10-Q 1 c64426e10-q.txt QUARTERLY REPORT FOR PERIOD ENDED JUNE 30, 2001 1 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, 2001. [ ] 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, 2001 ----- ------------- Common Stock, $0.01 par value 34,555,540 2 RENAISSANCE LEARNING, INC. INDEX TO FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001

PART I - FINANCIAL INFORMATION Page Number ------ ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets at June 30, 2001 (unaudited) and December 31, 2000.......................................................... 1 Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2001 and 2000 (unaudited)............................................. 2 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000 (unaudited)................................ 3 Notes to Unaudited 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 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................... 12 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...................................................... 12

- Index - 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements RENAISSANCE LEARNING, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)

JUNE 30, DECEMBER 31, 2001 2000 -------------------- -------------------- (unaudited) (audited) ASSETS Current assets: Cash and cash equivalents $ 33,917 $ 24,655 Investment securities 50,360 43,343 Accounts receivable, less allowance of $1,699 at June 30, 2001 and $985 at December 31, 2000 14,440 11,335 Inventories 1,520 1,523 Prepaid expenses 842 1,204 Deferred tax asset 3,265 2,922 Other current assets 948 845 ---------- --------- Total current assets 105,292 85,827 Property, plant and equipment, net 23,775 24,501 Deferred tax asset 1,801 2,127 Intangibles and goodwill, net 4,299 5,002 Capitalized software, net 818 581 Other non-current assets 533 183 ---------- --------- Total assets $ 136,518 $ 118,221 ========== ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,659 $ 2,166 Deferred revenue 5,795 5,484 Payroll and employee benefits 3,034 2,813 Income taxes payable 3,751 2,419 Other current liabilities 3,473 4,104 ---------- --------- Total current liabilities 18,712 16,986 Deferred revenue 1,136 1,380 ---------- --------- Total liabilities 19,848 18,366 Minority interest 181 185 Shareholders' equity 116,489 99,670 ---------- --------- Total liabilities and shareholders' equity $ 136,518 $ 118,221 ========== =========

See accompanying notes to consolidated financial statements. - 1 - 4 RENAISSANCE LEARNING, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2001 2000 2001 2000 --------------- -------------- -------------- -------------- (In thousands, except per share amounts) Net sales: Products $ 28,522 $ 22,195 $ 52,884 $ 40,567 Services 4,144 4,227 9,963 9,925 --------------- -------------- -------------- -------------- Total net sales 32,666 26,422 62,847 50,492 --------------- -------------- -------------- -------------- Cost of sales: Products 4,013 2,881 7,309 5,398 Services 1,680 2,167 5,355 5,216 --------------- -------------- -------------- -------------- Total cost of sales 5,693 5,048 12,664 10,614 --------------- -------------- -------------- -------------- Gross profit 26,973 21,374 50,183 39,878 Operating expenses: Product development 4,497 3,838 8,889 7,008 Selling and marketing 7,435 6,129 15,426 12,762 General and administrative 3,703 3,030 7,118 5,863 --------------- -------------- -------------- -------------- Total operating expenses 15,635 12,997 31,433 25,633 --------------- -------------- -------------- -------------- Operating income 11,338 8,377 18,750 14,245 Other income: Interest income 960 666 1,974 1,241 Other, net 195 117 170 263 --------------- -------------- -------------- -------------- Income before taxes 12,493 9,160 20,894 15,749 Income tax provision 4,810 3,623 8,044 6,214 --------------- -------------- -------------- -------------- Net income $ 7,683 $ 5,537 $ 12,850 $ 9,535 =============== ============== ============== ============== Basic earnings per share $ 0.22 $ 0.16 $ 0.37 $ 0.28 Diluted earnings per share $ 0.22 $ 0.16 $ 0.37 $ 0.28

