This report contains forward-looking statements. Forward-looking statements are not historical facts but rather are based on current expectations about our business and industry, as well as our beliefs and assumptions. Words such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue" and variations and negatives of these words and similar expressions are used to identify forward-looking statements. Statements regarding our expectations for our future business results and financial position, our business strategies and objectives, and trends in our market are forward-looking statements. Forward-looking statements are not guarantees of future performance or events, and are subject to risks, uncertainties and other factors, many of which are beyond our control and some of which we may not even be presently aware. As a result, our future results and other future events or trends may differ materially from those anticipated in our forward-looking statements. Specific factors that might cause such a difference include, but are not limited to, the risks and uncertainties discussed in this Management's Discussion and in the Risk Factors section of this report. We also refer you to the risk factors that are or may be discussed from time to time in our public announcements and filings with the SEC, including our future Forms 8-K, 10-Q and 10-K. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect our view only as of the date of this report. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this report.

Overview

We develop, distribute and license technology that accelerates learning by improving the processing efficiency of the brain. Based on more than 30 years of neuroscience and cognitive research, our family of products improves brain fitness with technology-based exercises that build the cognitive skills required to read and learn effectively. Extensive outcomes research by independent researchers, our founding scientists, school districts and our company demonstrates the rapid and lasting gains achieved through participation in our products. Our products are marketed primarily to K-12 schools in the US, to whom we sell through a direct sales force. To facilitate the use of our products, we offer a variety of on-site and remote professional and technical services, as well as phone, email and web-based support. Since our inception, learners have used our products nearly 1.8 million times and approximately 6,000 schools have purchased at least $10,000 of our product licenses and services. As of September 30, 2009 we had 199 full-time equivalent employees, compared to 223 at December 31, 2008.

In January 2009 we announced a 14% reduction in our workforce which was implemented during the first quarter of 2009. On September 1, 2009, we announced a plan to consolidate our product development and product management leadership functions in our Oakland, California headquarters. Under this plan, we expect to close our Waltham, Massachusetts office by the end of 2009. Approximately seven Waltham employees are expected to leave the company by the end of 2009.

Business Highlights

We market our Fast ForWord and Reading Assistant products primarily as a reading intervention solution for struggling and special education students and English Language Learners. According to the U.S. Department of Education, in 2007, 33% of fourth graders in the United States had "below basic" reading scores and 67% were not proficient in reading, and between 1992 and 2007 there was only a modest improvement in the proportion of fourth graders performing at the "below basic" level. While our installed base is growing, the approximately 6,000 schools that have purchased at least $10,000 of our product licenses and services represent a small fraction of the approximately 115,000 K-12 schools in the US.

Federal education funds are a critical resource in helping school districts address the needs of the most challenged learners. We believe that a significant proportion of our sales are funded by federal sources, particularly Title One and IDEA (special education) grants. With the passage of the American Recovery and Reinvestment Act ("ARRA" - the recent stimulus bill), these two federal sources are together projected to increase from $24.9 billion in the 2008 - 2009 school year to $37 billion in the 2009 - 2010 school year. In most states the ARRA funds have been and are being disbursed to school districts, and we believe that the ARRA funding has had a substantial positive impact on our 2009 sales.

State funds also provide school districts with funds that are used to purchase our products. State funds provide school districts with the majority of their funding, and those funds are also sometimes used to purchase our products. States faced severe budget shortfalls in fiscal 2009 and forecast continuing funding difficulties in 2010. The National Conference of State Legislatures estimates that the cumulative state budget gap was $113.2 billion in fiscal 2009, and in June 2009, forecast a cumulative budget gap for fiscal 2010 of $142.6 billion, involving 46 states.

