UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006.

OR

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

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission file number: 0-22187

RENAISSANCE LEARNING, INC.

(Exact name of Registrant as specified in its charter)

Wisconsin		39-1559474
(State or other		(I.R.S. Employer
jurisdiction of incorporation)		Identification No.)

2911 Peach Street
P.O. Box 8036
Wisconsin Rapids, Wisconsin
(Address of principal executive offices)

54495-8036
(Zip Code)

(715) 424-3636
(Registrant’s telephone number, including area code)

     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 þ No o

     Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer o      Accelerated filer þ      Non-accelerated filer o

     Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

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

		Outstanding at
Class		October 31, 2006
Common Stock, $0.01 par value		29,152,888

 

 

RENAISSANCE LEARNING, INC.

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005			1
Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2006 and 2005			2
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005			3
Notes to Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			7
Item 3. Quantitative and Qualitative Disclosures About Market Risk			11
Item 4. Controls and Procedures			12
PART II — OTHER INFORMATION
Item 1A. Risk Factors			12
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			12
Item 5. Other Information			13
Item 6. Exhibits			13
Restricted Unit Agreement
Amendment to Credit Agreement
Certification
Certification
Certification
Certification

-Index-

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

		September 30,				December 31,
		2006				2005
		(In Thousands, Except Share and Per
		Share Amounts)
ASSETS
Current assets:
Cash and cash equivalents		$	13,112			$	7,083
Investment securities			7,219				23,363
Accounts receivable, less allowances of $1,183 and $1,340, respectively			13,711				11,393
Inventories			3,550				4,138
Prepaid expenses			1,856				1,722
Income taxes receivable			1,510				—
Deferred tax asset			4,576				3,693
Other current assets			208				390
Total current assets			45,742				51,782
Investment securities			2,444				4,132
Property, plant and equipment, net			11,740				11,475
Deferred tax asset			—				738
Goodwill			46,872				45,906
Other intangibles, net			6,274				6,787
Capitalized software, net			850				420
Other receivables			5,768				5,909
Other non-current assets			468				1,233
Total assets		$	120,158			$	128,382
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,730			$	3,280
Deferred revenue			22,818				18,255
Payroll and employee benefits			3,898				4,156
Income taxes payable			—				313
Other current liabilities			3,892				4,239
Total current liabilities			34,338				30,243
Deferred revenue			670				670
Deferred compensation and other employee benefits			1,631				1,603
Deferred tax liability			998				—
Total liabilities			37,637				32,516
Shareholders’ equity:
Common stock, $.01 par; shares authorized: 150,000,000; issued:
34,736,647 shares at September 30, 2006 and December 31, 2005			347				347
Additional paid-in capital			55,551				56,522
Retained earnings			123,988				118,233
Treasury stock, at cost: 5,534,354 shares at September 30, 2006 4,387,594 shares at December 31, 2005			(95,958	)			(78,845	)
Unearned restricted stock compensation			(1,457	)			(438	)
Accumulated other comprehensive income			50				47
Total shareholders’ equity			82,521				95,866
Total liabilities and shareholders’ equity		$	120,158			$	128,382

See accompanying notes to condensed consolidated financial statements.

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2006				2005				2006				2005
						(In Thousands, Except Per Share Amounts)
Net sales:
Products		$	19,533			$	25,615			$	69,783			$	70,375
Services			5,634				5,774				15,822				16,918
Total net sales			25,167				31,389				85,605				87,293
Cost of sales:
Products			3,708				5,297				13,019				8,812
Services			2,691				2,100				7,372				6,672
Total cost of sales			6,399				7,397				20,391				15,484
Gross profit			18,768				23,992				65,214				71,809
Operating expenses:
Product development			3,990				4,927				12,477				12,583
Selling and marketing			8,036				8,325				24,781				22,432
General and administrative			3,755				3,341				12,653				9,370
Total operating expenses			15,781				16,593				49,911				44,385
Operating income			2,987				7,399				15,303				27,424
Other income, net			316				404				942				1,363
Income — continuing operations before income taxes			3,303				7,803				16,245				28,787
Income taxes — continuing operations			1,222				2,887				6,011				10,651
Income — continuing operations			2,081				4,916				10,234				18,136
Income from discontinued operations, net of tax benefit of $1,417 for the nine months ended September 30, 2005			—				—				—				584
Net income		$	2,081			$	4,916			$	10,234			$	18,720
Earnings per share:
Basic:
Continuing operations		$	0.07			$	0.16			$	0.34			$	0.58
Discontinued operations			0.00				0.00				0.00				0.02
Net income		$	0.07			$	0.16			$	0.34			$	0.60
Diluted:
Continuing operations		$	0.07			$	0.16			$	0.34			$	0.58
Discontinued operations			0.00				0.00				0.00				0.02
Net income		$	0.07			$	0.16			$	0.34			$	0.60
Cash dividends declared per share		$	0.05			$	0.05			$	0.15			$	0.15

See accompanying notes to condensed consolidated financial statements.

