  | -----------------------
|2. |  | ACQUISITIONS, Continued

NetSchools Corporation, Continued

In connection with this acquisition, we developed plans for employee
relocations and workforce and facility reductions. The aggregate
estimated costs of these plans are $767 which consisted of $315
related to the elimination of 39 positions, $282 related to lease
termination and $170 related to employee relocation. As of July 31,
2002, severance payments of $79 had been made related to the
termination of ten of these employees, and payments of $137 and $20
had been made related to lease termination and employee relocation,
respectively. We expect to complete these activities within one
year from the acquisition date. Until these activities are completed, the
allocation of the purchase price is preliminary and subject to adjustment.

Total cash usage related to this acquisition in 2002 is expected to be
approximately $12,000 which includes $6,050 cash paid as part of the purchase
price, $3,575 in direct acquisition fees, and $2,366 of NetSchools bank debt
repaid subsequent to the closing date of the acquisition.

The valuation of identified intangible assets, consisting of a customer list,
acquired technology and in-process research and development, was performed by
an independent appraisal firm. Goodwill and intangible assets are subject to
the provisions of SFAS 142. Goodwill will not be amortized; however, it will be
tested for impairment on an annual basis. The customer list and acquired
technology are being amortized over five to seven years.

At the date of acquisition, $360 of the purchase price was expensed for
purchased in-process research and development related to a new version of
NetSchools Orion product, which had not yet reached technological feasibility
and had no alternative future use. The Orion product is an online tool for
curriculum management and correlation to state education standards. The value
assigned to this in-process research and development was determined by
estimating the total costs required to develop the new product. At the
acquisition date, the new Orion product was approximately 67% complete and is
expected to be completed in 2002 at an estimated cost of approximately $200.

Unaudited ProForma Data

In April 2001, we acquired Wasatch Interactive Learning Corporation
(Wasatch). For further information regarding this acquisition, refer to Note
2 of Notes to Consolidated Financial Statements included in our Annual Report
on Form 10-K for the fiscal year ended October 31, 2001.

The operating results of Wasatch and NetSchools were included in our
consolidated statements of operations from the date of acquisition. Our
unaudited pro forma consolidated results of

9



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                        
|-- |  | -----------------------
|2. |  | ACQUISITIONS, Continued

Unaudited ProForma Data,Continued

operations, as if the Wasatch and NetSchools acquisitions had occurred at the
beginning of the periods presented, were as follows:

|                       |  |                            |        |   |      |   |        |  
|---------------------- |  | -------------------------- | ------ | - | ---- | - | ------ | -
|                       |  | Nine Months Ended July 31, |       
|                       |  |                            |       
|                       |  | 2002                       |        |   | 2001 |  
|                       |  |                            |        |   |      |  
|Revenues               |  | $                          | 56,302 |   |      | $ | 60,887 |  
|Net loss               |  |                            | (6,017 | ) |      |   | (9,951 | )
|Diluted loss per share |  |                            | (0.35  | ) |      |   | (0.73  | )

The unaudited pro forma consolidated results of operations are for comparative
purposes only and do not necessarily reflect the results that would have
occurred had the acquisitions occurred at the beginning of the periods
presented or the results which may occur in the future.

|   |  |                    
|-- |  | -------------------
|3. |  | ACCOUNTS RECEIVABLE

Accounts receivable include installment receivables of $17,460 and $16,087 at
July 31, 2002 and October 31, 2001, respectively. Installment receivables to
be billed beyond one year from the balance sheet date were $1,622 and $2,021 at
July 31, 2002 and October 31, 2001, respectively, and are included in other
assets on the consolidated balance sheets.

|   |  |                                     
|-- |  | ------------------------------------
|4. |  | GOODWILL AND OTHER INTANGIBLE ASSETS

Effective November 1, 2001, we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142).

Goodwill

Under SFAS 142, goodwill is no longer amortized to expense and must be
periodically reviewed for impairment with any related losses recognized when
incurred. We have completed the transitional impairment test of goodwill as of
November 1, 2001 and the carrying value of goodwill was not impaired. The
carrying value of our goodwill was $16,152 at November 1, 2001 and $38,486 at
July 31, 2002. At July 31, 2002, our goodwill was not impaired; however,
subsequent to that date, the market value of our common stock had declined to a
point where our market capitalization was below our net book value. This may
indicate a potential impairment of our goodwill if the market value of our
common stock does not increase.

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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                                                
|-- |  | -----------------------------------------------
|4. |  | GOODWILL AND OTHER INTANGIBLE ASSETS, Continued

Goodwill,Continued

For the three and nine months ended July 31, 2001, $663 and $1,077 of goodwill
amortization expense was recorded. The following table presents the impact of
SFAS 142 on net income (loss) and the related per share amounts as if it had
been in effect for the three and nine months ended July 31, 2001:

|                                            |  |                    |       |  |                   |           |      |  |         |   |      |  |           |   |       |       |  |   |         |  |  |   |      | 
|------------------------------------------- |  | ------------------ | ----- |  | ----------------- | --------- | ---- |  | ------- | - | ---- |  | --------- | - | ----- | ----- |  | - | ------- |  |  | - | ---- | 
|                                            |  | Three Months Ended |       |  | Nine Months Ended |          
|                                            |  | July 31, 2001      |       |  | July 31, 2001     |          
|                                            |  |                    |       |  |                   |          
|                                            |  |                    |       |  |                   | Per Share |      |  |         |   |      |  | Per Share |  
|                                            |  |                    |       |  |                   |           |      |  |         |   |      |  |           |  
|                                            |  |                    |       |  |                   | Basic     |      |  | Diluted |   |      |  |           |   |       | Basic |  |   | Diluted | 
|                                            |  |                    |       |  |                   |           |      |  |         |   |      |  |           |   |       |       |  |   |         | 
|Reported net income (loss)                  |  | $                  | 3,573 |  |                   | $         | 0.24 |  |         | $ | 0.22 |  |           | $ | 2,047 |       |  | $ | 0.17    |  |  | $ | 0.15 | 
|Add back goodwill amortization (net of tax) |  |                    | 385   |  |                   |           | 0.03 |  |         |   | 0.03 |  |           |   | 625   |       |  |   | 0.05    |  |  |   | 0.05 | 
|                                            |  |                    |       |  |                   |           |      |  |         |   |      |  |           |   |       |       |  |  
|Adjusted net income (loss)                  |  | $                  | 3,958 |  |                   | $         | 0.27 |  |         | $ | 0.25 |  |           | $ | 2,672 |       |  | $ | 0.22    |  |  | $ | 0.20 | 
|                                            |  |                    |       |  |                   |           |      |  |         |   |      |  |           |   |       |       |  |  