See accompanying notes to consolidated financial statements. - 2 - 5 RENAISSANCE LEARNING, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2001 2000 -------------------- -------------------- (In thousands) Reconciliation of net income to net cash provided by operating activities: Net income $ 12,850 $ 9,535 Noncash (income) expenses included in net income - Depreciation and amortization 2,898 2,223 Deferred income taxes (16) (349) Change in assets and liabilities - Accounts receivable (3,105) 2,543 Inventory 3 490 Prepaid expenses 361 590 Accounts payable and other current liabilities 3,209 294 Deferred revenue 67 (899) Other current assets (102) (1,113) Other (110) (48) -------------------- -------------------- Net cash provided by operating activities 16,055 13,266 -------------------- -------------------- Cash flows from investing activities: Purchase of property, plant and equipment (1,233) (2,233) Purchase of short-term investments, net (7,017) (12,230) Capitalized software development costs (474) - Acquisitions (704) - -------------------- -------------------- Net cash used in investing activities (9,428) (14,463) -------------------- -------------------- Cash flows provided by financing activities: Proceeds from issuance of stock 814 490 Return of capital to minority interest - (60) Purchase of treasury stock - (325) Proceeds from exercise of stock options 1,821 50 -------------------- -------------------- Net cash provided by financing activities 2,635 155 -------------------- -------------------- Net increase (decrease) in cash 9,262 (1,042) Cash and cash equivalents, beginning of period 24,655 22,882 -------------------- -------------------- Cash and cash equivalents, end of period $ 33,917 $ 21,840 ==================== ====================

See accompanying notes to consolidated financial statements. - 3 - 6 RENAISSANCE LEARNING, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. CONSOLIDATION The consolidated financial statements include the financial results of Renaissance Learning, Inc. and our consolidated subsidiaries. All significant intercompany transactions have been eliminated in the consolidated financial statements. Our name was legally changed from Advantage Learning Systems, Inc. to Renaissance Learning, Inc. on April 18, 2001. On April 20, 2001, our stock trading symbol on The Nasdaq Stock Market changed to RLRN to reflect the legal name change. 2. BASIS OF PRESENTATION The 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. Certain previously reported amounts have been reclassified to conform with the 2001 presentation. These financial statements should be read in conjunction with the financial information contained in our Annual Report on Form 10-K which is on file with the U.S. Securities and Exchange Commission. Effective November 17, 2000, we acquired the business and assets of Engineering Software Associates, Inc. ("ESA"), Minneapolis, Minnesota, a provider of electronic assessment products and services to textbook publishers. The transaction was accounted for using the purchase method of accounting, with a total purchase price of $3.8 million including the assumption of less than $100,000 of certain liabilities. The purchase price was subject to certain post-closing adjustments. The purchase price was allocated based on the fair values of the assets acquired and liabilities assumed and included an allocation to intangibles and goodwill. The operating results of ESA are included in our consolidated financial statements since the date of acquisition. The results of operations for the three and six month periods ended June 30, 2001 and 2000 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 January 3, 2000, our Board of Directors authorized the repurchase of up to 1,000,000 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, 2001, we had repurchased 25,100 shares. The weighted average shares outstanding during the three months and six months ended June 30, 2001 and 2000 are as follows:

THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2001 2000 2001 2000 ---------------- ---------------- --------------- ----------------- Basic Weighted Average Shares 34,490,014 34,213,934 34,460,632 34,217,379 Impact of Stock Options 406,948 95,909 361,651 105,319 Diluted Weighted Average Shares 34,896,962 34,309,843 34,822,283 34,322,698

- 4 - 7 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 math software and sold separately, and service revenue from the sale of software support agreements. The training segment provides professional development training seminars and related products to train and support teachers in implementing our model for educational improvement. 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 School Renaissance Conference, and product revenue from the sale of training materials. We evaluate the performance of our operating segments based on operating income before nonrecurring items. 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, 2001 2000 2001 2000 --------------- -------------- --------------- --------------- (In thousands) Revenues: $ 29,372 $ 23,223 $ 54,825 $ 42,686 Software 3,294 3,199 8,022 7,806 Training --------------- -------------- --------------- --------------- $ 32,666 $ 26,422 $ 62,847 $ 50,492 Total revenues =============== ============== =============== =============== Operating income: $ 12,309 $ 8,859 $ 20,787 $ 14,898 Software (971) (482) (2,037) (653) Training --------------- -------------- --------------- --------------- $ 11,338 $ 8,377 $ 18,750 $ 14,245 Total operating income =============== ============== =============== ===============

