RENAISSANCE LEARNING INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934: FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

COMMISSION FILE NO. 0-22187

RENAISSANCE LEARNING, INC.
(formerly known as Advantage Learning Systems, Inc.)
(Exact name of Registrant as specified in its charter)

WISCONSIN 39-1559474
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

2911 PEACH STREET 54495-8036
P.O. BOX 8036 (Zip Code)
WISCONSIN RAPIDS, WISCONSIN
(Address of principal executive offices)

Registrant's telephone number, including area code: (715) 424-3636

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $.01 PAR VALUE
(Title of class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of the voting stock held by nonaffiliates of the
Registrant was approximately $338,620,000 as of February 28, 2002. As of
February 28, 2002, there were 34,645,255 of the Registrant's shares of common
stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III is incorporated by reference from the Proxy Statement for the
Annual Meeting of Shareholders to be held on April 17, 2002.

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PART I

ITEM 1. BUSINESS

Our name was legally changed from Advantage Learning Systems, Inc. to
Renaissance Learning, Inc. on April 18, 2001. On April 20, 2001, our stock
trading symbol on the Nasdaq stock market changed to RLRN to reflect the legal
name change.

OVERVIEW

Renaissance Learning, Inc. is a leading provider of comprehensive school
improvement programs to kindergarten through senior high ("K-12") schools in the
United States and Canada. Our software products, teacher training and consulting
help educators motivate students, accelerate learning, improve test scores, and
help students master standards. Our computer-based learning information systems
consist of computer software and the related training designed to improve
student academic performance by increasing the quality, quantity, and timeliness
of performance data available to educators and by facilitating increased student
practice of essential skills. Learning information systems provide benefits to
educators similar to those management information systems provide to business
managers. As of December 31, 2001, we had sold our products to more than 59,000,
or nearly 50%, of the K-12 schools in North America.

Our flagship product, Accelerated Reader*, is software for motivating and
monitoring increased literature-based reading practice. We believe that
Accelerated Reader has achieved a leading market position as a result of its
demonstrated effectiveness in improving student reading levels and overall
academic performance. In the second quarter of 2001, we began shipments of AR
Universal*, the new version of our Accelerated Reader program which supports new
recorded-voice versions of quizzes on literature books for emergent readers and
new quizzes for assessing reading instruction assignments such as those found in
reading textbooks and other curricula.

Our other primary learning information system products include STAR
Reading*, Accelerated Math*, STAR Math*, Perfect Copy*, Surpass* and STAR Early
Literacy*. Initial shipments of STAR Early Literacy began in the second quarter
of 2001. In late 2001 and early 2002, we announced several new products which we
expect to be released during 2002: Fluent Reader* repeated reading software for
struggling readers; StandardsMaster* instant assessment and Web-based reporting
software; Accelerated Writer* writing improvement system; Accelerated
Vocabulary* vocabulary development software; and AccelTest* test creation,
scoring and gradebook software.

In addition to our learning information system products, we provide
professional development training for educators through Reading Renaissance*,
Math Renaissance*, School Renaissance* and other training programs. We also
provide electronic assessment software and services to educational publishers
and Total Knowledge Management* ("TKM"*) enterprise software for training and
knowledge management throughout organizations. AccelScan*, our optical-mark card
scanner, was totally reengineered in 2001 for lower cost and improved
performance, including the use of intelligent mark recognition technology.

Renaissance Learning, Inc. was founded in 1986 and is incorporated under
the laws of the State of Wisconsin. Our common stock trades on The Nasdaq Stock
Market(R) under the symbol "RLRN." Our principal executive offices are located
at 2911 Peach Street, P.O. Box 8036, Wisconsin Rapids, Wisconsin 54495-8036
(telephone: (715) 424-3636).

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* Accelerated Reader(R), AccelScan(R), STAR Reading(R), Accelerated Math(R),
STAR Math(R), Reading Renaissance(R), Math Renaissance(R) and School
Renaissance(R) are registered trademarks of the company. Perfect Copy(TM),
Perfect Copy High School(TM), Surpass(TM), Renaissance(TM), Renaissance
Learning(TM), STAR Early Literacy(TM), Fluent Reader(TM), StandardsMaster(TM),
Accelerated Writer(TM), Accelerated Vocabulary(TM), AccelTest(TM),
eSchoolOffice(TM), Generation21(TM), Writing Renaissance(TM), Total Knowledge
Management(TM), and TKM(TM) are common law trademarks of the company.

PRODUCTS

SOFTWARE AND SUPPORT SERVICES

We offer software products to educators for use in the K-12 marketplace, as
well as support services to the users of our software products. These software
products help educators improve student academic performance by intensifying
skills practice and increasing the quality, quantity, and timeliness of
information available to educators. We also sell training and knowledge
management software to corporate customers and provide electronic assessment
software and services to educational publishers. Our software and support
services accounted for approximately 86%, 85%, and 86% of our net sales in 2001,
2000, and 1999, respectively. Summary financial information relating to the
software segment of our business can be found in Item 8, Financial Statements
and Supplementary Data (specifically, refer to note 14 of the Notes to
Consolidated Financial Statements).

ACCELERATED READER

Accelerated Reader is a learning information system for motivating and
monitoring increased literature-based reading practice. Accelerated Reader is
designed to be very easy to use by students and educators alike. A student
selects a book at an appropriate reading level from a list of books for which
the school has an Accelerated Reader quiz and reads the book. The student then
takes a multiple-choice quiz on a computer. The questions contained in the
quizzes are carefully drafted to ensure that a student who has thoroughly read a
book at the appropriate level will pass. For each book read, Accelerated Reader
tracks the amount of reading practice achieved by calculating points based on
the length and difficulty of the book and the student's performance on the quiz.
The information generated from this process -- titles read, percent of
comprehension and amount of reading done -- creates a database of student
reading achievement. From this database, Accelerated Reader generates more than
30 different reports from which educators can monitor the amount and quality of
reading practice for each of their students and easily identify individual
students who may require special attention. AR Universal, the most recent
version of Accelerated Reader, supports new recorded-voice versions of quizzes
on literature books for emergent readers and new quizzes for assessing reading
instruction assignments such as those found in reading textbooks, magazines and
other curricula. Accelerated Reader includes built-in Spanish-English
capabilities and supports Literacy Skills quizzes. Literacy Skills quizzes allow
educators using Accelerated Reader to assess students' proficiency on 24
specific skills found in state and district language arts standards and many
standardized tests. We developed quizzes on over 12,000 book titles in 2001 and
currently have a library of computerized book quizzes on more than 51,000
titles. Titles on disk are organized by reading level and subject matter.
Continued usage of Accelerated Reader creates demand for additional quizzes,
STAR Reading, Reading Renaissance training, and related products.

STAR READING

STAR Reading is a computer-adaptive reading test that we believe is the
first software to provide to classroom teachers reading scores statistically
correlated to national norms in ten minutes or less at the computer. STAR
Reading adapts itself to each student's reading level by applying a proprietary
branching logic that evaluates the pattern of the student's answers to determine
the level of difficulty required for subsequent questions. The results from this
test provide educators with a database of statistically accurate reading level
information on their students from which they can generate useful reports and
adjust instructional strategies accordingly. STAR Reading is easy to use and can
be administered several times per year. STAR Reading uses a two-stage test to
help educators pinpoint students' reading levels more accurately and
efficiently.

ACCELERATED MATH

Accelerated Math is a task-level learning information system that helps
students to meet math objectives, first grade through calculus. It employs
algorithm technology to automatically align assignments to academic objectives
and tracks mastery of each objective. Like Accelerated Reader, Accelerated Math
encourages and

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monitors student practice of foundational skills, while providing immediate
feedback on performance to students and teachers. An AccelScan optical-mark card
scanner is included with the sale of Accelerated Math site licenses to
efficiently handle all scoring and record-keeping chores, minimizing teacher
effort and paperwork. Many additional scanners are sold separately. In 2001, we
began shipment of several new products for use with the Accelerated Math system:
state standards tags for over 30 additional states; a specialized Texas state
standards aligned library; textbook-aligned libraries for popular math
textbooks; and math learning cards, which are instructional supplements for
assisting with teaching math objectives aligned to Accelerated Math libraries.

STAR MATH

STAR Math is a computer-adaptive math test and database that provides the
same benefits as STAR Reading. STAR Math reports provide objective information
to help educators instantly place new students, monitor progress, and match
instruction to individual student levels. Quick, accurate, and easy to
administer, STAR Math provides math scores for third grade through high school
in approximately 15 minutes. Like STAR Reading, it can be administered
throughout the school year to track math development.

PERFECT COPY

Perfect Copy is software that helps educators improve students' core
writing skills. It uses in-context editing to cover the rules of grammar,
punctuation, and word usage. Detailed reports from Perfect Copy help teachers
monitor student progress and point out areas that need improvement. Perfect Copy
High School, introduced in 2000, is our first product aimed specifically at the
secondary education market.

STAR EARLY LITERACY

STAR Early Literacy is computer-adaptive diagnostic assessment software
that can pinpoint the phonemic awareness, phonics, vocabulary and other key
literacy skills of pre-K-3 students in approximately 10 minutes per student. The
software's computer-adaptive testing and 2,400-item test bank allow repeated
assessments throughout the school year, identifying specific strengths and
diagnosing specific weaknesses in skills covered by early literacy curricula and
standards.

SURPASS

Surpass test-preparation software generates practice tests that mirror
state standardized tests in content, format, and the test-taking experience.
Surpass reports enable educators to immediately diagnose problems, focus on each
student's strengths and weaknesses, and develop effective intervention
strategies to raise test scores. Instant feedback is provided to students
including explanations for both correct and incorrect answers. Currently, there
are versions of Surpass available for the TAAS, SAT 9, California standards,
ITBS and Terra Nova standardized tests.

TOTAL KNOWLEDGE MANAGEMENT ("TKM")

The TKM system is integrated, enterprise-wide training and knowledge
management software. The system creates, launches, and manages training in all
media including intranet, internet, CD-ROM, print, and instructor-led training
and includes features which allow access to knowledge data bases via wireless
technology. We sell the system primarily to businesses and government agencies.

EXPERT SUPPORT PLANS

We offer Expert Support Plans ("ESPs") that provide users of our products
access to telephone support. Packaged with kits and also sold separately under
12 or 24-month agreements, ESPs entitle educators to expert help resolving
questions regarding technical problems with our products, networks, and other
software interacting with our products.