Other Intangible Assets

Acquired intangible assets subject to amortization at July 31, 2002 were as
follows:

|                      |  |                |       |  |              |   |       |                    |  |   |       | 
|--------------------- |  | -------------- | ----- |  | ------------ | - | ----- | ------------------ |  | - | ----- | 
|                      |  | Gross Carrying |       |  | Accumulated  |   |       |                    |  |  
|                      |  | Value          |       |  | Amortization |   |       | Net Carrying Value | 
|                      |  |                |       |  |              |   |       |                    | 
|Acquired technology   |  | $              | 6,252 |  |              | $ | 659   |                    |  | $ | 5,593 | 
|Trademark             |  |                | 1,380 |  |              |   | 394   |                    |  |   | 986   | 
|Customer lists        |  |                | 1,300 |  |              |   | 276   |                    |  |   | 1,024 | 
|Employment agreement  |  |                | 413   |  |              |   | 112   |                    |  |   | 301   | 
|Noncompete agreements |  |                | 90    |  |              |   | 90    |                    |  |   |      | 
|                      |  |                |       |  |              |   |       |                    | 
|                      |  | $              | 9,435 |  |              | $ | 1,531 |                    |  | $ | 7,904 | 
|                      |  |                |       |  |              |   |       |                    | 

Amortization expense for intangible assets was $418 and $930 for the three and
nine months ended July 31, 2002, respectively, of which $75 and $225 was
included in product development and customer support expense for each period.
Amortization expense for the three and nine months ended July 31, 2001 was $230
and $435, respectively, of which $75 and $100 was included in product
development and customer support expense for each period.

The estimated annual amortization expense for intangible assets is as follows:

|           |  |   |       | 
|---------- |  | - | ----- | 
|2002       |  | $ | 1,354 | 
|2003       |  |   | 1,697 | 
|2004       |  |   | 1,522 | 
|2005       |  |   | 1,263 | 
|2006       |  |   | 1,078 | 
|Thereafter |  |   | 1,920 | 
|           |  |   |      
|           |  | $ | 8,834 | 
|           |  |   |      

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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |     
|-- |  | ----
|5. |  | DEBT

Revolving Loan

We closed a new revolving loan agreement on December 20, 2001 that provides for
a maximum $12,500 line of credit through July 1, 2003. Substantially all of
our assets are pledged as collateral under the agreement.

Borrowings are limited by the available borrowing base, as defined, consisting
of certain accounts receivable and bear interest at the prime rate plus 0.25%
or the London Interbank Offered Rate (LIBOR) plus 1.75 to 2.75%, depending on
cash flow leverage, as defined, at our option pursuant to the agreement. A
commitment fee is payable quarterly based on the unused portion of the line of
credit.

The agreement contains restrictive financial covenants (including Minimum
Tangible Net Worth, Minimum Debt Service Coverage, Maximum Leverage, Maximum
Cash Flow Leverage, Minimum Current Ratio and Maximum Annual Capital
Expenditures) and restrictions on additional borrowings, asset sales and
dividends, as defined. We did not comply with the Minimum Debt Coverage
covenant for the period ended July 31, 2002 and we received a waiver from our
lender covering this noncompliance for such period.

At July 31, 2002, there were no borrowings outstanding under the revolving loan
agreement and our unused borrowing capacity was $12,500.

Capital Lease Obligations

At July 31, 2002, our only debt consisted of various capital lease obligations
for equipment. Amounts due in the next twelve months under these leases are
classified as a current liability in the consolidated balance sheets.

|   |  |                     
|-- |  | --------------------
|6. |  | STOCKHOLDERS EQUITY

We issued approximately 166,000 shares of our common stock upon the exercise of
outstanding stock options during the nine months ended July 31, 2002.

In May 2002, we issued 800,000 shares of our common stock and warrants to
purchase 200,000 shares of our common stock at $17.00 per share through May 9,
2007 in connection with the acquisition of NetSchools (see Note 2). The
warrants were assigned a value of $969 using the Black-Scholes option pricing
model.

