Click2Learn (CLKS) 10-Q 2002 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-24289

CLICK2LEARN, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization) 91-1276003
(I.R.S. Employer Identification No.)

110-110th Avenue NE, Bellevue, Washington 98004
(Address of principal executive offices) (Zip Code)
 
(425) 462-0501
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x     No  o

The number of shares outstanding of the issuer’s Common Stock, par value $0.01, as of March 31, 2002 was 24,259,692 shares.

TABLE OF CONTENTS

		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II—OTHER INFORMATION
	Item 1. Legal Proceedings.
	Item 2. Changes In Securities and Use of Proceeds.
	Item 3. Defaults Upon Senior Securities.
	Item 4. Submission of Matters to a Vote of Securities Holders.
	Item 5. Other Information.
	Item 6. Exhibits and Reports on Form 8-K.
SIGNATURES
EXHIBIT INDEX
EXHIBIT 10.01
EXHIBIT 10.02
EXHIBIT 10.03
EXHIBIT 10.04

CLICK2LEARN, INC.

FORM 10-Q

For the Quarter Ended March 31, 2002

TABLE OF CONTENTS

PART I —FINANCIAL INFORMATION		Page
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001	4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	22
Item 2.	Change in Securities and Use of Proceeds	22
Item 3.	Defaults upon Senior Securities	22
Item 4.	Submission of Matters to a Vote of Securities Holders	22
Item 5.	Other Information	22
Item 6.	Exhibits and Reports on Form 8-K	22
SIGNATURES		23

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CLICK2LEARN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

			March 31,			December 31,
			2002			2001
Assets
Current assets:
	Cash and cash equivalents		$	6,546		$	9,553
	Accounts receivable, net of allowance for returns and doubtful accounts of $1,143 in 2002 and $1,430 in 2001			15,134			19,449
	Inventories			69			62
	Prepaid royalties and licenses			242			180
	Receivables from related companies			26			9
	Other			1,326			1,001
		Total current assets		23,343			30,254
Property and equipment, net				1,761			2,250
Goodwill and other intangible assets, net				8,378			6,061
Other				700			789
		Total assets	$	34,182		$	39,354
Liabilities and Stockholders’ Equity
Current liabilities:
	Accounts payable		$	3,235		$	2,617
	Accrued compensation and benefits			2,965			2,788
	Deferred revenue			2,136			2,453
	Customer prepayments			104			166
	Other			1,202			1,353
		Total current liabilities		9,642			9,377
Other noncurrent liabilities				292			417
		Total liabilities		9,934			9,794
Stockholders’ equity:
	Preferred stock			—			—
	Common stock			243			242
	Additional paid-in capital			242,146			241,769
	Accumulated deficit			(217,579	)		(211,894	)
	Deferred stock compensation			—			(5	)
	Accumulated other comprehensive loss			(562	)		(552	)
		Total stockholders’ equity		24,248			29,560
		Total liabilities and stockholders’ equity	$	34,182		$	39,354

See accompanying notes to Condensed Consolidated Financial Statements

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CLICK2LEARN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)

			Three Months Ended
			March 31,
			2002			2001
Revenue:
	Platforms		$	5,419		$	3,006
	Tools			1,258			2,021
	Content services			854			5,628
		Total revenue		7,531			10,655
Cost of revenue:
	Platforms			1,574			655
	Tools			395			486
	Content services			2,215			5,130
		Total cost of revenue		4,184			6,271
Gross margin				3,347			4,384
Operating expenses:
	Research and development			2,282			2,340
	Sales and marketing			4,432			4,656
	General and administrative			2,048			1,637
	Amortization of goodwill			—			239
	Employee severance and excess facility costs			1,138			—
		Total operating expenses		9,900			8,872
Loss from operations				(6,553	)		(4,488	)
Gain on sale of assets				927			—
Other income, net				16			172
Equity in losses of affiliate				(75	)		(100	)
Net loss			$	(5,685	)	$	(4,416	)
Net loss per share, basic and diluted			$	(0.23	)	$	(0.24	)
Weighted average common shares outstanding, basic and diluted				24,199			18,044

See accompanying notes to Condensed Consolidated Financial Statements

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CLICK2LEARN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

					Three Months Ended
					March 31,
					2002			2001
Cash flows from operating activities:
	Net loss				$	(5,685	)	$	(4,416	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization				662			705
		Write-off property and equipment				270			—
		Stock compensation expense				5			16
		Gain on sale of assets				(927	)		—
		Loss on affiliate				75			100
		Changes in assets and liabilities:
			Accounts receivable			4,315			(1,426	)
			Inventories			(7	)		32
			Prepaid royalties and licenses			(62	)		30
			Receivables from related companies			(17	)		—
			Other current assets			(343	)		(477	)
			Accounts payable			619			(68	)
			Accrued liabilities			176			(79	)
			Deferred revenue			(317	)		385
			Other current liabilities			(200	)		(184	)
				Net cash used in operating activities		(1,436	)		(5,382	)
Cash flows from investing activities:
		Purchase of property and equipment				(2,813	)		(176	)
		Proceeds from sale of assets				1,000			—
		Investment in Click2learn Japan KK				—			(639	)
		Sale (purchase) of other assets				13			(4	)
				Net cash used in investing activities		(1,800	)		(819	)
Cash flows from financing activities:
		Repayment of notes and loans payable				(138	)		(4	)
		Proceeds from exercise of stock options				43			45
		Proceeds from sale of common stock				335			572
				Net cash provided by financing activities		240			613
		Effect of foreign exchange rate changes				(11	)		(142	)
				Net decrease in cash and cash equivalents		(3,007	)		(5,730	)
Cash and cash equivalents at beginning of period						9,553			15,321
Cash and cash equivalents at end of period					$	6,546		$	9,591

See accompanying notes to Condensed Consolidated Financial Statements

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CLICK2LEARN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001

Note 1. Summary Of Significant Account Policies

(a) Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Click2learn, Inc. (“Click2learn”) include the accounts of Click2learn and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

     These statements reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Interim results of operations for the three months ended March 31, 2002 are not necessarily indicative of the operating results for the full fiscal year. Factors that may affect such operating results, include, but are not limited to, those discussed in“Factors That May Affect Future Results of Operations”.Certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

     These condensed consolidated financial statements and notes should be read in conjunction with Click2learn’s audited consolidated financial statements included in Click2learn’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

(b) Net Loss Per Share

     Basic net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing the net loss by the weighted average number of common and dilutive shares outstanding during the period. As Click2learn had a net loss in each of the periods presented, basic and diluted net loss per share are the same.

