Back to GetFilings.com

Table of Contents

UNITED STATES

FORM 10-K

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended December 31, 2002

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-22187

RENAISSANCE LEARNING, INC.

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

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

         Indicate by check mark 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. þ

         Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act of 1934). Yes þ  No o

         The aggregate market value of the voting stock held by nonaffiliates of the Registrant was approximately $225,200,000 as of June 30, 2002. As of February 28, 2003, there were 31,501,855 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 16, 2003.

Table of Contents

PART I

Item 1. Business

Overview

      Renaissance Learning, Inc. is a leading provider of learning information systems software and school improvement programs to pre-kindergarten through senior high (“pre-K-12”) schools in the United States and Canada. Our computer-based learning information systems and related training, school improvement programs, professional development and consulting help educators motivate students, accelerate learning, improve test scores, and help students master standards by increasing the quality, quantity, and timeliness of performance data available to educators to facilitate increased student practice of essential skills and support instruction. Learning information systems provide benefits to educators similar to those management information systems provide to business managers. As of December 31, 2002, we had sold our products to more than 62,000, or approximately 50% of the K-12 schools in North America.

      Our flagship product, Accelerated Reader*, is software which provides information for motivating and monitoring increased literature-based reading practice and to support instruction. 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. AR Universal*, the latest version of our Accelerated Reader program, supports recorded-voice versions of quizzes on literature books for emergent readers and quizzes for assessing reading instruction assignments such as those found in reading textbooks, magazines, and other curricula.

      Our other primary learning information system products include STAR Reading*, Accelerated Math*, STAR Math*, STAR Early Literacy*, and Perfect Copy*. In 2002, we released several new products: Fluent Reader* repeated reading software for struggling readers; StandardsMaster* instant assessment and Web-based reporting software; Accelerated Writer* writing improvement system; AccelTest* test preparation and management software; MathFacts in a Flash* software for mastering computational fluency; and Accelerated Vocabulary* vocabulary development software. Our newest product, Accelerated Grammar and Spelling*, is expected to be released prior to the beginning of the 2003-2004 school year. Accelerated Grammar and Spelling uses real-world applications to help teachers build the language skills of students and diagnose students’ grammar and spelling skills, and will replace Perfect Copy when it is released later in 2003.

      In addition to our learning information system products, we provide professional development opportunities for educators through on- and off-site seminars, consulting services, Web-based training, and educator support materials. Renaissance* practices enable educators to use the information provided by our technology to increase guided practice time with essential skills and personalized instruction for every student. Our seminars include Reading Renaissance*, Math Renaissance*, Writing Renaissance*, Renaissance Early Literacy, The Reading Renaissance Librarian, Renaissance Diagnosis and Intervention, Renaissance Leadership, Renaissance Classroom Management, and Renaissance Test Strategies. Our consultants work with teachers, librarians, principals and administrators to improve instructional programs, solve problems and help achieve optimal results through Renaissance implementation.

      We provide custom assessment software and related services to educational publishers which support many of the popular textbook series used in K-12 and post-secondary educational institutions. Additionally, we sell Generation21* enterprise software for training and knowledge management throughout organizations. AccelScan*, our optical-mark card scanner, is used with several of our learning information system products to automate scoring and recordkeeping tasks for educators and students.

Table of Contents

      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® 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). You may obtain, free of charge, copies of this Annual Report on

Products

Software and Support Services

      We offer software products to educators primarily for use in the pre-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 to support instruction. We also sell training and knowledge management software and services to corporate and governmental customers and provide custom assessment software and related services to educational publishers. Our software and support services accounted for approximately 87%, 86%, and 85% of our net sales in 2002, 2001, and 2000, 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 is a learning information system for motivating and monitoring increased literature-based reading practice and for providing information to support instruction. A student selects a book at an appropriate reading level from a list of books for which the school has an Accelerated Reader quiz, reads the book, and then takes a multiple-choice quiz on a computer. 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 which educators can generate reports to monitor the amount and quality of reading practice for each of their students and provide information to support teachers’ instruction of comprehension, vocabulary, and fluency. AR Universal, the most recent version, supports recorded-voice versions of quizzes on literature books for emergent readers and quizzes for assessing reading instruction assignments found in reading textbooks, magazines and other curricula. Accelerated Reader includes built-in Spanish-English capabilities and supports Literacy Skills quizzes which allow educators to assess students’ proficiency on 24 specific skills found in state and district language arts standards and standardized tests. We developed quizzes on over 11,000 book titles in 2002 and currently have a library of computerized book quizzes on more than 62,000 titles.