In December 2001, our Board of Directors approved a stock repurchase plan that
authorizes us to repurchase up to $15,000 of our common stock in the open
market and in privately negotiated transactions. The plan has no set
termination date and the timing of any repurchases will be dependent on
prevailing market conditions and alternative uses of capital. For the nine
months

12Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                                
|-- |  | -------------------------------
|6. |  | STOCKHOLDERS EQUITY, Continued

ended July 31, 2002, we repurchased approximately 953,000 shares of our common
stock for $11,089 and these shares were reflected as treasury stock in the
consolidated balance sheet. The repurchase of these shares had no significant
impact on our reported net earnings (loss) per share.

|   |  |                          
|-- |  | -------------------------
|7. |  | EARNINGS (LOSS) PER SHARE

|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |      |  |   |        |       | 
|----------------------------------------------------------------------------------------------------- | -------------------------- | - | ------------------ | - |  | ----------------- | ------ | ----- | ---- | - | ------ | ---- |  | - | ------ | ----- | 
|                                                                                                      |                            |   | Three Months Ended |   |  | Nine Months Ended |       
|                                                                                                      |                            |   | July 31,           |   |  | July 31,          |       
|                                                                                                      |                            |   |                    |   |  |                   |       
|                                                                                                      |                            |   | 2002               |   |  | 2001              |        |       | 2002 |   |        | 2001 | 
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |      | 
|Basic:                                                                                                |                            |   |                    |   |  |                   |        |       |      |   |        |      |  |   |        |      
|Net earnings (loss)                                                                                   |                            | $ | (200               | ) |  | $                 | 3,573  |       |      | $ | (1,260 | )    |  | $ | 2,047  |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Weighted average common shares outstanding                                                            |                            |   | 16,676             |   |  |                   | 14,758 |       |      |   | 16,512 |      |  |   | 12,390 |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Basic earnings (loss) per share                                                                       |                            | $ | (0.01              | ) |  | $                 | 0.24   |       |      | $ | (0.08  | )    |  | $ | 0.17   |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Diluted:                                                                                              |                            |   |                    |   |  |                   |        |       |      |   |        |      |  |   |        |      
|Net earnings (loss)                                                                                   |                            | $ | (200               | ) |  | $                 | 3,573  |       |      | $ | (1,260 | )    |  | $ | 2,047  |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Weighted average common shares outstanding                                                            |                            |   | 16,676             |   |  |                   | 14,758 |       |      |   | 16,512 |      |  |   | 12,390 |      
|Potential common shares:                                                                              |                            |   |                    |   |  |                   |        |       |      |   |        |      |  |   |        |      
|                                                                                                      | Stock options and warrants |   |                    |  |  |                   |        | 1,195 |      |   |        |     |  |   |        | 1,026 | 
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Weighted average common and potential
common shares outstanding for diluted
earnings (loss) per share |                            |   | 16,676             |   |  |                   | 15,953 |       |      |   | 16,512 |      |  |   | 13,416 |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     
|Diluted earnings (loss) per share                                                                     |                            | $ | (0.01              | ) |  | $                 | 0.22   |       |      | $ | (0.08  | )    |  | $ | 0.15   |      
|                                                                                                      |                            |   |                    |   |  |                   |        |       |      |   |        |     

Diluted loss per share is the same as basic loss per share for each of the
three and nine months ended July 31, 2002 as approximately 2,421,000 potential
shares of common stock from conversion of outstanding stock options and
warrants were anti-dilutive. The impact on weighted average shares outstanding
related to these potential common shares was approximately 369,000 and 568,000
for the three and nine months ended July 31, 2002, respectively.

|   |  |                            
|-- |  | ---------------------------
|8. |  | COMPREHENSIVE INCOME (LOSS)

Total comprehensive income (loss) was as follows:

|                                                       |                                   |  |   |                    |    |  |                   |       |       |      |   |        |        |   |   |       |       |  | 
|------------------------------------------------------ | --------------------------------- |  | - | ------------------ | -- |  | ----------------- | ----- | ----- | ---- | - | ------ | ------ | - | - | ----- | ----- |  | 
|                                                       |                                   |  |   | Three Months Ended |    |  | Nine Months Ended |      
|                                                       |                                   |  |   | July 31,           |    |  | July 31,          |      
|                                                       |                                   |  |   |                    |    |  |                   |      
|                                                       |                                   |  |   | 2002               |    |  | 2001              |       |       | 2002 |   |        | 2001   |  
|                                                       |                                   |  |   |                    |    |  |                   |       |       |      |   |        |        |  
|Net income (loss)                                      |                                   |  | $ | (200               | )  |  | $                 | 3,573 |       |      | $ | (1,260 | )      |   | $ | 2,047 |      
|Cumulative foreign currency translation
gains (losses) |                                   |  |   | 242                |    |  |                   | (12   | )     |      |   | 231    |        |   |   | (101  | )    
|                                                       |                                   |  |   |                    |    |  |                   |       |       |      |   |        |       
|                                                       | Total comprehensive income (loss) |  |   | $                  | 42 |  |                   | $     | 3,561 |      |   | $      | (1,029 | ) |   | $     | 1,946 | 
|                                                       |                                   |  |   |                    |    |  |                   |       |       |      |   |        |       

13



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

|   |  |                 
|-- |  | ----------------
|9. |  | SUBSEQUENT EVENT

Acquisition of LearningElements

In August 2002, we acquired LearningElements, a privately-held corporation and
Maryland-based provider of comprehensive K-3 reading curriculum, for $2,950 in
cash and $3,050 of our common stock. This acquisition will enhance our growing
curriculum solution for elementary schools by providing a research-based early
reading product line that meets new federal education guidelines.

14



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##### Table of Contents






MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

OVERVIEW

We enhance the learning process by providing computer-based and e-learning
instruction software and related services, offering basic to advanced
level courseware in reading, writing, math, science, social studies and
life and job skills. Our PLATO® Learning System and PLATO® Web Learning
Network provide more than 3,500 hours of objective-based, problem solving
courseware and include assessment, alignment and management tools to
create standards-based curricula and facilitate the learning process.
PLATO courseware is delivered via networks, CD-ROM, private intranets and
the Internet. In addition, single topic PLATO courseware is available
through our e-commerce web site and distributors. We market our
courseware products and services to K-12 schools, colleges, job training
programs, correctional institutions, military education programs,
corporations and individuals.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of results of operations and financial condition is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses. We continually evaluate
our critical accounting policies and have identified revenue recognition, the
valuation of accounts receivable, the capitalization of product development
costs and the valuation of our deferred tax asset as the critical accounting
policies that are significant to the financial statement presentation and
require difficult, subjective and complex judgments.

