10-Q 1 c71257e10vq.txt FORM 10-Q FOR QUARTER ENDING JUNE 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002. [ ] 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 (IRS EMPLOYER JURISDICTION OF INCORPORATION) IDENTIFICATION NO.) PO BOX 8036 2911 PEACH STREET 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 [ X ] No [ ] 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 JULY 31, 2002 ----- ------------- Common Stock, $0.01 par value 34,140,486

RENAISSANCE LEARNING, INC. INDEX TO FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

PART I - FINANCIAL INFORMATION Page Number ------ ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets at June 30, 2002 and December 31, 2001.......................................................... 1 Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2002 and 2001......................................................... 2 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001............................................ 3 Notes to Unaudited Consolidated Financial Statements................................... 4 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................................... 8 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................................................................ 13 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................... 14 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................... 14

- Index - PART I - FINANCIAL INFORMATION Item 1. Financial Statements RENAISSANCE LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

JUNE 30, DECEMBER 31, 2002 2001 ---------- --------- ASSETS ------ Current assets: Cash and cash equivalents $ 38,152 $ 35,904 Investment securities 49,628 49,288 Accounts receivable, less allowance of $1,499 in 2002 and $1,723 in 2001 14,060 12,397 Inventories 1,450 1,648 Prepaid expenses 699 1,063 Deferred tax asset 3,666 3,606 Other current assets 1,484 1,312 --------- --------- Total current assets 109,139 105,218 Investment securities 39,992 24,364 Property, plant and equipment, net 22,231 23,007 Deferred tax asset 2,212 2,238 Goodwill 2,313 2,313 Other intangibles, net 1,143 1,412 Capitalized software, net 594 506 Other non-current assets 475 903 --------- --------- Total assets $ 178,099 $ 159,961 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable $ 3,349 $ 2,769 Deferred revenue 7,699 7,184 Payroll and employee benefits 3,296 3,845 Income taxes payable 2,640 4,196 Other current liabilities 4,707 4,143 --------- --------- Total current liabilities 21,691 22,137 Deferred revenue 941 1,097 --------- --------- Total liabilities 22,632 23,234 Minority interest 197 196 Shareholders' equity Common stock, $.01 par; shares authorized: 150,000,000; issued: 34,717,965 -June 30, 2002 34,617,861 -June 30, 2001 347 346 Additional paid-in capital 54,134 51,702 Retained earnings 101,176 84,618 Accumulated other comprehensive income (loss) (62) 190 Treasury stock, at cost (25,100 shares) (325) (325) --------- --------- Total shareholders' equity 155,270 136,531 --------- --------- Total liabilities and shareholders' equity $ 178,099 $ 159,961 ========= =========

See accompanying notes to consolidated financial statements. - 1 - RENAISSANCE LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2002 2001 2002 2001 --------- --------- --------- --------- (In thousands, except per share amounts) Net sales: Products $29,045 $28,522 $57,931 $52,884 Services 4,175 4,144 9,979 9,963 ------- ------- ------- ------- Total net sales 33,220 32,666 67,910 62,847 ------- ------- ------- ------- Cost of sales: Products 2,964 4,013 5,827 7,309 Services 1,803 1,680 5,036 5,355 ------- ------- ------- ------- Total cost of sales 4,767 5,693 10,863 12,664 ------- ------- ------- ------- Gross profit 28,453 26,973 57,047 50,183 Operating expenses: Product development 4,181 4,497 8,626 8,889 Selling and marketing 7,481 7,435 15,973 15,426 General and administrative 3,472 3,703 7,435 7,118 ------- ------- ------- ------- Total operating expenses 15,134 15,635 32,034 31,433 ------- ------- ------- ------- Operating income 13,319 11,338 25,013 18,750 Other income: Interest income 880 960 1,742 1,974 Other, net 209 195 304 170 ------- ------- ------- ------- Income before taxes 14,408 12,493 27,059 20,894 Income tax provision 5,605 4,810 10,501 8,044 ------- ------- ------- ------- Net income $ 8,803 $ 7,683 $16,558 $12,850 ======= ======= ======= ======= Basic earnings per common share $ 0.25 $ 0.22 $ 0.48 $ 0.37 Diluted earnings per common share $ 0.25 $ 0.22 $ 0.47 $ 0.37

