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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 April 30, 2004 Commission File Number 0-20842 PLATO LEARNING, INC.   Delaware
    
    36-3660532(State or other jurisdiction
    
    (I.R.S. Employerof 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 o Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act: Yes x  No o 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
    
    22,996,004 sharesClass
    
    Outstanding as of June 1, 2004
 1




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PLATO Learning, Inc.
Form 10-Q INDEX PageNumberPART I. FINANCIAL INFORMATIONItem 1. Consolidated Financial Statements (Unaudited):Consolidated Statements of Operations for the
Three and Six Months Ended April 30, 2004 and 2003
    
    
    3Consolidated Balance Sheets as of
April 30, 2004 and October 31, 2003
    
    
    4Consolidated Statements of Cash Flows for the
Six Months Ended April 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of
Results of Operations and Financial Condition
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    37Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
    
    
    37Item 3. Defaults Upon Senior Securities
    
    
    37Item 4. Submission of Matters to a Vote of Security Holders
    
    
    37Item 5. Other Information
    
    
    37Item 6. Exhibits and Reports on Form 8-K
    
    
    38SIGNATURES
    
    
    39Certification of CEO - Section 302Certification of CFO - Section 302Certification of CEO - Section 906Certification of CFO - Section 906
  2




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PLATO Learning, Inc. and Subsidiaries 
 Consolidated Statements of Operations
 (Unaudited, in thousands, except per share amounts)
 Three Months Ended
    
    Six Months EndedApril 30,
    
    April 30,2004
    
    2003
    
    2004
    
    2003Revenues:License fees
    
    $
    17,213
    
    
    $
    9,752
    
    
    $
    30,272
    
    
    $
    17,197Subscriptions
    
    
    5,325
    
    
    
    1,767
    
    
    
    9,833
    
    
    
    3,391Services
    
    
    7,197
    
    
    
    4,296
    
    
    
    13,534
    
    
    
    7,679Other
    
    
    2,585
    
    
    
    1,652
    
    
    
    5,129
    
    
    
    2,657Total revenues
    
    
    32,320
    
    
    
    17,467
    
    
    
    58,768
    
    
    
    30,924Cost of revenues:License fees
    
    
    3,234
    
    
    
    1,917
    
    
    
    6,575
    
    
    
    3,674Subscriptions
    
    
    2,061
    
    
    
    786
    
    
    
    3,740
    
    
    
    1,355Services
    
    
    4,570
    
    
    
    3,008
    
    
    
    8,334
    
    
    
    5,378Other
    
    
    2,342
    
    
    
    1,311
    
    
    
    4,541
    
    
    
    2,302Total cost of revenues
    
    
    12,207
    
    
    
    7,022
    
    
    
    23,190
    
    
    
    12,709Gross profit
    
    
    20,113
    
    
    
    10,445
    
    
    
    35,578
    
    
    
    18,215Operating expenses:Sales and marketing
    
    
    15,793
    
    
    
    9,946
    
    
    
    30,978
    
    
    
    19,184General and administrative
    
    
    5,040
    
    
    
    3,035
    
    
    
    9,532
    
    
    
    6,311Product development
    
    
    1,346
    
    
    
    627
    
    
    
    3,549
    
    
    
    1,188Amortization of intangibles
    
    
    1,102
    
    
    
    147
    
    
    
    2,085
    
    
    
    294Restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    380Total operating expenses
    
    
    23,281
    
    
    
    13,755
    
    
    
    46,144
    
    
    
    27,357Operating loss
    
    
    (3,168
    )
    
    
    (3,310
    )
    
    
    (10,566
    )
    
    
    (9,142
    )Interest income
    
    
    138
    
    
    
    92
    
    
    
    257
    
    
    
    212Interest expense
    
    
    (37
    )
    
    
    (30
    )
    
    
    (72
    )
    
    
    (54
    )Other expense, net
    
    
    (13
    )
    
    
    (8
    )
    
    
    (84
    )
    
    
    (29
    )Loss before income taxes
    
    
    (3,080
    )
    
    
    (3,256
    )
    
    
    (10,465
    )
    
    
    (9,013
    )Income tax expense (benefit)
    
    
    150
    
    
    
    (1,435
    )
    
    
    300
    
    
    
    (3,785
    )Net loss
    
    $
    (3,230
    )
    
    $
    (1,821
    )
    
    $
    (10,765
    )
    
    $
    (5,228
    )Loss per share:Basic and diluted
    
    $
    (0.14
    )
    
    $
    (0.11
    )
    
    $
    (0.48
    )
    
    $
    (0.31
    )Weighted average common shares outstanding:Basic and diluted
    
    
    22,989
    
    
    
    16,534
    
    
    
    22,236
    
    
    
    16,657
 See Notes to Consolidated Financial Statements 3




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PLATO Learning, Inc. and Subsidiaries 
 Consolidated Balance Sheets
 (In thousands, except per share amounts)
 April 30,
    
    October 31,2004
    
    2003(Unaudited)
    
    (See Note)AssetsCurrent assets:Cash and cash equivalents
    
    $
    17,942
    
    
    $
    23,834Accounts receivable, net
    
    
    41,183
    
    
    
    39,176Prepaid expenses and other current assets
    
    
    8,795
    
    
    
    4,819Deferred income taxes
    
    
    
    
    
    
    2,218Total current assets
    
    
    67,920
    
    
    
    70,047Long-term marketable securities
    
    
    3,779
    
    
    
    3,862Equipment and leasehold improvements, net of accumulated
depreciation and amortization of $8,784 and $7,536, respectively
    
    
    6,964
    
    
    
    5,024Product development costs, net of accumulated
amortization of $15,341 and $11,838, respectively
    
    
    15,579
    
    
    
    14,738Goodwill
    
    
    69,570
    
    
    
    39,609Identified intangible assets, net
    
    
    43,266
    
    
    
    14,707Other assets
    
    
    1,820
    
    
    
    1,975Total assets
    
    $
    208,898
    
    
    $
    149,962Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    3,876
    
    
    $
    2,876Accrued employee salaries and benefits
    
    
    6,110
    
    
    
    6,678Accrued liabilities
    
    
    9,313
    
    
    
    3,600Deferred revenue
    
    
    32,292
    
    
    
    22,192Total current liabilities
    
    
    51,591
    
    
    
    35,346Deferred revenue
    
    
    6,029
    
    
    
    4,372Deferred income taxes
    
    
    1,013
    
    
    
    Other liabilities
    
    
    209
    
    
    
    312Total liabilities
    
    
    58,842
    
    
    
    40,030Stockholders equity:Common stock, $.01 par value, 50,000 shares authorized;
23,016 shares issued and 22,996 outstanding at April 30,
2004; 17,671 shares issued and 16,370 shares outstanding
at October 31, 2003
    
    
    230
    
    
    
    164Additional paid in capital
    
    
    162,507
    
    
    
    123,135Treasury stock at cost, 20 and 1,301 shares, respectively
    
    
    (205
    )
    
    
    (11,652
    )Accumulated deficit
    
    
    (11,787
    )
    
    
    (1,022
    )Accumulated other comprehensive loss
    
    
    (689
    )
    
    
    (693
    )Total stockholders equity
    
    
    150,056
    
    
    
    109,932Total liabilities and stockholders equity
    
    $
    208,898
    
    
    $
    149,962
 Note: The balance sheet at October 31, 2003 has been derived from our audited
financial statements at that date. See Notes to Consolidated Financial Statements 4




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PLATO Learning, Inc. and Subsidiaries 
 Consolidated Statements of Cash Flows
 (Unaudited, in thousands)
 Six Months EndedApril 30,2004
    
    2003Operating activities:Net loss
    
    $
    (10,765
    )
    
    $
    (5,228
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Deferred income taxes
    
    
    300
    
    
    
    (3,785
    )Amortization of capitalized product development costs
    
    
    3,478
    
    
    
    2,624Amortization of identified intangible assets
    
    
    3,763
    
    
    
    970Depreciation and amortization of equipment and
leasehold improvements
    
    
    1,837
    
    
    
    1,106Provision for doubtful accounts
    
    
    827
    
    
    
    1,052Stock-based compensation
    
    
    217
    
    
    
    Loss on disposal of equipment
    
    
    1
    
    
    
    59Changes in assets and liabilities, net of effects of acquisitions:Accounts receivable
    
    
    5,775
    
    
    
    4,579Prepaid expenses and other current and noncurrent assets
    
    
    (755
    )
    
    
    280Accounts payable
    
    
    (1,854
    )
    
    
    1,003Accrued liabilities, accrued employee salaries and
benefit sand other liabilities
    
    
    (6,210
    )
    
    
    (2,403
    )Deferred revenue
    
    
    (834
    )
    
    
    (195
    )Total adjustments
    
    
    6,545
    
    
    
    5,290Net cash provided by (used in) operating activities
    
    
    (4,220
    )
    
    
    62Investing activities:Acquisitions, net of cash acquired
    
    
    2,460
    
    
    
    Capitalization of product development costs
    
    
    (4,291
    )
    
    
    (3,168
    )Capital expenditures
    
    
    (1,112
    )
    
    
    (828
    )Purchases of marketable securities
    
    
    (287
    )
    
    
    Sales of marketable securities
    
    
    370
    
    
    
    Net cash used in investing activities
    
    
    (2,860
    )
    
    
    (3,996
    )Financing activities:Repurchase of common stock
    
    
    (205
    )
    
    
    (2,161
    )Net proceeds from issuance of common stock
    
    
    1,491
    
    
    
    35Repayments of capital lease obligations
    
    
    (70
    )
    
