10-Q 1 c18511e10vq.htm QUARTERLY REPORT e10vq
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2007
Commission File Number 0-20842
PLATO LEARNING, INC.
(Exact name of Registrant as specified in its charter)
     
Delaware   36-3660532
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification Number)
10801 Nesbitt Avenue South, Bloomington, MN 55437
(Address of principal executive offices)
(952) 832-1000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
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 Registrant’s classes of common stock, as of the latest practicable date. 23,808,997 shares of common stock, $.01 par value, outstanding as of August 31, 2007.
 
 

 


 

PLATO LEARNING, INC.
Form 10-Q
Quarterly Period Ended July 31, 2007
TABLE OF CONTENTS
         
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 Forms of Employee Restricted Stock Agreement
 Board of Directors' Compensation Plan, as Amended
 Certification
 Certification
 Certification
 Certification

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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)
                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
    2007     2006     2007     2006  
REVENUES
                               
Subscriptions
  $ 6,532     $ 4,373     $ 17,045     $ 12,783  
License fees
    5,940       11,689       13,652       27,658  
Services
    6,731       7,394       20,745       26,476  
 
                       
Total revenues
    19,203       23,456       51,442       66,917  
 
                       
 
                               
COST OF REVENUES
                               
Subscriptions
    4,140       1,539       11,075       6,436  
License fees
    2,066       4,051       6,212       9,705  
Services
    3,496       4,174       9,837       13,436  
 
                       
Total cost of revenues
    9,702       9,764       27,124       29,577  
 
                       
 
GROSS PROFIT
    9,501       13,692       24,318       37,340  
 
                       
 
                               
OPERATING EXPENSES
                               
Sales and marketing
    7,579       9,539       22,682       28,849  
General and administrative
    2,865       4,064       8,983       13,026  
Product maintenance and development
    499       1,210       3,412       3,974  
Amortization of intangibles
    438       904       1,352       2,806  
Restructuring, net
    (766 )     21       (766 )     360  
 
                       
Total operating expenses
    10,615       15,738       35,663       49,015  
 
                       
 
                               
OPERATING LOSS
    (1,114 )     (2,046 )     (11,345 )     (11,675 )
 
                               
Other income, net
    218       405       917       1,238  
 
                       
 
                               
LOSS BEFORE INCOME TAXES
    (896 )     (1,641 )     (10,428 )     (10,437 )
 
                               
Income tax expense
    150       150       450       450  
 
                       
 
                               
NET LOSS
  $ (1,046 )   $ (1,791 )   $ (10,878 )   $ (10,887 )
 
                       
 
                               
NET LOSS PER SHARE
                               
Basic and diluted
  $ (0.04 )   $ (0.08 )   $ (0.46 )   $ (0.46 )
 
                       
 
                               
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
                               
Basic and diluted
    23,762       23,701       23,747       23,668  
 
                       
See Notes to Condensed Consolidated Financial Statements.

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PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except per share amounts)
                 
    July 31,     October 31,  
    2007     2006  
ASSETS
               
 
               
Current assets:
               
Cash and cash equivalents
  $ 22,351     $ 33,094  
Accounts receivable, net
    15,173       18,529  
Inventories
    970       1,832  
Other current assets
    5,567       6,346  
 
           
Total current assets
    44,061       59,801  
 
               
Equipment and leasehold improvements, net
    5,971       6,308  
Product development costs, net
    29,304       25,363  
Goodwill
    71,865       71,865  
Identified intangible assets, net
    8,576       10,545  
Other long-term assets
    3,491       2,348  
 
           
Total assets
  $ 163,268     $ 176,230  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current liabilities:
               
Accounts payable
  $ 4,258     $ 4,685  
Accrued compensation
    6,324       5,990  
Other accrued liabilities
    3,595       6,622  
Deferred revenue
    33,640       33,736  
 
           
Total current liabilities
    47,817       51,033  
 
               
Long-term deferred revenue
    8,013       8,110  
Deferred income taxes
    2,981       2,531  
Other long-term liabilities
          106  
 
           
Total liabilities
    58,811       61,780  
 
           
 
               
Stockholders’ equity:
               
Common stock, $.01 par value, 50,000 shares authorized; 23,829 shares issued and 23,809 shares outstanding at at July 31, 2007; 23,761 shares issued and 23,741 shares outstanding at October 31, 2006
    238       237  
Additional paid-in capital
    169,612       168,597  
Treasury stock at cost
    (205 )     (205 )
Accumulated deficit
    (63,896 )     (53,017 )
Accumulated other comprehensive loss
    (1,292 )     (1,162 )
 
           
Total stockholders’ equity
    104,457       114,450  
 
           
Total liabilities and stockholders’ equity
  $ 163,268     $ 176,230  
 
           
See Notes to Condensed Consolidated Financial Statements.