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CUSTOM ASSESSMENT PRODUCTS

We provide custom assessment products to educational publishers for the
K-12 and post-secondary education market. We customize the content of these
products to precisely align with specific publisher textbooks and other
publisher instructional materials. Our custom alignment process allows educators
to effectively integrate the use of these products into the classroom utilizing
existing curricula and classroom materials.

RENAISSANCE PROFESSIONAL DEVELOPMENT

We offer professional development programs and products that help educators
successfully combine use of our software products with proven classroom
techniques in order to increase the effectiveness of their instruction, leading
to improved student achievement. Revenues from professional development
accounted for approximately 14%, 15%, and 14% of our net sales in 2001, 2000,
and 1999, respectively.

We offer a variety of seminars and workshops, including one and two-day
training programs, which are conducted throughout the year at various hotel
locations in the United States, and on-site training programs pursuant to which
our training staff visits an individual school, school district or region to
conduct a seminar or workshop. Since its inception in late 1993 through December
31, 2001, we have trained over 350,000 educators, of whom approximately 80,000
were trained in 2001. We believe that our professional development programs
increase the utilization of our learning information systems in schools,
resulting in increased sales of add-on products such as Accelerated Reader
quizzes, Accelerated Math libraries, student software expansions and to overall
increased customer interest in, and thereby, purchases of, our other products
and services which tend to complement each other.

To encourage educators who have completed Renaissance training to fully
implement the methodology, we initiated the "Model Classroom" certification
program in 1995. This program recognizes educators who meet certain objective
implementation standards related to the amount of accountable student practice
of essential skills, regular diagnosis and intervention with at-risk students,
and other key variables. As of February 1, 2002, the program has certified over
12,000 reading "Model Classroom" teachers, and over 400 reading "Model Schools"
in which the majority of classrooms have "Model Classroom" teachers.

Summary financial information relating to the training segment of our
business can be found in Item 8, Financial Statements and Supplementary Data
(specifically, refer to note 14 of the Notes to Consolidated Financial
Statements).

READING RENAISSANCE

The Reading Renaissance program provides educators with professional
development training to most effectively use the Accelerated Reader, STAR
Reading, and the learning information they generate. This training combines
technology and classroom techniques to increase in-school accountable reading
practice.

MATH RENAISSANCE

One-day Math Renaissance seminars instruct educators in techniques to
enhance their math curriculum and instruction methods through effective use of
Accelerated Math, STAR Math and the information from the detailed reports that
the programs produce.

RENAISSANCE SCHOOLWIDE

Renaissance Schoolwide, sometimes referred to as School Renaissance, is a
comprehensive multi-year school and district-wide improvement program.
Renaissance Schoolwide combines implementation of our major software products,
professional development training, and consulting services over a period of
several years to entire schools and school districts.

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OTHER RENAISSANCE SEMINARS

Our other professional development programs include: Using STAR Early
Literacy and Renaissance In Your Pre-K-3 Classroom; The Reading Renaissance
Librarian; Renaissance Diagnosis and Intervention; Renaissance Leadership;
Renaissance Classroom Management; and Renaissance Test Strategies. These
professional development seminars combine effective use of technology with
proven classroom techniques to increase both educator effectiveness and student
achievement.

EDUCATOR RESOURCES

We also produce videotapes, handbooks, lesson books, math learning cards
and workbooks, to be used by educators in conjunction with our training
programs. Further, we conduct research on best practices, perform field
validation of techniques, publish internally generated as well as third-party
research and gather information to guide the development of our learning
information systems.

PRODUCT DEVELOPMENT

We believe that continued substantial investment in product development is
required to remain competitive and grow in the K-12 marketplace. We invest
continuously in the development of new products, enhancement of existing
products, and development of tools to increase the efficiency of product
development. For the years ended December 31, 2001, 2000, and 1999, we expended
approximately $18.3 million, $15.4 million, and $8.9 million, respectively, on
product development (including amounts capitalized).

We generate new software product concepts that we believe will help
educators improve student academic performance, based on our understanding of
learning information theory and the need for practice of essential academic
skills. These product concepts are then refined based on feedback from our
customers, which we continuously solicit and incorporate throughout the new
product development process. Based on the refined product concepts, product
proposals are then formulated by the product management, marketing and software
engineering groups and reviewed by management to determine which should be
developed into prototypes. These prototypes are then tested in customer schools.
Before beginning production, management makes a final evaluation of each new
product to determine that it is both desired by educators and effective in
meeting their needs.

The professional development training programs were originally developed,
and are continually refined, through field experience with our products and
research by our staff. We conduct research into effective education techniques
related to our products and services. This research provides the staff with a
standard against which to develop and refine training programs to help educators
accelerate learning.

SELLING AND MARKETING

We market our products primarily to individual educators in the K-12
market, including teachers, school librarians, and principals. We also market
our products to entire schools and school districts, as well as internationally
through our subsidiaries in Canada, the United Kingdom and Australia. Our
training and knowledge management software is currently sold primarily to
corporate customers. Our sales and marketing strategy consists primarily of
direct marketing to potential and existing customers, and through sales staff in
the field. We use a variety of lead-generating techniques, including trade
shows, advertisements in educational publications, direct mail, websites, and
referrals. Once product literature has been forwarded to a current or potential
customer, one of our in-house staff of telephone sales representatives contacts
the customer to answer questions and, ultimately, direct the customer to a
purchase. For potential district sales, a sales meeting is arranged with a field
representative to discuss purchase and implementation of our software products,
professional development training and consulting services on a district-wide,
multi-year basis.

In addition, we have resale arrangements with various book dealers and book
publishers that are authorized to sell our products to their customers. These
firms are particularly receptive to such alliances because use of our products
in schools encourages, rather than competing with, the sale of books and other

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products sold by these firms. Sales to one of the distributors, Perma-Bound, a
division of Hertzberg-New Method, Inc. ("Perma-Bound"), accounted for 7.0%,
8.5%, and 11.5% of our net sales in 2001, 2000, and 1999, respectively. We do
not offer price protection or stock balancing rights to our resellers and
distributors.

Part of our distribution strategy is to develop cross-marketing
arrangements with third-party firms selling non-competing products into the
education market. We have formed strategic alliances with book distributors and
publishers in order to develop additional new product opportunities and to
enhance the channels available to sell and distribute existing products. We have
alliances with several leading educational publishers including Scott Foresman,
Houghton Mifflin Company's School Division, McGraw-Hill, and Harcourt School
Publishers, in which we offer Accelerated Reader quizzes aligned to the
publishers' reading selections to help teachers assess student comprehension and
monitor students' reading growth. We have similar alliances with Houghton
Mifflin Company's School Division and with Glencoe/McGraw-Hill in which we offer
Accelerated Math software aligned with their school textbook programs that
mirror the objectives, problem types, and presentations in their textbooks.

We held our second annual National School Renaissance Conference in March
2001 in Las Vegas, Nevada. The conference provided over 5,000 teachers and
administrators with opportunities to network, receive professional development
training, hear the latest research, view our newest products and services, and
plan future uses of our Renaissance Schoolwide improvement process. The 2002
conference will be held at San Antonio, Texas in February 2002.

PRODUCTION

Currently, most of our software products are distributed on CD-ROM or
diskettes. Bulk CD-ROMs are produced by a third-party contractor. We produce
order-specific and smaller batches of CD-ROMs at our shipping and fulfillment
facility. Diskettes are duplicated and packaged at our shipping and fulfillment
facility. Other related products, including videotapes, books, graphics, and
motivational items, are produced by third-party vendors. Scanners are produced
to our specifications by a contract manufacturer. Our on-line ordering and
delivery system introduced in 1999 has been highly successful in selling
Accelerated Reader quizzes over the Internet.

COMPETITION

The K-12 educational technology and professional development markets in
which we operate are very competitive. We compete primarily against more
traditional methods of education, training, and testing, including pencil and
paper testing. In addition, we compete with other companies offering educational
software products and professional development services to schools. Our reading
products also compete more directly with products such as Scholastic's Reading
Counts. Many other companies provide educational software products which we
believe are not marketed primarily to schools. Our existing competitors may
continue to broaden their product lines, and potential competitors, including
large hardware manufacturers, software developers, and educational publishers,
may enter or increase their focus on the school market, resulting in greater
competition for us. Success in selling our products, particularly our reading
products, may cause competitors to focus on our products in their marketing
efforts thereby increasing direct competition. There can be no assurance that we
will continue to be able to market our products successfully or compete
effectively in the educational product marketplace.

INTELLECTUAL PROPERTY

We regard certain of our technologies as proprietary and rely primarily on
a combination of patent, copyright, trademark and trade secret laws and employee
non-disclosure agreements to establish and protect our proprietary rights. There
can be no assurance that the steps taken by us to protect our rights will be
adequate to prevent or deter misappropriation. In addition, while we do not
believe that our products, trademarks or other proprietary rights infringe upon
the proprietary rights of third parties, there can be no assurance that a third
party will not make a contrary assertion. The cost of responding to such an
assertion

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may be material, whether or not the assertion is validated. The software market
has traditionally experienced widespread unauthorized reproduction of products
in violation of intellectual property rights. Such activity is difficult to
detect and legal proceedings to enforce intellectual property rights are often
burdensome and involve a high degree of uncertainty and costs. There can be no
assurance that our software products will not experience unauthorized
reproduction, which would have a material adverse effect on our business,
financial condition, and results of operations.

EMPLOYEES

As of February 1, 2002, we had 991 full and part-time employees. We believe
our relations with employees are good. None of our employees is represented by a
union or subject to collective bargaining agreements.

BACKLOG

As of December 31, 2001 and 2000, we had backlogs that aggregated
approximately $7.4 million and $7.8 million, respectively. The backlogs at
December 31, 2001 and 2000 are primarily made up of training seminars and
programs not yet conducted and for registrations for our National School
Renaissance Conference. Substantially all of the 2001 backlog is expected to be
realized during 2002.