See accompanying notes to consolidated financial statements. - 2 - RENAISSANCE LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2002 2001 ---------------- ----------------- (In thousands) Reconciliation of net income to net cash provided by operating activities: Net income $ 16,558 $ 12,850 Noncash (income) expenses included in net income - Depreciation and amortization 2,384 2,898 Deferred income taxes (34) (16) Change in assets and liabilities - Accounts receivable (1,663) (3,105) Inventories 198 3 Prepaid expenses 364 361 Accounts payable and other current liabilities (584) 3,209 Deferred revenue 360 67 Other current assets (172) (102) Other 201 (110) -------- -------- Net cash provided by operating activities 17,612 16,055 -------- -------- Cash flows from investing activities: Purchase of property, plant and equipment (1,089) (1,233) Purchase of investment securities, net (15,968) (7,017) Capitalized software development costs (363) (474) Acquisitions -- (704) -------- -------- Net cash used in investing activities (17,420) (9,428) -------- -------- Cash flows provided by financing activities: Proceeds from issuance of stock 1,066 814 Proceeds from exercise of stock options 990 1,821 -------- -------- Net cash provided by financing activities 2,056 2,635 -------- -------- Net increase in cash 2,248 9,262 Cash and cash equivalents, beginning of period 35,904 24,655 -------- -------- Cash and cash equivalents, end of period $ 38,152 $ 33,917 ======== ========

See accompanying notes to consolidated financial statements. - 3 - RENAISSANCE LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. CONSOLIDATION The consolidated financial statements include the financial results of Renaissance Learning, Inc. ("Renaissance Learning") and our subsidiaries. Our significant subsidiaries include Renaissance Corporate Services, Inc. and Generation21 Learning Systems, LLC ("Generation21"). School Renaissance Institute, Inc., formerly a wholly-owned subsidiary of Renaissance Learning, was merged into Renaissance Learning on December 31, 2001, and is currently doing business under the name Renaissance Learning Madison. All significant intercompany transactions have been eliminated in the consolidated financial statements. 2. BASIS OF PRESENTATION In the opinion of management of Renaissance Learning, the consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, 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, 2001, which is on file with the U.S. Securities and Exchange Commission. The results of operations for the three and six month periods ended June 30, 2002 and 2001 are not necessarily indicative of the results to be expected for the full year. 3. EARNINGS PER COMMON SHARE Basic earnings per common share has been computed based on the weighted average number of common shares 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 dilutive potential common shares had been issued. On April 17, 2002, our Board of Directors authorized a new repurchase program which provides for the repurchase of up to 5,000,000 shares of our common stock. No time limit was placed on the duration of the repurchase program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. As of June 30, 2002, we had repurchased 25,100 shares under a previous repurchase program. During the period of July 1, 2002 through July 31, 2002, we repurchased 570,191 shares at a cost of $11,327,000 under the current repurchase program. The weighted average shares outstanding during the three months and six months ended June 30, 2002 and 2001 are as follows:

Three Months Ended June 30, Six Months Ended June 30, 2002 2001 2002 2001 ---------------- ---------------- --------------- ----------------- Basic Weighted Average Shares 34,680,079 34,490,014 34,662,259 34,460,632 Impact of Stock Options 272,022 406,948 273,120 361,651 Diluted Weighted Average Shares 34,952,101 34,896,962 34,935,379 34,822,283