      Fluent Reader is a system for improving the fluency of emergent and struggling students. This program incorporates four proven strategies of modeled reading, repeated oral reading, self-monitoring and information feedback to help improve reading fluency. Fluent Reader includes a placement test to determine students’ independent reading level, features to identify specific words that are causing difficulty, handles record-keeping chores and provides key management reports to monitor student progress.

      STAR Reading is a computer-adaptive reading test that provides classroom teachers with reading scores statistically correlated to national norms in ten minutes or less at the computer. STAR Reading adapts itself to

2

Table of Contents

      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.

      Accelerated Vocabulary is vocabulary management software that helps teachers and librarians accelerate student vocabulary acquisition, reduce paperwork, support instruction, and make vocabulary learning fun for students. Accelerated Vocabulary promotes word learning from research proven in-context reading of Accelerated Reader books. Reports help educators assess and monitor each student’s vocabulary progress and provide individualized lists of mastered vocabulary words for students.

      Accelerated Math is a task-level learning information system that helps students 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 monitors student practice of foundational skills, while providing immediate feedback on performance to students and teachers. Using the reports and assignments Accelerated Math generates, teachers can individualize instruction without increasing their workload. Accelerated Math offers state standards-aligned libraries, textbook-aligned libraries for popular math textbooks, extended response libraries that integrate the application of multiple math objectives, and math learning cards, which are instructional supplements for assisting with teaching math objectives aligned to Accelerated Math libraries. 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. Additional scanners are also sold separately.

      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 first grade through high school in approximately 15 minutes, provides comparisons to national norms and forecasts results on major high-stakes tests. Like STAR Reading, it can be administered throughout the school year to track math development.

      MathFacts in a Flash software helps educators motivate students to master computational fluency. It gives students at all skill levels valuable practice on their addition, subtraction, multiplication, and division facts as well as on mental math skills such as squares and fraction/ decimal conversion. Timed tests administered by the system accurately measure students’ practice and mastery, while detailed reports give educators timely reliable feedback of how individuals or entire classes are progressing.

3

Table of Contents

      Accelerated Writer is a writing improvement system that combines short, focused lessons with powerful writing management software to help educators teach students how to recognize specific qualities of good writing, improve the use of those qualities in their own writing, and anonymously rate those qualities in each others writing. Through use of the Accelerated Writer system, students increase their writing practice and learn to become skilled evaluators of writing. This system also allows educators to more easily monitor students’ writing activities and progress, and provides them with continuous detailed feedback on student writing achievement.

      Perfect Copy software helps educators improve students’ core writing skills using in-context editing to cover the rules of grammar, punctuation, and word usage. Our Perfect Copy product offering will be replaced by Accelerated Grammar and Spelling which has a more comprehensive set of features for the improvement of writing skills.

      Accelerated Grammar and Spelling software offers practice and skills assessment in grammar, usage, mechanics, and spelling skills of students in grades 2-9, with high school content also available. This innovative program helps educators diagnose students’ grammar and spelling skills while also helping to capture students’ interest and motivate them to improve. It uses in-context editing and spelling to give students valuable practice locating and correcting the most common language skills errors. Schools can expand their usage of the program by purchasing additional grade-level specific content libraries covering grammar, usage and mechanics or spelling. Accelerated Grammar and Spelling will replace Perfect Copy when it is released later in 2003.

      StandardsMaster is an instant assessment and Web-based reporting system that provides feedback to educators on how students are progressing toward state standards in reading, math and language arts. Informative feedback provided by the program helps educators adjust instruction, intervene with specific student groups, and ensure adequate progress on the year-end summative state test. Students take paper-and-pencil or online assessments and results become available immediately by district, school, teacher, class, student and other relevant demographic characteristics. StandardsMaster is provided on a subscription basis to assure that educators have up-to-date versions of software and assessment items each year.

      AccelTest is a test creation, scoring and gradebook system that enables educators to create and manage quizzes, tests and other exercises, score them immediately and have results automatically entered into an electronic gradebook. Using the system, an educator works through easy-to-follow prompts to generate assignments containing different types of questions, such as multiple choice, true/false and matching. Other features of the system include automatic shuffling of questions and answer order, instant scoring using our AccelScan card reader, instant grade recording and the ability to monitor late and incomplete assignments.

      AccelScan is our optical mark card reader that offers intelligent mark recognition capability. This capability results in more accurate recognition of student marks by distinguishing many degrees of darkness from a variety of marking instruments and ignoring lighter erasures. This high-speed reader works with Accelerated Math, Accelerated Writer, AccelTest, and StandardsMaster software. The use of AccelScan allows for automatic scoring of assignments and updating of student records, providing educators with immediate information on student progress without spending time grading paperwork.