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

		For the Nine Months Ended
		September 30,
		2006				2005
		(In Thousands)
Reconciliation of net income to net cash provided by operating activities:
Net income		$	10,234			$	18,720
Income from discontinued operations			—				(584	)
Income from continuing operations			10,234				18,136
Adjustments to arrive at cash provided by operating activities
Depreciation and amortization			2,585				2,460
Amortization of investment discounts/premiums			153				332
Restricted stock compensation expense			490				—
Deferred income taxes			1,860				(281	)
Excess tax benefits from share based payment arrangements			(393	)			(104	)
Change in assets and liabilities, excluding the effects of acquisitions and divestitures
Accounts receivable			(2,245	)			(1,663	)
Inventories			223				1,018
Prepaid expenses			(315	)			238
Income taxes			(1,070	)			177
Accounts payable and other liabilities			(881	)			1,143
Deferred revenue			4,564				1,035
Other current assets			182				838
Other			(108	)			(225	)
Cash provided by continuing operating activities			15,279				23,104
Cash used by discontinued operations			—				(116	)
Net cash provided by operating activities			15,279				22,988
Cash flows from investing activities:
Purchase of property, plant and equipment			(2,096	)			(1,724	)
Purchase of investment securities			(356	)			(247	)
Maturities/sales of investment securities			18,035				18,143
Capitalized software development costs			(689	)			(4	)
Net proceeds from sale of subsidiary			—				75
Acquisition of business, net of cash acquired			—				(33,988	)
Net cash provided (used) by investing activities			14,894				(17,745	)
Cash flows from financing activities:
Proceeds from exercise of stock options			16				1,676
Payment for cancellation of stock options			(993	)			—
Excess tax benefits from share based payment arrangements			393				104
Dividends paid			(4,479	)			(4,657	)
Purchase of treasury stock			(19,081	)			(14,037	)
Net cash used by financing activities			(24,144	)			(16,914	)
Net increase (decrease) in cash and cash equivalents			6,029				(11,671	)
Cash and cash equivalents, beginning of period			7,083				27,460
Cash and cash equivalents, end of period		$	13,112			$	15,789

See accompanying notes to condensed consolidated financial statements.

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

1. Consolidation

     The condensed consolidated financial statements include the financial results of Renaissance Learning, Inc. and our subsidiaries. Generation21 Learning Systems, LLC (“Generation21”) was divested during the first quarter of 2005 and, therefore, its results for all periods presented in the financial statements are reflected as discontinued operations.

2. Basis of Presentation

     The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in our opinion, necessary for a fair presentation of the results of the interim periods, and are presented on an unaudited basis. These financial statements should be read in conjunction with the financial information contained in our Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Annual Report”), which is on file with the U.S. Securities and Exchange Commission (the “SEC”).

     The results of operations for the three and nine month periods ended September 30, 2006 and 2005 are not necessarily indicative of the results to be expected for the full year.

3. Earnings Per Common Share

     Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Shares issued and shares reacquired during the period are weighted for the portion of the period they were outstanding. Diluted earnings per common share has been computed based on the weighted average number of common shares outstanding, increased by the number of additional common shares that would have been outstanding if the potentially dilutive stock option shares and restricted shares had been issued.

     The weighted average shares outstanding are as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Basic weighted average shares outstanding			29,257,702				31,598,830				29,740,992				31,013,660
Dilutive effect of outstanding stock options			3,103				97,461				7,044				70,092
Dilutive effect of restricted shares			8,228				—				8,228				—
Diluted weighted average shares outstanding			29,269,033				31,696,291				29,756,264				31,083,752

     For the three months ended September 30, 2006 and 2005, there were 872,192 and 817,169 shares, respectively, attributable to outstanding stock options excluded from the calculation of diluted earnings per share because their effect was antidilutive. For the nine months ended September 30, 2006 and 2005, there were 848,876 and 900,800 shares, respectively, attributable to outstanding stock options excluded from the calculation of diluted earnings per share because their effect was antidilutive. These options could be dilutive in the future.