     Excluded from the computation of diluted earnings per share for the three months ended March 31, 2002 are options to acquire approximately 5,570,735 shares of common stock with a weighted average exercise price of $6.23 and warrants to purchase 3,633,686 shares of common stock with a weighted average exercise price of $5.75 because their effects would be anti-dilutive. Options to acquire approximately 5,637,373 shares of common stock with a weighted average exercise price of $8.60 and warrants to purchase 1,797,829 shares of common stock with a weighted exercise share price of $8.45 have been excluded from the computation of diluted earnings per share for the three months ended March 31, 2001 because their effects would be anti-dilutive.

(c) Revenue Recognition

     Click2learn recognizes revenue in accordance with Statement of Position 97-2 (“SOP 97-2”),Software Revenue Recognition,issued by the American Institute of Certified Public Accountants, which, as amended, stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based upon the relative fair values of the elements, such as software products, upgrades, enhancements, post contract customer support, installation or training, using evidence which is specific to the vendor. If such evidence of fair value for each element does not exist, all revenue from the arrangement is deferred until such time that fair value does exist or until all elements are delivered. Revenue from software licenses is recognized upon shipment provided vendor specific evidence exists for remaining obligations, if any, and collection of the resulting receivable is probable. An allowance for product returns is provided at the time of the sale. Revenue from subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract.

     Click2learn recognizes revenue from non-refundable minimum royalties from distributors or resellers in the amount of the non-refundable royalties when product has been delivered to the distributor or reseller, provided no

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significant obligations remain outstanding and collection of the resulting receivable is probable. Additional royalties are earned to the extent the minimums are exceeded and these additional royalties are recognized as revenue when received, based on the distributor’s or reseller’s contractual reporting obligations.

     Professional services revenue is recognized from fixed price contracts as services are provided or by using the percentage-of-completion method of accounting, based on the ratio of costs incurred to the total estimated project cost, for individual fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses become evident. Revenue from time and materials contracts is recognized as services are performed.

     Revenue from the e-Learning Network, Platforms offering no longer offered to new customers, includes site fees, hosting, royalties and content sales. The revenues are determined by individual contracts, one to three years in length, which specify functionality of the site and the commerce conducted on the site. The e-Learning Network fees are recognized ratably over the life of the contract. Royalty revenue is recognized as earned. Content revenue is either recognized evenly over the life of the contract for course usage on bundled curriculum courses or recognized at the time of the purchase of individual e-Learning courses. Revenues from tangible goods, including books, videotapes and CD-ROMs are recognized at the time of shipment.

(d) Comprehensive Loss

     The following table sets forth the components of comprehensive loss for the periods presented below:

	Three Months
	Ended March 31,
	2002			2001
Net loss	$	(5,685	)	$	(4,416	)
Foreign currency translation adjustment		(10	)		6
Total comprehensive loss	$	(5,695	)	$	(4,410	)

(e) Derivative Financial Instruments

     Click2learn had no derivative financial instruments outstanding at March 31, 2002.

(f) Adoption of Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board issued Statement No. 141, “Business Combinations” (“Statement 141”), and Statement No. 142, “Goodwill and Other Intangible Assets” (“Statement 142”). Statement 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and specifies criteria for recognizing intangible assets acquired in a business combination. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Intangible assets with definite useful lives will continue to be amortized over their respective estimated useful lives.

     Click2learn adopted the provisions of Statement 141 as of June 30, 2001. No business combinations have been initiated since July 1, 2001. Goodwill resulting from business combinations completed prior to June 30, 2001 was amortized through December 31, 2001. Based upon Click2learn's analysis, there was no impairment upon adoption of Statement 142 on January 1, 2002. Click2learn's identifiable intangible assets as of January 1, 2002 consisted of acquired technology. Click2learn has reviewed the useful lives of identifiable intangible assets as of January 1, 2002 and determined that the original useful lives of 3 to 5 years was appropriate. Click2learn plans to conduct its annual goodwill impairment testing during the fourth quarter of each year.

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     Net loss and loss per share for the quarters ended March 31, 2002 and 2001 adjusted to exclude goodwill amortization expense are as follows (in thousands, except per share data):

			Three Months
			Ended March 31,
			2002			2001
Net loss:
	Reported net loss		$	(5,685	)	$	(4,416	)
	Goodwill amortization			—			239
		Adjusted net loss	$	(5,685	)	$	(4,177	)
Basic and diluted net loss per share:
	Reported loss per share		$	(0.23	)	$	(0.24	)
	Goodwill amortization			—			.01
		Adjusted basic and diluted net loss per share	$	(0.23	)	$	(0.23	)

     Goodwill and other intangibles are as follows:

	March 31, 2002						December 31, 2001
	Gross Carrying		Accumulated				Gross Carrying		Accumulated
	Amount		Amortization		Net Carrying Amount		Amount		Amortization		Net Carrying Amount
Goodwill	$	3,310	$	550	$	2,760	$	3,310	$	550	$	2,760
Acquired Technology		8,980		3,362		5,618		6,300		2,999		3,301
	$	12,290	$	3,912	$	8,378	$	9,610	$	3,549	$	6,061

     During the quarter ended March 31, 2002, acquired technology increased $2.7 million.

     In October 2001, the FASB issued Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“Statement 144”), which is effective for fiscal years beginning after December 15, 2001. Statement 144 supersedes certain provisions of APB Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, and supersedes Statement 121. Click2learn adopted Statement 144 as of January 1, 2002 and it did not have a material effect on its consolidated financial position or results of operations.

