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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

For the fiscal year ended October 31, 2003

Commission file number 0-20842

PLATO Learning, Inc.

Registrant’s telephone number, including area code:

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

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

      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 twelve months 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 the 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.     o

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

      The number of shares of the Registrant’s common stock, par value $.01, outstanding as of January 8, 2004 was 22,967,141 shares. The aggregate market value of common stock (based on the closing price on January 8, 2004) held by non-affiliates of the Registrant was approximately $265,890,000.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Company’s definitive Proxy Statement for the Company’s Annual Meeting of Stockholders to be held on March 4, 2004 (the “2004 Proxy Statement”) are incorporated by reference in Parts II and III.

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PLATO LEARNING, INC.

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PART I.

Overview

      PLATO Learning, Inc. is a leading provider of computer and web-based instruction, curriculum planning and management, assessment and related professional development and support services to K-12 schools. We also provide these products and services to two- and four-year colleges, job training programs, correctional institutions, military education programs, corporations and individuals. We benefit from our respected 40+ year heritage and proven track record of student achievement based on our award-winning instructional solutions. Our courseware and web-based accountability and assessment software are designed to help educators meet the demands of the No Child Left Behind (“NCLB”) and Reading First federal legislation. We also offer online and onsite staff development, alignment and correlation services to ensure optimal classroom integration of our products and to help schools meet their accountability requirements and school improvement plans.

      We provide an effective complement or supplement to classroom instruction that helps close the achievement gap for all learners. Our curriculum courseware components, while fully sequenced and integrated with each other, can also be selected individually to meet the differing needs of schools and teachers. They are aligned to local, state and national performance standards. The PLATO® Learning System consists of curriculum and instructional management tools, assessment, alignment and correlation tools, mastery-based courseware and related professional services, and is designed to help schools meet the mandates of federal and state accountability legislation, special programs such as Title I and special education, and other programs and learning environments.

      Our research-based courseware library includes over 4,000 hours of mastery-based instruction covering over 12,500 learning objectives in the subject areas of reading, writing, language arts, math, science, social studies and work skills. Our web-based assessment and alignment tools ensure that curriculum is aligned to local, state and national standards. Educators are able to identify each individual student’s instructional needs and prescribe a personalized learning program using PLATO® courseware, over 40,000 teacher-screened educational web sites, and the school’s own textbooks and software. A variety of reports are available to help educators identify gaps in student understanding and ensure that standards are being addressed. The web-based accountability and assessment products involve parents, students, teachers and administrators in the learning process.

      We operate our principal business in the single industry segment of educational software (see Note 16 to Consolidated Financial Statements).

Recent Developments

      In November 2003, we acquired Lightspan, Inc. (“Lightspan”) following approval by PLATO and Lightspan shareholders. Lightspan is a provider of curriculum-based educational software and on-line assessment products and services that increase student achievement and enhance teacher professional development. These products are used in schools and homes and align with all key federal reform initiatives, offering school districts a comprehensive achievement and accountability system to assess, align, instruct and evaluate. This acquisition is expected to strengthen our product offerings in the K-8 and post-secondary markets and enhance our ability to provide comprehensive solutions to K-12 and adult learning institutions.

      In December 2003, we acquired New Media (Holdings) Limited (“New Media”), a United Kingdom (“U.K.”) based publisher of curriculum-focused software primarily for teaching secondary school science and math. New Media’s products are used in U.K. schools and are sold worldwide. New Media also provides in-service training for secondary school science and math teachers, and develops educational software and training programs under contract to the U.K. Education Department. This acquisition enhances our science offering, provides a science simulation development capability that we did not previously have and will allow us to introduce New Media’s products to markets in the United States for the first time. An expanded science

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      In January 2004, we announced that we had signed a Letter of Agreement with the Idaho Department of Education valued at $16.8 million over ten years. This agreement, which is subject to state funding out clauses, final contract and integration of PLATO software with a student information management system, represents the first time a student information system and a curriculum management system will be fully integrated and delivered across the Internet, providing consistent information management and reporting for schools, districts and the state as mandated by NCLB. While this contract represents a major project for us, with significant milestones that must be met, it reconfirms the importance of our 2002 NetSchools acquisition and our continued development of the PLATO Orion management system, which forms the foundation for the curriculum management system in Idaho.

Market

      We estimate that the current U.S. market for our K-12 products is approximately $1.5 billion dollars annually and is currently growing by approximately ten to twelve percent per year. We anticipate that growth in this market will continue over the next few years as a result of the increasing emphasis on quality of education at local, state and national levels. Schools and school districts are increasingly being held accountable for the academic achievement of their students, which is frequently measured by standardized tests. Furthermore, the NCLB legislation, enacted in January 2002, is an education reform plan that is heavily focused on assessment and accountability standards, as well as teacher quality and early reading skills.

      Over the last four years, federal programs have allocated over $7.5 billion dollars to schools to create state-of-the-art technology infrastructures for the 21st century. The resulting growth in the number of computers, Internet connections and telecommunications systems in schools has created the technological infrastructure necessary to implement sophisticated courseware and web-based applications. Increasingly, our customers are turning to computer-aided and web-based methods of instruction as a complement or supplement to their instructor-led programs due to the flexibility, cost-efficiency and demonstrated effectiveness of e-learning products.

      Historically we have provided products and services primarily to the secondary school segment of K-12, which represents approximately forty percent of the K-12 market, and to the adult education markets. With the acquisitions of Wasatch Interactive Learning Corporation (“Wasatch”) (April 2001), LearningElements (August 2002) and Lightspan (November 2003), we now offer courseware to the elementary school market, which represents the remaining approximate sixty percent of the K-12 market. In addition, with the acquisitions of TeachMaster Technologies, Inc. (September 2001) and NetSchools Corporation (May 2002), we now specialize in cross-platform standards-based curriculum management and accountability and assessment solutions for K-12.

Products

      Customers use our products to:

	•	ensure that NCLB requirements for “adequate yearly progress” are met;
	•	support administrator needs for curriculum aligned to local, state and national standards;
	•	assess and identify individual student instructional needs;
	•	prescribe a personalized course of instruction;
	•	develop foundational reading skills for emerging readers;
	•	complement instructor-led education and focus on difficult subject matter;

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	•	supplement classroom learning and provide additional instruction and practice;
	•	monitor and report on student learning progress in relation to local, state and national academic standards;
	•	prepare students for standards-based and high-stakes state examinations;
	•	help teachers align instructional time to standards and make instructional decisions;
	•	develop teacher skills and abilities to teach to standards to increase classroom effectiveness;
	•	assist learners in community, technical and four-year colleges in meeting their college-level reading, math and writing skills;
	•	prepare adult students to complete high-school graduation and GED requirements;
	•	support adult learners in job training programs and workplace training; and
	•	provide support for skill development in youth and adult correctional education programs.

      With its wide scope and coverage, PLATO courseware is appropriate in context and learning style for learners at grade level, as well as learners in remedial programs. Our courseware employs sophisticated interactive simulations, online coaching and advanced multimedia and graphics to create an exciting learning environment that fosters critical-thinking skills. The instructional strategy, design and modular structure of the courseware allow educators to provide personalized instruction to meet both individual student needs and specific program objectives.

      Our instructional courseware packages are pre-aligned to over 250 state, provincial, federal and international standards. PLATO courseware is designed to be effective in a variety of settings, including mainstream classrooms, alternative education programs, mandated state accountability test preparation, graduation standards prep labs, school-to-work programs, adult basic education, GED preparation, developmental studies, employment preparation, workplace training and military basic skills programs. Whether used for distance learning, as a complement or supplement to a traditional instructor-led program, or as an advanced course offering, our instructional solutions are intended to motivate and engage a wide range of students.

      Our courseware is recognized for its academic content, instructional integrity, innovative instructional design and ability to captivate and motivate students. As in past years, leading industry associations and publications in several categories recognized our products:

	•	EdNet Pioneer Award for PLATO Learning, September 2003
	•	eSchool News Readers’ Choice Award for Best High School Math Software — PLATO Algebra 1 & 2, Spring 2003
	•	eSchool News Readers’ Choice Award for Best High School Science Software — PLATO Science Series, Spring 2003
	•	Technology & Learning Magazine Award of Excellence for Language Arts — PLATO Focus Reading and Language Program, December 2003
	•	Media & Methods Magazine Awards Portfolio — PLATO Algebra 1 & 2, Summer 2003
	•	Media & Methods Magazine Awards Portfolio — CyberEd Life Sciences, Summer 2003
	•	ComputEd Learning Center’s Best Children’s Educational Software Award (“BESSIE”) for Best Middle School Math Software — PLATO Algebra 1 & 2, Spring 2003
	•	ComputEd Learning Center’s BESSIE Award for Best Middle School Science Software — CyberEd Life Sciences, Spring 2003

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	•	2004 Codie Award Finalist, Best Secondary Education Instructional Solution — PLATO Middle School Solution, December 2003
	•	AEP Distinguished Achievement Award, eNewsletter Finalist — Nettie’s Net News, June 2003

      We regularly update our courseware library and continually develop new products to extend and enhance our product offerings. Over ninety percent of our products have been developed or updated within the last three years. In 2003, we introduced several new products and initiatives, including PLATO Intermediate Writing Process and Practice, the first in a planned series of writing products, and PLATO Life Sciences, the first in a planned series of science products, both targeted to middle school learners.

      PLATO® Pathways and the PLATO® Web Learning Network provide curriculum management infrastructure in LAN/ WAN/standalone and web-based environments, respectively. PLATO Pathways is an easy-to-use software program and versatile educational tool that integrates assessment, instruction and management. Updated in 2003, this instructional management system diagnoses strengths and weaknesses and adaptively prescribes individualized menus ensuring targeted, personalized instruction keyed to program goals. The PLATO Web Learning Network offers the same targeted, personalized instruction keyed to program goals, as well as high-quality instructional content and essential student management services as an Application Service Provider (“ASP”) product over the Internet.