4

Table of Contents

      We offer Expert Support Plans (“ESPs”) that provide users of our software products access to telephone support. Packaged with kits and also sold separately under 12- or 24-month agreements, ESPs entitle educators to unlimited expert phone support to resolve technical issues with our products, networks, and other software interacting with our products.

      Generation21 is an integrated training and knowledge management system that captures, stores and delivers knowledge enterprise-wide. The system spans enterprise learning needs including a full suite of integrated e-learning features supporting content creation and management, instructor-led training, and remote learning. Additionally, the Generation21 system includes features which allow access to knowledge databases via wireless technology. We sell the system primarily to businesses and government agencies.

      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 align with specific textbooks and other publisher instructional materials. The intuitive educator interface and precisely aligned content of these products assure that they are easy and effective for educators to use with existing curricula and classroom materials.

Renaissance Professional Development

      We offer professional development programs, consulting services, Web-based training, 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 13%, 14%, and 15% of our net sales in 2002, 2001, and 2000, respectively.

      We offer a variety of seminars and workshops, 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 the inception of our training programs in late 1993 through December 31, 2002, we have trained over 430,000 educators, of whom approximately 75,000 were trained in 2002. 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 as well as increase overall customer interest in 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 Renaissance 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. Renaissance Certification gives administrators an effective way to manage the implementation of Renaissance methodology by motivating teachers, librarians and principals and providing clear, measurable standards. As of February 1, 2003 more than 15,000 teachers, librarians and principals have certified as Renaissance Model and Master Educators.

      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).

      The Reading Renaissance program provides educators with professional development training to most effectively use our software products such as the Accelerated Reader, STAR Reading, STAR Early Literacy

5

Table of Contents

      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 MathFacts in a Flash. The information provided by the software enables educators to improve math skills for every student, first grade through calculus, and increase test scores.

     Other Renaissance Seminars

      Our other professional development programs include: Renaissance Early Literacy; Writing Renaissance; The Reading Renaissance Librarian; Renaissance Diagnosis and Intervention; Renaissance Leadership; Renaissance Classroom Management; and Renaissance Test Strategies. These professional development seminars and workshops combine effective use of technology with proven classroom techniques to increase both educator effectiveness and student achievement. In addition, we offer a Grant-Writing Workshop to teach the process of successfully securing grants.

     Educator Resources

      We also produce videotapes, handbooks, lesson books, math learning cards, and workbooks for use by educators in conjunction with our software and 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 educational marketplace. We invest continuously in the development of new products and services, enhancement of existing products and services, development of tools to increase the efficiency of product development, and scientific research which both generates concepts for new products and services as well as validates and provides valuable feedback on the effectiveness of existing products and services. For the years ended December 31, 2002, 2001, and 2000, respectively, our development expenditures were $18.0 million, $18.3 million, and $15.4 million (including capitalized amounts of $729,000, $484,000 and $477,000).

      We conduct research on our products and services in order to accumulate information against which to develop new, and refine existing, products and services. We conduct rigorous scientific research into learning theory, information theory and the effectiveness of our products and services in accelerating learning as well as patterns of usage of our products in actual classroom settings. Data acquired and understanding gained from this process are used as an integral part of our product development process to develop new product concepts and to improve the effectiveness of our existing products and services.

      These concepts for new products and services are then refined based on feedback from our customers, which we solicit and incorporate throughout our development process. Based on the refined concepts, proposals are then formulated by our product management, product development, marketing and 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 or service to determine that it is desired by educators, is effective in meeting their needs, is scientifically based, and satisfies the requirements of major state and federal guidelines.

6

Table of Contents

Selling and Marketing

      We market our educational products and services to teachers, school librarians, principals, entire schools, and school districts, as well as internationally through our subsidiaries in Canada, Australia, and the United Kingdom. Our custom assessment products provided to educational publishers are typically distributed by publishers to educators in conjunction with sales of their related textbooks. Our training and knowledge management software is currently sold primarily to corporate and governmental customers. We experience seasonal variations in our sales due to the budget and school year cycles of our school customers. Additionally, our service revenues tend to be more seasonal than product revenues, with service revenues typically being highest in the third quarter.

      Our sales and marketing strategy consists primarily of direct marketing to potential and existing customers, and through our geographically dispersed field sales representatives. 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, customer meetings are arranged with a field sales representative to discuss purchase and implementation of our software products and professional development services on a comprehensive 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 increased purchases of the books and other products that they sell. 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, Macmillan/ McGraw-Hill, Houghton Mifflin Company’s School Division, 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, Saxon, and with Glencoe/ McGraw-Hill in which we offer Accelerated Math software libraries aligned with their school textbook programs that mirror the objectives, problem types, and presentations in their textbooks.