Note 2. Segment Information

     Click2learn’s internal reporting includes three reportable segments: Platforms, Tools, and Content Services. Platforms includes software licenses, subscription and hosting fees, implementation, and training and support for the Aspen Enterprise Learning Platform as well as the Ingenium learning management system which is now part of the Aspen platform and the e-Learning Network, which is no longer offered to new customers. Tools include software licenses and technical support and training for ToolBook II product line. Content Services includes custom development of e-Learning courses, consulting, licensing and hosting fees for ReDS, a content development system that is no longer offered, and royalties from sales of third party content.

     Click2learn’s operating committee, which includes its Chief Executive Officer and Chief Financial Officer, has been identified as the Chief Operating Decision Maker (CODM) as it assesses the performance of the business units and decides how to allocate resources to the business units. Segment income is the measure of profit and loss that the CODM uses to assess performance and make decisions. Segment income represents revenues less cost of revenues incurred within the operating segments as presented in Click2learn’s consolidated statements of operations. Click2learn does not allocate operating expenses including research and development, sales and marketing, general and administrative, or amortization of goodwill to its operating segments. In addition, other income (expense) is also not allocated to operating segments.

     There are no intersegment revenues. Click2learn’s CODM does not review total assets or depreciation and amortization by operating segment. The accounting policies for reported segments are the same as Click2learn as a whole.

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     Revenues by geographic region which are based on the location of the customers are as follows (in thousands):

		Three Months Ended
		March 31,
		2002		2001
Revenue:
	Domestic	$	6,739	$	9,605
	International — primarily Europe		792		1,050
		$	7,531	$	10,655

     Long-lived assets by geographic location are as follows (in thousands):

		March 31,		December 31,
		2002		2001
Long-lived assets Domestic		$	9,980	$	8,081
	International — primarily Europe		159		230
		$	10,139	$	8,311

Note 3. Sale of Certain Assets and Employee Severance and Loss on Excess Facilities

     During January 2002, Click2learn sold certain assets of its custom content development business, including equipment and a customer list, to NIIT (USA), Inc. (“NIIT”) under an Asset Purchase Agreement for $1 million, resulting in a gain of $927,000 based on the book value of the assets. As a result of the transaction, NIIT will be Click2learn’s primary strategic partner for custom content development services. If certain targets for the referral of custom content development business to NIIT are attained, NIIT will pay Click2learn up to an additional $1 million in each of 2002 and 2003. In addition, Click2learn receives a commission on certain custom content development or software implementation business referred to NIIT.

     As a result of the transaction with NIIT, Click2learn significantly reduced the headcount of its custom content development business and closed certain facilities. During the quarter ended March 31, 2002, Click2learn had employee severance and excess facilities costs of $1.1 million, which included $196,000 of severance benefits, $270,000 to write-down leasehold improvements to net realizable value and $672,000, representing the excess of our future lease commitments over estimated income from subleasing activities. As of March 31, 2002, all employee severance benefits had been paid and $524,000 was included in accrued expenses for the loss on excess office facilities. Although, Click2learn believes that its estimates of future sublease income and the time required to locate tenants are reasonable, losses may increase if actual experience differs from Click2learn’s estimates.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion of the financial condition and results of operations of Click2learn should be read in conjunction with Click2learn’s Condensed Consolidated Financial Statements and related Notes thereto included elsewhere in this Report. This Report and the documents incorporated herein by reference include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Report are forward-looking. Such forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. Such forward-looking statements include, among others, those statements including the words “expect”, “anticipate”, “intend”, “believe” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to those discussed in “Factors That May Affect Future Results of Operations.” You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

     We are a leading developer and provider of enterprise learning software products and services for companies, government agencies and educational institutions. We design, develop, market, license and support an integrated suite of enterprise learning software products and related services that allow our customers to cost-effectively create, personalize and manage the delivery of educational content. In the third quarter of 2001, we introduced our new Aspen platform that unifies collaborative content development, personalized content delivery and comprehensive learning management in an integrated system designed to be open, flexible and scalable. We provide our enterprise learning products and services to customers across a broad range of industries including financial services, accounting, healthcare, insurance, technology, manufacturing, telecommunications, transportation, utilities, government and education.

     As part of our ongoing focus on the Aspen platform, in February 2002, we purchased synchronous learning technology to enable real-time collaboration among remote users of our Aspen platform, which will be incorporated as an option in the future releases of the product. We also decided to focus our services offerings on those directly related to the Aspen platform and our ToolBook II product line. As a result, in January 2002 we sold certain assets of our custom content development business to NIIT (USA), Inc. (“NIIT”), the U.S. operation of NIIT Limited, a global custom software development firm. In addition, we significantly reduced the headcount of our custom content development business and closed certain facilities.

     We group revenues around the primary components of our solutions:

• Platforms revenues include software licenses, subscription and hosting fees, implementation, customization, training and support related to the Aspen platform, our Ingenium learning management system, the precursor product to the Aspen Learning Management Server, and our e-Learning Network, which is no longer offered to new customers.

• Tools revenues primarily include software licenses, technical support and training related to our ToolBook II line of products.

• Content Services revenues are derived from the creation of custom learning content, consulting, fees for licensing, implementing and hosting our Rapid e-Learning Development System (“ReDS”), which is no longer offered, and sales of third party off-the-shelf content. ReDS is a collaborative development system that was licensed in connection with certain custom content development engagements and is no longer offered.

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Critical Accounting Policies and Estimates

     Our critical accounting policies and estimates are as follows:

• Revenue recognition

• Estimating allowances for sales returns and the allowance for doubtful accounts

• Valuation of goodwill

     Revenue Recognition.We recognize revenue pursuant to the requirements of Statement of Position No. 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by Statement of Position No. 98-9, “Software Revenue Recognition with Respect to Certain Arrangements.” Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does not require significant customization of the software.

     For all sales, we use either a binding purchase order or signed agreement, depending on the nature of the transaction, as evidence of an arrangement. Sales through our significant resellers are evidenced by a master agreement governing the relationship.

     For software license fees in single element arrangements and multiple element arrangements which do not include customization or consulting services, delivery typically is deemed to occur when the product is shipped to customers.