Company Highlights

For the three months ended September 30, 2009, our total revenue increased by 60% compared to the three months ended September 30, 2008 and for the nine months ended September 30, 2009 our total revenue increased 12%. These revenue increases were primarily caused by strong sales driven by the improvement in the school funding environment, resulting from the temporary federal stimulus funding, and by sales productivity enhancements. Revenue for the three months ended September 30, 2009 also benefited from the recognition of approximately $2 million of revenue that was previously deferred at June 30, 2009 relating to our Reading Assistant Expanded edition product upon the product's release in September 2009. Product revenue increased by 107% and 22% for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. Service and support revenue decreased by 8% in the three months ended September 30, 2009 compared to the three months ended September 30, 2008 and by 2% for the nine month period, mainly because of incremental OEM revenue that was recognized in 2008.

For the three months and nine months ended September 30, 2009, our total booked sales increased by 72% and 27%, respectively, over the same periods in 2008. (Booked sales is a non-GAAP financial measure. For more explanation on booked sales, see Revenue below). K-12 sales increased by 83% and 36% in the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008, and non school sales, including private practice, international and OEM customers, decreased by 38% and 35% in the same periods. The flow of federal stimulus funds to individual school districts and the spending requirements linked to these funds put school districts in a better position to execute new purchases during the quarter. Booked sales also benefited from a large $6.9 million deal that closed in early July. For the three months ended September 30, 2009, we closed 38 transactions in excess of $100,000, compared to 23 in the third quarter of 2008. We believe that the decrease in non school sales is primarily caused by adverse economic conditions affecting our customers in both the private practice and international markets.

For the three months and nine months ended September 30, 2009, gross margin improved by 8% and 4% compared to the same periods in 2008, mainly due to a change in revenue mix towards higher margin product. Operating expenses increased by 11% and decreased by 8% for the three months and nine months ended September 30, 2009, respectively, as cost savings resulting from our restructuring initiative in January 2009 were partially offset by increased bonus and commission expense arising from our strong financial performance in the current quarter.

We recorded a net income of $6.5 million for the three months ended September 30, 2009 compared to a net income of $590,000 in the same period in 2008. We recorded a net income of $3.3 million for the nine months ended September 30, 2009 compared to a net loss of $4.5 million in the same period in 2008.

At September 30, 2009 we had no borrowings under our credit line with Comerica Bank.

Results of Operations

Revenues

Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands) 2009 Change 2008 2009 Change 2008 Products $ 15,510 107 % $ 7,475 $ 25,630 22 % $ 21,009 Service and support 4,783 -8 % 5,220 13,904 -2 % 14,252 Total revenues $ 20,293 60 % $ 12,695 $ 39,534 12 % $ 35,261

Product revenues increased by 107% and 22% during the three months and nine months ended September 30, 2009 respectively, compared to the same periods in 2008. The increase in the three months ended September 30, 2009 was due to higher booked sales, including one transaction for $6.9 million where we recognized product revenue of $3.2 million, and the recognition of approximately $2 million of revenue related to our Reading Assistant Expanded Edition product. This revenue resulted from sales in prior quarters that included Reading Assistant Expanded Edition software, which was deferred until the product's release in September 2009. The increase in the nine months ended September 30, 2009 is primarily due to higher booked sales, reflecting the impact of federal stimulus funding and sales productivity improvements.

Our service and support revenue decreased by 8% and 2% respectively during the three months and nine months ended September 30, 2009 compared to the same periods in 2008, mainly due to the recognition during 2008 of OEM revenue relating to the operations we purchased in our acquisition of Soliloquy in January 2008. Excluding the impact of OEM revenue, service and support revenue is essentially flat over 2008.

Booked sales and selling activity: Booked sales is a non-GAAP financial measure that management uses to evaluate current selling activity. We believe that booked sales is a useful metric for investors as well as management because it is the most direct measure of current demand for our products and services. Booked sales equals the total value (net of allowances) of software, services and support invoiced in the period. We record booked sales and deferred revenue when all of the requirements for revenue recognition have been met, other than the requirement that the revenue for software licenses and services has been earned. We use booked sales information for resource allocation, planning, compensation and other management purposes. We believe that revenue is the most comparable GAAP measure to booked sales. However, booked sales should not be considered in isolation from revenues, and is not intended to represent a substitute measure of revenues or any other performance measure calculated under GAAP.