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PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
                 
    Nine Months Ended  
    July 31,  
    2007     2006  
OPERATING ACTIVITIES:
               
Net loss
  $ (10,878 )   $ (10,887 )
 
           
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
Deferred income taxes
    450       450  
Amortization of capitalized product development costs
    7,777       5,443  
Amortization of identified intangible and other long-term assets
    2,248       3,961  
Depreciation and amortization of equipment and leasehold improvements
    1,835       1,848  
Provision for doubtful accounts
    (539 )     164  
Stock-based compensation
    888       1,038  
Gain on sale of marketable securities
          (37 )
(Loss) gain on disposal of equipment
    (26 )     61  
Changes in operating assets and liabilities:
               
Accounts receivable
    3,895       1,201  
Inventories
    862       2,001  
Other current and long-term assets
    (120 )     790  
Accounts payable
    (428 )     (1,065 )
Other current and long-term liabilities
    (2,793 )     (4,238 )
Deferred revenue
    (193 )     (1,313 )
 
           
Total adjustments
    13,856       10,304  
 
           
Net cash provided by (used in) operating activities
    2,978       (583 )
 
           
INVESTING ACTIVITIES:
               
Capitalized internal product development costs
    (11,718 )     (10,665 )
Purchased product development
          (3,000 )
Purchases of equipment and leasehold improvements
    (1,471 )     (1,682 )
Purchases of marketable securities
          (4,250 )
Sales of marketable securities
          229  
Maturities of marketable securities
          2,750  
 
           
Net cash used in investing activities
    (13,189 )     (16,618 )
 
           
FINANCING ACTIVITIES:
               
Net proceeds from issuance of common stock
    155       670  
Payment of debt financing fees
    (523 )        
Repayments of capital lease obligations
    (34 )     (84 )
 
           
Net cash (used in) provided by financing activities
    (402 )     586  
 
           
EFFECT OF CURRENCY EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
    (130 )     (63 )
 
           
Net decrease in cash and cash equivalents
    (10,743 )     (16,678 )
Cash and cash equivalents at beginning of period
    33,094       46,901  
 
           
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 22,351     $ 30,223  
 
           
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Interest paid
  $ 21     $ 32  
 
           
ADDITIONAL NON-CASH INFORMATION:
               
Capital lease additions
  $ 27     $  
 
           
See Notes to Condensed Consolidated Financial Statements.

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PLATO Learning, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1. General
Basis of Presentation
     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The October 31, 2006 condensed consolidated balance sheet data was derived from our audited financial statements at that date. Accordingly, these financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. We have included all normal recurring and other adjustments considered necessary to give a fair statement of our operating results for the interim periods shown. Operating results for these interim periods are not necessarily indicative of the results to be expected for the full fiscal year. For further information, refer to the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2006.
Consolidation
     The accompanying unaudited condensed consolidated financial statements include the accounts of PLATO Learning, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Fiscal Periods
     Our fiscal year is from November 1 to October 31. Unless otherwise stated, references herein to our third quarter relate to the three month period ended July 31.
Note 2. Summary of Significant Accounting Policies
General
     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the areas identified below as the critical accounting policies and estimates that are significant to the financial statement presentation, and that require difficult, subjective, or complex judgments:
    Revenue recognition
 
    Capitalized product development costs
 
    Valuation of our deferred income taxes
 
    Valuation and impairment analysis of goodwill and identified intangible assets
     There have been no significant changes to our accounting policies during the first three quarters of 2007. For a more complete discussion of these policies refer to Note 2 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2006.

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License Agreements
     We have a variety of license agreements for third-party products and content that we license to our customers.
Net Loss Per Share
     Basic and diluted net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the periods as follows (in thousands):
                                 
    Three Months Ended July 31,     Nine Months Ended July 31,  
    2007     2006     2007     2006  
Net loss
  $ (1,046 )   $ (1,791 )   $ (10,878 )   $ (10,887 )
 
                       
 
                               
Basic and diluted weighted average common shares outstanding
    23,762       23,701       23,747       23,668  
 
                       
Basic and diluted net loss per share
  $ (0.04 )   $ (0.08 )   $ (0.46 )   $ (0.46 )
 
                       
     Potential common shares, which consist of stock options and warrants and restricted stock, are anti-dilutive in a net loss situation and are therefore disregarded in the calculation of diluted net loss per share. Accordingly, the calculation of diluted loss per share for the periods presented for 2007 and 2006 exclude the effect of approximately 2,730,000 and 3,218,000 potential common shares, respectively, from the conversion of outstanding options and warrants and restricted common shares.
New Accounting Pronouncements
     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115,” (“SFAS No. 159”). This standard permits entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective beginning in our fiscal year 2009 and are currently not expected to have a material effect on our consolidated financial statements.
     In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” Interpretation 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, “Accounting for Income Taxes.” Interpretation 48 is effective for the first quarter fiscal year 2008 and is currently not expected to have a material effect on our consolidated financial statements.
Note 3. Stock-Based Compensation
     Effective at the beginning of our fiscal year 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), using the modified prospective transition application method. Under this method, compensation expense is

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recognized for employee awards granted, modified, or settled subsequent to October 31, 2005, and the unvested portion of awards granted to employees prior to November 1, 2005. We use the straight-line method to recognize compensation expense over the requisite service period of the award.
         