      We held our third annual National School Renaissance Conference in February 2002 in San Antonio, Texas. The conference provided about 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 products and services. The 2003 conference was held at Nashville, Tennessee in February 2003 with over 5,000 educators in attendance.

Production

      Currently, most of our software products are distributed on CD-ROM or diskettes. Bulk CD-ROMs are produced by third-party contractors. We produce order-specific and smaller batches of CD-ROMs at our distribution facilities. Diskettes are duplicated and packaged at our distribution facilities. Other related products, including videotapes, books, graphics, and motivational items, are produced by third-party vendors. AccelScan scanners are manufactured to our specifications by a third-party contract manufacturer. Our on-line ordering and delivery system introduced in 1999 has been highly successful in selling Accelerated Reader quizzes as well as other products over the Internet. Additionally, our users can download selected patches and software updates from our website.

7

Table of Contents

Competition

      The educational technology and professional development markets in which we operate are very competitive. We compete with other companies offering educational software products and professional development services to schools. In addition, we compete against more traditional methods of education, training and testing, including pencil and paper testing. 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 and services successfully or compete effectively in the educational 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 as well as employee non-disclosure agreements to establish and protect our proprietary rights. We also employ serialization techniques to prevent unauthorized installation of our products and content. 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 publishing industry 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, 2003, we had 997 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, 2002 and 2001, we had backlogs that aggregated approximately $11.7 million and $7.4 million, respectively. The backlogs at December 31, 2002 and 2001 are primarily made up of professional development services not yet performed and of registrations for our National School Renaissance Conference. Substantially all of the 2002 backlog is expected to be realized during 2003.

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

8

Table of Contents

      Reliance on Single Product Line. Our Accelerated Reader software and supplemental Accelerated Reader quizzes accounted for approximately 35%, 34%, and 34% of our net sales in 2002, 2001, and 2000, 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 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 introduce new products in a timely fashion and our ability to respond quickly and in a cost effective 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 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 historically experienced rapid growth. Rapid growth 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 could be adversely affected.

      Selling and Marketing Strategy and Product Acceptance. Our business strategy includes the introduction of new products and services directed at new markets as well as the development of new sales and distribution channels. For example, our Generation21 Learning Systems subsidiary, sells enterprise software for training and knowledge management primarily to businesses and government organizations. We have historically focused on the education market and have significantly less experience in developing and marketing products and services to business or government customers. Additionally, in the educational market, we are increasing our district-level field sales efforts. Historically our primary selling efforts have been directed towards individual schools through telephone sales representatives and we have significantly less experience selling our products and services to school districts through a field sales force. There can be no assurance that we will be successful in offering new products and services, entering new markets and developing new sales and distribution channels 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

9

Table of Contents

      Educational Philosophies. Our products do not espouse a particular philosophy of instruction; rather we support all teaching methods and curricula by focusing on continuous feedback, increased student practice of essential skills, and demonstrated product effectiveness through measurable results. Certain educators, academics, politicians, and theorists, however, declaim strong philosophies of instruction, that can lead them to oppose educational products or services that fall outside a very narrow definition. These philosophies can include, but are not limited to, opposition to standardized testing or over-reliance on the same; opposition to computers or motivational techniques; exclusive focus on particular types of direct instruction; and highly technical definitions of acceptable research. Some of these philosophical stances have the capacity to influence the market for our products and services, and such influence could have a material adverse impact on demand and thus on 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 and services 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 and services, which could adversely affect our business, financial condition, and results of operations.

      Geographic Concentration of Sales. A substantial portion of our sales is concentrated in several states, including California, Texas, Florida, North Carolina, and Georgia, which accounted for approximately $19.1 million, $12.2 million, $6.0 million, $5.3 million, and $5.2 million, respectively, of our net sales in 2002. 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 and services, our business, financial condition, and results of operations would be materially adversely affected.

      Highly Competitive Industry. The educational technology and professional development markets in which we operate are very competitive. We compete with other companies offering educational software products to schools. In addition, we compete against more traditional methods of education, training and testing, including pencil and paper testing. 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 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 chairman, Judith Paul, and our chief executive officer, Terrance Paul. Ms. Paul acts as our spokesperson and coordinates our public relations and customer communications policies. Mr. Paul is responsible for our long-term strategic planning, new product development strategy, sales and marketing strategy and overall direction of our company, and plays a key role in our research activities. 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 the services of either of these persons would have a material adverse effect on our business, financial condition, and results of operations.

10

Table of Contents

      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, sales, 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 closing of large contract sales, such as those to school districts;
	•	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 intangible assets, and similar items;
	•	charges related to obsolete or impaired assets;
	•	supply-chain issues such as manufacturing problems, delivery delays, or quality issues;
	•	expenses related to product development and marketing initiatives; and
	•	expenses for product support costs.

