Fiscal Year

Our fiscal year is from November 1 to October 31. Unless otherwise stated, references to the years 2008, 2007, and 2006 relate to the fiscal years ended October 31, 2008, 2007, and 2006, respectively. References to future years also relate to our fiscal year ending October 31.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the following areas as those that are significant to our financial statement presentation, and 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

Our discussion of these policies is intended to supplement, but not replace, the more detailed discussion of these and other accounting policies and disclosures contained in the Notes to Consolidated Financial Statements.

Revenue Recognition. We derive our revenues from three sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our online, web-based products; (2) license revenues from non-cancelable perpetual license agreements; and (3) related professional and support services and other revenue.

We recognize revenue when all of the following conditions are met:
· There is persuasive evidence of an arrangement;

· Access to our online subscription products has been provided to the customer or the perpetual courseware has been delivered;

· The amount of fees to be paid by the customer is fixed and determinable; and

· The collectability of the fee is probable.

Revenue from the licensing of software under subscription arrangements is recognized on a ratable basis over the subscription period starting the later of the first day of the subscription period or when all revenue recognition criteria identified above have been met. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Amounts due under non-cancelable subscription agreements are not recognized in accounts receivable or deferred revenue until such amounts are invoiced to the customer.

We also provide professional services, which consist of training and implementation services, as well as ongoing customer support and maintenance. Training and implementation services are not essential to the functionality of our software products. Revenues from these services are recognized separately upon delivery where there is objective and reliable evidence of fair value of each deliverable. Software support revenue is deferred and recognized ratably over the support period.

For revenue arrangements with multiple deliverables, we allocate the total amount the customer will pay to the separate units of accounting based on their relative fair values, as determined by the price of the undelivered items when sold separately.

If collectability of the fee is not probable, revenue is recognized as payments are received from the customer provided all other revenue recognition criteria have been met. If the fee due from the customer is not fixed or determinable, revenue is recognized as the payments become due provided all other revenue recognition criteria have been met.

Capitalized Product Development Costs. Our investments in product development are significant, and the rules that govern how these costs are accounted for in our financial statements can have a significant impact on our operating results from period to period.

Our product development costs relate to the research, development, enhancement, and maintenance of our perpetual and subscription-based software products. We account for software development costs in accordance with the provisions of SFAS No. 86. "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Costs related to the initial design and development of new products and the routine enhancement and maintenance of existing products are expensed as incurred. When projects reach technological feasibility we begin capitalization of the related project costs. Capitalization ends when a product is available for general release to our customers, at which time amortization of the capitalized costs begins. The amortization of these costs is included in cost of revenues related to license fees and subscriptions.

We evaluate our capitalized costs on a quarterly basis to determine if the unamortized cost related to any product, or group of products, exceeds its estimated net realizable value. Estimating net realizable value requires us to use judgment in projecting future revenues and cash flows to be generated by the product and thereby quantifying the amount, if any, to be written off. Actual cash flows realized could differ materially from those estimated. In addition, any future changes to our software product offerings could result in write-offs of previously capitalized costs and have a significant impact on our consolidated results of operations. Our analysis as of October 31, 2008 and 2007 resulted in impairment charges on these assets of $4.6 million and $0.5 million, respectively.

Valuation of Deferred Income Taxes. Our accounting policy for the valuation of deferred income taxes is considered critical for several reasons. Significant judgment is required in the assessment of the need for a valuation allowance. In addition, income tax accounting rules, in combination with purchase accounting rules applied in the acquisition of Lightspan in 2004, resulted in a complex tax accounting situation in which, until 2008, we have not recognized tax benefits on operating losses or on the realization of deferred tax assets, but regardless of our operating results, have been recognizing tax expense on future tax liabilities related to tax deductible goodwill.

The majority of our deferred tax assets represent net operating loss carryforwards which are available to offset future taxable income. These loss carryforwards include those acquired in the acquisition of Lightspan in 2004, as well as carryforward losses that existed prior to, or were incurred after, the acquisition. Our ability to realize the benefit of these loss carryforwards is dependent upon our ability to generate future taxable income., Our history of cumulative operating losses over the past several years has led to our current assessment that it is more likely than not that our net deferred taxes will not be realized. As a result, our deferred tax assets are fully reserved and will remain fully reserved until the related tax benefits are realized through the generation of taxable income in a particular year, or until we can demonstrate a history of generating taxable income.