FORWARD-LOOKING STATEMENTS

In accordance with the Private Securities Litigation Reform Act of 1995, we
can obtain a "safe-harbor" for forward-looking statements by identifying those
statements and by accompanying those statements with cautionary statements which
identify factors that could cause actual results to differ materially from those
in the forward-looking statements. Accordingly, the following information
contains or may contain forward-looking statements: (1) information included or
incorporated by reference in this Annual Report on Form 10-K, including, without
limitation, statements made under Item 1, Business and Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
including, without limitation, statements with respect to growth plans,
projected sales, revenues, earnings and costs, and product development schedules
and plans, (2) information included or incorporated by reference in our future
filings with the Securities and Exchange Commission including, without
limitation, statements with respect to growth plans, projected sales, revenues,
earnings and costs, and product development schedules and plans and (3)
information contained in written material, releases and oral statements issued
by us, or on our behalf, including, without limitation, statements with respect
to growth plans, projected sales, revenues, earnings and costs, and product
development schedules and plans. Our actual results may differ materially from
those contained in the forward-looking statements identified above. Factors
which may cause such a difference to occur include, but are not limited to, the
following:

Reliance on Single Product Line and Significant Distributor. Our
Accelerated Reader software and supplemental Accelerated Reader quizzes
accounted for approximately 34%, 34%, and 40% of our net sales in 2001, 2000,
and 1999, respectively. Sales of our products through one book distributor
accounted for 7.0%, 8.5%, and 11.5% of net sales in 2001, 2000, and 1999,
respectively. An overall decline in sales of Accelerated Reader and supplemental
quizzes, including sales through book distributors, would have a material
adverse effect on our business, financial condition, and results of operations.

Dependence on Continued Product Development. The K-12 educational
technology and professional development markets in which we compete are
characterized by evolving industry standards, frequent product introductions,
and sudden technological change. Our future success will depend, to a
significant extent, on a number of factors, including our ability to enhance our
existing products and develop and successfully introduce new products, including
new products designed for use in other areas of the curriculum, our ability to
ship new products in a timely fashion and our ability to respond quickly and in
a cost efficient manner to technological change, including shifts in operating
systems, languages, alternative delivery systems and other environments. There
can be no assurance that new products will be as well received as our
established

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products, particularly since such other products may require technology and/or
resources not generally available in all schools. We attempt to maintain high
standards for the demonstrated academic effectiveness of our products. Our
adherence to these standards could delay or inhibit the introduction of new
products. Moreover, there can be no assurance that our products will not be
rendered obsolete or that we will have sufficient resources to make the
necessary investments or be able to develop and market the products required to
maintain our competitive position.

Management of Growth. We have experienced rapid growth. If such growth
continues, it may place a strain on our financial, management, systems, and
other resources. Our ability to manage our growth effectively will require us to
attract, train, motivate, manage, and retain key employees and to improve our
operational, financial, and management information systems. If we were unable to
maintain and manage growth effectively, our business, financial condition, and
results of operations would be adversely affected.

Risks of New Products and Services for New Markets. Our business strategy
includes the introduction of new products and services directed at new markets.
Through our Generation21 Learning Systems subsidiary, we sell enterprise
software for training development and management primarily to businesses and
government organizations. We have historically focused on the education market
and have little, if any, experience in developing and marketing products and
services to business or government customers. There can be no assurance that we
will be successful in offering new products and services and entering new
markets as planned or that any such products or services, if introduced, will
achieve acceptance in the marketplace.

Risks of International Expansion. A key component of our growth strategy is
to continue to expand our operations into international markets. Doing business
in international markets is subject to a number of risks, including, among
others: acceptance by foreign educational systems of our approach to educational
products; lack of existing customer base; unexpected changes in regulatory
requirements; potentially adverse tax consequences; tariffs and other trade
barriers; difficulties in staffing and managing foreign operations; changing
economic conditions; exposure to different legal standards (particularly with
respect to intellectual property); burdens of complying with a variety of
foreign laws; and fluctuations in currency exchange rates. If any of these risks
were to materialize, our business, financial condition, and results of
operations could be adversely affected.

Opposing Educational Philosophies. We focus on developing and marketing
educational products and services that demonstrate effectiveness through
measurable results. This approach, however, is not accepted by all academics and
educators, some of whom formulate opinions about the desirability of a
particular educational product or service based on philosophical or other
concerns rather than the effectiveness of the product. Certain academics and
educators are opposed to the principles and methodologies underlying and
associated with our products, such as the use of objective standards,
standardized testing, computers and motivational techniques, among others. Some
of these philosophical opponents of our products and services have the capacity
to influence the market for our products, and such influence could have a
material adverse impact on demand for our products and, thus, our business,
financial condition, and results of operations.

Dependence on Educational Institutions and Government
Funding. Substantially all of our revenue is derived from sales to educational
institutions, individual educators, and suppliers thereto. There can be no
assurance that educational institutions and/or individual educators will
continue to invest in technology-based products and professional development for
reading and other curricula or continue to respond favorably to our marketing.
Our inability to increase the number of products sold or number of schools
served would adversely affect our business, financial condition, and results of
operations. Because of our dependence on educational institutions, the funding
of which is largely dependent on government support, a substantial decrease in
government budgets or funding for educational software or technology would have
a material adverse effect on our business, financial condition, and results of
operations. Any economic slow down which would negatively affect school funding
could adversely impact the sale of our products to schools. In addition, certain
aspects of government sponsored education initiatives may not endorse, or be
complementary to, the principles and methodologies underlying and associated
with our products, which could adversely affect our business, financial
condition, and results of operations.

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Geographic Concentration of Sales. A substantial portion of our sales is
concentrated in several states, including California, Texas, Florida, Georgia,
and North Carolina, which accounted for approximately $16.9 million, $13.0
million, $6.6 million, $5.8 million, and $5.1 million, respectively, of our net
sales in 2001. If large numbers of schools or a district or districts
controlling a large number of schools in such states were to discontinue
purchasing our products, our business, financial condition, and results of
operations would be materially adversely affected.

Highly Competitive Industry. The K-12 educational technology and
professional development markets in which we operate are very competitive. We
compete primarily against more traditional methods of education, training and
testing, including pencil and paper testing. In addition, we compete with other
companies offering educational software products to schools. Our reading
products also compete more directly with products such as Scholastic's Reading
Counts. Many other companies provide educational software products which we
believe are not marketed primarily to schools. Our existing competitors may
continue to broaden their product lines, and potential competitors, including
large hardware manufacturers, software developers and educational publishers,
may enter or increase their focus on the school market, resulting in greater
competition for us. Success in selling our products, particularly our reading
products, may cause competitors to focus on our products in their marketing
efforts thereby increasing direct competition. There can be no assurance that we
will continue to be able to market our products successfully or compete
effectively in the educational product marketplace.

Dependence on Key Personnel. Our success depends to a significant extent
upon the continued active participation of certain key members of management,
including our co-chairmen, Judith Paul and Terrance Paul. Ms. Paul acts as our
spokesperson and coordinates our public relations and customer communications
policies. Mr. Paul is primarily responsible for our long-term strategic planning
and new product development strategy. We do not have employment agreements with
either of these persons and have no current intention of entering into any such
employment agreements. The loss of services of either of these persons would
have a material adverse effect on our business, financial condition, and results
of operations.

Ability to Attract and Retain Qualified Personnel. Our future success will
depend, in part, upon our continuing ability to retain the employees, including
senior management personnel, who have assisted in the development and marketing
of our products and to attract and retain qualified additional employees trained
in computer technology, marketing, finance, and other disciplines to enhance our
product offerings and broaden our operations. There can be no assurance that we
will continue to be able to attract and retain such personnel. The failure to
attract or retain the necessary personnel would have a material adverse effect
on our business, financial condition, and results of operations.

Fluctuations in Quarterly Performance. We generally ship products as orders
are received, and therefore, we have historically operated without a significant
backlog of products. Thus, product revenues in any quarter are substantially
dependent on the quantity of product orders received in that quarter. The
quantity of product orders in any quarter can be affected by a variety of
factors, including the following:

- delays in the development and/or shipment of new products can adversely
affect our revenue in one or more quarters;

- the shipment of new products for which orders have been building for some
period of time can cause the revenues in the quarter in which shipment
occurs to be higher than revenues in preceding or subsequent quarters;
and

- seasonal variations due to, among other things, the budget and school
year cycles of our school customers.

In addition to fluctuations in product orders, our quarterly results can
also be affected by the following:

- charges related to acquisitions, including acquisition expenses, the
write-off of in-process research and development, the amortization of
goodwill, and similar items;

9

- charges related to obsolete or impaired assets; and

- expenses related to product development and marketing initiatives.

Our overall gross margins also fluctuate based upon the mix of product
sales and service sales. We realize significantly higher margins on our product
sales. Service revenues tend to be more seasonal than product revenues,
resulting in seasonal variations in margins. Quarterly service revenues are
typically highest in the third quarter.

Share Price Volatility. Numerous factors, many of which are beyond our
control, may cause the market price of our common stock to fluctuate
significantly. These factors include announcements of technological innovations
and/or new products by us and our competitors, earnings releases and earnings
warnings by us and our competitors, expectations regarding government funding
levels for education, market conditions in the industry, and the general state
of the securities markets. The market price of our common stock may decline
significantly if we fail to meet the published earnings estimates of analysts
and others. In addition, quarterly fluctuations of our results of operations as
described above may cause a significant variation in the market price of our
common stock.

Limited Protection of Intellectual Property and Proprietary Rights. We
regard certain of our technologies as proprietary and rely primarily on a
combination of patent, copyright, trademark and trade secret laws and employee
non-disclosure agreements to establish and protect our proprietary rights. There
can be no assurance that the steps taken by us to protect our rights will be
adequate to prevent or deter misappropriation. In addition, while we do not
believe that our products, trademarks or other proprietary rights infringe upon
the proprietary rights of third parties, there can be no assurance that a third
party will not make a contrary assertion. The cost of responding to such an
assertion may be material, whether or not the assertion is validated. The
software market has traditionally experienced widespread unauthorized
reproduction of products in violation of intellectual property rights. Such
activity is difficult to detect and legal proceedings to enforce intellectual
property rights are often burdensome and involve a high degree of uncertainty
and costs. There can be no assurance that our software products will not
experience unauthorized reproduction, which would have a material adverse effect
on our business, financial condition, and results of operations.

War, Acts of War and Terrorism. Delays and reductions in purchases of our
products may occur as a result of war, acts of war and terrorism, and the
related impacts, including: a reduction of funds available to our customers to
purchase our products and services and disruptions in our ability to develop,
produce and distribute products and services to our customers. These events
would have a material adverse effect on our business, financial condition and
results of operations.