    
    (147
    )Net cash provided by (used in) financing activities
    
    
    1,216
    
    
    
    (2,273
    )Effect of foreign currency on cash
    
    
    (28
    )
    
    
    19Net decrease in cash and cash equivalents
    
    
    (5,892
    )
    
    
    (6,188
    )Cash and cash equivalents at beginning of period
    
    
    23,834
    
    
    
    30,390Cash and cash equivalents at end of period
    
    $
    17,942
    
    
    $
    24,202
 See Notes to Consolidated Financial Statements 5




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PLATO Learning, Inc. and Subsidiaries 
 Notes to Consolidated Financial Statements
  1. Business We enhance the learning process by providing computer-based and e-learning
instruction software for kindergarten through adult learners, offering
curricula in reading, writing, mathematics, science, social studies and life
and job skills. We also offer innovative online assessment and accountability
solutions and standards-based professional development services. With over
6,000 hours of objective-based, problem-solving courseware, plus assessment,
alignment and curriculum management tools, we create standards-based curricula
that facilitate learning and school improvement. 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 primarily to K-12
schools and colleges. We also sell to job training programs, correctional
institutions, military education programs, corporations and individuals. We are subject to risks and uncertainties including, but not limited to,
dependence on information technology spending by our customers,
well-established competitors, customers dependent on government funding,
fluctuations of our quarterly results, a lengthy and variable sales cycle,
dependence on key personnel, dependence on our intellectual property
rights, rapid technological change and our ability to integrate
acquisitions. 2. 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, 2003. The accompanying unaudited consolidated financial statements include the
accounts of PLATO Learning, Inc. and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated. Certain reclassifications of previously reported amounts have been made to
conform to the current period presentation in the consolidated statements of
operations. These reclassifications did not change previously reported
revenues, operating loss or net loss and related per share amounts. For more
information on these reclassifications, refer to Note 3 to Consolidated
Financial Statements in our Annual Report on Form 10-K for the year ended
October 31, 2003. 6




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) 3. Summary of Significant Accounting Policies For more information on our significant accounting policies, refer to Note 2 to
Consolidated Financial Statements in our Annual Report on Form 10-K for the
year ended October 31, 2003. Stock-Based Compensation We account for our stock-based employee compensation arrangements in accordance
with the provisions of Accounting Principles Board Opinion No. 25 Accounting
for Stock Issued to Employees and comply with the disclosure provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation and SFAS No. 148 Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment of Financial Accounting
Standards Board (FASB) Statement No. 123. We have adopted the disclosure-only provisions of SFAS No. 123. For purposes
of the pro forma disclosures below, the estimated fair value of stock-based
employee compensation is amortized to expense over the vesting period of the
related arrangement. Had compensation expense for the stock-based employee
compensation been recognized based on the fair value at the grant date
consistent with the provisions of SFAS No. 123, reported results would have
been adjusted to the pro forma amounts presented below: Three Months Ended
    
    Six Months EndedApril 30,
    
    April 30,2004
    
    2003
    
    2004
    
    2003Net loss, as reported
    
    $
    (3,230
    )
    
    $
    (1,821
    )
    
    $
    (10,765
    )
    
    $
    (5,228
    )Add: stock-based compensation expense included
in reported net loss
    
    
    217
    
    
    
    
    
    
    
    217
    
    
    
    Deduct: stock-based compensation expense determined
using the fair value based method for all awards,
net of related tax effects in 2003
    
    
    (2,269
    )
    
    
    (1,141
    )
    
    
    (3,895
    )
    
    
    (2,101
    )Pro forma net loss
    
    $
    (5,282
    )
    
    $
    (2,962
    )
    
    $
    (14,443
    )
    
    $
    (7,329
    )Basic and diluted loss per share:As reported
    
    $
    (0.14
    )
    
    $
    (0.11
    )
    
    $
    (0.48
    )
    
    $
    (0.31
    )Pro forma
    
    $
    (0.23
    )
    
    $
    (0.18
    )
    
    $
    (0.65
    )
    
    $
    (0.44
    )
 New Accounting Pronouncements In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities. In December 2003, the FASB
issued a revised version of this Interpretation, FIN 46(R). FIN 46(R)
addresses the requirements for business enterprises to consolidate related
entities, in which they do not have controlling interests through voting or
other rights, if they are determined to be the primary beneficiary of these
entities as a result of variable economic interests. FIN 46 or FIN 46(R) must
be applied to Special Purpose Entities 7




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) (SPEs) created prior to
February 1, 2003 and all entities, including SPEs, created subsequent to January 31, 2003 in our first quarter of fiscal year 2004. FIN 46(R)
also must be applied for all entities created prior to February 1, 2003 in our second
quarter of fiscal year 2004. We adopted FIN 46(R) beginning in our first quarter of fiscal year 2004, and no
variable interests with SPEs or entities created subsequent to January 31, 2003
have been identified; therefore, there was no impact on our consolidated
financial statements, and no disclosures were required. The adoption of FIN
46(R) for entities created prior to February 1, 2003 is not expected to have a
material impact on our consolidated financial statements. While we currently
have no arrangements of this nature, if we enter into any such arrangements in
the future, our consolidated financial statements may be adversely effected. 4. Acquisitions We account for business combinations in accordance with SFAS No. 141, Business
Combinations. All of our acquisitions, including those prior to the adoption
of SFAS No. 141, were accounted for using the purchase method of accounting.
The assets and liabilities acquired were recorded at their estimated fair
values on the dates of acquisition. Operating results of the acquired
companies were included in our consolidated financial statements from the dates
of acquisition. Acquisition-related goodwill and identified intangible assets
are subject to the provisions of SFAS No. 142, Goodwill and Other Intangible
Assets, which require goodwill to be tested periodically for impairment, but
not be amortized. Identified intangible assets are amortized over their
estimated lives. See Note 6 for additional information regarding goodwill and
identified intangible assets. Lightspan, Inc. On November 17, 2003, we acquired Lightspan, Inc. (Lightspan), a
publicly-held corporation and provider of curriculum-based educational software
and online assessment products used in schools, at home and in community
colleges. This acquisition is expected to strengthen our product offerings in
the K-8 and post-secondary markets and enhance our ability to provide
comprehensive solutions to K-12 and adult learning institutions. We acquired all of the outstanding shares of Lightspan for 6,576,129 shares of
our common stock valued at $52,082 for accounting purposes, $26,031 for assumed
liabilities, $2,700 for estimated severance payments, $1,000 for estimated
lease termination costs, and direct acquisition fees of $1,931. Direct
acquisition fees consisted primarily of investment banking, legal and
professional fees. The number of shares issued included shares issued for
Lightspans in-the-money stock options. The fair value of the Lightspan
options and warrants assumed in connection with the merger and converted to
PLATO options and warrants was not significant. 8




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) The purchase price consisted of the following components: Fair value of common stock issued
    
    $
    52,082Direct acquisition fees
    
    
    1,931Estimated severance payments
    
    
    2,700Estimated lease termination costs
    
    
    1,000Liabilities assumed
    
    
    26,031$
    83,744
 The allocation of the total purchase price, including acquisition fees, was as
follows: Fair value of tangible assets acquired
    
    $
    28,021Fair value of identified intangible assets
    
    
    30,400Estimated goodwill
    
    
    28,449Deferred income taxes
    
    
    (3,126
    )$
    83,744
 An appraisal firm assisted us with the valuation of identified intangible
assets, consisting of $19,800 for customer relationships, $7,300 for developed
content and technology, $2,300 for trademarks and trade names and $1,000 for a
non-compete agreement. These identified intangible assets are being amortized
over periods of seven years for customer relationships, nine years for
developed content and technology, four and one-half years for trademarks and
trade names and two years for the non-compete agreement. In connection with this acquisition, we developed plans for workforce and
facility reductions. The aggregate estimated costs of these plans is $3,700,
which consisted of $2,700 related to the elimination of 144 positions in the
United States and $1,000 related to lease termination, which ends October 31,
2004 and has a minimum monthly lease payment of $106. As of April 30, 2004,
approximately $1,668 of the estimated $2,700 of severance costs have been paid.
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. New Media (Holdings) Limited On December 17, 2003, we acquired New Media (Holdings) Limited (New Media), a
United Kingdom (U.K.) based publisher of curriculum-focused software
primarily for teaching secondary school science and math, for approximately
$6,800 in cash. This acquisition enhances our science offering, provides a
science simulation development capability that we did not previously have and
will allow us to introduce New Medias products to markets in the United States
for the first time. Additionally, this acquisition is expected to provide
critical mass and revenue diversification in the U.K. and strengthen our
relationships with the U.K. Education Department. 9




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) The purchase price consisted of the following components: Cash paid
    
    $
    6,750Direct acquisition fees
    
    
    429Liabilities assumed
    
    
    864$
    8,043
 The allocation of the total purchase price, including acquisition fees, was as follows: Fair value of tangible assets acquired
    
    $
    1,664Estimated fair value of identified intangible assets
    
    
    1,939Estimated goodwill
    
    
    4,440$
    8,043
 An appraisal firm assisted us with the valuation of identified intangible
assets, consisting of $1,804 for developed content and technology and $135 for
customer relationships. These identified intangible assets are being amortized
over periods of four to seven years for developed content and technology and
one to five years for customer relationships. Unaudited Pro Forma Data Our unaudited pro forma consolidated results of operations, as if the Lightspan
acquisition had occurred at the beginning of the periods presented, were as
follows: Six Months EndedApril 30,2004
    
    2003(Unaudited)
    