Until 2008, our calculation of net deferred tax assets excluded a deferred tax liability related to tax deductible goodwill. The timing of the reversal of this difference was considered indefinite because it would not reverse until the underlying assets that created the goodwill were disposed of or sold. In 2008, the goodwill was determined to be fully impaired, and as a result, the deferred tax liability associated with tax deductible goodwill was reversed.

Goodwill and Identified Intangible Assets. Goodwill and identified intangible assets are recorded when the purchase price paid for an acquisition exceeds the fair value of the tangible assets acquired. Most of the companies we have acquired have not had significant tangible assets. As a result, a significant portion of the purchase price paid in acquisitions has been allocated to identified intangible assets and/or goodwill.

Identified intangible assets are amortized to expense over their expected useful lives and goodwill is not amortized. Once established, these assets are subject to periodic impairment assessments to determine if their current carrying values are recoverable based on information available at the time these assessments are made. Significant assumptions and estimates are required in making these assessments. Accordingly, the assumptions and estimates we use in implementing this policy affect the amount of identified intangible asset amortization and impairment charges, if any, reflected in our operating results. Our impairment assessments at October 31, 2008 resulted in the elimination of goodwill and a related impairment charge of $71.9 million, and impairment charges of $1.9 million on identified intangible technology and customer assets acquired in previous acquisitions. There were no impairment charges on identified intangible assets or goodwill in 2007.

General Factors Affecting our Financial Results

There are a number of general factors that affect our results from period to period. These factors are discussed below.

Revenue. We are transitioning our business model from one that sells one-time perpetual licenses to our software, for which revenue is generally recognized up-front upon delivery, to one that sells subscription-based 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 2006 when we introduced many of our new subscription-based products. As subscription revenues grow as a percentage of total revenues, we expect our period to period revenues to become more comparable and predictable.

Because subscription revenues are recognized ratably over the future subscription period, changes in subscription revenue lag behind changes in orders for subscription products. Periods of strong subscription order growth and increasing deferred revenue balances are generally followed by periods of strong subscription revenue growth, and vice versa. In 2008, a meaningful, but declining portion of our revenues continued to be derived from sales of perpetual licenses to 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. 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. Subscription revenues are less seasoned because they are recognized ratably over the subscription period. 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 historically have had 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. 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.

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.

Product maintenance and development expense in our consolidated statement of operations does not reflect our total level of spending in these areas. 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. Accordingly, product maintenance and development expense in our 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.

Non-GAAP Financial Measures

The following discussion and analysis of our financial condition and results of operations includes non-GAAP financial measures, identified in the reconciliations below, that is not prepared in accordance with generally accepted accounting principles and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. These non-GAAP financial measures have been used because we believe they are useful to investors by providing greater transparency to supplemental information used in our internal financial and operational analysis. Investors are encouraged to review the following reconciliations of the non-GAAP financial measures used herein to their most directly comparable GAAP financial measures as provided with our consolidated financial statements.

Reconciliation of GAAP Net Loss and Loss Per Share to Non-GAAP Net Loss and Loss Per Share Before Impairments, Restructuring and Other Charges and Benefits (in

thousands, except per share amounts)

                                                       2008          2007          2006
Net Loss:
Net loss, as reported                                $ (91,897 )   $ (14,876 )   $ (22,480 )
Goodwill impairment                                     71,865             -             -
Income tax benefit related to goodwill impairment
change                                                  (3,137 )           -             -
Restructuring, impairment and other charges             11,833            53        10,182
Net loss before impairments, restructuring and
other charges and benefits                           $ (11,336 )   $ (14,823 )   $ (12,298 )

Loss per Share (basic and diluted):
Loss per share , as reported                         $   (3.85 )   $   (0.63 )   $   (0.95 )
Goodwill impairment                                       3.01             -             -
Income tax benefit related to goodwill impairment
charge                                                   (0.13 )           -             -
Restructuring, impairment and other charges               0.49          0.01          0.43
Loss per Share before impairments, restructuring
and other charges and benefits                       $   (0.48 )   $   (0.62 )   $   (0.52 )

Basic and diluted weighted average common shares
outstanding (GAAP)                                      23,854        23,754        23,679

Reconciliation of GAAP Operating Expense to Non-GAAP Operating Expenses before Impairments, Restructuring and Other Charges (in thousands)

                                                       2008          2007          2006
Total operating expenses, as reported                $ 122,221     $  47,540     $  73,517
Goodwill impairment                                     71,865             -             -
Restructuring, impairment and other charges
(benefit)                                                6,748          (478 )       9,093
Operating expenses before impairments,
restructuring  and other charges                     $  43,608     $  48,018     $  64,424

Overview of Financial Results

The transition of our company to a software-as-a-service ("SaaS") business model that began in 2005 continued throughout 2006, 2007 and most of 2008. Although revenues in 2008 continued to be adversely affected by declining emphasis on sales of legacy perpetual products and related software maintenance, strong growth in subscription revenues on our SaaS products have now substantially offset these declines. Compared to 2007, total 2008 revenues declined $1.2 million, or 1.8%, to $68.4 million.

Our cost management activities throughout the transition have led to significant declines in the costs of operating our business. Together with the moderating revenue declines, these cost declines led to an improvement in our 2008 non-GAAP net loss excluding impairments, restructuring and other charges and benefits, to ($11.3) million, or ($0.48) per share, from ($14.8) million, or ($0.62) per share, in 2007. On a GAAP basis, our net loss was ($91.9) million for 2008 compared to ($14.9) million for 2007, with the increase primarily attributable to the non-cash impairment charge to goodwill described below.

In each of the years of our SaaS transition we have incurred impairment, restructuring and other charges that were generally unrelated to our day-to-day operating activities, but were a necessary part of our long-term transition. In 2008 we recorded a non-cash impairment charge of $71.9 million on goodwill acquired in acquisitions made prior to launching our SaaS strategy, $6.5 million in non-cash impairment charges on software development costs and previously acquired intangible assets, and $5.3 million in cash restructuring and other charges related to a transition in our leadership and activities that we believe will ensure continued operating expense savings in 2009.

By the end of 2008, we completed the first phase of our transition strategy marked by the achievement of double-digit order and revenue growth from our new internet-based subscription products, the moderation of our product investment to levels consistent with our long-term business model, reduction in our cost structure to ensure we move closer to profitability in 2009, and the transition to a new generation of leadership to execute the next phase of our strategy.

We will continue in 2009 to execute the next phase of our long-term strategy, focusing on refining our interactions with customers, building out our product capabilities and how we package and sell them in the market, and improving the overall experience of our customers. We will continue to develop our sales organization and look forward to building continuous relationships with our customers throughout the entire subscription life cycle. The financial effects of the transition to subscription products, however, may continue to adversely affect the comparability of our year-over-year financial results in the near term. This and other risks we face in our business are discussed in more detail in Item 1A of Part I of this report.

Results of Operations

Our discussion and analysis of results of operations should be read in conjunction with the section above captioned "General Factors Affecting our Financial Results".

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)

                                            2008                           2007                   2006

                                                Change from                    Change from
                                   Amount          2007           Amount          2006           Amount
Order Value:
Subscriptions                        43,585            19.8 %       36,368            38.5 %       26,259
License fees                          7,886           (53.4 %)      16,931           (54.2 %)      36,974
Services                             20,637           (15.3 %)      24,377           (16.5 %)      29,177
                                  $  72,108            (7.2 %)   $  77,676           (15.9 %)   $  92,410

Percent of Total Order Value:
Subscriptions                            60 %                           47 %                           29 %
License fees                             11 %                           22 %                           40 %
Services                                 29 %                           31 %                           31 %
                                        100 %                          100 %                          100 %

Revenue by Category (in thousands)

                                            2008                           2007                   2006

                                                Change from                    Change from
                                   Amount          2007           Amount          2006           Amount
Subscriptions                     $  35,221            45.7 %    $  24,173            33.0 %    $  18,176
License fees                          8,458           (52.2 %)      17,712           (52.5 %)      37,322
Services                             24,722           (10.9 %)      27,747           (21.2 %)      35,221
                                  $  68,401            (1.8 %)   $  69,632           (23.2 %)   $  90,719

2008 vs. 2007.

Total revenues decreased $1.2 million, or 1.8%, to $68.4 million in 2008. Subscription revenues increased $11.0 million, or 45.7%, to $35.2 million as strong growth in subscription product orders in 2007 and 2008 were recognized as revenue over the portion of the subscription periods occurring in 2008. While subscription revenue growth was strong, it was not sufficient to fully offset a decline in license fees and services revenues. Our strategic shift away from legacy perpetual software products resulted in a $9.3 million, or 52.2%, decline in license fee revenues to $8.5 million. Services revenues declined 10.9% to $24.7 million due primarily to a decline in software support revenues on previously purchased perpetual products.

Total orders declined from $77.7 million in 2007 to $72.1 million in 2008, reflecting a slowing of orders in the second half of the fourth quarter of 2008 as news worsened on the broader U.S. economy and school districts put spending decisions on hold as they evaluated the effects on their budgets. The order decline also reflects the continuing transition from selling products that are licensed on a perpetual basis, which have higher one-time selling prices, to those that are licensed on a subscription basis, which have lower selling prices but are renewable at the end of each subscription period.

2007 vs. 2006.

Total revenues decreased 23.2% to $69.6 million in 2007 from $90.7 million in 2006, due primarily to the $19.6 million decline in perpetual license fee revenues that reflected our shifting sales emphasis from legacy perpetual products to subscription products delivered on PLE. Subscription revenues increased 33.0% compared to 2006 and surpassed license revenue as a percent of total revenue. Services revenues declined 21.2% from 2006 on a decline in revenues from professional services and technical services, which are tied closely to perpetual license orders.

Gross Profit

To aid in the understanding of our discussion and analysis of gross profit, the following tables summarize the percentage of total revenue, and the gross profit percentage for each revenue category:

Gross Profit Percentage

                                                           Increase (Decrease)

Revenue Category    2008       2007       2006       2007 to 2008        2006 to 2007
Subscriptions        47.0 %     35.7 %     50.5 %             11.3 %             (14.8 %)
License fees         37.6 %     52.6 %     64.6 %            (15.0 %)            (12.0 %)
Services             49.7 %     53.0 %     50.3 %             (3.3 %)              2.7 %
Total (1)            39.4 %     46.1 %     55.0 %             (6.7 %)             (8.9 %)

(1) Asset impairment charges of $5.1 million, $0.5 million and $1.1 million in 2008, 2007 and 2006, respectively, are reflected in the Total Gross Profit Percentage in the table, but are not reflected in the individual revenue category gross profit percentages.

Percentage of Total Revenue

Revenue Category    2008        2007        2006
Subscriptions         51.5 %      34.7 %      20.0 %
License fees          12.4 %      25.4 %      41.2 %
Services              36.1 %      39.9 %      38.8 %
Total                100.0 %     100.0 %     100.0 %

2008 vs. 2007

The total gross profit percentage declined to 39.4% in 2008, and includes the negative effect of $5.1 million in asset impairment charges which had the effect of decreasing 2008 reported margins by 7.4 percentage points compared to a total gross profit margin in 2007 of 46.1%.

The changes from 2007 to 2008 in the gross profit percentages of each revenue category were as follows:

· The increase in the subscription gross profit percentage, from 35.7% in 2007 to 47.0% in 2008, reflects the lower delivery and support costs of our internet-based subscription products. Subscription revenues increased $11.0 million while increases in subscription related product development amortization, royalty costs and support services increased only $3.1 million, resulting in a gross profit percentage on incremental subscription revenues of approximately 72%.

· The decline in the license fee gross profit percentage, from 52.6% in 2007 to . . .