Revenue Recognition

Revenue recognition rules for software companies are very complex. We follow
specific and detailed guidelines in determining the proper amount of revenue to
be recorded; however, certain judgments affect the application of our revenue
recognition policy. Revenue results are difficult to predict, and any shortfall
in revenue or delay in recognizing revenue could cause our operating results to
vary significantly from quarter to quarter.

The most significant judgments for revenue recognition typically involve
whether there are any significant uncertainties regarding customer acceptance
and whether collectibility can be considered probable. In addition, our
transactions often consist of multiple element arrangements which must be
analyzed to determine the relative fair value of each element, the amount of
revenue to be recognized upon shipment, if any, and the period and conditions
under which deferred revenue should be recognized.

For additional description of our revenue recognition policy, see Note 1 to
Consolidated Financial Statements.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

CRITICAL ACCOUNTING POLICIES, Continued

Allowance for Doubtful Accounts

We determine an allowance for doubtful accounts based upon an analysis of the
collectibility of specific accounts, historical experience and the aging of the
accounts receivable. Bad debt expense is recorded as an operating expense in
our consolidated statement of earnings. The assumptions and estimates used to
determine the allowance are subject to constant revision. The primary factors
that impact these assumptions include the efficiency and effectiveness of our
billing and collection functions and our credit assessment process. Actual
collection results could differ materially from those estimated and have a
significant impact on our results of operations and financial condition.

Capitalization of Product Development Costs

Our product development expense includes costs related to the development,
enhancement and maintenance of our courseware products, and the effect of
product development cost capitalization and amortization. We capitalize our
product development costs when the projects under development reach
technological feasibility, as defined by the accounting standards, and amortize
these costs over the estimated useful lives of the courseware products.

The most significant judgments regarding capitalization of product development
costs typically involve the determination of when development efforts reach
technological feasibility and the recoverability of capitalized costs. We
continually evaluate our capitalized costs to determine if the unamortized
balance related to any given product exceeds the estimated net realizable value
of that product. Estimating net realizable value requires us to estimate
future cash flows to be generated by the product and to use judgment in
quantifying the amount, if any, to be written off. Actual cash flows and
amounts realized from the courseware products could differ materially from
those estimated. In addition, any future changes to our courseware product
offerings could result in write-offs of previously capitalized costs and have a
significant impact on our results of operations and financial condition.

For additional description of our policy regarding product development,
enhancement and maintenance costs, see Note 1 to Consolidated Financial
Statements.

Deferred Tax Asset

We account for deferred income taxes based upon differences between the
financial reporting and income tax bases of our assets and liabilities. The
measurement of the deferred tax asset is adjusted by a valuation allowance, if
necessary, to recognize the extent to which the future tax benefits will be
recognized.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

CRITICAL ACCOUNTING POLICIES, Continued

Deferred Tax Asset,Continued

At July 31, 2002 we had a net deferred tax asset of approximately $10,843.
This deferred tax asset is net of a valuation allowance related to a foreign
net operating loss carryforward. A substantial portion of the deferred tax
asset relates to our net operating loss carryforward in the United States. We
have recorded the net deferred tax asset as we believe that it is more likely
than not that we will be able to realize the asset through generation of future
taxable income in the United States. We base this belief upon the levels of
taxable income generated historically as well as projections of future taxable
income. If future levels of taxable income in the United States are not
consistent with our expectations, we may be required to record a valuation
allowance, which could reduce our net income by a material amount.

ACQUISITION

In May 2002, we acquired NetSchools Corporation (NetSchools), a provider of
Internet-based e-learning software and services solutions for the K-12 market.
NetSchools offers a web-based curriculum and instructional management delivery
platform that facilitates delivery of school curriculum aligned to local, state
and national standards and facilitates online assessment, lesson planning and
content delivery. This acquisition will enhance our ability to provide
enterprise-wide solutions that align classroom education across all standards
and deliver compelling and effective content through NetSchools instructional
management platform.

We acquired all the shares of NetSchools for $6,050 in cash; 800,000 shares of
our common stock; 200,000 warrants to purchase shares of our common stock at
$17.00 per share through May 9, 2007; assumed liabilities and transaction
expenses; and additional consideration of up to approximately $6,000,
contingent on the NetSchools product and services revenues generated through
October 2004. If earned, any additional consideration will be recorded as
additional goodwill.

The NetSchools acquisition was accounted for using the purchase method of
accounting (see Note 2 to Consolidated Financial Statements) and the operating
results of NetSchools were included in our financial statements from the date
of acquisition.

Direct acquisition fees consisted of $1,700 for investment banking, legal and
professional fees, $1,125 for NetSchools change-in-control and management
incentive payments, and $750 for lease termination costs. Substantially all of
these fees have been paid as of July 31, 2002.

In connection with this acquisition, we developed plans for employee
relocations and workforce and facility reductions. The aggregate
estimated costs of these plans are $767 which consisted of $315
related to the elimination of 39 positions, $282 related to lease
termination and $170 related to employee relocation. As of July 31,
2002, severance payments of $79 had been made related to the
termination of ten of these employees, and payments of $137 and $20
had been made related to lease termination and employee relocation,
respectively. We expect to complete these activities within one
year from

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

ACQUISITION, Continued

the acquisition date. Until these activities are completed, the allocation of
the purchase price is preliminary and subject to adjustment.

Total cash usage related to this acquisition in 2002 is expected to be
approximately $12,000 which includes $6,050 cash paid as part of the purchase
price, $3,575 in direct acquisition fees, and $2,366 of NetSchools bank debt
repaid subsequent to the closing date of the acquisition.