     At the time of each transaction, we assess whether the fee associated with our revenue is fixed and determinable and whether or not collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, based upon a variable matrix such as a minimum level of distribution or subject to refund, we account for the fee as not being fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable.

     We assess the probability of collection based on a number of factors, including past transaction history with the customer and the current financial condition of the customer. We do not request collateral from our customers. If we determine at the time of the transaction that collection of a fee is not reasonably assured, we defer revenue until the time collection becomes reasonably assured.

     For multiple element arrangements, when Company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements in the arrangement, we recognize revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, we defer revenue for the fair value of its undelivered elements such as consulting services and product support and upgrades, and recognize the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses, when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support and upgrades of standard products for which no installation or customization is required based upon the amounts we charge when support and upgrades are sold separately. For multiple element arrangements involving installation or customization, Company-specific objective evidence is established for support and maintenance arrangements if our customers have an optional annual renewal rate specified in the arrangement and the rate is substantive. Company-specific objective evidence is established for consulting and installation services based on the hourly rates we charge for our employees when they are performing these services provided we have the ability to accurately estimate the hours required to complete a project based upon our experience with similar projects.

     Professional services revenue is recognized from fixed price contracts as services are provided or by using the percentage-of-completion method of accounting, based on the ratio of costs incurred to the total estimated project cost, for individual fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made in

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the period in which such losses become evident. Professional services revenue from time and materials contracts and training services is recognized as revenue as services are performed.

     We recognize revenue from non-refundable minimum royalty agreements from distributors or resellers upon delivery of product to the distributor or reseller, provided no significant obligations remain outstanding and the conditions of SOP 97-2 have been met. Additional royalties are recognized as revenue to the extent the minimums are exceeded when earned, based on the distributor’s or reseller’s contractual reporting obligations.

     Revenue from subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract.

     Allowances for Sales Returns and Doubtful Accounts.The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we must make estimates of potential future product returns related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant judgments and estimates must be made and used in connection with establishing reserves for sales returns and the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our revenue for any period if we made different judgments or utilized different estimates. Similarly, we must make estimates of the uncollectability of our accounts receivables. We specifically analyze the age of accounts receivable and analyze historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.

     Valuation of Goodwill.We assess the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicate the fair value of a reporting unit to which goodwill relates is less than its carrying value. Factors we consider important which could trigger an impairment review include poor economic performance relative to expected historical or projected future operating results, significant negative industry, economic or company specific trends and changes in the manner of our use of the assets or the plans for our business. If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill based upon the annual test or the existence of one or more of the above indicators of impairment, than we would measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating the fair value of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of reporting unit goodwill. To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference.

Results of Operations

     Revenue.Total revenues were $7.5 million for the quarter ended March 31, 2002, a decrease of 29% from $10.7 million for the quarter ended March 31, 2001. The decline in total revenue reflects the impact of the sale of our certain content development assets to NIIT in January 2002.

     Platforms revenue was $5.4 million for the quarter ended March 31, 2002, an increase of 80% from $3.0 million for the quarter ended March 31, 2001. The increase was due to the continued demand for the Aspen platform from new and existing customers. Platform revenue as a percentage of total revenue was 72% for the quarter ended March 31, 2002 as compared with 28% for the quarter ended March 31, 2001.

     Tools revenue was $1.3 million for the quarter ended March 31, 2002, a decrease of 38% from $2.0 for the quarter ended March 31, 2001. The decline is due to our decision to focus more of our research and development and sales and marketing efforts on the Aspen platform. Tools revenue as a percentage of total revenue was 17% for the quarter ended March 31, 2001 as compared with 19% for the quarter ended March 31, 2001.

     Content services revenue was $854,000 for the quarter ended March 31, 2002, a decrease of 85% from $5.6 million for the quarter ended March 31, 2001. The decrease was a result of the sale of the certain assets of our custom content development business to NIIT. We will continue to offer custom content development services directly to the

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Washington National Guard, which was not part of the sale to NIIT in January 2002. As a result, content services revenue will be significantly reduced compared to prior years.

     Cost of Revenue.The total cost of revenue was $4.2 million for the quarter ended March 31, 2002, a decrease of 33% from $6.3 million for the quarter ended March 31, 2001. Platform and Tools revenues have a lower cost as a percent of revenue than does Content Services therefore the decrease was a result of the change in mix of our revenues and reduced costs associated with our commercial content development business as certain of those assets were transitioned to NIIT, and our headcount was reduced significantly.

     Cost of platform revenue includes labor costs associated with software implementations, costs of packaging and duplication. Cost of platform revenue was $1.6 million for the quarter ended March 31, 2002, an increase of 140% from $655,000 for the quarter ended March 31, 2001 and increased as a percentage of platform revenue to 29% for the quarter ended March 31, 2002 from 22% the year ago period. The increase in costs is a result of the increase in platform revenues and an increase in the portion of costs associated with software implementations labor.

     Cost of tools revenue includes labor costs associated with training Toolbook customers, costs of packaging, duplication, and royalties. Cost of tools revenue was $395,000 for the quarter ended March 31, 2002, a decrease of 19% from $486,000 for the quarter ended March 31, 2001 and as a percentage of tools revenue increased to 31% for the quarter ended March 31, 2002 compared to 24% the period a year ago. The decrease in costs is primarily due to a decrease in revenue. The increase in cost as a percent of tools revenue was a result of a greater portion of tools revenue in the quarter ended March 31, 2002 coming from higher cost services than the period a year ago.

     Cost of content services revenue includes personnel costs for professional services provided. Cost of content services revenue was $2.2 million for the quarter ended March 31, 2002, a decrease of 57% from $5.1 million for the quarter ended March 31, 2001 and as a percentage of content services revenue increased to 259% for the quarter ended March 31, 2002 from 91% for the quarter ended March 31, 2001. The increase as a percent of content services revenue for the quarter ended March 31, 2002 as compared to the prior year was due primarily to the excess capacity from transitioning certain assets of our content development business to NIIT. As a result, future costs will be significantly reduced compared to prior years.