      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. We also employ serialization techniques to prevent unauthorized installation of our products and content. 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

11

Table of Contents

      War, Acts of War and Terrorism. Delays and reductions in purchases of our products and services 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, 2003, our principal shareholders, Judith Paul, our chairman, and Terrance Paul, our chief executive officer, beneficially owned approximately 75% 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 of the common stock. As of February 28, 2003, approximately 23.6 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. We intend to file an amendment to the registration statement relating to our 1997 Stock Incentive Plan in April 2003 to register an additional 3,000,000 shares thereafter (assuming we receive shareholder approval of this increase under the plan).

      Our principal shareholders, Judith and Terrance Paul, have adopted a securities trading plan with respect to a portion of their company common stock. The plan provides for the sale of approximately 2% of the Pauls’ current holdings of common stock on an annual basis. The plan provides for monthly sales, subject to various legal and contractual limitations.

      Cash Dividends. We currently intend to retain all of our future earnings to fund growth, acquisition opportunities and the operation of our business. 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.

      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 and software operations are located in Wisconsin Rapids, Wisconsin, in a 125,000 square foot facility owned by us which was constructed in 1996. We also own a 34,000 square foot distribution facility in Wisconsin Rapids, Wisconsin. Our field sales, training, and field research operations are located in a 74,000 square foot facility, constructed in 1998, 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

12

Table of Contents

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 position, results of operations or shareholders’ equity.

      There were no matters submitted during the fourth quarter of fiscal 2002 to a vote of our security holders.

13

Table of Contents

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.

14

Table of Contents

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®, 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® during the indicated quarters.

Holders

      As of February 7, 2003, there were 863 record holders of the common stock.

Historical Dividends

      For the years ended December 31, 2002 and 2001, no dividends or other distributions were paid to shareholders. We currently intend to retain all of our future earnings to fund growth, acquisition opportunities and the operation of our business. 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, 2002.

15

Table of Contents

Item 6. Selected Financial Data

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

(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.

16

Table of Contents

Overview

      Renaissance Learning, Inc. is a leading provider of learning information systems software and school improvement programs to pre-kindergarten through senior high (”pre-K-12”) schools in the United States and Canada. Our computer-based learning information systems and related training, school improvement programs, professional development and consulting help educators motivate students, accelerate learning, improve test scores, and help students master standards by increasing the quality, quantity, and timeliness of performance data available to educators to facilitate increased student practice of essential skills and support instruction.

      Our flagship product, Accelerated Reader, is software which provides information for motivating and monitoring increased literature-based reading practice and to support instruction. AR Universal, the latest version of our Accelerated Reader program, supports recorded-voice versions of quizzes on literature books for emergent readers and quizzes for assessing reading instruction assignments such as those found in reading textbooks, magazines and other curricula. Our software products also include: STAR Reading, a computer-adaptive reading test and database and Accelerated Math and STAR Math, software products that apply to math the principles that have made the reading software effective in improving academic performance. Additionally, we publish and distribute several other learning information system products, including: STAR Early Literacy, Perfect Copy, Fluent Reader, StandardsMaster, Accelerated Writer, AccelTest, MathFacts in a Flash, and Accelerated Vocabulary.

      In 2002, we released several new products: Fluent Reader repeated reading software for struggling readers; StandardsMaster instant assessment and Web-based reporting software; Accelerated Writer writing improvement system; AccelTest test preparation and management software; MathFacts in a Flash software for mastering computational fluency; and Accelerated Vocabulary vocabulary development software. In addition, we provide custom assessment software and services to educational publishers, enterprise software for training and knowledge management throughout organizations, and an optical-mark card scanner.

      We develop and perform Renaissance professional development services, which provide educators with professional development opportunities through on- and off-site seminars, consulting services, Web-based training, and educator support materials. We provide teacher training through our Reading Renaissance, Math Renaissance, Writing Renaissance, Renaissance Early Literacy, The Reading Renaissance Librarian, Renaissance Diagnosis and Intervention, Renaissance Leadership, Renaissance Classroom Management, and Renaissance Test Strategies seminars.

      Our sales are derived primarily from the sale of software products, software support agreements, and professional development services. 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 software products which require significant customization or modification on the percentage-of-completion method of accounting. Revenue from subscription-based products is recognized on a straight-line basis over the subscription period.

      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 delivered, (ii) advance payments on contract revenues, (iii) payments received for training and consulting

17

Table of Contents

      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 implementations, customers commit to a comprehensive package of software and professional development services 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 professional development services. 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 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. Late in 2001, we began selling our new lower cost scanner which resulted in an increase in the gross profit margin that we realize on hardware sales.