The reported measures are consistent with those used in measuring amounts in the consolidated financial statements. Such measurements are generally along legal entity lines as aggregated. It is our opinion, however, that because many flows of value 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 $13,093,000 and $9,496,000 in the first six months of 2001 and 2000, respectively. Our comprehensive income includes foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. - 5 - 8 6. GOODWILL AND OTHER INTANGIBLE ASSETS On June 30, 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 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 will no longer be 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. In addition, under the new rules, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged. SFAS 142 requires that a new fair-value-based test be applied to determine if intangible assets are impaired. We will perform an impairment analysis of intangible assets by the end of 2001 and of goodwill by the end of the first quarter of 2002 in accordance with the new standard. For the years ended December 31, 2000, 1999 and 1998, goodwill expense of $311,000, $205,000 and $176,000, respectively, is included in our statement of income. During 2001 we recorded goodwill expense of $235,000 for the six months ended June 30 and expect to record goodwill expense of $470,000 on an annual basis. We have estimated that goodwill amortization of approximately $470,000 will not be recognized in 2002 as a result of adopting this statement. - 6 - 9 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, 2001 2000 2001 2000 ---------------- ----------------- ---------------- --------------- Net Sales: Products 87.3 % 84.0 % 84.1 % 80.3 % Services 12.7 16.0 15.9 19.7 ---------------- ----------------- ---------------- --------------- Total net sales 100.0 % 100.0 % 100.0 % 100.0 % ================ ================= ================ =============== Cost of sales: Products 14.1 % 13.0 % 13.8 % 13.3 % Services 40.5 51.3 53.7 52.6 Total cost of sales 17.4 19.1 20.2 21.0 Gross profit: Products 85.9 87.0 86.2 86.7 Services 59.5 48.7 46.3 47.4 Total gross profit 82.6 80.9 79.8 79.0 Operating expenses: Product development 13.8 14.5 14.1 13.9 Selling and marketing 22.8 23.2 24.6 25.3 General and administrative 11.3 11.5 11.3 11.6 ---------------- ----------------- ---------------- --------------- Total operating expenses 47.9 49.2 50.0 50.8 ---------------- ----------------- ---------------- --------------- Operating income 34.7 31.7 29.8 28.2 Other income: Interest income 2.9 2.5 3.1 2.5 Other, net 0.6 0.5 0.3 0.5 ---------------- ----------------- ---------------- --------------- Total other income 3.5 3.0 3.4 3.0 ---------------- ----------------- ---------------- --------------- Income before taxes 38.2 34.7 33.2 31.2 Income tax provision 14.7 13.7 12.8 12.3 ---------------- ----------------- ---------------- --------------- Net income 23.5 % 21.0 % 20.4 % 18.9 % ================ ================= ================ ===============