Concentration of Share Ownership; Control by Principal
Shareholders/Management. As of February 28, 2002, our principal shareholders,
Judith and Terrance Paul, our co-Chairmen, beneficially owned approximately 68%
of our outstanding common stock. As a result, these principal shareholders have
the ability to control and direct our business and affairs.

Shares Eligible for Future Sale. Sales of a substantial number of shares of
our common stock in the public market could adversely affect the market price
for the common stock. As of February 28, 2002, approximately 23.7 million shares
of our common stock were held by "affiliates" and may be publicly sold only if
registered under the Securities Act of 1933 or sold in accordance with an
applicable exemption from registration, such as Rule 144. In addition, we have
filed registration statements under the Securities Act of 1933 to register an
aggregate of 3,000,000 shares of common stock reserved for issuance under our
1997 Stock Incentive Plan and an aggregate of 500,000 shares of common stock
reserved for issuance under our Employee Stock Purchase Plan, which will, when
issued in accordance with such plans, be eligible for immediate sale in the
public market, subject to the Rule 144 resale limitations for affiliates.

Our principal shareholders, Judith and Terrance Paul, have adopted a
securities trading plan with respect to a portion of their Renaissance Learning,
Inc. common stock. The plan provides for the sale of approximately 4% of the
Paul's current holdings of common stock on an annual basis. The plan provides
for monthly sales, subject to various legal and contractual limitations.

10

No Payment of Cash Dividends. We do not anticipate paying any cash
dividends in the foreseeable future.

Possible Antitakeover Effects of Certain Articles and By-Law Provisions and
Provisions of Wisconsin Law. Our Amended and Restated Articles of Incorporation
and Amended and Restated By-Laws, along with Wisconsin statutory law, contain
provisions that could discourage potential acquisition proposals and might delay
or prevent a change in control of Renaissance Learning, Inc. Such provisions
could result in our being less attractive to a potential acquirer and could
result in the shareholders receiving less for their common stock than otherwise
might be available in the event of a takeover attempt.

ITEM 2. PROPERTIES

Our corporate headquarters are located in Wisconsin Rapids, Wisconsin, in a
125,000 square foot facility owned by us. We also own a 34,000 square foot
shipping and fulfillment facility in Wisconsin Rapids, Wisconsin. Our training
operations are located in a 74,000 square foot facility in Madison, Wisconsin
owned by Athena Holdings LLC ("Athena"). We own 70% of Athena and we lease
43,000 square feet of the facility from Athena. Additionally, we lease various
other office space to accommodate subsidiary operations.

ITEM 3. LEGAL PROCEEDINGS

We are subject to various claims and proceedings covering a wide range of
matters that arise in the ordinary course of our business activities. We believe
that any liability that may ultimately arise from the resolution of these
matters will not have a material adverse effect on our financial condition or
results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There was no matter submitted during the fourth quarter of fiscal 2001 to a
vote of our security holders.

11

EXECUTIVE OFFICERS OF THE REGISTRANT

The term of office of each executive officer is from one annual meeting of
the board of directors until the next annual meeting of the board of directors
or until a successor for each is selected.

There are no arrangements or understandings between any of our executive
officers and any other person (not an officer or director of the company acting
as such) pursuant to which any of the executive officers were selected as an
officer of the company.

13

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Our common stock is traded under the symbol "RLRN" on The Nasdaq Stock
Market(R), and quotations are supplied by the National Association of Securities
Dealers, Inc. The table below sets forth the reported high and low closing sale
prices for shares of our common stock on The Nasdaq Stock Market(R) during the
indicated quarters.

HOLDERS

As of February 11, 2002, there were 744 record holders of the common stock.

HISTORICAL DIVIDENDS

For the years ended December 31, 2001 and 2000, no dividends or other
distributions were paid to shareholders. We intend to retain all of our future
earnings to fund growth, acquisition opportunities and the operation of our
business and therefore do not anticipate paying any cash dividends in the
foreseeable future. Future cash dividends, if any, will be at the discretion of
our board of directors and will depend upon, among other things, our future
operations and earnings, capital requirements and surplus, general financial
condition, contractual restrictions, and such other factors as the board of
directors may deem relevant.

RECENT SALES OF UNREGISTERED SECURITIES

There were no sales of unregistered securities during the year ended
December 31, 2001.

14

ITEM 6. SELECTED FINANCIAL DATA

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

- -------------------------

(1) In July 1999, we acquired Generation21 Learning Systems, LLC in a
transaction accounted for as a pooling-of-interests. Accordingly, financial
information for all periods presented has been restated to include the
results of Generation21.

(2) Per share data have been restated to reflect a 2-for-1 stock split in the
form of a dividend effective February 26, 1999.

(3) For the years ended December 31, 2001, 2000 and 1999, no cash dividends were
paid to shareholders.

15

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

Renaissance Learning, Inc. is a leading provider of comprehensive school
improvement to kindergarten through senior high ("K-12") schools in the United
States and Canada. Our software products, teacher training, and consulting help
educators motivate students, accelerate learning, improve test scores, and help
students master standards. The computer-based learning information systems and
related training we offer are designed to improve student academic performance
by increasing the quality, quantity, and timeliness of performance data
available to educators and by facilitating increased student practice of
essential skills. Our flagship product, Accelerated Reader, is software for
motivating and monitoring increased literature-based reading practice. Our
software products also include: STAR Reading, a computer-adaptive reading test
and database; Accelerated Math and STAR Math, software products that apply to
math the principles that have made the reading software effective in improving
academic performance; STAR Early Literacy computer-adaptive diagnostic test for
phonemic awareness and other emergent reading skills; Perfect Copy writing
skills development software; and Surpass test preparation software.

In 2001 we introduced and shipped AR Universal, a new version of our
Accelerated Reader reading management program which supports new recorded-voice
versions of quizzes on literature books for emergent readers and new quizzes for
assessing reading instruction assignments such as those found in reading
textbooks, magazines and other curricula. STAR Early Literacy was released late
in the second quarter of 2001. In late 2001 and early 2002, we announced several
new products which we expect to be released during 2002: Fluent Reader repeated
reading software for struggling readers; StandardsMaster instant assessment and
Web-based reporting software; Accelerated Writer writing improvement system;
Accelerated Vocabulary vocabulary development software; and AccelTest test
creation, scoring and gradebook software. In addition, we provide electronic
assessment software and services to educational publishers, enterprise software
for training and knowledge management throughout organizations, and an
optical-mark card scanner which was totally reengineered in 2001 for lower cost
and improved performance.

Our comprehensive school improvement products also include Reading
Renaissance, Math Renaissance and other programs through which we provide
professional development training for educators. Our School Renaissance program
is a comprehensive package of software, professional development training, and
consulting services aimed at accelerating learning and improving test scores in
reading, math, writing, and overall academic performance throughout schools and
school districts. In 2001, we introduced the seminar, Using STAR Early Literacy
and Renaissance in Your Pre-K-3 Classroom, that shows teachers how to use the
new STAR Early Literacy program. Early in 2002, we announced that Writing
Renaissance is expected to be available sometime later in 2002.

Our sales are derived primarily from the sale of software products,
software support agreements, and training seminars and programs. Revenues are
recorded net of an allowance for estimated returns. Allowances for bad debts are
also recorded at the time of the sale. Product revenue is derived primarily from
the sale of software products. We recognize revenue from sales of our
off-the-shelf software products at the time of shipment to customers. We
recognize revenue from the sale of custom software products on the
percentage-of-completion method of accounting.

Service revenue is derived from (i) training seminars, (ii) consulting
services, and (iii) software support agreements whereby we provide ongoing
customer support as well as unspecified product upgrades if and when available.
Revenue from training seminars is recognized when the seminar is performed.
Revenue from consulting services is recognized as the service is performed or on
a straight-line basis over the contractual period. Telephone support included
with software sales has a duration of twelve months or less and is recognized at
the time the software is shipped with the related costs of providing the
telephone support accrued for at the same time. Revenue from separately sold
software support agreements is initially recorded as deferred revenue and
recognized as revenue on a straight-line basis over 12 or 24 months depending on
the term of the support agreement. Deferred revenue includes (i) payments
received for products not yet

16

delivered, (ii) advance payments on contract revenues, (iii) payments received
for seminars not yet held, and (iv) that portion of separately sold software
support agreements that has not yet been recognized as revenue.

Because software products are generally shipped as orders are received, we
have historically operated without a significant backlog of products. However,
it is our practice to announce new products prior to the time at which such
products will be ready for shipment to allow customers sufficient lead time for
budgeting and curriculum purposes. This practice can result in a significant
backlog for orders of new products. These orders are generally filled within a
relatively short period of time after the product is ready for shipment.
Registrations for training seminars are generally received from customers in
advance of training events, resulting in a backlog for these services.
Additionally, under district-wide school improvement agreements, customers
commit to a comprehensive package of software, training, and consulting in
advance of delivery of the products and services. The delivery of backlogged
products and services in certain periods can cause those periods to have
somewhat higher sales and higher sales growth rates than other periods.

Cost of sales consists of expenses associated with sales of software
products, support agreements, and training seminars and programs. These costs
include: (i) personnel-related costs, (ii) costs of purchased materials such as
optical-mark card scanners, educational products, training materials, manuals
and motivational items, (iii) shipping and freight costs, (iv) amortization of
capitalized development costs, and (v) other overhead costs. We recognize
significantly higher gross margins on our product sales than on our service
sales. An optical-mark card scanner is included with the sale of all Accelerated
Math site licenses and many additional scanners are sold separately. The gross
profit margin on hardware is not as high as the gross profit margin on software.
We began shipping hardware in 1998 and as sales of hardware increased the
overall product margin percentage declined in 1999 and 2000.

We expense all development costs associated with a software product until
technological feasibility is established, after which time such costs are
capitalized until the product is available for general release to customers.
Capitalized product development costs are amortized into cost of sales generally
using the straight-line method over 24 months.

In November 2000, our subsidiary, Renaissance Corporate Services, Inc.,
acquired the assets and business of Engineering Software Associates, Inc.
("ESA"), Minneapolis, Minnesota, a provider of test generation and tutorial
software to college textbook publishers. Post-secondary textbook publishers have
commissioned ESA software to support textbooks on a wide variety of subjects.
Instructors using the texts can administer tests to students on paper, via
networks or over the Internet. The acquisition is not expected to have a
material impact on our overall results of operations in the near term.