      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 using the straight-line method over the estimated economic life of the product, which is generally estimated to be 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.

18

Table of Contents

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, 2002 and 2001

      Net Sales. Our net sales decreased by $1.2 million, or 0.8%, to $131.2 million in 2002 from $132.4 million in 2001. Product sales decreased by $1.2 million, or 1.1%, to $109.5 million in 2002 from $110.7 million in 2001. In 2002, we experienced revenue declines for nearly all of our products due to the current economic downturn which has resulted in school funding pressures and, consequently, decreased demand for our products. Sales of Accelerated Reader quizzes and STAR Early Literacy software increased somewhat and, together with sales of the new products we introduced in 2002, partially offset the declines in sales of our other products.

      Our new products which began shipping in 2002 include: Fluent Reader repeated reading software for struggling readers; StandardsMaster instant assessment and Web-based reporting software; Accelerated Writer writing improvement system; AccelTest test preparation and management software; MathFacts in a Flash software for mastering computational fluency; and Accelerated Vocabulary vocabulary development software. Our newest product, Accelerated Grammar and Spelling, is expected to be released prior to the beginning of the 2003-2004 school year and will replace Perfect Copy. Accelerated Grammar and Spelling uses real-world applications to help teachers build the language skills of students, and diagnose students’ grammar and spelling skills.

19

Table of Contents

      Service revenue, which consists primarily of revenue from sales of training and consulting sessions and software support agreements, was $21.7 million in 2002, an increase of $77,000 over 2001, or 0.4%. Increased software support and consulting revenues were offset by a decline in our training revenues. Approximately 75,000 educators attended our Renaissance training programs in 2002 compared to approximately 80,000 in 2001.

      We believe that school funding pressures will continue into 2003 and expect that first quarter 2003 revenues will likely be down from the same quarter in 2002. Further, we believe that the positive impacts of our field sales force expansion, marketing initiatives, and the new products introduced in 2002 will result in positive year over year revenue growth in the second half of 2003 and, as a result, we expect that revenues for the full year of 2003 will be up modestly over 2002.

      Cost of Sales. The cost of sales of products decreased by $2.9 million, or 19.7%, to $11.9 million in 2002 from $14.9 million in 2001. As a percentage of product sales, the cost of sales of products decreased to 10.9% from 13.4% in 2001. Our re-engineered, lower cost AccelScan scanner, completed late in 2001, is the primary reason for the improvement in the gross profit margin on sales of products.

      The cost of sales of services decreased by $195,000, or 2.0%, to $9.7 million in 2002 from $9.9 million in 2001. As a percentage of sales of services, the cost of sales of services decreased to 44.8% in 2002 from 45.9% in 2001. The improved margin on service sales is primarily due to software support services, for which revenues increased while the related costs remained relatively constant.

      Our overall gross profit margin increased 2.2% to 83.5% in 2002 from 81.3% in 2001 due primarily to the improved profit margin on scanners.

      Product Development. Product development expenses decreased by $534,000, or 3.0%, to $17.3 million in 2002 from $17.8 million in 2001. These costs decreased primarily due to staff level and facilities cost reductions in certain subsidiary operations during 2002, and to slightly higher levels of software development costs capitalized due to the introduction of a number of new products in 2002. We continue to invest in the development of new products, enhancement of existing products, and development of tools to increase the efficiency of product development. As a percentage of net sales, product development costs decreased to 13.2% in 2002 from 13.4% in 2001. We expect product development expenses to continue at approximately these levels for the near term.

      Selling and Marketing. Selling and marketing expenses increased by $1.2 million, or 4.2%, to $31.0 million in 2002 from $29.7 million in 2001. These expenses increased primarily due to increased costs of selling at the district level, and increased wages and related benefit costs associated with hiring additional personnel to (i) support sales of our expanded product line and district contracts and (ii) pursue state and federal funding opportunities. As a percentage of net sales, selling and marketing expenses increased to 23.6% in 2002 from 22.6% in 2001. Sales and marketing expenses are expected to increase in 2003 compared to 2002 due to expansion of our field sales force, however, first quarter costs are expected to be at a similar level to first quarter of 2002.

      General and Administrative. General and administrative expenses decreased by $492,000, or 3.4%, to $13.8 million in 2002 from $14.3 million in 2001. These costs decreased primarily due to reduced wages and reduced benefit costs associated with certain staff reductions, lower professional fees, and reduced recruiting costs associated with lower levels of new general and administrative staff hires in 2002. As a percentage of net sales, general and administrative costs decreased to 10.5% in 2002 from 10.8% in 2001.