    Options
    Outstanding
    (in thousands)
Options outstanding at October 31, 2006
    2,876  
Options granted
    199  
Options exercised
     
Options forfeited or cancelled
    (497 )
 
       
Options outstanding at July 31, 2007
    2,578  
 
       
Options exercisable at July 31, 2007
    2,058  
 
       
     Total stock-based compensation expense recorded for the three and nine months ended July 31 was as follows (in thousands):
                 
    2007   2006
Three months ended
  $ 347     $ 235  
Nine months ended
  $ 888     $ 1,038  
     Stock option forfeitures reduced stock-based compensation expense by $230,000 and $3,000 for the nine months ended July 31, 2007 and 2006, respectively. There were no stock option forfeitures during the three months ended in both fiscal years.
Note 4. Accounts Receivable
     The components of accounts receivable were as follows (in thousands):
                 
    July 31,     October 31,  
    2007     2006  
Trade accounts receivable
  $ 14,609     $ 18,450  
Installment accounts receivable
    889       1,007  
Allowance for doubtful accounts
    (325 )     (928 )
 
           
 
  $ 15,173     $ 18,529  
 
           
     Installment receivables to be billed one year from the balance sheet date are included in other long-term assets on the consolidated balance sheets and were $564,000 at July 31, 2007 and $24,000 at October 31, 2006.

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     A reconciliation of the allowance for doubtful accounts from the beginning of the fiscal year through the end of the third quarter is as follows (in thousands):
                 
    2007     2006  
Balance, October 31
  $ 928     $ 1,647  
Provision for doubtful accounts, net of other reserve adjustments
    (539 )     164  
Write-offs net of recoveries
    (64 )     (303 )
 
           
Balance, July 31
  $ 325     $ 1,508  
 
           
     The provision for doubtful accounts is included in general and administrative expense on the consolidated statements of operations.
     In 2005, we reduced the variety of payment terms offered to our customers and implemented credit and other policies which had the effect of reducing our bad debt exposure. During the third quarter 2007, we reduced the allowance for doubtful accounts reserve by $375,000 and the deferred revenue reserve by $419,000 as we continue to experience a reduction in our exposure to bad debt and deferred revenue adjustments.
Note 5. Inventories
     Supplemental information regarding our inventories is as follows (in thousands):
                 
    July 31,     October 31,  
    2007     2006  
Third-party hardware
  $ 474     $ 1,027  
Media, documentation, and packaging materials
    496       805  
 
           
 
  $ 970     $ 1,832  
 
           
Note 6. Product Development Costs
     A reconciliation of capitalized product development costs from the beginning of the fiscal year through the end of the third quarter is as follows (in thousands):
                         
    Carrying     Accumulated     Net Carrying  
    Value     Amortization     Value  
Balance, October 31, 2006
  $ 40,577     $ (15,214 )   $ 25,363  
Capitalized product development costs
    11,718             11,718  
Write-off of fully amortized costs
    (4,843 )     4,843        
Amortization of product development costs
          (7,777 )     (7,777 )
 
                 
Balance, July 31, 2007
  $ 47,452     $ (18,148 )   $ 29,304  
 
                 
Note 7. Goodwill and Identified Intangible Assets
     There were no changes in goodwill from October 31, 2006.

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     Identified intangible assets subject to amortization were as follows (in thousands):
                                                 
    July 31, 2007     October 31, 2006  
    Gross             Net     Gross             Net  
    Carrying     Accumulated     Carrying     Carrying     Accumulated     Carrying  
    Value     Amortization     Value     Value     Amortization     Value  
Acquired technology
  $ 13,563     $ (10,089 )   $ 3,474     $ 21,940     $ (17,850 )   $ 4,090  
Trademarks and tradenames
    1,380       (1,380 )           2,892       (2,744 )     148  
Customer relationships and lists
    20,200       (15,098 )     5,102       21,100       (14,793 )     6,307  
Noncompete agreements
                      1,000       (1,000 )      
 
                                   
 
  $ 35,143     $ (26,567 )   $ 8,576     $ 46,932     $ (36,387 )   $ 10,545  
 
                                   
     Amortization expense for the identified intangible assets presented above was as follows (in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
    2007     2006     2007     2006  
Amortization of intangible assets included in:
                               
Cost of revenues
  $ 205     $ 301     $ 616     $ 904  
Operating expenses
    439       905       1,353       2,807  
 
                       
 
  $ 644     $ 1,206     $ 1,969     $ 3,711  
 
                       
     In the first quarter of 2007, we wrote off approximately $11,789,000 of identified intangible assets and related accumulated amortization which as of November 1, 2006 was fully amortized and no longer considered substantially in use with existing products.
     The estimated future annual amortization expense for identified intangible assets is as follows (in thousands):
                         
    Cost of     Operating        
    Revenues     Expense     Total  
Remainder of 2007
  $ 205     $ 388     $ 593  
2008
    821       1,550       2,371  
2009
    749       1,550       2,299  
2010
    647       1,550       2,197  
2011
    526       65       591  
Thereafter
    525             525  
 
                 
 
  $ 3,473     $ 5,103     $ 8,576  
 
                 
     The future annual amortization amounts presented above are estimates. Actual amortization expense may be different due to the acquisition, impairment, or accelerated amortization of identified intangible assets, and other factors.