      PLATO software is configured for computers using Microsoft®, Apple® Macintosh® and Linux® operating systems. There are multiple ways in which our software can be delivered, including:

	•	Internet delivery. The complete PLATO Learning System, including courseware and management capabilities, is available in an ASP web-delivered model called the PLATO Web Learning Network. Customers can free up technical and hardware replacement budgets by eliminating the need to fund local area networks at every location and gain added purchasing flexibility to provide more students with the opportunity to achieve academic success using PLATO courseware. Customers with the technical expertise may host the system locally. By using the Internet, learners and teachers are able to access their PLATO courseware and records anytime, anywhere.
	•	Local Area Networks (LAN). With a LAN configuration, all courseware, management software, student records and files are centralized. Courseware can be accessed by any student at any learning station. The Company offers LAN configurations utilizing Microsoft® Windows® NT/2000 or Novell® NetWare® servers.
	•	CD-ROM or Desktop Launch. PLATO courseware can be delivered directly on a computer workstation with or without a management system. Individual student sign-on, bookmarking, record keeping and reporting are available.

      Our Correlation Services provides alignment and correlation of assessments, textbooks and other resources, such as web sites and software, to standards. Curriculum alignment is the process of assuring that curriculum standards and benchmarks, instruction, assessment and reporting are all closely related. This is often a complex task and a difficult challenge. Early research by M. David Merrill and his students (Merrill, et. al., 1979) demonstrated that more than fifty percent of the variation in achievement is directly related to errors in alignment. Alignment of objectives, instruction, and assessment is central to the success of any standards-based effort to improve teaching. Each member of our Correlations Services team correlates textbooks, web sites and other resources to state standards and assessments in their area of curriculum expertise, down to the most detailed level of the standard being addressed. We believe this in-depth approach distinguishes the correlations program from those of our competitors.

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      PLATO Accountability Solutions and PLATO Assessment Solutions, sold on an annual subscription basis, are aligned to state and national performance standards and consist of PLATO Orion, PLATO Polaris, PLATO Link, and PLATO State Standards Toolkit. They are designed to provide interactive individualized standards-based instruction in a broad range of subject areas and contain a suite of web-based tools designed to address the growing importance of standards-based instruction and assessment, as well as provide educators with a variety of options to meet differing needs. Research shows that student achievement improves when teachers are confident that instruction is aligned with standards, and this suite of products can help reduce the achievement gap for all learners.

      PLATO Orion is a curriculum management system that provides administrators and teachers tools to manage curriculum from the state or district level to the local building. The product contains a powerful correlation engine that allows educators to align state standards with their onsite instructional resources, including textbooks and software, and with the PLATO database of over 40,000 teacher-screened educational web sites. This database effectively reduces the time educators need to search the Internet for appropriate instructional resources, and allows educators to refine their search based on 19 different criteria, including grade level, learning modality and level of interactivity. In addition, many textbook publishers have recently adopted our PLATO Orion product for correlations.

      PLATO Accountability Solutions and PLATO Assessment Solutions analyze student performance with diagnostic assessments correlated to standards and suggest options for remediation with personal Academic Assistance Plans derived from activities based on a school’s textbooks and other resources, the PLATO database of web sites and PLATO courseware. Local and state Performance Indicators are incorporated into daily lessons and student assignments are made based on those indicators using lesson plans and templates. These products help educators tailor their curriculum to the needs of each individual student and address the requirements of local, state and federal accountability legislation, as well as programs such as Title I and special education. They also address the challenging issues of data-driven decision-making and continuous school improvement planning identified in the NCLB legislation. To help educators and parents keep effective records of student progress, the system creates graphical and text reports for every student, which can be viewed online by both parents and students. In addition, educators can view individual student reports and class performance data, while administrators can view data by class, school or district.

      Educators can select from different modules within the system depending on their needs. The PLATO Orion option is an ASP web-delivered model and involves all members of the learning community: students, teachers, administrators and parents. The PLATO Polaris option may be ASP or client-hosted and functions as a customizable tool to help classroom teachers adjust their daily teaching in accordance with standards requirements. PLATO Link provides state-standards practice tests and skills assessments with immediate scoring and links to PLATO Instructional Solutions designed to help students improve in areas of weakness. There are also assessment solutions for GED preparation and for teacher and paraprofessional certification.

      The PLATO Professional Services Group ensures that customers receive the consultation, training, and services needed to successfully implement their PLATO Learning System. Our highly skilled consultants work with schools to develop customized staff development plans that are tied to standards and/or a school’s unique accountability and assessment needs. To help schools meet their accountability mandates and the goals of their school improvement plans, we offer services in three areas:

	•	Performance Essentials, for immediate in-service needs;
	•	Consulting Partnerships, focused on long-term systemic change; and
	•	Correlation Services, to provide correlation of assessments, textbooks and other resources, such as web sites and software, to standards.

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      We offer flexible delivery of these services. Schools are offered a choice of schedules so that staff development can take place at times convenient to them: throughout the school year and throughout the school day, after school and during planning time, for large or small groups, and one-on-one. Schools are able to minimize the expense and inconvenience of bringing in substitute teachers while their staff attends in-service training. The PLATO professional service model is built on the recommended staff development standards of the National Staff Development Council.

      Each member of our Correlations Services team, all former teachers, correlates textbooks, web sites and other resources to state standards and assessments in their area of curriculum expertise, down to the most detailed level of the standard being addressed. We believe this in-depth approach distinguishes our correlations program from those of our competitors.

      Our field engineers and technicians provide onsite installation and specialized technical consulting to those customers who desire to supplement their technical staff. Our customers can access our product specialists and software analysts to answer questions or solve problems with their PLATO software. Support is available via a toll-free telephone number, e-mail, the PLATO Support web site and a PLATO Support CD-ROM. Customers also receive updates and enhancements to their PLATO software.

      Our customer support group provides a full range of support services to ensure customer satisfaction. Full-time professionals, with general technical expertise and extensive operational knowledge of our products, provide pre-sale technical consultation and support to our field sales organization and are responsible for the final technical review and approval of all proposed delivery platforms and installation configurations. These professionals consult and coordinate with the customer, account manager and installation team regarding site preparation and system installation. They also confirm full customer acceptance and monitor customer satisfaction and support requirements.

      We integrate our products into existing customer hardware, or provide a complete turnkey solution if necessary, by purchasing component parts from a network of external suppliers under a just-in-time inventory system. We have supplier relationships with several hardware and software vendors. These relationships are important to us; however, we believe that, in the event that such products or services were no longer available, alternative suppliers could be found on acceptable terms. We do not use raw materials and maintain a limited amount of inventory.

      All manufacturers’ warranties are passed through to our customers. After the warranty periods are over, we offer maintenance contracts through third-party service providers. We contract with outside vendors to provide for hardware installation and maintenance services for our customers. In addition, we distribute a limited amount of third-party courseware and also purchase off-the-shelf software and hardware products from Novell®, Microsoft®, Dell and other vendors.

Strategy

      Our strategy is to provide a broad range of interactive, multimedia, self-paced educational courseware tied to standards, delivered on computer networks, personal computers and over the Internet, to address the needs of learners of all ages throughout their lifetimes. Critical elements of our strategy include:

	•	working closely with customers to design products that meet specific instructional needs and applicable academic standards using the design and structural advantages inherent in our proprietary software;
	•	expanding sales of courseware and services, including subscription-based products, that generate higher profit margins and greater growth opportunities;
	•	building the PLATO Learning brand to promote the attributes of heritage, ingenuity, and passionate commitment to education;
	•	expanding our accountability and assessment product line to capitalize on the increased emphasis on accountability and standardized testing;

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	•	building our PLATO elementary and PLATO FocusTM Reading and Language Program products to claim a leadership position in the elementary school market;
	•	targeting NCLB, Reading First, Title I and special education funds that are highly appropriate for our products and services;
	•	pursuing large grant and request for proposal opportunities;
	•	leveraging the Internet to include parents, students, teachers and administrators in the learning process;
	•	extending existing distribution channels to include catalogs, business-to-business, educational portals and home sales;
	•	partnering with influential educational associations on mutually beneficial initiatives; and
	•	addressing the needs for learner preparation to meet college-level standards and for GED and employability skills development in adult education and job training.

Sales and Marketing

      Our sales and marketing efforts are designed to expand market share in our core markets and reinforce our reputation for product quality, service and customer satisfaction. We target potentially large and growing market segments to which existing and future products and services can be sold through a variety of distribution networks and channels.

      We use a combination of direct sales, inside sales and strategic sales resources, distributors and a reseller network using e-commerce, catalogs, portals and a comprehensive Internet web site (www.plato.com).

      In 2002, in response to the growing importance of state and federal funding sources, resulting from the NCLB legislation, we established a grants and funding team to pursue large funding grants and request for proposal opportunities. This led to several significant wins in 2003, including the renewal of our agreement with the U.S. Department of Navy to provide educational services.

Competition

      In all of our markets, we compete primarily against more traditional methods of education and training, principally live classroom instruction. Within the e-learning market, we compete most directly with other learning system providers, including divisions within Pearson plc, McGraw-Hill McMillan and WRC Media, and with Riverdeep Group plc and Renaissance Learning. Generally, WRC Media’s Compass Learning competes in the elementary market and McGraw-Hill McMillan in the adult and college markets. Pearson’s NCS Learn and Riverdeep each offer a K-12 line of products. In the post-secondary education and training markets there are many regional and specialized competitors. We also compete with companies providing single-title retail products, software publishers and Internet content and service providers.