- 4 - 4. SEGMENT REPORTING Our reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. We have two reportable segments: software and training. The software segment produces learning information system software for the K-12 school market in the United States, Canada, the United Kingdom and Australia. The software assists educators in assessing and monitoring student development by increasing the quantity, quality and timeliness of student performance data in the areas of reading, math and writing. The software segment also includes training and knowledge management enterprise software, which is currently sold primarily to corporate customers, and electronic assessment products and services sold to educational publishers. Revenue from the software segment includes product revenue principally from the sale of software, product revenue from scanners sold with software and sold separately, and service revenue from the sale of software support agreements. The training segment provides professional development training seminars and district-wide school improvement programs including training, consulting and educator resource materials. The training programs instruct educators on how to accelerate learning in the classroom through use of the information that our learning information systems provide. Revenue from the training segment includes service revenue from a variety of seminars presented in hotels and schools across the country and from the annual National Renaissance Conference, and product revenue from the sale of training materials. We evaluate the performance of our operating segments based on operating income. Intersegment sales and transfers and revenue derived outside of the United States are not significant. Summarized financial information concerning our reportable segments is shown in the following table:

Three Months Ended Six Months Ended June 30, June 30, 2002 2001 2002 2001 ------------- ------------ ------------- ------------- (In thousands) Revenues: Software $ 29,851 $ 29,372 $ 59,559 $ 54,825 Training 3,369 3,294 8,351 8,022 -------- -------- -------- -------- Total revenues $ 33,220 $ 32,666 $ 67,910 $ 62,847 ======== ======== ======== ======== Operating income: Software $ 14,125 $ 12,309 $ 26,654 $ 20,787 Training (806) (971) (1,641) (2,037) -------- -------- -------- -------- Total operating income $ 13,319 $ 11,338 $ 25,013 $ 18,750 ======== ======== ======== ========

The reported measures are consistent with those used in measuring amounts in the consolidated financial statements. It is our opinion, however, that because many synergistic benefits between the segments cannot be precisely quantified, this information provides an incomplete measure of the training segment profit or loss, and should not be viewed in isolation. We evaluate the performance of the training segment based on many factors not captured by the financial accounting system and often evaluate our financial performance on a total entity basis. 5. COMPREHENSIVE INCOME Total comprehensive income was $16,306,000 and $13,093,000 in the first six months of 2002 and 2001, respectively. For the quarters ended June 30, 2002 and 2001, comprehensive income was $8,703,000 and $7,844,000 respectively. Our comprehensive income includes foreign currency translation adjustments and the remaining balance of unrealized gains and losses on our held-to-maturity securities that were previously classified as available-for-sale securities. - 5 - 6. GOODWILL AND OTHER INTANGIBLE ASSETS On June 30, 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142 " Goodwill and Other Intangible Assets". Under this new standard, goodwill acquired after June 30, 2001 is not amortized over its useful life and starting January 1, 2002, amortization expense is no longer recorded for goodwill acquired on or before June 30, 2001. SFAS 142 requires that goodwill be assessed at least annually for impairment by applying a fair-value-based test. We adopted the provisions of SFAS No. 142 effective January 1, 2002. Assembled workforce does not meet the criteria of SFAS No. 142 for recognition apart from goodwill, therefore, as of January 1, 2002, we reclassified the $441,000 unamortized balance of assembled workforce to goodwill. SFAS 142 requires that a new fair-market-value test be applied to determine if goodwill and other intangible assets with indefinite lives are impaired based on their values as of January 1, 2002. We completed this testing in the first quarter of 2002 and found no instances of impairment of our recorded goodwill. All of our goodwill and other intangible assets are assigned to our software segment. In accordance with SFAS No. 142, the effect of this accounting change is reflected prospectively. Supplemental comparative disclosure as if the change had been retroactively applied to the three months and the six months ended June 30, 2001 is as follows:

Three Months Ended Six Months Ended June 30, June 30, 2002 2001 2002 2001 --------- ------- ---------- ------- (In thousands) (In thousands) Net income: Reported net income $ 8,803 $ 7,683 $ 16,558 $12,850 Goodwill amortization, net of tax -- 86 -- 173 --------- ------- ---------- ------- Adjusted net income $ 8,803 $ 7,769 $ 16,558 $13,023 ========= ======= ========== ======= Adjusted Earnings per share: Basic 0.25 0.23 0.48 0.38 Diluted 0.25 0.22 0.47 0.37