The valuation of identified intangible assets, consisting of a customer list,
acquired technology and in-process research and development, was performed by
an independent appraisal firm. Goodwill and intangible assets are subject to
the provisions of SFAS 142. Goodwill will not be amortized; however, it will be
tested for impairment on an annual basis. The customer list and acquired
technology are being amortized over five to seven years.

At the date of acquisition, $360 of the purchase price was expensed for
purchased in-process research and development related to a new version of
NetSchools Orion product, which had not yet reached technological feasibility
and had no alternative future use. The Orion product is an online tool for
curriculum management and correlation to state education standards. The value
assigned to this in-process research and development was determined by
estimating the total costs required to develop the new product. At the
acquisition date, the new Orion product was approximately 67% complete and is
expected to be completed in 2002 at an estimated cost of approximately $200.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

RESULTS OF OPERATIONS

Operating Results as a Percentage of Revenue

|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |      |       |  |     |      |       | 
|----------------------------------- | --------------------------------------------------- | ------------------------ | ---- | ------------------ | ----- |  | ----------------- | ---- | ----- | ---- | ---- | ---- | ----- |  | --- | ---- | ----- | 
|                                    |                                                     |                          |      | Three Months Ended |       |  | Nine Months Ended |     
|                                    |                                                     |                          |      | July 31,           |       |  | July 31,          |     
|                                    |                                                     |                          |      |                    |       |  |                   |     
|                                    |                                                     |                          |      | 2002               |       |  | 2001              |      |       | 2002 |      |      | 2001  | 
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |      |       | 
|Revenues:                           |                                                     |                          |      |                    |       |  |                   |      |       |      |      |      |       |  |     |     
|                                    | License fees                                        |                          |      | 79.1               | %     |  |                   | 87.3 | %     |      |      | 77.7 | %     |  |     | 82.6 | %    
|                                    | Services                                            |                          |      | 14.7               |       |  |                   | 8.3  |       |      |      | 15.8 |       |  |     | 11.5 |      
|                                    | Other                                               |                          |      | 6.2                |       |  |                   | 4.4  |       |      |      | 6.5  |       |  |     | 5.9  |      
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|                                    |                                                     | Total revenues           |      |                    | 100.0 |  |                   |      | 100.0 |      |      |      | 100.0 |  |     |      | 100.0 | 
|Cost of revenues                    |                                                     |                          | 11.7 |                    |       |  | 7.3               |      |       |      | 12.6 |      |       |  | 9.6 |     
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|                                    | Gross profit                                        |                          |      | 88.3               |       |  |                   | 92.7 |       |      |      | 87.4 |       |  |     | 90.4 |      
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|Operating expenses:                 |                                                     |                          |      |                    |       |  |                   |      |       |      |      |      |       |  |     |     
|                                    | Selling, general and administrative                 |                          |      | 68.2               |       |  |                   | 52.4 |       |      |      | 72.4 |       |  |     | 64.4 |      
|                                    | Product development and customer support            |                          |      | 19.9               |       |  |                   | 9.8  |       |      |      | 18.2 |       |  |     | 12.7 |      
|                                    | Amortization of intangibles                         |                          |      | 1.8                |       |  |                   | 3.6  |       |      |      | 1.4  |       |  |     | 2.9  |      
|                                    | Acquired research and development                   |                          |      | 1.8                |       |  |                   |     |       |      |      | 0.7  |       |  |     |     |      
|                                    | Special charges                                     |                          |      |                   |       |  |                   |     |       |      |      |     |       |  |     | 2.6  |      
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|                                    |                                                     | Total operating expenses |      |                    | 91.7  |  |                   |      | 65.8  |      |      |      | 92.7  |  |     |      | 82.6  | 
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|Operating profit (loss)             |                                                     |                          | (3.4 | )                  |       |  | 26.9              |      |       |      | (5.3 | )    |       |  | 7.8 |     
|                                    | Interest income and interest and other expense, net |                          |      | 0.6                |       |  |                   | 0.1  |       |      |      | 0.9  |       |  |     | (0.4 | )    
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|Earnings (loss) before income taxes |                                                     |                          | (2.8 | )                  |       |  | 27.0              |      |       |      | (4.4 | )    |       |  | 7.4 |     
|                                    | Income tax expense (benefit)                        |                          |      | (1.8               | )     |  |                   | 11.3 |       |      |      | (1.9 | )     |  |     | 3.1  |      
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     
|Net earnings (loss)                 |                                                     |                          | (1.0 | )%                 |       |  | 15.7              | %    |       |      | (2.5 | )%   |       |  | 4.3 | %   
|                                    |                                                     |                          |      |                    |       |  |                   |      |       |      |      |     

Revenues

Total Revenues.Total revenues decreased 14.0% to $19,606 for the three months
ended July 31, 2002 from $22,803 for the same period in 2001. The decrease was
primarily due to the $4,394 decrease in license fees revenues slightly offset
by the $984 increase in services revenues.

Total revenues increased 6.1% to $50,865 for the nine months ended July 31,
2002 from $47,921 for the same period in 2001. The increase was primarily due
to the $2,550 increase in services revenues.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

RESULTS OF OPERATIONS, Continued

Revenues,Continued

License Fees.Revenues from license fees decreased 22.1% to $15,509 for the
three months ended July 31, 2002 from $19,903 for the same period in 2001. As
a percentage of total revenues, license fees revenues were 79.1% for the three
months ended July 31, 2002, down from 87.3% for the same period in 2001.
Revenues from license fees for the nine months ended July 31, 2002 were $39,509
compared to $39,572 for the same period in 2001. As a percentage of total
revenues, license fees revenues were 77.7% for the nine months ended July 31,
2002, down from 82.6% for the same period in 2001. After growing license fees
revenues year over year for the first two quarters of 2002, we experienced a
downturn in these revenues during the third quarter of 2002 due to federal
funding delays and economic uncertainties which significantly impacted the
level of purchasing done by our customers. These conditions have impacted our
2002 revenues and will continue to do so for at least the near-term.