- 7 - 10 THREE MONTHS ENDED JUNE 30, 2001 AND 2000 Net Sales. Our net sales increased by $6.2 million, or 23.6%, to $32.7 million in the second quarter of 2001 from $26.4 million in the second quarter of 2000. Product sales increased by $6.3 million, or 28.5%, to $28.5 million in the second quarter of 2001 from $22.2 million in the second quarter of 2000. The increase in product sales is primarily attributable to (i) increased sales of Accelerated Math products, including follow-on sales of subject libraries and optical-mark card scanners, (ii) increased sales of Accelerated Reader quizzes, with over 45,000 available book titles, to a larger base of Accelerated Reader schools and (iii) increased sales of electronic assessment products to educational publishers from the acquisition of Engineering Software Associates, Inc. ("ESA") completed late last year. Two new products were released late in the second quarter as scheduled: STAR Early Literacy, a diagnostic test for phonics and other key early language skills for students from pre-kindergarten to second grade, and AR Universal, the new version of our Accelerated Reader reading management program which supports new recorded-voice versions of quizzes on literature books for emergent readers and new quizzes for assessing reading instruction assignments such as those found in reading textbooks and other curricula. We continue to expect revenue growth for 2001 to be at or near last year's growth rate with broadening adoption of our new STAR Early Literacy software as well as continued strong sales of our other reading and math software to both new and existing school customers. Service revenue, which consists of revenue from sales of training sessions and software support agreements, decreased by $83,000, or 2.0%, to $4.1 million in the second quarter of 2001 from $4.2 million in the second quarter of 2000. This decrease is due primarily to a 15% decline in sales from our training business as we continue to transition this business toward more district-wide sales, as opposed to selling single training events. The decline in training revenues was offset by a 21% increase in software support revenues, which benefited from stronger support plan renewals. We expect to see service revenue resume at least modest growth in the third quarter. Cost of Sales. The cost of sales of products increased by $1.1 million, or 39.3%, to $4.0 million in the second quarter of 2001 from $2.9 million in the second quarter of 2000. As a percentage of product sales, the cost of sales of products increased to 14.1% in the second quarter of 2001 from 13.0% in the second quarter of 2000. The increase in cost of sales of products is due to higher sales of scanners, for use with math software, as well as higher sales of assessment products from the ESA acquisition, both of which carry somewhat lower margins than our other software products. The cost of sales of services decreased by $487,000, or 22.5%, to $1.7 million in the second quarter of 2001 from $2.2 million in the second quarter of 2000. As a percentage of sales of services, the cost of sales of services decreased to 40.5% in the second quarter of 2001 from 51.3% in the second quarter of 2000. The improvement was due to stronger sales in the software support business and from a favorable training product mix. Compared to the second quarter of 2000, the second quarter of 2001 training revenue contained a higher proportion of onsite events, which are more profitable than hotel events. Our overall gross profit margin increased to 82.6% in the second quarter of 2001 from 80.9% in the second quarter of 2000. The increase is primarily due to a higher proportion of products to services in the 2001 revenue mix. Product Development. Product development expenses increased by $659,000, or 17.2%, to $4.5 million in the second quarter of 2001 from $3.8 million in the second quarter of 2000. These expenses increased primarily due to continued aggressive investment in product development including STAR Early Literacy and AR Universal, released late in the second quarter, and the development of additional Accelerated Math libraries, eSchool office school administration software, and a number of other new products at various stages of development. As a percentage of net sales, product development costs decreased to 13.8% in the second quarter of 2001 from 14.5% in the second quarter of 2000. We expect product development costs to continue to increase throughout 2001 by somewhat larger increments than the second quarter reflecting our continued aggressive investment plans to drive future growth. Product development costs, however, are not expected to increase significantly as a percentage of sales in the near term. Selling and Marketing. Selling and marketing expenses increased by $1.3 million, or 21.3%, to $7.4 million in the second quarter of 2001 from $6.1 million in the second quarter of 2000. These expenses increased due to a more aggressive sales and marketing plan including (i) increased costs of promoting the district-wide Renaissance schoolwide improvement process, (ii) the costs of marketing the Generation21 enterprise-wide training and knowledge management software, (iii) costs of marketing our new STAR Early Literacy and AR Universal products and (iv) other initiatives. As a - 8 - 11 percentage of net sales, selling and marketing expenses declined to 22.8% in the second quarter of 2001 from 23.2% in the second quarter of 2000. We expect that selling and