    (Unaudited)Revenues
    
    $
    59,737
    
    
    $
    53,816Net loss
    
    
    (12,496
    )
    
    
    (16,844
    )Basic and diluted loss per share
    
    
    (0.55
    )
    
    
    (0.73
    )
 The unaudited pro forma data gives effect to actual operating results prior to
the acquisition and adjustments to reflect increased identified intangible
asset amortization and the current accounting treatment of income taxes. No
effect has been given to cost reductions or operating synergies in this
presentation. 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 acquisition occurred at the beginning of the
periods presented or the results which may occur in the future. The pro forma
data does not include New Media, as the effects of this acquisition were not
material on a pro forma basis. 10




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) 5. Accounts Receivable The components of accounts receivable were as follows: April 30,
    
    October 31,2004
    
    2003Trade accounts receivable
    
    $
    26,882
    
    
    $
    21,415Installment accounts receivable
    
    
    19,050
    
    
    
    22,015Allowance for doubtful accounts
    
    
    (4,749
    )
    
    
    (4,254
    )$
    41,183
    
    
    $
    39,176
 The provision for doubtful accounts, included in general and administrative
expense on the consolidated statements of operations, was $481 and $527 for the
three months and $827 and $1,052 for the six months ended April 30, 2004 and
2003, respectively. 6. Goodwill and Identified Intangible Assets We account for goodwill and identified intangible assets in accordance with the
provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS
No. 142, goodwill and intangible assets with indefinite lives are no longer
amortized to expense and must be periodically reviewed for impairment. If such
review indicates that the carrying amount of an intangible asset exceeds its
fair value, an impairment loss would be recognized equal to that excess amount. Goodwill The changes in goodwill from October 31, 2003 were as follows: Balance, October 31, 2003
    
    $
    39,609Acquisition of Lightspan
    
    
    28,449Acquisition of New Media
    
    
    4,440Release of shares from escrow
    
    
    (2,895
    )Foreign currency translation
    
    
    (33
    )Balance, April 30, 2004
    
    $
    69,570
 Goodwill was decreased by $2,895 during the three months ended January 31, 2004
as a result of the release of escrow shares relating to the NetSchools
acquisition in 2002. As of April 30, 2004, 100,000 shares remained in escrow
relating to this acquisition. 11




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) Identified Intangible Assets Identified intangible assets subject to amortization were as follows: April 30, 2004
    
    October 31, 2003Gross Carrying
    
    Accumulated
    
    Net Carrying
    
    Gross Carrying
    
    Accumulated
    
    Net CarryingValue
    
    Amortzation
    
    Value
    
    Value
    
    Amortzation
    
    ValueAcquired technology
    
    $
    24,798
    
    
    $
    (4,191
    )
    
    $
    20,607
    
    
    $
    15,717
    
    
    $
    (2,589
    )
    
    $
    13,128Trademark
    
    
    3,680
    
    
    
    (972
    )
    
    
    2,708
    
    
    
    1,380
    
    
    
    (640
    )
    
    
    740Customer relationships
    
    
    21,233
    
    
    
    (2,119
    )
    
    
    19,114
    
    
    
    1,300
    
    
    
    (595
    )
    
    
    705Employment agreement
    
    
    413
    
    
    
    (347
    )
    
    
    66
    
    
    
    413
    
    
    
    (279
    )
    
    
    134Noncompete agreements
    
    
    1,090
    
    
    
    (319
    )
    
    
    771
    
    
    
    90
    
    
    
    (90
    )
    
    
    $
    51,214
    
    
    $
    (7,948
    )
    
    $
    43,266
    
    
    $
    18,900
    
    
    $
    (4,193
    )
    
    $
    14,707
 Amortization expense for identified intangible assets was $1,983 and $494 for
the three months ended April 30, 2004 and 2003, respectively, of which $881 and
$347 was included in cost of revenues for each period. Amortization expense
was $3,763 and $970 for the six months ended April 30, 2004 and 2003,
respectively, of which $1,678 and $676 was included in cost of revenues for
each period. The estimated future annual amortization expense for identified intangible
assets is as follows: Remainder of 2004
    
    
    3,9112005
    
    
    7,5802006
    
    
    6,9042007
    
    
    6,6802008
    
    
    6,095Thereafter
    
    
    12,096$
    43,266
 7. Debt Revolving Loan On June 10, 2004, we extended our revolving loan agreement with Wells Fargo
Bank, N.A. through July 1, 2005. The revolving loan agreement provides for a
maximum $12,500 line of credit. Substantially all of our assets are pledged as
collateral under the agreement. There were no borrowings outstanding at April
30, 2004 or October 31, 2003. The agreement contains restrictive financial covenants (including Minimum
Tangible Net Worth, Minimum Debt Service Coverage, Maximum Leverage, Maximum
Cash Flow Leverage and Maximum Annual Capital Expenditures) and restrictions on
additional borrowings, asset sales and dividends, as defined. All applicable
covenants were satisfied as of and for the twelve-month period ended April 30,
2004. 12




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) 8. Deferred Revenue The components of deferred revenue were as follows: April 30,
    
    October 31,2004
    
    2003License fees
    
    $
    7,192
    
    
    $
    4,762Subscriptions
    
    
    8,774
    
    
    
    4,134Services
    
    
    22,160
    
    
    
    17,360Other
    
    
    195
    
    
    
    30838,321
    
    
    
    26,564Less: long-term amounts
    
    
    (6,029
    )
    
    
    (4,372
    )$
    32,292
    
    
    $
    22,192
 9. Restructuring Charges In May 2003, we replaced our Managing Director of operations in the United
Kingdom, and severed relationships with two senior executives (our Chief
Operating Officer and a co-founder of NetSchools) and three other employees in
connection with a restructuring plan to align our cost structure with future
expectations. The consolidated statement of operations for 2003 included a
restructuring charge of $422 recorded in the third quarter for severance costs
related to this action. As of October 31, 2003, approximately $252 of these
severance costs had been paid and as of April 30, 2004 approximately $383 of
these severance costs had been paid. The remaining costs are expected to be
paid by August 2004. In December 2002, we reduced the size of our workforce by approximately 30
positions and closed approximately 30 open job requisitions, all in the United
States, which together represented about 10% of our planned workforce, in
connection with a restructuring plan to align our cost structure with future
expectations. The consolidated statement of operations for 2003 included a
restructuring charge of $380 recorded in the first quarter for severance costs
related to this reduction. All of these severance costs were paid as of
October 31, 2003. 13




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) 10. Income Taxes At October 31, 2003, we had a net deferred income tax asset of $2,218.
Approximately $7,377 of the deferred tax asset related to our net operating
loss carryforwards in the United States of approximately $18,500, which expire
in varying amounts between 2004 and 2023. We also have net operating loss
carryforwards of approximately $3,000 related to our foreign subsidiaries. We
have provided a full valuation allowance related to these foreign deferred tax
assets due to the uncertainty in realization of future taxable income in these
foreign jurisdictions. Realization of our deferred tax asset is dependent on generating sufficient
taxable income in the United States prior to expiration of these loss
carryforwards. Although realization was not assured at October 31, 2003, we
believed it was more likely than not that all of the deferred tax asset would
be realized. We based this belief upon the levels of taxable income generated
historically, as well as projections of future taxable income. However, our
merger with Lightspan in the first quarter of fiscal 2004 impacted our
assessment of the realization of deferred tax assets because the merged company
is considered one consolidated taxable entity. As a result of the merger, we
acquired approximately $290,000 of Lightspans net operating loss
carryforwards. Based on a preliminary Section 382 limitation analysis, the
usage of these net operating loss carryforwards is limited to approximately
$2,500 per year and, therefore, approximately $35,000 of the acquired net
operating loss carryforwards are available to the combined entity. These
amounts are preliminary and may change as the Section 382 limitation analysis
is finalized. Our combined net operating loss carryforwards as of the acquisition date were
approximately $57,000. The combined net operating loss carryforwards, which
represent the majority of the merged companys deferred tax assets, must be
reviewed for realization primarily based upon historical results and
secondarily upon projected results. Although we expect taxable income in 2004,
this expectation is highly dependent on the integration of the Lightspan
acquisition. Lightspan has historically incurred significant operating losses
which carry more weight than the projected results. Consequently, it is our
current view that, while we had cumulative taxable income for the last three
fiscal years, our historical operating results were insufficient to support the
combined post-merger deferred tax assets. As a result, net deferred tax
assets, excluding the deferred tax liability relating to tax deductible
goodwill, which cannot be used to support realization of the other net deferred
tax assets, were fully reserved for in the purchase accounting for the
Lightspan acquisition in our first quarter of 2004 thereby increasing goodwill.
Any subsequent reversal of the valuation allowance recorded on the combined
entitys pre-acquisition deferred tax assets will be recorded as a reduction of
goodwill. 11. Per Share Data Basic loss per share is calculated by dividing net loss by the weighted average
number of common shares outstanding during the period. Diluted loss per share
is calculated by dividing net 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. 14




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PLATO Learning, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts) The calculation of basic and diluted loss per share was as follows: Three Months Ended
    
    Six Months EndedApril 30,
    
    April 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (3,230
    )
    
    $
    (1,821
    )
    
    $
    (10,765
    )
    
    $
    (5,228
    )Basic:Weighted average common shares outstanding
    
    
    22,989,000
    
    
    
    16,534,000
    
    
    
    22,236,000
    
    
    
    16,657,000Basic loss per share
    
    $
    (0.14
    )
    
    $
    (0.11
    )
    
    $
    (0.48
    )
    