      We compete primarily on the basis of the breadth, depth and recognized quality of our courseware and services, as well as our ability to deliver flexible, timely, cost-effective and customized solutions to the education and training needs of our customers. Our stability, longevity, record of student improvement, and new product development also differentiate us from the competition. Based on our experience, we believe that these are some of the key factors that buyers use in evaluating competitive offerings.

Product Development

      Our product development group develops, enhances and maintains the courseware, learning management software and delivery system platforms. We employ a rigorous multi-phased product development methodology and process management system. Based on classical instructional design concepts and models, as well as systems development management techniques, our product development methodology has been constructed to specifically address the creation of individualized, student-controlled, interactive instruction using the full multimedia capabilities of today’s personal computing, communication and other related technologies. Our rigorous instructional design and software development methodology assures the instructional effectiveness

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      Central to the courseware development process are the following proprietary software tools:

	•	PLATO Pathways — the PLATO instructional management system designed for system control, tracking and reporting of student performance, and administration on standalone and network systems;
	•	Micro PLATO Authoring System (MPAS) — tools for the enhancement and maintenance of part of our courseware library;
	•	PLATO Curriculum Design, Development and Delivery (PCD3) System — tools for the enhancement and maintenance of part of our courseware library;
	•	Win PLATO — a software framework for authoring and delivering Windows® courseware;
	•	WebPLATO — a software framework for authoring and delivering web-based courseware;
	•	PLATO Web Learning Network — a software framework for creating and delivering web pages for instructional management, student record keeping, courseware delivery, access control and site monitoring;
	•	PLATO Orion development framework — for creating and delivering web pages for standards-based learning management, student record keeping, access control and site monitoring; and
	•	PLATO Orion Academic Information System for Accountability — a correlation engine based on the PLATO Learning Index and sophisticated web-based tools to support correlations.

Proprietary Rights

      We regard our courseware as proprietary and protect it primarily under a combination of the laws of copyrights, trademarks, patents and trade secrets. We also utilize license and distribution agreements, employee and third-party non-disclosure agreements and other methods to protect our proprietary rights. We regard many of our intellectual property rights as important to our business. We enforce our intellectual property rights when we become aware of any infringements or potential infringements.

      We own and maintain numerous federal registrations of various trademarks and service marks, including, but not limited to, the PLATO, CyberEd, NetSchools, TeachMaster Technologies, Lightspan, Academic Systems, Edutest and Achieve Now marks in the United States and in other countries that are important to our business. We have not applied for trademark registrations at the state level and rely on our federal registrations and common-law rights to protect our trademarks, service marks, trade names, domain names and trade dress.

      In 1989, Control Data assigned to our predecessor-in-interest the registered copyrights in the then-existing PLATO courseware. We rely on the laws of copyright to protect all versions of PLATO courseware and software, but in many instances have not obtained federal registrations or recorded the assignments from Control Data in these copyrights because we believe the additional statutory rights conferred from recordation are not essential for the protection of our rights.

      Our courseware also contains certain copyrighted material that we have lawfully acquired pursuant to a perpetual, exclusive license from CyberEd, Wasatch, TeachMaster, NetSchools, LearningElements, Lightspan, Academic Systems and New Media. In addition, we license a limited amount of software from third-party developers to incorporate into our courseware and software products.

      We do not include any technological mechanisms to prevent or inhibit unauthorized copying of our software products, but generally require the execution of a written license agreement, which restricts use and copying of our courseware and software products.

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Backlog

      We have little backlog, as we generally ship all products when orders are received. Our deferred revenue was approximately $26.6 million and $18.8 million at October 31, 2003 and 2002, respectively. At October 31, 2003, approximately $4.4 million of deferred revenue is expected to be recognized subsequent to fiscal year 2004. These amounts exclude revenue that we expect to earn from the U.S. Department of Navy and Idaho Department of Education contracts mentioned earlier. Contracts and agreements are subject to the delivery of products and services, collection and other conditions.

Seasonality

      Our quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions, client spending patterns, budget cycles and fiscal year ends and promotional programs. We historically have experienced our lowest revenues in the first quarter and increasingly higher levels of revenues in each of the next three quarters. Because of these factors, the results for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year.

Employees

      As of January 1, 2004, we had 750 full-time employees, including 275 in sales and marketing and 132 in product development. We have never experienced a work stoppage as a result of a labor dispute, and none of our employees are represented by a labor organization.

Non-Audit Services Performed by Independent Auditors

      Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for disclosing to investors the non-audit services approved by our Audit Committee to be performed by PricewaterhouseCoopers LLP, our independent auditors. Non-audit services are defined as services other than those provided in connection with an audit or a review of our financial statements. During the period covered by this Annual Report on Form 10-K, our Audit Committee pre-approved non-audit services, consisting primarily of tax planning and compliance services and services rendered in connection with registration statements, acquisitions and employee benefit plans, which subsequently were or are being performed by PricewaterhouseCoopers LLP.

Web Site Access to Reports

      Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statements on Schedule 14A, Current Reports on Form 8-K, and any amendments to those reports, are made available free of charge on our web site (www.plato.com) as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission (“SEC”). Statements of changes in beneficial ownership of our securities on Form 4 by our executive officers and directors are made available on our web site by the end of the business day following the submission of such filings to the SEC. All reports mentioned above are also available from the SEC’s web site (www.sec.gov).

Forward-Looking Statements

      Any statements in this Annual Report on Form 10-K about expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “will continue,” “anticipate,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook.” Accordingly, these statements involve estimates, assumptions and uncertainties, which could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this document. The following cautionary statements identify important factors that could

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	•	general economic and business conditions; the existence or absence of adverse publicity; changes in marketing and technology; changes in political, social and economic conditions;
	•	competition in the computer-based education and training industry; general risks of the computer-based education and training industry;
	•	success of acquisitions and operating initiatives; changes in business strategy or development plans; management of growth;
	•	dependence on senior management; business abilities and judgment of personnel; availability of qualified personnel; labor and employee benefit costs;
	•	ability to integrate effectively the technology, operations and personnel of our acquisitions in a timely and efficient manner;
	•	ability to retain and hire key executives, technical personnel and other employees;
	•	ability to manage growth and the difficulty of successfully managing a larger, more geographically dispersed organization;
	•	ability to manage successfully changing relationships with customers, suppliers, value-added resellers and strategic partners; and
	•	ability of our customers to accept new product offerings.

      These factors and the risk factors referred to below could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us, and you should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

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RISK FACTORS

Risks Relating to Our Business and Operations

      We derive a substantial portion of our revenues from public school funding, which is heavily dependent on support from federal, state and local governments. Government budget deficits may adversely affect the availability of this funding. In addition, the government appropriations process is often slow, unpredictable and subject to factors outside of our control. Curtailments, delays or reductions in the funding of schools or colleges, for example a reduction of funds allocated to schools under Title I of the Elementary and Secondary Education Act, could delay or reduce our revenues, in part because schools may not have sufficient capital to purchase our products or services. Funding difficulties experienced by schools or colleges could also cause those institutions to be more resistant to price increases in our products, compared to other businesses that might better be able to pass on price increases to their customers. The growth of our business depends on continued investment by public school systems in interactive educational technology and products. Changes to funding of public school systems could slow this type of investment.

      We have been profitable from 1997 to 2001. In 2002 and 2003, we incurred net losses and we may not be able to achieve profitability in the future. Future revenues and profits, if any, will depend upon various factors, including continued market acceptance of our combined products and services. We expect to continue to incur significant costs and expenses associated with the operation and development of an expanding business. These costs and expenses include, but are not limited to, sales and marketing, personnel and product development and enhancement. As a result of these expenses, we will need to generate significant revenues to sustain our profitability.

      Many of our customers purchase systems and license courseware on a perpetual license basis. Accordingly, new customers must be found or new or additional products or licenses must be sold to existing customers in order to maintain and expand our revenue stream and sustain profitability.

      We expect to continue to generate a substantial portion of our revenues from curriculum-based educational software products and will need to increase these revenues in order to more effectively grow other areas of our business. Revenues from licenses will depend principally on broadening market acceptance of that software, which may not occur due to a number of factors, including:

	•	teacher, parent and student preferences for interactive educational technology are subject to changes in popular entertainment and educational theory;
	•	some teachers may be reluctant to use interactive educational technology to supplement their customary teaching practices;
	•	we may be unable to continue to demonstrate improvements in academic performance at schools or colleges that use our educational software; and
	•	our failure to detect bugs in our software could result in product failures or poor product performance.

      If market acceptance of curriculum-based educational software is not broadened, our future revenue growth will be adversely impacted and we may never become profitable.

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      To achieve our operating goals and objectives, we will need to derive an increasing portion of our revenues from our fee-based online subscription business. Our ability to increase revenues from our fee-based online subscription business depends on:

	•	our ability to increase the subscriber base of our fee-based online subscription products while maintaining a subscription fee; and
	•	improvement of the accessibility and ease of use of our web sites.

      The future success of our fee-based online subscription business is highly dependent on an increase in the number of users who are willing to subscribe to our subscription products. The number of users willing to pay for online educational products may not continue to increase. If the market for subscription-based online educational products develops more slowly than we expect, or if our efforts to attract new subscribers are not successful or cost effective our operating results and financial condition may be materially and adversely affected.

      If we are unable to substantially increase our revenues from our online subscription businesses, we will be unable to execute our current business model. As a result, we may need to reevaluate that business model, or we may never become profitable.

      Our revenues and profitability may fluctuate as a result of many factors, including the size, timing and product mix of orders and the capital and operating spending patterns of our customers. We sell our courseware directly to school districts and other clients. The timing of our revenues is difficult to forecast because our sales cycle is relatively long and our services are affected by the financial conditions and management decisions of our clients, as well as general economic conditions. Historically we have experienced our lowest revenues in the first fiscal quarter and increasingly higher levels of revenues in each of the next three fiscal quarters.