marketing expenses will continue at a higher level than the prior year but will decline as a percent of sales in the third quarter compared to the second quarter 2001. General and Administrative. General and administrative expenses increased by $673,000, or 22.2%, to $3.7 million in the second quarter of 2001 from $3.0 million in the second quarter of 2000. The higher expenses for the second quarter of 2001 are largely due to increased costs associated with the hiring of additional personnel, including wages and related benefits, and increased personnel from the ESA acquisition in late 2000. As a percentage of net sales, general and administrative costs decreased slightly to 11.3% in the second quarter of 2001 from 11.5% in the second quarter of 2000, but remain within our expected annual range of 11% to 12% of sales. Operating Income. Operating income increased by $3.0 million, or 35.3%, to $11.3 million in the second quarter of 2001 from $8.4 million in the second quarter of 2000. As a percentage of net sales, operating income increased to 34.7% in the second quarter of 2001 from 31.7% in the second quarter of 2000. We expect our 2001 operating margin to be at or slightly above the 2000 margin levels. Income Tax Expense. Income tax expense of $4.8 million was recorded in the second quarter of 2001 at an effective income tax rate of 38.5% of pre-tax income compared to $3.6 million, or 39.6% of pre-tax income in the second quarter of 2000. We expect to maintain our effective tax rate at or below 39% for 2001. SIX MONTHS ENDED JUNE 30, 2001 AND 2000 Net Sales. Our net sales increased by $12.4 million, or 24.5%, to $62.8 million in the six months ended June 30, 2001 from $50.5 million in the first six months of 2000. Product sales increased by $12.3 million, or 30.4%, to $52.9 million in the first six months of 2001 from $40.6 million in the same period in 2000. The increase in product sales is primarily attributable to (i) increased sales of Accelerated Math products, including follow-on sales of subject libraries and optical-mark card scanners, (ii) increased sales of Accelerated Reader quizzes, with over 45,000 available book titles, to a larger base of Accelerated Reader schools and (iii) increased sales of electronic assessment products to educational publishers from the ESA acquisition completed late last year. We continue to expect revenue growth to be at or near last year's growth rate with broadening adoption of our new STAR Early Literacy software as well as continued strong sales of our other reading and math software to both new and existing school customers. Service revenue remained relatively constant at $10.0 million in the first six months of 2001 compared to $9.9 million in the same period in 2000. Training revenues declined in 2001 as we continue to transition this business toward more district-wide sales, as opposed to selling single training events. Our annual National School Renaissance Conference held in the first quarter drew somewhat fewer attendees in 2001 than in 2000. The decline in training revenues was offset by increased software support revenues, which benefited from stronger support plan renewals. Cost of Sales. The cost of sales of products increased by $1.9 million, or 35.4%, to $7.3 million in the first six months of 2001 from $5.4 million in the first six months of 2000. As a percentage of product sales, the cost of sales of products increased to 13.8% in the first half of 2001 from 13.3% in the first half of 2000. The increase in cost of sales is primarily due to higher sales of scanners, for use with math software, as well as higher sales of assessment products from the ESA acquisition, both of which carry somewhat lower margins than our other software products. The cost of sales of services increased by $138,000, or 2.7%, to $5.4 million in the first six months of 2001 from $5.2 million in the same period in 2000. As a percentage of sales of services, the cost of sales of services increased to 53.7% in the first six months of 2001 from 52.6% in the first six months of 2000. Increased costs associated with the location and timing of the annual National School Renaissance Conference presented in the first quarter of 2001 were offset by stronger sales in the software support business. Our overall gross profit margin increased to 79.8% in the first six months of 2001 from 79.0% in the first six months of 2000. The increase is primarily due to the revenue mix of a higher proportion of products to services in 2001, as products carry a higher gross profit margin than services. Product Development. Product development expenses increased by $1.9 million, or 26.8%, to $8.9 million in the six months ended June 30, 2001 as compared to $7.0 million in the corresponding 2000 period. These expenses increased primarily due to continued aggressive investment in product development including STAR Early Literacy and AR Universal, released late in the second quarter, and the development of additional Accelerated Math libraries, eSchool - 9 - 12 office school administration software, and a number of other new products at various stages of development. As a percentage of net sales, product development costs increased to 14.1% in the first half of 2001 from 13.9% in the first half of 2000. We expect product development costs to continue to rise throughout 2001, reflecting our continued aggressive investment plans to drive future growth. Product development costs, however, are not expected to increase significantly