    $
    (0.31
    )Diluted:Weighted average common shares outstanding
    
    
    22,989,000
    
    
    
    16,534,000
    
    
    
    22,236,000
    
    
    
    16,657,000Potential common shares:Stock options and warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common shares held in escrow
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restricted common shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weighted average common and potential common
shares outstanding for diluted loss per share
    
    
    22,989,000
    
    
    
    16,534,000
    
    
    
    22,236,000
    
    
    
    16,657,000Diluted loss per share
    
    $
    (0.14
    )
    
    $
    (0.11
    )
    
    $
    (0.48
    )
    
    $
    (0.31
    )
 The calculation of diluted loss per share for the three and six months ended
April 30, 2004 and 2003 excluded the effect of approximately 3,502,000 and
3,146,000 potential common shares from the conversion of outstanding options
and warrants and common shares held in escrow, respectively, as they were
antidilutive. 12. Comprehensive Loss Total comprehensive loss was as follows: Three Months Ended
    
    Six Months EndedApril 30,
    
    April 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (3,230
    )
    
    $
    (1,821
    )
    
    $
    (10,765
    )
    
    $
    (5,228
    )Foreign currency translation adjustments
    
    
    (233
    )
    
    
    (86
    )
    
    
    4
    
    
    
    34Total comprehensive loss
    
    $
    (3,463
    )
    
    $
    (1,907
    )
    
    $
    (10,761
    )
    
    $
    (5,194
    )
 13. Segment and Geographic Information We operate and manage our business as one segment, the development and
marketing of educational software and related services. We have foreign subsidiaries in Canada and the United Kingdom. Our foreign
operations are not significant to our consolidated business. At April 30,
2004, less than 1% of our long-term assets
are located in foreign countries, and for the six months ended April 30, 2004,
approximately 3% of our revenues are from foreign countries. 15




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PLATO Learning, Inc. and Subsidiaries 
 Managements Discussion and Analysis of Results of
Operations and Financial Condition
 OVERVIEW We enhance the learning process by providing computer-based and e-learning
instruction software for kindergarten through adult learners, offering
curricula in reading, writing, mathematics, science, social studies and life
and job skills. We also offer innovative online assessment and accountability
solutions and standards-based professional development services. With over
6,000 hours of objective-based, problem-solving courseware, plus assessment,
alignment and curriculum management tools, we create standards-based curricula
that facilitate learning and school improvement. PLATO courseware is delivered
via networks, CD-ROM, private intranets and the Internet. We market our
courseware products and services primarily to K-12 schools and colleges. We
also sell to job training programs, correctional institutions, military
education programs, corporations and individuals. In November 2003, we acquired Lightspan, Inc. (Lightspan), a provider of
curriculum-based educational software and on-line assessment products and
services that increase student achievement and enhance teacher professional
development. These products are used in schools and homes and align all key
federal reform initiatives, offering school districts a comprehensive
achievement and accountability system to assess, align, instruct and evaluate.
This acquisition is expected to strengthen our product offerings, with two
strong and complimentary brands, in the K-8 and post secondary markets. We
also expect this acquisition to enhance our ability to provide comprehensive
solutions to K-12 and adult learning institutions. The combination of Lightspan and PLATO also unites Lightspans Academic Systems
products with our community college products to establish the largest provider
of on-line content for under-prepared college students. In addition, the
merger of sales forces will provide critical mass for servicing elementary,
secondary, district level, and colleges across all product lines and services.
We believe these advantages, plus the elimination of significant duplicate
costs, will provide greater earnings and cash flow potential for the combined
company, and ultimately a greater valuation. Lightspan generated revenues of approximately $50,000 in its fiscal year ended
January 31, 2003. We expect to achieve approximately $17.5 million of cost
reductions in 2004 and annualized cost reductions of between $20.0 and $25.0
million thereafter, primarily through workforce reductions and the elimination
of duplicate costs. The acquisition is expected to be modestly dilutive to our
earnings per share in 2004, particularly in the earlier quarters of the year.
Earnings per share will be impacted by non-cash charges for the amortization of
identified intangible assets acquired with this transaction. In December 2003, we acquired New Media (Holdings) Limited (New Media), a
United Kingdom (U.K.) based publisher of curriculum-focused software
primarily for teaching secondary school science and math. This acquisition
enhances our science offering, provides a
science simulation development capability that we did not previously have and
will allow us to introduce New Medias products to markets in the 16




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) United States
for the first time. Additionally, this acquisition is expected to provide
critical mass and revenue diversification in the U.K. and strengthen our
relationships with the U.K. Education Department. We are subject to risks and uncertainties including, but not limited to,
dependence on information technology spending by our customers,
well-established competitors, customers dependent on government funding,
fluctuations of our quarterly results, a lengthy and variable sales cycle,
dependence on key personnel, dependence on our intellectual property
rights, rapid technological change and our ability to integrate
acquisitions. As provided for in the Private Securities Litigation Reform
Act of 1995, we caution investors that these factors could cause our
future results of operations to vary from those anticipated in previously
made forward-looking statements and any other forward-looking statements
made in this document and elsewhere by or on behalf of us. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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. 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 estimates, and have identified revenue recognition, the
allowance for doubtful accounts, capitalized product development costs, the
valuation of our deferred income taxes, and the valuation and impairment
analysis of goodwill and identified intangible assets as the critical
accounting policies and estimates that are significant to the financial
statement presentation and require difficult, subjective and complex judgments. See Note 2 to Consolidated Financial Statements in our Annual Report on Form
10-K for the fiscal year ended October 31, 2003 for additional discussion on
these and other accounting policies and disclosures required by accounting
principles generally accepted in the United States of America. 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 significant judgments for revenue recognition typically involve whether
collectibility can be considered probable and whether fees are fixed or
determinable. In addition, our transactions often consist of multiple element
arrangements, which must be analyzed to determine the 17




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) 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. 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. 104, Revenue
Recognition in Financial Statements. We license software under non-cancelable
license and subscription agreements. We also provide related professional
services, including consulting, training and implementation services, as well
as ongoing customer support and maintenance. Consulting, training and
implementation services are not essential to the functionality of our software
products. Accordingly, revenues from these services are recognized separately. Revenue from the sale of courseware licenses is recognized upon meeting the
following criteria: (i) a written customer order has been executed, (ii)
courseware has been delivered, (iii) the license fee is fixed or determinable
and (iv) collectibility of the fee is probable. We do not generally provide
acceptance clauses to our customers. In situations where we do provide
acceptance clauses, revenue is deferred until the clause expires or acceptance
criteria are met. For software arrangements that include more than one element, we allocate the
total arrangement fee among each deliverable based on vendor-specific objective
evidence (VSOE) of the relative fair value of each deliverable. VSOE is
determined using the price charged when that element is sold separately. For
software arrangements in which we do not have VSOE for undelivered elements,
revenue is deferred until the earlier of when VSOE is determined for the
undelivered elements or when all elements for which we do not have VSOE have
been delivered. If collectibility of the fee is not probable, revenue is recognized as payments
are received from the customer provided all other revenue recognition criteria
have been met. If the fee due from the customer is not fixed or determinable,
revenue is recognized as the payments become due provided all other revenue
recognition criteria have been met. Subscription revenue, primarily fees charged for our on-line subscription
products, is recognized on a ratable basis as the products are delivered over
the subscription period. Services revenue consists of software support and maintenance, which is
deferred and recognized ratably over the support period, and consulting,
training and implementation services, which are recognized as the services are
performed. Other revenue, primarily from hardware and third-party software products, is
recognized as the products are delivered and all other revenue recognition
criteria are met. 18




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) 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
trade and installment accounts receivable. Bad debt expense is included in
general and administrative expense in our consolidated statement of operations.
The assumptions and estimates used to determine the allowance are subject to
constant revision and involve significant assumptions and judgment. The
primary factors that impact these assumptions include the efficiency and
effectiveness of our billing and collection functions, our historical
experience and our credit assessment process. We believe that the current
budget difficulties facing many states will not have a significant impact on
the collection of our accounts receivable. However, a change in the underlying
conditions contributing to our belief could impact our assessment of
collectibility and, therefore, require a change in the allowance for doubtful
accounts and the amount of bad debt expense. Actual collection results could
differ materially from those estimated and have a significant impact on our
consolidated results of operations. Our provision for bad debts is based on
our historical experience using a detailed analysis of customer-specific
activity and receivable balances performed on a quarterly basis. Our allowance
for doubtful accounts increased to $4,749, or 10.2% of gross accounts
receivable, at April 30, 2004, from $4,254, or 9.8%, at October 31, 2003. Capitalized Product Development Costs Our product development costs relate to the research, development, enhancement
and maintenance of our courseware products. The amortization of capitalized
product development costs is included in cost of revenues. Research and
development costs, relating principally to the design and development of new
products, and the routine enhancement and maintenance of existing products are
expensed as incurred. We capitalize product development costs when the
projects under development reach technological feasibility. A significant
portion of our product development costs qualify for capitalization due to the
concentration of our development efforts on the content of our courseware.
Capitalization ends when a product is available for general release to our
customers, at which time amortization of the capitalized costs begins. We
amortize these costs using the greater of: (a) the amount determined by the
ratio of the products current revenue to total expected future revenue, or (b)
the straight-line method over the estimated useful life of the product, which
is generally three years. During all periods presented, we used the
straight-line method to amortize the capitalized costs as this method resulted
in greater amortization. The significant judgment regarding capitalization of product development costs
involves the recoverability of capitalized costs. We evaluate our capitalized
costs at least annually, or more frequently if events or changes in
circumstances indicate that the asset might be impaired, 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 revenues and cash flows to be generated by the product and
to use judgment in quantifying the 19