Sales of our PLATO Web Learning Network (PWLN) product continue to grow. Our
order intake for PWLN during the three months ended July 31, 2002 was
approximately $1,800 and we recognized $969 of ratable revenue. This compares
to approximately $1,100 of order intake and $315 of recognized revenue in the
comparable period of 2001. Since launching this product late in the first
quarter of 2001, we have taken orders for approximately $7,300 of PWLN product
and have recognized $3,400 of ratable revenue through July 31, 2002. New
products from the acquisitions of TeachMaster Technologies, Inc. in September
2001 and NetSchools Corporation in May 2002 contributed approximately $600 and
$900 of license fees revenues for the three and nine months ended July 31,
2002, respectively.

Services.Revenues from services increased 51.9% to $2,880 for the three
months ended July 31, 2002 from $1,896 for the same period in 2001. As a
percentage of total revenues, services revenues were 14.7% for the three months
ended July 31, 2002 up from 8.3% for the same period in 2001. Revenues from
services increased 46.2% to $8,067 for the nine months ended July 31, 2002 from
$5,517 for the same period in 2001. As a percentage of total revenues,
services revenues were 15.8% for the nine months ended July 31, 2002 up from
11.5% for the same period in 2001. This revenue increase resulted from
increased services to correlate curriculum to standards and to aid in the
professional development of teachers and the continued growth in customer
acceptance of our training and technical support services. New services from
the acquisitions of TeachMaster Technologies, Inc. in September 2001 and
NetSchools Corporation in May 2002 contributed approximately $600 and $850 of
services revenues for the three and nine months ended July 31, 2002,
respectively.

Other.Other revenues, including hardware and third-party courseware products,
increased 21.2% to $1,217 for the three months ended July 31, 2002 from $1,004
for the same period in 2001. As a percentage of total revenues, other revenues
were 6.2% for the three months ended July 31, 2002 and 4.4% for the same period
in 2001. Other revenues increased 16.1% to $3,289

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

RESULTS OF OPERATIONS, Continued

Revenues,Continued

for the nine months ended July 31, 2002 from $2,832 for the same period in
2001. As a percentage of total revenues, other revenues were 6.5% for the nine
months ended July 31, 2002 and 5.9% for the same period in 2001.

Cost of Revenues

Total cost of revenues increased 37.3% to $2,289 for the three months ended
July 31, 2002 from $1,667 for the same period in 2001. Total cost of revenues
increased 38.9% to $6,412 for the nine months ended July 31, 2002 from $4,615
for the same period in 2001. The increase was primarily due to the increases
in services and other revenues, including third party courseware product
royalties. Gross profit margin was 88.3% for the three months ended July 31,
2002, down from 92.7% for the same period in 2001, and was 87.4% for the nine
months ended July 31, 2002, down from 90.4% for the same period in 2001. This
decrease in gross profit margin resulted primarily from a lower proportion of
license fees revenues included in our product sales mix. We expect our gross
profit margin in the fourth quarter of 2002 and in 2003 to be in the range of
88% to 90%; however our future gross profit margin will be dependent primarily
on the product mix underlying our revenues.

Operating Expenses

Selling, General and Administrative.Selling, general and administrative
expenses increased 11.9% to $13,372 for the three months ended July 31, 2002
from $11,950 for the same period in 2001. Selling, general and administrative
expenses increased 19.5% to $36,848 for the nine months ended July 31, 2002
from $30,844 for the same period in 2001. The increased expenses resulted from
a number of factors including increased headcount from our acquisitions in 2001
and 2002, increased marketing costs necessary to generate planned revenue
growth, and additions to our management team and infrastructure necessary to
grow our business over the long-term. As a percentage of total revenues,
selling, general and administrative expenses were 68.2% for the three months
ended July 31, 2002, up from 52.4% for the same period in 2001, and 72.4% for
the nine months ended July 31, 2002 compared to 64.4% for the same period in
2001. Our ability to continue to leverage our cost structure and improve
profitability is primarily dependent on our ability to increase revenues,
achieve our sales targets and integrate our acquisitions.

Product Development and Customer Support.Product development and customer
support expenses increased 74.2% to $3,899 for the three months ended July 31,
2002 from $2,238 for the same period in 2001. Product development and customer
support expenses increased 52.5% to $9,257 for the nine months ended July 31,
2002 from $6,070 for the same period in 2001.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

RESULTS OF OPERATIONS, Continued

Operating Expenses,Continued

Product Development and Customer Support,Continued

As a percentage of total revenues, product development and customer support
expenses were 19.9% for the three months ended July 31, 2002, up from 9.8% for
the same period in 2001, and 18.2% for the nine months ended July 31, 2002, up
from 12.7% for the same period in 2001. These increases reflect a high level
of spending needed to complete the new version of the NetSchools Orion product
and our increased spending to enhance and replace certain existing courseware
products and to develop a new standards-based reference network. As part of
our growth strategy, we intend to introduce a number of new products and
product improvements. The extent of our future product development spending
and the amount of our future capitalized product development costs and related
amortization are dependent on our ability to introduce new products and product
improvements on a cost-effective and timely basis. Capitalized development
costs were $1,752 and $5,014 for the three and nine months ended July 31, 2002,
respectively, compared to $1,589 and $3,541 for the same periods in 2001.
Amortization of previously capitalized development costs was $1,066
and $3,006
for the three and nine months ended July 31, 2002, respectively, up from $863
and $2,114 for the same periods in 2001, as projects completed during prior
periods are now being amortized to expense.

