Archipelago Learning 10Q 2010 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010


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

For the transition period from to .

Commission File Number: 001-34555

Archipelago Learning, Inc.

(Exact Name of Registrant as Specified in its Charter)


Delaware (State or Other Jurisdiction of Incorporation or Organization)		27-0767387 (I.R.S. Employer Identification No.)

3232 McKinney Avenue, Suite 400, Dallas, Texas (Address of Principal Executive Offices)		75204 (Zip Code)

(800) 419-3191
(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. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filero	Accelerated filero	Non-accelerated filerþ	Smaller reporting companyo
	(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Act). Yeso Noþ

As of November 5, 2010, the number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 26,349,790.

Special Note Regarding Forward-Looking Statements

Certain disclosures and analyses in this Form 10-Q, including information incorporated herein by reference, may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are considered forward-looking statements and reflect current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements generally can be identified by use of phrases or terminology such as “anticipate,” “estimate,” “expect,” “project,” “forecast,” “plan,” “intend,” “believe,” “may,” “should,” “can have,” “likely,” “future” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.

These forward-looking statements are based on assumptions that we have made in light of our industry experience and on our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. These statements are not guarantees of performance or results. They are subject to risks and uncertainties which may be beyond our control, including those discussed below, in the “Risk Factors” section in Item 1A of our Form 10-K, and elsewhere in this Form 10-Q and the documents incorporated by reference herein. Although we believe that these forward-looking statements are based on reasonable assumptions, many factors could cause actual results to vary materially from those anticipated in such forward-looking statements, including:

	•		Most of our customers are public schools, which rely on state, local and federal funding. If any state, local or federal funding is materially reduced, our public school customers may no longer be able to afford to purchase our products and services;

	•		If national educational standards and assessments are adopted, or if existing metrics for applying state standards are revised, new competitors could more easily enter our markets or the demands in the markets we currently serve may change;

	•		If Congress does not reauthorize the Elementary and Secondary Education Act, commonly referred to as ESEA, or other legislation does not continue to mandate state educational standards and annual assessments, demand for our products and services could be materially adversely affected;

	•		Our recent rapid growth, the recent introduction of a number of our products and services and our entry into new markets make it difficult for us to evaluate our current and future business prospects, and we may be unable to effectively manage our growth and new initiatives;

	•		The recent ongoing adoption of online learning in established education markets makes it difficult for us to evaluate our current and future business prospects. If web-based education fails to achieve widespread acceptance by students, parents, teachers, schools and other institutions, our growth and profitability may materially suffer;

	•		Our revenue is primarily generated by sales of subscriptions to our Study Island and EducationCity products over the term of the subscription. Our customer renewal rates are difficult to predict and declines in our sales of Study Island or EducationCity products or our customer renewal rates may materially adversely affect our business and results of operations; and

	•		Our Study Island and EducationCity products are predominantly purchased by individual schools, and any decisions at the district or state level to use the products and services of one of our competitors, or to limit or reduce the use of web-based educational products, could materially adversely affect our ability to attract and retain customers.

Any forward-looking statement contained herein speaks only as of the date on which we make it. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

“Archipelago Learning,” “Study Island,” “Northstar Learning,” “EducationCity,” “Reading Eggs” and their respective logos are our trademarks. Solely for convenience, we refer to our trademarks in this Form 10-Q without the TM and^® symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights to our trademarks. Other service marks, trademarks and trade names referred to in this document are the property of their respective owners.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ARCHIPELAGO LEARNING, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS —(UNAUDITED)
(in thousands, except share data)


	As of		As of
	September 30,		December 31,
	2010		2009
Assets
Current assets:
Cash and cash equivalents	$	24,305	$	58,248
Accounts receivable, net		13,700		7,535
Deferred tax assets		2,026		2,528
Prepaid expenses and other current assets		3,282		1,809

Total		43,313		70,120
Property and equipment, net		3,490		2,620
Goodwill		165,955		94,373
Intangible assets, net		38,615		12,327
Investment		6,446		6,446
Notes receivable		4,931		4,931
Other long-term assets		1,717		1,718

Total assets	$	264,467	$	192,535


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable — trade	$	467	$	1,254
Accrued employee-related expenses		1,449		2,033
Other accrued expenses		1,276		927
Taxes payable		660		625
Deferred tax liabilities		857		—
Deferred revenue		44,968		31,181
Current portion of note payable to related party		2,461		—
Current portion of long-term debt		850		700
Interest rate swap		288		1,149
Other current liabilities		542		—

Total		53,818		37,869
Long-term deferred tax liabilities		13,220		5,093
Long-term deferred revenue		13,374		5,262
Long-term note payable to related party, net of current and discount		2,316		—
Long-term debt, net of current		75,126		60,876
Other long-term liabilities		725		425

Total liabilities		158,579		109,525
Commitments and contingencies
Stockholders’ equity:
Preferred stock ($0.001 par value, 10,000,000 shares authorized, none issued and outstanding at September 30, 2010 and December 31, 2009)		—		—
Common stock ($0.001 par value, 200,000,000 shares authorized, 26,349,790 and 25,110,255 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively)		26		25
Additional paid-in capital		94,833		76,072
Accumulated other comprehensive income		2,042		—
Retained earnings		8,987		6,913

Total stockholders’ equity		105,888		83,010

Total liabilities and stockholders’ equity	$	264,467	$	192,535

See the accompanying notes to the unaudited condensed consolidated financial statements.

ARCHIPELAGO LEARNING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME —(UNAUDITED)
(in thousands, except share and per share data)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
Revenue	$	15,449		$	10,601		$	41,595		$	30,801
Cost of revenue		1,534			751			3,476			2,186

Gross profit		13,915			9,850			38,119			28,615
Operating Expense:
Sales and marketing		5,711			3,424			13,679			9,682
Content development		1,195			998			3,462			2,586
General and administrative		5,529			2,556			14,909			6,890

Total		12,435			6,978			32,050			19,158

Income from continuing operations		1,480			2,872			6,069			9,457
Other income (expense):
Interest expense		(1,260	)		(722	)		(2,909	)		(2,071	)
Interest income		136			30			439			44
Foreign currency loss		(121	)		—			(220	)		—
Derivative loss		(32	)		(267	)		(78	)		(436	)

Total		(1,277	)		(959	)		(2,768	)		(2,463	)

Net income from continuing operations before tax		203			1,913			3,301			6,994
Provision for income tax		51			217			1,227			449

Net income from continuing operations		152			1,696			2,074			6,545


Income from discontinued operation before tax		—			147			—			230
Benefit from income tax on discontinued operation		—			(2	)		—			(101	)

Net income from discontinued operation		—			149			—			331


Net income	$	152		$	1,845		$	2,074		$	6,876


Earnings per share:
Basic:
Continuing operations	$	0.01		$	0.08		$	0.08		$	0.33
Discontinued operation		—			0.01			—			.01

Total	$	0.01		$	0.09		$	0.08		$	0.34

Diluted:
Continuing operations	$	0.01		$	0.08		$	0.08		$	0.33
Discontinued operation		—			0.01			—			.01

Total	$	0.01		$	0.09		$	0.08		$	0.34


Weighted-average shares outstanding:
Basic		25,133,092			19,965,866			24,395,043			19,965,866
Diluted		25,491,238			19,965,866			24,770,214			19,965,866

See the accompanying notes to the unaudited condensed consolidated financial statements.

ARCHIPELAGO LEARNING, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY AND COMPREHENSIVE
INCOME—(UNAUDITED)
(in thousands)


	Preferred				Common							Accumulated
	Stock				Stock					Additional		Other
			Par					Par		Paid-in		Comprehensive		Retained		Total
	Shares		Value		Shares			Value		Capital		Income		Earnings		Equity
Balance at December 31, 2009		—	$	—		25,110		$	25	$	76,072	$	—	$	6,913	$	83,010
Stock-based compensation expense		—		—		—			—		1,366		—		—		1,366
Grants of stock and restricted stock		—		—		12			—		—		—		—		—
Forfeiture of restricted stock		—		—		(14	)		—		—		—		—		—
Purchase of shares from employee stock purchase plan		—		—		—			—		3		—		—		3
Issuance of shares in acquisition		—		—		1,242			1		17,392		—		—		17,393
Comprehensive income:
Net income		—		—		—			—		—		—		2,074		2,074
Currency translation adjustment		—		—		—			—		—		2,042		—		2,042

Total																	4,116


Balance at September 30, 2010		—	$	—		26,350		$	26	$	94,833	$	2,042	$	8,987	$	105,888

See the accompanying notes to the unaudited condensed consolidated financial statements.

ARCHIPELAGO LEARNING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS —(UNAUDITED)
(in thousands)


	Nine Months Ended
	September 30,
	2010			2009
Cash flows from operating activities
Net income	$	2,074		$	6,876
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of debt financing costs		249			154
Depreciation and amortization		2,964			1,995
Stock-based compensation		1,366			298
Provision for uncollectable accounts receivable		—			63
Unrealized gain on interest rate swap		(861	)		(535	)
Deferred income taxes		765			(1	)
Deferred rent		770			—
Loss on disposal of assets		166			—
Deduction of net income from discontinued operation		—			(331	)
Operating cash used by discontinued operation		—			(64	)
Changes in operating assets and liabilities, net of acquisition, disposition and discontinued operation:
Accounts receivable		(1,870	)		(4,076	)
Prepaid expenses and other		(1,095	)		(486	)
Accounts payable		(82	)		(55	)
Accrued expenses		(749	)		563
Deferred revenue		11,496			8,727
Other liabilities		180			230

Net cash provided by operating activities		15,373			13,358
Cash flows from investing activities
Purchase of EducationCity		(61,472	)		—
Proceeds from escrow for sale of TeacherWeb		650			—
Investment in Edline		—			(2,734	)
Funding of note receivable from Edline		—			(2,144	)
Purchase of property and equipment		(959	)		(1,049	)

Net cash used in investing activities		(61,781	)		(5,927	)
Cash flows from financing activities
Proceeds from supplemental term note		15,000			—
Proceeds from revolver		10,000			—
Payment of debt financing costs		(804	)		—
Tax distributions to members		—			(1,250	)
Purchase of common stock from ESPP		3			—
Payment of offering costs		(1,460	)		(1,165	)
Payment of revolver		(10,000	)		—
Payments on term note		(600	)		(1,049	)

Net cash provided by (used in) financing activities		12,139			(3,464	)
Effect of foreign exchange on cash and cash equivalents		326			—

Net change in cash and cash equivalents		(33,943	)		3,967
Beginning of period		58,248			13,144

End of period	$	24,305		$	17,111

Supplemental information
Cash paid for interest	$	2,611		$	2,004

Cash paid for income taxes	$	1,270		$	95

Non-cash investing and financing activities
Accrued purchases of property and equipment	$	574		$	161

Issuance of common stock for purchase of EducationCity	$	17,393		$	—

Issuance of note payable for purchase of EducationCity	$	4,687		$	—

See the accompanying notes to the unaudited condensed consolidated financial statements.

ARCHIPELAGO LEARNING, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

Archipelago Learning, Inc. (the “Company”) is a leading subscription-based online education company. The Company provides standards-based instruction, practice, assessments and productivity tools that improve the performance of educators and students via proprietary web-based platforms. Study Island, the Company’s core product line, helps students in Kindergarten through 12th grade, or K-12, master grade level academic standards in a fun and engaging manner. As of September 30, 2010, Study Island products were utilized by approximately 10.7 million students in 23,355 schools in all 50 states, Washington, D.C., and Canada who answered approximately 2.7 billion practice questions during the nine months ended September 30, 2010. In the second quarter of 2009, the Company began offering online postsecondary programs through its Northstar Learning product line.

Archipelago Learning, Inc. was incorporated as a Delaware corporation on August 4, 2009. Prior to November 19, 2009, the Company was operated under Archipelago Learning Holdings, LLC (the “LLC”). On November 19, 2009, in connection with the Company’s initial public offering (the “IPO”), the Company entered into a transaction (the “Reorganization”) whereby all of the shares of the LLC were exchanged for common stock and restricted common stock in the Company, and the LLC became a wholly-owned subsidiary of the Company. The Reorganization was accounted for as a transaction with entities under common control, thus assets, liabilities, operations and cash flows of the LLC prior to the Reorganization are presented as the results of the Company and earnings per share data is presented under the equity structure of the Company, utilizing the number of shares of the LLC exchanged for common stock of the Company, applied to past transactions.