Operating Expenses

     Research and Development. Research and development expenses consist primarily of salaries and related personnel costs, depreciation of development equipment, supplies, and overhead allocations. Research and development costs remain unchanged at $2.3 million for the quarters ended March 31, 2002 and 2001. Research and development costs as a percent of revenue increased to 30% for the quarter ended March 31, 2002 from 22% for the quarter ended March 31, 2001 due to lower revenues.

     Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related personnel costs, sales commissions, advertising, trade shows, and overhead allocations. Sales and marketing expenses were $4.4 million for the quarter ended March 31, 2002, a decrease of 5% from $4.7 million for the quarter ended March 31, 2001. Sales and marketing costs as a percent of revenue increased to 59% for the quarter ended March 31, 2002 as compared to 44% for the quarter ended March 31, 2001 due to lower revenues.

     General and Administrative.General and administrative expenses consist primarily of salaries and related personnel costs for administrative, executive and finance personnel as well as outside advisors. General and administrative expenses were $2.0 million for the quarter ended March 31, 2002, an increase of 25% from $1.6 million for the quarter ended March 31, 2001. The higher costs were attributable to transition costs incurred during the quarter as a result of the assets sold to NIIT. General and administrative expenses as percent of revenue increased to 27% for the quarter ended March 31, 2002 as compared to 15% for the quarter ended March 31, 2001 due to the higher costs and lower revenue.

     Amortization of Goodwill.Goodwill amortization for the quarter ended March 31, 2002 were $0 as compared to $239,000 for the quarter ended March 31, 2001. As of January 1, 2002, we adopted SFAS 142 which requires that goodwill is no longer amortized, but subject to an annual impairment test.

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     Other Income. Interest income, net, on cash and cash equivalents for the quarter ended March 31, 2002 was $16,000 as compared to $172,000 for the quarter ended March 31, 2001. The decrease was due to lower interest rates and lower investment balances. Click2learn Japan K.K. is a joint venture which we account for our interest using the equity method of accounting. We recorded a loss of $75,000 and $100,000 for the quarters ended March 31, 2002 and 2001, respectively, representing our equity share of losses.

Sale of Certain Assets and Employee Severance and Loss on Excess Facilities

     During January 2002, we sold certain assets of our content development business, including equipment and a customer list to NIIT under an Asset Purchase Agreement for $1 million, resulting in a gain of $927,000 based on the book value of those assets during the quarter ended March 31, 2002. As a result of the transaction, NIIT will be our primary strategic partner for custom content development services and we will refer or subcontract custom content development work to NIIT. If certain targets are attained, NIIT will pay us up to $1 million additional in each of 2002 and 2003. In addition, we will receive a commission on certain business referred to NIIT.

     As a result of the transaction with NIIT, we significantly reduced the headcount of our custom content development business and closed certain facilities. During the quarter ended March 31, 2002, we had employee severance and excess facilities costs of $1.1 million, which included $196,000 of severance benefits, $270,000 to write-down leasehold improvements to net realizable value and $672,000, representing the excess of our future lease commitments over estimated income from subleasing activities. As of March 31, 2002, all employee severance benefits had been paid and $524,000 was included in accrued expenses for the loss on excess office facilities. Although we believe that our estimates of future sublease income and the time required to locate tenants are reasonable, losses may increase if actual experience differs from our estimates.

Adoption of Accounting Standards

     In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (“Statement 141”), and No. 142, “Goodwill and Other Intangible Assets” (“Statement 142”). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies certain criteria that intangible assets acquired in a purchase method business combination must meet in order to be recognized and reported apart from goodwill. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also required that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. The provisions of Statement 141 were adopted effective June 30, 2001. No business combinations were completed during the period July 1, 2001 to March 31, 2002. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 have been amortized through December 31, 2001.

     As of January 1, 2002, we have identified intangible assets, consisting of acquired technology and goodwill, net of accumulated amortization. Upon adoption of Statement 142, we ceased amortizing goodwill. During the quarter ended March 31, 2002, we completed our transitional goodwill impairment test. Based upon our analysis, there was no impairment of goodwill upon adoption of Statement 142 on January 1, 2002. We plan to conduct our annual impairment testing during the fourth quarter of each year. In addition, we reviewed the useful lives of our identifiable intangible assets and determined that the original estimated lives of 3 to 5 years remains appropriate.

     In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, “Accounting of the Impairment or Disposal of Long-Lived Assets” (“Statement 144”), which is effective for fiscal years beginning after December 15, 2001. Statement 144 supersedes certain provisions of APB Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions” and supersedes SFAS 121. We adopted Statement 144 as of January 1, 2002. Adoption of Statement 144 did not effect our consolidated financial position or results of operations.

Liquidity and Capital Resources

     At March 31, 2002, our principal source of liquidity was $13.7 million of working capital, a decrease of $7.2 million from December 31, 2001. At March 31, 2002, we had cash and cash equivalents totaling $6.5 million, a decrease of $3.0 million from December 31, 2001. The primary uses of cash were $1.4 million for operating activities and $1.8 for investing activities offset by $240,000 from financing activities. Uses of cash for investing activities consisted primarily of the purchase of synchronous technology for $2.7 million offset by $1.0 million for assets sold to NIIT. In addition to our cash and cash equivalents, the other primary component of working capital was our accounts receivable. At March 31, 2002, we had $15.1 million in receivables, down from $19.4 million at December 31, 2001, due to decreased revenues and improved collection efforts.

     In order to increase the liquidity of our receivables, we have established a $4 million working capital line of credit and a two-year $1 million term loan facility for purchases of capital assets with Silicon Valley Bank. Both lines bear interest at the Silicon Valley Bank prime rate plus 1.50% and are collateralized by our assets. Covenants in the loan agreements include restrictions on our ability to pay dividends or make other distributions, make acquisitions or investments, merge or consolidate with others or dispose of assets. If not renewed the working capital line terminates and any advances made are due on November 5, 2002. The term loan is payable in 24 monthly payments of $41,666.67 plus interest ending October 1, 2003. At March 31, 2002, we had a balance of $792,000 on the two-year term loan facility and $0 on the working capital line. Our loan agreement requires us to maintain certain financial ratios and meet other financial covenants. The failure to meet those covenants could prevent us from accessing the working capital line and result in the acceleration of any balances under either the working capital line or the term loan. We were in compliance with these covenants at March 31, 2002 or have obtained appropriate waivers from the bank at no cost to us.