Amortization of Intangibles.Expense for the three and nine months ended July
31, 2002 represented amortization of intangible assets, other than goodwill,
from our previous acquisitions. Effective November 1, 2001, we adopted
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142). Under SFAS 142, goodwill is no longer
amortized to expense and must be periodically reviewed for impairment with any
related losses recognized when incurred. We have completed the transitional
impairment test of goodwill as of November 1, 2001 and the carrying value of
goodwill was not impaired. At July 31, 2002, our goodwill was not impaired:
however, subsequent to that date, the market value of our common stock had
declined to a point where our market capitalization was below our net book
value. This may indicate a potential impairment of our goodwill if the market
value of our common stock does not increase. Expense for the same periods in
2001 included $663 and $1,077 of goodwill amortization and $155 and $335 of
intangible amortization, respectively.

Purchased In-Process Research and Development. This charge in 2002 represented
the write-off of in-process research and development related to the acquisition
of NetSchools as discussed earlier and in Note 2 to Consolidated Financial
Statements.

Special Charge.The special charge in 2001 represented costs associated with
the retirement of our founder and former chief executive officer and included
non-cash amounts of $463 for the accelerated vesting of stock options.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

RESULTS OF OPERATIONS, Continued

Interest Income

Interest income was $171 and $728 for the three and nine months ended July 31,
2002 compared to $313 and $344 for the same periods in 2001. The decreased
interest income for the three months ended July 31, 2002 is the result of lower
invested balances and lower interest rates in 2002. Invested balances
decreased due to cash being used for acquisitions and stock repurchases. The
increased interest income for the nine months ended July 31, 2002 is the result
of higher invested balances in 2002. We completed a public stock offering in
June 2001, which significantly increased our cash and cash equivalent balances.

Interest Expense

Interest expense was $34 and $107 for the three and nine months ended July 31,
2002 compared to $273 and $428 for the same periods in 2001. The decrease in
interest expense is the result of lower fees associated with our new revolving
loan agreement in 2002.

Income Taxes

Our effective income tax rate for the nine months ended July 31, 2002 was
43.6%, compared to the 42.0% effective rate for the same period in 2001. Our
effective income tax rate for the three months ended July 31, 2002 was
abnormally high due to the relatively small net loss and the need to adjust our
expected effective tax rate for the year 2002 due to the revenue shortfall from
our previous estimate. Our fiscal year 2002 effective tax rate is expected to
be between 44% and 46%; however, it will be highly dependent upon the taxable
income in each of our taxable jurisdictions.

FINANCIAL CONDITION

Liquidity and Capital Resources

At July 31, 2002, our principal sources of liquidity included cash and cash
equivalents of $32,827, net accounts receivable of $30,212, and our unused line
of credit. We had total installment receivables of $19,082 at July 31, 2002, of
which $17,460 is to be billed within one year from the balance sheet date and
is included in net accounts receivable. Working capital was $43,723 at July
31, 2002, a decrease of $30,326 from October 31, 2001, due primarily to
decreased cash and cash equivalents and increased deferred revenue. Cash and
cash equivalents decreased primarily due to cash used for acquisitions, product
development, capital expenditures and stock repurchases.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

FINANCIAL CONDITION, Continued

Liquidity and Capital Resources,Continued

Cash flows from operations were used principally to fund our working capital
requirements. Net cash provided by operating activities was $448 for the nine
months ended July 31, 2002 compared to $2,639 for the same period in 2001. The
decrease in operating cash flows is due primarily to the downturn in operating
results and changes in accounts receivable, accounts payable and deferred
revenue.

Net cash used in our investing activities was $16,916 for the nine months ended
July 31, 2002 compared to $8,679 for the same period in 2001. The increase in
net cash used was due to our acquisition of NetSchools, increased capital
expenditures, primarily related to the installation of a new enterprise
resource planning system that is expected to be completed in 2002, and our
increased investment in capitalized product development costs as we continue to
develop new courseware products.

Net cash used in our financing activities was $12,411 for the nine months ended
July 31, 2002 compared to net cash provided of $57,465 for the same period in
2001. In 2002, we repurchased shares of our common stock as discussed below.
In 2001, we completed a public stock offering resulting in net proceeds of
approximately $55,000. We have resources available under our revolving loan
agreement to provide borrowings up to $12,500, as determined by the available
borrowing base. We did not comply with the Minimum Debt Coverage covenant of
our revolving loan agreement for the period ended July 31, 2002 and we received
a waiver from our lender covering this noncompliance for such period. At July
31, 2002, there were no borrowings outstanding and our unused borrowing
capacity was $12,500.

In December 2001, our Board of Directors approved a stock repurchase plan that
authorizes us to repurchase up to $15,000 of our common stock in the open
market and in privately negotiated transactions. The plan has no set
termination date and the timing of any repurchases will be dependent on
prevailing market conditions and alternative uses of capital. For the nine
months ended July 31, 2002, we repurchased approximately 953,000 shares of our
common stock for $11,089. The repurchase of these shares had no significant
impact on our reported net earnings (loss) per share.

We maintain adequate cash balances and credit facilities to meet our
anticipated working capital, capital expenditure and business investment
requirements.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

FINANCIAL CONDITION, Continued

Disclosures about Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments consist of future
payments due under capital lease obligations and operating leases. For the
full fiscal year 2002, payments of approximately $285 are due under capital
lease obligations and payments of approximately $1,640 are due under operating
leases.

Factors Affecting Quarterly Operating Results

Our quarterly operating results fluctuate as a result of a number of factors
including the business and sales cycle, the amount and timing of new product
introductions, client spending patterns, budget cycles and fiscal year ends and
promotional programs. We historically have experienced our lowest revenues in
the first quarter and increasingly higher levels of revenues in each of the
next three quarters. Because of these factors, the results for the interim
periods presented are not necessarily indicative of the results to be expected
for the full fiscal year.