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Note 8. Deferred Revenue
     The components of deferred revenue were as follows (in thousands):
                 
    July 31,     October 31,  
    2007     2006  
Subscriptions
  $ 26,134     $ 20,192  
License fees
    928       2,282  
Services
    14,591       19,372  
 
           
Total
    41,653       41,846  
Less: long-term amounts
    (8,013 )     (8,110 )
 
           
Current portion
  $ 33,640     $ 33,736  
 
           
Note 9. Restructuring Charges
     During the third quarter of 2007, we terminated a lease for one of our United Kingdom facilities that was closed in connection with our restructuring activities that began in 2005. As a result of this transaction, we recorded a reduction in the restructure accrual related to this facility of approximately $766,000 with a corresponding benefit to earnings.
     Restructuring and other charges were $21,000 and $360,000 for the three and nine months ended July 31, 2006. For more information about our restructuring activities and related charges in 2006, refer to Note 14 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2006.
     The restructuring reserve activity from October 31, 2006 through July 31, 2007 was as follows (in thousands):
                                 
    Severance                    
    and related     Facility              
    costs     closings     Other     Total  
Reserve balance at October 31, 2006
  $ 1,235     $ 1,754     $ 85     $ 3,074  
Provision for restructuring
          (766 )           (766 )
Cash payments
    (850 )     (488 )     (63 )     (1,401 )
Translation adjustment
          111             111  
 
                       
Reserve balance at July 31, 2007
  $ 385     $ 611     $ 22     $ 1,018  
 
                       

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Note 10. Comprehensive Loss
     Total comprehensive loss was as follows (in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
    2007     2006     2007     2006  
Net loss
  $ (1,046 )   $ (1,791 )   $ (10,878 )   $ (10,887 )
Unrealized gains on available for sale securities
          (3 )           (1 )
Reclassifications to net loss of previously unrealized gain on available-for-sale securities
            (34 )             (20 )
Foreign currency translation adjustments
    (22 )     6       (130 )     (63 )
 
                       
Total comprehensive loss
  $ (1,068 )   $ (1,822 )   $ (11,008 )   $ (10,971 )
 
                       
     Income tax effects for the components of other comprehensive loss were not significant because our deferred tax assets are fully reserved. Accumulated other comprehensive loss was $1,292,000 and $1,162,000 at July 31, 2007 and October 31, 2006, respectively.
Note 11. Debt
      On June 4, 2007, we entered into a three-year senior secured credit facility which provides us with a revolving line of credit up to the lesser of $20 million or one times the Company’s trailing twelve months subscription and maintenance revenue. The Company has the option of selecting an interest rate for any drawdown under the facility equal to the applicable Prime or Libor Rate plus a sliding margin that is based on the amount of borrowings outstanding. Borrowings under the agreement are secured by all of the assets of the Company. Financial covenants are limited to minimum quarterly thresholds of earnings before interest, taxes, depreciation and amortization (EBITDA) that are tested only when the unused portion of the line of credit plus our cash and cash equivalents on hand is less than $12.5 million. We capitalized legal and banking fees of $523,000 associated with this credit facility. These costs will be amortized over the three-year term of the agreement.
     There were no borrowings outstanding at July 31, 2007.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Description
     PLATO Learning, Inc. is a leading provider of computer and web-based instruction, curriculum planning and management, assessment, and related professional development and support services to K–12 schools. We also provide these products and services to two- and four-year colleges, teacher education programs, correctional institutions, and military education programs. Our courseware and web-based accountability and assessment software are designed to help educators meet the demands of the No Child Left Behind (“NCLB”) as well as U.S. Department of Education initiatives on mathematics, science, special education, and ensuring teacher quality. We also offer online and onsite staff professional development, alignment, and correlation services to ensure optimal classroom integration of our products and to help schools meet their accountability requirements and school improvement plans.
     Our research-based courseware library includes thousands of hours of mastery-based instruction and related assessment covering discrete learning objectives in the subject areas of reading, writing, language arts, mathematics, science, and social studies. Our web-based assessment and alignment tools ensure that instruction is differentiated and targeted and that curriculum is aligned to state and national standards. Educators are able to identify each student’s instructional needs and prescribe an individual learning program using PLATO Learning courseware and assessments, educational web sites, and the school’s own textbooks and other core and supplemental instructional materials. A variety of reports are available to help educators identify gaps in student understanding and ensure that standards are being addressed. The web-based accountability and assessment products involve parents, students, teachers, and administrators in the learning process.
     We operate our principal business in one industry segment, which is the development and marketing of educational software and related services.
Critical Accounting Policies and Estimates
     Our discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the areas identified below as the critical accounting policies and estimates that are significant to the financial statement presentation, and that require difficult, subjective, or complex judgments:
    Revenue recognition
 
    Capitalized product development costs
 
    Valuation of our deferred income taxes
 
    Valuation and impairment analysis of goodwill and identified intangible assets
     There have been no significant changes to our accounting policies in these areas during the first nine months of 2007. For a complete discussion of these policies refer to Note 2 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2006.