4. Comprehensive Income

     Total comprehensive income was $10.2 million and $18.7 million in the first nine months of 2006 and 2005, respectively. For the quarters ended September 30, 2006 and 2005, comprehensive income was $2.1 million and $4.9 million, respectively. Our comprehensive income includes net income and foreign currency translation adjustments.

5. Goodwill and Other Intangible Assets

     In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized and we are required to assess goodwill at least annually for impairment by applying a fair-value-based test. The company performs its annual impairment test in the fourth quarter.

     The final purchase price allocation for the acquisition of AlphaSmart, Inc. (“AlphaSmart”) was completed in the second quarter of 2006, resulting in the assignment of $44.1 million of the purchase price to goodwill, an increase of approximately $1.0 million from the preliminary allocation as of December 31, 2005.

     Other intangibles consist of customer relationships and tradename, which were acquired in connection with the purchase of AlphaSmart (Note 8). The tradename has an indeterminate life and therefore is not amortized. The customer relationships intangible is amortized over its useful life of ten years, on the declining balance method.

     For the three months ended September 30, 2006 and 2005, we recognized amortization expense of $149,000 and $237,000, respectively. For the nine months ended September 30, 2006 and 2005, we recognized amortization expense of $513,000 and $346,000, respectively. Other intangibles consisted of the following (in thousands):

		September 30, 2006												December 31, 2005
		Gross				Accumulated								Gross				Accumulated
		Amount				Amortization				Net				Amount				Amortization				Net
Tradename		$	3,000			$	—			$	3,000			$	3,000			$	—			$	3,000
Customer relationships			4,150				876				3,274				4,150				363				3,787
		$	7,150			$	876			$	6,274			$	7,150			$	363			$	6,787

6. Share Based Compensation

     We have established the 1997 Stock Incentive Plan for our officers, key employees and non-employee directors. Effective January 1, 2006, we are required to follow SFAS 123R, “Accounting for Stock-Based Compensation.” Net income for the three and nine month periods ended September 30, 2006 includes an after tax charge of approximately $24,000 and $51,000, respectively, for outstanding stock option grants. Prior to January 1, 2006, we used the intrinsic value method as prescribed in APB 25, “Accounting for Stock Issued to Employees,” to account for stock based compensation arrangements. SFAS 123R requires us to report the tax benefit from the tax deduction related to share-based compensation that is in excess of recognized compensation costs (excess tax benefits) as a financing cash flow rather than operating cash flow.

     Options to purchase 9,616 shares of our common stock were granted during the nine months ended September 30, 2006 and options to purchase 223,044 shares of our common stock were granted in the nine months ended September 30, 2005. The exercise prices for all options are equal to the fair market value of our common stock on the date the options were granted.

     We also grant restricted shares or restricted share units to certain employees and our directors, (together, referred to as “restricted stock awards”). For employees, restricted stock awards generally vest over a period of four years and for directors, upon termination of the individual’s tenure on our board. Restricted stock awards made to our directors are expensed when granted, awards to employees are expensed ratably over the vesting period. We granted 120,199 shares of restricted stock during the nine months ended September 30, 2006, and we granted 21,882 shares of restricted stock in the nine months ended September 30, 2005. We value restricted stock awards at the closing market price of our common stock on the date of grant.

     As of September 30, 2006, the total unearned compensation related to share-based compensation awards, net of estimated forfeitures was $1.4 million, which will be amortized as expense over the weighted average remaining period of 3.6 years.

     A summary of restricted stock activity for the nine months ended September 30, 2006 is as follows:

						Weighted
						Average Value				Aggregate
		Shares				Per Share				Intrinsic Value
		(In thousands except per share amounts)
Balance at January 1, 2006			22			$	22.60			$	410
Granted			120				14.14
Vested			(4	)			10.87
Forfeitures			(11	)			18.38
Balance at September 30, 2006			127			$	15.34			$	1,822

     Had compensation cost been determined, in 2005, for share-based compensation based on the fair value method set forth under SFAS 123R, net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

		Three Months				Nine Months
		Ended September 30, 2005
		(In thousands except per share amounts)
Net Income, as reported		$	4,916			$	18,720
Add: Shared-based compensation expense included in reported net income, net of tax			13				13
Deduct: Total stock-based compensation expense determined under fair-value based method for all awards, net of tax			(922	)			(2,529	)
Pro forma net income		$	4,007			$	16,204
Earnings per share:
Basic as reported		$	0.16			$	0.60
Basic pro forma		$	0.13			$	0.52
Diluted as reported		$	0.16			$	0.60
Diluted pro forma		$	0.13			$	0.52

7. Dividends

     On October 18, 2006, our Board of Directors declared a quarterly cash dividend of $.05 per share, payable December 1, 2006 to shareholders of record as of November 10, 2006.

