Our results of operations can be affected by many factors including the general economic environment, state and federal government budgetary decisions and, the length and complexity of the sales cycle for school districts. National trends, federal and state legislation, Department of Education administrative policies and, the way the foregoing align with our products and services can impact our business.

An important component of our software product strategy is a transition to a subscription-based software sales model. We believe that a business model based on subscription-based software offers long-term advantages over traditional perpetual licensing, including: (i) improved product utilization leading to higher levels of customer satisfaction, (ii) product adoption by more schools and, (iii) more lifetime revenue per customer.

We believe the percentage of customers using the subscription-based Enterprise version of our reading and math products is an important indicator of: (i) the progress of this strategic growth initiative, (ii) the magnitude of the growth opportunities still existing with regard to this strategy and (iii) the impact of the new seasonal patterns on our business. As of the end of the first quarter 2009, about one-third of our active reading product customers were using the Enterprise version. Worldwide, we currently have approximately 55,000 active Accelerated Reader customers, 18,000 activeAccelerated Math customers and 47,000 active STAR Reading and STAR Math customers.

We have experienced a change in customer order patterns as the number of schools using our subscription-based products increases. Compared to orders for non-subscription-based offerings, customer orders of our subscription-based offerings tend to more closely follow school budgeting patterns resulting in a more seasonal order pattern weighted to the second and, even more so, third calendar quarters. Also, after customers convert to our subscription-based Enterprise products, they no longer order reading quizzes and math libraries since access to this content is included in their subscription. Historically, our customers have ordered more of this content in the first and fourth quarters. The combined effect is that a much greater proportion of a year's orders are expected in the second quarter and to an even greater extent in the third quarter than we have experienced historically. Transitioning our customer base to subscription-based software can also adversely impact orders for add-on reading quizzes and math libraries by customers who own our software under perpetual license agreements, as some may delay purchases of reading quizzes and math libraries while they contemplate converting to subscription-based versions of our products.

The foregoing can significantly affect reported financial results. Since our Renaissance Place product and service offerings are typically sold on a subscription basis with a term of 12 months, a large portion of our revenue is initially deferred and recognized into income over the subscription period. This timing difference between receipt of an order and revenue recognition, on subscription based products and services, can result in reported revenue being significantly lower or significantly higher than the amount of orders received in any given period and can also affect comparative results from one period to another.

Our Renaissance Place products are often sold at the school district level and district level sales are more complex, have a longer sales cycle, and are typically for a larger dollar amount than sales made to individual schools. Revenues from district sales are therefore more uneven and more difficult to accurately predict than individual school level sales. Consequently, our revenues and results of operations can be significantly impacted by the timing of large district orders.

In addition to the above factors, we believe that our first quarter orders were negatively affected by customers who were hesitant to place orders during the first quarter of 2009 due to the economic downturn and the impact on school budgets as well as by uncertainty about how funds available under the American Recovery and Reinvestment Act could help them and which programs would be funded. The focus of the education funds provided by the act is on achieving sustainable impacts to improve classrooms and advancing learning and, we believe that our products align well with these objectives.

We have implemented several cost savings initiatives including reducing laptop selling costs, implementing a general hiring freeze, reducing product development expenses related to some of our lower-performing product lines and, other general non-payroll cost constraints. There was minimal impact from these initiatives in the first quarter because the savings were offset by one-time severance and other charges.

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

                                      Three Months Ended March 31,
                                        2009                 2008                Change
                                                    (Dollars in Thousands)

    Net Sales:
    Products                     $ 20,661      71.6 % $ 22,205      75.6 % $ (1,544 )    -7.0 %
    Services                        8,209      28.4 %    7,181      24.4 %    1,028      14.3 %
    Total net sales                28,870     100.0 %   29,386     100.0 %     (516 )    -1.8 %

    Cost of sales:
    Products                        2,996      14.5 %    4,035      18.2 %   (1,039 )   -25.7 %
    Services                        2,906      35.4 %    3,762      52.4 %     (856 )   -22.7 %
    Total cost of sales             5,902      20.4 %    7,797      26.5 %   (1,895 )   -24.3 %
    Gross profit:
    Products                       17,665      85.5 %   18,170      81.8 %     (505 )    -2.8 %
    Services                        5,303      64.6 %    3,419      47.6 %    1,884      55.1 %
    Total gross profit             22,968      79.6 %   21,589      73.5 %    1,379       6.4 %

    Operating expenses:
    Product development             4,451      15.4 %    4,032      13.7 %      419      10.4 %
    Selling and marketing           8,921      30.9 %    9,373      31.9 %     (452 )    -4.8 %
    General and administrative      3,463      12.0 %    4,129      14.1 %     (666 )   -16.1 %
    Total operating expenses       16,835      58.3 %   17,534      59.7 %     (699 )    -4.0 %