      Our industry is intensely competitive, rapidly evolving and subject to technological change. Demand for particular courseware products, systems hardware and services may be adversely affected by the increasing number of competitive products from which a prospective customer may choose. We compete primarily against other organizations offering educational and training software and services. Our competitors include several large companies with substantially greater financial, technical and marketing resources than ours. We compete with comprehensive curriculum software publishers, companies providing single-title retail products, Internet content and service providers and computer hardware companies. Existing competitors may broaden their product lines and potential competitors may enter the market and/or increase their focus on e-learning, resulting in greater competition for us. Increased competition in our industry could result in price reductions, reduced operating margins or loss of market share, which could seriously harm our business, cash flows and operating results.

      The loss of one or more of our executive officers or other key personnel could inhibit the development of our business and, accordingly, harm our business and operating results. Qualified personnel are in great demand in our industry. Our future success depends in large part on the continued service of our key technical, marketing and sales personnel and on our ability to continue to attract, motivate and retain highly qualified employees. Our key employees may terminate their employment with us at any time. There is competition within the industry for such employees and the process of locating key technical and management personnel with suitable skills may be difficult.

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      We rely heavily on statistical studies to demonstrate that our curriculum-based educational software increase student achievement. We believe that these studies accurately reflect the performance of our products. However, these studies involve the following risks:

	•	the limited sample sizes used in our studies may yield results that are not representative of the general population of students who use our products;
	•	the methods used to gather the information upon which these studies are based depend on cooperation from students and other participants, and inaccurate or incomplete responses could distort results;
	•	schools studying the effectiveness of our products apply different methodologies and data collection techniques, making results difficult to aggregate and compare;
	•	we facilitate the collection and analysis of data for some of these studies; and
	•	we select and pay researchers to aggregate and present the results of some of these studies and, in some cases, to conduct the studies.

      There is growing demand from NCLB and other sources for research and studies to demonstrate the effectiveness of educational programs and products. Our sales and marketing efforts, as well as our reputation, could be adversely impacted if the public, including our existing and potential customers, perceives these studies to be biased due to our involvement, or if the results of these studies are not representative, which could lead to lower than expected revenues.

      We may encounter difficulties responding to technological changes that could delay our introduction of products and services or other existing products and services. Our industry is characterized by rapid technological change and obsolescence, frequent product introduction, and evolving industry standards. Our future success will depend, to a significant extent, on our ability to enhance our existing products, develop and introduce new products, satisfy an expanded range of customer needs and achieve market acceptance. We may not have sufficient resources to make the necessary investments to develop and implement the technological advances required to maintain our competitive position.

      Without the continued development and maintenance of the Internet infrastructure, we could fail to generate the revenues necessary for our fee-based online subscription business to succeed. In addition, some of our curriculum content is very media-rich and is not currently delivered over the Internet, due to bandwidth and other limitations. The continued development of the Internet includes maintenance of a reliable network with the necessary speed, data capacity and security, as well as timely development of complementary products for providing reliable Internet access and services. Because the online exchange of information and global commerce on the Internet is new and evolving, we cannot predict whether the Internet will prove to be an effective vehicle for delivering commercial content or will provide a viable marketplace for electronic commerce in the long term.

      As the number of Internet users continues to increase, and as these users increase their frequency of use and bandwidth requirements, the Internet infrastructure may be unable to support the demands. In addition, increased users or bandwidth requirements may adversely impact the performance of the Internet.

      We believe that maintaining and enhancing the value of the PLATO Learning brand is critical to attracting purchasers for our curriculum-based educational software and subscribers and users of our fee-based

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      We currently utilize the names of teachers and students who are registering for our online subscription products for purposes of accessing our web sites. However, we may in the future collect other personal information relating to students, teachers and parents, and may sell our user information on an aggregated, non-individual basis, though we do not intend to sell information relating to children under the age of thirteen. We could be subject to liability claims for misuses of information collected from our users, such as for unauthorized marketing purposes, and could face additional expenses to analyze and comply with increasing regulation in this area. The Federal Trade Commission, for example, has enacted regulations governing collection of personal information from children under the age of thirteen and is expected to issue and enforce additional regulations in this area. We could also be subject to liability based on claims relating to content that is published on our web sites or that is accessible from our network through links to other web sites. In addition to subjecting us to potential liability, claims of this type could require us to change our web sites in a manner that could be less attractive to our customers and divert our financial and development resources.

      We may not be able to raise capital in the future to meet our liquidity needs and finance our operations and future growth. We believe that our existing cash resources, the amounts available under our credit facility and cash generated from our operations will be sufficient to satisfy our operating cash needs for the foreseeable future. Any future decreases in our operating profit, cash flow or stockholders’ equity may impair our future ability to raise additional funds to finance operations. As a result, we may not be able to maintain adequate liquidity to support our operations or maintain our future growth.

      Our success depends in part on our intellectual property rights to the products and services that we develop. We rely primarily on a combination of statutory and common law copyright, trademark and trade secret laws, customer licensing agreements, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights. We own the federal registration of the PLATO and CyberEd trademarks as well as trademarks acquired through the NetSchools and LearningElements transactions. Certain product trademarks, including “NetSchools Orion” were acquired from the NetSchools transaction. Certain product trademarks, including “Focus” and “Ready to Focus” were acquired from the LearningElements transaction.

      In addition, we own or license all copyrights in our coursework, none of which is registered with the U.S. Copyright Office. We believe that the additional statutory rights resulting from registration of these copyrights are not necessary for the protection of our rights therein. In addition, in 1989 Control Data assigned the federally registered copyrights in the PLATO courseware to us. We have not recorded the assignment of these copyrights because we believe the additional statutory rights resulting from recordation are not necessary for the protection of our rights therein. We have federal copyrights on all of our courseware produced since 1989. We have not applied for trademark registration at the state level, but have instead relied on our federal registrations and state common law rights to protect our proprietary information. We have registered trademarks for PLATO in the United States and overseas. We regard these registrations as material to our business. We license some software from third-party developers and incorporate it into our courseware

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      We do not include in our products any mechanisms to prevent or inhibit unauthorized copying, but generally require the execution of a license agreement, which restricts copying and use of the courseware and software. We have no knowledge of the unauthorized copying of our products. However, if such copying or misuse were to occur to any substantial degree, our operating results could be adversely affected. In addition, our U.S. registrations may not be enforceable or effective in protecting our trademarks and copyrights, especially outside of the U.S.

      Although we believe our products and services have been independently developed and that none of our products or services infringes on the rights of others, third parties may assert infringement claims against us in the future. We may be required to modify our products, services or technologies or obtain a license to permit our continued use of those rights. We may not be able to do so in a timely manner or upon reasonable terms and conditions. Failure to do so could harm our business and operating results.

      We market our products worldwide and have operations in Canada and the United Kingdom. As a result, our financial results could be affected by changes in foreign currency exchange rates or weak economic conditions in foreign markets. Working funds necessary to facilitate the short-term operations of our foreign subsidiaries are kept in the local currencies in which they do business.

Risks Relating to Ownership of Our Common Stock

      The market price for our common stock is volatile and may decline in the future for a variety of reasons, including:

	•	quarterly variations in our operating results;
	•	changes in earnings estimates by analysts;
	•	announcements of new contracts or service offerings by us or our competitors;
	•	disputes or other developments concerning proprietary rights, including patents and litigation matters and our ability to patent our technologies;
	•	departures of key personnel;
	•	announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; or
	•	general market conditions.

      In particular, the realization of any of the risks described in these “Risk Factors” could have a dramatic and materially adverse impact on the market price of our common stock. In addition, the stock market and the NASDAQ National Market in particular, have experienced significant price and volume fluctuations that have affected the market prices of companies in recent years. These fluctuations may continue to occur and disproportionately impact our stock price. In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been instituted. This type of litigation could result in substantial costs and a diversion of management’s attention and resources, which could materially affect our business, financial condition, cash flows or results of operations.

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      Provisions of our certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We may issue shares of preferred stock in the future without stockholder approval and upon such terms as our board of directors may determine. Our issuance of preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of our outstanding stock and potentially prevent the payment of a premium to stockholders in an acquisition. Our charter and by-laws also provide that special stockholders meetings may be called only by our board of directors with the result that any third-party takeover not supported by the board of directors could be subject to significant delays and difficulties. In addition, our board of directors is divided into three classes, each of which serves for a staggered three-year term, which may make it more difficult for a third party to gain control of our board of directors.

      We currently intend to retain any future earnings for funding growth and, therefore, do not expect to pay any dividends in the foreseeable future. As a result of not collecting a dividend, stockholders will not experience a return on their investment, unless the price of our common stock appreciates and stockholders sell their shares of common stock.

Risks Relating to the Lightspan Merger

      PLATO and Lightspan entered into the merger agreement with the expectation that the merger will result in benefits to the combined company arising out of the combination of sales and marketing leadership, general and administration functions and facilities plus the elimination of costs relating to Lightspan’s status as a public reporting company. To realize any benefits from the merger, we will face the following post-merger challenges:

	•	expected cost savings and synergies from the merger may not be realized;
	•	the complementary competencies of Lightspan’s early elementary school, assessment and community college products may not be successfully integrated with PLATO’s portfolio of elementary, secondary and community college products;
	•	the management and employees of each company, particularly the sales force may not be retained and assimilated as expected;
	•	new products that utilize the assets and resources of both companies may not be developed;
	•	existing customers, strategic partners and suppliers of each company may not be retained; and
	•	uniform standards, controls, procedures, policies and information systems between the two companies may not be successfully developed or maintained.