For the three months ended June 30, 2002, we recognized amortization expense of $134,000 on other intangibles. No goodwill or other intangibles were acquired or impaired during the second quarter of 2002. During the first quarter of 2002, we retired a $210,000 trade name intangible which was fully amortized. Other intangibles are scheduled to be fully amortized by 2006 with corresponding amortization estimated to be $268,000, $396,000, $286,000, and $193,000, for the remainder of 2002 and the years ended 2003, 2004, and 2005, respectively. Other intangibles consisted of the following (in thousands):

June 30, 2002 December 31, 2001 ------------------------------------ ------------------------------------- Gross Other Gross Other Carrying Accumulated Intangibles Carrying Accumulated Intangibles Amount Amortization Net Amount Amortization Net --------- ------------ ---------- ---------- ------------ ----------- Algorithms and software code $2,124 $1,724 $ 400 $2,124 $1,565 $ 559 Trade name -- -- -- 210 210 -- Non-compete agreement 1,100 357 743 1,100 247 853 ------ ------ ------ ------ ------ ------ Other intangibles $3,224 $2,081 $1,143 $3,434 $2,022 $1,412 ====== ====== ====== ====== ====== ======

- 6 - 7. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations", which requires entities to recognize the fair value of a liability for legal obligations associated with the retirement of tangible long-lived assets in the period incurred, if a reasonable estimate of the fair value can be made. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment of long-lived assets. The statement provides a single accounting model for long-lived assets to be disposed of. Under SFAS No. 144, the presentation of discontinued operations is broadened to include a component of an entity rather than being limited to a segment of a business. Also, accrual of future operating losses of discontinued businesses will no longer be permitted. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses financial accounting and reporting associated with exit or disposal activities. Under SFAS No. 146, costs associated with an exit or disposal activity shall be recognized and measured at their fair value in the period in which the liability is incurred rather than at the date of a commitment to an exit or disposal plan. We are required to adopt SFAS No. 143 and SFAS No. 144 on January 1, 2003 and SFAS No. 146 for all exit and disposal activities initiated after December 31, 2002. We are currently evaluating the provisions of these recent pronouncements, but we believe there will be no material effect on our financial position, results of operations or shareholders' equity resulting from their adoption. - 7 - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2002 2001 2002 2001 ---------- ----------- --------- ---------- Net Sales: Products 87.4% 87.3% 85.3% 84.1% Services 12.6 12.7 14.7 15.9 ----- ----- ----- ----- Total net sales 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== Cost of sales: Products 10.2% 14.1% 10.1% 13.8% Services 43.2 40.5 50.5 53.7 Total cost of sales 14.3 17.4 16.0 20.2 Gross profit: Products 89.8 85.9 89.9 86.2 Services 56.8 59.5 49.5 46.3 Total gross profit 85.7 82.6 84.0 79.8 Operating expenses: Product development 12.6 13.8 12.7 14.1 Selling and marketing 22.5 22.8 23.5 24.6 General and administrative 10.5 11.3 10.9 11.3 ----- ----- ----- ----- Total operating expenses 45.6 47.9 47.1 50.0 ----- ----- ----- ----- Operating income 40.1 34.7 36.9 29.8 Other income: Interest income 2.6 2.9 2.6 3.1 Other, net 0.7 0.6 0.4 0.3 ----- ----- ----- ----- Total other income 3.3 3.5 3.0 3.4 ----- ----- ----- ----- Income before taxes 43.4 38.2 39.9 33.2 Income tax provision 16.9 14.7 15.5 12.8 ----- ----- ----- ----- Net income 26.5% 23.5% 24.4% 20.4% ===== ===== ===== =====