On July 2, 2009, the LLC changed its name from “Study Island Holdings, LLC” to “Archipelago Learning Holdings, LLC.” Study Island Holdings, LLC from January 10, 2007 to July 1, 2009 and Archipelago Learning Holdings, LLC from July 2, 2009 to the date of the Reorganization are collectively referred to herein as “the LLC.”

The Company completed its IPO on November 25, 2009. A total of 7,187,500 shares were sold, of which 3,125,000 were sold by the Company.

The Company completed its sale of TeacherWeb on November 2, 2009. The operations and cash flows of TeacherWeb have been presented as a discontinued operation in the Company’s condensed consolidated financial statements.

On June 9, 2010, the Company acquired Educationcity Limited (“EducationCity”), which provides online K-6 instructional content and assessments for reading, math and science. EducationCity products are used by 8,583 schools in the United Kingdom and 5,168 schools in the United States as of September 30, 2010.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the Company’s unaudited condensed consolidated financial statements and footnotes contained herein do not include all of the information and footnotes required by GAAP to be considered “complete financial statements.” However, in the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements and footnotes contain all adjustments, including normal recurring adjustments, considered necessary for a fair presentation of the Company’s consolidated financial information as of, and for, the periods presented. The condensed consolidated results of operations of the Company for an interim period are not necessarily indicative of its consolidated results of operations to be expected for its fiscal year. The December 31, 2009 consolidated balance sheet was included in the audited consolidated financial statements in the Company’s annual report on Form 10-K for the year ended December 31, 2009 (“2009 Annual Report”), which includes all disclosures required by GAAP. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company included in the 2009 Annual Report.

Derivatives and Hedging Activities— The Company’s overall risk management strategy includes utilizing an interest rate swap agreement. The Company managed its exposure to rate variability on the floating interest rate paid on its credit facility by entering into an interest rate swap agreement with a notional amount totaling $45.5 million, of which $30.5 million and $35.5 million remained in effect as of September 30, 2010 and December 31, 2009, respectively. Beginning in 2009, the notional amount of the interest rate swap began decreasing in periodic amounts, and will terminate in December 2010. The Company swapped a floating rate payment based on the three month London InterBank Offered Rate (LIBOR) for a fixed rate of 4.035% in order to minimize the variability in expected future cash flows due to interest rate movements on its LIBOR-based variable rate debt.

The Company has not designated the swap as a hedge. The fair value of the swap is recorded as interest rate swap in the Company’s condensed consolidated balance sheets and changes in the fair value of the swap in derivative loss in the Company’s condensed consolidated statements of income.

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2009-13,Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. ASU 2009-13 amends existing revenue guidance related to revenue arrangements with multiple deliverables to allow the use of companies’ estimated selling prices as the value for deliverable elements under certain circumstances and to eliminate the use of the residual method for allocation of deliverable elements. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010, with earlier adoption permitted. The Company is currently evaluating the impact this standard will have on its financial statements.

3. FAIR VALUE MEASUREMENTS

The three levels of inputs to valuation techniques used in fair value calculations are defined as follows:

	•		Level 1 — Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.

	•		Level 2 — Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

	•		Level 3 — Valuations based on models where significant inputs are not observable. The unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use.

The Company’s interest rate swap is valued using discounted cash flow techniques, which incorporate Level 1 and Level 2 inputs such as interest rates. These market inputs are utilized in the discounted cash flow calculation considering the instrument’s term, notional amount, discount rate, and credit risk. Significant inputs to the derivative valuation for interest rate swap are observable in the active markets and are classified as Level 2 in the hierarchy.

The following table summarizes assets and liabilities measured at fair value on a recurring basis (in thousands):


	Level 1		Level 2		Level 3		Total
As of September 30, 2010
Assets — cash equivalents	$	20,507		—		—	$	20,507
Liabilities — interest rate swap		—	$	288		—	$	288
As of December 31, 2009
Assets — cash equivalents	$	55,792		—		—	$	55,792
Liabilities — interest rate swap		—	$	1,149		—	$	1,149

The fair value of the Company’s long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.

The carrying amounts and estimated fair values of the Company’s financial instruments that are not reflected in the financial statements at fair value are as follows (in thousands):


	As of September 30, 2010				As of December 31, 2009
	Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value
Investment	$	6,446		n/a	$	6,446		n/a
Notes receivable	$	4,931	$	5,134	$	4,931	$	4,931
Note payable to related party	$	4,777	$	4,777	$	—	$	—
Term loan	$	75,976	$	75,976	$	61,576	$	61,229

The investment included in the table above is in a company that is not publicly traded and the fair value is not readily determinable.

4. DISCONTINUED OPERATION

On November 2, 2009, the Company completed the sale of the operations of TeacherWeb to Edline Holdings, Inc. (“Edline”) for an aggregate purchase price of $13.0 million, consisting of $6.5 million in cash (reduced by approximately $1.5 million of cash remaining on TeacherWeb’s balance sheet), Series A shares of Edline valued at $3.7 million and $2.8 million of five-year debt securities that bear interest at 9.5% per annum and require semi-annual interest-only payments. In addition, the Company made an approximately $1.6 million distribution to its members in the fourth quarter of 2009 to enable them to meet certain tax obligations associated with the TeacherWeb sale. As a result of the sale and the Company’s previous investment in Edline, the Company holds 11.2% of Edline’s outstanding Series A shares and $4.9 million of Edline’s senior debt. Edline is controlled by one of the Company’s stockholders who, prior to the initial public offering was the controlling shareholder of the Company. As such, the sale was treated as a transaction between entities under common control and the excess of the sale consideration received and the book value of net assets sold was recognized in additional paid-in capital. The operations of TeacherWeb during the period that the Company owned it are treated as a discontinued operation on the condensed consolidated statements of income and cash flows.

Revenue from TeacherWeb of $0.7 million and $1.9 million for the three months and nine months ended September 30, 2009 was reported in discontinued operations in the condensed consolidated statement of income.

5. ACQUISITION OF EDUCATIONCITY

On June 9, 2010, the Company acquired EducationCity pursuant to a Share Purchase Agreement with Matthew Drakard, Simon Booley and Tom Morgan. The Company purchased 100% of the equity of EducationCity for a purchase price of: (i) $65.1 million in cash; (ii) 1,242,408 shares of common stock of the Company; and (iii) $5.0 million in additional deferred cash consideration, of which $2.5 million will be paid by the Company on each of December 31, 2010 and December 31, 2011. The Company also paid the sellers $0.2 million for a post-closing working capital adjustment. The acquisition was financed with cash on hand and the proceeds of a new $15.0 million supplemental term loan and $10.0 million in revolving loan commitments.

As part of the acquisition, the Company incurred $0.1 million and $3.4 million in transaction costs, including legal and professional fees, which are recorded in general and administrative expense on the condensed consolidated statements of income for the three and nine months ended September 30, 2010.

Revenues of $2.1 million and $2.6 million and net losses of $0.7 million and $0.9 million arising from EducationCity are included in the condensed consolidated statements of income for the three and nine months ended September 30, 2010.

The following unaudited pro forma information summarizes the Company’s results of operations, as if the acquisition of EducationCity had occurred as of the beginning of each period presented. The pro forma information adjusts for the effects of amortization of acquired intangibles. For 2009, the pro forma basic and diluted earnings per share includes an additional 1,242,408 shares reflecting the effect of the acquisition. The unaudited pro forma financial data is presented for illustrative purposes only and is not necessarily indicative of the operating results that

would have been achieved if such acquisition had occurred on the dates indicated, nor is it necessarily indicative of future consolidated results (in thousands, except per share data):


	Three Months				Nine Months
	Ended September 30,				Ended September 30,
	2010		2009		2010		2009
Revenue	$	15,449	$	12,855	$	45,874	$	36,934
Net income from continuing operations	$	152	$	571	$	3,257	$	3,969
Net income	$	152	$	720	$	3,257	$	4,300
Basic earnings per share
Continuing operations	$	0.01	$	0.03	$	0.13	$	0.19
Total	$	0.01	$	0.03	$	0.13	$	0.20
Diluted earnings per share
Continuing operations	$	0.01	$	0.03	$	0.13	$	0.19
Total	$	0.01	$	0.03	$	0.13	$	0.20

During the quarter ended September 30, 2010, the Company finalized its purchase accounting for the acquisition of EducationCity. The final valuation of the fair value of the assets and liabilities acquired resulted in an increase in intangible assets of $0.6 million and a decrease in deferred revenue of $0.7 million. The following table presents the composition of the purchase price and the final amounts recorded in the Company’s balance sheet as of June 9, 2010 for assets and liabilities acquired (in thousands):


Purchase price:
Cash paid to sellers, net of cash received	$	61,472
Note payable		4,687
Issuance of common stock		17,393

Total	$	83,552


Assets (liabilities) acquired:
Accounts receivable	$	4,026
Deferred tax assets		1,890
Other assets		955
Intangible assets		26,860
Accounts payable and accrued expenses		(676	)
Deferred tax liabilities		(10,149	)
Deferred revenue		(9,900	)

Total	$	13,006


Remaining value, recorded to goodwill	$	70,546

The goodwill acquired is not expected to be deductible for tax purposes.

6. GOODWILL AND INTANGIBLE ASSETS

The Company has recorded goodwill and intangible assets in connection with the purchase of the Company by Providence Equity Partners in 2007 and the acquisition of EducationCity in June 2010. Finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives.

Amortization expense was recorded to the following captions in the condensed consolidated statements of income (in thousands):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2010		2009		2010		2009
Cost of revenue	$	78	$	21	$	120	$	63
Sales and marketing		725		341		1,526		1022
Content development		99		42		226		125
General and administrative		47		—		59		—
Income from discontinued operation		—		106		—		319

Total	$	949	$	510	$	1,931	$	1,529

The changes in the carrying amount of goodwill during the nine months ended September 30, 2010 are as follows (in thousands):


Balance as of December 31, 2009	$	94,373
Acquisition of EducationCity		70,546
Adjustment due to foreign currency		1,036

Balance as of September 30, 2010	$	165,955

The components of the balances of intangible assets are as follows (dollars in thousands):


					As of September 30, 2010							As of December 31, 2009
	Amortization		Gross					Foreign				Gross
	Period		Carrying		Accumulated			Currency				Carrying		Accumulated
	(Years)		Amount		Amortization			Translation		Net		Amount		Amortization			Net
Finite-lived intangible assets:
Study Island customer relationships		10	$	13,620	$	(5,071	)	$	—	$	8,549	$	13,620	$	(4,050	)	$	9,570
EducationCity customer relationships		9-11		15,750		(516	)		779		16,013		—		—			—
Study Island technical development/program content		10		2,500		(931	)		—		1,569		2,500		(743	)		1,757
EducationCity technical development/program content		15		7,060		(153	)		401		7,308		—		—			—
EducationCity noncompete agreements		5		1,040		(67	)		53		1,026		—		—			—

Indefinite-lived intangible assets:
Study Island trade name		n/a		1,000		—			—		1,000		1,000		—			1,000
EducationCity trade name		n/a		3,010		—			140		3,150		—		—			—

Total intangible assets			$	43,980	$	(6,738	)	$	1,373	$	38,615	$	17,120	$	(4,793	)	$	12,327

The estimated amortization expense for each of the years ended December 31 and thereafter as of September 30, 2010, is as follows (in thousands):


Remainder of 2010	$	995
2011		3,979
2012		3,979
2013		3,979
2014		3,979
Thereafter		17,554

	$	34,465

7. AMENDED CREDIT FACILITY

In June 2010, the credit agreement governing the term loan and the revolving credit facility (the “Credit Agreement”) with our subsidiary, Archipelago Learning, LLC (the “Borrower”), was amended to permit the acquisition of EducationCity and to add a $15.0 million supplemental term loan and an additional $10.0 million to the revolving credit facility, both of which were drawn in order to finance the acquisition. The Borrower subsequently repaid the $10.0 million revolving credit facility during the three months ended September 30, 2010. This amendment further modified certain terms of the Credit Agreement, including increasing the applicable margin on all loans by 0.50%, modifying the definition of permitted acquisitions, and increasing the letter of credit sublimit available to the Borrower under the Credit Agreement from $1.0 million to $2.0 million.

The Borrower had no amounts outstanding and $20.0 million of availability under the revolving credit facility as of September 30, 2010.

8. TAXES

Prior to the Reorganization, the LLC was not a taxpaying entity for federal income tax purposes. As a result, the LLC’s income was taxed to its members in their individual federal income tax returns. No federal income tax expense was recognized for the LLC prior to November 2009. Upon the Reorganization, the Company became a taxpaying entity and accordingly began recognizing tax expense.

Upon the acquisition of EducationCity, the Company recognized deferred tax asset and liability balances related to the adjustments in basis for assets acquired and liabilities assumed and became a taxpayer in the United Kingdom for the taxable income of Educationcity Limited. After reflecting the impact of these items, the Company’s effective tax rate was 25.1% and 37.2% for the three months and nine months ended September 30, 2010, respectively.

9. COMMITMENTS AND CONTINGENCIES

The Company has a distribution agreement with a supplier which includes a minimum royalty payment requirement to keep the contract in effect. The aggregate minimum requirement over the next ten years under the contract totals $12.4 million. The Company is obligated, as lessee, under noncancelable operating leases for office space in Dallas, Texas, Naperville, Illinois, and Rutland, United Kingdom expiring through 2020. The Company moved its corporate office during September 2010. As of September 30, 2010, the future minimum payments required under all operating leases with terms in excess of one year are as follows (in thousands):


Remainder of 2010	$	372
2011		1,469
2012		1,098
2013		1,105
2014		951
Thereafter		5,385

	$	10,380

10. EARNINGS PER SHARE

Subsequent to the Reorganization, earnings per share is computed using the two-class method, considering the restricted common shares, due to their participation rights in dividends of the Company. Under this method, the Company’s net income is reduced by the portion of net income attributable to the restricted common shares, and this amount is divided by the weighted average shares of common stock outstanding. Prior to the Reorganization, there were various classes of stock, which were entitled to earnings based on a priority established in the LLC agreement. The Class A shares were entitled to a return of capital and a preferred return before any other class of shares was entitled to earnings. The Class A shares were entitled to 100% of the earnings for the period from January 1, 2007 to the Reorganization. Earnings per share was calculated based on the shares of common stock that were exchanged for the Class A shares in the Reorganization for all periods prior to the Reorganization.

The components of earnings per share are as follows for the three months ended September 30 (in thousands):


	2010						2009
	Net Income			Shares			Net Income		Shares
Continuing operations:
Net income	$	152			26,355		$	1,696		19,966
Less: Income attributable to restricted shares		(7	)		(1,222	)		—		—

Net income available to common stockholders	$	145			25,133		$	1,696		19,966

Basic earnings per share	$	0.01					$	0.08

Dilutive effect of restricted common stock					358

Diluted earnings per share	$	0.01			25,491		$	0.08


Discontinued operation:
Net income	$	—					$	149		19,966
Less: Income attributable to restricted shares		—						—		—

Net income available to common stockholders		—					$	149		19,966

Basic and diluted earnings per share	$	—					$	0.01


Total:
Net income	$	152			26,355		$	1,845		19,966
Less: Income attributable to restricted shares		(7	)		(1,222	)		—		—

Net income available to common stockholders	$	145			25,133		$	1,845		19,966

Basic earnings per share	$	0.01					$	0.09

Dilutive effect of restricted common stock					358

Diluted earnings per share	$	0.01			25,491		$	0.09

The components of earnings per share are as follows for the nine months ended September 30 (in thousands):


	2010						2009
	Net Income			Shares			Net Income		Shares
Continuing operations:
Net income	$	2,074			25,628		$	6,545		19,966
Less: Income attributable to restricted shares		(100	)		(1,233	)		—		—

Net income available to common stockholders	$	1,974			24,395		$	6,545		19,966

Basic earnings per share	$	0.08					$	0.33

Dilutive effect of restricted common stock					375

Diluted earnings per share	$	0.08			24,770		$	0.33


Discontinued operation:
Net income	$	—					$	331		19,966
Less: Income attributable to restricted shares		—						—		—

Net income available to common stockholders		—					$	331		19,966

Basic and diluted earnings per share	$	—					$	0.01


Total:
Net income	$	2,074			25,628		$	6,876		19,966
Less: Income attributable to restricted shares		(100	)		(1,233	)		—		—

Net income available to common stockholders	$	1,974			24,395		$	6,876		19,966

Basic earnings per share	$	0.08					$	0.34

Dilutive effect of restricted common stock					375

Diluted earnings per share	$	0.08			24,770		$	0.34

For the three months and nine months ended September 30, 2010, options to purchase 694,565 and 652,445 weighted-average shares of common stock, respectively, were excluded from the diluted earnings per share calculation, as their effect was antidilutive. No options or shares of participating restricted stock were outstanding during the nine months ended September 30, 2009.

11. STOCK-BASED COMPENSATION

There are 1,216,698 shares of the Company’s restricted common stock and stock options for purchase of 683,028 shares of the Company’s common stock outstanding as of September 30, 2010. The stock options outstanding as of September 30, 2010 have a weighted-average exercise price of $16.34, have a weighted-average remaining contractual term of 9.2 years and are all “out of the money” at September 30, 2010, thus have no aggregate intrinsic value. None of the outstanding options were exercisable at September 30, 2010.

As of September 30, 2010, there was approximately $5.1 million of unrecognized stock-based compensation expense related to unvested restricted common stock and options for common stock that is expected to be recognized over a weighted average period of 3.0 years.

12. BUSINESS SEGMENT DATA AND GEOGRAPHICAL INFORMATION

Pursuant to the acquisition of EducationCity on June 9, 2010, the Company operates as three operating segments, Study Island, Educationcity Limited (a United Kingdom private company) and Educationcity Inc. (an Illinois company). The Company aggregated the three operating segments to one reportable segment based on the similar nature of the products, content and technical production processes, types of customers, methods used to distribute the products, and similar rates of profitability.

The three operating segments offer subscription-based online products that provide instruction, practice, assessment and productivity tools for teachers and students. The content and engineering teams operate in a similar manner to enhance and maintain the products. The primary customer bases for all three operating segments are schools. The markets for the U.S. and U.K. are both English-speaking, which is important from a product marketing and development perspective. The operating segments have similar rates of profitability.

Geographical areas are North America (which includes operations of the United States and Canada) and United Kingdom. The following geographical area information includes revenues based on the physical location of the operations (in thousands):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2010		2009		2010		2009
Revenue:
North America	$	14,184	$	10,601	$	40,000	$	30,801
United Kingdom		1,265		—		1,595		—

Total revenue	$	15,449	$	10,601	$	41,595	$	30,801

The following geographical area information includes total long-lived assets (which consist of all non-current assets, other than goodwill, indefinite-lived intangible assets and deferred tax assets) based on physical location (in thousands):


	September 30,		December 31,
	2010		2009
North America	$	36,627	$	27,042
United Kingdom		14,422		—

	$	51,049	$	27,042

13. RELATED-PARTY TRANSACTIONS

The Company is a party to an agreement with a stockholder to provide advisory services in connection with the identification, evaluation and acquisition of one or more businesses. The stockholder receives a transaction fee upon the successful consummation of any transaction that they identify. The amount of this transaction fee is dependent upon the size of the acquisition. Additionally, any reasonable expenses incurred in connection with this agreement are reimbursed. During the nine months ended September 30, 2010, the Company incurred and paid an aggregate of $1.5 million under this agreement related to the acquisition of EducationCity. During the three months ended September 30, 2010, and the three and nine months ended September 30, 2009, the Company did not incur or make any payments under this agreement.

The Company purchases equipment from an affiliate of Providence Equity Partners. Equipment purchases with this supplier totaled $0.4 million for the three months ended September 30, 2010, and $0.7 million and $0.2 million for the nine months ended September 30, 2010 and 2009, respectively.

Providence Equity Partners paid for certain costs related to travel and other expenses of members of the Company’s Board of Directors and other staff assisting those Directors in certain oversight functions and invoiced the Company for reimbursement. During the nine months ended September 30, 2010, $0.1 million of these costs were paid by the Company. No payments were made during the three months ended September 30, 2010.

During the nine months ended September 30, 2010, the Company made certain tax payments of $0.2 million to states on behalf of shareholders of the LLC for periods prior to the Reorganization. These amounts were invoiced to these stockholders for reimbursement.

As part of the sale of TeacherWeb, the Company signed a transition services agreement with Edline whereby the Company performs certain accounting and administrative functions related to TeacherWeb for a period not to exceed six months from the sale. In May 2010, the transition services agreement was extended to July 1, 2010. The transition services agreement was subsequently amended in August and September 2010, extending its term through October 31, 2010. During the transition period, certain costs are paid by the Company on behalf of TeacherWeb, which are billed to and reimbursed by Edline. The Company receives no fee for the performance of these services.

For the three months and nine months ended September 30, 2010, the Company paid $0.1 million and $0.9 million, respectively, to TeacherWeb vendors on behalf of Edline, of which a total of $0.1 million was receivable from Edline as of September 30, 2010, and is recorded in other current assets on the condensed consolidated balance sheet.

The building where EducationCity leases office space in Rutland, United Kingdom is owned by the pension funds of two officers and stockholders of the Company. The Company made payments under this lease for $0.1 million for the three and nine months ended September 30, 2010.

In connection with the purchase of EducationCity, the Company incurred a $5.0 million note payable to the sellers, payable in equal installments on December 31, 2010 and 2011. Upon the purchase, the sellers became officers of the Company and stockholders.

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

The following discussion is intended to assist in the understanding of our consolidated financial position and our results of operations. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes in Item 1 of this report.

Prior to our initial public offering in November 2009, we conducted our business through Archipelago Learning Holdings, LLC, formerly known as Study Island Holdings, LLC, and its subsidiaries. Prior to the consummation of the initial public offering, a reorganization occurred whereby Archipelago Learning Holdings, LLC became a wholly owned subsidiary of Archipelago Learning, Inc., a newly formed Delaware corporation. Unless the context requires otherwise, references throughout this report to “Archipelago Learning,” “we,” “us,” “our company” or similar terms refer to Archipelago Learning, Inc. and its subsidiaries, after giving effect to the reorganization.

Overview

Archipelago Learning is a leading subscription-based online education company. We provide standards-based instruction, practice, assessments and productivity tools that improve the performance of educators and students via proprietary web-based platforms. Study Island, our core product line, helps students in Kindergarten through 12th grade, or K-12, master grade level academic standards in a fun and engaging manner. As of September 30, 2010, Study Island products were utilized by approximately 10.7 million students in 23,355 schools in all 50 states, Washington D.C. and Canada. During the 2009-2010 school year, students answered approximately 3.8 billion of our practice questions. We recently began offering online postsecondary programs through our Northstar Learning product line. In August 2010, we began selling “Reading Eggs”, an online product focusing on teaching young children to read. Reading Eggs is sold under a distribution agreement with Blake Publishing Pty Limited (“Blake”), which requires us to pay a 35% royalty to Blake for every sale.

We were founded in 2000. In 2001, we launched our first Study Island products in two states. By 2009, we had developed Study Island products for all 50 states, in the subject areas of reading, writing, mathematics, social studies and science, and have grown from serving 57 schools in 2001 to 23,355 schools as of September 30, 2010. We entered the postsecondary educational market with the launch of Northstar Learning in April 2009, which uses the same web-based platform as our Study Island products to provide various instruction, assessment and exam preparation content.

In June 2008, we acquired TeacherWeb, a website portal and teacher productivity tool that provides educators with simple, easy-to-use templates to create district, school or classroom websites. In August 2009, we made a minority investment in Edline, a private educational technology company offering products and services similar to TeacherWeb, and we sold TeacherWeb to Edline in November 2009.