     Although we anticipate that our business will become cash flow positive during 2002, it currently does not generate the cash needed to finance our operations and may not begin to do so in 2002. Our long-term liquidity will be affected by numerous factors, including acquisitions of businesses or technologies, demand for our Aspen platform, the extent to which our enterprise learning solutions achieve market acceptance, the timing and extent to which we invest in new technology, the expenses of sales and marketing and new product development, the extent to which competitors are successful in developing their own products and services and increasing their own market share, the level and timing of revenues, the collection of these receivables, the availability of our lines of credit and other factors.

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To the extent that resources are insufficient to fund our activities, we may need to raise additional funds. Such additional funding, if needed, may not be available on attractive terms or at all. If adequate funds are not available on acceptable terms, we may be unable to expand our business, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business.

     Our contractual commitments at March 31, 2002 are substantially similar to those at December 31, 2001 disclosed in our annual report on Form 10-K.

Factors That May Affect Future Results of Operations

Our quarterly operating results are uncertain and may fluctuate significantly, which could negatively affect the value of your investment.

     Our operating results have varied significantly from quarter to quarter and are likely to continue to fluctuate as a result of a variety of factors, many of which we cannot control. Factors that may adversely affect our quarterly operating results include:

• the size and timing of product orders and the timing and execution of professional services engagements;

• the mix of revenue from products and services;

• the mix of products sold;

• the ability to meet client project milestones;

• the market acceptance of our products and services;

• our ability to develop and market new or enhanced products and services in a timely manner and the market acceptance of these products and services;

• the timing of revenues and expenses;

• recognition of impairment of existing assets; and

• the timing of revenue recognition.

     Our future revenues are difficult to predict and we may not be able to adjust spending in response to revenue shortfalls. Our limited operating history with our current enterprise learning solutions, possible acquisitions and the emerging nature of the enterprise learning market make prediction of future revenue and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and largely are fixed in the short term. We will likely be unable to, or may not elect to, reduce spending quickly enough to offset any unexpected revenue shortfall. If we are unable to predict future revenue accurately, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall.

We have a limited operating history in our current markets, which makes it difficult to predict our future performance.

     Our limited operating history in our current markets makes it difficult to predict our future performance and may not provide investors with a meaningful basis for evaluating an investment in our common stock. From our inception until early 1995, we were engaged in various research and development activities and in developing and marketing multimedia-authoring products, database and Internet tools, web publishing products and other ancillary products, most of which we do not currently sell. In 1995, we began to focus our development and marketing efforts on products and services for the enterprise learning market. We released the Aspen platform in September 2001. Accordingly, we have a limited operating history on which to evaluate our current business and future prospects.

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Our business currently does not generate the cash needed to finance our operations, and for that and other reasons we may need additional financing in the future, which we may be unable to obtain.

     Our business currently does not generate the cash needed to finance our operations and may not begin to do so in 2002. As a result, we may need additional funds to finance our operations in the future as well as to enhance our products and services, fund our expansion, respond to competitive pressures or acquire complementary businesses or technologies. In addition, poor financial results, additional expenses or unanticipated opportunities that require capital commitments could give rise to additional financing requirements sooner than we expect. We may be unable to obtain financing on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to finance our operations, enhance our services, fund our expansion, respond to competitive pressures or take advantage of business opportunities and we may need to significantly restrict our operations.

We have a history of losses and may have continued losses in the future.

     We incurred a net loss of approximately $5.7 million in the three months ended March 31, 2002. As of March 31, 2002, our accumulated deficit was $217.6 million. Although we anticipate that we will achieve profitability on a quarterly basis by the end of 2002, we have not yet achieved profitability and may not do so during 2002. Even if we do achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis.

We face risks encountered in emerging markets and may be unsuccessful in addressing these risks.

     We face risks frequently encountered in new and rapidly evolving markets. Specific risks we face relate to the demand for and market acceptance of our enterprise learning solutions. We may fail to adequately address these risks, and therefore our business may suffer. To address these risks, we must:

• effectively market our enterprise learning software to new and existing customers;

• continue to enhance the technology upon which our enterprise learning software is based;

• successfully implement our enterprise learning software for our customers and generate continuing revenues from those customers; and

• address and establish new technologies and technology standards.

The enterprise learning software market is in the early stages of development and may not grow to a sufficient size or at a sufficient rate to sustain our business.

     The enterprise learning software market is in the early stages of development, and may not grow to a sufficient size or at a sufficient rate for our business to succeed. Corporate training and education historically have been conducted primarily through classroom instruction and traditionally have been performed by internal personnel. Although technology-based training applications have been available for several years, they currently account for only a small portion of the overall training market. Accordingly, our success will depend on the extent to which companies migrate from traditional training methods to web-based solutions in connection with their training activities. In addition, our success will depend upon the extent to which companies utilize the products or services of third-party providers.

     Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or compete with their existing investments. Even if companies implement technology-based training or web-based learning solutions, they may still choose to design, develop, deliver or manage all or a part of their education and training internally. If the use of web-based learning solutions

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does not become widespread, or if companies do not use the products and services of third parties to develop, deliver or manage their learning, then our enterprise learning software may not be commercially successful.

A deterioration of general economic conditions may materially and adversely affect our business.

     Our revenues are subject to fluctuation as a result of general economic conditions. A significant portion of our revenue is derived from the sale of products and services to large companies or government agencies, which historically have reduced their expenditures for education and training during economic downturns. In recent months, our sales force has experienced increased delays, cancellations or reductions in scope of sales opportunities as a result of the downturn in the economy. Additional incidents of terrorism could cause the economy to weaken further. Should the economy weaken further in any future period, these organizations may further delay, cancel, or reduce their expenditures on education and training, which could adversely affect our business.

We face intense competition from other enterprise learning software providers and may be unable to compete successfully.

     The enterprise learning software market is highly fragmented and competitive, with no single firm accounting for a dominant market share. Our competitors vary in size, scope and the breadth of products and services offered. We face competition from:

• other developers of learning management systems, such as Saba and Docent, as well as publishers of e-Learning courses that sell management systems with their titles such as SmartForce;

• large professional consulting firms and in-house training departments;

• many small, regional e-Learning and technology-based training services businesses; and

• developers of web authoring tools.

     Certain of our existing and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other resources and therefore may be able to respond more quickly to new or changing opportunities, technologies, standards and customer requirements or to compete more aggressively on pricing. Price competition would likely result in reduced gross margins and may prevent the Aspen platform from yielding results sufficient for our business to succeed.

     Strategic relationships are important in expanding the distribution reach of companies in the enterprise learning market. If our competitors were to establish strategic relationships to bundle their products with the products and services of their strategic partners, the demand for our products and services might be substantially reduced and our ability to market and sell products and services successfully may be substantially diminished. In addition, the existence or announcement of strategic relationships involving our competitors could adversely affect our ability to attract and retain customers.

     Because of the lack of significant barriers to entry in the enterprise learning market, new competitors are likely to enter this market in the future. In particular, vendors of other enterprise software applications such as enterprise resource planning, human resource management or customer relationship management have indicated an intent to add learning delivery and management functionality to extend their current product lines within their existing customer base. If such vendors were to announce plans to add such functionality, our ability to sell to our products and service to their customers could be substantially diminished and our business could be adversely affected. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share. We may not be able to contend effectively with such increased competition.

Our Aspen platform is a new product and may contain defects or otherwise perform improperly.

     Our Aspen platform was initially released in September 2001, and we anticipate continuing to add new features, functionality and components. Complex enterprise software products frequently contain errors or failures,

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especially when first introduced or when new versions are released. In the past, we have discovered errors in our products after their initial release. Because the Aspen platform products are complex software packages with new features and functionality being added and new versions being released on a regular basis, there is a greater likelihood that they may contain such errors. In addition, since the Aspen platform is targeted at enterprise customers with large numbers of users, customers and potential customers may have a greater sensitivity to product defects or product integration than the market for software products generally. To date we have experienced minor errors in the Aspen platform that are typical of a newly released software product. Although these errors have not had a material impact on our business, serious product defects could result in loss of revenue or delay in market acceptance, diversion of development resources, damage to our reputation, or increased service and warranty costs.

If we are unable to build the Click2learn and Aspen brands, we may be unable to grow our business.

     We believe that establishing and maintaining the Click2learn and Aspen brands will be critical to the success of our enterprise learning strategy and that the importance of brand recognition will increase due to the growing number of enterprise learning software products. We intend to increase our marketing and branding expenditures in our effort to increase our brand awareness. If our brand building strategy is unsuccessful, these expenses may never be recovered, and our business could be materially harmed.

Acquisitions or investments may drain capital and equity resources, divert management’s attention or otherwise harm our business.

     In the future we may acquire or make investments in other businesses, products or technologies. Such acquisitions or investments may require that we pay significant cash, issue stock or incur substantial debt. In addition, such acquisitions or investments may require significant managerial attention, which may be diverted from our other operations. These capital, equity and managerial commitments may impair the operation of our business. Furthermore, acquired businesses may not be effectively integrated, may be unable to maintain key pre-acquisition business relationships, may contribute to increased fixed costs and may expose us to unanticipated liabilities.

International expansion may impose substantial burdens on our resources, divert management’s attention or otherwise harm our business.

     Our current and planned expansion into international markets will require extensive management attention and resources. In addition, we will need to rely extensively on third parties in foreign countries to help conduct our international operations and conduct sales and marketing efforts. Our success in international markets consequently will depend to a large degree on the success of these third parties, over which we have little control. If they are unwilling or unable to dedicate sufficient resources to our relationships, our international operations will suffer. Furthermore, our efforts abroad are subject to a number of additional risks inherent in international operations, including:

• difficulties and costs of staffing and managing foreign offices;

• different learning styles and cultures;

• numerous and potentially conflicting regulatory requirements;

• export controls, import tariffs and other barriers to trade;

• reduced protection of intellectual property rights;

• regional political and economic instability; and

• fluctuations in currency exchange rates.

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The loss of the services of our senior executives and key personnel would likely cause our business to suffer.

     Our success depends to a significant degree on the performance of the senior management team and other key employees. The loss of any of these individuals could harm our business. We do not have employment agreements with several of our executives or with any other key employees, and we do not maintain key person life insurance for any officers or key employees.

     Our success also depends on our ability to attract, integrate, motivate and retain additional highly skilled technical, sales and marketing and professional services personnel. Competition for qualified personnel in the enterprise software industry is intense. To the extent we are unable to attract and retain a sufficient number of additional skilled personnel our business will suffer.

We may not be able to adapt to rapidly changing technology and evolving industry standards.

     The enterprise learning software market is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our products and services obsolete. Our success depends on our ability to adapt to a rapidly changing landscape and to offer new products and services to address our customers’ changing demands. We may experience difficulties that delay or prevent the successful design, development, introduction or marketing of our products and services. To the extent we in fact experience such delays, we may experience difficulty in attracting new customers and may lose existing ones.

Our intellectual property may become subject to legal challenges, unauthorized use or infringement, any of which could diminish the value of our products and services.

     Our success depends in large part on our proprietary technology. We rely on a combination of copyrights, trademarks, trade secret laws, restrictions on disclosure and other methods to protect our proprietary technology. While we have patent applications pending, we do not have issued patents for any of the technology underlying our Aspen platform. If we fail to successfully enforce our intellectual property rights, the value of these rights, and consequently the value of our products and services to our customers, could diminish substantially. It may be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization, and it may be possible for third parties to independently develop substantially equivalent intellectual property.

     Litigation may be necessary in the future to enforce our intellectual property rights, to protect trade secrets or to determine the validity and scope of the proprietary rights of others. From time to time we have received, and may in the future receive, notice of claims of infringement of other parties’ proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. They could also delay product shipment or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not be available on reasonable terms, or at all.

Our products include third-party technology, the loss of which could materially harm our business.