- 8 - THREE MONTHS ENDED JUNE 30, 2002 AND 2001 Net Sales. Our net sales increased by $555,000, or 1.7%, to $33.2 million in the second quarter of 2002 from $32.7 million in the second quarter of 2001. Product sales increased by $523,000, or 1.8%, to $29.0 million in the second quarter of 2002 from $28.5 million in the second quarter of 2001. The increase in product sales is primarily attributable to (i) sales of STAR Early Literacy* software, which did not begin to ship until late in the second quarter of 2001, (ii) increased sales of Accelerated Reader* quizzes, with over 56,000 available book titles, to a larger base of Accelerated Reader schools, (iii) sales of our new products, Accelerated Writer* and Accelerated Vocabulary* software, released during the quarter, and (iv) increased sales of math products, including follow-on sales of Accelerated Math* libraries, optical-mark card scanners and Accelerated Math learning cards. Service revenue, which consists of revenue from sales of training sessions and software support agreements, increased by $31,000, or 0.8%, to $4.2 million in the second quarter of 2002 from $4.1 million in the second quarter of 2001. Software support revenues recognized during the quarter increased 21.7% over the same quarter in 2001, while sales from our training business declined by 14.0%. We expect that training revenues will continue to decline in 2002 versus a year ago, because of pressures on school funding. Overall, we expect revenue growth for 2002 to be in the range of 5% to 10%. Current school funding is weak and we do not expect it to improve any time soon. Three new products were released in the second quarter as scheduled: Accelerated Writer writing improvement system, Accelerated Vocabulary vocabulary development software, and StandardsMaster* instant assessment and Web-based reporting software. Three additional new products are expected to be ready for shipment in the third quarter: Fluent Reader* repeated reading software for improving reading fluency, MathFacts in a Flash* software to help educators improve students' computation fluency, and AccelTest* test creation, scoring, and gradebook software. Cost of Sales. The cost of sales of products decreased by $1.0 million, or 26.1%, to $3.0 million in the second quarter of 2002 from $4.0 million in the second quarter of 2001. As a percentage of product sales, the cost of sales of products decreased to 10.2% in the second quarter of 2002 from 14.1% in the second quarter of 2001. The decrease in cost of sales of products is due to the improved margins on scanners, as well as a sales mix of higher margin products. The cost of sales of services increased by $123,000, or 7.3%, to $1.8 million in the second quarter of 2002 from $1.7 million in the second quarter of 2001. As a percentage of sales of services, the cost of sales of services increased to 43.2% in the second quarter of 2002 from 40.5% in the second quarter of 2001 due to lower margins realized on training services. Our overall gross profit margin increased to 85.7% in the second quarter of 2002 from 82.6% in the second quarter of 2001. The increase is primarily due to higher profitability on scanners. Product Development. Product development expenses decreased by $316,000, or 7.0%, to $4.2 million in the second quarter of 2002 from $4.5 million in the second quarter of 2001. This decrease is a result of our aggressive investment in product development in 2001. As a percentage of net sales, product development costs decreased to 12.6% in the second quarter of 2002 from 13.8% in the second quarter of 2001. We expect that product development cost growth will moderate in 2002 compared to the previous year and that product development costs will decline as a percentage of sales for 2002 compared to 2001. Selling and Marketing. Selling and marketing expenses increased by $46,000, or 0.6%, to $7.5 million in the second quarter of 2002 from $7.4 million in the second quarter of 2001. As a percentage of net sales, selling and marketing expenses declined to 22.5% in the second quarter of 2002 from 22.8% in the second quarter of 2001. We plan to continue to be aggressive with a variety of sales and marketing initiatives in order to stimulate leads and orders for our new products and our expanded product line. ---------------- *Accelerated Reader(R), AccelScan(R), STAR Reading(R), Accelerated Math(R), Generation21(R), STAR Math(R), Reading Renaissance(R), Math Renaissance(R) and School Renaissance(R) are registered trademarks of the company. Perfect Copy(TM), Perfect Copy High School(TM), Surpass(TM), Renaissance(TM), Renaissance Learning(TM), STAR Early Literacy(TM), Fluent Reader(TM), StandardsMaster(TM), Accelerated Writer(TM), Accelerated Vocabulary(TM), AccelTest(TM), eSchoolOffice(TM), Writing Renaissance(TM), Total Knowledge Management(TM), MathFacts in a Flash(TM), and TKM(TM) are common law trademarks of the company. - 9 - General and Administrative. General and administrative expenses decreased by $231,000, or 6.2%, to $3.5 million in the second quarter of 2002 from $3.7 million in the second quarter of 2001. As a percentage of net sales, general and administrative costs decreased to 10.5% in the second quarter of 2002 from 11.3% in the second quarter of 2001. For the full year 2002, we expect to leverage our administrative infrastructure and reduce general and administrative costs as a percentage of sales compared to 2001 levels. Operating Income. Operating income increased by $2.0 million, or 17.5%, to $13.3 million in the second quarter of 2002 from $11.3 million in the second quarter of 2001. As a percentage of net sales, operating income increased to 40.1% in the second quarter of 2002 from 34.7% in the second quarter of 2001. Income Tax Expense. Income tax expense of $5.6 million was recorded in the second quarter of 2002 at an effective income tax rate of 38.9% of income before taxes compared to $4.8 million, or 38.5% of income before taxes in the second quarter of 2001. We expect to maintain our effective tax rate at or below 39% for 2002. SIX MONTHS ENDED JUNE 30, 2002 AND 2001 Net Sales. Our net sales increased by $5.1 million, or 8.1%, to $67.9 million in the six months ended June 