    Operating income                6,133      21.2 %    4,055      13.8 %    2,078      51.2 %
    Other, net                        148       0.6 %      168       0.6 %      (20 )   -11.6 %
    Income before taxes             6,281      21.8 %    4,223      14.4 %    2,058      48.7 %
    Income taxes                    2,374       8.2 %    1,605       5.5 %      769      48.0 %
    Net income                   $  3,907      13.5 % $  2,618       8.9 % $  1,289      49.2 %

Net Sales. Our net sales decreased by $0.5 million, or 1.8%, to $28.9 million in the first quarter of 2009 from $29.4 million in the first quarter of 2008. Customer orders for our products decreased by approximately $4.1 million or 16%, in the first quarter of 2009 compared to the first quarter of 2008. Deferred revenue decreased by $8.8 million in the first quarter of 2009 versus a $5.0 million decrease in the prior year's first quarter.

Product revenue decreased by $1.5 million, or 7.0%, to $20.7 million in the first quarter of 2009 from $22.2 million in the first quarter of 2008. Product revenue was down primarily due to decreases in orders this quarter, somewhat offset by recognition of deferred revenue from orders received in prior periods.

Service revenue increased by $1.0 million, or 14.3%, to $8.2 million in the first quarter of 2009 from $7.2 million in the first quarter of 2008. Nearly all categories of service revenue were up except for National Conference revenues. We held a National Conference in the first quarter of 2008 but did not hold one in the first quarter of 2009. The most significant increases in service revenues occurred in hosting and other technical services. Service revenue increased primarily due to recognition of deferred revenue from orders received in prior periods.

Cost of Sales. The cost of sales of products decreased by $1.0 million, or 25.7%, to $3.0 million in the first quarter of 2009 from $4.0 million in the first quarter of 2008. As a percentage of product sales, the cost of sales of products decreased to 14.5% in the first quarter of 2009 from 18.2% in the first quarter of 2008 primarily due to the product mix being weighted more heavily to software and to reduced costs for some of our hardware products.

The cost of sales of services decreased by $0.9 million, or 22.7%, to $2.9 million in the first quarter of 2009 from $3.8 million in the first quarter of 2008. As a percentage of sales of services, the cost of sales of services decreased to 35.4% in the first quarter of 2009 from 52.4% in the first quarter of 2008. The improvement was due to the growth in our more profitable technical services areas, especially hosting, by better leveraging of our fixed costs and, because last year's first quarter costs were negatively impacted by our National Conference.

Product Development. Product development expenses increased by $0.4 million, or 10.4%, to $4.4 million in the first quarter of 2009 from $4.0 million in the first quarter of 2008. The increase in product development expenses is mainly due to capitalization of approximately $0.3 million of software development costs in 2008 compared to no costs capitalized in the current quarter. As a percentage of net sales, product development expenses increased to 15.4% in the first quarter of 2009 from 13.7% in the first quarter of 2008.

Selling and Marketing. Selling and marketing expenses decreased by $0.5 million, or 4.8%, to $8.9 million in the first quarter of 2009 from $9.4 million in the first quarter of 2008. Selling and marketing expenses decreased due to lower travel costs and reduced advertising spending. As a percentage of net sales, selling and marketing expenses decreased to 30.9% in the first quarter of 2009 from 31.9% in the first quarter of 2008.

General and Administrative. General and administrative expenses decreased by $0.6 million, or 16.1%, to $3.5 million in the first quarter of 2009 from $4.1 million in the first quarter of 2008. General and administrative expenses decreased primarily due to $0.4 million incurred in the prior year for cancellation fees related to termination of contracts for certain training events. As a percentage of net sales, general and administrative expenses decreased to 12.0% in the first quarter of 2009 from 14.1% in the first quarter of 2008.

Operating Income. Operating income increased by $2.0 million, or 51.2%, to $6.1 million in the first quarter of 2009 from $4.1 million in the first quarter of 2008. The increase was due to the gross profit margin improvements and decreased operating expenses as explained in more detail above. As a percentage of net sales, operating income increased to 21.2% in the first quarter of 2009 from 13.8% in the first quarter of 2008.

Income Tax. Income tax expense of $2.4 million was recorded in the first quarter of 2009 at an effective income tax rate of 37.8% of pre-tax income, compared to $1.6 million, or 38.0% of pre-tax income in the first quarter of 2008.

As of March 31, 2009, our cash, cash equivalents and investment securities were $19.1 million, up $1.3 million from $17.8 million at December 31, 2008. During the first quarter 2009, we generated operating cash flow of $2.9 million offset by $2.0 million used to pay dividends.

As of March 31, 2009 we have a $15.0 million secured revolving line of credit with a bank which is available until July 1, 2009. The line of credit bears interest at either a floating rate or a fixed rate for a period of up to 90 days based on LIBOR plus 1.5%. The rate is at our option and is determined at the time of borrowing. We also have a $2.0 million unsecured revolving line of credit with a bank available until April 30, 2010 which bears interest at the prime rate. As of March 31, 2009, the lines of credit had not been used.

On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock; on February 9, 2005, our Board of Directors authorized the repurchase of an additional 3,000,000 shares and; on February 6, 2008, our Board of Directors authorized the repurchase of an additional 1,000,000 shares under the stock repurchase program. No time limit was placed on the duration of the repurchase program, nor is there any dollar limit on the program. We repurchase shares on the open market as well as from employees who elect to surrender shares at the time of vesting to pay their payroll withholding taxes. Repurchased shares will become treasury shares and may be used for stock-based employee benefit plans, equity compensation plans and, for other general corporate purposes. From January 1, 2009 through March 31, 2009, we repurchased approximately 3,600 shares at a cost of $29,000. Since the original authorization of the repurchase program in 2002, we have repurchased approximately 7.8 million shares at a cost of $135.0 million. Depending on our stock valuation, cash availability and other factors, we may repurchase additional shares as a beneficial use of our cash to enhance shareholder value.

We paid quarterly cash dividends of $0.07 per share in each of the four quarters of 2008 along with a special dividend of $0.75 per share in the fourth quarter of 2008. In the first quarter of 2009 we paid a cash dividend of $0.07 per share. On April 29, 2009, our Board of Directors declared a quarterly cash dividend of $0.07 per share, payable June 1, 2009 to shareholders of record as of May 15, 2009.

We intend to continue to pay quarterly cash dividends, subject to capital availability and a determination that cash dividends continue to be in the best interests of the company and our shareholders. Our Board of Directors also considers several additional factors when declaring dividends, including: the company's financial statements as of the most recent practicable date, the expected cash costs to deliver the products and services sold and recorded as deferred revenue, the company's ability to provide the products and services underlying the amounts recorded as deferred revenue, the likelihood of recognizing amounts recorded as deferred revenue as net sales based on the company's historical experience and most recent projections and the short time period over which such recognition has historically occurred and is expected to occur and, other information, opinions, reports and statements prepared and presented by the company's officers and employees about the company's business, operations and financial condition.

We believe our strong cash position coupled with cash flow from operations will be sufficient to meet both our short-term and long-term working capital requirements.

We do not have any off-balance sheet transactions, arrangements or obligations (including contingent obligations), that would have a material effect on our financial results.

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

Purchase Obligations. We enter into commitments with certain suppliers to purchase our hardware products, such as Neo laptops, AccelScanscanners and the 2Know! response system. The majority of these obligations will be satisfied within one year.

Tax Audit Settlements and Deposits. Currently we do not anticipate making any significant cash payments related to the settlement of tax audits or deposits for unsettled audit issues. Estimation of the amounts and timing of payments in periods after 2009 are highly uncertain and therefore are not included in the table.

As of March 31, 2009, our approximate contractual obligations for operating leases, tax audit payments and purchase obligations (by period due) were as follows:

     Contractual Obligations                             Payments Due by Period
     (In Thousands)                             Less than      1-3      3-5     More than
                                      Total      1 year       years    years     5 years
     Operating lease obligations     $ 3,858   $     1,135   $ 1,701   $  934   $       88
     Purchase obligations              2,498         2,480        18        -            -
     Total                           $ 6,356   $     3,615   $ 1,719   $  934   $       88

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. There have been no significant changes to our critical accounting policies that were disclosed in our 2008 Annual Report.

In accordance with the Private Securities Litigation Reform Act of 1995, we can obtain a "safe-harbor" for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements which identify factors that could cause actual results to differ materially from those in the forward-looking statements. Accordingly, the foregoing "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the following "Quantitative and Qualitative Disclosures About Market Risk" may contain certain forward-looking statements regarding strategic growth initiatives, growth opportunities and management's expectations regarding orders and financial results for 2009 and future periods. These forward-looking statements are based on current expectations and current assumptions which management believes are reasonable. However, these statements involve risks and uncertainties that could cause actual results to differ materially from any future results encompassed within the forward-looking statements. Factors which may cause such a difference to occur include: (i) the failure of Accelerated Reader Enterprise, Accelerated Math Enterprise and laptop orders to achieve expected growth targets, (ii) a decline in reading quiz and math library sales that exceeds expectations, (iii) risks associated with our strategic growth initiative involving our transition to subscription-based products, (iv) dependence on educational institutions and government funding and (v) other risks affecting our business as described in our filings with the Securities and Exchange Commission, including our 2008 Annual Report on Form 10-K and later filed quarterly reports on Form 10-Q and current reports on Form 8-K, which factors are incorporated herein by reference. We expressly disclaim a duty to provide updates to forward-looking statements, whether as a result of new information, future events or other occurrences.