      Operating Income. Operating income increased by $1.8 million, or 3.9%, to $47.5 million in 2002 from $45.7 million in 2001. As a percentage of net sales, operating income increased to 36.2% in 2002 from 34.5% in 2001.

      Income Taxes. Income tax expense of $19.8 million was recorded in 2002 at an effective income tax rate of 38.7% compared to $19.2 million and 38.5% effective income tax rate in 2001. We expect to maintain our effective tax rate below 39.0% in 2003.

20

Table of Contents

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 accelerated math libraries and optical-mark card scanners, (ii) increased sales of Accelerated Reader quizzes, 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. A fourth quarter 2001 math software promotion contributed to a quarterly increase of about 1,400 schools using math products.

      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 on software support agreements. Revenues from training sessions grew slightly over 2000. Approximately 80,000 educators attended our Renaissance training programs in 2001.

      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. The lower cost has enabled us to lower the list price 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.

      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, MathFacts in a Flash, Accelerated Vocabulary, and AccelTest, which shipped 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. 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%.

      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 Engineering Software Associates 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.

21

Table of Contents

      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.

      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.

Liquidity and Capital Resources

      As of December 31, 2002, our cash, cash equivalents and investment securities were $99.8 million, down by $9.7 million from the December 31, 2001 total of $109.6 million. The net decrease is due primarily to $41.5 million in net cash provided by operating activities offset by stock repurchases of $49.0 million. 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, 2002, we had a $15.0 million unsecured revolving line of credit with a bank which is available until March 31, 2004. 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 available until April 30, 2004. The line of credit bears interest based on the prime rate less 1.0%. As of December 31, 2002, the lines of credit had not been used.

      On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. 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. During the period of July 1, 2002 through December 31, 2002 we repurchased 2,712,572 shares at a cost of $49,155,463. Subsequently, during the period of January 1, 2003 through February 28, 2003 we repurchased 565,845 shares at a cost of $10,060,259.

Off-Balance Sheet Arrangements

      We do not utilize any special purpose entities or other off-balance sheet arrangements.

Critical Accounting Policies and Estimates

      The foregoing discussion is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The following is a list of our critical accounting policies and is not intended to be a comprehensive list of all of our accounting policies. Our significant accounting policies are more fully described in Note 4 to our Notes to Consolidated Financial Statements. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and/or require management’s significant judgments and estimates.

      Revenue Recognition. We recognize revenue in accordance with Statement of Position No. 97-2 “Software Revenue Recognition” issued by the Accounting Standards Executive Committee of the AICPA. Under this accounting standard, revenue is recognized when the following have occurred: persuasive evidence of an arrangement exists, product delivery and acceptance has occurred or a service has been performed, pricing is fixed and determinable, and collectibility is probable. Revenue is recognized as follows: (i) at the time of shipment to customers for off-the-shelf software products and related telephone support with a duration of 12 months or less sold with the product, (ii) on the percentage-of-completion basis for software products which require significant customization or modification, (iii) as seminars are performed for training, (iv) straight-line over the term of the support agreement for separately sold software support agreements,

22

Table of Contents

      Expenses are recognized and matched against revenues for the reporting period presented in the financial statements. We record accruals for sales returns and doubtful accounts at the time of revenue recognition based upon historical experience. Changes in such allowances may be required if future returns or bad debt activity differs from historical experience.

      Impairment of Long-Lived Assets. We evaluate the recoverability of the carrying amount of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. We evaluate the recoverability of goodwill and other intangible assets with indefinite useful lives annually or more frequently if events or circumstances indicate that an asset may be impaired. Management uses judgement when applying impairment rules to determine when an impairment test is necessary. Examples of factors which could trigger an impairment review include a significant decrease in the market value of an asset, a significant change in the extent or manner in which an asset is used, and significant adverse changes in legal factors or the business climate that impact the value of an asset.

      Impairment losses are measured as the amount by which the carrying value of an asset exceeds its estimated fair value. We are required to make estimates of future cash flows related to the asset subject to review. These forecasts require assumptions about demand for our products and services, future market conditions and technological developments. Other assumptions include determining the discount rate and future growth rates. Changes to these assumptions could result in an impairment charge in future periods.

      Software Support and Warranty Obligations. We record a liability for the estimated cost of software support and hardware warranty obligations at the time of sale. Estimated costs are based upon our historical cost experience of fulfilling these obligations as well as other factors that in our judgment could reasonably be expected to affect those costs, such as trends in the cost of providing telephone support and anticipated hardware warranty claim rates. If the actual costs of fulfilling these obligations differ from our estimates, it could result in additional charges to cost of sales in future periods.