      If we are not successful in addressing these and other challenges, then the benefits of the merger may not be realized and, as a result, our operating results and the market price of our common stock may be adversely affected. These challenges, if not successfully met, could result in possible unanticipated costs, diversion of management attention and loss of personnel.

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      We incurred significant transaction costs as a result of the merger, and expect to incur consolidation and integration expenses as we combine the operations of PLATO and Lightspan. These integration costs may substantially exceed our current estimates and may affect our financial condition and operating results negatively. If the benefits of the merger do not exceed the costs associated with the merger, including the dilution to our stockholders resulting from the issuance of shares in connection with the merger, our financial results could be adversely affected, including increased losses.

      The market price of our common stock may decline as a result of the merger for a number of reasons, including if:

	•	the integration of PLATO and Lightspan is not completed in a timely and efficient manner;
	•	the combined company does not achieve the perceived benefits of the merger as rapidly or to the extent anticipated by financial or industry analysts;
	•	the effect of the merger on the combined company’s financial results is not consistent with the expectations of financial or industry analysts; or
	•	significant stockholders decide to dispose of their stock after the merger.

      We issued approximately 6.6 million shares of our common stock to acquire Lightspan. The sale of substantial amounts of our common stock may result in significant fluctuations in the price of our common stock and could cause our common stock price to fall. The sale of these shares could also impair our ability to raise capital through sales of additional common stock.

      We lease all of our facilities, including our corporate headquarters in Bloomington, Minnesota. We have sales offices throughout the United States and in the United Kingdom and Canada. Our leased facilities are adequate to meet our business requirements.

      We are not a party to any litigation that is expected to have a material adverse effect on our business or our consolidated financial statements.

      In October 2003, we submitted proposals to our stockholders to (1) approve the issuance of our common stock for the Lightspan merger and (2) amend our 2002 Stock Plan. A Special Meeting of Stockholders was held on November 17, 2003 for these matters and stockholders voted as follows:

	(1)	To approve the issuance of our common stock for the Lightspan merger:

	(2)	To amend our 2002 Stock Plan:

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PART II.

Market Information:

      Our common stock has traded publicly on the NASDAQ National Market under the symbol “TUTR” since December 23, 1992. The quarterly range of high and low prices per share of our common stock on the NASDAQ National Market was as follows:

Holders:

      There were approximately 8,000 stockholders of record as of January 8, 2004 (includes individual participants in security position listings).

Dividends:

      We have not declared or paid cash dividends on our common stock. Our ability to declare and pay dividends is restricted as defined by our revolving loan agreement (see Note 10 to Consolidated Financial Statements). While future cash dividend payments are at the discretion of our Board of Directors, we are growth-oriented and have no present intention to pay a cash dividend on our common stock.

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(1)	Certain reclassifications of previously reported amounts have been made to conform to the current year presentation. These reclassifications did not change previously reported revenues, operating profit (loss) or net earnings (loss) and related per share amounts. Sales and marketing expenses are now presented separately from general and administrative expenses. Previously, these expenses were presented together as selling, general and administrative expenses. In addition, certain costs previously reported as an element of operating expenses have been reclassified to cost of revenues as we believe this is best practice. These expenses include professional development costs, (previously a component of selling, general and administrative expenses), amortization of capitalized product development costs and customer support expenses (previously components of product development and customer support expense) and amortization of intangible assets related to acquired technology (previously a component of amortization of intangibles). For additional information on these reclassifications, see Note 3 to Consolidated Financial Statements.
(2)	Net earnings and basic and diluted earnings per share for 2001 and 2000, assuming we had adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” and excluded goodwill amortization, would have been $4,362, $0.33 and $0.30, and $4,898, $0.48 and $0.45, respectively.

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Overview

      We enhance the learning process by providing computer-based and e-learning instruction software and related services, offering basic to advanced level courseware in reading, writing, math, science, social studies and life and job skills. Our PLATO® Learning System and PLATO® Web Learning Network provide more than 4,000 hours of objective-based, problem solving courseware and include assessment, alignment and management tools to create standards-based curricula and facilitate the learning process. PLATO courseware is delivered via networks, CD-ROM, private intranets and the Internet. In addition, single topic PLATO courseware is available through our e-commerce web site and distributors. We market our courseware products and services primarily to K-12 schools. We also sell to colleges, job training programs, correctional institutions, military education programs, corporations and individuals.

      In November 2003, we acquired Lightspan, Inc. (“Lightspan”) following approval by PLATO and Lightspan shareholders. Lightspan is a provider of curriculum-based educational software and on-line assessment products and services that increase student achievement and enhance teacher professional development. These products are used in schools and homes and align all key federal reform initiatives, offering school districts a comprehensive achievement and accountability system to assess, align, instruct and evaluate. This acquisition is expected to strengthen our product offerings, with two strong and complimentary brands, in the K-8 and post secondary markets. We also expect this acquisition to enhance our ability to provide comprehensive solutions to K-12 and adult learning institutions.

      The combination of Lightspan and PLATO also unites Lightspan’s Academic Systems products with our community college products to establish the largest provider of on-line content for under-prepared college students. In addition, the merger of sales forces will provide critical mass for servicing elementary, secondary, district level, and colleges across all product lines and services. We believe these advantages, plus the elimination of significant duplicate costs, will provide greater earnings and cash flow potential for the combined company, and ultimately greater valuation.

      Lightspan generated revenues of $50,000 in its fiscal year ended January 31, 2003. We expect to achieve approximately $17.5 million of cost reductions in 2004 and annualized cost reductions of between $20.0 and $25.0 million thereafter, primarily through workforce reductions and the elimination of duplicate costs. The acquisition is expected to be modestly dilutive to our earnings per share in 2004, particularly in the earlier quarters of the year. Earnings per share will be impacted by non-cash charges for the amortization of identified intangible assets acquired with this transaction. The acquisition is expected to be accretive to earnings in 2004 excluding these charges, and is expected to be accretive to reported earnings in 2005.

      In December 2003, we acquired New Media (Holdings) Limited (“New Media”), a United Kingdom (“U.K.”) based publisher of curriculum-focused software primarily for teaching secondary school science and math. This acquisition enhances our science offering, provides a science simulation development capability that we did not previously have and will allow us to introduce New Media’s products to markets in the United States for the first time. Additionally, this acquisition is expected to provide critical mass and revenue diversification in the U.K. and strengthen our relationships with the U.K. Education Department.

      We are subject to risks and uncertainties including, but not limited to, dependence on information technology spending by our customers, well-established competitors, customers dependent on government funding, fluctuations of our quarterly results, a lengthy and variable sales cycle, dependence on key personnel, dependence on our intellectual property rights, rapid technological change and our ability to integrate acquisitions. As provided for in the Private Securities Litigation Reform Act of 1995, we caution investors that these factors could cause our future results of operations to vary from those anticipated in previously made forward-looking statements and any other forward-looking statements made in this document and elsewhere by or on behalf of us.

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      Our fiscal year is from November 1 to October 31. Unless otherwise stated, references to the years 2003, 2002 and 2001 relate to the fiscal years ended October 31, 2003, 2002, and 2001, respectively. References to future years also relate to our fiscal year ending October 31.

Critical Accounting Policies

      Our discussion and analysis of results of operations and financial condition is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We continually evaluate our critical accounting policies and have identified revenue recognition, the allowance for doubtful accounts, capitalized product development costs, the valuation of our deferred income taxes, and the valuation and impairment analysis of goodwill and identified intangible assets as the critical accounting policies that are significant to the financial statement presentation and require difficult, subjective and complex judgments.

      See Note 2 to Consolidated Financial Statements for additional discussion on these and other accounting policies and disclosures required by accounting principles generally accepted in the United States of America.

Revenue Recognition

      Revenue recognition rules for software companies are very complex. We follow specific and detailed guidelines in determining the proper amount of revenue to be recorded; however, certain judgments affect the application of our revenue recognition policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter.

      The significant judgments for revenue recognition typically involve whether collectibility can be considered probable and whether fees are fixed or determinable. In addition, our transactions often consist of multiple element arrangements, which must be analyzed to determine the relative fair value of each element, the amount of revenue to be recognized upon shipment, if any, and the period and conditions under which deferred revenue should be recognized.

      We recognize revenue in accordance with the provisions of Statement of Position No. 97-2, “Software Revenue Recognition”, as amended and modified, as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants, and Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” We license software under non-cancelable license and subscription agreements. We also provide related professional services, including consulting, training and implementation services, as well as ongoing customer support and maintenance. Consulting, training and implementation services are not essential to the functionality of our software products. Accordingly, revenues from these services are recognized separately.

      Revenue from the sale of courseware licenses is recognized upon meeting the following criteria: (i) a written customer order has been executed, (ii) courseware has been delivered, (iii) the license fee is fixed or determinable and (iv) collectibility of the fee is probable.

      For software arrangements that include more than one element, we allocate the total arrangement fee among each deliverable based on vendor-specific objective evidence (“VSOE”) of the relative fair value of each deliverable. VSOE is determined using the price charged when that element is sold separately. For software arrangements in which we do not have VSOE for undelivered elements, revenue is deferred until the earlier of when VSOE is determined for the undelivered elements or when all elements for which we do not have VSOE have been delivered.

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

      Subscription revenue, primarily fees charged for our PLATO Web Learning Network and PLATO Orion products, is recognized on a ratable basis as the products are delivered over the subscription period.

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      Services revenue consists of software support and maintenance, which is deferred and recognized ratably over the support period, and consulting, training and implementation services, which are recognized as the services are performed.

      Other revenue, primarily from hardware and third-party software products, is recognized as the products are delivered and all other revenue recognition criteria are met.