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) 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 consolidated results of
operations. Valuation of Deferred Income Taxes 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 deferred taxes is adjusted by a valuation allowance, if
necessary, to recognize the extent to which the future tax benefits will be
recognized. At October 31, 2003, we had a net deferred tax asset of $2,218. Approximately
$7,377 of the deferred tax asset relates to our net operating loss
carryforwards in the United States of approximately $18,500, which expire in
varying amounts between 2004 and 2023. We also have net operating loss
carryforwards of approximately $3,000 related to our foreign subsidiaries. We
have provided a full valuation allowance related to these foreign deferred
income tax assets due to the uncertainty in realization of future taxable
income in these foreign jurisdictions. Realization of our deferred tax asset is dependent on generating sufficient
taxable income in the United States prior to expiration of these loss
carryforwards. Although realization was not assured at October 31, 2003, we
believed it was more likely than not that all of the deferred tax asset would
be realized. We based this belief upon the levels of taxable income generated
historically, as well as projections of future taxable income. However, our
merger with Lightspan in the first quarter of fiscal 2004 impacted our
assessment of the realization of deferred tax assets because the merged company
is considered one consolidated taxable entity. As a result of the merger, we acquired approximately $290,000 of Lightspans
net operating loss carryforwards. Based on a preliminary Section 382
limitation analysis, the usage of these net operating loss carryforwards is
limited to approximately $2,500 and, therefore, approximately $35,000 of the
acquired net operating loss carryforwards are available to the combined entity. Our combined net operating loss carryforwards as of the acquisition date were
approximately $57,000 at April 30, 2004. The combined net operating loss
carryforwards, which represent the majority of the merged companys deferred
tax assets, must be reviewed for realization primarily based upon historical
results and secondarily upon projected results. Although we expect taxable
income in 2004, this expectation is highly dependent on the integration of the
Lightspan acquisition. Lightspan has historically incurred significant
operating losses which carry more weight than the projected results.
Consequently, it is our current view that, while we had cumulative taxable
income for the last three fiscal years, our historical operating results were
insufficient to support the combined post-merger deferred tax assets. As a
result, net deferred tax assets, excluding the deferred tax liability relating
to tax deductible goodwill, which cannot be used to support realization of the
other net 20




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) deferred tax assets, were fully
reserved for in the purchase
accounting for the Lightspan acquisition in our first quarter of 2004 thereby
increasing goodwill. Any subsequent reversal of the valuation allowance
recorded on the combined entitys pre-acquisition deferred tax assets will be
recorded as a reduction of goodwill. Goodwill and Identified Intangible Assets We record our acquisitions in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations. We allocate the cost of
acquired companies to the tangible and identified intangible assets and
liabilities acquired, with the remaining amount being recorded as goodwill.
Certain intangible assets, such as acquired technology, are amortized to
expense over their estimated useful lives, while in-process research and
development, if any, is recorded as a one-time charge at the acquisition date. Most of the companies we acquire do not have significant tangible assets and,
as a result, the majority of the purchase price is typically allocated to
identified intangible assets and/or goodwill, which increases future
amortization expense of identified intangible assets and the potential for
impairment charges that we may incur. Accordingly, the allocation of the
purchase price to intangible assets may have a significant impact on our future
operating results. In addition, the allocation of the purchase price requires
that we make significant assumptions and estimates, including estimates of
future cash flows expected to be generated by the acquired assets. Should
different conditions prevail, we may have to record impairment charges, which
may have a significant impact on our consolidated financial statements. We account for goodwill and other intangible assets in accordance with the
provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS
No. 142, goodwill and intangible assets with indefinite lives are not amortized
to expense and must be reviewed for impairment annually or more frequently if
events or changes in circumstances indicate that the asset might be impaired.
The first step of the goodwill impairment test, used to identify potential
impairment, compares the fair value of a reporting unit with its carrying
amount, including goodwill. We operate as one reporting unit and therefore
compare our book value to market value (market capitalization plus a control
premium). If our fair value exceeds our book value, goodwill is considered not
impaired, thus the second step of the impairment test is unnecessary. If our
book value exceeds our market value, the second step of the goodwill impairment
test shall be performed to measure the amount of impairment loss, if any. The
second step of the goodwill impairment test, used to measure the amount of
impairment loss, compares the implied fair value of the goodwill with the book
value of the goodwill. If the carrying amount of the goodwill exceeds the
implied fair value of the goodwill, an impairment loss would be recognized in
an amount equal to that excess. Any loss recognized cannot exceed the carrying
amount of goodwill. After a goodwill impairment loss is recognized, the
adjusted carrying amount of goodwill is its new accounting basis. Subsequent
reversal of a previously recognized goodwill impairment loss is prohibited once
the measurement of that loss is completed. We completed our annual goodwill
impairment assessment as of October 31, 2003, upon which no impairment charge
was recorded. 21




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) ACQUISITIONS Our acquisition strategy is to acquire complementary products or businesses
that will enable us to achieve our strategic goals, including market
leadership, growth rates that exceed the market, and providing innovative,
leading and distinct products and services. During the three months ended
January 31, 2004, we acquired Lightspan, Inc. and New Media (Holdings) Limited.
Lightspan was acquired in a stock transaction where we issued approximately
6.6 million shares of our common stock, valued at approximately $52,000 for
accounting purposes, for all of Lightspans outstanding stock. We acquired New
Media for approximately $6,800 in cash. See Note 4 to Consolidated Financial
Statements for more information on these strategic acquisitions. 22




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) RESULTS OF OPERATIONS Operating Results as a Percentage of Revenue Three Months Ended
    
    Six Months EndedApril 30,
    
    April 30,2004
    
    2003
    
    2004
    
    2003Revenues:License fees
    
    
    53.2
    %
    
    
    55.8
    %
    
    
    51.5
    %
    
    
    55.6
    %Subscriptions
    
    
    16.5
    
    
    
    10.1
    
    
    
    16.8
    
    
    
    11.0Services
    
    
    22.3
    
    
    
    24.6
    
    
    
    23.0
    
    
    
    24.8Other
    
    
    8.0
    
    
    
    9.5
    
    
    
    8.7
    
    
    
    8.6Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost of revenues:License fees
    
    
    10.0
    
    
    
    11.0
    
    
    
    11.2
    
    
    
    11.9Subscriptions
    
    
    6.4
    
    
    
    4.5
    
    
    
    6.4
    
    
    
    4.4Services
    
    
    14.1
    
    
    
    17.2
    
    
    
    14.2
    
    
    
    17.4Other
    
    
    7.3
    
    
    
    7.5
    
    
    
    7.7
    
    
    
    7.4Total cost of revenues
    
    
    37.8
    
    
    
    40.2
    
    
    
    39.5
    
    
    
    41.1Gross profit
    
    
    62.2
    
    
    
    59.8
    
    
    
    60.5
    
    
    
    58.9Operating expenses:Sales and marketing
    
    
    48.9
    
    
    
    57.0
    
    
    
    52.7
    
    
    
    62.0General and administrative
    
    
    15.6
    
    
    
    17.4
    
    
    
    16.2
    
    
    
    20.4Product development
    
    
    4.1
    
    
    
    3.6
    
    
    
    6.0
    
    
    
    3.9Amortization of intangibles and goodwill
    
    
    3.4
    
    
    
    0.8
    
    
    
    3.6
    
    
    
    1.0Restructuring charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.2Total operating expenses
    
    
    72.0
    
    
    
    78.8
    
    
    
    78.5
    
    
    
    88.5Operating loss
    
    
    (9.8
    )
    
    
    (19.0
    )
    
    
    (18.0
    )
    
    
    (29.6
    )Interest income and expense and
other expense, net
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.4Loss before income taxes
    
    
    (9.5
    )
    
    
    (18.7
    )
    
    
    (17.8
    )
    
    
    (29.2
    )Income tax expense (benefit)
    
    
    0.5
    
    
    
    (8.2
    )
    
    
    0.5
    
    
    
    (12.2
    )Net loss
    
    
    (10.0
    )%
    
    
    (10.5
    )%
    
    
    (18.3
    )%
    
    
    (17.0
    )%
 Certain reclassifications of previously reported amounts have been made to
conform to the current period presentation in the consolidated statements of
operations. These reclassifications did not change previously reported
revenues, operating loss or net loss and related per share amounts. For more
information on these reclassifications, refer to Note 3 to Consolidated
Financial Statements in our Annual Report on Form 10-K for the year ended
October 31, 2003. Revenues Total Revenues.Total reported revenues increased 85.0% to $32,320 for the
three months ended April 30, 2004 from $17,467 for the same period in 2003.
Total reported revenues increased 90.0% to $58,768 for the six months ended
April 30, 2004 from $30,924 for the same period 23




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) in
2003. Our significant revenue growth in 2004 reflected the acquisition of
Lightspan, and, while impacted by the economic conditions discussed below, also
reflected our increased focus on larger orders, subscriptions revenue, and
correlation and professional development services. The following tables present total revenues, as reported and on a pro forma
basis, as if Lightspan revenues prior to the acquisition had been included for
all periods presented: Three Months Ended April 30,2004
    
    2003Total Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    32,320
    
    
    
    100.0
    %
    
    $
    17,467
    
    
    
    100.0
    %
    
    
    85.0
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    10,489Pro forma
    
    $
    32,320
    
    
    
    100.0
    %
    
    $
    27,956
    
    
    
    100.0
    %
    
    
    15.6
    %
 Six Months Ended April 30,2004
    
    2003Total Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    58,768
    
    
    