8. Business Combinations

     On June 27, 2005, we acquired AlphaSmart, a provider of affordable, portable personal learning solutions for K-12 schools. The results of AlphaSmart’s operations are included in our consolidated financial statements since that date.

     The following table includes our unaudited pro forma results of operations for the nine month period ended September 30, 2005. The unaudited pro forma financial information summarizes the results of operations as if the AlphaSmart acquisition had occurred at the beginning of the period presented. The pro forma information contains Renaissance Learning’s actual operating results combined with AlphaSmart’s actual operating results, adjusted to include the pro forma impact of: the amortization of intangible assets, lower interest income as a result of the sale of available-for-sale securities to fund the acquisition and the elimination of merger related costs. This pro forma amount is not necessarily indicative of the results that would have been obtained if the acquisition occurred at the beginning of the period presented.

		Nine Months
		Ended
		September 30, 2005
(In thousands, except per share amounts)
Net sales		$	102,585
Income from continuing operations			18,072
Earnings per share from continuing operations
Basic earnings per share			0.57
Diluted earnings per share			0.57

9. Recent Accounting Pronouncement

     In June 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” This interpretation provides specific guidance on how enterprises recognize and measure tax benefits associated with uncertain tax positions. FIN 48 is effective for our Company on January 1, 2007. We are in the process of evaluating what impact, if any, that FIN 48 will have on our financial position, results of operations or shareholders’ equity and related disclosures.

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

Results of Operations

     Our results of operations can be affected by many factors including the general economic environment, state and federal budgetary decisions and the length and complexity of the sales cycle for school districts. Revenue can be significantly impacted by the proportion of sales attributable to our subscription-based product and service offerings relative to sales from non-subscription-based offerings, which can result in a portion of a period’s sales being initially deferred and recognized as revenue in future periods over the subscription period. We also believe our results of operations for the three and nine month periods ended September 30, 2006 were negatively impacted by transition activities and training needs, related to a reorganization and expansion of our sales groups.

     Generation21 was divested during the first quarter of 2005 and, therefore, its results for all periods presented in the financial statements are reflected as discontinued operations. Our acquisition of AlphaSmart was completed on June 27, 2005 and, therefore, our condensed consolidated income statements include the results of AlphaSmart for the nine months of 2006 as compared to only the last few days of the second quarter and the entire third quarter of 2005.

     Operating expenses for the nine months ended September 30, 2006 include a restructuring charge of $1.9 million that was recorded in the first quarter of 2006. The restructuring charge was primarily comprised of separation expenses for former executives.

     The following table sets forth certain consolidated income statement data as a percentage of net sales, except that individual components of costs of sales and gross profit are shown as a percentage of their corresponding component of net sales:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Net Sales:
Products			77.6	%			81.6	%			81.5	%			80.6	%
Services			22.4				18.4				18.5				19.4
Total net sales			100.0	%			100.0	%			100.0	%			100.0	%
Cost of sales:
Products			19.0	%			20.7	%			18.7	%			12.5	%
Services			47.8				36.4				46.6				39.4
Total cost of sales			25.4				23.6				23.8				17.7
Gross profit:
Products			81.0				79.3				81.3				87.5
Services			52.2				63.6				53.4				60.6
Total gross profit			74.6				76.4				76.2				82.3
Operating expenses:
Product development			15.9				15.7				14.6				14.4
Selling and marketing			31.9				26.5				28.9				25.7
General and administrative			14.9				10.6				14.8				10.8
Total operating expenses			62.7				52.8				58.3				50.9
Operating income			11.9				23.6				17.9				31.4
Other, net			1.3				1.3				1.1				1.6
Income — continuing operations before income taxes			13.2				24.9				19.0				33.0
Income taxes — continuing operations			4.9				9.2				7.0				12.2
Income — continuing operations			8.3				15.7				12.0				20.8
Income from discontinued operations, net of tax benefit of $1,417 in 2005			—				—				—				.6
Net income			8.3	%			15.7	%			12.0	%			21.4	%