Allowance for Doubtful Accounts

      We determine an allowance for doubtful accounts based upon an analysis of the collectibility of specific accounts, historical experience and the aging of the trade and installment accounts receivable. Bad debt expense is included in general and administrative expense in our consolidated statement of operations. The assumptions and estimates used to determine the allowance are subject to constant revision and involve significant assumptions and judgment. The primary factors that impact these assumptions include the efficiency and effectiveness of our billing and collection functions, our historical experience and our credit assessment process. We believe that the current budget difficulties facing many states will not have a significant impact on the collection of our accounts receivable. However, a change in the underlying conditions contributing to our belief could impact our assessment of collectibility and, therefore, require a change in the allowance for doubtful accounts and the amount of bad debt expense. Actual collection results could differ materially from those estimated and have a significant impact on our consolidated results of operations. In 2003, we recorded bad debt expense equal to 3.0% of total revenues, as compared to 3.4% in 2002. Our provision is based on our historical experience using a detailed analysis of customer-specific activity and receivable balances performed on a quarterly basis. Our allowance for doubtful accounts increased to $4,254, or 9.8% of gross accounts receivable, at October 31, 2003, from $2,767, or 7.7%, at October 31, 2002.

Capitalized Product Development Costs

      Our product development costs relate to the research, development, enhancement and maintenance of our courseware products. The amortization of capitalized product development costs is included in cost of revenues. Research and development costs, relating principally to the design and development of new products, and the routine enhancement and maintenance of existing products are expensed as incurred. We capitalize product development costs when the projects under development reach technological feasibility. The majority of our product development costs qualify for capitalization due to the concentration of our development efforts on the content of our courseware. Capitalization ends when a product is available for general release to our customers, at which time amortization of the capitalized costs begins. We amortize these costs using the greater of: (a) the amount determined by the ratio of the product’s current revenue to total expected future revenue, or (b) the straight-line method over the estimated useful life of the product, which is generally three years. During all periods presented, we used the straight-line method to amortize the capitalized costs as this method resulted in greater amortization.

      The significant judgment regarding capitalization of product development costs involves the recoverability of capitalized costs. We continually evaluate our capitalized costs to determine if the unamortized balance related to any given product exceeds the estimated net realizable value of that product. Estimating net realizable value requires us to estimate future revenues and cash flows to be generated by the product and to use judgment in quantifying the amount, if any, to be written off. Actual cash flows and amounts realized from the courseware products could differ materially from those estimated. In addition, any future changes to our courseware product offerings could result in write-offs of previously capitalized costs and have a significant impact on our consolidated results of operations.

Valuation of Deferred Income Taxes

      We account for deferred income taxes based upon differences between the financial reporting and income tax bases of our assets and liabilities. The measurement of deferred taxes is adjusted by a valuation allowance, if necessary, to recognize the extent to which the future tax benefits will be recognized.

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      At October 31, 2003, we had a net deferred tax asset of $2,218. Approximately $7,377 of the deferred tax asset relates to our net operating loss carryforward in the United States of approximately $18,500, which expire in varying amounts between 2004 and 2023. We also have net operating loss carryforwards of approximately $3,000 related to our foreign subsidiaries. We have provided a full valuation allowance related to these foreign deferred income tax assets due to the uncertainty in realization of future taxable income in these foreign jurisdictions.

      Realization of our deferred tax asset is dependent on generating sufficient taxable income in the United States prior to expiration of these loss carryforwards. Although realization is not assured at October 31, 2003, we believe it is more likely than not that all of the deferred tax asset will be realized. We base this belief upon the levels of taxable income generated historically, as well as projections of future taxable income. If future levels of taxable income in the United States are not consistent with our expectations, we may be required to record a valuation allowance for the entire deferred tax asset, which would have a significant impact on our consolidated financial statements.

      In November 2003, we acquired Lightspan, an entity that had accumulated significant operating losses during its history. This merger may change the outlook of recovering our deferred tax assets. In accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” and Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”), we will record the merger transaction in our quarter ending January 31, 2004 and will assess and weigh all available evidence, including the likelihood of generating sufficient future taxable income, in determining whether or not a valuation allowance is needed. We have reflected a full valuation allowance in our Form 8-K/ A filed January 9, 2004 relating to this acquisition, as this is presently the more likely outcome. Assuming we determine that a valuation allowance is necessary, our pre-acquisition deferred tax assets would be fully reserved through purchase accounting, and our future consolidated statements of operations will likely not reflect a normal tax provision or benefit. Income tax expense in this scenario would still be required to the extent we utilize fully reserved deferred tax assets that existed at the date of the Lightspan acquisition. Additionally, income tax expense is expected in the amount of approximately $600 per year relating to tax deductible goodwill even with losses in the United States. The valuation allowance, if any, will exclude the deferred tax liability relating to tax deductible goodwill, which cannot be used to support realization of the other net deferred tax assets.

Goodwill and Identified Intangible Assets

      We record our acquisitions in accordance with SFAS 141. We allocate the cost of acquired companies to the tangible and identified intangible assets and liabilities acquired, with the remaining amount being recorded as goodwill. Certain intangible assets, such as acquired technology, are amortized to expense over their estimated useful lives, while in-process research and development, if any, is recorded as a one-time charge at the acquisition date.

      Most of the companies we acquire do not have significant tangible assets and, as a result, the majority of the purchase price is typically allocated to identified intangible assets and/or goodwill, which increases future amortization expense of identified intangible assets and the potential for impairment charges that we may incur. Accordingly, the allocation of the purchase price to intangible assets may have a significant impact on our future operating results. In addition, the allocation of the purchase price requires that we make significant assumptions and estimates, including estimates of future cash flows expected to be generated by the acquired assets. Should different conditions prevail, we may have to record impairment charges, which may have a significant impact on our consolidated financial statements.

      We account for goodwill and other intangible assets in accordance with the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Under SFAS 142, goodwill and intangible assets with indefinite lives are not amortized to expense and must be reviewed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. We operate as one

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Acquisitions

      Our acquisition strategy is to acquire complementary products or businesses that will enable us to achieve our strategic goals, including market leadership, growth rates that exceed the market, and providing innovative, leading and distinct products and services.

      Since 2000, and as of October 31, 2003, we have made the following acquisitions:

      The revenue contribution from these acquisitions is discussed in more detail below (refer to the revenue section in “Results of Operations”). As of October 31, 2003, all of these acquisitions are fully integrated into our operations.

      Subsequent to October 31, 2003, as mentioned earlier, we acquired Lightspan, Inc. and New Media (Holdings) Limited. Lightspan was acquired in a stock transaction where we issued approximately 6.6 million shares of our common stock, valued at approximately $52,000, for all of Lightspan’s outstanding stock. We acquired New Media for approximately $6,800 in cash. See Note 18 to Consolidated Financial Statements.

Reclassification of Financial Information

      We continue to increase our focus on services and subscription-based products, rather than primarily on perpetual software licenses. In order to provide more meaningful disclosures, we will now present our revenues and cost of revenues in four categories: license fees, subscriptions, services and other.

      In addition, with the goal of providing more detail and greater understanding of our operating results, we have made certain other reclassifications.

      Sales and marketing expenses are now presented separately from general and administrative expenses. Previously, these expenses were presented together as selling, general and administrative expenses. Also, certain costs previously reported as an element of operating expenses have been reclassified to cost of

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      Previously reported amounts have been reclassified to conform to the current year presentation in the consolidated statements of operations. For additional information on these reclassifications, see Note 3 to Consolidated Financial Statements.

RESULTS OF OPERATIONS

Operating Results as a Percentage of Revenue

Revenues

      Total Revenues. Total revenues increased 10.5% to $82,192 for 2003 from $74,391 for 2002. Our revenue growth in 2003, while impacted by the economic conditions discussed below, reflected our increased focus on larger orders, subscriptions revenue, and correlation and professional development services. Our 2002 acquisitions contributed approximately $2,900 of total revenue in 2003. Of this amount, approximately $1,800

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      We executed 116 orders of $100 or greater during 2003, as compared to 74 for 2002. Information regarding these orders was as follows:

      While these larger orders contributed to our revenue growth in 2003, they also significantly added to our deferred revenue balances due to an increase in services and subscription-based products. The number and magnitude of these larger orders can have a significant impact on our operating results.

      License Fees. Revenues from license fees decreased 3.1% to $52,439 for 2003 from $54,141 for 2002. We continue to feel the effects of federal funding delays and economic uncertainties, particularly state budget difficulties, which significantly impacted the level of purchasing done by our customers. While there has been improvement in the flow of federal funds to education in the second half of 2003, these conditions are expected to continue to impact our revenues into 2004. As a percentage of total revenues, license fees revenues were 63.8% for 2003, down from 72.8% for 2002, reflecting the increase in subscriptions and services revenues as discussed below.

      Revenues from license fees decreased to $54,141 for 2002 from $56,846 for 2001. As a percentage of total revenues, license fees revenues were 72.8% for 2002, down from 81.1% for 2001. License fees revenues decreased in 2002 compared to 2001 due to federal funding delays and economic uncertainties, which significantly impacted the level of purchasing done by our customers.

      Subscriptions. Revenues from subscriptions increased 101.4% to $7,151 for 2003 from $3,550 for 2002. We are experiencing an increasing shift away from perpetual license sales and a growing customer desire to license our products on a subscription basis. While this has a negative impact on revenues in the short-term, it has positive implications for the longer term, including greater predictability of future revenues. Sales of our subscription-based products continue to grow. Our order intake for subscription products was $7,809 and $5,843 for 2003 and 2002, respectively. As a percentage of total revenues, subscriptions revenues were 8.7% for 2003, up from 4.8% for 2002.

      Revenues from subscriptions increased 269.4% to $3,550 for 2002 from $961 for 2001. Sales of our subscription-based products continued to grow in 2002. Our order intake for subscription-based products in 2002 was approximately $5,843 compared to approximately $3,200 of order intake 2001. As a percentage of total revenues, subscriptions revenues were 4.8% for 2002, up from 1.4% for 2001.