30, 2002 from $62.8 million in the first six months of 2001. Product sales increased by $5.0 million, or 9.5%, to $57.9 million in the first six months of 2002 from $52.9 million in the same period in 2001. The increase in product sales is primarily attributable to (i) increased sales of STAR Early Literacy software, which did not begin to ship until late in the second quarter of 2001, (ii) increased sales of Accelerated Reader quizzes, with over 56,000 available book titles, to a larger base of Accelerated Reader schools and (iii) increased sales of Accelerated Math products, including follow-on sales of subject libraries, optical-mark card scanners and Accelerated Math learning cards. Service revenue remained constant at $10.0 million in the first six months of 2002 and 2001. Training revenues, including revenues from our National School Renaissance Conference, declined by 8.8% in the first half of 2002, while software support revenues increased by 18.8%. Revenues from our annual National School Renaissance Conference held in the first quarter were relatively unchanged in 2002 compared to 2001. Cost of Sales. The cost of sales of products decreased by $1.5 million, or 20.3%, to $5.8 million in the first six months of 2002 from $7.3 million in the first six months of 2001. As a percentage of product sales, the cost of sales of products decreased to 10.1% in the first half of 2002 from 13.8% in the first half of 2001. This decrease is primarily due to the improved margin on our AccelScan optical-mark card scanner and a sales mix weighted more heavily to higher margin products. The cost of sales of services decreased by $319,000, or 6.0%, to $5.0 million in the first six months of 2002 from $5.4 million in the same period in 2001. As a percentage of sales of services, the cost of sales of services decreased to 50.5% in the first six months of 2002 from 53.7% in the first six months of 2001. This decrease is primarily due to increased software support revenues while the related costs remained relatively constant. Our overall gross profit margin increased to 84.0% in the first six months of 2002 from 79.8% in the first six months of 2001. Product Development. Product development expenses decreased by $263,000, or 3.0%, to $8.6 million in the six months ended June 30, 2002 as compared to $8.9 million in the corresponding 2001 period. This decrease is a result of our aggressive investment in product development in 2001. As a percentage of net sales, product development costs decreased to 12.7% in the first half of 2002 from 14.1% in the first half of 2001. Selling and Marketing. Selling and marketing expenses increased by $547,000, or 3.5%, to $16.0 million in the first half of 2002 from $15.4 million in the first half of 2001. These expenses increased primarily due to (i) costs of selling and marketing our expanded product line, (ii) increased wages and benefit costs, and (iii) increased professional fees. As a percentage of net sales, selling and marketing expenses declined to 23.5% in the first half of 2002 from 24.6% in the first six months of 2001. General and Administrative. General and administrative expenses increased by $317,000, or 4.5%, to $7.4 million in the six months ended June 30, 2002 from $7.1 million in the same period in 2001. The higher expenses for 2002 are primarily due to increased wages and related benefit costs and increased professional fees. As a percentage of net sales, general and administrative costs decreased to 10.9% in the first six months of 2002 compared to 11.3% in the same period in 2001. - 10 - Operating Income. Operating income increased by $6.3 million, or 33.4%, to $25.0 million in the first six months of 2002 from $18.7 million in the same period in 2001. As a percentage of net sales, operating income increased to 36.9% in the first half of 2002 from 29.8% in the first half of 2001. Income Tax Expense. Income tax expense of $10.5 million was recorded in the first six months of 2002 at an effective income tax rate of 38.8% of income before taxes compared to $8.0 million, or 38.5% of income before taxes, in the first half of 2001. We expect to maintain our effective tax rate at or below 39% for 2002. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, our cash, cash equivalents and investment securities increased to $127.8 million from the December 31, 2001 total of $109.6 million. The increase of $18.2 million in the first half of 2002 is primarily due to $17.6 million in cash provided by operating activities. We believe our strong cash position coupled with cash flow from operations will be sufficient to meet both our short-term and long-term working capital requirements. At June 30, 2002, we had a $15.0 million unsecured revolving line of credit with a bank, which is available until March 31, 2004. 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, which is available until January 31, 2003. The line of credit bears interest based on the prime rate less 1.0%. As of June 30, 2002, 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. No time limit was placed on the duration of the repurchase program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. During the period of July 1, 2002 through July 31, 2002 we repurchased 570,191 shares at a cost of $11,327,000. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We have not made any changes in estimates or assumptions since December 31, 2001 that had a significant effect on the reported amounts. We believe the following are the critical accounting policies that could have the most significant effect on our reported results and that require the most subjective estimates by management. Revenue Recognition. We recognize revenue in accordance with Statement of Position No. 97-2 "Software Revenue Recognition" issued by the Accounting Standards Executive Committee of the AICPA. Under this accounting standard, revenue is recognized when the following have occurred: persuasive evidence of an arrangement exists, product delivery and acceptance has occurred or a service has been rendered, pricing is fixed and determinable, and collectibility is probable. Revenue is recognized as follows: (i) at the time of shipment to customers for off-the-shelf software