Interest Rate Risk

Our borrowing capacity primarily consists of a revolving loan with interest
rates that fluctuate based upon market indexes. At July 31, 2002, we did not
have any outstanding borrowings under this revolving loan. In addition, our
only debt consisted of capital lease obligations at fixed interest rates. As a
result, risk relating to interest fluctuation is considered minimal.

Foreign Currency Exchange Rate Risk

We market our products and services worldwide and have operations in Canada and
the United Kingdom. As a result, financial results and cash flows could be
affected by changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Working funds necessary to facilitate the
short-term operations of our foreign subsidiaries are kept in local currencies
in which they do business. Approximately 8% of our total revenues were
denominated in currencies other than the U.S. dollar for the nine months ended
July 31, 2002.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(Dollars in thousands, except per share amounts)

CAUTIONARY STATEMENTS

Except for historical information contained herein, the disclosures in this
Quarterly Report on Form 10-Q are forward-looking statements made under the
Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
anticipated. These risks and uncertainties include: the availability and
unpredictability of government funding on which our customers are dependent,
the capital and operating spending patterns of our customers, the ability to
attract and retain customers, the size, timing and product
mix of customer orders, the introduction and acceptance of competitive
products, our ability to adapt to technological changes and meet evolving
industry standards, and our ability to economically introduce new products on a
timely basis. These risks and other relevant risks are described in more
detail in our Annual Report on Form 10-K for the fiscal year ended October 31,
2001.

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##### Table of Contents






|        |  |                                                           
|------- |  | ----------------------------------------------------------
|Item 3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See the information set forth under the captions, Interest Rate Risk and
Foreign Currency Exchange Rate Risk in Managements Discussion and Analysis
of Results of Operations and Financial Condition.




|        |  |                  
|------- |  | -----------------
|Item 4. |  | INTERNAL CONTROLS

There were no significant changes in our internal controls or in other factors
that could significantly affect those controls subsequent to the date of our
most recent evaluation.

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##### Table of Contents









PART II. OTHER INFORMATION

|        |  |                  
|------- |  | -----------------
|Item 1. |  | Legal Proceedings



| |  | We are not a party to any litigation that is expected to have a
material adverse effect on our business.
| |  | --------------------------------------------------------------------------------------------------------




|        |  |                      
|------- |  | ---------------------
|Item 2. |  | Changes in Securities



| |  | On May 9, 2002 we issued 800,000 shares of our common stock for the
acquisition of NetSchools Corporation (see Note 2 to Consolidated
Financial Statements).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------




|        |  |                                
|------- |  | -------------------------------
|Item 3. |  | Defaults Upon Senior Securities



| |  | Not Applicable.
| |  | ---------------




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



| |  | Not Applicable.
| |  | ---------------




|        |  |                  
|------- |  | -----------------
|Item 5. |  | Other Information



| |  | Not Applicable.
| |  | ---------------




|        |  |                                 
|------- |  | --------------------------------
|Item 6. |  | Exhibits and Reports on Form 8-K



| |  | (a) Exhibits                                                                                                                                                                                                                                                                
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Exhibit Number and Description                                                                                                                                                                                                                                              
|
| |  | 10.37  Agreement and Plan of Merger dated May 9, 2002, among PLATO
Learning, Inc., PLATO, Inc., NSC Acquisition Corporation and NetSchools
Corporation is incorporated by reference to Exhibit 2 on our Current
Report on Form 8-K dated May 9, 2002 (File Number 0-20842).
|
| |  | (b) Reports on Form 8-K:                                                                                                                                                                                                                                                    
|
| |  | On May 23, 2002 we filed a Current Report on Form 8-K, dated
May 9, 2002, and on July 22, 2002 we filed Amendment Number 1 to
that report, both related to the acquisition of NetSchools
Corporation.                                                                       

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on September 16, 2002.

| |  |                                                                                                 
| |  | ------------------------------------------------------------------------------------------------
| |  | PLATO LEARNING, INC                                                                             
| |  |                                                                                                 
| |  | By /s/ John Murray                                                                              
| |  |                                                                                                 
| |  | President and
Chief Executive Officer
(principal executive officer)                             
| |  |                                                                                                 
| |  | /s/ Gregory J. Melsen                                                                           
| |  |                                                                                                 
| |  | Vice President Finance and
Chief Financial Officer
(principal financial officer)                
| |  |                                                                                                 
| |  | /s/ Mary Jo Murphy                                                                              
| |  |                                                                                                 
| |  | Vice President, Corporate Controller and
Chief Accounting Officer
(principal accounting officer)

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CERTIFICATIONS

Each of the undersigned, in his capacity as an officer of PLATO Learning, Inc.,
provides the following certifications required by 18 U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and 17
C.F.R. Section 240.13a-14.

I, John Murray, certify that:



|1. |  | I have reviewed this Quarterly Report on Form 10-Q of PLATO Learning,
Inc.;                                                                                                                                                                                                                                                       
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.                       

|                         |  |                                      
|------------------------ |  | -------------------------------------
|Date: September 16, 2002 |  | /s/ John Murray                      
|                         |  |                                      
|                         |  | President and
Chief Executive Officer

I, Gregory J. Melsen, certify that:



|1. |  | I have reviewed this Quarterly Report on Form 10-Q of PLATO Learning,
Inc.;                                                                                                                                                                                                                                                       
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.                       

|                         |  |                                                   
|------------------------ |  | --------------------------------------------------
|Date: September 16, 2002 |  | /s/ Gregory J. Melsen                             
|                         |  |                                                   
|                         |  | Vice President Finance and
Chief Financial Officer

EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representations 4, 5 and 6 of the
Certifications as set forth in Form 10-Q have been omitted, consistent with the
Transition Provisions of SEC Exchange Act Release No. 34-46427, because this
Quarterly Report on Form 10-Q covers a period ending before the Effective Date
of Rules 13a-14 and 15d-14.

30