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General Factors Affecting our Financial Results
     There are a number of general factors that affect our financial results from period to period. These factors are discussed below.
     Revenue. We are strategically transitioning our business model from one that emphasized the sale of one-time perpetual licenses to our software, for which revenue is generally recognized up-front upon delivery, to one that emphasizes the sale of internet-based subscription products, for which revenue is recognized over the subscription period. As a result, this transition will affect the comparability of our revenues from period to period until it is complete. The transition became most evident in the third quarter of 2006 when many of our new internet-based subscription products became available. As subscription revenues grow as a percentage of total revenues, we expect our period to period revenues to become more comparable.
     Until our transition to internet-based subscription products is closer to completion, a meaningful portion of our revenues will continue to be derived from perpetual license sales of our software products. These revenues are reported as license fees in our consolidated statement of operations. Changes in the quantity and size of individual license fee transactions can have a significant impact on revenues in a period. In addition, as is common with many software companies, a large portion of our customer orders tend to occur in the final weeks or days of each fiscal quarter. As a result, license revenues can be heavily influenced by events such as funding approvals that may be outside our control during this short span of time. Our business is also seasonal, with the largest portion of our license fees typically coming in the third and fourth quarters of our fiscal year, and professional service fees being the greatest during periods in which schools are in session. While this seasonality does not generally impact the comparability of our annual results, it can significantly impact our results from quarter to quarter.
     Gross Profit. Our gross profit during a period is dependent on a number of factors. License fee revenues have high gross profit due to the low direct cost of delivering these products. As a result, the mix of license fee revenues to total revenues in a given period significantly influences reported total gross profit. In addition, a large portion of our costs of revenue are fixed in nature. These costs include amortization of capitalized software development and purchased technology, depreciation and other infrastructure costs to support our hosted subscription services, customer support operations, and full-time professional services personnel who deliver our training services. Accordingly, increases in revenues allow us to leverage these costs resulting in higher gross profit, while decreases in revenues have the opposite effect.
     Operating Expenses. Incentive compensation is a significant variable component of our sales and marketing expenses, approximating 8% to 9% of total revenues in any given period. Sales and marketing expenses also include costs such as travel, tradeshows, and conferences that can vary with revenue activity or individual events that occur during the period.
     General and administrative expenses are substantially fixed in nature. However, certain components such as our provision for bad debts, professional fees, and other expenses can vary based on business results, individual events, or initiatives we may be pursuing at various times throughout the year.
     Product maintenance and development expense in our consolidated statement of operations does not reflect our total level of spending on product activities. Costs to enhance or maintain existing products, or to develop products prior to achieving technological feasibility, are charged to product maintenance and development expense as incurred. Costs incurred to develop new products after technological feasibility is achieved, which represent the majority of our total development spending, are capitalized and amortized to cost of revenues. Product maintenance and development expense in our

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consolidated statement of operations can fluctuate from period to period, in terms of both total dollars and as a percentage of revenue, based on the nature and timing of activities occurring during the period.
     Amortization of intangibles represents the amortization of certain identified intangible assets acquired through various acquisitions. While these expenses are generally predictable from period to period because they are fixed over the course of their individual useful lives, they can be affected by events and other factors that result in impairment of these assets and a corresponding reduction in future amortization.
Overview of Financial Results
     Total orders for the third quarter of 2007 were $26.3 million compared to $34.4 million in 2006. Orders for our internet-based subscription courseware products – which are the foundation of our growth strategy — increased $4.1 million, or 59% over the third quarter of 2006. However, this increase was not sufficient to offset a $7.7 million decline in orders for our legacy products sold on a perpetual license basis. This continuing transition from our legacy perpetual license products to our new subscription products also contributed to the decline in year to date orders to $51.7 million in 2007 from $66.7 million for the same period last year.
     Revenues for the third quarter of 2007 were $19.2 million, a decline of $4.3 million, or 18.1%, from the third quarter of 2006. Year to date revenue was $51.4 million compared to $66.9 million for the nine-month period in 2006. Subscription revenues grew 49% in the quarter to $6.5 million, but were offset by a decline in license fees from legacy perpetual products as we continue our transition from a perpetual software licensing model, for which revenue is recognized upon delivery, to a software-as-a-service model in which revenue is recognized over a subscription period.
     Cost of revenues and operating expenses combined declined by $5.2 million in the third quarter compared to the same period last year as we continued to drive efficiencies into our business and lower our cost structure. As a result, our third quarter net loss improved by $0.7 million, from ($1.8) million, or ($0.08) cents per share in 2006, to ($1.0) million or ($0.04) per share in 2007. On a year to date basis, our net loss remained unchanged from the prior year at ($10.9) million, or ($0.46) per share, as the decline in revenue of $15.5 million was offset by declines in cost of revenue and operating expenses, including a one-time benefit of $0.8 million related to the early termination of the lease on our former U.K. office facility.