17

RESULTS OF OPERATIONS

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

YEARS ENDED DECEMBER 31, 2001 AND 2000

Net Sales. Our net sales increased by $25.4 million, or 23.7%, to $132.4
million in 2001 from $107.0 million in 2000. Product sales increased by $23.7
million, or 27.2%, to $110.7 million in 2001 from $87.0 million in 2000. The
increase in product sales is primarily attributable to (i) increased sales of
math products, including follow-on sales of subject libraries and optical-mark
card scanners, (ii) increased sales of Accelerated Reader quizzes, with over
51,000 available book titles, to a larger base of Accelerated Reader schools,
and (iii) sales of STAR Early Literacy, which was released late in the second
quarter of 2001.

Service revenue, which consists primarily of revenue from sales of training
sessions and software support agreements, increased by $1.7 million, or 8.3%, to
$21.7 million in 2001 from $20.0 million in 2000. The majority of this increase
is attributable to a 20.5% increase in revenue recognized software support
agreements. Revenues from training sessions grew slightly over 2000.
Approximately 80,000 educators attended our Renaissance training programs in
2001.

We expect overall 2002 revenue growth to be similar to 2001. Revenue growth
is anticipated to be higher in the second half of the year than the first due to
the availability of increased federal funds to schools and the expected shipment
of our new products in spring and summer. Our new products include: Fluent
Reader repeated reading software for struggling readers; StandardsMaster instant
assessment and Web-based reporting software; Accelerated Writer writing
improvement system; Accelerated Vocabulary vocabulary development software; and
AccelTest test creation, scoring and gradebook software. A fourth quarter 2001

18

math software promotion contributed to a quarterly increase of about 1,400
schools using math products, bringing the total number of schools using our math
products to about 16,000. We expect continued growth in follow-on sales of
libraries, scanners, math learning cards and training. We also expect continued
steady growth of our reading products and continued expansion of our
district-wide school improvement business.

Cost of Sales. The cost of sales of products increased by $3.2 million, or
27.8%, to $14.9 million in 2001 from $11.6 million in 2000. As a percentage of
product sales, the cost of sales of products remained constant at 13.4%. Late in
2001 we completed the reengineering of our AccelScan optical-mark card scanner
for lower cost and improved performance. The lower cost has enabled us to lower
the list price by $50.00 in January 2002 and still achieve improved margins on
the new scanner sales.

The cost of sales of services decreased by $364,000, or 3.5%, to $9.9
million in 2001 from $10.3 million in 2000. As a percentage of sales of
services, the cost of sales of services decreased to 45.9% in 2001 from 51.5% in
2000. The improvement was due to stronger sales in the software support business
and improved cost efficiencies in both the training and software support
businesses. Service gross profit margin is expected to be somewhat lower in
first quarter 2002 due to the National School Renaissance Conference, as has
been the previous pattern. On an annual basis in 2002, we anticipate a moderate
improvement in service gross profit margins over 2001.

Our overall gross profit margin increased 1.8% to 81.3% in 2001 from 79.5%
in 2000 due to improved gross profit margins on services and to a higher
proportion of products in the sales mix during 2001.

Product Development. Product development expenses increased by $2.9
million, or 19.3%, to $17.8 million in 2001 from $14.9 million in 2000. These
expenses increased primarily due to increased staff and consulting costs
associated with new product development including several new products announced
in late 2001 and early 2002: Fluent Reader, StandardsMaster, Accelerated Writer,
Accelerated Vocabulary, and AccelTest, which are scheduled to be available for
shipment in 2002.

Increased product development expenses are also attributed to: our new
AccelScan optical-mark card scanner which was totally reengineered in 2001;
continued development of a suite of Web-based versions of our existing core
products; and new products at various stages of development which we expect to
announce in the future. We anticipate that the growth of product development
costs will moderate in 2002. As a percentage of net sales, product development
costs decreased to 13.4% in 2001 from 13.9% in 2000.

Selling and Marketing. Selling and marketing expenses increased by $5.6
million, or 23.0%, to $29.7 million in 2001 from $24.2 million in 2000. These
expenses increased primarily due to (i) direct mailings to an increased customer
and prospect base, (ii) increased wages and related benefit costs associated
with hiring additional personnel to market and promote a broader product line,
(iii) costs related to selling and marketing our district-wide school
improvement program, and (iv) costs of marketing the Generation21
enterprise-wide training and knowledge management software. As a percentage of
net sales, selling and marketing expenses remained constant at 22.6%. We
anticipate that selling and marketing expenses will generally continue to rise
as we aggressively market our existing products and promote our new products in
2002.

General and Administrative. General and administrative expenses increased
by $2.5 million, or 21.0%, to $14.3 million in 2001 from $11.8 million in 2000.
The higher expenses for 2001 are largely due to increased wages and related
benefit costs associated with the hiring of additional personnel, and
professional fees, to support a larger base of business including Generation21
and the acquisition of ESA which was completed in November of 2000. As a
percentage of net sales, general and administrative costs decreased to 10.8% in
2001 from 11.1% in 2000. We expect that general and administrative costs will
increase to support our growth, but will decrease somewhat as a percentage of
net sales in 2002.

Operating Income. Operating income increased by $11.6 million, or 33.8%, to
$45.7 million in 2001 from $34.1 million in 2000. As a percentage of net sales,
operating income increased to 34.5% in 2001 from 31.9% in 2000.

19

Income Taxes. Income tax expense of $19.2 million was recorded in 2001 at
an effective income tax rate of 38.5% compared to $14.6 million and 38.9%
effective income tax rate in 2000. We expect to maintain our effective tax rate
at or below 39% in 2002.

YEARS ENDED DECEMBER 31, 2000 AND 1999

Net Sales. Our net sales increased by $23.4 million, or 28.0%, to $107.0
million in 2000 from $83.6 million in 1999. Product sales increased by $19.4
million, or 28.7%, to $87.0 million in 2000 from $67.6 million in 1999. The
increase in product sales is primarily attributable to (i) increased sales of
math products, including follow-on sales of subject libraries and optical-mark
card scanners and (ii) increased sales of Accelerated Reader quizzes to a larger
base of Accelerated Reader schools.

Service revenue, which consists of revenue from sales of training sessions
and software support agreements, increased by $4.0 million, or 25.1%, to $20.0
million in 2000 from $16.0 million in 1999. Approximately $2.0 million of this
increase is attributable to our first annual National School Renaissance
Conference presented in February 2000 and the balance of the increase is
primarily due to increased revenue from Renaissance training sessions. We
trained over 89,000 educators in our Renaissance training programs in 2000.

Revenue growth rates slowed in 2000 due in part to the late fall 1999
shipment of our new version of Accelerated Reader. We missed the prime fall
buying season for schools, which slowed follow-on purchases of Accelerated
Reader quizzes as well as adoptions by new schools in late 1999 and early 2000.
Sales of follow-on quizzes improved in late 2000 as schools had installed the
new Accelerated Reader software and returned to their normal buying patterns.
Sales of Accelerated Math increased significantly in 2000 with a growing
customer base adopting Accelerated Math for their school, and existing customers
purchasing additional subject libraries and scanners to expand utilization
throughout their schools.

Cost of Sales. The cost of sales of products increased by $3.9 million, or
49.6%, to $11.6 million in 2000 from $7.8 million in 1999. As a percentage of
product sales, the cost of sales of products increased to 13.4% in 2000 compared
to 11.5% in 1999 primarily due to increased sales of optical-mark card scanners.
A scanner is included with the sale of all Accelerated Math site licenses and
many additional scanners are sold separately. The gross profit margin on
hardware is not as high as the gross profit margin on software.

The cost of sales of services increased by $2.7 million, or 36.3%, to $10.3
million in 2000 from $7.6 million in 1999. This increase is primarily the result
of costs associated with (i) our first annual National School Renaissance
Conference presented in early 2000, (ii) increased technical support costs due
to a broader product line and the introduction of new versions of existing
products and (iii) increased costs of delivering training sessions. As a
percentage of sales of services, the cost of sales of services increased to
51.5% in 2000 from 47.3% in 1999 due to the higher costs of providing technical
support for our broader product line and new versions of existing products.

Our overall gross profit margin decreased 2.2% to 79.5% in 2000 from 81.7%
in 1999 due to decreased gross profit margins on both products and services.

Product Development. Product development expenses increased by $6.4
million, or 75.5%, to $14.9 million in 2000 from $8.5 million in 1999. These
expenses increased primarily due to increased staff and consulting costs
associated with new product development including several new products announced
in 2000: eSchoolOffice Web-based school administration software, new versions of
Generation21's Total Knowledge Management enterprise training software, and STAR
Early Literacy diagnostic assessment for grades K-2. Increased product
development expenses are also attributed to the development of localized
versions of our products for international markets; the completion of new
Accelerated Reader quizzes; Surpass test-preparation software released for sale
in Texas in late 2000; creation of additional Surpass test-preparation
libraries; continued development of a suite of Web-based versions of our
existing core products; and a number of new products at various stages of
development. As a percentage of net sales, product development costs increased
to 13.9% in 2000 from 10.2% in 1999.

20

Selling and Marketing. Selling and marketing expenses increased by $2.6
million, or 12.2%, to $24.2 million in 2000 from $21.5 million in 1999. These
expenses increased primarily due to (i) salary and recruiting costs associated
with hiring additional personnel to market and promote a broader product line,
(ii) costs of marketing the new Generation21 enterprise-wide training and
knowledge management software, (iii) expenses related to our first National
School Renaissance Conference and (iv) international marketing efforts. As a
percentage of net sales, selling and marketing expenses decreased to 22.6% in
2000 from 25.8% in 1999.

General and Administrative. General and administrative expenses increased
by $1.7 million, or 17.0%, to $11.8 million in 2000 from $10.1 million in 1999.
The higher expenses for 2000 are largely due to increased costs associated with
the hiring of additional personnel, including wages and related benefits, to
support a larger base of business including new initiatives such as Generation21
and the expansion internationally. As a percentage of net sales, general and
administrative costs decreased to 11.1% in 2000 from 12.1% in 1999.