      Software Development Costs. We capitalize certain software development costs incurred after technological feasibility is achieved. 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. If the actual economic life of our products is shorter than our estimates, it could result in an impairment charge in future periods.

      Taxes. At the end of each interim reporting period, we estimate the effective income tax rate expected to be applicable for the full fiscal year. The estimated effective income tax rate contemplates the expected jurisdiction where income is earned (e.g., United States compared to non-United States) as well as tax planning strategies. If the actual distribution of taxable income by jurisdiction varies from our expectations or if the results of tax planning strategies are different from our estimates, adjustments to the effective income tax rate may be required in the period such determination is made.

      We record a liability for potential tax assessments based on our estimate of the potential exposure. Due to the subjectivity and complex nature of the underlying issues, actual payments or assessments may differ from our estimates and require tax provision adjustments in future periods.

      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.

23

Table of Contents

      Market Risk. Our exposure to market risk relates to the quality of the holdings in our investment security portfolio. The fair market value of our investments is subject to increases or decreases in value resulting from the performance of the securities issuer and from upgrades or downgrades in the credit worthiness of the securities issuer. We seek to manage our exposure to market risk by investing according to our board-approved investment policy which has the following goals: (i) preservation of capital, (ii) provision of adequate liquidity to meet projected cash requirements, (iii) minimization of risk of principal loss through diversified short and medium term investments, and (iv) maximization of yields in relationship to the guidelines, risk, market conditions and tax considerations.

      Our investment policy specifically defines that our investments (i) have a maximum maturity of 36 months or less, (ii) meet a minimum portfolio liquidity requirement that 10% of the portfolio shall be available on 30 days notice and not more than 30% of the portfolio will have a maturity in excess of 24 months, (iii) meet minimum credit quality requirements specified in the plan based on the type of investment, (iv) meet the concentration limit of not more than 10% in any one issuer other than the US Treasury or its agencies, or money market funds, and (v) meet certain maximum maturity or tender option limits based on its minimum credit rating. As of December 31, 2002 our investment securities had a market value of approximately $82,134,000 and a carrying value of $81,616,000.

      Our investment policy parameters preclude investment in equity securities and require that the Board of Directors review the policy annually and on an interim basis as required.

      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 income. 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.

24

Table of Contents

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Shareholders of

      We have audited the accompanying consolidated balance sheet of Renaissance Learning, Inc. (a Wisconsin Corporation) and subsidiaries, as of December 31, 2002, and the related consolidated statement of income, shareholders’ equity and cash flows for the year then ended. 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 audit. The consolidated financial statements of Renaissance Learning, Inc. as of December 31, 2001 and for the years ended December 31, 2001 and 2000 were audited by other auditors who have ceased operations. Those other auditors expressed an unqualified opinion on those consolidated financial statements in their report dated January 18, 2002.

      We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion.

      In our opinion, such 2002 financial statements present fairly, in all material respects, the financial position of Renaissance Learning, Inc. and subsidiaries, as of December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

      As described in note 5 to the consolidated financial statements, on January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”.

	DELOITTE & TOUCHE LLP

Milwaukee, Wisconsin

25

Table of Contents

      THE REPORT SET FORTH BELOW IS A COPY OF A PREVIOUSLY ISSUED AUDIT REPORT BY ARTHUR ANDERSEN LLP. THIS REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH ITS INCLUSION IN THIS FORM 10-K.

      WE WILL NOT BE ABLE TO OBTAIN THE WRITTEN CONSENT OF ARTHUR ANDERSEN LLP AS REQUIRED BY SECTION 7 OF THE SECURITIES ACT OF 1933 FOR OUR REGISTRATION STATEMENTS ON FORM S-8. ACCORDINGLY, INVESTORS WILL NOT BE ABLE TO SUE ARTHUR ANDERSEN LLP PURSUANT TO SECTION 11(a)(4) OF THE SECURITIES ACT WITH RESPECT TO ANY SUCH REGISTRATION STATEMENTS AND, THEREFORE, ULTIMATE RECOVERY ON A SUCCESSFUL CLAIM MAY BE LIMITED. THE ABILITY OF INVESTORS TO RECOVER FROM ARTHUR ANDERSEN LLP MAY ALSO BE LIMITED AS A RESULT OF ARTHUR ANDERSEN LLP’S FINANCIAL CONDITION OR OTHER MATTERS RESULTING FROM THE VARIOUS CIVIL AND CRIMINAL LAWSUITS AGAINST THAT FIRM.

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

26

Table of Contents

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

27

Table of Contents

CONSOLIDATED STATEMENTS OF INCOME

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

28

Table of Contents

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY