Renaissance Learning (RLRN) 10-K 2005 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

þ  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended December 31, 2005

OR

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

Commission File No. 0-22187

RENAISSANCE LEARNING, INC.

(Exact name of Registrant as specified in its charter)

Wisconsin	39-1559474
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2911 Peach Street P.O. Box 8036 Wisconsin Rapids, Wisconsin (Address of principal executive offices)	54495-8036 (Zip Code)

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

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

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

Common Stock, $.01 par value

(Title of class)

     Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes o          No þ

      Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes o          No þ

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

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

      Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer o          Accelerated filer þ          Non-accelerated filer o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ

      The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $171,728,000 as of June 30, 2005. As of February 17, 2006, there were 30,179,253 of the Registrant’s shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      Part III is incorporated by reference from the Proxy Statement for the Registrant’s Annual Meeting of Shareholders to be held on April 19, 2006

INDEX

		Page
PART I
Item 1.	Business		2
	Overview		2
	Software, Portable Computing Solutions and Other Educational Products		3
	Professional Services		5
	Product Development		6
	Selling and Marketing		6
	Production		7
	Competition		7
	Intellectual Property		7
	Employees		8
	Backlog		8
	Forward-Looking Statements		8
Item 1A.	Risk Factors		8
Item 1B.	Unresolved Staff Comments		12
Item 2.	Properties		13
Item 3.	Legal Proceedings		13
Item 4.	Submission of Matters to a Vote of Security Holders		13
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities		15
Item 6.	Selected Financial Data		16
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		25
Item 8.	Financial Statements and Supplementary Data		26
Item 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure		46
Item 9A.	Controls and Procedures		46
Item 9B.	Other Information		48
PART III
Item 10.	Directors and Executive Officers of the Registrant		49
Item 11.	Executive Compensation		49
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters		49
Item 13.	Certain Relationships and Related Transactions		50
Item 14.	Principal Accountant Fees and Services		50
PART IV
Item 15.	Exhibits and Financial Statement Schedules		51
Second Amendment to Credit Agreement
Third Amendment to Credit Agreement
Non-Employee Director Compensation Summary
Subsidiaries of the Company
Consent of Independent Registered Public Accounting Firm
Power of Attorney
302 Certification of CEO
302 Certification of CFO
906 Certification of CEO
906 Certification of CFO
Schedule II - Valution and Qualifying Accounts

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PART I

Item 1.  Business

Overview

      Renaissance Learning, Inc. is a leading provider of computerized assessment and progress monitoring tools for pre-kindergarten through senior high (“pre-K-12”) schools in North America. Our computerized assessment and progress monitoring tools accelerate learning and improve test scores by helping educators motivate students, increasing the quality, quantity, and timeliness of performance data available to educators, facilitating increased student practice of essential skills and providing student access to low cost computing solutions.

      Our educational software products are available as traditional desktop versions that run on local area networks of individual schools or asRenaissance Place* editions which can provide access for entire school districts from a central server. Our desktop products are relatively simple to set up and maintain for an individual school, are designed to require only modest technology resources and are competitively priced at or below the discretionary spending level of most school principals. Our traditional desktop products are typically sold as school-wide perpetual software licenses with optional annual support plans.

      To meet the needs of district-wide installations, we offerRenaissance Placeeditions of our popular desktop applications.Renaissance Placemeets district-wide needs such as scalability, remote access, centralized database and server for multiple campus use, sophisticated statistical analysis, ease of administration and district support, and integration with student data from other district systems. We introducedRenaissance Placeeditions of ourSTAR ReadingandSTAR Mathproducts in 2003 followed byAccelerated ReaderandAccelerated Mathin mid-2004. Most of our assessment and progress monitoring software products are available inRenaissance Placeeditions. In contrast to our traditional desktop software,Renaissance Placeproducts are sold primarily on a subscription basis for terms of one year.

      Our flagship product,Accelerated Reader, is software which provides information for motivating and monitoring increased literature-based reading practice and to support instruction. We believe thatAccelerated Readerand our other products have achieved their significant market positions as a result of demonstrated effectiveness in assisting educators to improve student achievement in essential skills and overall academic performance. Our broad line of educational software products help educators guide instruction, manage important classroom tasks and measure student progress, thereby enabling educators to more effectively target and adjust curriculum and instruction in order to accelerate student learning.

      Our educational software covers a wide range of subject areas including reading, early literacy, mathematics, writing, vocabulary, test preparation, standards assessment and language acquisition. We provide customized assessment software to educational publishers which supports many of the popular textbook series used in K-12 and post-secondary educational institutions.

      Our acquisition of AlphaSmart, Inc. in June 2005 brings theAlphaSmart 3000,NeoandDanaportable computing solutions into our product line.AlphaSmartproducts are portable,easy-to-use computing devices that run curriculum-specific software focused on skills improvement and real-time formative assessments. The units offer schools the ability to provide students with significantly improved access to portable computing at a fraction of the cost of conventional personal computers.

*  AR, AccelScan, AccelTest, Accelerated Math, Accelerated Reader, Accelerated Vocabulary, AlphaSmart, AlphaSmart 3000, Dana, English in a Flash, Math Facts in a Flash, Neo, Read Now with Power Up!, Renaissance, Renaissance Learning, Renaissance Place, STAR Early Literacy, STAR Reading, STAR Math and TestCheck are trademarks of Renaissance Learning, Inc. registered^®, common law or pending registration in the United States and other countries. Other trademarks are the property of their respective owners.

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      In late 2005, we began shipping our newRenaissance Classroom Response System. This interactive system allows educators to easily encourage student classroom participation and obtain instantaneous feedback that can be used to quickly assess student comprehension and performance. The system employsstate-of-the art radio frequency technology allowing wireless communication between students’ handheld devices andRenaissance Learningsoftware.

      Additionally, we sell a patented optical-mark card scanner which is used with several of our software applications to automate scoring and recordkeeping tasks. Lastly, our product offerings include supplemental resources for educators and classroom use such as handbooks, workbooks, learning cards and motivational items.

      We offer a full line of professional service and support solutions that integrate with, complement, and enhance the effectiveness of, our products. Sold separately or bundled with our products to provide a complete solution, our service offerings include training workshops and seminars, report and data analysis, program evaluation, guided implementation, distance training, software support, software installation, database conversion and integration services, and application hosting.

      Renaissance Learning, Inc. was founded in 1986 and is incorporated under the laws of the State of Wisconsin. Our common stock trades on The NASDAQ Stock Market^® under the symbol “RLRN.” Our principal executive offices are located at 2911 Peach Street, P.O. Box 8036, Wisconsin Rapids, Wisconsin 54495-8036 (telephone: (715) 424-3636). You may obtain, free of charge, copies of this Annual Report on Form 10-K as well as our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K (and amendments to those reports) filed with, or furnished to, the Securities Exchange Commission as soon as reasonably practicable after we have filed, or furnished, such reports by accessing our website athttp://www.renlearn.com, clicking on “About Us” and scrolling down to the “SEC Filings” link. Information contained on our website is not part of this Annual Report on Form 10-K.

Software, Portable Computing Solutions and Other Educational Products

      We offer software products to educators primarily for use in pre-K-12 schools. We also provide customized assessment software to educational publishers which they distribute mainly for use in the pre-K-12 education market. These software products help educators improve student academic performance by intensifying skills practice and increasing the quality, quantity, and timeliness of information available to educators to support instruction. Our products are offered in desktop editions which serve the needs of individual schools or inRenaissance Placeeditions which are scalable to meet the needs of the largest school districts from a centralized server and database.

     Accelerated Readeris software for motivating and monitoring increased literature-based reading practice and for providing educators with student progress information to support instruction. A student selects a book at an appropriate reading level from a list of books for which the school has anAccelerated Readerquiz, reads the book, and then takes a multiple-choice quiz on a computer. For each book read,Accelerated Readertracks the amount of reading practice achieved by calculating points based on the length and difficulty of the book and the student’s performance on the quiz. The information generated from this process — titles read, percent of comprehension and amount of reading completed — creates a database of student reading achievement, from which reports are generated that help educators monitor the amount and quality of reading practice for each individual student and thereby effectively target their instruction of comprehension, vocabulary and fluency.Accelerated Reader supports recorded-voice versions of quizzes on literature books for emergent readers and quizzes for assessing reading instruction assignments found in reading textbooks, magazines and other curricula.Accelerated Readerincludes built-in Spanish-English capabilities and supportsLiteracy Skillsquizzes which allow educators to assess students’ proficiency on specific skills found in state and district language arts standards. We currently have a library of computerized book quizzes on over 100,000 titles.

     STAR Readingis an easy to use, computer-adaptive reading assessment system that determines a student’s reading level, statistically correlated to national norms, in ten minutes or less.STAR Readingadapts itself during testing by utilizing proprietary branching logic that evaluates the pattern of the student’s answers to determine the level of difficulty required for subsequent questions. Tests can be administered several times a year and the results provide educators with a database of statistically accurate reading level information on

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their students, grades 1-12, from which they can generate useful diagnostic reports and adjust instructional strategies accordingly.

     STAR Early Literacysoftware provides educators with a fast, accurate and easy solution to assess the phonemic awareness, phonic and other readiness and literacy skills of students in grades pre-K-3. The software helps educators identify each student’s specific strengths and to diagnose specific weaknesses in skills covered by all early literacy curricula and standards.STAR Early Literacyallows for the assessment process to be quickly and easily repeated several times throughout a school year at a lower cost and on a more timely basis than conventional assessments.

     Accelerated Vocabularysoftware helps educators maximize their students’ vocabulary growth while reducing paperwork, supporting instruction, and making vocabulary learning fun for students.Accelerated Vocabularypromotes word learning from research proven in-context reading of book passages. Reports generated by the system help educators assess student progress and monitor their vocabulary skills practice.

     Read Now with Power Up!is a comprehensive reading intervention solution that combines the instructional materials ofSteck-Vaughnwith the progress-monitoring assessment technology of Renaissance Learning to help educators assist students identified as struggling readers.Read Now with Power Up!employs a comprehensive instruction model, multimedia instructional materials, a softwaree-learning package hosted on a dedicated interactive website, and professional development services to support educators with implementation. These components work together to help educators direct students to material appropriate to their reading ability, provide the extensive practice crucial to improving reading skills, and develop the range of skills necessary to read successfully, from phonemic awareness through fluency and comprehension.Read Now with Power Up!is sold as a subscription package consisting of a one-time purchase price and an annual subscription fee.

     Accelerated Mathsoftware helps educators personalize math instruction and manage the extensive practice students need to develop math skills, master state standards and to ensure math success for students of all abilities — average, gifted and remedial  — from grade one through calculus.Accelerated Mathsoftware generates personalized assignments at each student’s level and scores them automatically using ourAccelScanoptical mark reader.Accelerated Mathoffers state standards-aligned libraries, textbook-aligned libraries for popular math textbooks and extended response libraries that integrate the application of multiple math objectives. The software provides educators with detailed reports to help them monitor progress and target instruction in a timely, effective manner.

     STAR Mathis a computer-adaptive math test and database that provides the same benefits asSTAR Reading.STAR Mathreports provide objective information to help educators instantly place their students, monitor progress, and match instruction to individual student levels. Quick, accurate, and easy to administer,STAR Mathprovides math scores for first grade through high school in approximately 15 minutes, provides comparisons to national norms, forecasts results on major high-stakes tests, and can be administered several times throughout the school year to track math development.

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

     English in a Flashsoftware utilizes a research-based approach to helping educators accelerate the language acquisition of English Language Learners (ELLs) and English as a Second Language (ESL) students. This approach is based on a systematic method of learning language without reliance upon translation, grammatical instruction, or multimedia distractions, which is significantly faster than traditional methods of language acquisition.

     AlphaSmart Productsare rugged, portable,easy-to-use, low total-cost-of-ownership computing devices that can operate independently or complement existing computers. Models offered include theAS3000,NeoandDana.AlphaSmartcomputing devices run curriculum-specific software focused on skills improvement

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and real-time formative assessment in writing, language arts, mathematics, science, keyboarding, social studies, technology literacy and special needs. In addition, the devices perform word-processing, function as a calculator, are expandable and feature advanced wireless capabilities, increasing student access to affordable portable computing.

     AccelScanis our innovative, patented optical mark card reader that offers intelligent mark recognition capability. This capability results in more accurate recognition of student marks by distinguishing many degrees of darkness from a variety of marking instruments and ignoring lighter erasures. This high-speed reader is used in conjunction with several of our software products to automate scoring of assignments and updating of student records, thereby providing educators with immediate information on student progress without time-intensive manual scoring of assignments.

     Renaissance Classroom Response Systemis an interactive system that allows educators to easily encourage student classroom participation and obtain instantaneous feedback that can be used to quickly assess student comprehension and performance. The system employsstate-of-the art radio frequency technology allowing wireless communication between students’ handheld devices andRenaissance Learningsoftware. Educators can use the system for quizzes, tests, surveys and exercises while encouraging increased classroom participation and saving time though automatic real-time scoring.

     Educator Resource Products. We also produce videotapes, handbooks, lesson books, math learning cards, workbooks and motivational items for use by educators in conjunction with our software and training programs. Further, we conduct research on best practices, perform field validation of techniques, publish internally generated as well as third-party research and gather information to guide the development of new and improved products.

Professional Services

      We offer a full line of professional services to our customers. Our services include support plans for our software solutions, professional development programs, web-based training, consulting and evaluation services and technical services.

     Support Plans. We offer Expert Support Plans (“ESPs”) that provide users of our products access to telephone support. Packaged with software kits and also sold separately under 12- or24-month agreements, ESPs entitle educators to unlimited expert phone support.

     Training and Professional Development Services. We offer a variety of seminars and workshops, which are conducted throughon-site training programs in which our training staff visits an individual school, school district or region to conduct a seminar or workshop; or remotely by utilizing the internet. Our professional development programs instruct educators in proven best practices to enhance their curriculum and instruction through more effective use of our products and the information they generate. Our professional development programs increase customer satisfaction with, and utilization of, our software in schools, resulting in additional sales of add-on products such asAccelerated Readerquizzes, Accelerated Mathlibraries, student software expansions as well as increased overall customer interest in our other products and services which tend to complement each other.

      We also hold ourNational School Renaissance Conferenceannually. The conference provides teachers and administrators with opportunities to network, receive professional development training, hear the latest research, view our newest products and services, and plan future uses of our products and services. Our 2006National School Renaissance Conference,held in Nashville Tennessee during February 2006, was attended by approximately 3,200 educators. About 3,500 educators attended our conference in 2005 and about 3,000 in 2004.

     Renaissance Consultinghelps teachers, principals and administrators work together for dramatic schoolwide improvement.Renaissanceconsulting provides educators with personalized advice for improving their programs, practical suggestions for solving schoolwide problems and tips on how to get the best results from theirRenaissanceimplementations. In ourRenaissanceconsulting solutions, a consultant meets with a

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customer throughon-site visits, distance consultations or a combination of the two, to assist in analyzing reports and data, and to offer advice and help develop strategies to more effectively target instruction. Our leadership consulting services offer on- and off-site sessions with principals and administrators to help them lead the way to an effective implementation of theirRenaissanceprograms.

     Renaissance Evaluation Serviceis an ongoing implementation assessment and consulting solution that assists administrators in achieving student academic growth. An evaluation services package typically covers an academic school year, providing analysis of diagnostic reports, practical tips and strategies, phone consultations, a summative analysis of student skills practice and academic growth as well as a school climate inventory survey designed to assess the impact of leadership, environment, expectations, involvement and instruction on program effectiveness and how to develop strategies for improving the effectiveness of curriculum, instruction and implementation ofRenaissanceproducts.

     Remote Guided Implementationprovides teachers or other school staff with a personal implementation specialist who provides ongoing support and assistance that typically covers an academic school year. Our implementation specialists conduct conference call sessions to kick-off aRenaissanceimplementation and provide ongoing best practices assistance. Guided implementation includes remote software training, installation assistance, marking period and year report analysis and program evaluation together with an assessment of program strengths and weaknesses combined with recommendations for program improvement.

     Renaissance Technical Servicesprovide our customers with a variety of services to help with the implementation and support of theirRenaissance programs. These include system setup, software installation, troubleshooting, technical training, data conversion, interface programming for most common student information systems and custom report writing. In addition, we offer web hosting forRenaissance Placeapplications as well as an educational technology assessment service to assist schools and districts with assessing their specific system needs.

Product Development

      We believe that continued substantial investment in product development is required to remain competitive and grow in the educational marketplace. We invest continuously in the development of new products and services, enhancement of existing products and services, development of tools to increase the efficiency of product development, and scientific research which generates concepts for new products and services, validates the efficacy of our existing products and services and provides useful feedback for improvement of new and existing products and services. For the years ended December 31, 2005, 2004, and 2003, our development expenditures were $17.0 million, $14.5 million, and $14.9 million (excluding capitalized amounts of $279,000, $563,000 and $448,000, respectively).

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

Selling and Marketing

      We market our educational products and services to teachers, school librarians, principals, entire schools, and school district personnel, as well as internationally through our sales offices and distributors. Our customized assessment software for educational publishers is typically distributed by publishers to educators in conjunction with sales of their related textbooks. We experience seasonal variations in our sales due to the budget and school-year cycles of our customers. Additionally, our service revenues tend to be more seasonal than product revenues due to customer preferences as to when services are delivered and due to the timing of ourNational School Renaissance Conference.

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      Our sales and marketing strategy consists primarily of direct marketing to potential and existing customers through our geographically dispersed field sales representatives. We use a variety of lead-generating techniques, including trade shows, advertisements in educational publications, direct mail, websites and referrals.

      We also have resale arrangements with various book dealers and book publishers that sell our products to their customers. These firms are particularly receptive to such alliances because the use of our products in schools encourages increased purchases of the books and other products that they sell. We do not offer price protection or stock balancing rights to our resellers.

      Part of our distribution strategy is to develop cross-marketing arrangements with third-party firms which sell non-competing products into the education market. We have formed strategic alliances with book distributors and publishers in order to develop additional new product opportunities and to enhance the channels available to sell and distribute our products. We have alliances with several leading educational publishers including Scott Foresman, Macmillan/ McGraw-Hill, Houghton Mifflin’s School Division, and Harcourt School Publishers, in which we offerAccelerated Readerquizzes aligned to the publishers’ reading selections. We have similar alliances with textbook publishers in which we offerAccelerated Mathsoftware libraries aligned to mirror the sequence, objectives, problem types, and presentations in their textbooks.

Production

      Our software products are generally distributed on CD-ROM. Bulk CD-ROMs are produced by third-party contractors. We produce order-specific and smaller batches of CD-ROMs at our distribution facilities.Accelerated Readerquizzes andAccelerated Mathlibraries can be purchased and downloaded from our website. Other related products, including videotapes, books, graphics, and motivational items, are produced by third-party vendors. OurAlphaSmart portable computing devices, theRenaissance Classroom Response Systemand ourAccelScanscanners are produced to our specifications by third-party contract manufacturers. Additionally, our users can download selected patches and software updates from our website.

Competition

      The educational technology and professional development markets in which we operate are very competitive and fragmented. We compete with many other companies offering educational software products, computing devices, interactive response systems, professional development and technology consulting services to schools. Education continues to emerge as a major global industry and potential competitors, including large hardware manufacturers, software developers, educational publishers, and consulting firms, may enter or increase their focus on the schools market, resulting in greater competition for us. In addition, we compete against other more traditional methods of education, training and testing, including pencil and paper testing.

      As we enter into new markets, existing competitors could increase the barriers to entering these markets by driving prices lower or making modifications to enhance their products. Success in selling our established products and services may cause competitors to focus on us in their marketing efforts thereby increasing direct competition. There can be no assurance that we will continue to be able to market our products and services successfully or compete effectively in the educational marketplace.

Intellectual Property

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

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

Employees

      As of February 1, 2006, we had 956 full-time and part-time employees. We believe our relations with employees are good. None of our employees is represented by a union or subject to collective bargaining agreements.

Backlog

      As of December 31, 2005 and 2004, we had backlogs that aggregated approximately $20.4 million and $20.2 million, respectively. These backlogs are primarily composed of the deferred revenue related to: software support agreements, subscription-based sales, services not yet performed and registrations for ourNational School Renaissance Conference. Substantially all of the 2005 backlog is expected to be realized during 2006.

Forward-Looking Statements

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

Item 1A.  Risk Factors

     Reliance on Single Product Line. OurAccelerated Readersoftware and supplementalAccelerated Readerquizzes accounted for approximately 37%, 40%, and 36% of our net sales in 2005, 2004, and 2003, respectively. An overall decline in sales ofAccelerated Readerand supplemental quizzes would have a material adverse effect on our business, financial condition, and results of operations.

     Dependence on Continued Product Development. The educational technology and services markets in which we compete are characterized by evolving industry standards, frequent product introductions, and sudden technological change. Our future success depends, to a significant extent, on a number of factors, including our ability to enhance our existing products, develop and successfully introduce new products in a timely fashion, and respond quickly and cost effectively to technological change, including: shifts in operating systems, hardware platforms, programming languages, alternative delivery systems, the internet and other uncertainties. There can be no assurance that new products will be as well received as our established products, particularly since they may require technology and/or resources not generally available in all

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

     Reliance on statistical studies to demonstrate effectiveness of our products and services. We rely on statistical studies to demonstrate that our products and related services improve student achievement. We believe that these studies accurately reflect the performance of our products. These studies, however, involve the following risks: (i) the sample sizes used in our studies may yield results that are not representative of the general population of students who use our products; (ii) 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; (iii) schools studying the effectiveness of our products may apply different methodologies and data collection techniques, making results difficult to aggregate and compare; (iv) we facilitate the collection and analysis of data for some of these studies; and (v) we hire 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 the No Child Left Behind Act (NCLB) and other sources for research and studies to demonstrate the effectiveness of educational programs and products. Our selling and marketing efforts, as well as our reputation, could be adversely impacted if the public, including our existing and potential customers, is not convinced that the product effectiveness is proven by the studies.

     Management of Growth. We have experienced periods of rapid growth in the past and anticipate continued growth in the future. Rapid growth may place a strain on our financial, management, systems, and other resources. Our ability to manage our growth effectively will require us to attract, train, motivate, manage, and retain key employees and to improve our operational, financial, and management information systems. If we are unable to maintain and manage growth effectively, our business, financial condition, and results of operations could be adversely affected.

     Selling and Marketing Strategy and Product Acceptance. Our business strategy includes the introduction of new products and services directed at new markets as well as the development of new sales and distribution channels. There can be no assurance that we will be successful in offering new products and services, entering new markets and developing new sales and distribution channels or that any such products or services, if introduced, will achieve acceptance in the marketplace.

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

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

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

     Geographic Concentration of Sales. A substantial portion of our sales is concentrated in several states, including California, Texas, Florida, Michigan, and Georgia, which accounted for approximately $14.8 million, $13.2 million, $6.6 million, $4.3 million, and $4.3 million, respectively, of our net sales in 2005. If large numbers of schools or a district or districts controlling a large number of schools in such states were to discontinue purchasing our products and services, our business, financial condition, and results of operations would be materially adversely affected.

     Highly Competitive Industry. The educational technology and professional development markets in which we operate are very competitive and fragmented. We compete with other companies offering educational software products, computing devices, interactive response systems, professional development, and technology consulting services to schools. Education continues to emerge as a major global industry and potential competitors, including large hardware manufacturers, software developers, educational publishers, and consulting firms, may enter or increase their focus on the schools market, resulting in greater competition for us. In addition, we compete against more traditional methods of education, training and testing, including pencil and paper testing.

      As we enter into new markets, existing competitors could increase the barriers to entering this market by driving prices lower or making modifications to enhance their products. Success in selling our established products and services may cause competitors to focus on us in their marketing efforts thereby increasing direct competition. There can be no assurance that we will continue to be able to market our products successfully or compete effectively in the educational marketplace.

     Dependence on Key Personnel. Our success depends to a significant extent upon the continued active participation of certain key members of management. We do not have employment agreements with these individuals and have no current intention of entering into any such employment agreements. The loss of the services of key personnel could have a material adverse effect on our business, financial condition, and results of operations.

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

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

•  delays in the development and/or shipment of new products;

•  the closing of large contract sales, such as those to school districts;

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•  the shipment of new products for which orders have been building for a period of time; and

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

In addition, our quarterly results can also be affected by:

•  charges related to acquisitions and divestitures, including related expenses, the write-off of in-process research and development, the amortization of intangible assets, asset impairments and similar items;

•  charges related to obsolete or impaired assets;

•  supply-chain issues such as manufacturing problems, delivery delays, or quality issues;

•  expenses related to product development and marketing initiatives; and

•  expenses for product support costs.

      Our overall gross margins also fluctuate based upon the mix of software, hardware and service sales. We realize higher margins on our software product sales than our hardware and service sales. Some of our revenues tend to be seasonal due to customer preferences as to when products and services are delivered and due to the timing of ourNational School Renaissance Conference, resulting in seasonal variations in margins.

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

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

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

     Concentration of Share Ownership; Control by Principal Shareholders/ Management. As of February 17, 2006, our principal shareholders, Judith Paul and Terrance Paul, co-chairmen and co-founders of the company, beneficially owned approximately 74% of our outstanding common stock. As a result, these principal shareholders have the ability to control and direct our business and affairs.

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     Shares Eligible for Future Sale. Sales of a substantial number of shares of our common stock in the public market could adversely affect the market price of the common stock. As of February 17, 2006, approximately 22.4 million shares of our common stock were held by “affiliates” and may be publicly sold only if registered under the Securities Act of 1933 or sold in accordance with an applicable exemption from registration, such as Rule 144. In addition, we have filed registration statements under the Securities Act of 1933 to register an aggregate of 6,000,000 shares of common stock reserved for issuance under our 1997 Stock Incentive Plan and an aggregate of 500,000 shares of common stock reserved for issuance under our Employee Stock Purchase Plan (“ESPP”), which will, when issued in accordance with such plans, be eligible for immediate sale in the public market, subject to the Rule 144 resale limitations for affiliates. We did not offer the ESPP to our employees in 2003, 2004 or 2005 and have no intention of offering it in 2006.

     Cash Dividends. We declared quarterly cash dividends of $.05 per share for each of the four quarters of 2005. We intend to continue to pay quarterly cash dividends, subject to capital availability and a determination that cash dividends continue to be in the best interests of the company and our shareholders. However, our dividend policy may be affected by, among other things, our views on potential future capital requirements, including those related to research and development, creation and expansion of sales distribution channels, acquisitions, legal risks, and stock repurchases. Our dividend policy may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. A change in our dividend policy could have a negative effect on the market price of our common stock.

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

     Acquisitions. In order to strengthen our business, we continually evaluate strategic opportunities, including acquisitions. Acquisitions involve a number of difficulties and risks, including, among others: the failure to integrate personnel, technology, research and development, marketing and sales operations of the acquired company; the diversion of management time and resources and the resulting disruption to our ongoing business; the potential loss of the acquired company’s customers, as well as our own; and unanticipated costs and liabilities. If we fail to integrate an acquired company or business successfully, our business, financial condition, and results of operations could be adversely affected. Any integration process will require significant time and resources, and we may not be able to manage the process successfully. If customers of the acquired company, or our customers, are uncertain about our ability to operate on a combined basis with the acquired company, they could delay or cancel orders for products and services. Moreover, we may not successfully evaluate or utilize the acquired technology or accurately forecast the financial impact of an acquisition transaction.