as a percentage of sales in the near term. Selling and Marketing. Selling and marketing expenses increased by $2.7 million, or 20.9%, to $15.4 million in the first half of 2001 from $12.8 million in the first half of 2000. These expenses increased primarily due to (i) increased costs of promoting the district-wide Renaissance schoolwide improvement process, (ii) the costs of marketing the Generation21 enterprise-wide training and knowledge management software, (iii) costs of marketing our new STAR Early Literacy and AR Universal products and (iv) other initiatives. As a percentage of net sales, selling and marketing expenses declined to 24.6% in the first half of 2001 from 25.3% in the first six months of 2000. We anticipate that selling and marketing expenses will generally continue at a higher level than the prior year but will decline as a percent of sales in the third quarter compared to the second quarter 2001. General and Administrative. General and administrative expenses increased by $1.3 million, or 21.4%, to $7.1 million in the six months ended June 30, 2001 from $5.9 million in the same period in 2000. The higher expenses for 2001 are largely due to increased costs associated with the hiring of additional personnel, including wages and related benefits, and increased personnel from the ESA acquisition in late 2000. As a percentage of net sales, general and administrative costs decreased slightly to 11.3% in the first six months of 2001 compared to 11.6% in the same period in 2000, but remain within our expected annual range of 11% to 12% of sales. Operating Income. Operating income increased by $4.5 million, or 31.6%, to $18.7 million in the first six months of 2001 from $14.2 million in the same period in 2000. As a percentage of net sales, operating income increased to 29.8% in the first half of 2001 from 28.2% in the first half of 2000. We expect our 2001 operating margin to be at or slightly above the 2000 margin levels. Income Tax Expense. Income tax expense of $8.0 million was recorded in the first six months of 2001 at an effective income tax rate of 38.5% of pre-tax income compared to $6.2 million, or 39.5% of pre-tax income in the first half of 2000. We expect to maintain our effective tax rate at or below 39% for 2001. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2001, our cash, cash equivalents and short-term investments increased to $84.3 million from the December 31, 2000 total of $68.0 million. The increase of $16.3 million in the first half of 2001 is primarily due to $16.1 million in cash provided by operating activities. We believe cash flow from operations and our current cash position will be sufficient to meet our working capital requirements and fund future growth acquisition opportunities for the foreseeable future. At June 30, 2001, we had a $10.0 million unsecured revolving line of credit with a bank, which is available until March 31, 2002. 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 April 30, 2002. The line of credit bears interest based on the prime rate less 1.0%. As of June 30, 2001, the lines of credit had not been used. 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 those factors identified in Item 1, Business, Forward-Looking Statements, contained in our Form 10-K for the year ended December 31, 2000, which factors are incorporated herein by reference to such Form 10-K. - 10 - 13 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. Since we expect to be able to hold these investments to maturity, we do not expect to recognize any losses or gains related to an increase or decrease in market interest rates. 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 unless there would be a sale or complete liquidation of an underlying foreign investment. Aggregate foreign currency transaction gains and losses are included in determining net earnings. 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 material. - 11 - 14 Part II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders (a) On April 18, 2001, 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. 1. Eight directors were elected to serve until the 2002 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 30,302,205 714,733 (2) Terrance D. Paul 29,584,302 1,432,636 (3) Michael H. Baum 30,959,152 57,786 (4) John R. Hickey 30,959,505 57,433 (5) Timothy P. Welch 30,959,740 57,198 (6) John H. Grunewald 30,963,373 53,565 (7) Gordon H. Gunnlaugsson 30,963,606 53,332 (8) Harold E. Jordan 30,963,327 53,611

2. Approval was given to amend the Articles of Incorporation to authorize the change of the name of the corporation to Renaissance Learning, Inc. with 30,966,106 votes for this action, 35,573 votes against, and 12,259 votes abstained. 3. Renaissance Learning, Inc.'s 1997 Stock Incentive Plan was approved with 29,423,175 votes for this action, 246,169 votes against, 26,299 votes abstained and 1,321,295 broker non-votes. (d) Not applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Not applicable. (b) Forms 8-K. We filed no reports on Form 8-K during the quarter covered by this report. - 12 - 15 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, 2001 /s/ Michael H. Baum --------------- ------------------------------ Date Michael H. Baum Chief Executive Officer (Principal Executive Officer) August 13, 2001 /s/ Steven A. Schmidt --------------- ------------------------------ Date Steven A. Schmidt Secretary, Vice President, and Chief Financial Officer (Principal Financial and Accounting Officer)