In June 2010, we acquired Educationcity Limited (“EducationCity”), a leading developer and publisher of EducationCity.com, an online K-12 educational content and assessment program for schools in the U.K. and U.S. Similar to Study Island, EducationCity maps to standards, combines rigorous content and interactive animations, fun games, and motivational rewards to drive academic success in a fun and engaging manner. Unlike Study Island, EducationCity core classroom and individualized instruction is geared toward the initial teaching phases of academic content. EducationCity helps students learn basic skills and concepts while Study Island helps assess, reinforce and master this knowledge. When used in conjunction with one another, EducationCity and Study Island provide a powerful comprehensive teaching and reinforcement solution to enhance student learning and teacher performance. As of September 30, 2010, EducationCity was being used by 8,583 schools in the United Kingdom and 5,168 schools in the United States.

We capitalize on two significant trends in the education market: (1) an increased focus on higher academic standards and educator accountability for student achievement, which has led to periodic assessment in the classroom to gauge student learning and inform instruction, also known as formative assessment, and (2) the increased availability and utilization of web-based technologies to enhance and supplement teacher instruction, engage today’s technology-savvy learners and improve student outcomes.

In the US, the increased focus on higher academic standards and assessments as a means to measure educator accountability is largely reflected in legislative efforts such as No Child Left Behind, the common name under the Bush administration for the 2001 reauthorization of the Elementary and Secondary Education Act, or ESEA. ESEA required all states to have academic standards in place for K-12 students in reading, math and science, and to assess student achievement annually with end of school year assessments. Moreover, districts and schools were required to set Adequate Yearly Progress, or AYP, milestones each year leading to all students performing on grade level by 2014. Those districts not meeting AYP milestones for two or more years faced significant consequences.

The ESEA legislation was initially scheduled for reauthorization in October 2008, but has been continually extended. While many politicians, including President Obama, believe that the nation’s primary education law needs to be revised now, the results of the November mid-term elections now make it quite certain that this will not happen until next year at the earliest, and perhaps beyond. In his 2010 State of the Union address, President Obama proposed an overhaul of the primary law outlining an increased federal role in public schools and the administration distributed a blueprint for the reauthorization in March, which provided broad concepts regarding changes to the current version of the law. While Congress has held hearings on reauthorization throughout the spring and summer months, we believe the law and the proposed changes have been controversial and other competing legislative priorities have placed reauthorization on the back-burner. The presumptive new Chairman of the House Education Sub-Committee, John Kline (Republican-Minnesota), favors less federal involvement in education and is not supportive of several of the key tenants of the Obama Blueprint, including the Race to the Top competition, national standards and assessments. There are also a few issues on which Representative Kline sees eye-to-eye with the administration, such as the need to encourage the proliferation of high-quality charter schools. In addition, the presumptive new House Majority Leader, John Boehner (Republican — Ohio), has also opposed a national curriculum and standardized test system. Moreover, the GOP’s recent Pledge to America does not include the word “education.” So, at this time there is great uncertainty about the timing and direction of ESEA reauthorization and we do not expect clarity until the new Congress resumes ESEA reauthorization hearings.

In its 2011 fiscal year budget proposal and blueprint for change, the Obama administration recommended several key changes to ESEA, all of which are controversial, and may not survive now that the Republicans have a majority in the House of Representatives:

	(1)		“Growth” model to replace “absolute” model: The accountability system established in No Child Left Behind would be replaced with a new system built around the goal of helping all students graduate high school college- and career-ready. President Obama has suggested replacing the Adequate Yearly Progress, or “AYP” benchmarks with new “common core standards” based on college and career readiness, which are in the process of being finalized. President Obama’s proposal eliminates the No Child Left Behind mandate that all students be proficient in reading and math by 2014, the “absolute” model, with one that measures whether or not each student progresses at least one academic year from their proficiency level at the beginning of the year. The Obama administration argues that a teacher that helps a sixth grade student, for example, progress from a second grade proficiency level to a fourth grade proficiency level in one year should be rewarded for helping a student grow two academic years in proficiency, the “growth” model, as opposed to being penalized for the student not reaching sixth grade proficiency. The Obama administration and its supporters suggest that the “absolute” threshold model was unfair and that the initial No Child Left Behind goal of universal “absolute” student proficiency by 2014 was an impossible target. Opponents, including some GOP Congressmen and former Secretary of Education, Margaret Spellings, contend that backing away from this “absolute” mandate is a mistake in a field where nothing short of high-stakes testing grabs the attention of students, parents, teachers, and school administrators.

	(2)		Competition — reward excellence: The proposal seeks to shift the method of distributing federal education dollars from formula alone to a system that also rewards excellence based on competition and performance. The new accountability system would divide schools into more categories, offering recognition and additional funds for those states, districts and schools that are succeeding and providing large new amounts of money to help either improve or close chronically failing schools. GOP opponents argue that this shift to competition and performance formulas is too rigid and will penalize students for adult mistakes.

	(3)		Longitudinal data systems: The blueprint calls for comprehensive state and district data systems, including disaggregated data. It also proposes the collection of information related to teaching and learning conditions, school climate, student, teacher and school leader attendance, disciplinary incidents and student, parent or school staff surveys.

	(4)		Teacher and school leader effectiveness: In the area of teacher and school leader effectiveness, states would be required to develop definitions for “effectiveness.” The plan also calls for state data systems that link information on teacher and principal preparation programs to job placement, student growth and retention outcomes of their graduates. District-level evaluation systems would need to differentiate teacher and principal effectiveness, using at least three performance measures, one of which would be performance on high-stakes assessments.

While uncertainty continues to surround the substance and timing of ESEA reauthorization, we believe that higher standards, more rigorous assessments and accountability will remain key components of the revised ESEA. In addition, we believe the focus of school reform will shift from the increased Federal involvement and funding of the past two years — via the American Reinvestment and Recovery Act (ARRA stimulus) and Race to the Top — to greater state and local control of education and less funding from the Federal government. Republican leadership will be under great pressure from new and old members of the 112th Congress to cut federal spending, and education spending will almost certainly fall under that mandate. That said, we believe that Federal education spending will hold flat at 2008 budget levels with ESEA reauthorization focused on those areas that have bipartisan support: higher and more rigorous standards and assessments across all states, but not national standards and assessments; closing the achievement gap between U.S. students and those of other developed countries; closing the achievement gap between students across the socioeconomic spectrum; driving innovation via technology and charter schools; and, improving the high school graduate rate along with college and career readiness. We also believe that Title I and IDEA funding, the largest grants of the Federal budget, have bipartisan support and will continue to be sources of funds for schools and districts to purchase our products. We further believe that our Study Island, EducationCity and Northstar Learning core products are well positioned for this dynamic period of K-12 and postsecondary education reform driven by school budget pressures, the accelerating shift from print to online educational solutions and the demand for integrated curriculum and assessment to provide differentiated instruction to improve students’ academic performance, high school graduation rates and college and career success.

In addition, most of our U. S. customers are public schools and school districts that have to comply with state educational standards. As a result, our sales depend on the availability of public funds, which have become more limited as many states or districts face budget cuts due to decreases in their tax bases and rates. Revenues are still well below pre-recession levels and are expected to remain so for the foreseeable future.

State and federal educational funding is primarily funded through income taxes, and local educational funding is primarily funded through property taxes. As a result of the ongoing recession, income tax revenue for the 2008 and 2009 tax years has decreased, which has put pressure on state and federal budgets. In addition, with the recent decline in real estate values in almost every state and the resulting reassessments, property tax revenue is expected to decline over the next few years. According to the Nelson A. Rockefeller Institute of Government, the second quarter of 2010 represented the second period in a row that states reported overall gains in tax collections following five straight quarters of decline. Yet when the full 2009-10 fiscal year is considered, overall tax collections for the states declined from the previous year and remain below pre-recession levels. For the year ending in June 2010 — the period corresponding to most states’ fiscal years — tax collections declined by $19 billion or 2.7 percent from the preceding year, and were down $84 billion or 10.8 percent compared to fiscal year 2008. With revenue growth still below historical averages, many states will likely be forced to make more budget cuts and to consider further increases in taxes and charges.

Continued declining tax revenues and unfavorable economic conditions may result in education budget cuts and lead to lower overall spending, including lower technology spending, by our current and potential clients, which may materially adversely affect our revenue. According to the Center on Budget and Policy Priorities, at least 34 states have made cuts or have proposed cuts to K-12 and early education funding since the recession began in 2008. Declines in tax receipts and gaps in states’ budgets, estimated to be a total of $260 billion over the next two fiscal years, could result in decreased education spending as well as cuts in recently enacted federal education spending programs, reduced school budgets and reduced availability of discretionary funds, all of which could materially

adversely affect our revenue and results of operations. However, we believe that our high impact and low cost programs are well positioned to weather these macroeconomic conditions as schools and districts look for efficient, effective and proven online programs to offset cuts in teacher staffing and other areas.

To help offset state budget shortfalls, the U.S. Department of Education released approximately $5.0 billion in additional AARA stimulus funds to 21 states during the first and second quarters of 2010, primarily in the form of school improvement grants to turn around persistently lowest achieving schools. Another approximate $0.9 billion in grants was released to states in July to save teachers jobs, help improve the lowest performing schools, enhance education through technology, and drive other innovative educational reforms. In addition, the U.S. Department of Education announced in early August the top 49 scoring applicants that will be receiving $650 million of Investing in Innovation (I3) grants, to be funded after their 20 percent matching fund grants are secured by September 2010. Also, in late July the Senate and House passed a $26 billion aid bill that provides $10 billion to states for education jobs. President Obama signed the bill on August 11, 2010. The $10 billion in education job funds was distributed to states in September and October, with states distributing such funds to districts via the Title I formula, and will be used within the 2010-2011 school year. Funds may only be used for expenses necessary to retain existing school employees or to hire new employees for early childhood or K-12 education services. Additionally, in order to receive this Federal funding, states are required to maintain their funding of education at 2009 levels for 2010 and at 2010 levels for 2011.

The U.S. Department of Education is also in the process of implementing its highly publicized Race to the Top (RttT) competition whereby winning states were awarded funds totaling $3.4 billion in aggregate for agreeing to implement bold educational reforms. In Phase I, completed in March 2010, Tennessee and Delaware were the only winning states and were awarded approximately $500 million and $100 million, respectively. In Phase II, 9 states and the District of Columbia received the following grants: Florida: $700 million; New York: $700 million; Georgia: $400 million; North Carolina: $400 million; Ohio: $400 million; Maryland: $250 million; Massachusetts: $250 million; District of Columbia: $75 million; Hawaii: $75 million; and Rhode Island: $75 million. States receiving these RttT funds are expected to implement educational reforms over the next several years, in order to: achieve teacher mastery and delivery of common standards and assessments; use, learn and leverage high quality assessment information to drive increased student performance; ensure all students have access to effective teachers and principals; turn around persistently lowest-achieving schools; and improve the high school graduation rate and ensure each student is college and career ready.

A requirement for RttT applicants is to signal their intent to officially adopt the Common Core Standards for K-12 in reading and mathematics, released in June 2010. As of October 31, 2010, 38 states, the District of Columbia, American Samoa Islands, Guam, Northern Mariana Islands and Puerto Rico had officially adopted the new standards, although adoption of the standards does not bring immediate change in the classroom. We believe that implementation of the Common Core Standards will be a long-term process, as states rethink their teacher training, curriculum, instructional materials and testing. In addition, states are concerned that RttT funding is inadequate to implement the curriculum, assessments and teacher professional development that will be required, and a growing number of public policy groups are objecting to the new standards as a federal takeover of local education. Thus, regardless of how states have voted, actual implementation of the Common Core Standards is uncertain and expected to be a long process. In addition, presumptive new House Majority Leader, John Boehner, and presumptive House Education Sub-Committee Chairman, John Kline, favor higher standards and assessments, but are opposed to national standards and assessments. They are strong proponents of less Federal involvement in education and greater state and local control. Moreover, Secretary of Education, Arne Duncan, speaking in Virginia several weeks ago, suggested more flexibility on this issue when he complemented Governor Bob McConnell on his education reform initiatives even though Virginia decided not to adopt the common core standards, stating, “The goal is to raise the bar. And there are a couple different ways to do it.” In summary, we continue to believe that common core standards implementation will evolve in different ways across the adopting states and will raise the overall rigor of curriculum and assessments, but we increasingly believe that the Federal government will not mandate national standards and assessments.