     Divestitures. From time to time, we may, for any number of reasons, determine it is in our best interests and in the interests of our shareholders to dispose of a business or product line. Divestitures involve a number of difficulties and risks, including, among others, the diversion of management time and resources and the resulting disruption to our ongoing business, and unanticipated costs and liabilities. If we are unable to manage the divestiture process successfully or if we are incorrect in our assumptions regarding the costs associated with a disposition, our business, financial condition and results of operations could be adversely affected.

Item 1B.  Unresolved Staff Comments

      As of December 31, 2005, we have not received any written comments from the Commission regarding our periodic or current reports under the Exchange Act.

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Item 2.  Properties

      Our corporate headquarters are located in Wisconsin Rapids, Wisconsin, in a 125,000 square foot facility owned by us which was constructed in 1996. We also own a 34,000 square foot distribution facility in Wisconsin Rapids, Wisconsin. Additionally, we lease various other office and warehouse space. We believe our facilities are adequate to support our operations for the foreseeable future.

Item 3.  Legal Proceedings

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

Item 4.  Submission of Matters to a Vote of Security Holders

      We did not submit any matters to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2005.

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EXECUTIVE OFFICERS OF THE REGISTRANT

Name and Age of Officer	Office
Judith Ames Paul   Age 59	Ms. Paul is the co-founder of the company and has been chairman of the board of directors since February 2006. From 1986 until July 2001, and again from August 2002 until July 2003, Ms. Paul served as chairman of the board, and from July 2001 until August 2002, and again from July 2003 until February 2006, Ms. Paul served as co-chairman with Mr. Paul. Ms. Paul has been a director since 1986. Ms. Paul acts as our spokesperson and is a leading teacher advocate. Ms. Paul holds a bachelor’s degree in elementary education from the University of Illinois. Judith Paul is Terrance Paul’s wife.
Terrance D. Paul   Age 59	Mr. Paul is the co-founder of the company and has been our president and chief executive officer since February 2006. From August 2002 until July 2003, Mr. Paul served as our chief executive officer. From July 1996 until July 2001, Mr. Paul served as vice chairman of the board and from July 2001 until August 2002, and again from July 2003 until February 2006, Mr. Paul served as co-chairman with Ms. Paul. Mr. Paul has been a director since 1986. Mr. Paul holds a law degree from the University of Illinois and an MBA from Bradley University. Terrance Paul is Judith Paul’s husband.
Mary T. Minch   Age 39	Ms. Minch has been our chief financial officer and secretary since November 2004 and has served as vice-president, finance since December 2003. From February 2003 to December 2003, Ms. Minch held the position of North American division controller for Stora Enso North American, Corp., a forest product company whose parent company acquired Consolidated Papers, Inc. From October 2000 to February 2003, she served as controller-magazine papers at Stora Enso North American, Corp. From April 1999 to October 2000, she was assistant controller at Consolidated Papers, Inc., a paper processing company. Ms. Minch holds bachelor’s degrees in managerial accounting and finance from the University of Wisconsin-Stevens Point and a master’s degree from the University of Wisconsin-Oshkosh, and is a Certified Public Accountant.

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

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

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PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

      Our common stock is traded under the symbol “RLRN” on The NASDAQ Stock Market^®, and quotations are supplied by the National Association of Securities Dealers, Inc. Information regarding the market prices of our common stock may be found in Note 16 of Notes to Consolidated Financial Statements included in “Item 8 — Financial Statements and Supplementary Data.”

Holders

      As of February 17, 2006, there were 635 record holders of the common stock.

Historical Dividends

      For the year ended December 31, 2003, no dividends or other distributions were paid to shareholders. We declared a special cash dividend of $2.15 per share on January 28, 2004 and also declared quarterly cash dividends of $0.04 per share for each of the four quarters of 2004 and $0.05 for each of the four quarters of 2005. We intend to continue to pay quarterly cash dividends, subject to capital availability and a determination that cash dividends continue to be in the best interests of the company and our shareholders.

Recent Sales of Unregistered Securities

      There were no sales of unregistered securities during the year ended December 31, 2005.

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

      On April 17, 2002, our Board of Directors authorized a repurchase program which provides for the repurchase of up to 5,000,000 shares of our common stock. On February 9, 2005, our Board of Directors authorized an additional 3,000,000 shares under the stock repurchase program.

      No time limit was placed on the duration of the repurchase program, nor is there any dollar limit on the program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes.

      The following table shows information relating to the repurchase of shares of our common stock during the three months ended December 31, 2005:

							Total Number of
							Shares Purchased		Maximum Number of
							as Part of		Shares that May yet
		Total Number			Average		Publicly		be Purchased Under
		of Shares			Price Paid		Announced Plans		the Plans or
Period		Purchased			per Share		or Programs		Programs
October 1-31			201,600		$	16.16		201,600		2,676,958
November 1-30			577,743	(1)		17.85		572,743		2,104,215
December 1-31			253,688			19.08		253,688		1,850,527
	Total		1,033,031		$	17.84		1,028,031

(1)  Includes 5,000 shares purchased in an open-market transaction by one of our directors, Addison L. Piper.

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Item 6.  Selected Financial Data

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

(In thousands, except per share amounts)

				Year Ended December 31,
				2005		2004			2003			2002			2001
Consolidated Income Statement Data
Net sales:
	Products			$	94,296	$	91,482		$	106,080		$	108,406		$	109,758
	Services				21,987		20,242			21,552			20,985			21,159
		Total net sales			116,283		111,724			127,632			129,391			130,917
Cost of sales:
	Products				12,917		6,167			10,656			11,782			14,425
	Services				8,669		9,532			9,628			9,243			9,721
		Total cost of sales			21,586		15,699			20,284			21,025			24,146
			Gross profit		94,697		96,025			107,348			108,366			106,771
Operating expenses:
	Product development				17,046		14,536			14,881			14,960			15,626
	Selling and marketing				30,778		30,551			27,997			28,013			26,508
	General and administrative				12,989		12,005			12,346			12,682			12,305
		Total operating expenses			60,813		57,092			55,224			55,655			54,439
		Operating income			33,884		38,933			52,124			52,711			52,332
	Other, net				3,494		1,640			2,267			3,760			4,177
Income — continuing operations before income taxes					37,378		40,573			54,391			56,471			56,509
Income taxes — continuing operations					13,211		15,012			19,406			21,744			21,673
Income — continuing operations					24,167		25,561			34,985			34,727			34,836
Income (loss) — discontinued operations					584		(2,859	)		(2,444	)		(3,289	)		(4,167	)
Net income				$	24,751	$	22,702		$	32,541		$	31,438		$	30,669
Earnings (loss) per share:
	Basic:
		Continuing operations			0.78		0.82			1.12			1.03			1.01
		Discontinued operations			0.02		(0.09	)		(0.07	)		(0.10	)		(0.12	)
		Net income		$	0.80	$	0.73		$	1.05		$	0.93		$	0.89
	Diluted:
		Continuing operations			0.78		0.82			1.12			1.02			1.00
		Discontinued operations			0.02		(0.09	)		(0.08	)		(0.10	)		(0.12	)
		Net income		$	0.80	$	0.73		$	1.04		$	0.92		$	0.88
Cash dividends declared per share				$	0.20	$	2.31*		$	—		$	—		$	—
Consolidated Balance Sheet Data
Working capital				$	21,539	$	41,815		$	103,240		$	74,496		$	83,383
Total assets					128,382		114,724			159,601			147,611			159,961
Shareholders’ equity					95,866		84,417			133,330			121,236			136,531

*  Includes a special dividend of $2.15 per share.

      Generation21 was divested during 2005 and, therefore, its results for all periods presented in the consolidated financial statements are reflected as discontinued operations.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

      Renaissance Learning, Inc. is a leading provider of computerized assessment and progress monitoring tools for pre-kindergarten through senior high (“pre-K-12”) schools in North America. Our computerized assessment and progress monitoring tools accelerate learning and improve test scores by helping educators motivate students, increasing the quality, quantity, and timeliness of performance data available to educators, facilitating increased student practice of essential skills and providing student access to low cost computing solutions.

      Our sales are derived primarily from the sale of software products, computerized hardware products and related services. Revenues are recorded net of an allowance for estimated returns. Allowances for bad debts are also recorded at the time of the sale. Product revenue is primarily derived from educational software and hardware products. We recognize revenue from sales of our perpetually licensedoff-the-shelf software products and hardware at the time of shipment to customers. Revenue from subscription-based products is recognized on a straight-line basis over the subscription period. We recognize revenue from the sale of software products which require significant customization or modification on thepercentage-of-completion method of accounting.

      Service revenue is primarily derived from: (i) training seminars, (ii) software telephone support agreements, (iii) consulting services and (iv) technical services. Revenue from training seminars is recognized when the seminar or workshop is performed. Revenue from consulting and technical services is recognized as the services are performed or on a straight-line basis over the contractual period. Telephone support included with sales of perpetual software licenses has a duration of twelve months or less and is recognized at the time the software is shipped with the related costs of providing the telephone support accrued for at the same time. Revenue from other product support agreements is initially recorded as deferred revenue and recognized as revenue on a straight-line basis over 12 or 24 months depending on the term of the agreement. Deferred revenue includes: (i) amounts invoiced for products not yet delivered and services not yet performed, (ii) advance invoicing on contracts and (iii) that portion of product support agreements and subscription-based product sales that has not yet been recognized as revenue.

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

      Cost of sales consists of expenses associated with sales of our software and hardware products and the delivery of services. These costs include: (i) personnel-related costs, (ii) costs of purchased materials such as our portable computing devices, optical-mark card scanners, interactive response systems, educational products, training materials, manuals and motivational items, (iii) shipping and freight costs, (iv) amortization of capitalized development costs and (v) other overhead costs. We realize higher gross margins on our software product sales than on our hardware and service sales.

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

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Acquisition and Divestiture

      On June 27, 2005, we acquired AlphaSmart, Inc. a provider of affordable, portable computing solutions for K-12 schools. The results of AlphaSmart’s operations are included in our consolidated financial statements since that date. AlphaSmart products are portable,easy-to-use computing devices that run curriculum-specific software focused on skills improvement and real-time formative assessments. The units offer schools the ability to provide students with significantly improved access to portable computing at a fraction of the cost of conventional personal computers. AlphaSmart, based in Los Gatos, California, was founded in 1992 by former Apple Computer engineers. The acquisition provides opportunities to achieve future long-term synergies related to the complementary nature of AlphaSmart’s hardware products and Renaissance’s software products. AlphaSmart’s products have the future potential to run Renaissance’s software, thus enabling students greater access to our software where ready availability of computer access is currently a product-use limitation.

      In February 2005, we consummated the sale of our Generation21 subsidiary, a non-core part of our business. The results of Generation21, for all periods presented in our consolidated financial statements, are reflected as discontinued operations. Except as indicated, amounts referred to in this Item 7 relate to continuing operations.

Results of Operations

      Our annual results of operations can be influenced by, among other things, general economic factors and the related impact on state and federal budgetary policy. School funding is typically a priority budget item and thus exhibits less volatility in economic downturns than other programs. However, in highly recessionary periods or in periods of sustained economic slow down, curtailments in school funding can be significant. The difficult educational funding environment in recent years has contributed to the decline in our results from continuing operations we experienced for 2005 and 2004.

      OurRenaissance Placeproducts are designed to meet the needs of entire districts from a central server. Sales of products and services at a district level are more complex, have a longer sales cycle, and are typically for a larger dollar amount than sales made to individual schools. Thus, revenues from district sales can be more uneven and are more difficult to accurately predict. Consequently, our revenues and results of operations can be significantly impacted by the timing of large district orders.

      Since ourRenaissance Placeproduct and service offerings are typically sold on a subscription basis with a term of twelve months, a greater portion of our revenue is initially deferred and recognized into income over the subscription period. This can cause our revenue to show a greater decline than it would have if these products had been sold as perpetual licenses, for which the revenue is recognized immediately upon shipment. Deferred revenue increased $1.8 million and $6.0 million, over the years ended December 31, 2005 and 2004, respectively.

      Our net income and results of operations can also be affected by other items, as was the case during 2005 relating to: (i) the acquisition of AlphaSmart, (ii) the divestiture of Generation21, (iii) the sale of our Madison, Wisconsin office building and (iv) the tax benefit related to the settlement of certain state and federal tax positions in 2005. Each of these items had a significant impact on our income reported for the year ended December 31, 2005.

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

			For the Years Ended
			December 31,
			2005			2004			2003
Net Sales:
	Products			81.1	%		81.9	%		83.1	%
	Services			18.9			18.1			16.9
		Total net sales		100.0	%		100.0	%		100.0	%
Cost of sales:
	Products			13.7	%		6.7	%		10.0	%
	Services			39.4			47.1			44.7
		Total cost of sales		18.6			14.1			15.9
Gross profit:
	Products			86.3			93.3			90.0
	Services			60.6			52.9			55.3
		Total gross profit		81.4			85.9			84.1
Operating expenses:
	Product development			14.7			13.0			11.7
	Selling and marketing			26.5			27.4			21.9
	General and administrative			11.1			10.7			9.7
Operating income				29.1			34.8			40.8
Other, net				3.1			1.5			1.8
Income — continuing operations before income taxes				32.2			36.3			42.6
Income taxes — continuing operations				11.4			13.4			15.2
Income — continuing operations				20.8			22.9			27.4
Income — discontinued operations				0.5			(2.6	)		(1.9	)
Net Income				21.3	%		20.3	%		25.5	%

Years Ended December 31, 2005 and 2004

     Net Sales. Our net sales increased by $4.6 million or 4.1%, to $116.3 million in 2005 from $111.7 million in 2004. The increase in sales is due to the inclusion of AlphaSmart revenues in the results of operations for 2005 partially offset by declines in other product and service offerings. Product sales increased by $2.8 million, or 3.1%, to $94.3 million in 2005 from $91.5 million in 2004.