      Services. Revenues from services increased 42.1% to $16,738 for 2003 from $11,780 for 2002. As a percentage of total revenues, services revenues were 20.4% for 2003 up from 15.8% for 2002. These revenue increases resulted from increased correlation and professional development services, demonstrating the strategic value of our acquisitions in 2002, and from the continued growth in customer demand for our training and technical support services.

      Revenues from services increased 40.9% to $11,780 for 2002 from $8,359 for 2001. As a percentage of total revenues, services revenues were 15.8% for 2002 up from 11.9% for 2001. This revenue increase resulted from increased correlation and professional development services, demonstrating the strategic value of the TeachMaster and NetSchools acquisitions, and from the continued growth in customer demand for our training and technical support services. We also focused on selling services as an independent product.

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      Other. Other revenues, consisting primarily of hardware and third-party courseware products, increased 19.2% to $5,864 for 2003 from $4,920 for 2002. As a percentage of total revenues, other revenues were 7.1% for 2003 and 6.6% for 2002. These revenue increases were primarily due to an increased level of hardware sales, resulting from an assumed NetSchools contract. Other revenue is not expected to be a focus for us in the future or represent a significant component of total revenues.

      Other revenues increased 24.8% to $4,920 for 2002 from $3,941 for 2001. As a percentage of total revenues, other revenues were 6.6% for 2002 and 5.6% for 2001. This increase in other revenues was primarily due to increased sales of hardware products, resulting from an assumed NetSchools contract.

Cost of Revenues

      Total cost of revenues increased 31.9% to $28,181 for 2003 from $21,363 for 2002. These increases were primarily due to the changes in revenue discussed above, and increased professional development expenses of $2,295, increased amortization of capitalized product development costs of $1,543, increased amortization of acquired technology of $902 and increased costs related to hardware revenue of $1,740.

      Total cost of revenues increased 37.9% to $21,363 for 2002 from $15,496 for 2001. The increase was primarily due to the changes in revenue discussed above, and increased professional development expenses of $954, increased customer support expenses of $626, increased amortization of capitalized product development costs of $1,157 and increased amortization of acquired technology of $564. In addition, increased costs associated with third party courseware product royalties, support for the NetSchools Orion product (a subscription-based curriculum management system) and commitments for hardware products assumed with the NetSchools acquisition contributed to the change in total cost of revenues.

      Amortization of previously capitalized product development costs, a component of cost of sales, was $5,720, $4,177 and $3,020 for 2003, 2002 and 2001, respectively. Amortization has increased as projects completed during prior periods are now being amortized to expense. We expect this amortization to increase in 2004 as additional products are completed. Capitalized development costs were $6,863, $7,738 and $5,030 for 2003, 2002 and 2001, respectively.

      A comparison of gross profit margin by revenue category is as follows:

      Gross profit margin was 65.7% for 2003, down from 71.3% for 2002. The decrease in gross profit margin resulted primarily from the higher proportion of other revenues included in our product sales mix in 2003, which carry lower margins, and the increased professional development expenses, amortization of capitalized product development costs and amortization of acquired technology as discussed above. Future gross profit margin will be dependent primarily on our revenue mix, the amount of professional development expenses and amortization of capitalized product development costs.

      Gross profit margin was 71.3% for 2002, down from 77.9% for 2001. This decrease in gross profit margin resulted primarily from a lower proportion of license fees revenues included in our product sales mix, as well as the NetSchools hardware commitments, increased professional development expenses and increased amortization of capitalized product development costs mentioned above.

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Operating Expenses

      Sales and Marketing. Sales and marketing expenses increased 5.6% to $39,438 for 2003 from $37,335 for 2002. As a percentage of total revenues, sales and marketing expenses were 48.0% for 2003, down from 50.2% for 2002.

      Sales and marketing expenses increased in 2003 due to a number of factors, including increased commissions resulting from the growth in revenue, increased headcount from the NetSchools acquisition in the second half of 2002, additional investment in sales and marketing on the East Coast of the United States, increased marketing costs necessary to generate our future revenue growth, and additions to our infrastructure necessary to grow our business over the long-term. We continue to believe the benefits from this infrastructure investment will generate increased revenues in the future. Our ability to continue to leverage our cost structure and improve profitability is primarily dependent on our ability to generate higher revenues, integrate our acquisitions and realize sales force productivity improvements.

      Sales and marketing expenses increased 6.9% to $37,335 for 2002 from $34,927 for 2001. As a percentage of total revenues, sales and marketing expenses were 50.2% in 2002, up slightly from 49.8% in 2001. The increased expenses resulted from a number of factors including increased headcount from our acquisitions in 2001 and 2002, increased marketing costs, and additions to our management team and infrastructure.

      General and Administrative. General and administrative expenses increased 6.1% to $13,182 for 2003 from $12,422 for 2002. As a percentage of total revenues, general and administrative expenses were 16.0% for 2003, down from 16.7% for 2002.

      The increased general and administrative expenses for 2003 resulted from a number of factors, including increased headcount from the NetSchools acquisition in the second half of 2002, increased insurance and professional services costs resulting from the changing regulatory environment, and additions to our infrastructure, including the installation of a new enterprise resource planning system, and, most recently, a customer relationship management (CRM) system, which will help grow our business over the long-term. We continue to believe the benefits from this infrastructure investment will increase controls and generate increased revenues in the future.

      General and administrative expenses increased 56.3% to $12,422 for 2002 from $7,948 for 2001. As a percentage of total revenues, general and administrative expenses were 16.7% in 2002, up from 11.4% in 2001. The increased expenses resulted from a number of factors including increased headcount from our acquisitions in 2001 and 2002 and additions to our management team and infrastructure.

      Product Development. The majority of our product development costs qualify for capitalization. Product development expense does not reflect these capitalized costs, as they are amortized through cost of revenues. Accordingly, our product development expense, as a percentage of revenue, does not demonstrate our total level of development activity.

      Product development spending, before capitalization, was 11.1% of total revenues for 2003, compared to 15.0% for 2002. Product development expenses decreased 33.4% to $2,267 for 2003 from $3,405 for 2002. As a percentage of total revenues, product development expenses were 2.8% for 2003, down from 4.6% for 2002.

      Our acquisitions of developed technologies and curriculum content and the completion of several significant projects in 2002 contributed to the decrease in product development spending in 2003. As part of our growth strategy, we intend to continually introduce new products and product improvements. The extent of our future product development spending and the amount of our future capitalized product development costs are dependent on our ability to develop and introduce new products and product improvements on a cost-effective and timely basis.

      Product development spending, before capitalization, was 15.0% of total revenues for 2002, compared to 9.3% for 2001. Product development expenses increased 131.1% to $3,405 for 2002 from $1,472 for 2001. As a percentage of total revenues, product development expenses were 4.6% for 2002, up from 2.1% for 2001. The increase reflects the spending needed to complete the next version of the NetSchools Orion product and our

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      Amortization of Intangibles and Goodwill. Expenses for 2003 and 2002 represented the amortization of identified intangible assets, other than goodwill and acquired technology, from our acquisitions. With the adoption of SFAS 142 in 2002, goodwill is no longer amortized to expense. Acquired technology intangible assets are amortized through cost of revenues. Goodwill amortization for 2001 was $1,714. See Note 9 to Consolidated Financial Statements for additional information on goodwill and identified intangible assets.

      Restructuring and Special Charges. In May 2003, we replaced our Managing Director of operations in the United Kingdom, and severed relationships with two senior executives (our Chief Operating Officer and a co-founder of NetSchools) and three other employees. The consolidated statement of operations for 2003 included a restructuring charge of $422 for severance costs related to this action. As of October 31, 2003, approximately $252 of these severance costs have been paid, with the remaining costs expected to be paid by August 2004.

      In December 2002, we reduced the size of our workforce by approximately 30 positions and closed approximately 30 open job requisitions, all in the United States, which together represented about 10% of our planned workforce. The consolidated statement of operations for 2003 included a restructuring charge of $380 for severance costs related to this reduction. All of these severance costs have been paid as of October 31, 2003.

      The special charges in 2001 represented costs associated with the retirement of our founder and former chief executive officer and included non-cash amounts of $463 for the accelerated vesting of stock options.

      Purchased In-Process Research and Development. This charge in 2002 represented the write-off of in-process research and development related to the acquisition of NetSchools as discussed earlier under “Acquisitions” and in Note 4 to Consolidated Financial Statements.

Interest Income

      Interest income was $317, $851 and $817 for 2003, 2002 and 2001. The decrease in 2003 from 2002 was due to lower invested balances at lower interest rates as compared to 2002. Invested balances decreased due to cash being used for our acquisitions in 2002 and our stock repurchases in 2003.

Interest Expense

      Interest expense was $104, $131 and $585 for 2003, 2002 and 2001, respectively. The decrease in 2002 from 2001 was the result of lower fees associated with a new revolving loan agreement in 2002.

Income Taxes

      We recorded an income tax benefit of $441 for 2003. We recorded income tax expense of $600 for 2002, despite incurring a pretax loss of $(541), due to a relatively small pretax loss and the fact that our U.S. operations were profitable while our foreign subsidiaries incurred losses for which we do not recognize a tax benefit. Income tax expense was $3,505 for 2001. Our effective income tax rate for 2003 was 20.9%, compared to (110.9)% for 2002 and 50% for 2001. The fluctuations in our effective tax rate are the result of the relative amount of taxable income or loss in each of our taxable jurisdictions. We do not record an income tax benefit in our foreign jurisdictions due to the uncertainty of realizing these tax benefits in future years.