Three Months Ended September 30, 2006 and 2005

     Net Sales. Our net sales decreased by $6.2 million, or 19.8%, to $25.2 million in the third quarter of 2006 from $31.4 million in the third quarter of 2005. The decrease is attributable to a 37.6% decline in laptop revenues and to our customers transitioning their purchases to more subscription-based products and services, particularly Accelerated Reader*, as compared to the same quarter last year. Revenues from subscription-based products are initially deferred and then recognized ratably over the subscription period, generally one year, while the majority of revenues from non-subscription-based sales are recognized immediately upon delivery. During the third quarter 2006, deferred revenue increased by $5.2 million, primarily due to subscription-based products and services, as compared to an increase of $2.6 million in the same quarter last year. Product revenues decreased by $6.1 million, or 23.7%, to $19.5 million in the third quarter of 2006 from $25.6 million in the third quarter of 2005. Product revenues, exclusive of laptops, declined by $3.1 million, or 17.6%, compared to last year, despite orders for other Renaissance Learning products being up 2% for the quarter. We believe that orders and revenue excluding the impact of laptops are useful metrics for investors because they provide a basis upon which to compare the performance of our business, as it existed prior to the AlphaSmart acquisition, to earlier periods.

     Service revenue for the third quarter of 2006 was $5.6 million, a decrease of $0.1 million from the third quarter 2005. Service revenues were down 2.4% primarily due to a decrease in onsite training revenue that was nearly offset by increases in technical consulting and other remote services.

     Cost of Sales. The cost of sales of products decreased by $1.6 million, or 30.0%, to $3.7 million in the third quarter of 2006 from $5.3 million in the third quarter of 2005. As a percentage of product sales, the cost of sales of products decreased to 19.0% in the third quarter of 2006 from 20.7% in the third quarter of 2005. The decrease is primarily the result of a greater mix of software products in the current quarter than in last year’s third quarter.

     The cost of sales of services increased by $0.6 million, or 28.1%, to $2.7 million in the third quarter of 2006 from $2.1 million in the third quarter of 2005. As a percentage of sales of services, the cost of sales of services increased to 47.8% in the third quarter of 2006 from 36.4% in the third quarter of 2005. The increased cost of sales percentage is primarily due to pricing changes for our onsite training events for which we lowered the price of consecutive training days in order to improve implementations.

     Product Development. Product development expenses decreased by $0.9 million, or 19.0%, to $4.0 million in the third quarter of 2006 from $4.9 million in the third quarter of 2005. As a percentage of net sales, product development costs increased to 15.9% in the third quarter of 2006 from 15.7% in the third quarter of 2005. During the third quarter of 2006, we capitalized $0.7 million of software development costs as compared to none in the same period as last year. We had a number of new products in 2006, the Renaissance Place version of KeyWords and the UK versions of several products, for which we capitalized development costs in 2006, compared to 2005, when we did not have any new products which were at a point of technological feasibility.

     Selling and Marketing. Selling and marketing expenses of $8.0 million in the third quarter of 2006 were down by $0.3 million, or 3.5%, from $8.3 million in the third quarter of 2005. As a percentage of net sales, selling and marketing expenses increased to 31.9% in the third quarter of 2006 from 26.5% in the third quarter of 2005, as a result of lower net sales in 2006 versus 2005. The reduced expense is mainly due to lower advertising expenses resulting from a more targeted directed marketing approach partially offset by higher selling expenses for additional staffing related to expansion of our sales force.

     General and Administrative. General and administrative expenses were $3.8 million for the third quarter of 2006, compared to $3.3 million in the third quarter of 2005. As a percentage of net sales, general and administrative expenses increased to 14.9% in the third quarter of 2006 from 10.6% in the third quarter of 2005. General and administrative expenses increased primarily due to share-based compensation expense related to grants of restricted stock.

     Operating Income. Operating income was $3.0 million, or 11.9% of net sales in the third quarter of 2006 compared to $7.4 million, or 23.6% of net sales in the third quarter of 2005.

     Income Tax Expense — Continuing Operations. Income tax expense of $1.2 million, for continuing operations, was recorded in the third quarter of 2006 at an effective income tax rate of 37.0% of pre-tax income, compared to $2.9 million, or 37.0% of pre-tax income in the third quarter of 2005.

Nine Months Ended September 30, 2006 and 2005

     Net Sales. Our net sales decreased by $1.7 million, or 1.9%, to $85.6 million in the first nine months of 2006 from $87.3 million in the first nine months of 2005. Excluding laptops, our revenues declined by $10.1 million, or 12.8%, compared to the prior year. Product sales decreased by $0.6 million, or 0.8%, to $69.8 million in the first nine months of 2006 from $70.4 million in the same period in 2005. Product revenues, exclusive of laptops, declined by $9.0 million, or 14.6%, compared to last year, due to declines across all product lines. We believe that orders and revenue excluding the impact of laptops are useful metrics for investors because they provide a basis upon which to compare the performance of our business, as it existed prior to the AlphaSmart acquisition, to earlier periods.