     We use some licensed third-party technology components in our products. Future licenses to this technology may not be available to us on commercially reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or could force us to discontinue offering portions of our enterprise learning solutions until equivalent technology, if available, is identified, licensed and integrated. Furthermore, we may become subject to legal claims related to licensed technology based on product liability, infringement of intellectual property or other legal theories.

We face the risk of liability for failures to meet unique customer requirements, and the risk of cost overruns on fixed-price projects.

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     The failure or inability to meet a customer’s unique expectations or requirements in the performance of services could impair our reputation or result in a claim for damages, regardless of our responsibility for the failure. Although generally we attempt to limit contractually our liability for damages arising from product defects and other mistakes in rendering professional services, these contractual protections are not always obtained and may not be enforced or otherwise may not protect us from liability. Our insurance may not be sufficient to cover any of these claims.

     In addition, many of our professional services projects are performed on a fixed-price basis rather than on a time and materials basis. If we do not accurately predict the costs of these projects, we could incur unexpected costs. If we do not complete fixed-price engagements within budget, on time and to clients’ satisfaction, we bear the risk of cost overruns.

Security and privacy breaches could subject us to litigation and liability.

     We host many of our customers’ enterprise learning software implementations at our data center and provide access to that software using the Internet. The Internet is a public network and data is sent over this network from many sources. Although we take reasonable steps in accordance with current industry practices to ensure the security of our hosting systems and customer data, computer viruses could be introduced into our systems or those of our customers, which could disrupt the operation of our hosting systems or make them inaccessible to users. In addition, well-publicized Internet security breaches could deter customers from using the Internet to conduct transactions that involve the transmission of confidential information. We depend on Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations. Each of these has experienced significant outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our systems.

     We could become subject to litigation and liability if third parties penetrate security for our hosting systems or otherwise misappropriate our users’ confidential information or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new discoveries in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or cause interruptions in our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service interruptions.

Our debt covenants may significantly restrict our operations.

     We are subject to numerous covenants in our agreement with Silicon Valley Bank that impose financial and operating restrictions on our business. These restrictions may affect our ability to operate our business, may limit our ability to take advantage of potential business opportunities as they arise, and may adversely affect the conduct of our current business. These covenants place restrictions on our ability to, among other things:

• incur more debt;

• pay dividends, redeem or repurchase our stock or make other distributions;

• make acquisitions or investments;

• use assets as security in other transactions;

• enter into transactions with affiliates;

• merge or consolidate with others;

• dispose of assets or use asset sale proceeds;

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• create liens on our assets; and

• extend credit.

     In addition, the terms of our indebtedness require that we meet certain financial ratios and tests. The covenants governing our existing indebtedness restrict our operations and those of our subsidiaries, and these limitations could impair our ability to meet such financial ratios and tests. In addition, our ability to meet these ratios and tests and to comply with other provisions governing our indebtedness may be affected by changes in economic or business conditions or other events beyond our control. Moreover, our failure to comply with our debt-related obligations could result in an event of default that, if not cured or waived, could result in an acceleration of our indebtedness.

     As a result of taking a charge with respect to the impairment of goodwill related to our custom development business in the fourth quarter of 2001 and the expenses related to the transition of this business to NIIT in the first quarter of 2002, we are in violation of a covenant limiting the amount of our quarterly losses. As a result of our use of cash to fund operations and acquire synchronous learning technology in the first quarter of 2002, we are in violation of a covenant requiring us to maintain a certain level of tangible net worth. The bank has waived these violations of the covenants without cost to us, and has indicated that it is willing to amend the covenants requiring a certain level of tangible net worth so that we are no longer in violation. However, we cannot assure you that the bank will amend the tangible net worth covenant, that we will not violate these or other covenants in the future or that the bank will waive any such future violations at no cost to us, or at all.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Market Rate Risk.We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

     Interest Rate Risk.We hold our assets primarily in cash and cash equivalents, such as short-term marketable debt securities, money market funds and other cash equivalents. We minimize risk by investing in financial instruments with maturity of three months or less. As a result, if market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2001, the fair value of cash and cash equivalents would not change by a material amount.

     Foreign Currency Exchange Risk.We have foreign currency risk as a result of foreign subsidiary activities. For the three months ended March 31, 2002, international revenues from foreign subsidiaries accounted for approximately 11% of total revenues. All foreign subsidiaries use the local currency as their functional currency.

     Our exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which costs incurred in the United States are charged to the foreign subsidiaries. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated in U.S. dollars in consolidation. As exchanges rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations for the three months ended March 31, 2002 was not material. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

     Not Applicable.

Item 2. Changes In Securities and Use of Proceeds.

     Not Applicable.

Item 3. Defaults Upon Senior Securities.

     Not Applicable.

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

     Not Applicable.

Item 5. Other Information.

     Not Applicable

Item 6. Exhibits and Reports on Form 8-K.

(a)	Exhibits
	10.01	Employment Agreement dated March 21, 2002, between Click2learn and Kevin Oakes.
	10.02	Asset Purchase Agreement dated January 15, 2002, between Click2learn and NIIT (USA), Inc.
	10.03	Custom Software Development Agreement.
	10.04	Click2learn’s 1998 Equity Incentive Plan, as amended to date.1
(b)	Reports on Form 8-K
	A report on Form 8-K dated April 4, 2001 was filed announcing Click2learn’s preliminary results for fiscal first quarter 2002 and the departure of Dennis Worsley as Executive Vice President, Worldwide Sales and Marketing. No financial statements were filed with such report.

¹ Compensation Plan or Arrangement

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SIGNATURES

     Pursuant to the requirements 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.

	CLICK2LEARN, INC.
May 15, 2002	/s/John D. Atherly
Date	John D. Atherly Vice President, Finance and Administration and Chief Financial Officer (Duly Authorized Officer and Chief Accounting Officer)

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EXHIBIT INDEX

10.01	Employment Agreement dated March 21, 2002, between Click2learn and Kevin Oakes.
10.02	Asset Purchase Agreement dated January 15, 2002, between Click2learn and NIIT (USA), Inc.
10.03	Custom Software Development Agreement
10.04	Click2learn’s 1998 Equity Incentive Plan