Purchased Research and Development. In connection with the acquisitions of
computerActive, Inc. and the assets of Humanities Software, Incorporated in
1999, $900,000 and $180,000, respectively, of the purchase price was allocated
to purchased research and development which was expensed in 1999. The
computerActive purchased research and development related to a web-server based
school administration and student information system. The elements of this
purchased research and development primarily consisted of partially complete
computer code and related documentation. At the time of acquisition, this
project was less than 50% complete and had not yet reached the stage of
technological feasibility. We believe that work required to reach technological
feasibility and commercialization will take approximately three years from the
acquisition date. Risk factors that may affect the timely completion and
commercialization of the project include evolving industry standards, dependence
on key personnel, and our ability to respond quickly and in a cost efficient
manner to technological change, including shifts in operating systems,
languages, and alternative delivery systems. We incurred approximately $1.1
million dollars in costs on the project in 2000.

Operating Income. Operating income increased by $7.1 million, or 26.4%, to
$34.1 million in 2000 from $27.0 million in 1999. As a percentage of net sales,
operating income decreased to 31.9% in 2000 from 32.3% in 1999. Excluding the
effects of the purchased research and development expense in 1999, operating
income would have increased by $6.0 million, or 21.5%, in 2000 from 1999, or
31.9% of net sales in 2000 compared to 33.6% of net sales in 1999.

Income Taxes. Income tax expense of $14.6 million was recorded in 2000 at
an effective income tax rate of 38.9% compared to $11.9 million and 41.1%
effective income tax rate in 1999.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2001, our cash, cash equivalents and investment
securities increased $41.6 million to $109.6 million from the December 31, 2000
total of $68.0 million. The net increase is due primarily to $41.2 million in
net cash provided by operating activities. 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.

At December 31, 2001, we had a $10.0 million unsecured revolving line of
credit with a bank which is available until March 31, 2002 and which is expected
to be extended for an additional two years. The line of credit bears interest at
either a floating rate based on the prime rate less 1.0%, or a fixed rate for a
period of up to 90 days based on LIBOR plus 1.25%. The rate is at our option and
is determined at the time of borrowing. We also have a $2.0 million unsecured
revolving line of credit with a bank which is available until April 30, 2002,
which was renewed in January 2002 for an additional year. The line of credit
bears interest based on the prime rate less 1%. As of December 31, 2001, the
lines of credit had not been used.

On January 3, 2000 our Board of Directors authorized the repurchase of up
to 1,000,000 shares of our common stock. No time limit was placed on the
duration of the repurchase program. Repurchased shares will become treasury
shares and will be used for stock-based employee benefit plans and for other
general corporate purposes. As of December 31, 2001, we had repurchased 25,100
shares.

21

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Interest Rate Risk. Our exposure to market interest rate risk consists of:
(i) the increase or decrease in the amount of interest income we can earn on our
investment portfolio, and (ii) the decrease or increase in value of our
investment security portfolio if market interest rates increase or decrease,
respectively. We anticipate that we will have sufficient liquidity to hold our
investments to maturity, therefore, we do not expect to recognize any material
losses or gains related to an increase or decrease in market interest rates.

Foreign Currency Exchange Rate Risk. The financial position and results of
operations of our foreign subsidiaries are measured using local currency.
Revenues and expenses of such subsidiaries have been translated into U.S.
dollars at average exchange rates prevailing during the period. Assets and
liabilities have been translated at the rates of exchange at the balance sheet
date. Translation gains or losses are deferred as a separate component of
shareholders' equity. Aggregate foreign currency transaction gains and losses
are included in determining net earnings. As such, our operating results are
affected by fluctuations in the value of the U.S. dollar compared to the
Australian dollar, British pound, Canadian dollar, and Indian Rupee. At this
time, foreign operations are not material.

22

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
RENAISSANCE LEARNING, INC. AND SUBSIDIARIES:

We have audited the accompanying consolidated balance sheets of Renaissance
Learning, Inc. (a Wisconsin corporation, "the Company") and subsidiaries as of
December 31, 2001 and 2000, and the related consolidated statements of income,
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Renaissance
Learning, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States.

ARTHUR ANDERSEN LLP

Milwaukee, Wisconsin
January 18, 2002

23

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2000

The accompanying notes to the consolidated financial statements are an integral
part of these balance sheets.

24

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

The accompanying notes to the consolidated financial statements are an integral
part of these statements.

25

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

- -------------------------
(1) Common Stock, $0.01 par value, 150,000,000 shares authorized.

(2) See Note 3 of Notes to Consolidated Financial Statements.

The accompanying notes to the consolidated financial statements are an integral
part of these statements.

26

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

The accompanying notes to the consolidated financial statements are an integral
part of these statements.

27

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) CONSOLIDATION

The consolidated financial statements include the financial results of
Renaissance Learning, Inc. ("Renaissance Learning") and its subsidiaries
(collectively, the "Company"). Renaissance Learning's significant subsidiaries
include Renaissance Corporate Services, Inc. and Generation21 Learning Systems,
LLC ("Generation21"). School Renaissance Institute, Inc., formerly a
wholly-owned subsidiary of Renaissance Learning, was merged into Renaissance
Learning on December 31, 2001, and is currently doing business under the name of
Renaissance Learning Madison. All significant intercompany transactions have
been eliminated in the consolidated financial statements.

On April 18, 2001, the Company name was legally changed from Advantage
Learning Systems, Inc. to Renaissance Learning, Inc. On April 20, 2001, the
Company's stock trading symbol on the Nasdaq stock market changed to RLRN to
reflect the legal name change.

(2) NATURE OF OPERATIONS

Renaissance Learning is a provider of learning information systems to K-12
schools in the United States and Canada. The Company's flagship product is the
Accelerated Reader, a learning information system for motivating and monitoring
increased literature-based reading practice. The Company's software products
also include STAR Reading, a computer-adaptive reading test and database;
Accelerated Math and STAR Math, software products that apply to math the
principles that have made the reading software effective in improving academic
performance; STAR Early Literacy computer-adaptive diagnostic test for phonemic
awareness and other emergent reading skills; Perfect Copy writing skills
development software; and Surpass test preparation software.

Renaissance Learning Madison develops and conducts Renaissance training
programs, which provide educators with professional development training to most
effectively use the Company's products and the learning information they
generate. The firm provides teacher training through its Reading Renaissance,
Math Renaissance, and other seminars. Renaissance Learning Madison's School
Renaissance program is a comprehensive package of software, professional
development training, educator resource materials, and consulting services aimed
at accelerating learning and improving test scores in reading, math, writing,
and overall academic performance throughout schools and school districts.

Renaissance Corporate Services, Inc. provides customized test-generation
software to educational publishers for assessment and skills practice in math,
science, and other subjects and also develops content for math products
distributed by the Company. Generation21 sells enterprise software for
organization-wide training and knowledge management to corporate customers.
Renaissance Learning also has subsidiaries in Australia, Canada, India, and the
United Kingdom.

(3) ACQUISITIONS

Effective November 17, 2000, the Company acquired the business and assets
of Engineering Software Associates, Inc. ("ESA"), Minneapolis, Minnesota, a
provider of test generation and tutorial software to college textbook
publishers. The transaction was accounted for using the purchase method of
accounting, with a total purchase price of $3.8 million including the assumption
of less than $100,000 of certain liabilities. The purchase price was subject to
post-closing adjustments related to the finalization of certain estimated
working capital accounts. The purchase price was allocated based on the fair
values of the assets acquired and liabilities assumed and included an allocation
to intangibles and goodwill (see Note 5). The operating results of ESA are
included in the consolidated financial statements of the Company since the date
of acquisition.

Effective December 29, 1999, the Company acquired computerActive, Inc.
("computerActive"), an Ottawa, Canada-based software development firm
specializing in Web-based applications. The transaction was accounted for using
the purchase method of accounting, with a total purchase price of $1.3 million,

28

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

representing $680,000 of cash, $346,000 of the Company's common stock and the
assumption of certain liabilities. The operating results of computerActive are
included in the consolidated financial statements of the Company since the date
of acquisition. The allocated purchase price includes valuation of certain
acquired in-process research and development costs which resulted in a pre-tax
charge of $900,000 in the fourth quarter of 1999. The in-process research and
development costs were valued by an independent professional appraisal firm
which used the income approach to determine fair market value at the acquisition
date. The significant assumptions used by the appraiser included projections for
initial sales in 2001 through 2003, with a revenue growth rate of 2% annually
thereafter, normalized operating profit consistent with our other software
products, and a risk-weighted discount rate of 40%.

Effective July 1, 1999, the Company acquired Generation21 Learning Systems,
LLC ("Generation21"), a training and knowledge management enterprise software
firm in Golden, Colorado. The transaction was accounted for as a
pooling-of-interests. Accordingly, the Company's financial information for all
periods presented has been restated to include the results of Generation21 since
its inception in July 1997. The Company issued 166,443 shares of common stock
with a market value of $4.0 million to effect the transaction. Third quarter
1999 results include a non-recurring pre-tax charge of $365,000 for transaction
costs associated with the acquisition.

Effective June 9, 1999, the Company acquired the assets of Humanities
Software, Incorporated ("Humanities"), an Oregon-based firm specializing in
writing software. The transaction was accounted for using the purchase method of
accounting with a total purchase price of $1.7 million, representing $920,000 of
cash, $666,000 of the Company's common stock and the assumption of certain
liabilities. The operating results of Humanities are included in the
consolidated financial statements of the Company since the date of acquisition.
The allocated purchase price includes valuation of certain acquired in-process
research and development costs which resulted in a pre-tax charge of $180,000 in
the second quarter of 1999.

Pro forma data is not provided relating to the above acquisitions because
it would not differ significantly from historical results.

(4) SIGNIFICANT ACCOUNTING POLICIES

(a) Use of estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

(b) Revenue recognition

The Company recognizes revenue in accordance with Statement of Position No.
97-2 "Software Revenue Recognition" issued by the Accounting Standards Executive
Committee of the AICPA. Revenues are recorded net of an allowance for estimated
returns. Allowances for bad debts are also recorded at the time of the sale.

Product revenue is derived primarily from the sale of software products.
The Company recognizes revenue from sales of its off-the-shelf software products
at the time of shipment to customers. The Company recognizes revenue from the
sale of custom software products on the percentage-of-completion method of
accounting. Accordingly, revenue is deferred for advance payments from customers
that are in excess of revenues earned on custom software sales. Included in
accounts receivable at December 31, 2001 and 2000 is $443,000 and $442,000,
respectively, of amounts earned which are not yet billed to the customer for
custom software products.