      Our historical effective income tax rate has been highly volatile due to the mix between our U.S. operating results, for which we record income taxes, and our foreign operating results, for which we provide a full valuation allowance. Our 2004 effective income tax rate is highly dependent upon whether or not we deem our net deferred tax assets are recoverable following the merger with Lightspan and upon the future taxable income or loss in each of our taxable jurisdictions. We have reflected a full valuation allowance in our Form 8-K/A filed January 9, 2004 relating to this acquisition, as this is presently the more likely outcome. Assuming we determine that a valuation allowance is necessary, our pre-acquisition deferred tax assets would

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FINANCIAL CONDITION

Liquidity and Capital Resources

      At October 31, 2003, our principal sources of liquidity included cash and cash equivalents of $23,834, net accounts receivable of $39,176, long-term marketable securities of $3,862 and our unused line of credit. Working capital was $34,701 and $44,455 at October 31, 2003 and 2002, respectively. The decrease in working capital was primarily due to a decrease in cash and cash equivalents of $6,556 and increases in deferred revenue of $7,301 and accounts payable of $1,988, offset by an increase in net accounts receivable of $6,142. Cash and cash equivalents decreased as cash was used for product development, capital expenditures, stock repurchases and investments in marketable securities. Deferred revenue increased as a result of increased sales of our services and subscription-based products. Accounts payable increased due to timing of invoices and payments. Accounts receivable increased due to revenue growth in the second half of 2003.

      Cash flow from operations, excluding changes in our working capital accounts, was $10,615, $9,753 and $14,512 for 2003, 2002 and 2001, respectively. While such cash flows were relatively flat from 2002 to 2003, the decrease from 2001 to 2002 was primarily due to increased general and administrative costs discussed earlier in the “Results of Operations” section.

      During 2003, the decrease in cash and cash equivalents of $6,556 and the cash flow from operations, excluding changes in our working capital accounts, of $10,615 were used to fund the changes in our working capital accounts of $2,050, our investing activities of $12,793 and financing activities of $2,337. Changes in our working capital accounts were primarily due to increased accounts receivable partially offset by increased deferred revenue.

      During 2002, the decrease in cash and cash equivalents of $31,178 and the cash flow from operations, excluding changes in our working capital accounts, of $9,753 were used to fund the changes in our working capital accounts of $4,985, our investing activities of $23,383 and financing activities of $12,670. Changes in our working capital accounts were primarily due to increased accounts receivable, prepaid expenses and other assets and decreased accounts payable, which were partially offset by increased deferred revenue.

      During 2001, the increase in cash and cash equivalents of $55,153 was a result of the proceeds from our public stock offering of $58,139 and cash flow from operations, excluding changes in our working capital accounts, of $14,512, which were used to fund the changes in our working capital accounts of $4,207 and our investing activities of $12,906. Changes in our working capital accounts were primarily due to increased accounts receivable partially offset by increased deferred revenue.

      Net cash used in our investing activities was $12,793, $23,383 and $12,906 for 2003, 2002 and 2001, respectively. In 2003, as compared to 2002, we decreased our capital expenditures by $1,187, primarily because we purchased and installed a new enterprise resource planning system in 2002. Additionally, in 2003 we purchased a new customer relationship management (CRM) system. In 2002, we used $12,370 for our acquisitions of NetSchools and LearningElements.

      Net cash used in our financing activities was $2,337 for 2003 and $12,670 for 2002, compared to net cash provided of $57,827 in 2001. In 2003, we repurchased 457,000 shares of our common stock for an aggregate cost of $2,161. In 2002, we repurchased 988,000 shares for an aggregate cost of $11,340. Our Board of Directors approved a stock repurchase plan in December 2001, which authorizes us to repurchase up to $15,000 of our common stock in the open market and in privately negotiated transactions. The plan has no set termination date and the timing of any repurchases will be dependent on prevailing market conditions and alternative uses of capital.

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      Cumulatively, we have repurchased approximately 1,445,000 shares for an aggregate cost of $13,501 under the repurchase plan and approximately $1,500 remains available for future repurchases, if any. In addition, in 2002, we received approximately $1,331 from the exercise of stock options and warrants and paid $2,366 to retire bank debt assumed with the NetSchools acquisition. In 2001, we completed a public stock offering resulting in net proceeds of approximately $55,000 and received approximately $3,300 from the exercise of stock options and warrants.

      We have resources available under our revolving loan agreement, which expires on July 1, 2004, to provide borrowings up to $12,500, as determined by the available borrowing base. At October 31, 2003, there were no borrowings outstanding and our unused borrowing capacity was $12,500. The agreement contains restrictive financial covenants (including Minimum Tangible Net Worth, Minimum Debt Service Coverage, Maximum Leverage, Maximum Cash Flow Leverage, Minimum Current Ratio, and Maximum Annual Capital Expenditures) and restrictions on additional borrowings, asset sales and dividends, as defined. We did not comply with the Minimum Debt Service Coverage covenant for the twelve-month period ended October 31, 2003, and we have received a waiver from our lender covering this noncompliance for such period.

      From time to time, we evaluate potential acquisitions of products or businesses that complement our core business. We may consider and acquire other complementary businesses, products, or technologies in the future. As discussed earlier, we acquired Lightspan, in a stock transaction, and New Media, for $6,800 in cash, subsequent to October 31, 2003.

      We anticipate using cash during the first half of 2004 to fund expected losses from operations and our capital expenditure needs given the historic seasonality of our operations. Cash used during the first half of 2004 is expected to be greater than cash used during the first half of 2003 as we integrate the operations of Lightspan.

      We maintain adequate cash balances and credit facilities to meet our anticipated working capital, capital expenditure and business investment requirements for at least the next twelve months.

Disclosures About Off-Balance Sheet Arrangements

      We do not have any off-balance sheet arrangements as of October 31, 2003.

Disclosures About Contractual Obligations and Commercial Commitments

      Our contractual obligations and commercial commitments consist of future payments due under capital lease obligations and operating leases. In addition, any future borrowings under our revolving loan agreement, which provides for a maximum $12,500 line of credit through July 1, 2004, would require future use of cash.

      At October 31, 2003, we had no significant commitments for capital expenditures. With the NetSchools acquisition in 2002, additional cash consideration may be due of up to approximately $6,000, contingent on the NetSchools product and services revenues generated through October 2004. If earned, any additional consideration will be recorded as additional goodwill. As of October 31, 2003, no additional consideration has been earned.

Interest Rate Risk

      Our borrowing capacity primarily consists of a revolving loan with interest rates that fluctuate based upon the Prime Rate and LIBOR market indexes. At October 31, 2003, we did not have any outstanding borrowings

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Foreign Currency Exchange Rate Risk

      We market our products and services worldwide and have operations in Canada and the United Kingdom. As a result, financial results and cash flows could be affected by changes in foreign currency exchange rates or weak economic conditions in foreign markets. Working funds necessary to facilitate the short-term operations of our foreign subsidiaries are kept in local currencies in which they do business. Any gains or losses from foreign currency transactions are included in the consolidated statements of operations. Approximately 3%, 6% and 8% of our total revenues were denominated in currencies other than the U.S. dollar for 2003, 2002 and 2001, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

      In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51” (“FIN 46”). FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the VIE was established. The effective dates of certain elements of FIN 46 have been deferred. We currently have no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN 46 did not have a material effect on our consolidated financial statements. However, if we enter into any such arrangement with a variable interest entity in the future, our consolidated financial statements may be adversely effected.

      In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). This statement establishes standards for how an issuer classifies and measures financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability. Many of those instruments were previously classified as equity. The effective dates of certain elements of SFAS 150 have been deferred. We currently have no financial instruments of this nature and the adoption of SFAS 150 did not have a material impact on our consolidated financial statements. However, if we enter into any such arrangements in the future, our consolidated financial statements may be adversely effected.

      The information appearing under the captions “Interest Rate Risk” and “Foreign Currency Exchange Risk” in Item 7 of this Annual Report on Form 10-K is incorporated herein by reference.

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      (a)(1) Consolidated Financial Statements:

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REPORT OF MANAGEMENT

      The management of PLATO Learning, Inc. is responsible for the preparation, integrity and objectivity of the accompanying financial statements. The financial statements were prepared in accordance with accounting principles generally accepted in the United States of America and include amounts which reflect management’s best estimates based on its informed judgment and consideration given to materiality. Management is also responsible for the accuracy of the related data in the annual report and its consistency with the financial statements.

      In the opinion of management, the Company’s accounting systems and procedures, and related internal controls, provide reasonable assurance that transactions are executed in accordance with management’s intention and authorization, that financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and that assets are properly accounted for and safeguarded. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits to be derived there from. Management reviews and modifies the system of internal controls to improve its effectiveness. The effectiveness of the controls system is supported by the selection, retention and training of qualified personnel, an organizational structure that provides an appropriate division of responsibility and a budgeting system of control.

      The adequacy of the Company’s internal accounting controls, the accounting principles employed in its financial reporting and the scope of independent audits are reviewed by the Audit Committee of the Board of Directors, consisting solely of outside directors. The independent auditors meet with, and have confidential access to, the Audit Committee to discuss the results of their audit work.

	/s/ JOHN MURRAY
	John Murray
	Chairman, President and Chief Executive Officer
	/s/ GREGORY J. MELSEN
	Gregory J. Melsen
	Vice President Finance and Chief Financial Officer

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REPORT OF INDEPENDENT AUDITORS

To the Stockholders and

      In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders’ equity and comprehensive income (loss), and of cash flows present fairly, in all material respects, the financial position of PLATO Learning, Inc. and its subsidiaries at October 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2003 in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      As discussed in Note 2 to the consolidated financial statements, the Company ceased amortizing goodwill on November 1, 2001.

	/s/ PRICEWATERHOUSECOOPERS LLP
	PricewaterhouseCoopers LLP

Minneapolis, Minnesota

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PLATO LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS