##### Table of Contents



UNITED STATES 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, 2006
 Commission File Number 0-20842
 PLATO LEARNING, INC.
 (Exact name of Registrant as specified in its charter)
 Delaware
    
    36-3660532(State or other jurisdiction of incorporation or organization)
    
    (IRS Employer Identification Number)
 10801 Nesbitt Avenue South, Bloomington, MN 55437  (Address of principal executive offices)
 (952) 832-1000  (Registrants telephone number, including area code)
 Not Applicable  (Former name, former address and former fiscal year, if changed since last report)
  þ o
  o þ o
  o þ
    1




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##### 



PLATO LEARNING, INC.
Form 10-Q
Quarterly Period Ended July 31, 2006
 TABLE OF CONTENTS
 PagePART I.FINANCIAL INFORMATIONITEM 1.
    
    Financial Statements:Condensed Consolidated Statements of Operations for the Three and Nine Months Ended July 31, 2006 and 2005 (Unaudited)
    
    
    3Condensed Consolidated Balance Sheets as of July 31, 2006 and October 31, 2005 (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2006 and 2005 (Unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17ITEM 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    27ITEM 4.
    
    Controls and Procedures
    
    
    27PART II.OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    28ITEM 1A.
    
    Risk Factors
    
    
    28ITEM 6.
    
    Exhibits
    
    
    28SIGNATURES
    
    
    
    
    29Form of Indemnification Agreement1993 Employee Stock Purchase Plan (As Amended by the Second Amendment)Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 PLATO Learning, Inc. and Subsidiaries
 
 Condensed Consolidated Statements of Operations (Unaudited)
 (In thousands, except per share amounts)
 Three Months Ended
    
    
    Nine Months EndedJuly 31,
    
    
    July 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:License fees
    
    $
    11,689
    
    
    $
    18,604
    
    
    $
    27,658
    
    
    $
    45,905Subscriptions
    
    
    4,373
    
    
    
    4,400
    
    
    
    12,783
    
    
    
    13,450Services
    
    
    7,394
    
    
    
    8,235
    
    
    
    26,476
    
    
    
    28,768Total revenues
    
    
    23,456
    
    
    
    31,239
    
    
    
    66,917
    
    
    
    88,123Cost of revenues:License fees
    
    
    4,051
    
    
    
    4,858
    
    
    
    9,705
    
    
    
    13,505Subscriptions
    
    
    1,539
    
    
    
    1,780
    
    
    
    6,436
    
    
    
    6,235Services
    
    
    4,174
    
    
    
    5,595
    
    
    
    13,436
    
    
    
    19,168Total cost of revenues
    
    
    9,764
    
    
    
    12,233
    
    
    
    29,577
    
    
    
    38,908Gross profit
    
    
    13,692
    
    
    
    19,006
    
    
    
    37,340
    
    
    
    49,215Operating expenses:Sales and marketing
    
    
    9,539
    
    
    
    11,520
    
    
    
    28,849
    
    
    
    38,256General and administrative
    
    
    4,064
    
    
    
    5,141
    
    
    
    13,026
    
    
    
    14,193Product maintenance and development
    
    
    1,210
    
    
    
    1,227
    
    
    
    3,974
    
    
    
    3,920Amortization of intangibles
    
    
    904
    
    
    
    1,075
    
    
    
    2,806
    
    
    
    3,247Restructuring and other charges
    
    
    21
    
    
    
    200
    
    
    
    360
    
    
    
    3,121Total operating expenses
    
    
    15,738
    
    
    
    19,163
    
    
    
    49,015
    
    
    
    62,737Operating loss
    
    
    (2,046
    )
    
    
    (157
    )
    
    
    (11,675
    )
    
    
    (13,522
    )Other income (expense):Interest income
    
    
    378
    
    
    
    251
    
    
    
    1,249
    
    
    
    631Interest expense
    
    
    (5
    )
    
    
    (46
    )
    
    
    (32
    )
    
    
    (89
    )Other, net
    
    
    32
    
    
    
    (209
    )
    
    
    21
    
    
    
    (362
    )Loss before income taxes
    
    
    (1,641
    )
    
    
    (161
    )
    
    
    (10,437
    )
    
    
    (13,342
    )Income tax expense
    
    
    150
    
    
    
    150
    
    
    
    450
    
    
    
    450Net loss
    
    $
    (1,791
    )
    
    $
    (311
    )
    
    $
    (10,887
    )
    
    $
    (13,792
    )Loss per share:Basic and diluted
    
    $
    (0.08
    )
    
    $
    (0.01
    )
    
    $
    (0.46
    )
    
    $
    (0.59
    )Weighted average common shares outstanding:Basic and diluted
    
    
    23,701
    
    
    
    23,490
    
    
    
    23,668
    
    
    
    23,325
 See Notes to Condensed Consolidated Financial Statements.
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PLATO Learning, Inc. and Subsidiaries
 
 Condensed Consolidated Balance Sheets (Unaudited)
 (In thousands, except per share amounts)
 July 31,
    
    
    October 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    30,223
    
    
    $
    46,901Marketable securities
    
    
    1,507
    
    
    
    213Accounts receivable, net
    
    
    21,403
    
    
    
    22,768Inventories
    
    
    2,025
    
    
    
    4,026Other current assets
    
    
    5,540
    
    
    
    6,351Total current assets
    
    
    60,698
    
    
    
    80,259Equipment and leasehold improvements, net
    
    
    5,484
    
    
    
    5,711Product development costs, net
    
    
    22,975
    
    
    
    14,753Goodwill
    
    
    71,865
    
    
    
    71,865Identified intangible assets, net
    
    
    18,794
    
    
    
    22,505Other long-term assets
    
    
    1,999
    
    
    
    2,235Total assets
    
    $
    181,815
    
    
    $
    197,328LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,873
    
    
    $
    2,938Accrued compensation
    
    
    6,784
    
    
    
    7,772Accrued liabilities
    
    
    5,955
    
    
    
    8,933Deferred revenue
    
    
    31,678
    
    
    
    35,218Total current liabilities
    
    
    46,290
    
    
    
    54,861Long-term deferred revenue
    
    
    7,440
    
    
    
    5,213Deferred income taxes
    
    
    2,381
    
    
    
    1,931Other long-term liabilities
    
    
    211
    
    
    
    496Total liabilities
    
    
    56,322
    
    
    
    62,501Stockholders equity:Common stock, $.01 par value, 50,000 shares authorized;
23,747 shares issued and 23,727 shares outstanding at July 31,
2006; 23,637 shares issued and 23,617 shares outstanding
at October 31, 2005
    
    
    237
    
    
    
    236Additional paid-in capital
    
    
    167,931
    
    
    
    166,295Treasury stock at cost
    
    
    (205
    )
    
    
    (205
    )Accumulated deficit
    
    
    (41,424
    )
    
    
    (30,537
    )Accumulated other comprehensive loss
    
    
    (1,046
    )
    
    
    (962
    )Total stockholders equity
    
    
    125,493
    
    
    
    134,827Total liabilities and stockholders equity
    
    $
    181,815
    
    
    $
    197,328
 See Notes to Condensed Consolidated Financial Statements.
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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
 
 Condensed Consolidated Statements of Cash Flows (Unaudited)
 (In thousands)
 Nine Months EndedJuly 31,2006
    
    
    2005Operating activities:Net loss
    
    $
    (10,887
    )
    
    $
    (13,792
    )Adjustments to reconcile net loss to net cash (used) provided by
operating activities:Deferred income taxes
    
    
    450
    
    
    
    450Amortization of capitalized product development costs
    
    
    5,443
    
    
    
    5,521Amortization of identified intangible and other long-term assets
    
    
    3,961
    
    
    
    6,318Depreciation and amortization of equipment and leasehold improvements
    
    
    1,848
    
    
    
    2,637Provision for doubtful accounts
    
    
    164
    
    
    
    1,291Stock-based compensation
    
    
    1,038
    
    
    
    39Gain on sale of marketable securities
    
    
    (37
    )
    
    
    Loss on disposal of equipment
    
    
    61
    
    
    
    65Changes in operating assets and liabilities:Accounts receivable
    
    
    1,201
    
    
    
    12,093Inventories
    
    
    2,001
    
    
    
    (2,514
    )Other current and long-term assets
    
    
    790
    
    
    
    (410
    )Accounts payable
    
    
    (1,065
    )
    
    
    (1,902
    )Other current and long-term liabilities
    
    
    (4,238
    )
    
    
    (150
    )Deferred revenue
    
    
    (1,313
    )
    
    
    (9,629
    )Total adjustments
    
    
    10,304
    
    
    
    13,809Net cash (used) provided by operating activities
    
    
    (583
    )
    
    
    17Investing activities:Capitalized internal product development costs
    
    
    (10,665
    )
    
    
    (7,906
    )Purchased product development
    
    
    (3,000
    )
    
    
    Purchases of equipment and leasehold improvements
    
    
    (1,682
    )
    
    
    (1,450
    )Purchases of marketable securities
    
    
    (4,250
    )
    
    
    (9,266
    )Sales of marketable securities
    
    
    229
    
    
    
    4,559Maturities of marketable securities
    
    
    2,750
    
    
    
    20,985Net cash (used) provided by investing activities
    
    
    (16,618
    )
    
    
    6,922Financing activities:Net proceeds from issuance of common stock
    
    
    670
    
    
    
    2,271Repayments of capital lease obligations
    
    
    (84
    )
    
    
    (185
    )Net cash provided by financing activities
    
    
    586
    
    
    
    2,086Effect of currency exchange rate changes on cash and cash equivalents
    
    
    (63
    )
    
    
    666Net (decrease) increase in cash and cash equivalents
    
    
    (16,678
    )
    
    
    9,691Cash and cash equivalents at beginning of period
    
    
    46,901
    
    
    
    29,235Cash and cash equivalents at end of period
    
    $
    30,223
    
    
    $
    38,926
 See Notes to Condensed Consolidated Financial Statements.
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##### Table of Contents



PLATO LEARNING, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 Note 1. General
 Basis of Presentation
  Consolidation
  Fiscal Periods
  Reclassifications
 Other Revenues:
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##### Table of Contents



Revenue
    
    
    Cost of RevenueIn thousands
    
    License
    
    
    Service
    
    
    Other
    
    
    License
    
    
    Service
    
    
    OtherQuarter Ended January 31, 2005:As previously classified
    
    $
    11,095
    
    
    $
    8,196
    
    
    $
    1,631
    
    
    $
    3,432
    
    
    $
    6,126
    
    
    $
    1,700Reclassifications
    
    
    907
    
    
    
    724
    
    
    
    (1,631
    )
    
    
    972
    
    
    
    728
    
    
    
    (1,700
    )As reclassified
    
    $
    12,002
    
    
    $
    8,920
    
    
    $
    
    
    
    $
    4,404
    
    
    $
    6,854
    
    
    $
    Quarter Ended April 30, 2005:As previously classified
    
    $
    14,233
    
    
    $
    10,908
    
    
    $
    1,771
    
    
    $
    2,869
    
    
    $
    6,108
    
    
    $
    1,985Reclassifications
    
    
    1,066
    
    
    
    705
    
    
    
    (1,771
    )
    
    
    1,374
    
    
    
    611
    
    
    
    (1,985
    )As reclassified
    
    $
    15,299
    
    
    $
    11,613
    
    
    $
    
    
    
    $
    4,243
    
    
    $
    6,719
    
    
    $
    Quarter Ended July 31, 2005:As previously classified
    
    $
    16,747
    
    
    $
    7,440
    
    
    $
    2,652
    
    
    $
    3,001
    
    
    $
    4,892
    
    
    $
    2,560Reclassifications
    
    
    1,857
    
    
    
    795
    
    
    
    (2,652
    )
    
    
    1,857
    
    
    
    703
    
    
    
    (2,560
    )As reclassified
    
    $
    18,604
    
    
    $
    8,235
    
    
    $
    
    
    
    $
    4,858
    
    
    $
    5,595
    
    
    $
    Year Ended October 31, 2005:As previously classified
    
    $
    57,803
    
    
    $
    38,342
    
    
    $
    7,662
    
    
    $
    12,353
    
    
    $
    21,809
    
    
    $
    7,876Reclassifications
    
    
    4,724
    
    
    
    2,938
    
    
    
    (7,662
    )
    
    
    5,327
    
    
    
    2,549
    
    
    
    (7,876
    )As reclassified
    
    $
    62,527
    
    
    $
    41,280
    
    
    $
    
    
    
    $
    17,680
    
    
    $
    24,358
    
    
    $
    
 Cash Flow Statement:
 Note 2. Summary of Significant Accounting Policies
 General
  
    
    Revenue recognition
    
    Allowance for doubtful accounts
    
    Capitalized product development costs
    
    Valuation of our deferred income taxes
    
    Valuation and impairment analysis of goodwill and identified intangible assets
  License
agreements
  7




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##### Table of Contents



Stock-Based Compensation
 Share-Based Payment , Accounting
for Stock Issued to Employees, Accounting for
Stock-Based Compensation
   Loss Per Share
  New Accounting Pronouncements
 Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109. Accounting for Income
Taxes.
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##### Table of Contents



Note 3. Stock-Based Compensation
    Share-Based Payment
 Fiscal Year2006
    
    Fiscal YearAwards to
    
    2005Date
    
    AwardsExpected life
    
    

    4.3
    years
    
    
    5.0
    yearsRisk-free rate of return
    
    
    4.0%- 4.5
    %
    
    
    3.9
    %Volatility
    
    
    49.0
    %
    
    
    62.0
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
 9




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##### Table of Contents



Three Months
    
    
    Nine MonthsEnded
    
    
    EndedJuly 31, 2006
    
    
    July 31, 2006Stock options granted prior to the adoption of SFAS 123(R)
    
    $
    116
    
    
    $
    369Stock options granted after the adoption of SFAS 123(R)
    
    
    117
    
    
    
    510Restricted stock awards
    
    
    
    
    
    
    59Bonus unit agreements
    
    
    (19
    )
    
    
    71Employee stock purchase plan
    
    
    21
    
    
    
    29$
    235
    
    
    $
    1,038
   Three Months
    
    
    Nine MonthsEnded
    
    
    EndedJuly 31, 2005
    
    
    July 31, 2005Net loss, as reported
    
    $
    (311
    )
    
    $
    (13,792
    )Stock-based compensation expense included in
reported net loss
    
    
    
    
    
    
    39Stock-based compensation expense determined using
the fair value based method for all awards
    
    
    (547
    )
    
    
    (2,052
    )Pro forma net loss
    
    $
    (858
    )
    
    $
    (15,805
    )Basic and diluted loss per share:As reported
    
    $
    (0.01
    )
    
    $
    (0.59
    )Pro forma
    
    $
    (0.04
    )
    
    $
    (0.68
    )
  10




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##### Table of Contents



WeightedWeighted
    
    AverageAverage
    
    Contractual
    
    AggregateOptions
    
    Exercise Price
    
    Term (in
    
    IntrinsicOutstanding
    
    per Share
    
    years)
    
    ValueOptions outstanding at October 31, 2005
    
    
    2,652
    
    
    $
    9.51Options granted
    
    
    812
    
    
    
    7.65Options exercised
    
    
    (88
    )
    
    
    6.62Options forfeited or cancelled
    
    
    (430
    )
    
    
    11.00Options outstanding at July 31, 2006
    
    
    2,946
    
    
    $
    8.86
    
    
    
    5.9
    
    
    $
    132Options exercisable at July 31, 2006
    
    
    2,068
    
    
    $
    9.45
    
    
    
    5.4
    
    
    $
    132
   Note 4. Accounts Receivable
  July 31,
    
    
    October 31,2006
    
    
    2005Trade accounts receivable
    
    $
    21,472
    
    
    $
    21,930Installment accounts receivable
    
    
    1,439
    
    
    
    2,485Allowance for doubtful accounts
    
    
    (1,508
    )
    
    
    (1,647
    )$
    21,403
    
    
    $
    22,768
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##### Table of Contents



2006
    
    
    2005Balance, beginning of fiscal year
    
    $
    1,647
    
    
    $
    2,712Provision for doubtful accounts (included in general
and administrative expenses):Three months ended January 31
    
    
    227
    
    
    
    305Three months ended April 30
    
    
    108
    
    
    
    369Three months ended July 31
    
    
    (171
    )
    
    
    617Write-offs of doubtful accounts, net of recoveries
    
    
    (303
    )
    
    
    (537
    )Balance, July 31
    
    $
    1,508
    
    
    $
    3,466
 Note 5. Inventories
  July 31,
    
    
    October 31,2006
    
    
    2005Third-party hardware
    
    $
    813
    
    
    $
    1,779Media, documentation, and packaging materials
    
    
    1,212
    
    
    
    2,247$
    2,025
    
    
    $
    4,026
 Note 6. Product Development Costs
  Gross Carrying
    
    
    Accumulated
    
    
    Net CarryingValue
    
    
    Amortization
    
    
    ValueBalance, October 31, 2005
    
    $
    29,142
    
    
    $
    (14,389
    )
    
    $
    14,753Capitalized internal product development costs
    
    
    10,665
    
    
    
    
    
    
    
    10,665Purchased product development
    
    
    3,000
    
    
    
    
    
    
    
    3,000Write-off of fully amortized costs
    
    
    (6,881
    )
    
    
    6,881
    
    
    
    Amortization of product development costs
    
    
    
    
    
    
    (5,443
    )
    
    
    (5,443
    )Balance, July 31, 2006
    
    $
    35,926
    
    
    $
    (12,951
    )
    
    $
    22,975
  12




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##### Table of Contents



Note 7. Goodwill and Identified Intangible Assets
   July 31, 2006
    
    
    October 31, 2005Gross
    
    
    
    
    
    
    Net
    

    

    Gross
    
    

    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingValue
    
    
    Amortization
    
    
    Value
    
    
    Value
    
    
    Amortization
    
    
    ValueAcquired technology
    
    $
    23,029
    
    
    $
    (17,549
    )
    
    $
    5,480
    
    
    $
    23,029
    
    
    $
    (16,645
    )
    
    $
    6,384Trademarks and tradenames
    
    
    3,680
    
    
    
    (2,567
    )
    
    
    1,113
    
    
    
    3,680
    
    
    
    (2,036
    )
    
    
    1,644Customer relationships
and lists
    
    
    21,100
    
    
    
    (8,899
    )
    
    
    12,201
    
    
    
    21,100
    
    
    
    (6,644
    )
    
    
    14,456Noncompete agreements
    
    
    1,000
    
    
    
    (1,000
    )
    
    
    
    
    
    
    1,000
    
    
    
    (979
    )
    
    
    21$
    48,809
    
    
    $
    (30,015
    )
    
    $
    18,794
    
    
    $
    48,809
    
    
    $
    (26,304
    )
    
    $
    22,505
  Three Months Ended
    
    
    Nine Months EndedJuly 31,
    
    
    July 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Amortization of intangible assets included in:Cost of revenues
    
    $
    301
    
    
    $
    796
    
    
    $
    904
    
    
    $
    2,904Operating expenses
    
    
    905
    
    
    
    1,075
    
    
    
    2,807
    
    
    
    3,247$
    1,206
    
    
    $
    1,871
    
    
    $
    3,711
    
    
    $
    6,151
  Cost of
    
    
    OperatingRevenues
    
    
    Expenses
    
    
    TotalRemainder of 2006
    
    $
    301
    
    
    $
    904
    
    
    $
    1,2052007
    
    
    1,206
    
    
    
    3,529
    
    
    
    4,7352008
    
    
    1,206
    
    
    
    3,105
    
    
    
    4,3112009
    
    
    1,069
    
    
    
    2,829
    
    
    
    3,8982010
    
    
    647
    
    
    
    2,829
    
    
    
    3,476Thereafter
    
    
    1,051
    
    
    
    118
    
    
    
    1,169$
    5,480
    
    
    $
    13,314
    
    
    $
    18,794
  13




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##### Table of Contents



Note 8. Debt
  Note 9. Deferred Revenue
  July 31,
    
    
    October 31,2006
    
    
    2005License fees
    
    $
    2,825
    
    
    $
    4,476Subscriptions
    
    
    16,643
    
    
    
    12,546Services and other
    
    
    19,650
    
    
    
    23,409Total
    
    
    39,118
    
    
    
    40,431Less: long-term amounts
    
    
    (7,440
    )
    
    
    (5,213
    )Current portion
    
    $
    31,678
    
    
    $
    35,218
 Note 10. Commitments and Contingent Liabilities
  14




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##### Table of Contents



Note 11. Restructuring and Other Charges
  Three Months Ended
    
    
    Nine Months EndedJuly 31,
    
    
    July 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Restructuring charges:Severance and related benefits for U.K.
headcount reduction
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    452Severance and related benefits for U.S.
headcount reduction
    
    
    23
    
    
    
    118
    
    
    
    264
    
    
    
    417U.K. facility closure liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    313Other
    
    
    (2
    )
    
    
    70
    
    
    
    96
    
    
    
    16221
    
    
    
    188
    
    
    
    360
    
    
    
    1,344Other charges:Executive officer changes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,595Other
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    182$
    21
    
    
    $
    200
    
    
    $
    360
    
    
    $
    3,121
   Severanceand related
    
    
    Facilitybenefits
    
    
    closings
    
    
    Other
    
    
    TotalReserve balance at October 31, 2005
    
    $
    1,598
    
    
    $
    177
    
    
    $
    401
    
    
    $
    2,176Provision for restructuring
    
    
    264
    
    
    
    43
    
    
    
    53
    
    
    
    360Cash payments
    
    
    (1,791
    )
    
    
    (163
    )
    
    
    (129
    )
    
    
    (2,083
    )Other
    
    
    
    
    
    
    
    
    
    
    (15
    )
    
    
    (15
    )Reserve balance at July 31, 2006
    
    $
    71
    
    
    $
    57
    
    
    $
    310
    
    
    $
    438
 15




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##### Table of Contents



Note 12. Comprehensive Loss
  Three Months Ended
    
    
    Nine Months EndedJuly 31,
    
    
    July 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net loss
    
    $
    (1,791
    )
    
    $
    (311
    )
    
    $
    (10,887
    )
    
    $
    (13,792
    )Unrealized gains on available for sale securities
    
    
    (3
    )
    
    
    2
    
    
    
    (1
    )
    
    
    54Reclassifications to net loss of previously
unrealized gain on available-for-sale securities
    
    
    (34
    )
    
    
    
    
    
    
    (20
    )
    
    
    Foreign currency translation adjustments
    
    
    6
    
    
    
    (684
    )
    
    
    (63
    )
    
    
    (386
    )Total comprehensive loss
    
    $
    (1,822
    )
    
    $
    (993
    )
    
    $
    (10,971
    )
    
    $
    (14,124
    )
  
 16




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Business Description
    Critical Accounting Policies and Estimates
  
    
    Revenue recognition
    
    Allowance for doubtful accounts
    
    Capitalized product development costs
    
    Valuation of our deferred income taxes
    
    Valuation and impairment analysis of goodwill and identified intangible assets
  17




---



##### Table of Contents



Share-Based Payment ,
 General Factors Affecting our Financial Results
  Revenue
  Gross Margin
 Operating Expenses
  18




---



##### Table of Contents



Overview of Financial Results
    19




---



##### Table of Contents




    
    Straight Curve Mathematics for grades 3-5 is the first product in our new Straight
Curve product line. Straight Curve is aimed at on-grade-level and advanced instruction
that is teacher directed in the classroom to supplement textbook coverage of concepts
that are most difficult for teachers to teach and students to learn. Straight Curve
Mathematics provides in-depth lessons for grades 3-5 in complex areas, including
fractions, decimals, measurement, probability, and problem solving.
    
    The expansion of our PLATO Courses product line. PLATO Courses are self-paced,
whole-course solutions for granting credit in an online, alternative learning
environment.
    
    The release of PLATO Learning Environment (PLE) which integrates key aspects of the
educational process including managing and delivering online courses and instructional
content, assessing student progress and prescribing individualized instruction,
managing national and state standards, and reporting and analyzing data.
    Results of Operations
 Revenues
  20




---



##### Table of Contents



U.S. Sales Order Information (in thousands)
 Three Months Ended
    
    
    Percent
    
    
    Nine Months Ended
    
    
    PercentJuly 31,
    
    
    Increase
    
    
    July 31,
    
    
    Increase2006
    
    
    2005
    
    
    (Decrease)
    
    
    2006
    
    
    2005
    
    
    (Decrease)Order Value:License fees
    
    $
    13,219
    
    
    $
    17,087
    
    
    
    (22.6
    %)
    
    $
    28,417
    
    
    $
    42,229
    
    
    
    (32.7
    %)Subscriptions
    
    
    10,932
    
    
    
    5,224
    
    
    
    109.3
    %
    
    
    16,319
    
    
    
    10,226
    
    
    
    59.6
    %Services
    
    
    10,226
    
    
    
    10,080
    
    
    
    1.4
    %
    
    
    21,972
    
    
    
    22,598
    
    
    
    (2.8
    %)$
    34,377
    
    
    $
    32,391
    
    
    
    6.1
    %
    
    $
    66,708
    
    
    $
    75,053
    
    
    
    (11.1
    %)Percent of Total Order Value:License fees
    
    
    38
    %
    
    
    53
    %
    
    
    
    
    
    
    43
    %
    
    
    56
    %Subscriptions
    
    
    32
    %
    
    
    16
    %
    
    
    
    
    
    
    24
    %
    
    
    14
    %Services
    
    
    30
    %
    
    
    31
    %
    
    
    
    
    
    
    33
    %
    
    
    30
    %100
    %
    
    
    100
    %
    
    
    
    
    
    
    100
    %
    
    
    100
    %
 Orders Greater Than $100,000
 Three Months Ended
    
    Percent
    
    Nine Months Ended
    
    PercentJuly 31,
    
    Increase
    
    July 31,
    
    Increase2006
    
    2005
    
    (Decrease)
    
    2006
    
    2005
    
    (Decrease)Number
    
    
    50
    
    
    
    50
    
    
    
    
    
    
    
    95
    
    
    
    108
    
    
    
    (12.0
    %)Value ($000)
    
    $
    10,136
    
    
    $
    11,079
    
    
    
    (8.5
    %)
    
    $
    19,507
    
    
    $
    26,613
    
    
    
    (26.7
    %)Average Value ($000)
    
    $
    203
    
    
    $
    222
    
    
    
    (8.6
    %)
    
    $
    205
    
    
    $
    246
    
    
    
    (16.7
    %)
 Revenue By Category (in thousands):
 Three Months Ended
    
    
    Percent
    
    
    Nine Months Ended
    
    
    PercentJuly 31,
    
    
    Increase
    
    
    July 31,
    
    
    Increase2006
    
    
    2005
    
    
    (Decrease)
    
    
    2006
    
    
    2005
    
    
    (Decrease)License fees
    
    $
    11,689
    
    
    $
    18,604
    
    
    
    (37.2
    %)
    
    $
    27,658
    
    
    $
    45,905
    
    
    
    (39.7
    %)Subscriptions
    
    
    4,373
    
    
    
    4,400
    
    
    
    (0.6
    %)
    
    
    12,783
    
    
    
    13,450
    
    
    
    (5.0
    %)Services
    
    
    7,394
    
    
    
    8,235
    
    
    
    (10.2
    %)
    
    
    26,476
    
    
    
    28,768
    
    
    
    (8.0
    %)$
    23,456
    
    
    $
    31,239
    
    
    
    (24.9
    %)
    
    $
    66,917
    
    
    $
    88,123
    
    
    
    (24.1
    %)
  21




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##### Table of Contents



Gross Margin
   Percentage of Total Revenue
 Three Months Ended
    
    Nine Months EndedJuly 31,
    
    July 31,Revenue Category
    
    2006
    
    2005
    
    2006
    
    2005License fees
    
    
    49.8
    %
    
    
    59.6
    %
    
    
    41.3
    %
    
    
    52.1
    %Subscriptions
    
    
    18.6
    %
    
    
    14.1
    %
    
    
    19.1
    %
    
    
    15.3
    %Services
    
    
    31.5
    %
    
    
    26.4
    %
    
    
    39.6
    %
    
    
    32.6
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 Gross Margin Percentage
 Three Months Ended July 31,
    
    Nine Months Ended July 31,Increase
    
    
    
    
    
    
    
    
    
    IncreaseRevenue Category
    
    2006
    
    2005
    
    (Decrease)
    
    2006
    
    2005
    
    (Decrease)License fees
    
    
    65.3
    %
    
    
    73.9
    %
    
    
    (8.6
    %)
    
    
    64.9
    %
    
    
    70.6
    %
    
    
    (5.7
    %)Subscriptions
    
    
    64.8
    %
    
    
    59.5
    %
    
    
    5.3
    %
    
    
    49.7
    %
    
    
    53.6
    %
    
    
    (3.9
    %)Services
    
    
    43.5
    %
    
    
    32.1
    %
    
    
    11.4
    %
    
    
    49.3
    %
    
    
    33.4
    %
    
    
    15.9
    %Total
    
    
    58.4
    %
    
    
    60.8
    %
    
    
    (2.4
    %)
    
    
    55.8
    %
    
    
    55.8
    %
    
    
    .0
    %
  22




---



##### Table of Contents



Operating Expenses
  Percentage of
    
    
    
    
    
    Percentage ofTotal Revenue
    
    Percent
    
    Total Revenue
    
    PercentThree Months Ended
    
    Increase
    
    Nine Months Ended
    
    IncreaseJuly 31,
    
    (Decrease)
    
    July 31,
    
    (Decrease)2006
    
    2005
    
    in Amount
    
    2006
    
    2005
    
    in AmountSales and marketing
    
    
    40.7
    %
    
    
    36.9
    %
    
    
    (17.2
    %)
    
    
    43.1
    %
    
    
    43.4
    %
    
    
    (24.6
    %)General and administrative
    
    
    17.3
    %
    
    
    16.5
    %
    
    
    (20.9
    %)
    
    
    19.5
    %
    
    
    16.1
    %
    
    
    (8.2
    %)Product maintenance and development
    
    
    5.2
    %
    
    
    3.9
    %
    
    
    (1.4
    %)
    
    
    5.9
    %
    
    
    4.4
    %
    
    
    1.4
    %Amortization of intangibles
    
    
    3.9
    %
    
    
    3.4
    %
    
    
    (15.9
    %)
    
    
    4.2
    %
    
    
    3.7
    %
    
    
    (13.6
    %)Operating expenses excluding
restructuring and other charges
    
    
    67.1
    %
    
    
    60.7
    %
    
    
    (17.1
    %)
    
    
    72.7
    %
    
    
    67.6
    %
    
    
    (18.4
    %)Restructuring and
other charges
    
    
    0.1
    %
    
    
    0.6
    %
    
    
    (89.5
    %)
    
    
    0.5
    %
    
    
    3.5
    %
    
    
    (88.5
    %)Total operating expenses
    
    
    67.2
    %
    
    
    61.3
    %
    
    
    (17.9
    %)
    
    
    73.2
    %
    
    
    71.1
    %
    
    
    (21.9
    %)
  23




---



##### Table of Contents



Interest Income
  Liquidity and Capital Resources
 Cash and Cash Equivalents
  Working Capital and Liquidity
  24




---



##### Table of Contents



Contractual Obligations and Commercial Commitments
   Disclosures about Off-Balance Sheet Arrangements
  Fiscal Year 2006 Outlook
  25




---



##### Table of Contents



Forward-Looking Statements
  Interest Rate Risk
  Foreign Currency Exchange Rate Risk
  26




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Interest Rate Risk Foreign Currency
Exchange Rate Risk
 
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Control Over Financial Reporting
  27




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
  
 ITEM 6. EXHIBITS
 Exhibit Number and Description
 10.11
    
    Form of Indemnification Agreement.10.28
    
    PLATO Learning, Inc. 1993 Employee Stock Purchase Plan (As Amended by the
Second Amendment).31.01
    
    Certification of Chief Executive Officer under Rule 13a-14(a) adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.02
    
    Certification of Chief Financial Officer under Rule 13a-14(a) adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.01
    
    Certification of Chief Executive Officer under 18 U.S.C. 1350 pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.32.02
    
    Certification of Chief Financial Officer under 18 U.S.C. 1350 pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 28




---



##### Table of Contents



SIGNATURES
  PLATO LEARNING, INC.
    
    By
    
    /s/ MICHAEL A. MORACHESeptember 11, 2006
    
    
    
    Michael A. MorachePresident and Chief Executive Officer(principal executive officer)/s/ LAURENCE L. BETTERLEY

Laurence L. BetterleySenior Vice President and Chief Financial Officer(principal financial officer)
 29