    100.0
    %
    
    $
    30,924
    
    
    
    100.0
    %
    
    
    90.0
    %Lightspan (pre-acquisition)
    
    
    969
    
    
    
    
    
    
    
    22,892Pro forma
    
    $
    59,737
    
    
    
    100.0
    %
    
    $
    53,816
    
    
    
    100.0
    %
    
    
    11.0
    %
 On a pro forma basis, assuming Lightspan had been included for all periods
presented, we executed 51 orders of $100 or greater during the three months
ended April 30, 2004, as compared to 39 for the same period in 2003. The
average size of orders between $100 and $249 remained relatively constant at
$149, while the average size of orders of $250 and greater increased 43.3% from
$439 to $629. The number and magnitude of these larger orders can have a
significant impact on our operating results. Information regarding these
orders was as follows: Three Months Ended April 30,Pro Forma
    
    2004 (1)
    
    2003 (2)
    
    % ChangeOrder Size
    
    Number
    
    Value
    
    Number
    
    Value
    
    Number
    
    Value$100 to $249
    
    
    40
    
    
    $
    5,961
    
    
    
    25
    
    
    $
    3,756
    
    
    
    60.0
    %
    
    
    58.7
    %$250 or greater
    
    
    11
    
    
    
    6,919
    
    
    
    14
    
    
    
    6,145
    
    
    
    -21.4
    %
    
    
    12.6
    %51
    
    
    $
    12,880
    
    
    
    39
    
    
    $
    9,901
    
    
    
    30.8
    %
    
    
    30.1
    %
 Six Months Ended April 30,Pro Forma
    
    2004 (1)
    
    2003 (2)
    
    % ChangeOrder Size
    
    Number
    
    Value
    
    Number
    
    Value
    
    Number
    
    Value$100 to $249
    
    
    70
    
    
    $
    10,270
    
    
    
    45
    
    
    $
    6,906
    
    
    
    55.6
    %
    
    
    48.7
    %$250 or greater
    
    
    25
    
    
    
    16,037
    
    
    
    23
    
    
    
    10,820
    
    
    
    8.7
    %
    
    
    48.2
    %95
    
    
    $
    26,307
    
    
    
    68
    
    
    $
    17,726
    
    
    
    39.7
    %
    
    
    48.4
    %
 (1) 2004 excludes amounts related to the Idaho Department of Education contract (2) 2003 include both PLATO Learning and Lightspan 24




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) License Fees.The following table presents license fees revenues, as reported
and on a pro forma basis, as if Lightspan revenues prior to the acquisition had
been included for all periods presented: Three Months Ended April 30,2004
    
    2003License Fees Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    17,213
    
    
    
    53.2
    %
    
    $
    9,752
    
    
    
    55.8
    %
    
    
    76.5
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    4,722Pro forma
    
    $
    17,213
    
    
    
    53.2
    %
    
    $
    14,474
    
    
    
    51.8
    %
    
    
    18.9
    %
 Six Months Ended April 30,2004
    
    2003License Fees Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    30,272
    
    
    
    51.5
    %
    
    $
    17,197
    
    
    
    55.6
    %
    
    
    76.0
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    10,904Pro forma
    
    $
    30,272
    
    
    
    50.7
    %
    
    $
    28,101
    
    
    
    52.2
    %
    
    
    7.7
    %
 The increase in reported license fees revenues for the three and six months
ended April 30, 2004, as compared to the same periods in 2003, was primarily
due to the Lightspan acquisition. We continue to feel the effects of federal
funding delays and economic uncertainties, particularly state budget
difficulties, which significantly impacted the level of purchasing done by our
customers. While there continues to be some improvement in the flow of federal
funds to education, these conditions are expected to continue to impact our
revenues during the remainder of 2004. As a percentage of total revenues, pro
forma license fees revenues increased slightly for the three months ended April
30, 2004 from the same period in 2003. As a percentage of total revenues, pro
forma license fees revenues decreased for the six months ended April 30, 2004
from the same period in 2003 reflecting the increase in subscriptions and
services revenues as discussed below. Subscriptions.The following table presents subscriptions revenues, as
reported and on a pro forma basis, as if Lightspan revenues prior to the
acquisition had been included for all periods presented: Three Months Ended April 30,2004
    
    2003Subscriptions Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    5,325
    
    
    
    16.5
    %
    
    $
    1,767
    
    
    
    10.1
    %
    
    
    201.4
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    2,865Pro forma
    
    $
    5,325
    
    
    
    16.5
    %
    
    $
    4,632
    
    
    
    16.6
    %
    
    
    15.0
    %
 25




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) Six Months Ended April 30,2004
    
    2003Subscriptions Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    9,833
    
    
    
    16.8
    %
    
    $
    3,391
    
    
    
    11.0
    %
    
    
    190.0
    %Lightspan (pre-acquisition)
    
    
    531
    
    
    
    
    
    
    
    5,842Pro forma
    
    $
    10,364
    
    
    
    17.3
    %
    
    $
    9,233
    
    
    
    17.2
    %
    
    
    12.2
    %
 Reported revenues from subscriptions increased for the three and six months
ended April 30, 2004, as compared to the same periods in 2003, primarily due to
the Lightspan acquisition and secondarily due to the growth in PLATO
subscriptions revenue. We are experiencing an increasing shift away from
perpetual license sales and a growing customer desire to license our products
on a subscription basis. Orders for our subscription-based products continue
to grow, and, while this has a negative impact on revenues in the short-term,
it has positive implications for the longer term, including greater
predictability of future revenues. As a percentage of total revenues, pro
forma subscriptions revenues were fairly constant for the three and six months
ended April 30, 2004 compared to the same periods in 2003. Services.The following table presents services revenues, as reported and on a
pro forma basis, as if Lightspan revenues prior to the acquisition had been
included for all periods presented: Three Months Ended April 30,2004
    
    2003Services Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    7,197
    
    
    
    22.3
    %
    
    $
    4,296
    
    
    
    24.6
    %
    
    
    67.5
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    2,189Pro forma
    
    $
    7,197
    
    
    
    22.3
    %
    
    $
    6,485
    
    
    
    23.2
    %
    
    
    11.0
    %
 Six Months Ended April 30,2004
    
    2003Services Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    13,534
    
    
    
    23.0
    %
    
    $
    7,679
    
    
    
    24.8
    %
    
    
    76.2
    %Lightspan (pre-acquisition)
    
    
    438
    
    
    
    
    
    
    
    4,614Pro forma
    
    $
    13,972
    
    
    
    23.4
    %
    
    $
    12,293
    
    
    
    22.8
    %
    
    
    13.7
    %
 Reported revenues from services increased for the three and six months ended
April 30, 2004, as compared to the same periods in 2003, due primarily to the
Lightspan acquisition and secondarily due to the increase in PLATO services
revenues, resulting from increased correlation and professional development
services and the continued growth in customer demand for our training and
technical support services. 26




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) Other.The following table presents other revenues, as reported and on a pro
forma basis, as if Lightspan revenues prior to the acquisition had been
included for all periods presented: Three Months Ended April 30,2004
    
    2003Other Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    2,585
    
    
    
    8.0
    %
    
    $
    1,652
    
    
    
    9.5
    %
    
    
    56.5
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    713Pro forma
    
    $
    2,585
    
    
    
    8.0
    %
    
    $
    2,365
    
    
    
    8.5
    %
    
    
    9.3
    %
 Six Months Ended April 30,2004
    
    2003Other Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    5,129
    
    
    
    8.7
    %
    
    $
    2,657
    
    
    
    8.6
    %
    
    
    93.0
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    1,532Pro forma
    
    $
    5,129
    
    
    
    8.6
    %
    
    $
    4,189
    
    
    
    7.8
    %
    
    
    22.4
    %
 Other revenues, consisting primarily of hardware and third-party courseware
products, increased principally due to the Lightspan acquisition. The
elementary grade products acquired from Lightspan run on PlayStation® game
consoles which, along with the sale of related accessories, are a component of
other revenues. Cost of Revenues The following table presents our total cost of revenues, as reported and on a
pro forma basis, as if Lightspan cost of revenues prior to the acquisition had
been included for all periods presented: Three Months Ended April 30,2004
    
    2003Total Cost of Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    12,207
    
    
    
    37.8
    %
    
    $
    7,022
    
    
    
    40.2
    %
    
    
    73.8
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    3,156Pro forma
    
    $
    12,207
    
    
    
    37.8
    %
    
    $
    10,178
    
    
    
    36.4
    %
    
    
    19.9
    %
 Six Months Ended April 30,2004
    
    2003Total Cost of Revenues
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    23,190
    
    
    
    39.5
    %
    
    $
    12,709
    
    
    
    41.1
    %
    
    
    82.5
    %Lightspan (pre-acquisition)
    
    
    242
    
    
    
    
    
    
    
    6,748Pro forma
    
    $
    23,432
    
    
    
    39.2
    %
    
    $
    19,457
    
    
    