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Results of Operations
Revenues
     The following tables summarize certain key information to aid in the understanding of our discussion and analysis of revenues:
Sales Order Information (in thousands)
                                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
                    Percent                     Percent  
                    Increase                     Increase  
    2007     2006*     (Decrease)     2007     2006*     (Decrease)  
Order Value:
                                               
Subscriptions
                                               
Courseware
  $ 11,118     $ 7,005       58.7 %   $ 19,692     $ 10,320       90.8 %
Assessment and other
    1,396       4,397       (68.3 %)     3,017       7,075       (57.4 %)
 
                                       
Total subscriptions
    12,514       11,402       9.8 %     22,709       17,395       30.5 %
 
                                               
License fees
    5,503       13,216       (58.4 %)     12,306       28,417       (56.7 %)
 
                                               
Services
    8,276       9,759       (15.2 %)     16,722       20,896       (20.0 %)
 
                                       
 
  $ 26,293     $ 34,377       (23.5 %)   $ 51,737     $ 66,708       (22.4 %)
 
                                       
 
                                               
Percent of Total Order Value:
                                               
Subscriptions
                                               
Courseware
    42.3 %     20.4 %             38.1 %     15.5 %        
Assessment and other
    5.3 %     12.8 %             5.8 %     10.6 %        
 
                                       
Total subscriptions
    47.6 %     33.2 %             43.9 %     26.1 %        
 
                                               
License fees
    20.9 %     38.4 %             23.8 %     42.6 %        
 
                                               
Services
    31.5 %     28.4 %             32.3 %     31.3 %        
 
                                       
 
    100.0 %     100.0 %             100.0 %     100.0 %        
 
                                       
    *Certain 2006 amounts previously reported as services orders have been reclassified to subscriptions orders to conform to the current period presentation.
Orders Greater Than $100,000
                                                 
    Three Months Ended   Nine Months Ended
    July 31,   July 31,
    2007   2006   % Change   2007   2006   % Change
Number
    37       50       (26.0 %)     70       95       (26.3 %)
Value ($000)
  $ 7,500     $ 10,136       (26.0 %)   $ 13,634     $ 19,507       (30.1 %)
Average Value ($000)
  $ 203     $ 203       0.0 %   $ 195     $ 205       (4.9 %)

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Revenue By Category (in thousands):
                                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
    2007     2006     % Change     2007     2006     % Change  
Subscriptions
  $ 6,532     $ 4,373       49.4 %   $ 17,045     $ 12,783       33.3 %
License fees
    5,940       11,689       (49.2 %)     13,652       27,658       (50.6 %)
Services
    6,731       7,394       (9.0 %)     20,745       26,476       (21.6 %)
 
                                       
 
  $ 19,203     $ 23,456       (18.1 %)   $ 51,442     $ 66,917       (23.1 %)
 
                                       
     Total revenues for the third quarter of 2007 declined 18.1% to $19.2 million, from $23.5 million for the same period in 2006, reflecting a significant decrease in license fee orders and revenues. The decline in license fee orders reflects our continuing transition from sales of legacy perpetual license products for which revenue is recognized upon delivery, to sales of subscription products for which revenue is recognized over the subscription period. This transition also accounts for the year-to-date revenue decline from $66.9 million in 2006 to $51.4 million in 2007.
     Subscription revenue in the third quarter of 2007 increased 49.4%, to $6.5 million reflecting our growing base of subscription customers. Revenue from services decreased 9.0% to $6.7 million in the third quarter of 2007, from $7.4 million for the same period in 2006. Professional services revenue declines made up the majority of the decrease driven primarily by lower training and project management orders on lower total product orders. For the first nine months of 2007, subscription revenue increased 33.3% to $17.0 million and license and service revenue declined 50.6% and 21.6% respectively, over the prior year for largely the same factors as those affecting third quarter revenues.
Gross Margin
Percentage of Total Revenue
                                 
    Three Months Ended     Nine Months Ended  
    July 31,     July 31,  
Revenue Category   2007     2006     2007     2006  
Subscriptions
    34.0 %     18.7 %     33.1 %     19.1 %
License fees
    30.9 %     49.8 %     26.6 %     41.3 %
Services
    35.1 %     31.5 %     40.3 %     39.6 %
 
                       
Total
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       
Gross Margin Percentage
                                                 
    Three Months Ended July 31,   Nine Months Ended July 31,
                    Increase                   Increase
Revenue Category   2007   2006   (Decrease)   2007   2006   (Decrease)
Subscriptions
    36.6 %     64.8 %     (28.2 %)     35.0 %     49.7 %     (14.7 %)
License fees
    65.2 %     65.3 %     (0.1 %)     54.5 %     64.9 %     (10.4 %)
Services
    48.1 %     43.5 %     4.6 %     52.6 %     49.3 %     3.3 %
Total
    49.5 %     58.4 %     (8.9 %)     47.3 %     55.8 %     (8.5 %)
     Total gross margin decreased to 49.5% for the third quarter of 2007, from 58.4% for the same period in 2006. The decline is due primarily to an increase in subscription royalty costs and the lower mix of higher margin perpetual revenues.

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     Subscription gross margin decreased to 36.6% in the third quarter 2007 from 64.8% for the same period in 2006. Third quarter 2006 subscription margins include a one-time benefit of approximately $760,000 related to a royalty agreement renegotiated at that time. Excluding this benefit, third quarter 2006 subscription margins would have been 47.5%. The remaining decline to 36.6% in third quarter 2007 reflects lower margins on incremental subscription revenues that result from straight-line amortization of capitalized subscription product investments relative to the gradual recognition of subscription revenues over time. Accordingly, subscription gross margins are generally expected to be lower early in the life cycle of new products and increase over time as subscription revenues grow.
     Services gross margin in the third quarter increased to 48.1% in 2007 from 43.5% in 2006. This improvement reflects a shift in services revenue mix toward higher margin software maintenance revenues caused by the decline in training and professional services revenues.
     The total gross margin for the nine month period was 47.3% compared to 55.8% for the same period last year. Similar factors as those identified above that affected third quarter gross margins also impacted the year to date gross margins.
Operating Expenses
     The following table summarizes the percentage of total revenue and percentage change in total spending from the previous year for certain operating expense line items. This information is provided as an aid to the understanding of our discussion and analysis of our operating expenses.
                                                 
    Percentage of             Percentage of        
    Total Revenue     Percent     Total Revenue     Percent  
    Three Months Ended     Increase     Nine Months Ended     Increase  
    July 31,     (Decrease)     July 31,     (Decrease)  
    2007     2006     in Amount     2007     2006     in Amount  
Sales and marketing
    39.5 %     40.7 %     (20.5 %)     44.1 %     43.1 %     (21.4 %)
General and administrative
    14.9 %     17.3 %     (29.5 %)     17.5 %     19.5 %     (31.0 %)
Product maintenance and development
    2.6 %     5.2 %     (58.8 %)     6.6 %     5.9 %     (14.1 %)
Amortization of intangibles
    2.3 %     3.9 %     (51.5 %)     2.6 %     4.2 %     (51.8 %)
 
                                       
Subtotal
    59.3 %     67.1 %     (27.6 %)     70.8 %     72.7 %     (25.1 %)
Restructuring and other charges
    (4.0 %)     0.1 %     (3,747.6 %)     (1.5 %)     0.5 %     (312.8 %)
 
                                       
Total operating expenses
    55.3 %     67.2 %     (32.6 %)     69.3 %     73.2 %     (27.2 %)
 
                                       
     Total operating expenses were $10.6 million for the third quarter of 2007, a decrease of 32.6% from the $15.7 million reported for the same period in 2006. On a year to date basis total operating expenses declined $13.4 million or 27.2%.
     Sales and marketing expenses decreased 20.5%, or $2.0 million, from the third quarter of 2006 to the third quarter of 2007, and 21.4%, or $6.2 million for the corresponding nine month periods. These declines reflect the reorganization and cost reduction activities we initiated at the end of 2006, and to a lesser extent, lower variable incentive compensation expense due to lower revenues.
     General and administrative expenses were $2.9 million in the third quarter of 2007, a decrease of 29.5% or $1.2 million compared to 2006. For the nine month period ended July 31, 2007, general and administrative expenses declined $4.0 million or 31.0% over the prior year. These declines reflect

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decreases in Sarbanes-Oxley compliance costs, lower external audit fees, reduced bad debt expense and other cost reduction activities we initiated at the end of 2006.
     Product maintenance and development expenses were $0.5 million in the third quarter of 2007, a decrease of $0.7 million, or 58.8%, reflecting lower maintenance costs on legacy products, continued reliability of our PLE platform and lower start-up costs on new product investments. For the first nine months of 2007, product maintenance and development expenses were $3.4 million, down $0.6 million from $4.0 million in the prior year. The decline during this period reflects decreasing maintenance costs associated with legacy products partially offset by early-stage development costs on new products and start-up support costs early in 2007 associated with the launch of our new instructional management system late in 2006.
     Amortization of intangibles expenses for the third quarter decreased 51.5%, or $0.5 million compared to 2006 and $1.5 million for the comparable nine month period. This decrease reflects the impairment write-down in the fourth quarter of 2006 of certain customer and trademark intangible assets acquired in previous acquisitions.
     The restructuring benefit of $0.8 million in the third quarter of 2007 related to the early termination of a U.K. facility lease. Upon exiting this facility in the fourth quarter of 2006, we expected to be liable for the full remaining rent payments under the committed term of the lease, and accordingly, accrued a related restructuring charge of $1.1 million at that time.
Other Income, Net
     Other income consists primarily of interest income on our cash and cash equivalent balances. Other income declined $0.2 million for the third quarter and $0.3 million for the first nine months of 2007 due to the decrease in our average cash and cash equivalents over the prior year.
Liquidity and Capital Resources
Cash and Cash Equivalents
     At July 31, 2007, cash and cash equivalents were $22.4 million, a decrease of $10.7 million from October 31, 2006. This decrease primarily represents the investments made in new product development of $11.7 million and equipment and leasehold improvements of $1.5 million offset by net cash provided by operations of $3.0 million.
Working Capital and Liquidity
     At July 31, 2007, our principal sources of liquidity included cash and cash equivalents of $22.4 million, and net accounts receivable of $15.2 million. During the third quarter, we entered into a three-year senior secured credit facility which provides us with a revolving line of credit up to the lesser of $20 million or one times the Company’s trailing twelve months subscription and maintenance revenue. The Company has the option of selecting an interest rate for any drawdown under the facility equal to the applicable Prime or Libor Rate plus a sliding margin that is based on the amount of borrowings outstanding. Borrowings under the agreement are secured by all of the assets of the Company. Financial covenants are limited to minimum quarterly thresholds of earnings before interest, taxes, depreciation and amortization (EBITDA) that are tested only when the unused portion of the line of credit plus our cash and cash equivalents on hand is less than $12.5 million.

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     Working capital, defined as current assets less current liabilities, was ($3.8) million at July 31, 2007 and $8.8 million at October 31, 2006. The decrease in working capital was primarily due to the decrease in cash and cash equivalents of $10.7 million as discussed above, a decrease in net accounts receivable of $3.4 million, offset by a decrease in other accrued liabilities of $3.0 million. Accounts receivable decreased due to the reduction in order levels previously discussed, a reduction in bad debt reserves of $0.6 million due to improved credit policies, and improved collections relating to customer funding schedules. Other accrued liabilities decreased primarily due to payments and adjustments to restructuring costs accrued in 2006.
     Our future liquidity needs will depend on, among other factors, the timing and extent of product development expenditures, order volume, and the timing and collection of receivables. We believe that existing cash and marketable securities balances, anticipated cash flow from operations and availability under our line of credit will be sufficient to fund our operations for the foreseeable future.
Contractual Obligations and Commercial Commitments
     Our contractual obligations and commercial commitments consist primarily of future minimum payments due under operating leases, royalty and software license agreements, capital lease obligations and amounts outstanding, if any, under our secured credit facility. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended October 31, 2006 for a table showing our contractual obligations. Other than our secured credit facility, under which no amounts were borrowed during the third quarter of 2007, there were no significant changes to our contractual obligations during the first nine months ended July 31, 2007.
     At July 31, 2007, we had no significant commitments for capital expenditures.
Disclosures about Off-Balance Sheet Arrangements
     We do not have any off-balance sheet arrangements as of July 31, 2007.
Forward-Looking Statements
     In addition to historical information, this Form 10-Q contains forward-looking statements. These forward-looking statements are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (“the Act”). The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “forecast,” “project,” “should” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Act. Forward-looking statements include, among others, statements about our future performance, the sufficiency of our sources of capital for future needs, and the expected impact of recently issued accounting pronouncements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Part II Item 1A of this Form 10-Q and Part I Item 1A of our Annual Report on Form 10-K for the fiscal year ended October 31, 2006. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements based on circumstances or events, which occur in the future. Readers should carefully review the risk factors described in this report on Form 10-Q and in other documents we file from time to time with the Securities and Exchange Commission.

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Interest Rate Risk
     Our borrowing capacity primarily consists of a revolving line of credit with interest rates that fluctuate based upon the Prime Rate and LIBOR market indexes. At July 31, 2007, we did not have any outstanding borrowings under this revolving credit facility. As a result, risk relating to interest fluctuation is considered minimal.
Foreign Currency Exchange Rate Risk
     Our foreign operations are not a significant component of our business, and as a result, risks relating to foreign currency fluctuation are considered minimal.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     See the information set forth under the captions, “Interest Rate Risk” and “Foreign Currency Exchange Rate Risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
     Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) 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 Securities and Exchange Commission rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
     There was no change in our internal control over financial reporting during the first nine months of fiscal 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II.
ITEM 1A. RISK FACTORS
     Our business is subject to a number of risks and uncertainties which we discussed in detail in Part I, Item 1A of our 2006 Annual Report on Form 10-K.
ITEM 6. EXHIBITS
Exhibit Number and Description
10.01   Forms of employee restricted stock agreement for 2006 Stock Incentive Plan.
 
10.02   Board of Directors’ Compensation Plan, as amended.
 
31.01   Certification of Chief Executive Officer under Rule 13a-14(a) adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
31.02   Certification of Chief Financial Officer under Rule 13a-14(a) adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
32.01   Certification of Chief Executive Officer under 18 U.S.C. 1350 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
32.02   Certification of Chief Financial Officer under 18 U.S.C. 1350 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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Table of Contents

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.
             
PLATO LEARNING, INC.
  By   /s/ MICHAEL A. MORACHE    
September 10, 2007
     
 
Michael A. Morache
   
 
      President and Chief Executive Officer    
 
      (principal executive officer)    
 
           
 
      /s/ ROBERT J. RUECKL    
 
           
 
      Robert J. Rueckl    
 
      Vice President and Chief Financial Officer    
 
      (principal financial officer)    

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