products and related telephone support with a duration of 12 months or less sold with the product, (ii) on the percentage of completion basis for custom software products, (iii) as seminars are performed for training, (iv) straight-line over the term of the support agreement for separately sold software support agreements, and (v) as the service is performed or on a straight-line basis over the contractual period for consulting services. Accordingly, management is required to make judgements as to whether pricing is fixed and determinable, whether collectibility is reasonably assured and what the percentage of completion is as of the financial reporting date for custom software products. Expenses are recognized and matched against revenues for the reporting period presented in the financial statements. We record accruals for sales returns and doubtful accounts at the time of revenue recognition based upon historical experience. Changes in such allowances may be required if future returns or bad debt activity differs from historical experience. - 11 - Impairment of Long-Lived Assets. We evaluate the recoverability of the carrying amount of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. We evaluate the recoverability of goodwill and other intangible assets with indefinite useful lives annually or more frequently if events or circumstances indicate that an asset might be impaired. Management uses judgement when applying impairment rules to determine when an impairment test is necessary. Examples of factors which could trigger an impairment review include a significant decrease in the market value of an asset, a significant change in the extent or manner in which an asset is used, and significant adverse changes in legal factors or the business climate that impact the value of an asset. Impairment losses are measured as the amount by which the carrying value of an asset exceeds its estimated fair value. We are required to make estimates of future cash flows related to the asset subject to review. These forecasts require assumptions about demand for our products and services, future market conditions and technological developments. Other assumptions include determining the discount rate and future growth rates. Changes to these assumptions could result in an impairment charge in future periods. Software Support Agreements. We record a liability for the estimated cost of software support obligations at the time of sale to customers based upon historical cost experience of providing telephone support. Adjustments to the software support liability may be required if actual costs differ from our estimates. Software Development Costs. We capitalize certain software development costs incurred after technological feasibility is achieved. Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the products, which is generally estimated to be 24 months. Amortization begins when the products are available for general release to customers. If the actual economic life of our products is shorter than our estimates, it could result in an impairment charge in future periods. Taxes. At the end of each interim reporting period, we estimate the effective income tax rate expected to be applicable for the full fiscal year. The estimated effective income tax rate contemplates the expected jurisdiction where income is earned (e.g., United States compared to non-United States) as well as tax planning strategies. If the actual distribution of taxable income by jurisdiction varies from our expectations or if the results of tax planning strategies are different from our estimates, adjustments to the effective income tax rate may be required in the period such determination is made. We record a liability for potential tax assessments based on our estimate of the potential exposure. Due to the subjectivity and complex nature of the underlying issues, actual payments or assessments may differ from estimates and require tax provision adjustments. 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" contains 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 1, Business, Forward-Looking Statements, contained in our Form 10-K for the year ended December 31, 2001, which factors are incorporated herein by reference to such Form 10-K. - 12 - 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 and from upgrades or downgrades in the credit worthiness of the securities issuer. We seek to manage our exposure to market risk by investing according to our board-approved investment policy which has the following goals: (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 specifically defines that our investments (i) have a maximum maturity of 36 months or less, (ii) meet a minimum portfolio liquidity requirement that 10% of the portfolio shall be available on 30 days notice and not more than 30% of the portfolio will have a maturity in excess of 24 months, (iii) meet minimum credit quality requirements specified in the plan based on the type of investment, (iv) meet the concentration limit of not more than 10% in any one issuer other than the US Treasury or its agencies, or money market funds, and (v) meet certain maximum maturity or tender option limits based on it's minimum credit rating. Our investment policy parameters preclude investment in equity securities and require that the Board of Directors review the policy annually and on an interim basis as required. 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 at 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 Australian dollar, British pound, Canadian dollar, and Indian Rupee. At this time, foreign operations are not significant. - 13 - Part II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders (a) On April 17, 2002, the Company held its Annual Meeting of Shareholders. (b) Not applicable. (c) Set forth below are descriptions of the matters voted upon at the Annual Meeting of Shareholders and the number of votes cast for, against or withheld, as well as the number of abstentions and broker non-votes, as to each such matter. Nine directors were elected to serve until the 2003 Annual Meeting of Shareholders and until their successors are elected and qualified. The results of this proposal are as follows:

For Withheld --- -------- (1) Judith A. Paul 33,262,740 544,307 (2) Terrance D. Paul 33,262,740 544,307 (3) Michael H. Baum 33,262,740 544,307 (4) John R. Hickey 33,262,670 544,377 (5) Timothy P. Welch 33,142,530 664,517 (6) John H. Grunewald 33,663,700 143,347 (7) Gordon H. Gunnlaugsson 33,663,700 143,347 (8) Harold E. Jordan 33,663,700 143,347 (9) Addison L. Piper 33,663,700 143,347

(d) Not applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit No. Description ----------- ----------- 99.1 Section 906 certification by Michael H. Baum 99.2 Section 906 certification by Steven A. Schmidt (b) Forms 8-K. The following Form 8-K filings were made during the three months ended June 30, 2002: 1. Form 8-K dated April 17, 2002 (filed on April 19, 2002); 2. Form 8-K dated May 22,2002 (filed on May 28, 2002); 3. Amend. No. 1 to Form 8-K dated May 22, 2002 (filed on June 19, 2002); and 4. Form 8-K dated June 27, 2002 (filed on June 28, 2002). - 14 - 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) August 13, 2002 /s/ Michael H. Baum --------------- ------------------------------ Date Michael H. Baum Chief Executive Officer (Principal Executive Officer) August 13, 2002 /s/ Steven A. Schmidt --------------- ------------------------------ Date Steven A. Schmidt Secretary, Vice President, and Chief Financial Officer (Principal Financial and Accounting Officer) Index to Exhibits Exhibit No. Description ----------- ----------- 99.1 Section 906 certification by Michael H. Baum 99.2 Section 906 certification by Steven A. Schmidt