    36.2
    %
    
    
    20.4
    %
 27




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) Total pro forma cost of revenues increased for the three months ended April 30,
2004, as compared to the same period in 2003, primarily due to the changes in
revenue discussed earlier,
and increased professional development expenses of $1,518, increased
amortization of capitalized product development costs of $384, increased
amortization of acquired technology of $534, increased customer support costs
of $622 and increased costs related to other revenue of $1,031, primarily the
cost of PlayStation® game consoles and related accessories, as mentioned
earlier. Total pro forma cost of revenues increased for the six months ended April 30,
2004, as compared to the same period in 2003, primarily due to the changes in
revenue discussed earlier, and increased professional development expenses of
$2,104, increased amortization of capitalized product development costs of
$854, increased amortization of acquired technology of $1,002, increased
customer support costs of $732 and increased costs related to other revenue of
$2,239, primarily the cost of PlayStation® game consoles and related
accessories, as mentioned earlier. Amortization of previously capitalized product development costs, a component
of cost of sales, was $1,714 and $1,330 for the three months and $3,478 and
$2,624 for the six months ended April 30, 2004 and 2003, respectively.
Amortization has increased as projects completed during prior periods are now
being amortized to expense. We expect this amortization to increase during the
remainder of 2004 as additional products are completed. Capitalized
development costs were $2,627 and $1,501 for the three months and $4,291 and
$3,168 for the six months ended April 30, 2004 and 2003, respectively. The
increase in capitalized product development costs was primarily due to the
acquisition of New Media. A comparison of gross profit margin by revenue category as reported and on a
pro forma basis, as if Lightspan revenues and cost of revenues prior to the
acquisition had been included for all periods presented, is as follows: Three Months Ended April 30,2004
    
    2003Revenue category
    
    As Reported
    
    As Reported
    
    Pro FormaLicense fees
    
    
    81.2
    %
    
    
    80.3
    %
    
    
    80.9
    %Subscriptions
    
    
    61.3
    %
    
    
    55.5
    %
    
    
    73.2
    %Services
    
    
    36.5
    %
    
    
    30.0
    %
    
    
    36.9
    %Other
    
    
    9.4
    %
    
    
    20.6
    %
    
    
    18.5
    %Total
    
    
    62.2
    %
    
    
    59.8
    %
    
    
    63.6
    %
 Six Months Ended April 30,2004
    
    2003Revenue category
    
    As Reported
    
    Pro Forma
    
    As Reported
    
    Pro FormaLicense fees
    
    
    78.3
    %
    
    
    78.3
    %
    
    
    78.6
    %
    
    
    77.9
    %Subscriptions
    
    
    62.0
    %
    
    
    63.0
    %
    
    
    60.0
    %
    
    
    77.5
    %Services
    
    
    38.4
    %
    
    
    39.0
    %
    
    
    30.0
    %
    
    
    37.5
    %Other
    
    
    11.5
    %
    
    
    11.5
    %
    
    
    13.4
    %
    
    
    17.1
    %Total
    
    
    60.5
    %
    
    
    60.8
    %
    
    
    58.9
    %
    
    
    63.8
    %
 28




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##### Table of Contents



PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) The decrease in pro forma gross profit margin from 2003 to 2004 resulted
primarily from the higher proportion of other revenues included in our product
sales mix in 2004, which carry lower margins, and the increased professional
development expenses, amortization of capitalized product development costs and
amortization of acquired technology as discussed above. Future gross profit
margin will be dependent primarily on our revenue mix, the amount of
professional development expenses and amortization of capitalized product
development costs and acquired technology. Operating Expenses Sales and Marketing.The following table presents sales and marketing
expenses, as reported and on a pro forma basis, as if Lightspan expenses prior
to the acquisition had been included for all periods presented: Three Months Ended April 30,2004
    
    2003Sales and Marketing
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    15,793
    
    
    
    48.9
    %
    
    $
    9,946
    
    
    
    57.0
    %
    
    
    58.8
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    8,459Pro forma
    
    $
    15,793
    
    
    
    48.9
    %
    
    $
    18,405
    
    
    
    65.8
    %
    
    
    -14.2
    %
 Six Months Ended April 30,2004
    
    2003Sales and Marketing
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    30,978
    
    
    
    52.7
    %
    
    $
    19,184
    
    
    
    62.0
    %
    
    
    61.5
    %Lightspan (pre-acquisition)
    
    
    1,282
    
    
    
    
    
    
    
    15,321Pro forma
    
    $
    32,260
    
    
    
    54.0
    %
    
    $
    34,505
    
    
    
    64.1
    %
    
    
    -6.5
    %
  Sales and marketing expenses, as reported, increased for the three and six
months ended April 30, 2004, as compared to the same periods in 2003, due
primarily to the Lightspan acquisition. As a percentage of total revenues,
however, reported and pro forma sales and marketing expenses decreased,
reflecting the cost reduction plan implemented and recorded in purchase
accounting as well as the synergistic benefits received from combining the
PLATO and Lightspan sales and marketing activities. Our ability to continue to
leverage our cost structure and improve
profitability is primarily dependent on our ability to generate higher
revenues, integrate our acquisitions and realize sales force productivity
improvements. 29




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) General and Administrative. The following table presents general and
administrative expenses, as reported and on a pro forma basis, as if Lightspan
expenses prior to the acquisition had been included for all periods presented: Three Months Ended April 30,2004
    
    2003General and Administrative
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    5,040
    
    
    
    15.6
    %
    
    $
    3,035
    
    
    
    17.4
    %
    
    
    66.1
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    2,138Pro forma
    
    $
    5,040
    
    
    
    15.6
    %
    
    $
    5,173
    
    
    
    18.5
    %
    
    
    -2.6
    %
 Six Months Ended April 30,2004
    
    2003General and Administrative
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    9,532
    
    
    
    16.2
    %
    
    $
    6,311
    
    
    
    20.4
    %
    
    
    51.0
    %Lightspan (pre-acquisition)
    
    
    310
    
    
    
    
    
    
    
    4,505Pro forma
    
    $
    9,842
    
    
    
    16.5
    %
    
    $
    10,816
    
    
    
    20.1
    %
    
    
    -9.0
    %
 General and administrative expenses, as reported, increased for the three and
six months ended April 30, 2004, as compared to the same periods in 2003, due
primarily to the Lightspan acquisition. The decrease in pro forma general and
administrative expense reflects the cost reduction plan implemented and
recorded in purchase accounting as well as the synergistic benefits received
from combining the PLATO and Lightspan general and administrative activities. Product Development. The following table presents product development
expenses, as reported and on a pro forma basis, as if Lightspan expenses prior
to the acquisition had been included for all periods presented: Three Months Ended April 30,2004
    
    2003Product Development
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    1,346
    
    
    
    4.1
    %
    
    $
    627
    
    
    
    3.6
    %
    
    
    114.7
    %Lightspan (pre-acquisition)
    
    
    
    
    
    
    
    
    
    
    2,382Pro forma
    
    $
    1,346
    
    
    
    4.1
    %
    
    $
    3,009
    
    
    
    10.8
    %
    
    
    -55.3
    %
 Six Months Ended April 30,2004
    
    2003Product Development
    
    $
    
    % of revenue
    
    $
    
    % of revenue
    
    % ChangePLATO (as reported)
    
    $
    3,549
    
    
    
    6.0
    %
    
    $
    1,188
    
    
    
    3.9
    %
    
    
    198.7
    %Lightspan (pre-acquisition)
    
    
    327
    
    
    
    
    
    
    
    5,400Pro forma
    
    $
    3,876
    
    
    
    6.5
    %
    
    $
    6,588
    
    
    
    12.2
    %
    
    
    -41.2
    %
 30




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) Product development expenses, as reported, increased for the three and six
months ended April 30, 2004, as compared to the same periods in 2003, due
primarily to the Lightspan acquisition.
The decrease in pro forma product development expense reflects the cost
reduction plan implemented and recorded in purchase accounting as well as the
synergistic benefits received from combining the PLATO and Lightspan product
development activities. A significant portion of PLATOs product development
costs qualify for capitalization. Product development expense does not reflect
these capitalized costs, as they are amortized through cost of revenues.
Accordingly, our product development expense, as a percentage of revenue, does
not demonstrate our total level of development activity. Product development spending, before capitalization, was 12.3% of total
revenues for the three months ended April 30, 2004, compared to 12.2% for the
same period in 2003. Product development spending, before capitalization, was
13.3% of total revenues for the six months ended April 30, 2004, compared to
14.1% for the same period in 2003. Our acquisitions of developed technologies
and curriculum content and the completion of several significant projects in
prior years contributed to the decrease in product development spending in
2004. As part of our growth strategy, we intend to continually introduce new
products and product improvements. The extent of our future product
development spending and the amount of our future capitalized product
development costs are dependent on our ability to develop and introduce new
products and product improvements on a cost-effective and timely basis. Amortization of Intangibles. Expenses for the three and six months ended April
30, 2004 and 2003 represented the amortization of identified intangible assets,
other than goodwill and acquired technology, from our previous acquisitions.
The increase from 2003 to 2004 was due primarily to the Lightspan acquisition.
With the adoption of SFAS No. 142 in 2002, goodwill is no longer amortized to
expense. Acquired technology intangible assets are amortized through cost of
revenues. See Note 6 to Consolidated Financial Statements for additional
information on goodwill and identified intangible assets. Restructuring Charge.In December 2002, we reduced the size of our workforce by
approximately 30 positions and closed approximately 30 open job requisitions,
all in the United States, which together represented about 10% of our planned
workforce, in connection with a restructuring plan to align our cost structure
with future expectations. The consolidated statement of operations for the six
months ended April 30, 2003 included a restructuring charge of $380 for
severance costs related to this reduction. All of these severance costs were
paid as of October 31, 2003. Income Taxes As discussed earlier in the Critical Accounting Policies and Estimates
section of this Managements Discussion and Analysis, as a result of the
Lightspan acquisition, net deferred tax assets, excluding the deferred tax
liability relating to tax deductible goodwill which cannot be used 31




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) to support
realization of the other net deferred tax assets, were fully reserved for in
purchase accounting, thereby increasing goodwill, in the first quarter of 2004.
Any subsequent reversal of the valuation allowance recorded on the combined
entitys pre-acquisition deferred tax assets will be recorded as a reduction to
goodwill. We recorded an income tax provision of $150 for the three months, and $300 for
the six months ended April 30, 2004, despite pre-tax losses for these periods,
related to the tax amortization of tax deductible goodwill. We recorded income
tax benefits of $1,435 for the three months and $3,785 for the six months ended
April 30, 2003 on pre-tax losses for these periods. These tax benefits were
recorded as it was more likely than not at that time that the tax benefits
would be realized. Our effective income tax rate for this fiscal year, and future quarters and
fiscal years, is dependent on us achieving both our overall operational goals
and our operational goals in each of the United States, Canada and the U.K. We
expect a normalized income tax rate of about 45% for the full year 2004. The
extent of any effective rate variance from this expectation is highly dependent
on our operating results in the U.K. A larger than expected loss in the U.K.
will likely result in a higher consolidated effective tax rate. Conversely, if
our U.K. subsidiary is more profitable than planned, our effective tax rate
could decline. FINANCIAL CONDITION Liquidity and Capital Resources At April 30, 2004, our principal sources of liquidity included cash and cash
equivalents of $17,942, net accounts receivable of $41,183, long-term
marketable securities of $3,779 and our unused line of credit. Working capital
was $16,329 and $34,701 at April 30, 2004 and October 31, 2003, respectively.
The decrease in working capital was primarily due to the decrease in deferred
income taxes of $2,218, and the increases in accounts payable and accrued
liabilities of $6,145 and deferred revenue of $10,100, offset by the increases
in net accounts receivable of $2,007 and prepaid expenses and other current
assets of $3,976. Deferred income taxes decreased due to our deferred income
tax assets being fully reserved through purchase accounting for the Lightspan
acquisition. Accrued liabilities and deferred revenue increased as a result of
the Lightspan acquisition. Deferred revenue also increased due to increased
sales of our services and subscription-based products. Accounts receivable
increased due to the Lightspan acquisition, offset by collections of year end
balances. Prepaid expenses and other current assets increased due to the
Lightspan acquisition. Cash used in operations, excluding changes in our working capital accounts, was
$342 and $3,202 for the six months ended April 30, 2004 and 2003, respectively. During the six months ended April 30, 2004, the net cash flow provided by
financing activities of $1,216 and the decrease in cash and cash equivalents
was used to fund the cash used in operations, excluding changes in our working
capital accounts, of $342, the changes in our 32




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) working capital accounts of
$3,878 and the net cash used in our investing activities of $2,860. Changes in
our working capital accounts were primarily due to decreased accounts
receivable, accounts payable, accrued liabilities and deferred revenue,
partially offset by increased prepaid expenses and other current assets. During the six months ended April 30, 2003, the decrease in cash and cash
equivalents of $6,188 was used to fund the cash used in operations, excluding
changes in our working capital accounts, of $3,202, the changes in our working
capital accounts of $3,264, our investing activities of $3,996 and financing
activities of $2,273. Changes in our working capital accounts were primarily
due to decreased accounts receivable and increased accounts payable, which were
partially offset by decreased accrued liabilities. Net cash used in our investing activities was $2,860 for the six months ended
April 30, 2004 and $3,996 for the same period in 2003. In 2004, as compared to
2003, we had net cash provided from acquisitions of $2,460, we increased our
capitalization of product development costs by $1,123 and we increased our
capital expenditures by $284. Net cash provided from the Lightspan acquisition
was $8,696 and net cash used for the New Media acquisition was $6,236. Net cash provided by our financing activities was $1,216 for the six months
ended April 30, 2004, as compared to net cash used of $2,273 for the same
period in 2003. In 2004, we received $1,491 from the exercise of outstanding
stock options and warrants and common stock issued under our employee stock
purchase plan. We also repurchased shares of our common stock for $205. In
2003, we repurchased shares of our common stock for an aggregate cost of
$2,161. Our Board of Directors approved a stock repurchase plan in December
2001, which 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. Cumulatively, we
have repurchased approximately 1,465,000 shares for an aggregate cost of
approximately $13,700 under the repurchase plan and approximately $1,300
remains available for future repurchases, if any. On June 10, 2004, we extended our revolving loan agreement with Wells Fargo
Bank, N.A. through July 1, 2005. We have resources available under this
revolving loan agreement to provide borrowings up to $12,500, as determined by
the available borrowing base. At April 30, 2004, there were no borrowings
outstanding and our unused borrowing capacity was $12,500. The agreement
contains restrictive financial covenants (including Minimum Tangible Net Worth,
Minimum Debt Service Coverage, Maximum Leverage, Maximum Cash Flow Leverage and
Maximum Annual Capital Expenditures) and restrictions on additional borrowings,
asset sales and dividends, as defined. All applicable covenants were satisfied
as of and for the twelve-month period ended April 30, 2004. From time to time, we evaluate potential acquisitions of products or businesses
that complement our core business. We may consider and acquire other
complementary businesses, products, or technologies in the future. As
discussed earlier, we acquired Lightspan, in a stock transaction, and New
Media, in a cash transaction, during the three months ended January 31,
2004. 33




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) We anticipate using cash during the first half of 2004 to fund expected losses
from operations and our capital expenditure needs given the historic
seasonality of our operations. Cash used during the first half of 2004 is
expected to be greater than cash used during the first half of 2003 as we
integrate the operations of Lightspan. We maintain adequate cash balances and credit facilities to meet our
anticipated working capital, capital expenditure and business investment
requirements for at least the next twelve months. Disclosures about Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements as of April 30, 2004. 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. In
addition, any future borrowings under our revolving loan agreement, which
provides for a maximum $12,500 line of credit through July 1, 2005, would
require future use of cash. Payments Due by PeriodLess than
    
    1 to 3
    
    4 to 5
    
    After 5Contractual Obligations
    
    Total
    
    1 year
    
    Years
    
    Years
    
    YearsCapital lease obligations
    
    $
    645
    
    
    $
    337
    
    
    $
    308
    
    
    $
    
    
    
    $
    Operating leases
    
    
    8,922
    
    
    
    2,764
    
    
    
    2,547
    
    
    
    2,062
    
    
    
    1,549Total
    
    $
    9,567
    
    
    $
    3,101
    
    
    $
    2,855
    
    
    $
    2,062
    
    
    $
    1,549
 At April 30, 2004, we had no significant commitments for capital expenditures.
With the NetSchools acquisition in 2002, additional cash consideration may be
due 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. As of April 30, 2004,
no additional consideration has been earned. Interest Rate Risk Our borrowing capacity primarily consists of a revolving loan with interest
rates that fluctuate based upon the Prime Rate and LIBOR market indexes. At
April 30, 2004, we did not have any outstanding borrowings under this revolving
credit facility. Our only debt consisted of capital lease obligations at fixed
interest rates. As a result, risk relating to interest fluctuation is
considered minimal. 34




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PLATO Learning, Inc. and Subsidiaries
Managements Discussion and Analysis of Results of
Operations and Financial Condition
(Dollars in thousands) 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. Any gains or losses from foreign currency
transactions are included in the consolidated statements of operations.
Approximately 3% of our total revenues were denominated in currencies other
than the U.S. dollar for the six months ended April 30, 2004. Our foreign
subsidiaries are not a significant component of our business, and, as a result,
risk relating to foreign currency fluctuation is considered minimal. 35




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##### Table of Contents



PART I 
 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. CONTROLS AND PROCEDURES As of April 30, 2004, our Chief Executive Officer and Chief Financial Officer
have conducted an evaluation of the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective to make known to them
in a timely fashion material information related to the Company required to be
filed in this report. There have been no significant changes in our internal
controls over financial reporting, or in other factors that could significantly
affect internal controls, subsequent to the date of their evaluation during the
most recent fiscal quarter. While we believe the present design of our disclosure controls and procedures
is effective to make known to our senior management in a timely fashion all
material information concerning our business, we will continue to improve the
design and effectiveness of our disclosure controls and procedures to the
extent necessary in the future to provide our senior management with timely
access to such material information, and to correct any deficiencies that we
may discover in the future. 36




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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 or our consolidated
financial statements. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities  The following table provides information about our common stock
repurchases during the quarter ended April 30, 2004:(Dollars in thousands, except per share amounts) ApproximateTotal Number of
    
    Dollar Value ofTotal Number
    
    
    
    
    
    Shares Purchased
    
    Shares that Mayof Shares
    
    Average Price
    
    as Part of Publicly
    
    Yet Be PurchasedMonth
    
    Purchased
    
    Paid per Share
    
    Announced Plans
    
    Under the PlanFebruary 2004
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,500March 2004
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,500April 2004
    
    
    20,000
    
    
    $
    10.27
    
    
    
    20,000
    
    
    $
    1,300
  Our Board of Directors approved a stock repurchase plan in December
2001, which 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. 
 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. 37




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Item 6. Exhibits and Reports on Form 8-K  (a) ExhibitsExhibit Number and Description  31.01
    
    Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.02
    
    Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.01
    
    Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.02
    
    Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.  (b) Reports on Form 8-K:On February 26, 2004 we filed a Current Report on Form 8-K to announce
our first quarter 2004 financial results. 38




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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 June 14, 2004. PLATO LEARNING, INC.By
    
    /s/John MurrayChairman, President andChief Executive Officer(principal executive officer)/s/Gregory J. MelsenVice President Finance andChief Financial Officer(principal financial officer)/s/Mary Jo MurphyVice President, Corporate Controller andChief Accounting Officer(principal accounting officer)
 39