The following reconciliation table sets forth our booked sales, revenues and change in deferred revenue for the three and nine months ended September 30, 2009 and 2008:

                              Three Months Ended September 30,                   Nine Months Ended September 30,
(dollars in
thousands)                  2009              Change          2008            2009             Change            2008
Total deferred
revenue beginning of
period                  $      18,614                       $  20,621     $     19,952                         $  22,955
Booked sales                   26,122               72 %       15,185           45,115                27 %        35,417
Less: revenue                  20,293               60 %       12,695           39,534                12 %        35,261
Other adjustments                 733                               -             (357 )                               -
Total deferred
revenue end of period   $      25,176                9 %    $  23,111     $     25,176                 9 %     $  23,111

For the three months and nine months ended September 30, 2009, our total booked sales increased by 72% and 27%, respectively, over the same periods in 2008. K-12 sales increased by 83% and 36% in the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. The flow of federal stimulus funds to individual school districts and the spending requirements linked to these funds put school districts in a better position to execute new purchases during the quarter. Booked sales also benefited from a large $6.9 million deal that closed in early July.

Booked sales to non school customers, including private practice clinicians and international customers, decreased by 38% and 35% in the three months and nine months ended September 30, 2009 compared to the same periods in 2008. We believe that the decrease in non school sales is primarily caused by adverse economic conditions affecting our customers in both the private practice and international markets.

During the third quarter of 2009, we closed 38 K-12 sales that had a contract value in excess of $100,000, compared to 23 for the same period in 2008. For the three months ended September 30, 2009, approximately 79% of our K-12 booked sales were realized from booked sales over $100,000. For the comparable period in 2008, these large booked sales accounted for approximately 60% of K-12 booked sales. Large booked sales include volume and negotiated discounts but the percentage discount applicable to any given transaction will vary and the relative percentage of large booked sales and smaller booked sales in a given quarter may fluctuate. Because we discount product license fees but do not discount service and support fees, product booked sales and revenue are disproportionately affected by discounting. We cannot predict the size and number of large transactions in the future.

Although the current economic and financial conditions, the temporary nature of federal stimulus funding, and federal, state and local budget pressures make for an uncertain funding environment for our customers, we remain optimistic about our growth prospects in the K-12 market. However, achieving our growth objectives will depend on increasing customer acceptance of our products, which requires us to continue to focus on improving our products' ease of use, their fit with school requirements, and our connection with classroom teachers and administrators. Our K-12 growth prospects are also influenced by factors outside our control, including general economic conditions and the overall level, certainty and allocation of state, local and federal funding. While federal funding for education has grown steadily over the last few decades, the current extraordinary federal commitments intended to stabilize the financial markets are likely to put pressure on all areas in the federal budget. In addition, school district spending based on federal education stimulus funding is expected to decline after 2010 and end after 2011. States are forecasting continued shortfalls in their taxation revenues for their fiscal 2010 largely due to the significant adverse conditions in the credit and housing markets and the national and global recession. These conditions may impact state education spending. In addition, the revenue recognized from our booked sales can be unpredictable. Our various license and service packages have substantially differing revenue recognition periods, and it is often difficult to predict which license package a customer will purchase, even when the amount and timing of a sale can be reasonably projected. See "Management's Discussion and Analysis
- Application of Critical Accounting Policies" in our Annual Report on Form 10-K for the year ended December 31, 2008 for a discussion of our revenue recognition policy. In addition, the timing of a single large order or its implementation can significantly impact the level of booked sales and revenue at any given time. See "Risk Factors" for a further discussion of some of the factors that affect our sales and revenue.

Gross Profit and Cost of Revenues

                                               Three Months Ended September 30,          Nine Months Ended September 30,
(dollars in thousands)                           2009                  2008                2009                  2008
Gross profit on products                      $    14,495         $         6,876     $        23,669       $        19,323
Gross profit margin on products                        93 %                    92 %                92 %                  92 %
Gross profit on service and support                 2,547                   2,809               7,462                 6,973
Gross profit margin on services and support            53 %                    54 %                54 %                  49 %
Total gross profit                            $    17,042         $         9,685     $        31,131       $        26,296
Total gross profit margin                              84 %                    76 %                79 %                  75 %

The overall gross profit margin increased by 8% and 4% respectively in the three months and nine months ended September 30, 2009 compared to the same periods in the prior year, mainly due to a revenue mix shift. Higher margin product revenues made up 76% and 65% of total revenues in the three and nine months ended September 30, 2009, respectively, compared to 59% and 60% in the same periods in 2008. Product margins increased by 1% in the three months ended September 30, 2009, and were flat for the nine month period, as increased amortization expense arising from the intangible assets acquired from Soliloquy and product costs associated with Reading Assistant were offset by proportionately lower royalty costs. Service and support margins improved in the nine months ended September 30, 2009 compared to the same period in 2008 principally due to year over year price increases and cost savings resulting from more efficient delivery of services.

Operating Expenses

Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands) 2009 Change 2008 2009 Change 2008 Sales and marketing $ 6,243 17 % $ 5,329 $ 16,967 -8 % $ 18,461 Research and development 1,846 19 % 1,545 4,588 -13 % 5,267 General and administrative 2,169 -10 % 2,398 6,019 -5 % 6,346 Total operating expenses $ 10,258 11 % $ 9,272 $ 27,574 -8 % $ 30,074

Sales and Marketing Expenses: For the three and nine months ended September 30, 2009, our sales and marketing expenses increased by 17% and decreased by 8%, respectively, compared to the same periods in 2008. The increase in the three months ended September 30, 2009 is mostly due to higher commission expense as a result of the strong sales performance. The decrease for the nine months ended September 30, 2009 is primarily due to lower headcount related costs as a result of the restructuring actions taken in January 2009. At September 30, 2009, we had 43 quota-bearing sales personnel compared to 51 at September 30, 2008.

Research and Development Expenses: Research and development expenses increased by 19% and decreased by 13% in the three and nine months ended September 30, 2009, compared to the same periods in 2008. The increase in the three months ended September 30, 2009 is mainly due to an increase in bonus expense of $273,000 and a decrease in OEM customization costs transferred to cost of revenue of $172,000. The decrease for the nine months ended September 30, 2009 is due to the capitalization of approximately $1.1 million of development costs, mostly relating to our Reading Assistant Expanded Edition product, and a decrease in headcount related costs of $366,000 as a result of the restructuring actions taken in January 2009, partially offset by a decrease in OEM customization costs transferred to cost of revenue of $415,000 and increased bonus expense of $402,000. Research and development expenses principally consist of compensation paid to employees and consultants engaged in research and product development activities and product testing, together with software and equipment costs.

General and Administrative Expenses: For the three and nine months ended September 30, 2009, our general and administrative expenses decreased by 10% and 5%, respectively, compared to the same periods in 2008. The decreases in the three and nine months ended September 30, 2009 are mainly due to a decrease in bad debt expense of $394,000 and $316,000, respectively. Increases in bonus expense were largely offset by decreases in headcount related costs.

Interest and Other Income (Expense)

                              Three Months Ended September 30,                   Nine Months Ended September 30,
(dollars in
thousands)                 2009            Change             2008           2009            Change             2008
Net interest income
(expense)               $       (5 )            -138 %     $       13     $      (24 )            -125 %     $       97
Reclassification of
service revenue                 40               -45 %             73            177               -18 %            217
Other                          (63 )            -215 %             55            (63 )            -140 %            159
Interest and other
income (expense), net   $      (28 )            -120 %     $      141     $       90               -81 %     $      473

Interest and other income decreased in both the three and nine month periods ended September 30, 2009 compared to the prior year periods because of lower reclassifications of service and support revenue relating to a customer for whom we are no longer performing services, less interest on our cash balances, interest expense on our bank loan from January through August 2009, a $54,000 loss on disposal of a fixed asset in the three months ended September 30, 2009 and the reclassification of royalty income from Posit Science which is now classified as product revenue.

Provision for Income Taxes

In the three and nine months ending September 30, 2009, we recorded income tax expense of $301,000 and $367,000, respectively. For the three and nine months ended September 30, 2008 we recorded an income tax benefit of $36,000 and an expense of $1.2 million, respectively. The tax expense for the nine months ended September 30, 2009 consists primarily of deferred tax expense relating to the amortization of acquired goodwill, federal tax expense, and state tax expense. The tax expense for the nine months ended September 30, 2008 consisted primarily of the establishment of valuation allowance against our deferred tax assets.

Statement of Financial Accounting Standards ASC 740, "Accounting for Income Taxes" provides for the recognition of deferred tax assets if realization of such assets is more likely than not. We have established and continue to maintain a full valuation allowance against our deferred tax assets as we do not believe that realization of those asserts is more likely than not.

At September 30, 2009, we have unrecognized tax benefits of approximately $1.9 million. We have approximately $4,000 of unrecognized tax benefits that, if recognized, would affect our effective tax rate. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months. Interest and penalty costs related to unrecognized tax benefits are insignificant and classified as a component of "Income Tax Expense" in the accompanying statement of operations.

We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. Tax returns remain open to examination by the appropriate governmental agencies for tax years 2006 to 2008. The federal and state taxing authorities may choose to audit tax returns for tax years beyond the statue of limitation period due to significant tax attribute carryforwards from prior years, making adjustments only to carryforward attributes. We are not currently under audit in any major tax jurisdiction.

Liquidity and Capital Resources

Our cash and cash equivalents were $16.9 million at September 30, 2009, compared to $7.6 million at December 31, 2008.

We expect that during at least the next twelve months our cash flow from operations together with our current cash balances will be our primary source of liquidity and will be sufficient to provide the necessary funds for our operations and capital expenditures. Historically, we have used cash in our operations during the first half of the year and built cash in the second half. This pattern results largely from our seasonally low sales in the first calendar quarter, which reflects our industry pattern, and the time needed to collect on sales made towards the end of the second quarter. Reflecting this pattern as well as the significant sales increase in the third quarter, in the first six months of 2009, we used $4.2 million in operating activities and in the three months ended September 30, 2009, we generated $14.7 million of cash from operations. We expect that cash flow from operations will be sufficient to fund our operating requirements during fiscal 2010. Accomplishing this, however, will require us to meet specific booked sales targets in the K-12 market. We cannot assure you that we will meet our targets with respect to booked sales, revenues, expenses or operating results.

We have a revolving line of credit agreement with Comerica Bank that expires on December 31, 2009. The maximum that can be borrowed under the agreement is $5.0 million. Borrowings under the line are subject to reporting covenants requiring the provision of financial statements to Comerica, and a financial covenant requiring us to maintain a minimum adjusted quick ratio of 1.15 and net worth not less than negative $2 million. The agreement allows us to issue letters of credit not to exceed $1.0 million. At September 30, 2009, we have an outstanding letter of credit for $206,000. There were no borrowings outstanding on the line of credit at September 30, 2009 and we were in compliance with all related covenants.

If we are unable to achieve sufficient cash flow from operations, we may seek other sources of debt or equity financing, or may be required to reduce expenses. Reducing our expenses could adversely affect operations by reducing the resources available for sales, marketing, research or product development. We cannot assure you that we will be able to secure additional debt or equity financing on acceptable terms, if at all.

Net cash provided by operating activities for the nine months ended September . . .