     Service revenue decreased by $1.1 million, or 6.5%, in the first nine months of 2006 to $15.8 million from $16.9 million in the first nine months of 2005. Service revenues were down due to a decrease in on-site training revenue that was offset by increases in technical consulting and other remote services.

     Cost of Sales. The cost of sales of products increased by $4.2 million, or 47.7%, to $13.0 million in the first nine months of 2006 from $8.8 million in the same period in 2005. As a percentage of product sales, the cost of sales of products increased to 18.7% in the first nine months of 2006 from 12.5% in the first nine months of 2005. This increase is due primarily to a higher proportion of revenue in 2006 attributable to hardware sales which generate lower gross margins than do our software sales. The increase in hardware sales for the nine month period is primarily due to the inclusion of AlphaSmart results of operations for the full nine month period in 2006 versus a partial period in 2005.

     The cost of sales of services increased by $0.7 million, or 10.5%, to $7.4 million in the first nine months of 2006 from $6.7 million in the same period in 2005. As a percentage of sales of services, the cost of sales of services increased to 46.6% in the first nine months of 2006 from 39.4% in the first nine months of 2005. The increased cost of sales percentage is attributable to the lower service revenues in 2006 and the fixed nature of a portion of the related costs.

     Product Development. Product development expenses were essentially unchanged at $12.5 million or 14.6% of sales in the first nine months of 2006, compared to $12.6 million or 14.4% of sales for the first nine months of 2005. AlphaSmart expenses were included for the entire nine months of 2006 compared to a partial period in 2005. We capitalized $0.7 million of software development costs in the first nine months of 2006 as compared to a nominal amount in the same period last year. We had a number of new products in 2006, the Renaissance Place version of KeyWords and the UK versions of several products, for which we capitalized development costs in 2006, compared to 2005, when we did not have any significant new products which were at a point of technological feasibility.

     Selling and Marketing. Selling and marketing expenses increased by $2.4 million, or 10.5%, to $24.8 million in the first nine months of 2006 from $22.4 million in the first nine months of 2005. As a percentage of net sales, selling and marketing expenses increased to 28.9% in the first nine months of 2006 from 25.7% in the first nine months of 2005, as a result of lower net sales in 2006 versus 2005. The increase is mainly due to additional staffing costs related to our sales force expansion partially offset by lower advertising expenses.

     General and Administrative. General and administrative expenses were $12.7 million, or 14.8% of sales in the first nine months of 2006 compared to $9.4 million or 10.8% of sales in the first nine months of 2005. General and administrative expenses increased in 2006 primarily due to: (i) a restructuring charge of $1.9 million that was comprised of separation expenses for former executives, (ii) the inclusion of AlphaSmart expenses for the full nine months in the current year as compared to part of the nine month period in 2005 and (iii) share-based compensation expense related to grants of restricted stock.

     Operating Income. Operating income decreased by $12.1 million, or 44.2%, to $15.3 million in the first nine months of 2006 from $27.4 million in the same period in 2005. As a percentage of net sales, operating income decreased to 17.9% in the first nine months of 2006 from 31.4% in the first nine months of 2005.

     Income Tax Expense — Continuing Operations. Income tax expense of $6.0 million, for continuing operations, was recorded for the first nine months of 2006 at an effective income tax rate of 37.0% of pre-tax income, compared to $10.7 million, or 37.0% of pre-tax income for the first nine months of 2005.

     Discontinued Operations. In the first nine months of 2005, we recorded a gain on the sale of Generation21 of approximately $0.7 million which included a one-time tax benefit of $1.1 million. When combined with the operating losses incurred in January and February 2005 for that subsidiary, the net income from discontinued operations totaled approximately $0.6 million in the first nine months of 2005.

Liquidity and Capital Resources

     As of September 30, 2006, our cash, cash equivalents and investment securities were $22.8 million, down $11.8 million from the December 31, 2005 total of $34.6 million. The decrease was primarily due to the use of $19.1 million to purchase treasury stock and dividend payments of $4.5 million offset by positive cash flow from operations. We continue to maintain a strong cash position, which we believe, when coupled with cash flow from operations, will be sufficient to meet both our short-term and long-term working capital requirements.

     At September 30, 2006, we had a $15.0 million unsecured revolving line of credit with a bank which is available until May 31, 2008. The line of credit bears interest at either a floating rate based on the prime rate less 1.0%, or a fixed rate for a period of up to 90 days based on LIBOR plus 1.25%. The rate is at our option and is determined at the time of borrowing. We also have a $2.0 million unsecured revolving line of credit with a bank available until April 30, 2007. The line of credit bears interest based on the prime rate less 1.0%. As of September 30, 2006, the lines of credit had not been used.