29

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Service revenue is derived from (i) training seminars, (ii) consulting
services, and (iii) software support agreements whereby the Company provides
ongoing customer support as well as unspecified product upgrades if and when
available. Revenue from training seminars is recognized when the seminar is
performed. Revenue from consulting services is recognized as the service is
performed or on a straight-line basis over the contractual period. Telephone
support included with software sales has a duration of twelve months or less and
is recognized at the time the software is shipped with the related costs of
providing the telephone support accrued for at the same time. Revenue from
separately sold software support agreements is initially recorded as deferred
revenue and recognized as revenue on a straight-line basis over 12 or 24 months
depending on the term of the support agreement.

Deferred revenue includes (i) payments received for products not yet
delivered, (ii) advance payments on contract revenues, (iii) payments received
for seminars not yet held, and (iv) that portion of separately sold software
support agreements that has not yet been recognized as revenue.

(c) Cash and cash equivalents

The Company considers cash amounts on deposit at banks and highly liquid
debt instruments purchased with an original maturity date of three months or
less to be cash equivalents. Debt instruments are carried at cost, which
approximates market value. Cash and cash equivalents consisted of the following
at December 31:

(d) Investment securities

Investment securities have an original maturity of more than three months
and a remaining maturity of less than twenty-four months. As of December 31,
2001 and 2000, investment securities consisted entirely of corporate notes and
municipal obligations. These securities are considered to be available for sale
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115
"Accounting for Certain Investments in Debt and Equity Securities". Accordingly,
these investments are stated at fair value, with the unrealized gains and
losses, net of tax, included in accumulated other comprehensive income in the
Company's consolidated statements of shareholders' equity.

(e) Supplemental disclosure of cash flow information

(f) Inventories

Inventories are carried at the lower of first-in, first-out (FIFO) cost or
market. Inventories primarily consist of purchased materials which include
optical-mark card scanners, educational products, training materials, manuals
and motivational items.

30

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(g) Catalog and advertising costs

Costs related to direct response advertising, primarily catalogs, are
capitalized and amortized over their expected period of future benefits, or one
year, whichever is less. At December 31, 2001 and 2000, capitalized catalog
costs of approximately $45,000 and $190,000, respectively, are included in
prepaid expenses. All other advertising costs are expensed the first time the
advertising takes place. Advertising expenses for 2001, 2000 and 1999 were
approximately $9,497,000, $8,015,000 and $9,206,000, respectively.

(h) Property, plant and equipment

Property, plant and equipment are recorded at cost and are depreciated over
the estimated useful lives of the assets using principally the straight-line
method for financial reporting purposes. Maintenance and repair costs are
charged to expense as incurred, and renewals and improvements that extend the
useful life of the assets are added to the plant and equipment accounts.
Depreciation expense was approximately $3,899,000, $3,568,000 and $2,468,000 for
2001, 2000 and 1999, respectively.

The estimated useful lives for property, plant and equipment are as
follows: buildings -- 25 to 40 years; furniture, fixtures and office
equipment -- 5 to 8 years; computer and production equipment -- 3 to 5 years;
vehicles -- 5 years; and leasehold improvements -- the lease term.

Net property, plant and equipment consisted of the following at December
31:

(i) Software development costs

The Company capitalizes certain software development costs incurred after
technological feasibility is achieved. Capitalized costs are reported at the
lower of amortized cost or net realizable value. Capitalized software
development costs are amortized on a product-by-product basis using the
straight-line method over the estimated economic life of the products which is
generally estimated to be 24 months. Amortization begins when the products are
available for general release to customers. All other research and development
expenditures are charged to product development expense in the period incurred.
When capitalized software is fully amortized, the balance is removed from
capitalized software and accumulated amortization of capitalized software.
Amounts capitalized were approximately $484,000, $477,000 and $432,000 in 2001,
2000 and 1999, respectively. Amortization expense of approximately $560,000,
$391,000 and $194,000 for 2001, 2000 and 1999, respectively, are included in
cost of sales-products in the consolidated statements of income. At December 31,
2001 and 2000, accumulated amortization of capitalized software development
costs was $905,000 and $543,000, respectively.

31

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(j) Sales and concentration of credit risks

For the years ended December 31, 2001, 2000 and 1999, one customer (a book
distributor) contributed 7.0%, 8.5% and 11.5% of total revenues, respectively.
In 2001 and 2000, no customer represented more than 10% of total revenues. On
December 31, 2001 and 2000, this customer had a receivable balance of 4.8% and
5.2% of total trade receivables, respectively.

The Company grants credit to customers in the ordinary course of business.
The majority of the Company's customers are schools. Concentrations of credit
risk with respect to trade receivables are limited due to the significant number
of customers and their geographic dispersion.

(k) Stock-based compensation

The Company elected, as permitted by SFAS No. 123 "Accounting for Stock
Based Compensation," to follow the intrinsic value based method of accounting
for stock options consistent with Accounting Principles Board Opinion No. 25
("APB 25") "Accounting for Stock Issued to Employees" and to provide the pro
forma disclosures of net income and earnings per share as if the fair value
based method had been applied. Under the intrinsic method, compensation cost for
stock options is measured by the excess, if any, of the quoted price of the
Company's stock at the measurement date over the exercise price. The
Black-Scholes option-pricing model was used to compute the fair value of each
option granted for purposes of the pro forma disclosures required by SFAS 123.

(l) Earnings per common share

Basic earnings per common share ("Basic EPS") has been computed based on
the weighted average number of common shares outstanding. Diluted earnings per
common share ("Diluted EPS") has been computed based on the weighted average
number of common shares outstanding, increased by the number of additional
common shares that would have been outstanding if the dilutive potential common
shares had been issued. All share and per share data has been adjusted to
reflect a 2-for-1 stock split in the form of a stock dividend effective February
26, 1999 (see Note 13).

The weighted average shares outstanding for 2001, 2000 and 1999 are as
follows:

(m) Income taxes

The Company accounts for income taxes according to the provisions of SFAS
No. 109, "Accounting for Income Taxes". SFAS 109 requires an asset and liability
based approach to accounting for income taxes. Deferred income tax assets and
liabilities are recorded to reflect the tax consequences on future years of
temporary differences between financial and tax accounting of revenue and
expense items. Valuation allowances are provided when it is anticipated that
some or all of a deferred tax asset is not likely to be realized.

(n) Derivative financial instruments

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities". This
standard, as amended, requires that entities recognize derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair

32

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

value. The Company adopted this standard on January 1, 2001. The adoption of
this statement has not had an impact on the consolidated financial statements,
as the Company has not utilized derivative instruments.

(o) Comprehensive income

The Company's comprehensive income includes foreign currency translation
adjustments and unrealized gains and losses on available-for-sale securities,
which are included in accumulated other comprehensive income in the Company's
consolidated statements of shareholders' equity.

(p) Reclassifications

Certain previously reported amounts have been reclassified to conform with
the 2001 presentation.

(5) INTANGIBLE ASSETS AND GOODWILL

Intangible assets, including goodwill, are amortized on the straight-line
basis over their estimated useful lives. The Company continually evaluates
whether events or circumstances have occurred that indicate the carrying amount
of goodwill, intangible assets or property plant and equipment may be impaired.
When factors indicate these assets should be evaluated for impairment, the
Company uses an estimate of the undiscounted cash flows over the remaining life
of the goodwill, intangible assets and property, plant and equipment in
measuring whether they are recoverable. To date, no such impairment of these
assets exists.

Intangible assets and goodwill consisted of the following at December 31:

On June 30, 2001, the FASB issued SFAS No. 142 "Goodwill and Other
Intangible Assets". Under this new standard, goodwill acquired after June 30,
2001 is not amortized over its useful life and starting January 1, 2002,
amortization expense will no longer be recorded for goodwill acquired on or
before June 30, 2001. SFAS 142 requires that goodwill be assessed at least
annually for impairment by applying a fair-value-based test. In addition, under
the new rules, an intangible asset acquired after June 30, 2001 should be
separately recognized if the benefit of the intangible asset is obtained through
contractual or other legal rights, or if the intangible asset can be sold,
transferred, licensed, rented, or exchanged.

The Company will adopt the provisions of SFAS No. 142 effective January 1,
2002. SFAS 142 requires that a new fair-market-value test be applied to
determine if goodwill and other intangible assets with indefinite lives are
impaired based on their values as of January 1, 2002. The transitional
provisions of SFAS 142 provide

33

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

that the impairment testing for intangible assets other than goodwill shall be
completed by March 31, 2002 and that the impairment test for goodwill shall be
completed by June 30, 2002.

Assembled workforce does not meet the criteria of SFAS No. 142 for
recognition apart from goodwill. SFAS 142, therefore, requires that the Company
reclassify the unamortized balance of assembled workforce as of January 1, 2002
to goodwill. For the years ended December 31, 2001, 2000 and 1999, goodwill and
assembled workforce amortization expense of $562,000, $353,000 and $218,000,
respectively, is included in our consolidated statement of income. Due to the
adoption of SFAS 142, the Company will not recognize in 2002, $562,000 in
amortization expense related to goodwill and assembled workforce that were
acquired prior to 2002.

(6) INCOME TAXES

The provision for income taxes consisted of:

Effective rate reconciliation:

34

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred tax assets consisted of the following at December 31:

(7) LINES OF CREDIT

The Company has a $10.0 million unsecured revolving line of credit with a
bank which is available until March 31, 2002 and which is expected to be
extended for an additional two years. The line of credit bears interest at
either a floating rate based on the prime rate less 1.0%, or a fixed rate for a
period of up to 90 days based on LIBOR plus 1.25%. The rate is at the option of
the Company and is determined at the time of borrowing. The Company also has a
$2.0 million unsecured revolving line of credit with a bank which is available
until April 30, 2002, which was renewed in January 2002 for an additional year.
The line of credit bears interest based on the prime rate less 1%. As of
December 31, 2001, the lines of credit had not been used.

(8) LEASE COMMITMENTS

The Company is party to various operating leases for equipment and for
office facilities at some of its subsidiaries. Rent expense for 2001, 2000 and
1999 was approximately $1,057,000, $840,000 and $468,000, respectively.