      Service revenue increased by $1.8 million, or 8.6%, to $22.0 million in 2005 compared to $20.2 million in 2004 Our service revenues continue to show positive growth over the prior year primarily driven by improvement in our newer service offerings such as guided implementation and installation services.

     Cost of Sales. The cost of sales of products increased by $6.7 million, or 109.5%, to $12.9 million in 2005 from $6.2 million in 2004. As a percentage of product sales, the cost of sales of products increased to 13.7% in 2005 from 6.7% in 2004. The increase in the cost of sales percentage was primarily due to the impact in 2005 of the AlphaSmart hardware product sales which generate lower gross margins than our software sales.

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      The cost of sales of services decreased by $0.8 million , or 9.1%, to $8.7 million in 2005 from $9.5 million in 2004. As a percentage of sales of services, the cost of sales of services decreased to 39.4% in 2005 from 47.1% in 2004. The improved service margins are the result of: (i) operating leverage in our newer service offerings for which we were ramping up costs ahead of revenue in 2004 and (ii) a more profitable 2005National School Renaissance Conference.

      Our overall gross profit margin percentage decreased to 81.4% in 2005 from 85.9% in 2004 primarily driven by the increased cost of sales percentage on product sales as discussed above.

     Product Development. Product development expense, which excludes amounts capitalized, increased to $17.0 million in 2005 from $14.5 million in 2004. As a percentage of net sales, product development expenses increased to 14.7% in 2005 from 13.0% in 2004. Product development expenses increased primarily due to the inclusion of AlphaSmart expenses in 2005 and in part to increases in product development expenditures related to new product offerings. We capitalized product development expenses of $279,000 in 2005 compared to $563,000 in 2004.

     Selling and Marketing. Selling and marketing expenses were relatively unchanged at $30.8 million in 2005 compared to $30.6 million in 2004. We experienced lower selling and marketing expenses in the first half of 2005 than in 2004 due to comparatively lower levels of field sales personnel. This was offset by higher expenses in the second half of 2005 due to the incremental inclusion of AlphaSmart’s selling and marketing expenses in our results. As a percentage of net sales, selling and marketing expenses were 26.5% in 2005 compared to 27.4% in 2004.

     General and Administrative. General and administrative expenses increased by $1.0 million, or 8.2%, to $13.0 million in 2005 from $12.0 million in 2004. General and administrative expenses increased primarily due to the inclusion of AlphaSmart expenses in 2005. As a percentage of net sales, general and administrative costs increased to 11.1% in 2005 from 10.7% in 2004.

     Operating Income. Operating income decreased by $5.0 million, or 13.0%, to $33.9 million in 2005 from $38.9 million in 2004. As a percentage of net sales, operating income decreased to 29.1% in 2005 from 34.8% in 2004 primarily due to the combined impact of the increased product development expenses and the lower gross margins related to the increased proportion of revenue from hardware sales which generate lower gross margins than our software sales.

     Other income. Other income increased $1.9 million to $3.5 million in 2005, from $1.6 million in 2004, primarily due to the sale of our Madison, Wisconsin office building which generated a $1.8 million pre-tax gain in 2005.

     Income Tax Expense — Continuing Operations. Income tax expense of $13.2 million, from continuing operations, was recorded in 2005 at an effective income tax rate of 35.3% of pre-tax income, compared to $15.0 million, or 37.0% of pre-tax income for 2004. In 2005, we recognized a tax benefit of approximately $0.8 million related to the favorable resolution of certain state and federal tax positions which was the primary reason for the 1.7 point decrease in the effective tax rate.

     Discontinued Operations. We recorded a gain on the sale of Generation21 of approximately $0.7 million, including a one-time tax benefit of $1.3 million. When combined with the operating losses incurred in January and February 2005 for that subsidiary, the net income from discontinued operations totaled approximately $0.6 million in 2005. The net operating loss from Generation21 in 2004 was approximately $2.9 million.

Years Ended December 31, 2004 and 2003

     Net Sales. Our net sales declined by $15.9 million, or 12.5%, to $111.7 million in 2004 from $127.6 million in 2003. The lower sales were attributed to two main factors, an increase in deferred revenue and an interruption of customer order patterns as a result of our new product offerings. Deferred revenue increased by $6.0 million during the year, mainly due to our transition to a subscription-based model forRenaissance Placeand several newer service offerings. We began to ship the newRenaissance Placeversions ofAccelerated ReaderandAccelerated Mathin May 2004.Renaissance Place, unlike our perpetually licensed

20

versions, is a subscription-based product that requires a significant portion of the sale to be initially recorded as deferred revenue and then recognized as revenue over the subscription period, typically 12 months. We believe the interruption in order patterns was caused by customers delaying their purchase decisions as they evaluated the newRenaissance Place versions of our software and by the longer sales cycles required when selling at the district level. Product sales decreased by $14.6 million, or 13.8%, to $91.5 million in 2004 from $106.1 million in 2003.

      Service revenue decreased by $1.4 million, or 6.1%, to $20.2 million in 2004 compared to $21.6 million in 2003. Lower attendance at our 2004National School Renaissance Conferenceresulted in about $700,000 less revenue compared to our 2003National School Renaissance Conference. Our onsite and hotel training revenues declined in the period, partially offset by some of our newer service offerings as we continued to de-emphasize our single event training offerings in favor of guided implementation, consulting, and other services during 2004.

     Cost of Sales. The cost of sales of products decreased by $4.5 million, or 42.1%, to $6.2 million in 2004 from $10.7 million in 2003. As a percentage of product sales, the cost of sales of products decreased to 6.7% in 2004 from 10.0% in 2003. The lower cost of sales was mainly due to lower scanner warranty costs, cost efficiencies achieved in the delivery of our custom assessment products and to the sales mix in 2004 compared to 2003 with proportionally lower sales of scanners, which is a lower gross profit margin product than our software products.

      The cost of sales of services was $9.5 million in 2004 and $9.6 million in 2003, a decrease of $0.1 million or 1.0%. As a percentage of sales of services, the cost of sales of services increased to 47.1% in 2004 from 44.7% in 2003. The increased percentage was mainly due to the costs of ramping up our new service offerings prior to their full utilization as well as lower attendance at our 2004National School Renaissance Conference. Since most of the costs to host the conference are relatively fixed, the lower revenue directly affected profitability.

      Our overall gross profit margin improved to 85.9% in 2004 from 84.1% in 2003 driven by the factors disclosed above in the product cost of sales analysis.

     Product Development. Product development expense, which excludes amounts capitalized, decreased slightly to $14.5 million in 2004 from $14.9 million in 2003 as we continued to invest in the development of new products and the enhancement of existing products. As a percentage of net sales, product development expenses increased to 13.0% in 2004 from 11.7% in 2003. We capitalized product development expenses of $563,000 in 2004 compared to $448,000 in 2003.

     Selling and Marketing. Selling and marketing expenses increased to $30.6 million in 2004 compared to $28.0 million in 2003. The increase was mainly due to additional costs related to the expansion of our field sales team. As a percentage of net sales, selling and marketing expenses were 27.4% in 2004 compared to 21.9% in 2003.

     General and Administrative. General and administrative expenses decreased slightly by $0.3 million, or 2.8%, to $12.0 million in 2004 from $12.3 million in 2003. The decline was primarily due to a one-time executive severance expense incurred in 2003. As a percentage of net sales, general and administrative costs increased to 10.7% in 2004 from 9.7% in 2003.

     Operating Income. Operating income decreased by $13.2 million, or 25.3%, to $38.9 million in 2004 from $52.1 million in 2003. As a percentage of net sales, operating income decreased to 34.8% in 2004 from 40.8% in 2003 due to the combination of lower revenue and higher operating expenses.

     Income Tax Expense — Continuing Operations. Income tax expense of $15.0 million, from continuing operations, was recorded for 2004 at an effective income tax rate of 37.0% of pre-tax income, compared to $19.4 million, or 35.6% of pre-tax income for 2003. The income tax expense for 2003 included a non-recurring benefit of $1.0 million related to tax credits for research activities in excess of previously estimated amounts which was the primary difference for the 1.4 point increase in the effective tax rate.

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     Discontinued Operations. The net operating loss, for Generation21, from discontinued operations totaled $2.9 million in 2004 compared to the net operating loss of $2.4 million in 2003.

Liquidity and Capital Resources

      As of December 31, 2005, our cash, cash equivalents and investment securities were $34.6 million, down $39.0 million from the December 31, 2004 total of $73.6 million. During 2005, we generated operating cash flow of $31.5 million and $3.2 million in proceeds from the sale of our Madison, Wisconsin office building. We used $34.0 million to fund the purchase of AlphaSmart and $32.4 million for repurchases of our common stock.

      At December 31, 2005, we had a $15.0 million unsecured revolving line of credit with a bank which is available until May 31, 2007. The line of credit bears interest at either a floating rate based on the prime rate less 1.0%, or a fixed rate for a period of up to 90 days based on LIBOR plus 1.25%. The rate is at our option and is determined at the time of borrowing. We also have a $2.0 million unsecured revolving line of credit with a bank available until April 30, 2007. The line of credit bears interest based on the prime rate less 1.0%. As of December 31, 2005, the lines of credit had not been used.

      On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. On February 9, 2005, our Board of Directors authorized an additional 3,000,000 shares under the stock repurchase program. No time limit was placed on the duration of the repurchase program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. During the period of January 1, 2005 through December 31, 2005, we repurchased 1.8 million shares at a cost of $32.4 million. Since authorization, we have repurchased 6.2 million shares at a cost of $110.9 million under this repurchase program. Depending on our stock valuation, cash availability and other factors, we may repurchase additional shares as a beneficial use of our cash to enhance shareholder value.

      We declared a special cash dividend of $2.15 per share on January 28, 2004, quarterly cash dividends of $0.04 per share for each of the four quarters of 2004 and quarterly cash dividends of $0.05 for each of the four quarters of 2005. We intend to continue to pay quarterly cash dividends, subject to capital availability and a determination that cash dividends continue to be in the best interests of the company and our shareholders.

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

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

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

     Operating Leases. We enter into operating leases, primarily for facilities that we occupy in order to carry out our business operations. We utilize operating leases for some of our facilities to gain flexibility as compared to purchasing facilities outright and limit our exposure to many of the risks of owning commercial property, particularly with regard to international operations. These agreements generally are for terms of one to five years and cannot be terminated by either the lessor or us for reasons other than breach of the lease agreement. We do not anticipate early termination of any of these agreements. For each of the years ended December 31, 2005, 2004 and 2003, respectively, we incurred expenses of approximately $0.9 million, $1.1 million, and $1.1 million, related to these operating leases.

     Purchase Obligations. We enter into commitments with certain suppliers to purchase components for our hardware products, such asAlphaSmartcomputing devices,AccelScanscanners and theRenaissance Classroom Response System. We typically commit to purchases of components in quantities to cover one to six months of advance production and therefore expect these obligations to be satisfied within one year.

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      As of December 31, 2005, our approximate contractual obligations for operating leases and purchase obligations (by period due) were as follows:

		Payments Due by Period
				Less Than		1-3		3-5		More Than
Contractual Obligations		Total		1 Year		Years		Years		5 Years
		(In Thousands)
Operating lease obligations		$	2,956	$	883	$	1,798	$	275	$	—
Purchase obligations			5,766		5,766		—		—		—
	Total	$	8,722	$	6,649	$	1,798	$	275	$	—

     Retirement Plan. We have established a Supplemental Executive Retirement Plan (“SERP”) for the provision of retirement benefits to members of our senior management. Under the terms of the plan, participants elect to defer receipt of a portion of their compensation and to hypothetically invest it in certain mutual fund investments. Upon a participant’s retirement (or certain other events), the Company has an obligation to repay the deferred compensation, a defined matching company contribution and the hypothetical market gain or loss of each participant’s investment selections. As of December 31, 2005, we have fully funded the $1.6 million aggregate contractual obligation for future payments to SERP participants. The SERP is more fully described in Note 11 of our Notes to Consolidated Financial Statements.

     Other Obligations. As of December 31, 2005, we did not hold any long-term debt obligations, long-term purchase obligations or material capital lease obligations.

Critical Accounting Policies and Estimates

      The foregoing discussion is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The following is a list of our critical accounting policies defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and/or require management’s significant judgments and estimates. This is not intended to be a comprehensive list of all of our accounting policies. Our significant accounting policies are more fully described in Note 5 of our Notes to Consolidated Financial Statements.

     Revenue Recognition. We recognize revenue from our software products in accordance with Statement of Position No. 97-2 “Software Revenue Recognition” issued by the Accounting Standards Executive Committee of the AICPA. Under this accounting standard, revenue is recognized when the following have occurred: persuasive evidence of an arrangement exists, product delivery and acceptance has occurred or a service has been performed, pricing is fixed and determinable, and collectibility is probable. Revenue is recognized as follows: (i) at the time of shipment to customers for perpetually licensedoff-the-shelf software products and related telephone support with a duration of 12 months or less sold with the product, (ii) on thepercentage-of-completion basis for software products which require significant customization or modification, (iii) as seminars are performed for training, (iv) straight-line over the term of the support agreement for other software support agreements, (v) as the service is performed or on a straight-line basis over the contractual period for technical and consulting services, and (vi) straight-line over the subscription period for subscription based products. Accordingly, management is required to make judgments as to whether pricing is fixed and determinable, whether collectibility is reasonably assured and what the percentage of completion is as of the financial reporting date.

      Expenses are recognized and matched against revenues for the reporting period presented in the financial statements. We record accruals for sales returns and doubtful accounts at the time of revenue recognition based upon historical experience as well as other factors that in our judgment could reasonably be expected to cause sales returns or doubtful accounts to differ from historical experience. Changes in such allowances may be required if future returns or bad debt activity differs from our estimates.