     On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. On February 9, 2005, our Board of Directors authorized the repurchase of up to an additional 3,000,000 shares under our stock repurchase program. No time limit was placed on the duration of the stock repurchase program, nor is there any dollar limit on the program. Repurchased shares become treasury shares and will be used for stock-based employee benefit plans, acquisitions and for other general corporate purposes. During the quarter and nine months ended September 30, 2006, we repurchased approximately 313,000 and 1,257,000 shares, respectively, at a cost of $4.1 and $19.0 million. As of September 30, 2006, the cumulative number of shares repurchased under this program was 7.4 million with an aggregate cost of $129.9 million. Depending on our stock valuation, cash availability and other factors, we may repurchase additional shares under this program.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

     As of September 30, 2006, we did not have any off-balance sheet transactions, arrangements or obligations (including contingent obligations) that would have a material effect on our financial results.

     Operating Leases. We enter into operating leases, primarily for facilities that we occupy in order to carry out our business operations. We utilize operating leases for some of our facilities to gain flexibility and limit our exposure to many of the risks of owning commercial property, particularly with regard to international operations. These agreements generally are for terms of one to five years and cannot be terminated by either the lessor or us for reasons other than breach of the lease agreement. We do not anticipate early termination of any of these agreements.

     Purchase Obligations. We enter into commitments with certain suppliers to purchase components for our hardware products, such as AlphaSmart computing devices, AccelScan scanners and the Renaissance Classroom Response System. We typically commit to purchases of components in quantities to cover one to six months of advance production and therefore expect these obligations to be satisfied within one year.

     As of September 30, 2006, our approximate contractual obligations for operating leases and purchase obligations were:

Contractual Obligations		Payments due by Period
(In thousands)						Less than 1												More than
		Total				year				1- 3 years				3-5 years				5 years
Operating lease obligations		$	4,428			$	467			$	3,350			$	611			$	—
Purchase obligations			3,854				3,769				85				—				—
Total		$	8,282			$	4,236			$	3,435			$	611			$	—

Critical Accounting Policies and Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. There have been no significant changes to our critical accounting policies that were disclosed in our 2005 Annual Report.

Forward-Looking Statements

     In accordance with the Private Securities Litigation Reform Act of 1995, we can obtain a “safe-harbor” for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements which identify factors that could cause actual results to differ materially from those in the forward-looking statements. Accordingly, the foregoing “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the following “Quantitative and Qualitative Disclosures About Market Risk” may contain certain forward-looking statements relating to growth plans, projected sales, revenues, earnings and costs, and product development schedules and plans. Our actual results may differ materially from those contained in the forward-looking statements herein. Factors which may cause such a difference to occur include (i) a delay or reduction in school purchases of our products due to state budgetary constraints resulting in a reduction in the funds available to schools and (ii) those factors identified in Item 1A, Risk Factors contained in our 2005 Annual Report, which factors are incorporated herein by reference to such report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Interest Rate Risk. Our exposure to market interest rate risk consists of: (i) the increase or decrease in the amount of interest income we can earn on our investment portfolio and (ii) the decrease or increase in value of our investment security portfolio if market interest rates increase or decrease, respectively. We anticipate that we will have sufficient liquidity to hold our investments to maturity; therefore, we do not expect to recognize any material losses or gains related to an increase or decrease in market interest rates.

     Market Risk. Our exposure to market risk relates to the quality of the holdings in our investment security portfolio. The fair market value of our investments is subject to increases or decreases in value resulting from the performance of the securities issuer, from upgrades or downgrades in the credit worthiness of the securities issuer and from changes in general market conditions.

     We seek to manage exposure to market risk by investing in accordance with our corporate investment policy as established by our Board of Directors. The goals of the policy are: (i) preservation of capital, (ii) provision of adequate liquidity to meet projected cash requirements, (iii) minimization of risk of principal loss through diversified short and medium term investments and (iv) maximization of yields in relationship to the guidelines, risk, market conditions and tax considerations.

     Our investment policy permits investments in obligations of the U.S. Treasury department and its agencies, money market funds and high quality investment-grade corporate and municipal interest-bearing obligations. The policy requires diversification to prevent excess concentration of issuer risk and requires the maintenance of minimum liquidity levels. The policy precludes investment in equity securities except for the specific purpose of funding the obligations related to our Supplemental Executive Retirement Plan. As of September 30, 2006, our investment securities had a market value of approximately $9.6 million and a carrying value of $9.7 million. In addition, we held the first mortgage note on our former facility in Madison, Wisconsin, which had a balance of $5.8 million as of September 30, 2006. The mortgagee prepaid to us, in cash, the entire balance of the mortgage note in October 2006. Due to the type and duration of our investments, we do not expect to realize any material gains or losses related to market risk.

     Foreign Currency Exchange Rate Risk. The financial position and results of operations of our foreign subsidiaries are measured using local currency. Revenues and expenses of such subsidiaries have been translated into U.S. dollars using average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange at the balance sheet date. Translation gains or losses are deferred as a separate component of shareholders’ equity. Aggregate foreign currency transaction gains and losses are included in determining net income. As such, our operating results are affected by fluctuations in the value of the U.S. dollar compared to the British pound, Canadian dollar, Euro and Indian Rupee. At this time, foreign exchange rate risk is not significant due to the relative size of our foreign operations and revenues derived from sales in foreign countries.

Item 4. Controls and Procedures

     We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the company’s disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

     As of September 30, 2006, an evaluation was performed under the supervision and with the participation of management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the CEO and CFO, concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC.

     There has been no change in our internal control over financial reporting that has occurred during the quarter ended September 30, 2006, that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

Part II — OTHER INFORMATION

Item 1A. Risk Factors

     There have been no material changes from risk factors previously disclosed in our 2005 Annual Report in response to Item 1A to Part I of Form 10-K.

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

     On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. On February 9, 2005, our Board of Directors authorized the repurchase of up to an additional 3,000,000 shares under our stock repurchase program. No time limit was placed on the duration of the stock repurchase program, nor is there any dollar limit on the program. Repurchased shares become treasury shares and will be used for stock-based employee benefit plans, acquisitions and for other general corporate purposes.

     The following table shows information relating to the repurchase of shares of our common stock during the three months ended September 30, 2006:

										Total Number of				Maximum Number
										Shares Purchased				of Shares that May
		Total Number								as Part of Publicly				Yet Be Purchased
		of Shares				Average Price				Announced Plans				Under the Plans or
Period		Purchased				Paid per Share				or Programs				Programs
July 1-31, 2006 (1)			26,252			$	12.19				25,687				880,868
August 1-31, 2006			182,300				12.87				182,300				698,568
September 1-30, 2006			105,505				14.10				105,505				593,063
Total			314,057			$	13.23				313,492

Item 5. Other Information

     On September 1, 2006, restricted stock units were granted under our 1997 Stock Incentive Plan to each of our non-employee directors (John H. Grunewald, Gordon H. Gunnlaugsson, Harold E. Jordan, Addison L. Piper and Judith A. Ryan). The restricted stock units were granted subject to the terms of a restricted stock unit agreement, the form of which is attached as Exhibit 10.1 and incorporated herein by reference. The restricted stock unit agreement provides that the restricted stock units granted to each of the non-employee directors will fully vest upon a non-employee director’s termination of service as a member of the Board.

Item 6. Exhibits

Exhibits.

Exhibit No.		Description
10.1		Form of Restricted Stock Unit Agreement with Certain Non-Employee Directors
10.2		Form of Stock Certificate (1)
10.3		Fourth Amendment to Credit Agreement dated as of June 30, 2006 by and between Wells Fargo Bank, National Association and Registrant
31.1		Section 302 certification by Terrance D. Paul
31.2		Section 302 certification by Mary T. Minch
32.1		Section 906 certification by Terrance D. Paul
32.2		Section 906 certification by Mary T. Minch

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.

		RENAISSANCE LEARNING, INC.
		(Registrant)
November 6, 2006		/s/ Terrance D. Paul
Date		Terrance D. Paul
		Chief Executive Officer and a Director
		(Principal Executive Officer)
November 6, 2006		/s/ Mary T. Minch
Date		Mary T. Minch
		Vice President-Finance, Chief Financial Officer and Secretary
		(Principal Financial and Accounting Officer)

Index to Exhibits

Exhibit No.		Description
10.1		Form of Restricted Unit Agreement with Certain Non-Employee Directors
10.2		Form of Stock Certificate (1)
10.3		Fourth Amendment to Credit Agreement dated as of June 30, 2006 by and between Wells Fargo Bank, National Association and Registrant
31.1		Section 302 certification by Terrance D. Paul
31.2		Section 302 certification by Mary T. Minch
32.1		Section 906 certification by Terrance D. Paul
32.2		Section 906 certification by Mary T. Minch