Future approximate minimum rental payments (including estimated operating
costs) required under the operating leases as of December 31, 2001 are as
follows:

(9) LITIGATION

The Company is subject to various claims and proceedings covering a wide
range of matters that arise in the ordinary course of its business activities.
Management believes that any liability that may ultimately arise from the
resolution of these matters will not have a material adverse effect on the
financial condition or results of operations of the Company.

35

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(10) DEFINED CONTRIBUTION BENEFIT PLAN

The Company has a defined contribution 401(k) benefit plan covering all of
its full-time employees meeting certain service requirements. The plan provides
for matching employer contributions based on 66% of employees' elective
contributions up to 6% of compensation. The plan allows employee contributions
of up to 15% of compensation. Discretionary employer contributions may also be
made to the plan. There were no discretionary contributions made in 2001, 2000
or 1999. Expense under the plan totaled approximately $1,002,000 in 2001,
$814,000 in 2000 and $564,000 in 1999.

(11) STOCK OPTION PLAN

The Company has established the 1997 Stock Incentive Plan (the "Plan") for
its officers, key employees, non-employee directors and consultants. Options
granted under the plan may be in the form of nonqualified stock options ("NSO")
or incentive stock options which comply with section 422 of the Internal Revenue
Code ("ISO"). A combined maximum of 3,000,000 options, stock appreciation rights
("SARs") and share awards may be granted under the plan. Of this amount, not
more than 1,500,000 shares may be subject to ISOs. The exercise price of the
stock options is the market value of the common stock at the date of grant.
Generally, the options vest and become exercisable ratably over a four-year
period, commencing one year after the grant date. The options expire 10 years
from the grant date.

Had compensation cost been determined for the Company's stock option
portion of the plan based on the fair value at the grant dates for awards
consistent with the alternative method set forth under SFAS 123, the Company's
net income and earnings per share would have been adjusted to the pro forma
amounts indicated below:

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 2001, 2000 and 1999, respectively: dividend yield of 0%,
expected volatility of 85.19%, 88.12% and 76.73%, risk-free interest rates of
4.78%, 6.21% and 6.23%, and expected lives of 10 years for the options.

36

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As of December 31, 2001, only NSOs have been granted; no ISOs, SARs or
share awards have been granted under the plan. A summary of stock option
activity under the plan for 2001, 2000 and 1999 is as follows:

The following table summarizes information about stock options outstanding
at December 31, 2001:

(12) EMPLOYEE STOCK PURCHASE PLAN

Effective July 1, 1998, the Company adopted an Employee Stock Purchase Plan
which allows employees to purchase shares of common stock through payroll
deductions, up to 10% of eligible compensation. The purchase price is equal to
85% of the fair market value of the common stock on either the first or last day
of the subscription period, whichever is lower. A total of 500,000 shares are
available for purchase under the plan. The Company has elected to apply
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees", as amended by FASB Interpretation No. 44, in accounting for its
stock-based plans. Accordingly, the Company will not recognize compensation
expense for employee stock purchases. The Company issued approximately 43,000
and 82,000 shares of common stock in January 2002 for fiscal 2001 and in January
2001 for fiscal 2000 with respect to the plan, at a per share price,
representing 85% of the fair market value as described above, of $24.65 and
$9.93, respectively.

(13) SHAREHOLDERS' EQUITY

On January 3, 2000, the Company's Board of Directors authorized the
repurchase of up to 1,000,000 shares of the Company's common stock. No time
limit was placed on the duration of the repurchase program. Repurchased shares
will become treasury shares and will be used for stock-based employee benefit
plans and for other general corporate purposes. As of December 31, 2001, the
Company had repurchased 25,100 shares.

37

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On April 14, 1999, the Company's shareholders approved an amendment to the
Company's Amended and Restated Articles of Incorporation to increase the
authorized common stock of the Company from 50,000,000 shares to 150,000,000
shares with a $.01 par value per share. The Company's Amended and Restated
Articles of Incorporation also includes authorization to issue up to 5,000,000
shares of preferred stock with a $.01 par value per share. No preferred stock
has been issued.

On January 18, 1999, the Board of Directors of the Company authorized a
2-for-1 split of common stock in the form of a stock dividend payable on
February 26, 1999 to shareholders of record on February 11, 1999. Accordingly,
all share and per share data presented herein have been restated to reflect this
split.

(14) SEGMENT REPORTING

The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. The Company has
two reportable segments: software and training.

The software segment produces learning information system software
primarily for the K-12 school market in the United States, Canada, the United
Kingdom and Australia. The software assists educators in assessing and
monitoring student development by increasing the quantity, quality and
timeliness of student performance data in the areas of reading, math and
writing. The software segment also includes training and knowledge management
enterprise software, which is currently sold primarily to corporate customers
and electronic assessment products and services sold to educational publishers.
Revenue from the software segment includes product revenue principally from the
sale of software, product revenue from scanners sold with math software and sold
separately, and service revenue from the sale of software support agreements.

The training segment provides professional development training seminars
and district-wide school improvement programs including training, consulting and
educator resource materials. The training programs instruct educators on how to
accelerate learning in the classroom through use of the information that the
Company's learning information systems provide. Revenue from the training
segment includes service revenue from a variety of seminars presented in hotels
and schools across the country, and from the annual National School Renaissance
Conference, and product revenue from the sale of training materials.

The accounting policies of the reportable segments are the same as those
described in Note 4 of Notes to Consolidated Financial Statements. The Company
evaluates the performance of its operating segments based on operating income
before nonrecurring items. Intersegment sales and transfers and revenue derived
outside of the United States are not significant.

38

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Summarized financial information concerning the Company's reportable
segments is shown in the following table:

- -------------------------
(1) Operating income Total differs from Operating income in the Consolidated
Statements of Income due to $1,080,000 purchased research and development
expense in 1999 not included above.

The reported measures are consistent with those used in measuring amounts
in the consolidated financial statements. Such measurements are generally along
legal entity lines as aggregated. Effective January 1, 2000, the Company
re-evaluated and changed certain cost allocations between the software and
training segments. The result of the re-evaluation on previously reported
segment disclosures is not material.

It is management's opinion, however, that because many flows of value
between the segments cannot be precisely quantified, this information provides
an incomplete measure of the training segment profit or loss, and should not be
viewed in isolation. Management evaluates the performance of the training
segment based on many factors not captured by the financial accounting system
and often evaluates the Company's financial performance on a total entity basis.

39

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(15) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table sets forth unaudited consolidated income statement data
for each quarter of the Company's last two fiscal years. The unaudited quarterly
financial information has been prepared on the same basis as the annual
information presented in the consolidated financial statements and, in
management's opinion, reflects all adjustments (consisting of normal recurring
entries) necessary for a fair presentation of the information provided. The
operating results for any quarter are not necessarily indicative of results for
any future period.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS

None.

40

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a) Executive Officers. Reference is made to "Executive Officers of the
Registrant" in Part I hereof.

(b) Directors. The information required by this Item is set forth in our
Proxy Statement for the Annual Meeting of Shareholders to be held on April 17,
2002 under the caption "Proposal One: Election of Directors," which information
is incorporated by reference herein.

(c) Section 16 Compliance. The information required by this Item is set
forth in our Proxy Statement for the Annual Meeting of Shareholders to be held
on April 17, 2002 under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance," which information is incorporated by reference herein.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is set forth in our Proxy Statement
for the Annual Meeting of Shareholders to be held on April 17, 2002 under the
captions "Executive Compensation," "Non-Employee Director Compensation,"
"Compensation Committee Report," "Compensation Committee Interlocks and Insider
Participation," and "Performance Graph," which information is incorporated by
reference herein.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is set forth in our Proxy Statement
for the Annual Meeting of Shareholders to be held on April 17, 2002 under the
caption "Security Ownership of Management and Certain Beneficial Owners," which
information is incorporated by reference herein.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is set forth in our Proxy Statement
for the Annual Meeting of Shareholders to be held on April 17, 2002 under the
caption "Certain Relationships," which information is incorporated by reference
herein.

41

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(A)(1) FINANCIAL STATEMENTS.

Consolidated Financial Statements

Report of Independent Public Accountants

Consolidated Balance Sheets as of December 31, 2001 and 2000

Consolidated Statements of Income for the years ended December 31, 2001,
2000 and 1999

Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2001, 2000 and 1999

Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2000 and 1999

Notes to Consolidated Financial Statements

(A)(2) FINANCIAL STATEMENT SCHEDULES.

See the Exhibit Index, which is incorporated by reference herein.

(A)(3) EXHIBITS.

See (c) below.

(B) REPORTS ON FORM 8-K.

There were no reports on Form 8-K filed for the three months ended December
31, 2001.

(C) EXHIBITS.

See the Exhibit Index, which is incorporated by reference herein.

(D) FINANCIAL STATEMENTS EXCLUDED FROM ANNUAL REPORT TO SHAREHOLDERS.

Not applicable.

42

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

RENAISSANCE LEARNING, INC.

By: /s/ MICHAEL H. BAUM
------------------------------------
Michael H. Baum
Chief Executive Officer

Date: March 7, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

- -------------------------
*Pursuant to authority granted by powers of attorney, copies of which are filed
herewith.

43

EXHIBIT INDEX

- -------------------------
(1) Incorporated by reference to Registrant's Registration Statement on Form
S-1 (Registration No. 333-22519).

(2) Incorporated by reference to Registrant's Form 10-Q for the quarter ended
September 30, 1997 (SEC File No. 0-22187).

(3) Incorporated by reference to Registrant's Form S-8 filed on October 28,
1997 (Registration No. 333-38867).

(4) Incorporated by reference to Registrant's Form 10-K for the fiscal year
ended December 31, 1997 (SEC File No. 0-22187).

(5) Incorporated by reference to Registrant's Form 10-K for the fiscal year
ended December 31, 1998 (SEC File No. 0-22187).

(6) Incorporated by reference to Registrant's Form 10-K for the fiscal year
ended December 31, 1999 (SEC File No. 0-22187).

(7) Incorporated by reference to Registrant's Form 10-Q for the quarter ended
March 31, 2000 (SEC File No. 0-22187).

(8) [Reserved].

44

(9) Incorporated by reference to Registrant's form 10-K for the fiscal year
ended December 31, 2000 (SEC File No. 0-22187).

(10) Incorporated by reference to Registrant's Form 10-Q for the quarter ended
March 31, 2001 (SEC File No. 0-22187).

* Management contracts or compensatory plans or arrangements.

45