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

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

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

     Software Development Costs. We capitalize certain software development costs incurred after technological feasibility is achieved. Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the products, which is generally estimated to be 24 months. Amortization begins when the products are available for general release to customers. If the actual economic life of our products is shorter than our estimates, it could result in an impairment charge in future periods.

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

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

Recent Accounting Pronouncement

      In December 2004, the FASB issued SFAS 123R (revised 2004), “Share-Based Payment”. This statement revises SFAS 123, “Accounting for Stock-Based Compensation”, and requires companies to expense the value of employee stock option grants, restricted stock and similar awards. The statement is effective for the company on January 1, 2006.

      Historically, we have elected to follow the intrinsic value method of accounting for our employee stock options. Accordingly, because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, we have not recognized any compensation expense related to grants of stock options to our employees.

      Upon the adoption of SFAS 123R, we will expense stock option grants in our Consolidated Statement of Income based on the grant-date fair value of the instruments issued using an option pricing model and will be recognized over the requisite service period. For the years ended December 31, 2005, 2004 and 2003, total

24

stock-based employee compensation expense, net of related tax effects determined under this new standard, would have been $2.5, $1.7 and $3.8 million, respectively (See Note 5(j)). The adoption of SFAS 123R will not have a material effect on our financial results as we do not have a substantial number of unvested options outstanding at December 31, 2005. Stock option expense in 2006 will be dependent on a number of factors, including the fair value of awards at the time of grant.

Subsequent Event

      Our former president and chief executive officer resigned effective February 15, 2006 and we entered into a severance agreement with him at that time. As a result of this severance agreement, we expect to record an expense in the first quarter of 2006 of approximately $0.9 million ($0.6 million after tax).

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

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

     Market Risk. Our exposure to market risk relates to the quality of the holdings in our investment security portfolio. The fair market value of our investments is subject to increases or decreases in value resulting from the performance of the securities issuer, from upgrades or downgrades in the credit worthiness of the securities issuer, and from changes in general market conditions.

      We seek to manage our exposure to market risk by investing in accordance with our corporate investment policy as established by our Board of Directors. The goals of the policy are: (i) preservation of capital, (ii) provision of adequate liquidity to meet projected cash requirements, (iii) minimization of risk of principal loss through diversified short and medium term investments, and (iv) maximization of yields in relationship to the guidelines, risk, market conditions and tax considerations.

      Our investment policy permits investments in obligations of the U.S. Treasury and Agencies, money market funds, and high quality investment-grade corporate and municipal interest-bearing obligations. The policy requires diversification to prevent excess concentration of issuer risk and requires the maintenance of minimum liquidity levels. The policy precludes investment in equity securities except for the specific purpose of funding the obligations related to our Supplemental Executive Retirement Plan (see Note 11 of our Notes to Consolidated Financial Statements). As of December 31, 2005, our investment securities had a market value of approximately $27.4 million and a carrying value of $27.5 million. In addition, we hold the first mortgage note on our former facility in Madison, Wisconsin, which had a balance of $5.9 million as of December 31, 2005. The mortgage note matures on December 31, 2008 and is secured by the value of the underlying real estate. Due to the type and duration of our investments we do not expect to realize any material gains or losses related to market risk.

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

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Item 8.  Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Renaissance Learning, Inc. and Subsidiaries

      We have audited the accompanying consolidated balance sheets of Renaissance Learning, Inc. and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

      In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Renaissance Learning, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Milwaukee, Wisconsin

February 22, 2006

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 2005 and 2004

				2005			2004
				(In Thousands, Except
				Share and
				Per Share Amounts)
ASSETS
Current assets:
	Cash and cash equivalents			$	7,083		$	27,460
	Investment securities				23,363			25,103
	Accounts receivable, less allowance of $1,340 and $1,283, respectively				11,393			8,441
	Inventories				4,138			2,364
	Prepaid expenses				1,722			1,194
	Deferred tax asset				3,693			3,800
	Assets of discontinued operations				—			1,149
	Other current assets				390			453
			Total current assets		51,782			69,964
Investment securities					4,132			21,003
Property, plant and equipment, net					11,475			18,552
Deferred tax asset					738			1,620
Goodwill					45,906			2,757
Other intangibles, net					6,787			192
Capitalized software, net					420			636
Other receivables					5,909			—
Other non-current assets					1,233			—
			Total assets	$	128,382		$	114,724
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Accounts payable			$	3,280		$	1,226
	Deferred revenue				18,255			16,484
	Payroll and employee benefits				4,156			3,983
	Income taxes payable				313			925
	Liabilities of discontinued operations				—			1,650
	Other current liabilities				4,239			3,881
			Total current liabilities		30,243			28,149
Deferred revenue					670			620
Deferred compensation					1,603			1,354
			Total liabilities		32,516			30,123
Minority interest					—			184
Shareholders’ equity:
	Common stock, $.01 par; shares authorized: 150,000,000; issued: 34,736,647 shares at December 31, 2005 and 2004				347			347
		Additional paid-in capital			56,522			54,490
		Retained earnings			118,233			99,689
		Treasury stock, at cost: 4,387,594 shares at December 31, 2005; 3,865,280 shares at December 31, 2004			(78,845	)		(70,213	)
		Unearned restricted stock compensation			(438	)		—
		Accumulated other comprehensive income			47			104
			Total shareholders’ equity		95,866			84,417
			Total liabilities and shareholders’ equity	$	128,382		$	114,724

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

For the Years Ended December 31, 2005, 2004 and 2003

					2005		2004			2003
					(In Thousands, Except Per Share
					Amounts)
Net Sales:
	Products				$	94,296	$	91,482		$	106,080
	Services					21,987		20,242			21,552
			Total net sales			116,283		111,724			127,632
Cost of sales:
	Products					12,917		6,167			10,656
	Services					8,669		9,532			9,628
			Total cost of sales			21,586		15,699			20,284
			Gross profit			94,697		96,025			107,348
Operating expenses:
	Product development					17,046		14,536			14,881
	Selling and marketing					30,778		30,551			27,997
	General and administrative					12,989		12,005			12,346
			Total operating expenses			60,813		57,092			55,224
			Operating income			33,884		38,933			52,124
Other income:
	Interest income					1,324		1,072			1,927
	Other, net					2,170		568			340
Income — continuing operations before income taxes						37,378		40,573			54,391
Income taxes — continuing operations						13,211		15,012			19,406
Income — continuing operations						24,167		25,561			34,985
Income (loss) — discontinued operations						584		(2,859	)		(2,444	)
Net Income					$	24,751	$	22,702		$	32,541
Earnings (Loss) per share:
		Basic — Continuing operations			$	0.78	$	0.82		$	1.12
		Discontinued operations				0.02		(0.09	)		(0.07	)
				Net income	$	0.80	$	0.73		$	1.05
		Diluted — Continuing operations			$	0.78	$	0.82		$	1.12
		Discontinued operations				0.02		(0.09	)		(0.08	)
				Net income	$	0.80	$	0.73		$	1.04

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Years Ended December 31, 2005, 2004 and 2003

																	Other			Accumulated
			Common		Additional									Unearned			Comprehensive			Total
			Stock		Paid-in			Retained			Treasury			Restricted Stock			Income			Shareholders’
			Amount		Capital			Earnings			Stock			Compensation			(Loss)			Equity
			(In Thousands)
Balance, December 31, 2002			$	347	$	54,423		$	116,055		$	(49,480	)	$	—		$	(109	)	$	121,236
	Net income			—		—			32,541			—			—			—			32,541
	Foreign currency translation			—		—			—			—			—			167			167
		Comprehensive income																			32,708
	Stock repurchased for treasury			—		—			—			(23,727	)		—			—			(23,727	)
	Employee stock purchase plan			—		(131	)		—			1,177			—			—			1,046
	Exercise of stock options			—		(561	)		—			2,192			—			—			1,631
	Tax benefit on stock options			—		393			—			—			—			—			393
	Stock option grants to non-employees			—		43			—			—			—			—			43
Balance, December 31, 2003				347		54,167			148,596			(69,838	)		—			58			133,330
	Net income			—		—			22,702			—			—			—			22,702
	Foreign currency translation			—		—			—			—			—			46			46
		Comprehensive income																			22,748
	Dividends ($2.31 per share)			—		—			(71,609	)		—			—			—			(71,609	)
	Stock repurchased for treasury			—		—			—			(5,539	)		—			—			(5,539	)
	Exercise of stock options			—		(833	)		—			5,164			—			—			4,331
	Tax benefit on stock options			—		1,156			—			—			—			—			1,156
Balance, December 31, 2004				347		54,490			99,689			(70,213	)		—			104			84,417
	Net income			—		—			24,751			—			—			—			24,751
	Foreign currency translation			—		—			—			—			—			(57	)		(57	)
		Comprehensive income																			24,694
	Dividends ($.20 per share)			—		—			(6,207	)		—			—			—			(6,207	)
	Stock repurchased for treasury			—		—			—			(32,374	)		—			—			(32,374	)
	Treasury shares issued for purchase of AlphaSmart			—		2,171			—			20,895			—			—			23,066
	Exercise of stock options			—		(350	)		—			2,455			—			—			2,105
	Tax benefit on stock options			—		112			—			—			—			—			112
	Restricted stock grants			—		99			—			392			(491	)		—			—
	Restricted stock compensation			—		—			—			—			53			—			53
Balance, December 31, 2005			$	347	$	56,522		$	118,233		$	(78,845	)	$	(438	)	$	47		$	95,866

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

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2005, 2004 and 2003

				2005			2004			2003
				(In Thousands)
Reconciliation of net income to net cash provided by operating activities:
	Net income			$	24,751		$	22,702		$	32,541
	(Income) loss from discontinued operations				(584	)		2,859			2,444
	Income from continuing operations				24,167			25,561			34,985
	Noncash (income) expenses included in net income —
		Depreciation and amortization			3,179			3,315			3,650
		Amortization of investment discounts/premiums			396			696			1,616
		Deferred income taxes			1,437			118			114
		Gain on sale of property			(1,798	)		—			—
	Change in assets and liabilities, excluding the effects of acquisitions and divestitures
		Accounts receivable			1,903			4,090			9
		Inventories			568			(94	)		(623	)
		Prepaid expenses			(369	)		107			9
		Accounts payable and other liabilities			(1,532	)		(720	)		(1,311	)
		Deferred revenue			1,821			6,034			47
		Income tax benefit from the exercise of stock options			112			1,156			393
		Other current assets			1,460			437			443
		Other			181			(23	)		419
	Cash provided by operating activities				31,525			40,677			39,751
	Cash used by discontinued operations				(116	)		(3,437	)		(1,723	)
	Net cash provided by operating activities				31,409			37,240			38,028
Cash flows from investing activities:
	Purchase of property, plant and equipment				(2,419	)		(1,046	)		(2,082	)
	Purchase of investment securities				(6,834	)		(46,408	)		(42,357	)
	Maturities/sales of investment securities				25,049			48,949			73,045
	Capitalized software development costs				(279	)		(563	)		(448	)
	Net proceeds from sale of property				3,166			—			—
	Net proceeds from sale of subsidiary				75			—			—
	Acquisitions of business, net of cash acquired				(33,970	)		—			(521	)
	Cash provided by investing activities				(15,212	)		932			27,637
	Cash used by discontinued operations				—			(365	)		(354	)
			Net cash (used) provided by investing activities		(15,212	)		567			27,283
Cash flows from financing activities:
	Return of capital to minority interest				(98	)		(54	)		—
	Proceeds from issuance of stock				—			—			1,046
	Proceeds from exercise of stock options				2,105			4,331			1,674
	Dividends paid				(6,207	)		(71,609	)		—
	Purchase of treasury stock				(32,374	)		(5,539	)		(23,727	)
			Net cash used by financing activities		(36,574	)		(72,871	)		(21,007	)
Net (decrease) increase in cash					(20,377	)		(35,064	)		44,304
Cash and cash equivalents, beginning of period					27,460			62,524			18,220
Cash and cash equivalents, end of period				$	7,083		$	27,460		$	62,524
Supplemental cash flow information
Cash paid during the year for — Interest				$	—		$	—		$	—
	Income taxes (net of refunds)			$	11,121		$	13,054		$	17,172

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Consolidation

      Our consolidated financial statements include the financial results of Renaissance Learning, Inc. (“Renaissance Learning”) and our subsidiaries (collectively, the “Company”). Our significant operating subsidiaries include AlphaSmart, LLC (“AlphaSmart”), which we acquired in June 2005, and Renaissance Corporate Services, Inc. Generation21 Learning Systems, LLC (“Generation21”) was divested during the first quarter of 2005 and, therefore, its results for all periods presented in the consolidated financial statements are reflected as discontinued operations. All significant intercompany transactions have been eliminated in the consolidated financial statements.

(2) Basis of presentation

      Except as indicated, amounts reflected in the consolidated financial statements or the notes thereto, relate to our continuing operations. Certain prior year amounts have been reclassified to conform to the current year presentation. Generation21 was divested during the first quarter of 2005 and, therefore, its results for all periods presented in the consolidated financial statements are reflected as discontinued operations.

(3) Nature of operations

      Renaissance Learning, Inc. is a provider of computerized assessment and progress monitoring tools for pre-kindergarten through senior high (“pre-K-12”) schools in North America. Our computerized assessment and progress monitoring tools accelerate learning and improve test scores by helping educators motivate students, increasing the quality, quantity, and timeliness of performance data available to educators, facilitating increased student practice of essential skills and providing student access to low cost computing solutions.

      We offer a full line of professional service and support solutions that integrate with, complement, and enhance the effectiveness of, our products. Sold separately or bundled with our products to provide a complete solution, our service offerings include training workshops and seminars, report and data analysis, program evaluation, guided implementation, distance training, software support, software installation, database conversion and integration services, and application hosting.

      Our educational software covers a wide range of subject areas including reading, early literacy, mathematics, writing, vocabulary, test preparation, standards assessment and language acquisition. We provide customized assessment software to educational publishers which supports many of the popular textbook series used in K-12 and post-secondary educational institutions. Our flagship product isAccelerated Reader, which provides educators with information for motivating and monitoring increased literature-based reading practice and to support instruction. Our other software and service solution brands include:STAR Reading, STAR Early Literacy, Accelerated Vocabulary, Read Now with Power Up!, Accelerated Math, STAR Math, MathFacts in a Flash, and English in a Flash.

      Our hardware products includeAlphaSmartportable computing devices that run curriculum-specific software focused on skills improvement and real-time formative assessments. The units offer schools the ability to provide students with significantly improved access to portable computing at a fraction of the cost of conventional personal computers. In late 2005, we begin shipping ourRenaissance Classroom Response System. This interactive system allows educators to easily encourage student classroom participation and obtain instantaneous feedback that can be used to quickly assess student comprehension and performance. Additionally, we sell our patentedAccelscanoptical-mark card scanner which is used with several of our software applications to automate scoring and recordkeeping tasks.

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(4)  Acquisition

      On June 27, 2005, we acquired AlphaSmart, a provider of portable computing devices for K-12 schools. The results of AlphaSmart’s operations are included in our consolidated financial statements since that date. AlphaSmart products are portable,easy-to-use computing devices that run curriculum-specific software focused on skills improvement and real-time formative assessments. The units offer schools the ability to provide students with significantly improved access to portable computing at a fraction of the cost of conventional personal computers.

      AlphaSmart, based in Los Gatos, California, and was founded in 1992 by former Apple Computer engineers. The acquisition provides opportunities to achieve future long-term synergies related to the complementary nature of AlphaSmart’s hardware products and Renaissance’s software products. AlphaSmart’s products have the future potential to run Renaissance’s software, thus enabling students greater access to our software where ready availability of computer access is currently a product-use limitation.

      The aggregate purchase price was approximately $58 million dollars which consisted of $34 million in cash, $23 million of our common stock (1,157,355 shares) and $1 million of transaction costs. The purchase price was allocated to the assets acquired and liabilities assumed according to their estimated fair values. The values assigned to tradename and customer relationships are based on an independent appraisal. The tradename has an indeterminate life and will not be amortized. The customer relationships intangible has a10-year estimated useful life and is being amortized on an accelerated method (Note 6). The purchase price allocation is subject to change, up to one year from the date of acquisition, as we continue to refine the estimated fair value of assets acquired and liabilities assumed.

      The following table summarizes the estimated fair values of the assets acquired and liabilities assumed on June 27, 2005. The excess of the purchase price over the fair values of assets acquired and liabilities assumed was allocated to goodwill. The final purchase price allocation will be completed in 2006.

		(In Thousands)
Goodwill		$	43,134
Intangible assets:
	Tradename		3,000
	Customer relationships		4,150
Other assets			11,609
	Assets acquired		61,893
	Liabilities assumed		4,015
Net assets acquired		$	57,878

      The following table summarizes the change in goodwill during 2004 and 2005:

		(In Thousands)
Balance at December 31, 2003		$	2,642
	Translation		115
Balance at December 31, 2004			2,757
	Acquisition		43,134
	Translation		15
Balance at December 31, 2005		$	45,906

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table includes our pro forma results of operations ended December 31, 2005 and 2004. The pro forma financial information summarizes the results of operations for the periods indicated as if the AlphaSmart acquisition had occurred at the beginning of each of the years presented. The pro forma information contains the actual operating results of AlphaSmart with the results prior to the acquisition date adjusted to include the pro forma impact of: the amortization of intangible assets, lower interest income as a result of the sale of available-for-sale securities to fund the acquisition and the elimination of merger related costs. These pro forma amounts are not necessarily indicative of the results that would have been obtained if the acquisition occurred at the beginning of each of the years presented.

		Twelve Months Ended
		December 31,
		2005		2004
		(In Thousands, Except
		per Share Amounts)
Net sales		$	131,576	$	147,151
Income from continuing operations			24,104		26,971
Earnings per share from continuing operations:
	Basic earnings per share		.75		.83
	Diluted earnings per share		.75		.82

(5)  Significant accounting policies

(a) Use of estimates

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

(b) Revenue recognition

      We recognize revenue from our software products in accordance with Statement of Position No. 97-2 “Software Revenue Recognition” issued by the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants. Revenues are recorded net of an allowance for estimated returns. Allowances for bad debts are also recorded at the time of the sale.

      Product revenue is derived primarily from the sale of educational software and hardware products. We recognize revenue from sales of perpetually licensedoff-the-shelf software products and hardware at the time of shipment to customers. Revenue from sales of hardware is generally recognized when the product is shipped. Revenue from subscription-based products is recognized on a straight-line basis over the subscription period. We recognize revenue from the sale of software products which require significant modification or customization on thepercentage-of-completion method of accounting. Accordingly, revenue is deferred for advance payments from customers that are in excess of revenues recognized under thepercentage-of-completion method of accounting. Included in accounts receivable at December 31, 2005 and 2004 is $108,000 and $181,000, respectively, of amounts recognized as revenue under thepercentage-of-completion method which are not yet billed to the customers.

      Service revenue is derived from (i) training seminars, (ii) telephone support agreements, (iii) consulting services and (iv) technical services. Revenue from training seminars is recognized when the seminar or workshop is performed. Revenue from consulting and technical services is recognized as the service is performed or on a straight-line basis over the contractual period. Telephone support included with sales of

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

perpetually licensed software has a duration of twelve months or less and is recognized at the time the software is shipped with the related costs of providing the telephone support accrued for at the same time. Revenue from other support agreements is initially recorded as deferred revenue and recognized as revenue on a straight-line basis over 12 or 24 months depending on the term of the agreement.

      Deferred revenue includes (i) amounts invoiced for products not yet delivered and services not yet performed, (ii) advance invoicing on contracts and (iii) that portion of support agreements and subscription-based product sales that has not yet been recognized as revenue.

(c) Cash and cash equivalents

      Cash amounts on deposit at banks and highly liquid debt instruments purchased with an original maturity date of three months or less are included in cash and cash equivalents. Debt instruments are carried at cost, which approximates market value due to the short-term nature of those instruments. Cash and cash equivalents consisted of the following at December 31:

	2005		2004
	(In Thousands)
Cash and time deposits	$	7,083	$	11,060
Municipal obligations		—		16,400
	$	7,083	$	27,460

(d) Investment securities

      We classify our investment securities as“held-to-maturity” or “trading” in accordance with the provisions of Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (SFAS 115). We do not have any investments classified as “available for sale”.

      Debt securities have an original maturity of more than three months and a remaining maturity of less than twenty-four months. All of our debt securities are classified asheld-to-maturity and are carried at amortized cost. The fair value of our debt securities listed below are based on quoted market prices. Our investments in debt securities consist of commercial paper, corporate bonds and municipal obligations.

      The equity securities we own are held for the purpose of funding our Supplemental Executive Retirement Plan (“SERP”), as further described in Note 11. These equity securities are classified as trading and are therefore carried at their current fair value based on quoted market prices. Our investments in equity securities consist entirely of various mutual fund shares in amounts that conform to the aggregate investment selections of the participants in the SERP.

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Investment securities consisted of the following at December 31:

			2005				2004
			Carrying		Fair		Carrying		Fair
			Value		Value		Value		Value
			(In Thousands)
Debt securities due in less than 1 year:
	Commercial paper		$	—	$	—	$	1,496	$	1,500
	Corporate bonds			3,000		2,976		3,762		3,748
	Municipal bonds			20,363		20,270		19,845		19,790
		Current investment securities		23,363		23,246		25,103		25,038
Debt securities due in 1 to 2 years:
	Corporate bonds			—		—		3,000		2,968
	Municipal bonds			2,529		2,513		16,649		16,593
Equity securities:
	Mutual fund investments			1,603		1,603		1,354		1,354
		Non-current investment securities		4,132		4,116		21,003		20,915
Total investment securities			$	27,495	$	27,362	$	46,106	$	45,953

(e) Inventories

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

(f) Advertising costs

      Advertising costs are expensed as the advertising takes place. Advertising expenses for 2005, 2004 and 2003 were approximately $8.2 million, $7.7 million and $7.2 million, respectively.

(g) Property, plant and equipment

      Property, plant and equipment are recorded at cost and are depreciated over their estimated useful lives using principally the straight-line method for financial reporting purposes. Maintenance and repair costs are charged to expense as incurred, and renewals and improvements that significantly extend the useful life of an asset are added to the plant and equipment accounts. Depreciation expense was $2.1 million, $2.5 million and $2.8 million for 2005, 2004 and 2003, respectively.

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

		2005		2004
		(In Thousands)
Land and improvements		$	1,219	$	3,646
Buildings			9,991		16,042
Furniture, fixtures and office equipment			4,729		5,641
Computer and production equipment			11,274		9,092
Other			1,667		1,700
	Total property, plant and equipment		28,880		36,121
Less — accumulated depreciation and amortization			17,405		17,569
Property, plant and equipment, net		$	11,475	$	18,552

(h) Software development costs

      We capitalize certain software development costs incurred after technological feasibility is achieved. Capitalized costs are reported at the lower of amortized cost or net realizable value. Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the products which is generally estimated to be 24 months. Amortization begins when the products are available for general release to customers. All other research and development expenditures are charged to product development expense in the period incurred. When capitalized software is fully amortized, the balance is removed from the capitalized software and accumulated amortization accounts. Amounts capitalized were approximately $279,000, $563,000 and $448,000 in 2005, 2004 and 2003, respectively. Amortization expense of approximately $495,000, $553,000 and $481,000 for 2005, 2004 and 2003, respectively, is included in cost of sales-products in the consolidated statements of income. At December 31, 2005 and 2004, accumulated amortization of capitalized software development costs was $0.9 million and $1.0 million, respectively.

(i) Sales and concentration of credit risks

      We grant credit to our customers in the ordinary course of business. The majority of our customers are schools or school districts, although we do sell some of our products through resellers. Concentrations of credit risk with respect to trade receivables are limited due to the significant number of customers and their geographic dispersion. In 2005, 2004, and 2003, no customer represented more than 10% of net sales.

(j) Stock options

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

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Had compensation cost been determined for the stock option grants based on the fair value method set forth under SFAS 123, net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

		2005		2004		2003
		(In Thousands,
		Except Per Share Amounts)
Net Income, as reported		$	24,751	$	22,702	$	32,541
Deduct: total stock-based compensation expense determined under fair-value based method for all awards, net of tax			2,485		1,681		3,767
Pro forma net income		$	22,266	$	21,021	$	28,774
Basic earnings per share:
	As reported	$	0.80	$	0.73	$	1.05
	Pro forma		0.72		0.68		0.92
Diluted earnings per share:
	As reported	$	0.80	$	0.73	$	1.04
	Pro forma		0.72		0.67		0.92
The per share weighted average fair value of options granted under the plan during the year is:		$	10.06	$	14.08	$	12.30

      The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

	2005			2004
Dividend yield		1.01	%		0.64	%
Expected volatility		57.08	%		62.48	%
Risk-free interest rate		4.00	%		3.39	%
Expected life (in years)		5			6

      In April 2005, our Board of Directors approved the acceleration of vesting of the unvested stock options under our 1997 Stock Incentive Plan. This resulted in options to purchase approximately 438,000 shares of our common stock becoming immediately exercisable. All of the unvested stock options for which vesting was accelerated were “underwater,” with exercise prices greater than the closing price of our common stock on the date of acceleration. Vesting of the options was accelerated as part of our plan to transition the equity-based portion of our executive compensation plan from stock options to grants of restricted stock, which we believe will be a more effective performance incentive and retention tool. Also, accelerated vesting of the options will produce a more favorable impact on our future results of operations in light of SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”).

      SFAS 123R, which we will be required to adopt effective January 1, 2006, requires that compensation cost attributed to stock options and other forms of share-based payment be recognized in the financial statements. We estimate that early vesting of these options will result in approximately $1.0 million less future compensation expense that would otherwise have been recognized over the remaining life of the options beginning on January 1, 2006.

(k) Restricted Stock

      The compensation cost is recognized over the periods in which the related employee services are rendered, generally over a four year period.

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(l) Earnings per common share

      Earnings per share is computed in accordance with SFAS 128 “Earnings per Share”. Basic earnings per common share (“Basic EPS”) is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Shares issued and shares reacquired during the period are weighted for the portion of the period they were outstanding.

      Diluted earnings per common share (“Diluted EPS”) is computed similarly to Basic EPS except that the weighted average number of shares outstanding is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. Our potentially dilutive common shares consist of unexercised stock options.

      The computation of Diluted EPS does not assume conversion, exercise or contingent issuance of securities that may have an antidilutive effect on earnings per share. Consequently, stock options with an exercise price greater than the average market price for the period are not included in the computation of potentially dilutive common shares. For the years ended December 31, 2005, 2004 and 2003, respectively, there were approximately 895,000, 768,000 and 807,000 antidilutive options excluded from the computation of diluted earnings per share.

      The weighted average shares outstanding are as follows:

	2005		2004		2003
Basic weighted average shares outstanding		30,966,501		31,046,200		31,110,578
Dilutive effect of outstanding stock options		63,151		153,611		194,853
Diluted weighted average shares outstanding		31,029,652		31,199,811		31,305,431

(m) Income taxes

      We account for income taxes according to the provisions of SFAS 109, “Accounting for Income Taxes”. SFAS 109 requires an asset and liability based approach to accounting for income taxes. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between financial and tax accounting of revenue and expense items. Valuation allowances are provided when it is anticipated that a deferred tax asset is not likely to be fully realized. We record a liability for income tax exposures when they are probable and the amount is reasonably estimable.

(n) Comprehensive income (loss)

      Our comprehensive income (loss) includes foreign currency translation adjustments, which are included in accumulated other comprehensive income in the consolidated statements of shareholders’ equity. At December 31, 2005, 2004 and 2003, accumulated other comprehensive income consisted entirely of foreign currency translation adjustments.

(o) Shipping and handling revenues and costs

      We include shipping and handling fees billed to customers in net sales. The related shipping and handling costs are included in cost of sales.

(p) Other receivable

      Other receivable consists entirely of a $5.9 million note receivable secured by a first mortgage on our former office facility in Madison, Wisconsin. The note bears interest at the rate of 6.32% per annum. Payments

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

are due monthly in the amount of $46,480. The final payment on the Note for approximately $5.3 million is due on December 31, 2008.

(q) Reclassifications

      Certain previously reported amounts have been reclassified to conform to the 2005 presentation.

(6)  Goodwill and other intangible assets

      Under SFAS 142 “Goodwill and Other Intangible Assets”, we are required to assess goodwill at least annually for impairment by applying a fair-value-based test. We completed this testing at December 31, 2005 and 2004. We found no instances of impairment of our recorded goodwill.

      For the years ended December 31, 2005, 2004, and 2003, we recognized amortization expense of $556,000, $286,000 and $396,000, respectively, on other intangibles with finite lives. Intangible amortization expense is estimated to be $662,000, $545,000, $451,000, $374,000 and $339,000 for 2006, 2007, 2008, 2009 and 2010, respectively. The tradename has an indeterminate life and is not amortized. The customer relationships intangible has a10-year estimated useful life and is being amortized on an accelerated method.

      Other intangibles consisted of the following:

	December 31, 2005						December 31, 2004
	Gross		Accumulated				Gross		Accumulated
	Amount		Amortization		Net		Amount		Amortization		Net
	(In Thousands)
Non-compete agreement	$	1,100	$	1,100	$	—	$	1,100	$	908	$	192
Tradename		3,000		—		3,000		—		—		—
Customer relationships		4,150		363		3,787		—		—		—
Other intangibles	$	8,250	$	1,463	$	6,787	$	1,100	$	908	$	192

(7)  Income taxes

      The provision for income taxes from continuing operations consisted of:

		2005		2004		2003
		(In Thousands)
Current tax provision:
	U.S. federal	$	9,840	$	12,341	$	16,189
	State and local		1,850		2,497		2,798
	Foreign		84		56		305
Total current tax provision			11,774		14,894		19,292
Deferred tax provision:
	U.S. federal		1,329		113		105
	State and local		108		5		9
Total deferred tax provision			1,437		118		114
Provision for income taxes		$	13,211	$	15,012	$	19,406

39

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		2005					2004					2003
		(In Thousands)
Effective rate reconciliation:
	Income tax provision at statutory tax rate	$	13,083		35.0	%	$	14,201		35.0	%	$	19,037		35.0	%
	State and local taxes, net of federal tax benefit		1,273		3.4	%		1,640		4.0	%		1,852		3.3	%
	Federal tax credits		(327	)	(0.8	)%		(262	)	(0.6	)%		(1,051	)	(1.9	)%
	Resolution of prior period tax matters		(779	)	(2.1	)%		—		0.0	%		—		(0.0	)%
	Other		(39	)	(0.2	)%		(567	)	(1.4	)%		(432	)	(0.8	)%
	Provision for income taxes	$	13,211		35.3	%	$	15,012		37.0	%	$	19,406		35.6	%

      Deferred tax assets consisted of the following at December 31:

		2005			2004
		(In Thousands)
Current deferred tax assets:
	Deferred revenue	$	854		$	1,228
	Expenses not currently deductible		2,839			2,572
Net current deferred tax assets			3,693			3,800
Noncurrent deferred tax assets/(liabilities):
	Deferred revenue		100			77
	Expenses not currently deductible		1,676			—
	Depreciation and amortization		255			173
	Intangibles		(1,293	)		1,370
Net noncurrent deferred tax assets			738			1,620
Total deferred tax assets		$	4,431		$	5,420

(8)  Lines of credit

      We have a $15.0 million unsecured revolving line of credit with a bank, which is available until May 31, 2007. The line of credit bears interest at either a floating rate based on the prime rate less 1.0%, or a fixed rate for a period of up to 90 days based on LIBOR plus 1.25%. The rate is at our option and is determined at the time of borrowing. We also have a $2.0 million unsecured revolving line of credit with a bank available until April 30, 2007. The line of credit bears interest based on the prime rate less 1.0%. As of December 31, 2005 and 2004, the lines of credit had not been used.

(9)  Lease commitments

      We are party to various operating leases, primarily for facilities we occupy to carry out our business operations. Approximate rent expense for 2005, 2004 and 2003, respectively, was $0.9 million, $1.1 million and $1.1 million.

40

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Future approximate minimum rental payments (including estimated operating costs) required under operating leases as of December 31, 2005 are as follows:

	(In Thousands)
2006	$	883
2007		790
2008		631
2009		378
2010		262
After 2010		12
	$	2,956

(10)  Litigation

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

(11)  Retirement plans

      In order to provide retirement benefits for our employees, we have established a defined contribution 401(k) Savings Plan covering all employees in the United States who meet certain service requirements and a Supplemental Executive Retirement Plan (“SERP”) available to senior management.

      Employees participating in the 401(k) plan may elect to contribute up to 50% of their annual pretax compensation subject to certain IRS limitations. SERP participants may elect to defer up to 20% of their annual pretax compensation to the SERP.

      Vesting and employer matching contributions are the same under both plans. Beginning in 2003, vesting of employer contributions takes place ratably over an employee’s first four years of service with full vesting of past and future employer contributions once four years of service is reached. Prior to 2003, employees were fully vested in employer contributions immediately.

      Employer matching contributions are currently $0.75 for each $1.00 contributed by a participant and are limited to a maximum of 4.5% of a participant’s pretax compensation. For those employees participating in the SERP, the maximum employer contribution is determined on a combined basis with the 401(k) plan. Discretionary employer contributions may also be made to the plans. There were no discretionary contributions made in 2005, 2004 or 2003 to the plans.

      All amounts credited to a SERP participant’s account are hypothetically invested in certain publicly traded investment funds, as directed by each participant. Prior to 2004, we had not funded this liability. In late 2004, we funded our liability for benefits payable to SERP participants with investments that mirror their investment selections. Prior to the funding of the liability, changes in the market value of the investment funds chosen by SERP participants caused our liability for this benefit to increase or decrease and a corresponding loss or gain to be recognized in our statement of income and results of operations. The liability for the SERP is classified as deferred compensation and the related investments are classified under investment securities on our consolidated balance sheets. Our liability for the SERP was $1,603,000 at December 31, 2005 and $1,354,000 at December 31, 2004.

41

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following summarizes our expense under these retirement plans:

		2005		2004		2003
		(In Thousands)
Employer matching contribution — 401(k) Plan		$	1,027	$	1,124	$	1,133
Employer matching contribution — SERP			16		24		24
Loss related to unfunded SERP liability			—		16		118
	Total	$	1,043	$	1,164	$	1,275

(12) Stock incentive plan

      We have established the 1997 Stock Incentive Plan (the “Plan”) for our officers, key employees, non-employee directors and consultants. A combined maximum of 6,000,000 options, stock appreciation rights (“SAR”) and share awards may be granted under the plan. No ISOs or SARs have been granted under the plan. At December 31, 2005, there were approximately 2.5 million shares available for issuance under our 1997 Stock Incentive Plan.

      (a) Stock option awards — Options granted under the plan may be in the form of nonqualified stock options (“NSO”) or incentive stock options which comply with Section 422 of the Internal Revenue Code (“ISO”). The exercise price of the options is the market value of our common stock at the date of grant. Options become exercisable ratably over their respective vesting period which ranges from immediate vesting up to a four year vesting period. The options expire 10 years from the grant date.

      A summary of stock option activity under the plan is as follows:

	2005					2004					2003
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price
Outstanding at beginning of year		1,625,038		$	22.85		1,989,383		$	21.82		1,818,257		$	22.16
Granted		223,044			20.58		122,067			24.73		386,720			18.33
Exercised		(135,880	)		15.49		(285,522	)		15.17		(121,394	)		13.44
Cancelled		(192,382	)		28.82		(200,890	)		24.68		(94,200	)		24.78
Outstanding at end of year		1,519,820			22.42		1,625,038			22.85		1,989,383			21.82
Options exercisable at end of year		1,515,381		$	22.44		1,074,182		$	23.12		1,079,932		$	21.43

      The following table summarizes information about stock options outstanding at December 31, 2005:

	Outstanding Options						Exercisable Options
			Weighted Average						Weighted Average
Range of	Options		Remaining		Weighted Average		Options		Exercise Price of
Exercise price	Outstanding		Contractual Life		Exercise Price		Exercisable		Exercisable Options
$ 8.00 to $16.00		159,813		2.74	$	10.29		159,813	$	10.29
$16.01 to $22.00		617,334		6.40		17.68		612,895		17.69
$22.01 to $28.00		312,725		8.64		24.37		312,725		24.37
$28.01 to $34.00		282,305		5.40		30.66		282,305		30.66
$34.01 to $40.00		147,109		4.91		35.45		147,109		35.45
$40.01 to $52.00		534		5.55		51.49		534		51.49
$ 8.00 to $51.58		1,519,820		6.14	$	22.42		1,515,381	$	22.44

42

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      (b) Restricted stock awards — Restricted shares generally vest ratably over a four-year period, commencing one year after the grant date. Unearned restricted stock compensation is recorded based on the market price on the grant date and is expensed equally over the vesting period. No restricted shares were awarded in 2004 or 2003. In 2005, 23,409 restricted shares were granted at a weighted average market price at the grant date of $22.70. Compensation expense related to restricted shares was approximately $53,000 for the year ended December 31, 2005.

(13)  Employee stock purchase plan

      Effective July 1, 1998, we adopted an Employee Stock Purchase Plan (“ESPP”) which allows employees to purchase shares of common stock through payroll deductions, up to 10% of eligible compensation. The purchase price is equal to 85% of the fair market value of the common stock on either the first or last day of the subscription period, whichever is lower. A total of 500,000 shares are available for purchase under the plan, of which 239,394 shares were issued for years from 1999 to 2003. We did not offer the ESPP to our employees in 2003, 2004 or 2005 and do not intend to offer the ESPP in 2006.

(14)  Shareholders’ equity

      On April 17, 2002, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. On February 9, 2005, our Board of Directors authorized the repurchase of an additional 3,000,000 shares of common stock. No time limit was placed on the duration of the repurchase program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. During the period of January 1, 2005 through December 31, 2005, we repurchased 1.8 million shares at a cost of $32.4 million. Since authorization, we have repurchased 6.2 million common shares of common stock at a cost of $110.9 million under this repurchase program.

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

(15)  Segment reporting

      Beginning in 2004, our results are presented as one operating segment. We had previously reported two operating segments: (i) software and (ii) training. We are no longer organized by these segments and we now manage our operations as one business. These changes were made to better support our customers’ needs through offerings of bundled solutions which consist of software, portable computing solutions, professional development, implementation assistance, technical consulting, and ongoing maintenance and support plans. Accordingly, we do not produce discrete financial information or make resource allocation decisions for separately reportable segments as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”. Foreign market operations are not significant at this time.

43

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(16)  Quarterly results of operations (unaudited)

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

				Quarter Ended
				March 31			June 30			September 30			December 31
				(In Thousands, Except Per Share Amounts)
2005
	Net sales			$	27,557		$	28,346		$	31,389		$	28,991
	Gross profit				23,608			24,210			23,992			22,887
	Operating income				8,876			11,150			7,399			6,459
	Income — continuing operations before income taxes				9,332			11,652			7,803			8,591
	Income taxes — continuing operations				3,453			4,311			2,887			2,560
	Income — continuing operations				5,879			7,341			4,916			6,031
	Income — discontinued operations				584			—			—			—
	Net income				6,463			7,341			4,916			6,031
	Earnings (loss) per share:
		Basic and diluted:
			Continuing operations		0.19			0.24			0.16			0.20
			Discontinued operations		0.02			—			—			—
			Net income		0.21			0.24			0.16			0.20
	Common stock price per share:
			High		18.39			20.30			24.16			20.29
			Low		15.25			15.67			16.09			13.69
2004
	Net sales			$	30,955		$	30,499		$	25,011		$	25,259
	Gross profit				25,717			26,787			21,483			22,038
	Operating income				10,360			13,204			6,804			8,565
	Income — continuing operations before income taxes				10,749			13,499			7,335			8,990
	Income taxes — continuing operations				4,005			5,020			2,739			3,248
	Income — continuing operations				6,744			8,479			4,596			5,742
	Loss — discontinued operations				(802	)		(794	)		(728	)		(535	)
	Net income				5,942			7,685			3,868			5,207
	Earnings (loss) per share:
		Basic and diluted:
			Continuing operations		0.22			0.27			0.14			0.18
			Discontinued operations		(0.03	)		(0.02	)		(0.02	)		(0.01	)
			Net income		0.19			0.25			0.12			0.17
	Common stock price per share:
			High		31.00			26.54			24.50			20.41
			Low		23.97			20.91			20.35			18.46

44

RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Earnings per share amounts for each quarter are required to be calculated independently and therefore may not total to the amount calculated for the year.

      Generation 21 was divested during the first quarter of 2005 and, therefore, its results for all periods presented in the consolidated financial statements are reflected as discontinued operations.

(17)  Recent accounting pronouncements

      In December 2004, the FASB issued SFAS 123R (revised 2004), “Share-Based Payment”. This statement revises SFAS 123, “Accounting for Stock-Based Compensation”, and requires companies to expense the value of employee stock option grants, restricted stock and similar awards. The statement is effective for the company on January 1, 2006.

      Historically, we have elected to follow the intrinsic value method of accounting for our employee stock options. Accordingly, because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, we have not recognized any compensation expense related to grants of stock options to our employees.

      Upon the adoption of SFAS 123R, we will expense stock option grants in our Consolidated Statement of Income based on the grant-date fair value of the instruments issued using an option pricing model and will be recognized over the requisite service period. For the years ended December 31, 2005, 2004 and 2003, total stock-based employee compensation expense, net of related tax effects determined under this new standard, would have been $2.5, $1.7 and $3.8 million, respectively (See Note 5(j)). The adoption of SFAS 123R will not have a material effect on our financial results as we do not have a substantial number of unvested options outstanding at December 31, 2005. Stock option expense in 2006 will be dependent on a number of factors, including the fair value of awards at the time of grant.

(18)  Discontinued operations

      In February 2005, we consummated the sale of our Generation21 subsidiary, a non-core part of our business, for $75,000. The results of Generation21 for all periods presented in our consolidated financial statements are reflected as discontinued operations.

      Results of discontinued operations consist of the following:

			2005			2004			2003
			(In Thousands)
Operating (loss)			$	(192	)	$	(4,538	)	$	(3,877	)
Income tax benefit				76			1,679			1,433
		Loss from operations, net		(116	)		(2,859	)		(2,444	)
(Loss) on disposal				(642	)		—			—
	Tax benefit on disposal			1,342			—			—
Gain on disposal, net				700			—			—
Gain (loss) from discontinued operations, net			$	584		$	(2,859	)	$	(2,444	)

(19)  Subsequent events

      On February 15, 2006 our Board of Directors declared a quarterly cash dividend of $.05 per share.

45

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

      Not applicable.

Item 9A.  Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

      Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, management, including our chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were effective as of December 31, 2005.

      There has been no change in our internal control over financial reporting that has occurred during the quarter ended December 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

      Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined under Rule 13a-15(f) promulgated under the Exchange Act. Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation using the framework inInternal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2005 and during the year then ended.

      Our management’s assessment of the effectiveness of our internal control over financial reporting has been audited by Deloitte & Touche LLP, our independent registered public accounting firm, as stated in their report which is included herein.

46

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Renaissance Learning, Inc. and Subsidiaries

      We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting that Renaissance Learning, Inc. and Subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

      A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2005 of the Company and our report dated February 22, 2006 expressed an unqualified opinion on those financial statements.

DELOITTE & TOUCHE LLP

Milwaukee, Wisconsin

February 22, 2006

47

Item 9B.  Other Information

     Not applicable.

48

PART III

Item 10.  Directors and Executive Officers of the Registrant

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

      (b) Directors. The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Proposal One: Election of Directors,” which information is incorporated by reference herein.

      (c) Section 16 Compliance. The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Section 16(a) Beneficial Ownership Reporting Compliance,” which information is incorporated by reference herein.

      (d) Code of Ethics. We have adopted a code of ethics pursuant to Item 406 of Regulation S-K. A copy of our code of ethics is incorporated by reference herein (see Exhibit 14.1 of Exhibit Index).

      (e) Audit Committee. The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Proposal One: Election of Directors — Audit Committee,” which information is incorporated by reference herein.

Item 11.  Executive Compensation

      The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the captions “Executive Compensation,” “Severance Agreements,” “Non-Employee Director Compensation,” “Compensation Committee Report,” “Compensation Committee Interlocks and Insider Participation,” and “Performance Graph,” which information is incorporated by reference herein.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

      The information required by Item 403 of Regulation S-K is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Security Ownership of Management and Certain Beneficial Owners,” which information is incorporated by reference herein.

49

      The information required by Item 201(d) of Regulation S-K is set forth below.

EQUITY COMPENSATION PLAN INFORMATION

      The following table sets forth certain information about shares of our common stock outstanding and available for issuance under our existing equity compensation plans, which consist of our 1997 stock incentive plan and our 1998 employee stock purchase plan (this latter plan is currently inactive). The table details securities authorized for issuance under our equity compensation plans as of December 31, 2005. The table below does not include awards, exercises or cancellations under our equity compensation plans subsequent to December 31, 2005.

					Number of Securities
					Available for Future
	Number of Securities				Issuance Under
	to be Issued Upon		Weighted-Average		Equity Compensation
	Exercise of		Exercise Price of		Plans (Excluding
	Outstanding Options,		Outstanding Options,		Securities Reflected
Plan Category	Warrants and Rights		Warrants and Rights		in First Column)
Equity compensation plans approved by security holders		1,515,381	$	22.44		2,749,630	(1)
Equity compensation plans not approved by security holders(2)		N/A		N/A		N/A
Total		1,515,381	$	22.44		2,749,630

(1)

Of the 6,000,000 shares currently authorized for issuance under our 1997 stock incentive plan, 2,510,236 remain available for future issuance. Under our 1998 employee stock purchase plan (ESPP), eligible employees may purchase shares annually by payroll deductions, subject to certain aggregate limitations, at a purchase price equal to the lower of either 85% of the fair market value of the company’s shares on the offering commencement date or 85% of the fair market value of the company’s shares one year from such date. Of the 500,000 shares authorized under the ESPP, 239,394 remain available for future issuance. We did not offer the ESPP to employees in 2005 and do not intend to offer the plan to employees in 2006.

(2)

Both of the company’s equity compensation plans have been approved by shareholders.

Item 13.  Certain Relationships and Related Transactions

      The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Certain Relationships and Transactions,” which information is incorporated by reference herein.

Item 14.  Principal Accountant Fees and Services

      The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on April 19, 2006 under the caption “Audit Committee Report,” which information is incorporated by reference herein.

50

PART IV

Item 15.  Exhibits and Financial Statement Schedules

(a)(1) Financial Statements.

Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2005 and 2004

Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2005, 2004 and 2003

Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003

Notes to Consolidated Financial Statements

(a)(2) Financial Statement Schedules.

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

(a)(3)Exhibits.

      See (b) below.

(b) Exhibits.

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

(c) Financial Statements Excluded from Annual Report to Shareholders.

      Not applicable.

51

SIGNATURES

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

RENAISSANCE LEARNING, INC.
By:	/s/Terrance D. Paul ---------------------------------------------- Terrance D. Paul President, Chief Executive Officer and a director
Date: February 22, 2006

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

Name		Title	Date
/s/Terrance D. Paul Terrance D. Paul		President, Chief Executive Officer (Principal Executive Officer) and a director	February 22, 2006
/s/Mary T. Minch Mary T. Minch		Vice President-Finance, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)	February 22, 2006
Directors: Judith A. Paul, Addison L. Piper, John H. Grunewald, Gordon H. Gunnlaugsson, Harold E. Jordan and Judith A. Ryan
By:	/s/Mary T. Minch Mary T. Minch Attorney-In-Fact*		February 22, 2006

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

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Exhibit Index

Exhibit
Number			Exhibit
	2	.1	LLC Interest purchase Agreement dated as of February 28, 2005 among Renaissance Learning, Inc., Generation 21 Learning Systems, LLC and John Stearns (pursuant to Item 601(b)(2) of Regulation S-K, the schedules and exhibits to the LLC Interest Purchase Agreement have been omitted; a copy of such schedules and exhibits will be supplementally provided to the Securities and Exchange Commission upon request).(17)
	2	.2	Agreement and Plan of Merger and Reorganization by and among Renaissance Learning, Inc., RLI Acquisition Corp., Inc., RLI Acquisition Sub, LLC and AlphaSmart, Inc. dated as of January 24, 2005, as amended on April 20, 2005 (pursuant to Item 601(b)(2) of Regulation S-K, the annex, exhibits and schedules to the Agreement and Plan of Merger and Reorganization have been omitted; a copy of such annex, exhibits and schedules will be supplementally provided to the Securities and Exchange Commission upon request).(18)
	2	.3	Purchase Agreement dated as of November 1, 2005 among Renaissance Learning, Inc. and DezCon, LLC (pursuant to Item 601(b)(2) of regulation S-K, the exhibits to the Purchase Agreement have been omitted; a copy of such exhibits will be supplementally provided to the Securities and Exchange Commission upon request).(19)
	3	.1	Amended and Restated Articles of Incorporation of Registrant, as amended.(10)
	3	.2	Amended and Restated By-laws of Registrant, as amended.(7)
	4	.1	Form of Stock Certificate.(2)
	10	.1	1997 Stock Incentive Plan (as amended and restated).(3)*
	10	.2	Credit Agreement dated as of December 1, 2003, by and between Wells Fargo Bank, National Association and Registrant.(16)
	10	.3	First Amendment to Credit Agreement dated as of September 1, 2004 by and between Wells Fargo Bank, National Association and Registrant.(15)
	10	.4	Second Amendment to Credit Agreement dated as of May 31, 2005 by and between Wells Fargo Bank, National Association and Registrant.
	10	.5	Third Amendment to Credit Agreement dated as of October 1, 2005 by and between Wells Fargo Bank, National Association and Registrant.
	10	.6	Amended and Restated Employee Stock Purchase Plan.(9)*
	10	.7	Expense Allocation Agreement dated October 19, 1999 between Registrant, Judith A. Paul and Terrance D. Paul.(6)*
	10	.8	Severance Agreement between Registrant and Michael H. Baum dated June 27, 2003.(13)*
	10	.9	Severance Agreement between Registrant and John R. Hickey dated February 15, 2006.(22)*
	10	.10	Incentive Bonus Plan.(13)*
	10	.11	Transfer Agreement dated as of June 16, 2004 between Registrant and Terrance D. Paul.(14)*
	10	.12	Assignment and Assumption of Transfer Agreement dated as of June 16, 2004 between Registrant and Terrance D. Paul.(14)*
	10	.13	Non-Employee Director Compensation Summary.*
	10	.14	Executive Officer Compensation Summary.(20)*
	10	.15	Offer to Purchase effective as of November 1, 2005 among Renaissance Learning, Inc. and Planning Design Build, Inc.(19)
	10	.16	Form of Restricted Stock Agreement.(20)*
	10	.17	Form of Nonstatutory Stock Option Agreement between Renaissance Learning, Inc. and John R. Hickey.(22)*
	10	.18	Form of Nonstatutory Stock Option Agreement between Renaissance Learning, Inc. and certain employees and consultants.(21)*
	10	.19	Form of Nonstatutory Stock Option Agreement between Renaissance Learning, Inc. and certain non-employee directors.(21)*

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Exhibit
Number			Exhibit
	14	.1	Code of Business Conduct and Ethics.(16)
	21	.1	Subsidiaries of Registrant.
	23	.1	Consent of Independent Registered Public Accounting Firm.
	24	.1	Directors’ Powers of Attorney.
	31	.1	Section 302 Certification by Terrance D. Paul, Chief Executive Officer.
	31	.2	Section 302 Certification by Mary T. Minch, Chief Financial Officer.
	32	.1	Section 906 Certification by Terrance D. Paul, Chief Executive Officer.
	32	.2	Section 906 Certification by Mary T. Minch, Chief Financial Officer.
	99	.1	Schedule II — Valuation and Qualifying Accounts.

(1)	[Reserved].
(2)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended September 30, 1997 (SEC File No. 0-22187).
(3)	Incorporated by reference to Registrant’s Form S-8 filed on April 18, 2003 (Registration No. 333-104622).
(4)	Incorporated by reference to Registrant’s Form 10-K for the fiscal year ended December 31, 1997 (SEC File No. 0-22187).
(5)	Incorporated by reference to Registrant’s Form 10-K for the fiscal year ended December 31, 1998 (SEC File No. 0-22187).
(6)	Incorporated by reference to Registrant’s Form 10-K for the fiscal year ended December 31, 1999 (SEC File No. 0-22187).
(7)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2000 (SEC File No. 0-22187).
(8)	[Reserved].
(9)	Incorporated by reference to Registrant’s Form 10-K for the fiscal year ended December 31, 2000 (SEC File No. 0-22187).

(10)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2001 (SEC File No. 0-22187).
(11)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2002 (SEC File No. 0-22187).
(12)	Incorporated by reference to Registrant’s Form 8-K dated May 22, 2002 (SEC File No. 0-22187).
(13)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended June 30, 2003 (SEC File No. 0-22187).
(14)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended June 30, 2004 (SEC File No. 0-22187).
(15)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended September 30, 2004 (SEC File No. 0-22187).
(16)	Incorporated by reference to Registrant’s Form 10-K for the fiscal year ended December 31, 2003 (SEC File No. 0-22187).
(17)	Incorporated by reference to Registrant’s Form 8-K filed on March 4, 2005 (SEC File No. 0-22187).
(18)	Incorporated by reference to Registrant’s Form 8-K filed on April 26, 2005 (SEC File No. 0-22187).
(19)	Incorporated by reference to Registrant’s Form 8-K filed on November 4, 2005 (SEC File No. 0-22187).
(20)	Incorporated by reference to Registrant’s Form 10-Q for the quarter ended June 30, 2005 (SEC File No. 0-22187).

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(21)	Incorporated by reference to Registrant’s Form 8-K filed on March 7, 2005 (SEC File No. 0-22187).
(22)	Incorporated by reference to Registrant’s Form 8-K filed on February 21, 2006 (SEC File No. 0-22187).

* Management contracts or compensatory plans or arrangements.

THE REGISTRANT WILL FURNISH A COPY OF ANY OF THE FOREGOING EXHIBITS UPON THE REQUEST OF A SHAREHOLDER AFTER THE PAYMENT OF A FEE BY SUCH SHAREHOLDER WHICH SHALL REPRESENT REGISTRANT’S REASONABLE EXPENSES INCURRED IN FURNISHING ANY SUCH EXHIBIT. REQUESTS SHOULD BE SENT TO RENAISSANCE LEARNING, INC., 2911 PEACH STREET, P.O. BOX 8036, WISCONSIN RAPIDS, WISCONSIN 54495-8036, ATTENTION: CORPORATE SECRETARY.

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