Study Island products are specifically built from the varying academic and assessment standards in all 50 states, which we believe differentiates them from the products offered by our competitors. However, given the uncertainty regarding the common core standards movement, we have had to invest both in development of new common core products for the 39 adopting states (including the District of Columbia) as well as continue developing new products

and enhancements for existing state standards, which may require additional investment and/or delay of other product initiatives. Moreover, if national standards and assessments replace the current state assessments — which is uncertain — it would be easier for competitors to develop similar products tailored to one national set of standards rather than multiple state standards. If such an increase in competition occurred, our ability to compete effectively could be negatively impacted and our revenue and profitability could materially decline.

Also of note, the 2011 U.S. Federal budget was not passed by Congress before October 1, 2010, which is the official start date of the 2011 fiscal year. Thus, the Federal education budget remains in limbo, with the preliminary versions from the President, House and Senate ranging from flat to an increase of $2.59 billion over prior year. It is expected that the lame duck Congress will take this up and try to secure passage before the end of this year. If this does not happen, education funding and other nondefense-related discretionary spending is where the Republican controlled House of Representatives will look first to find spending cuts in 2011 and beyond. Both Study Island and EducationCity products are eligible for purchase from the majority of Federal funding sources, so any cuts to key programs, especially Title I (grants to free- and reduced-lunch schools) and IDEA (special education) funding, could negatively impact available district and school funding for purchase of educational programs.

While the federal legislative efforts and budgetary challenges in schools could present challenges to our future sales, we believe that we are positioned to perform well in the current environment for various reasons: (1) we are well aligned with educational reform policies and initiatives, including the Common Core Standards, (2) we make innovation easy as schools shift from print-based solutions to online digital content, instruction, assessment and data reporting, (3) we have a proven model and track record for engaging and improving learning outcomes, (4) we are affordable compared to other educational product offerings and (5) we still have relatively low overall school penetration with room for growth.

With the acquisition of EducationCity, the U.K. market and industry trends are also of importance to our business. There are approximately 30,388 schools in the U.K., 24,437 of which are in England, with approximately 4.9 million students. In addition, the seasonality of the business is different from the U.S., with first quarter the strongest invoiced sales period and third quarter the weakest. While the global economic recession has impacted the U.K., the new government under British Prime Minister, David Cameron, has attempted to protect education, with the Department for Education budget rising from £35.4 billion to £39 billion over the next four years. This is the money that goes direct to schools. In addition, teachers will be given greater freedom from bureaucratic burdens to use their professional judgment to meet the needs of their pupils. Head teachers will have increased flexibility over their budgets, including through simpler, fairer and more transparent funding streams. We believe these trends are positive for our business.

In the U.S., seasonal trends associated with school budget years and state testing calendars also affect the timing of our sales of subscriptions to new and existing customers. As a result, most new subscriptions and renewals occur in the third quarter because teachers and school administrators typically make purchases for the new academic year at the beginning of their district’s fiscal year, which is usually July 1. Subscriptions to our products generate substantially all of our revenue, and customers enter into subscriptions which average 15-month terms. We rely significantly on our ability to secure renewals for subscriptions to our products as well as sales to new customers. We generally contact schools several months in advance of the expiration of their subscription, to attempt to secure renewal subscriptions. If a school does not renew its subscription within six months after its expiration, we categorize it as a lost school, and if a school subsequently purchases a subscription after this renewal period, we consider it to be a new subscription.

2010 Events

We released Study Island Version 3, or “V3” in January 2010. V3 has been well received by our customers. Some key enhancements include a custom assessment builder, an online writing component, learning enhancements for special learners, and embedded “just-in-time” professional development. Educators are most excited about the new custom assessment builder, which enables teachers to easily build customized formative and benchmark assessments in reading and math, giving them the ongoing data they need to make informed instructional decisions. Additionally, the new writing assignment module is being widely used, as it gives teachers and students a paperless way to develop writing skills across the curriculum.

Our formal release of Study Island Version 4, or “V4” in August 2010 was well received by customers, with all features getting very favorable feedback. The flagship feature of V4 is a completely new high school website, which has a more mature look and feel. In conjunction with the enhanced game interface and the release of age-appropriate games for teen students, we have significantly upgraded our high school product offering. Other notable enhancements include a fully customizable teacher portal, a rich data-laden weekly principal report, and interactive flashcard capabilities for students and teachers.

We published 128 new Study Island products during the nine months ended September 30, 2010, with a focus on expanding our high school product line across all major subject areas in our largest states, including publishing new SAT, ACT and advanced placement test preparation products and filling in grade level and subject area holes in our elementary and middle school line-up for mid-size and small states. We also developed a new set of products based on Common Core Standards in grades 2 through 8 as well as high school, and we began rolling out these new products to the many states who have adopted them.

In June 2010, the Company acquired EducationCity, which provides online K-6 instructional content and assessments for reading, math and science, and is used by 8,583 schools in the United Kingdom and 5,168 schools in the United States as of September 30, 2010.

Results of Operations

Comparison of the Three Months Ended September 30, 2010 and 2009

The following table summarizes our consolidated operating results for the three months ended September 30 (dollars in thousands):


							Change
	2010			2009			Dollars			Percentage
Revenue	$	15,449		$	10,601		$	4,848			45.7	%
Cost of revenue		1,534			751			783			104.3	%

Gross profit		13,915			9,850			4,065			41.3	%
Operating expense:
Sales and marketing		5,711			3,424			2,287			66.8	%
Content development		1,195			998			197			19.7	%
General and administrative		5,529			2,556			2,973			116.3	%

Total		12,435			6,978			5,457			78.2	%

Income from continuing operations		1,480			2,872			(1,392	)		(48.5	%)
Other income (expense):
Interest expense		(1,260	)		(722	)		(538	)		74.5	%
Interest income		136			30			106			353.3	%
Foreign currency loss		(121	)		—			(121	)		**
Derivative loss		(32	)		(267	)		235			(88.0	)%

Total		(1,277	)		(959	)		(318	)		33.2	%

Net income from continuing operations before tax		203			1,913			(1,710	)		(89.4	%)
Provision for income tax		51			217			(166	)		(76.5	%)

Net income from continuing operations	$	152		$	1,696		$	(1,544	)		(91.0	%)


**		Percentage not meaningful for analysis.

Revenue.

Revenue for the three months ended September 30, 2010 was $15.4 million, representing an increase of $4.8 million, or 45.7%, as compared to revenue of $10.6 million for the three months ended September 30, 2009. Subscription and training revenue is recognized over the term of the subscription, which averages 15 months. Consequently, our revenue in any month is impacted by invoiced sales from subscriptions purchased or renewed during the current and prior periods. The increase in revenue during the period is due to increased traction in states newly entered in the prior year, increased products in our more mature states leading to additional sales to existing customers, our increased focus on existing customers and renewal efforts, and our our sales force expansion, as well as $2.1 million in revenues attributable to EducationCity.

The following table sets forth information regarding our invoiced sales as well as other metrics that impact our revenue for the three months ended September 30 (dollars in thousands):


	2010			2009
Invoiced sales:
Study Island new customers	$	4,542		$	4,362
Study Island existing customers		18,294			14,967
Study Island other sales		388			205
EducationCity		3,480			—

Total		26,704			19,534
Royalties on invoiced sales		(31	)		—
Change in deferred revenue(1)		(11,224	)		(8,933	)

Revenue	$	15,449		$	10,601



(1) Change in deferred revenue in 2010 excludes the amount of deferred revenue assumed with the acquisition of EducationCity and includes foreign exchange fluctuation impacts.

Other metrics:
Schools using Study Island products		23,355			20,812
Study Island products available		1,377			1,190

Our subscription purchases are generally evidenced by a purchase order or signed sales quote. We recognize an invoiced sale in the period in which the purchase order is received and the invoice is issued, which may be at a different time than the commencement of the subscription. Revenue for invoiced sales is deferred and recognized ratably over the subscription term beginning on the commencement date of the applicable subscription. We present invoiced sales data to provide a supplemental measure of our operating performance. We believe the various invoiced sales metrics enable investors to evaluate our sales performance in isolation and on a consistent basis without the affects of revenue deferral and revenue recognition from sales in prior periods. In addition, invoiced sales to new customers and existing customers and invoiced other sales provide investors with important information regarding the source of orders for our products and services and our sales performance in a particular period. Invoiced sales are not recognized under accounting principles generally accepted in the United States, or GAAP, and should not be used an as indicator of, or an alternative to, revenue and deferred revenue. Invoiced sales metrics have significant limitations as analytical tools because they do not take into account the requirement to provide the applicable product or service over the subscription period and they do not match the recognition of revenue with the associated cost of revenue. Reconciliation is provided in the table above between invoiced sales and revenue, the closest GAAP measure to invoiced sales.

Due to purchase accounting for the acquisition of EducationCity, we do not recognize the full amounts paid by customers for acquired subscriptions prior to the acquisition. Consequently, the deferred revenue balance at the date of acquisition was reduced from $15.6 million to $9.9 million. The purchase accounting adjustment reduced our revenues by $1.0 million for the three months ended September 30, 2010.

As of September 30, 2010, 23,355 schools used Study Island products. A school is considered to be using our products if it has an active subscription for any or all of the Study Island products available to it. The number of schools using our products will increase for sales to new schools and will decrease if schools do not renew their subscriptions. We generally contact schools several months in advance of the expiration of their subscription to attempt to secure renewal subscriptions. If a school does not renew its subscription within six months after its expiration, we categorize it as a lost school. If the school subsequently purchases a subscription to our products after this renewal period, we consider it to be a new subscription. For the twelve months ended March 31, 2010, we had a renewal rate of 78.2% from our Study Island customers, which reflects the percentage of schools that subscribed for our products throughout those twelve months and then subscribed for our products again in the next period, within six months of their subscription end date. A Study Island product is any one subject for one grade level in a single state. As of September 30, 2010, 13,751 schools used EducationCity products. We are in process of putting in place similar data definitions and measurement procedures for EducationCity.

We generate revenue from: customer subscriptions to standards-based instruction, practice, assessments and productivity tools; training fees, for onsite or online training sessions that are primarily provided to new Study Island customers; and individual buys, which are individual purchases for access to a product (one subject in a specific state for a specific grade level). Customer subscriptions provide the vast majority of our revenue.

Factors affecting our revenue include: (i) the number of schools, classes or students purchasing our products; (ii) the term of the subscriptions; (iii) subscription renewals; (iv) the number of states or geographies in which we offer products; (v) the number of products we offer in a state or in a geographic region; (vi) the complexity and comprehensiveness of applicable standards, which impacts pricing; (vii) the effectiveness of our regional field-based and inside sales teams; (viii) recognition of revenue in any period from deferred revenue from subscriptions purchased or renewed during the current and prior periods; (ix) federal, state and local educational funding levels; and (x) discretionary purchasing funds available to our customers.

Pricing for Study Island subscriptions is based on a variety of factors. Study Island subscriptions are priced on a fixed price per class or a variable price per school based on the number of students per grade using the products. In addition, subscriptions are priced on a per subject matter basis with discounts given if all of the subjects for a given grade are purchased. Subscription prices also vary by state based on the number, complexity and comprehensiveness of the applicable standards. Our Study Island products are specifically built from the varying assessment standards in all 50 states, which we believe differentiates us from our competitors. For EducationCity, schools and/or districts (local authorities) pay a fixed annual subscription fee for each subject.

We increased our standard pricing for Study Island products in January 2010. We do not believe, however, that this pricing increase is meaningful to changes in our revenue. Our pricing structure is complex, using a set of standard prices, but offering discretionary discounts of different amounts for a wide range of circumstances with our clients. Additionally, considering that we recognize revenue from customer subscriptions ratably over the subscription periods (which average 15 months, but vary under many circumstances), price increases have a delayed impact on revenue within a single period presented in our financial statements.

The timing of sales to new and existing Study Island customers is affected by seasonal trends associated with school budget years and state testing calendars. As a result, most new subscriptions and renewals occur in the third quarter because teachers and school administrators typically make purchases for the new academic year at the beginning of their district’s fiscal year, which is usually July 1. Our fourth quarter has historically produced the second highest level of new subscriptions and renewals, followed by our second and first quarters. For EducationCity, the first quarter historically has been the strongest. Because revenue from customer subscriptions is deferred over the course of the subscription period and our customers pay for their subscriptions at the beginning of the subscription period, this seasonality does not cause our revenue to fluctuate significantly, but does impact our cash flow.

Cost of Revenue.

Cost of revenue for the three months ended September 30, 2010 increased by $0.8 million, or 104.3%, to $1.5 million from $0.7 million for the three months ended September 30, 2009. $0.4 million of this increase was due to the acquisition of EducationCity. The remainder of the increase in cost of revenue was primarily attributable to increased engineering salaries and contract labor costs resulting from increased headcount focusing on enhancing resources and management, along with increased costs for the Company’s disaster recovery site.

Cost of revenue consists of the costs to host and make available our products and services to our customers. A significant portion of the cost of revenue includes salaries and related expense for our engineering employees and contractors who maintain our servers and technical equipment and who work on our web-based hosted platform. Other costs include facility costs for our web platform servers and routers, network monitoring costs and amortization of our technical development intangible assets.

Sales and Marketing Expense.

Sales and marketing expense for the three months ended September 30, 2010 increased by $2.3 million, or 66.8%, to $5.7 million from $3.4 million for the three months ended September 30, 2009. $1.6 million of this increase was due to the acquisition of EducationCity. The remainder of the increase was primarily attributable to increases in salaries and related costs resulting from increased headcount, annual salary increases and bonus payments.

Our sales and marketing expense consists primarily of salaries, commissions, contract labor and related expenses for personnel in our inside and field sales teams, our new customer implementation and retention team, marketing, customer service, training and account management. Commissions are earned when sales are invoiced to customers. Other costs include marketing costs, travel and amortization of our customer relationship intangible assets. Marketing expense consists of direct mail, email prospecting, “pay per click” advertising, search engine optimization, printed material, marketing research, and trade shows. Marketing expense generally increases as our sales efforts increase, both in new and existing markets. Our marketing efforts are related to the launch of new product offerings, the introduction of our products and services in new states and geographic regions, and opportunities within a selected market associated with specific events such as timing for the standardized testing in a particular state and upcoming trade shows.

Content Development Expense.

Content development expense for the three months ended September 30, 2010 increased by $0.2 million, or 19.7%, to $1.2 million from $1.0 million for the three months ended September 30, 2009. This increase was primarily attributable to the acquisition of EducationCity.

Our content development expense primarily consists of salaries and related expense for our content development employees, who are responsible for writing the questions, lessons, activities and games content for our Study Island, EducationCity and Northstar Learning products, outsourced content writing costs, and amortization of our program content intangible assets.

General and Administrative Expense.

General and administrative expense for the three months ended September 30, 2010 increased by $3.0 million, or 116.3%, to $5.5 million from $2.5 million for the three months ended September 30, 2009. $0.8 million of this increase was related to the acquisition of EducationCity and $1.0 million of the increase was due to one-time expenses related to the move of our corporate headquarters. The remainder of the increase was primarily due to increased stock-based compensation expense from equity awards granted at our initial public offering, and increased audit, accounting and legal fees related to the requirements of being a public company.

Our general and administrative expense includes salaries and related expense for our executive, accounting, human resources and other administrative employees, professional services, board related expenses, regulatory requirements, rent, insurance, travel and other corporate expense.

Other Income (Expense).

Other income (expense) totaled $1.3 million of net expense for the three months ended September 30, 2010, which was an increase of expense of $0.3 million, or 33.2%, compared to net expense of $1.0 million for the three months ended September 30, 2009. The increase was primarily due to increased interest expense of $0.5 million during the period due to our additional loan on our term loan and draw on our revolving credit facility, which was partially offset by $0.1 million of interest income from our note receivable from Edline and a $0.2 million reduction in the loss from our interest rate swap.

Our other income (expense) includes interest expense, interest income and derivative and foreign currency losses. Interest expense includes interest on our $70.0 million term loan and $10.0 million revolving credit facility entered into in November 2007, interest on our $15.0 million supplemental term loan and $10.0 million supplemental revolving credit facility entered into in June 2010, and amortization of debt financing costs. We had no amounts outstanding under the revolving credit facility as of September 30, 2010. We borrowed $10.0 million under our revolving credit facility on June 9, 2010, in connection with our acquisition of EducationCity, and we subsequently repaid it during the three months ended September 30, 2010. No amounts were outstanding under the revolving credit facility during the nine months ended September 30, 2009. The amounts borrowed under our term loan bear interest at rates based upon either a base rate or LIBOR, plus an applicable margin. Interest income includes income on our cash and cash equivalent investments and from our note receivable from Edline. Derivative loss includes changes in the fair value and realized interest income and expense on our interest rate swap, which is required by the terms of our credit facility and is part of our overall risk management strategy. We entered into the swap arrangement in December 2007 with an initial notional amount of $45.5 million. In June 2009, the notional amount of the interest rate swap decreased to $40.5 million and will decrease in periodic amounts to a notional amount of $30.5 million at the December 31, 2010 termination date. At September 30, 2010, the notional amount of the interest rate swap was $30.5 million. We swapped a floating rate payment based on the three-month LIBOR for a fixed rate of 4.035% in order to minimize the variability in expected future cash flow due to interest rate movements on our LIBOR-based variable rate debt. We have not designated our interest rate swap as a cash flow hedge. The foreign currency loss was primarily related to payments of intercompany transactions between EducationCity in the United States and the United Kingdom.

Provision for Income Tax.

Our provision for income tax is comprised of federal, foreign, state and local taxes based on our income in the appropriate jurisdictions. Prior to the reorganization transaction where shareholders of Archipelago Learning Holdings, LLC exchanged their shares for stock in Archipelago Learning, Inc., we were treated as a partnership and were not a taxpaying entity for federal income tax purposes. As a result, our income was taxed to our members in their individual federal income tax returns. Upon the reorganization, we became taxed as a corporation. Upon our acquisition of EducationCity, we became a taxpayer in the United Kingdom for the taxable income of EducationCity

Limited. We recognized tax expense using an effective rate of 25.1% for the three months ended September 30, 2010. Tax expense for the three months ended September 30, 2009 represented unrecognized tax benefits related to a state tax filing position.

Comparison of the Nine Months Ended September 30, 2010 and 2009

The following table summarizes our consolidated operating results for the nine months ended September 30 (dollars in thousands):


							Change
	2010			2009			Dollars			Percentage
Revenue	$	41,595		$	30,801		$	10,794			35.0	%
Cost of revenue		3,476			2,186			1,290			59.0	%

Gross profit		38,119			28,615			9,504			33.2	%
Operating expense:
Sales and marketing		13,679			9,682			3,997			41.3	%
Content development		3,462			2,586			876			33.9	%
General and administrative		14,909			6,890			8,019			116.4	%

Total		32,050			19,158			12,892			67.3	%

Income from continuing operations		6,069			9,457			(3,388	)		(35.8	%)
Other income (expense):
Interest expense		(2,909	)		(2,071	)		(838	)		40.5	%
Interest income		439			44			395			897.7	%
Foreign currency loss		(220	)		—			(220	)		**
Derivative loss		(78	)		(436	)		358			(82.1	%)

Total		(2,768	)		(2,463	)		(305	)		12.4	%

Net income from continuing operations before tax		3,301			6,994			(3,693	)		(52.8	%)
Provision for income tax		1,227			449			778			173.3	%

Net income from continuing operations	$	2,074		$	6,545		$	(4,471	)		(68.3	%)


**		Percentage not meaningful for analysis.

Revenue.

Revenue for the nine months ended September 30, 2010 was $41.6 million, representing an increase of $10.8 million, or 35.0%, as compared to revenue of $30.8 million for the nine months ended September 30, 2009. $2.6 million of this increase was due to the acquisition of EducationCity. Subscription and training revenue is recognized over the term of the subscription, which averages 15 months. Consequently, our revenue in any month is impacted by invoiced sales from subscriptions purchased or renewed during the current and prior periods. The increase in revenue during the period is due to increased traction in states newly entered in the prior year, increased products in our more mature states leading to additional sales to existing customers, our increased focus on existing customers and renewal efforts, and our planned increases in our sales force.

The following table sets forth information regarding our invoiced sales as well as other metrics that impact our revenue for the nine months ended September 30 (dollars in thousands):


	2010			2009
Invoiced sales:
Study Island new customers	$	11,895		$	10,912
Study Island existing customers		35,548			27,806
Study Island other sales		955			810
EducationCity		4,584			—

Total		52,982			39,528
Royalties on invoiced sales		(31	)		—
Change in deferred revenue(1)		(11,356	)		(8,727	)

Revenue	$	41,595		$	30,801



(1) Change in deferred revenue in 2010 excludes the amount of deferred revenue assumed with the acquisition of EducationCity and includes foreign exchange fluctuation impacts.

Other metrics:
Schools using Study Island products		23,355			20,812
Study Island products available		1,377			1,190

We increased our standard pricing in January 2010. We do not believe, however, that this pricing increase is meaningful to changes in our revenue. Our pricing structure is complex, using a set of standard prices, but offering discretionary discounts of different amounts for a wide range of circumstances with our clients. Additionally, considering that we recognize revenue from customer subscriptions ratably over the subscription periods (which average 15 months, but vary under many circumstances), price increases have a delayed impact on revenue within a single period presented in our financial statements.

The timing of sales to new and existing Study Island customers is affected by seasonal trends associated with school budget years and state testing calendars. As a result, most new subscriptions and renewals occur in the third quarter because teachers and school administrators typically make purchases for the new academic year at the beginning of their district’s fiscal year, which is usually July 1. Our fourth quarter has historically produced the second highest level of new subscriptions and renewals, followed by our second and first quarters. Because revenue from customer subscriptions is deferred over the course of the subscription period and our customers pay for their subscriptions at the beginning of the subscription period, this seasonality does not cause our revenue to fluctuate significantly, but does impact our cash flow.

Due to purchase accounting for the acquisition of EducationCity, we do not recognize the full amounts paid by customers for acquired subscriptions prior to the acquisition. Consequently, the deferred revenue balance at the date of acquisition was reduced from $15.6 million to $9.9 million. The purchase accounting adjustment reduced our revenues by $1.2 million for the nine months ended September 30, 2010.

Cost of Revenue.

Cost of revenue for the nine months ended September 30, 2010 increased by $1.3 million, or 59.0%, to $3.5 million from $2.2 million for the nine months ended September 30, 2009. $0.5 million of this increase in costs was due to the acquisition of EducationCity. The remainder of the increase in cost of revenue was primarily attributable to increased engineering salaries and related costs resulting from increased headcount and annual salary increases focusing on enhancing resources and management, along with increased costs for the Company’s disaster recover site.

Sales and Marketing Expense.

Sales and marketing expense for the nine months ended September 30, 2010 increased by $4.0 million, or 41.3%, to $13.7 million from $9.7 million for the nine months ended September 30, 2009. $2.0 million of this increase was due to the acquisition of EducationCity. The remainder of the increase was primarily attributable to increases in salaries and related costs resulting from increased headcount, annual salary increases and bonus payments.

Content Development Expense.

Content development expense for the nine months ended September 30, 2010 increased by $0.9 million, or 33.9%, to $3.5 million from $2.6 million for the nine months ended September 30, 2009. $0.3 million of this increase was due to the acquisition of EducationCity. The remainder of this increase was primarily attributable to increases in salaries and related costs related to increased headcount for the development of our enhanced Study Island version 4 and the launch of additional products in Canada, along with annual salary increases and bonus payments, and increased outsourced content writing costs, primarily related to development of our new SAT and ACT products and to Northstar Learning.

General and Administrative Expense.

General and administrative expense for the nine months ended September 30, 2010 increased by $8.0 million, or 116.4%, to $14.9 million from $6.9 million for the nine months ended September 30, 2009. $1.0 million of this increase was due to EducationCity’s general and administrative costs subsequent to our acquisition. The remainder of this increase was primarily attributable to $3.4 million in transaction costs related to the acquisition of EducationCity, $1.0 million one-time expenses related to the move of our corporate headquarters, increases in salaries and related costs, primarily due to increased stock-based compensation expense from equity awards granted

at our initial public offering, and an increase in audit, accounting and legal fees related to the requirements of being a public company.

Other Income (Expense).

Other income (expense) totaled $2.8 million of net expense for the nine months ended September 30, 2010, which was an increase of 12.4% as compared to our net expense of $2.5 million for the nine months ended September 30, 2009. Interest expense increased $0.8 million during the period due to our additional loan on our term loan and draw on our revolving credit facility, which was offset by $0.4 million of interest income from our note receivable from Edline.

Provision for Income Tax.

Liquidity and Capital Resources

Our primary cash requirements include the payment of our operating expense, interest and principal payments on our debt, and capital expenditures. Prior to our reorganization and initial public offering, we used cash to make dividend payments and tax-related distributions to our equity holders. We do not anticipate paying any dividends on our capital stock for the foreseeable future. We may also incur unexpected costs and operating expenses related to any unforeseen disruptions to our servers, the loss of key personnel or changes in the credit markets and interest rates, which could increase our immediate cash requirements or otherwise impact our liquidity. We finance our operations primarily through cash flow from operations, which is typically the highest in the third and fourth quarters when our sales are highest and invoices are paid. Our cash flow from operations is typically flat in the first and second quarters. Several factors outside of our control may impact our cash flow. For example, we believe that there is substantial uncertainty around the substance and timing of the ESEA reauthorization. We believe that although the current presidential administration has stated that education reform is a priority for 2010, it is unlikely to occur this year. The terms of its extension, reauthorization or new legislation that would replace it may materially impact the demand for our products. If new legislation lessens the importance of standards, assessments and accountability, or introduces national standards or assessments that would make it easier for competitors to enter our markets, demand for our products may materially decrease, and we may experience lower cash flows, which would affect our liquidity. In addition, if sufficient funding is not provided to education and state and local budget cuts in education continue, our public school and school district customers may lack funding to buy our products which may result in fewer sales or require us to lower prices for our Study Island products, either of which would have a negative impact on our cash flows.

Our primary sources of liquidity are our cash and cash equivalent balances as well as availability under our revolving credit facility. As of September 30, 2010, we had cash and cash equivalents of $24.3 million and $20.0 million of availability under our revolving credit facility. Our total indebtedness was $76.0 million at September 30, 2010, including our additional term loan of $15.0 million in connection with the acquisition of EducationCity and amended credit agreement. We believe that our consistent cash flow and our $20.0 million availability combined with our low capital expenditure costs will provide us with sufficient capital to continue to grow our business. There can be no assurance, however, that cash resources will be available to us in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. Our ability to meet our debt service obligations and other capital requirements, including capital expenditures and acquisitions, will depend upon our future results of operations and our ability to obtain additional debt or equity capital and our ability to stay in compliance with our financial covenants, which, in turn, will be subject to general economic, financial, business,

competitive, legislative, regulatory and other conditions, many of which are beyond our control. We may also need to obtain additional funds to finance acquisitions, which may be in the form of additional debt or equity. Although we believe we have sufficient liquidity under our revolving credit facility, as discussed above, under extreme market conditions there can be no assurance that such funds would be available or sufficient, and in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all.

Cash Flows

Our net consolidated cash flows consist of the following, for the nine months ended September 30 (in thousands):


	2010			2009
Provided by (used in):
Operating activities	$	15,373		$	13,358
Investing activities		(61,781	)		(5,927	)
Financing activities		12,139			(3,464	)

Cash Flows from Operating Activities

Net cash provided by operating activities was $15.4 million for the nine months ended September 30, 2010, compared to $13.4 million during the nine months ended September 30, 2009. This $2.0 million increase was primarily due to increased cash generated from our invoiced sales which was partially offset by payments for transaction costs related to the acquisition of EducationCity of $3.4 million, partially offset by cash generated from net income, excluding transaction costs.

Cash Flows from Investing Activities

Net cash used for investing activities for the nine months ended September 30, 2010 included $61.5 million for the purchase of EducationCity, $0.6 million for receipt of part of the escrow from our sale of TeacherWeb and $1.0 million for the purchase of property and equipment. Net cash used for investing activities for the nine months ended September 30, 2009 was $5.9 million including $1.0 million used for the purchase of property and equipment and an investment in and note issued to Edline, for an aggregate of $4.9 million.

Cash Flow from Financing Activities

Net cash provided by financing activities in the nine months ended September 30, 2010 included $15.0 million of additional term note and $10.0 million drawn on our revolver, less $0.8 million paid in additional financing costs, in order to finance the acquisition of EducationCity, $1.5 million for the payment of offering costs accrued at December 31, 2009 and $0.6 million in principal payments on our term loan. The $10.0 million revolver was repaid during the three months ended September 30, 2010. Net cash used for financing activities in the nine months ended September 30, 2009 included $1.0 million of payments on our term loan, funding of $1.3 million to the members of the LLC related to member tax liabilities and $1.2 million paid for costs related to the offering.

Credit Facility

In November 2007, our subsidiary, Archipelago Learning, LLC (formerly Study Island, LLC) (the “Borrower”), entered into an $80.0 million credit facility with General Electric Capital Corporation, as agent, composed of a $70.0 million term loan and a $10.0 million revolving credit facility, which expires in November 2013. The proceeds of the term loan and $4.9 million in cash were used to pay a distribution of $73.2 million to holders of Class A shares of Archipelago Learning Holdings, LLC and debt financing costs. The term loan bears interest at rates based upon either a base rate or LIBOR plus an applicable margin (3.75% as of September 30, 2010 and 3.25% as of September 30, 2009, in each case for a LIBOR-based term loan) determined based on the Borrower’s leverage ratio. Amounts under the revolving credit facility can be borrowed and repaid, from time to time, at the Borrower’s option, subject to the pro forma compliance with certain financial covenants.

In May 2009, the credit agreement governing the term loan and the revolving credit facility (the “Credit Agreement”) was amended to permit the creation of AL Midco, LLC, or AL Midco, a new wholly owned subsidiary of Archipelago Learning Holdings, LLC, which assumed all of Archipelago Learning Holdings, LLC’s interests in the Borrower. AL Midco became a guarantor under the Credit Agreement and Archipelago Learning Holdings, LLC

was released as a guarantor. In November 2009, the Credit Agreement was further amended to permit the sale of TeacherWeb. This amendment further modified certain terms of the Credit Agreement, including adding a LIBOR floor of 1.25% to the calculation of the interest rates and reducing the letter of credit sublimit available to the Borrower under the Credit Agreement from $2.0 million to $1.0 million. In addition, the Borrower repaid an aggregate amount of $6.5 million upon the consummation of the sale of TeacherWeb, which was completed in November 2009. As a result of the sale, TeacherWeb was released as a guarantor.

In June 2010, the Credit Agreement was further amended to permit the acquisition of EducationCity and to add a $15 million supplemental term loan and an additional $10 million to the revolving credit facility. This amendment further modified certain terms of the Credit Agreement, including increasing the applicable margin on all loans by 0.50%, modifying the definition of permitted acquisitions, and increasing the letter of credit sublimit available to the Borrower under the Credit Agreement from $1.0 million to $2.0 million.

The Credit Agreement is secured on a first-priority basis by security interests (subject to permitted liens) in substantially all tangible and intangible assets owned by the Borrower and AL Midco. In addition, any future domestic subsidiaries of the Borrower will be required (subject to certain exceptions) to guarantee the Credit Agreement and grant liens on substantially all of its assets to secure such guarantee.

The Credit Agreement requires the Borrower to maintain certain financial ratios, including a leverage ratio (based on the ratio of consolidated indebtedness, net of cash and cash equivalents subject to control agreements, to Consolidated EBITDA, defined in the Credit Agreement as consolidated net income adjusted by adding back interest expense, taxes, depreciation, amortization and certain other non-recurring or otherwise permitted fees and charges), an interest coverage ratio (based on the ratio of Consolidated EBITDA to consolidated interest expense, as defined in the Credit Agreement) and a fixed charge coverage ratio (based on the ratio of Consolidated EBITDA to consolidated fixed charges, as defined in the Credit Agreement). Based on the formulations set forth in the Credit Agreement, as of September 30, 2010, the Borrower was required to maintain a maximum leverage ratio of 3.50 to 1.00, a minimum interest coverage ratio of 2.50 to 1.00 and a minimum fixed charge coverage ratio of 1.50 to 1.00. As of September 30, 2010, the Borrower’s leverage ratio was 2.02 to 1.00, its interest coverage ratio was 7.30 to 1.00 and its fixed charge coverage ratio was 3.71 to 1.00. The financial ratios the Borrower is required to maintain become more restrictive over time. Our next scheduled increase at December 31, 2010 will bring the maximum leverage ratio to 2.50 to 1.00, the minimum interest coverage ratio to 2.65 to 1.00 and the minimum fixed charge coverage ratio to 1.60 to 1.00.

The Credit Agreement also contains certain affirmative and negative covenants applicable to AL Midco, the Borrower and the Borrower’s subsidiaries that, among other things, limit the incurrence of additional indebtedness, liens on property, sale and leaseback transactions, investments, loans and advances, merger or consolidation, asset sales, acquisitions, dividends, transactions with affiliates, prepayments of subordinated indebtedness, modifications of the Borrower’s organizational documents and restrictions on the Borrower’s subsidiaries. The Credit Agreement contains events of default that are customary for similar credit facilities, including a cross-default provision with respect to other indebtedness and an event of default that would be triggered by a change of control, as defined in the Credit Agreement, and which was not triggered by our initial public offering. As of September 30, 2010 the Borrower was in compliance with all covenants.

The Borrower has the right to optionally prepay its borrowings under the Credit Agreement, subject to the procedures set forth in the Credit Agreement. The Borrower may be required to make prepayments on its borrowings under the Credit Agreement if it receives proceeds as a result of certain asset sales, debt issuances or events of loss. In addition, a mandatory prepayment of the borrowings under the Credit Agreement is required each fiscal year in an amount equal to (i) 75% of excess cash flow (as defined by the Credit Agreement) if the leverage ratio as of the last day of the fiscal year is greater than 4.00 to 1.00, (ii) 50% of excess cash flow if the leverage ratio as of the last day of the fiscal year is less than or equal to 4.00 to 1.00 but greater than 3.25 to 1.00, or (iii) 25% of excess cash flow if the leverage ratio as of the last day of the fiscal year is less than or equal to 3.25 to 1.00. No mandatory prepayment is required if the leverage ratio is less than or equal to 2.50 to 1.00 on the last day of the fiscal year.

As of September 30, 2010, $76.0 million of borrowings were outstanding under the term loans and no amounts were outstanding under the revolving credit facility. As of December 31, 2009, $61.6 million of borrowings were outstanding under the term loan and no amounts were outstanding under the revolving credit facility. For the three months ended September 30, 2010 and 2009, the weighted average interest rate under the term loans was 5.00% and 3.58%, respectively, and for the nine months ended September 30, 2010 and 2009, the weighted average interest rate

under the term loans was 4.62% and 3.71%, before giving effect to the Borrower’s interest rate swap. The rate on the interest rate swap is the difference between the Borrower’s fixed rate of 4.035% and the floating rate of three-month LIBOR.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our consolidated financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates including those related to long-lived intangible and tangible assets, goodwill and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. All intercompany balances and transactions have been eliminated in consolidation.

The accounting policies we believe to be most critical to understanding our results of operations and financial condition and that require complex and subjective management judgments are discussed in our annual report on Form 10-K. We have not adopted any changes to such policies during the three months ended September 30, 2010.

Recently Issued Accounting Standards

The Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2009-13,Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. ASU 2009-13 amends existing revenue guidance related to revenue arrangements with multiple deliverables to allow the use of companies’ estimated selling prices as the value for deliverable elements under certain circumstances and to eliminate the use of the residual method for allocation of deliverable elements. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010, with earlier adoption permitted. We are currently evaluating the impact this standard will have on our financial statements.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

Interest Rate Risk

We are exposed to interest rate risk in connection with our term loan and any borrowings under our revolving credit facility. Amounts borrowed under our term loan and our revolving credit facility bear interest at rates based upon a base rate or LIBOR, plus an applicable margin. To manage our interest rate exposure, and as a requirement under our term loan, we entered into an interest rate swap agreement with a notional amount totaling $45.5 million, of which $30.5 million remained in effect as of September 30, 2010. We swapped a floating rate payment based on three month LIBOR for a fixed rate of 4.035% in order to minimize the variability in expected future cash flow due to interest rate movements on our LIBOR-based variable rate debt. Based on the short-term LIBOR rate and our debt balance as of September 30, 2010, a 1% increase in the short-term LIBOR rate, before giving effect to the interest rate swap, would have no material impact on our interest rate on the term loan or our interest expense. Due to the LIBOR floor of 1.25%, a 1% decrease in the short-term LIBOR rate, before giving effect to the interest rate swap, would have no impact on our interest rate on the term loan or our interest expense.

In addition, our interest income is sensitive to changes in the general level of U.S. interest rates. We had cash and cash equivalents of $24.3 million and $58.2 million as of September 30, 2010 and December 31, 2009, respectively. Our cash and cash equivalents are maintained primarily in short term, treasury-backed accounts.

With the acquisition of EducationCity, we now transact business with our United Kingdom customers, employees and vendors in British Pounds. The change in the value of the United States dollar measured against British Pounds could positively or negatively affect our consolidated financial results, as expressed in United States

dollars. For the three months ended and nine months ended September 30, 2010, 8.2% and 3.8%, respectively, of our revenues were denominated in British Pounds. We expect the percentage of revenues denominated in foreign currencies will increase in future periods as such periods will reflect full period sales of our EducationCity products and as we expand our international operations.

Foreign Currency Risk

We do not currently hedge our foreign currency exposure using financial instruments. We maintain sufficient cash and cash equivalents in the United Kingdom to satisfy our anticipated payment needs in British Pounds. We cannot predict with any certainty our future exposure to such currency exchange rate fluctuations and the impact they may have on our consolidated financial position, results of operations, or cash flows. The current (spot), average, and low and high British Pounds currency exchange rates as compared to the United States dollar as of and for the nine months ended September 30, 2010 were as follows:


	Spot		Average		Low		High
British Pounds		1.5809		1.5343		1.4235		1.6457

Effects of Inflation

We do not believe that inflation has had a material impact on our results of operations in the periods presented. We cannot assure you that future inflation will not affect our operating expense in future periods.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of the Evaluation Date, these disclosure controls and procedures are effective.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

We currently are not subject to any material litigation or regulatory proceedings.

Item 1A. Risk Factors

In addition to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, we believe the following risk factors should also be considered in evaluating our business and future prospects:

We may not realize the expected benefits of the EducationCity acquisition because of integration difficulties and other challenges.

The success of the acquisition of EducationCity will depend, in part, on our ability to integrate EducationCity’s operations with our existing business. The integration process may be complex, costly and time-consuming. The difficulties of integrating the operations of EducationCity’s business include, among others:

	•		failure to implement our business plan for the acquired business;

	•		unanticipated issues in integrating sales, financial reporting and other systems;

	•		unanticipated changes in applicable laws, regulations and education requirements;

	•		failure to retain key employees;

	•		failure to retain customers;

	•		failure to maintain or increase sales volume;

	•		operating, competitive and market risks inherent in our business;

	•		the impact of the acquisition of EducationCity on our internal controls and compliance with the regulatory requirements under the Sarbanes-Oxley Act of 2002; and

	•		unanticipated issues, expenses and liabilities.

We may not accomplish the integration of EducationCity’s business smoothly, successfully or within the anticipated cost range or timeframe. The diversion of our management’s attention from our pre-existing operations to the integration effort and any difficulties encountered in combining operations could prevent us from realizing the full benefits anticipated to result from the acquisition of EducationCity and could adversely affect our business.

Fluctuations in exchange rates could have an adverse effect on our results of operations, even if our underlying business results improve or remain steady.

Our reporting currency is the U.S. dollar, and we are exposed to foreign exchange rate risk because, following our acquisition of EducationCity, a portion of our net sales and costs are denominated in British Pounds, which we convert to U.S. dollars for financial reporting purposes. We do not engage in any hedging activities with respect to currency fluctuations. Changes in exchange rates on the translation of the earnings in foreign currencies into U.S. dollars are directly reflected in our financial results. As such, to the extent the value of the U.S. dollar increases or decreases against British Pounds, it may negatively impact our reported net income, even if our results of operations denominated in local currency have improved or remained steady. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future, which could materially and adversely affect our financial position and results of operations.

System disruptions, vulnerability from security risks to our networks, databases and online applications and an inability to expand and upgrade our systems in a timely manner to meet unexpected increases in demand could damage our reputation, impact our ability to generate revenue and limit our ability to attract and retain customers.

The performance and reliability of our technology infrastructure is critical to our business. Any failure to maintain satisfactory online product performance, reliability, security or availability of our web platform infrastructure may significantly reduce customer satisfaction and damage our reputation, which would negatively impact our ability to attract new customers and obtain customer renewals. The risks associated with our web platform include:

	•		breakdowns or system failures resulting in a prolonged shutdown of our servers, including failures attributable to power shutdowns or attempts to gain unauthorized access to our systems, which may cause loss or corruption of data or malfunction of software or hardware;

	•		breakdowns or system failures resulting from the release of new features or functionality, which may cause unintended malfunctions of software or hardware;

	•		human error by systems engineers, programmers, other internal staff, collocation or other vendor staff; performance issues, such as low response time or bugs, that detract from the user experience;

	•		increased complexity or more difficult navigation resulting from implementation of new features and functionality, that detract from the user experience;

	•		disruption or failure in our colocation provider, which would make it difficult or impossible for students and teachers to log on to our websites;

	•		damage from fire, flood, tornado, power loss or telecommunications failures;

	•		infiltration by hackers or other unauthorized persons; and

	•		any infection by or spread of computer viruses.

In addition, increases in the volume of traffic on our websites could strain the capacity of our existing infrastructure, which could lead to slower response times or system failures. This would cause a disruption or suspension of our product and service offerings.

Any web platform interruption or inadequacy that causes performance issues or interruptions in the availability of our websites could reduce customer satisfaction and result in a reduction in the number of customers using our products and services. If sustained or repeated, these performance issues could reduce the attractiveness of our websites and products and services.

We may need to incur additional costs to upgrade our computer systems in order to accommodate system disruptions, security risks and increased demand if we anticipate that our systems cannot handle higher volumes of traffic in the future. We may also need to upgrade our web platform and systems as new technologies become available that we are required to implement in order to keep our infrastructure up-to-date and product offerings relevant, or we are forced to make upgrades in response to new competitors or significant improvements to existing competitors’ web platforms and system capabilities. However, the costs and complexities involved in expanding and upgrading our systems may prevent us from doing so in a timely manner and may prevent us from adequately meeting the demand placed on our systems.

Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our sales and marketing expenditures in recruiting new customers.

Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our sales efforts, including our ability to:

	•		secure additional new school and district customers as our penetration increases;

	•		retain existing customers and sell them additional products and services;

	•		continue our strong “word-of-mouth” customer referrals

	•		retain our most productive sales managers and staff;

	•		compete effectively against larger competitors to secure district level sales; and

	•		build an “education” thought leadership position with key state and district education administrators.

In addition, our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing expenditures, including our ability to:

	•		create greater awareness of our brands;

	•		select the right market, media and specific media vehicles in which to advertise;

	•		identify the most effective and efficient level of spending in each market, media and specific media vehicle;

	•		provide timely and appropriate sales collateral to assist the sales team;

	•		determine the appropriate creative message and media mix for advertising, marketing and promotional expenditures;

	•		determine the most appropriate pricing models and simple quote generator for customers and sales reps;

	•		effectively manage marketing costs, including creative and media expense, in order to maintain acceptable customer acquisition costs;

	•		keep the website navigation and messaging simple and relevant to customers;

	•		generate leads for sales, including obtaining educator lists in a cost-effective manner;

	•		drive traffic to our website; and

	•		convert customer inquiries into actual orders.

Our planned sales and marketing efforts and expenditures may not result in increased revenue or generate sufficient levels of product and brand awareness, and we may not be able to increase our net sales at the same rate as we increase our sales and marketing efforts and expenditures.

We operate in a highly competitive market subject to rapid technological changes, and increasing competition could lead to pricing pressures, reduced operating margins, loss of market share and increased capital expenditures.

The markets for our products and services are highly competitive, and we expect increased competition in the future that could adversely affect our revenue and market share. Our current competitors include but are not limited to:

	•		providers of online and offline supplemental instructional materials for the core subject areas of reading, mathematics, science and social studies for K-12 institutions;

	•		companies that provide K-12-oriented software and web-based educational assessment and remediation products and services to students, educators, parents and educational institutions;

	•		the textbook, supplemental and assessment divisions of established education publishers, including Pearson Education, Inc., The McGraw-Hill Companies and Houghton Mifflin Harcourt Company;

	•		providers of online and offline test preparation materials;

	•		traditional print textbook and workbook companies that publish K-12 core subject educational materials, standardized test preparation materials or paper and pencil assessment tools;

	•		summative assessment companies, which traditionally assess student learning at the end of a class period, that have expanded their line to include products that provide periodic assessment in the classroom to gauge student learning and inform instruction, also known as formative assessment;

	•		non-profit and membership educational organizations and government agencies that offer online and offline products and services, including in some cases at no cost, to assist individuals in standards mastery and test preparation; and

	•		existing customers, such as virtual school providers, that purchase our content today but may in the future either create their own content, license content from someone else, or acquire a company that provides similar content.

Some of our competitors may have more resources than we do, and several of the largest K-12 educational publishers may have more experience, larger customer bases and greater brand recognition in the markets we serve. Further, larger established companies with high brand recognition and extensive experience providing various educational products to the K-12 market may develop online products and services that are competitive with our core products and services. These competitors may be able to devote greater resources than us to the development, promotion and sale of their services and respond more quickly than we can to new technologies or changes in customer requirements or preferences. We may not be able to compete effectively with current or future competitors, especially those with significantly greater resources or more established customer bases, which may materially adversely affect our sales and our business.

The K12 supplemental market is also very fragmented and some of our competitors are relatively small, regional companies that tend to compete based on very low price points for their products. We may lose some new or existing business to these niche companies particularly in a period of significant school budget pressures.

If our products or services contain errors, new product releases could be delayed or our services could be disrupted. As a result, our customers may choose not to renew their subscriptions and our business could be materially adversely affected.

If our products or services contain defects, errors or security vulnerabilities, our reputation could be harmed, which could result in significant costs to us and impair our ability to sell our products and services in the future. Because our products and services are complex and because we do not “pre-launch” any of our products or upgrades to any third parties prior to the official launch, they may contain undetected errors or defects, known as bugs. Bugs can be detected at any point in time, but are more common when a new product or service is introduced or when new versions are released. We expect that, despite our testing, errors will be found in the future. If an error occurs, our product and service offerings may be disrupted, causing delays or interruptions. Significant errors, delays or disruptions could lead to:

	•		decreases in customer satisfaction with and loyalty toward our products and services;

	•		delays in or loss of market acceptance of our products and services;

	•		diversion of our resources;

	•		a lower rate of subscription renewals or upgrades;

	•		injury to our reputation;

	•		rebates or refunds of subscription fees;

	•		increased service expense or payment of damages; or

	•		increased competitive focus on our existing and prospective customer base.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 5. Other Information

None.

Item 6. Exhibits

See Index to Exhibits following the signature page of this Quarterly Report on Form 10-Q.

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, in the City of Dallas, State of Texas, on the 12^th day of November, 2010.


	ARCHIPELAGO LEARNING, INC.
	By:	/s/ Tim McEwen
		Tim McEwen
		President and Chief Executive Officer


	By:	/s/ James Walburg
		James Walburg
		Executive Vice President, Chief Financial Officer and Secretary

EXHIBIT INDEX


Exhibit
Number		Description of Exhibits

4.1		Registration Rights Agreement, dated as of June 9, 2010, by and among Archipelago Learning, Inc., Matt Drakard, Simon Booley and Tom Morgan. (Filed as Exhibit 4.1 to Current Report on Form 8-K (File No. 001-34555) filed on June 10, 2010)

10.1		Second Amendment to Employment Agreement, dated as of February 18, 2010, between Archipelago Learning, LLC and Ray Lowrey. (Filed as Exhibit 10.45 to Annual Report on Form 10-K (File No. 001-34555) filed on March 5, 2010)

10.2		Archipelago Learning, Inc. Amended and Restated 2009 Employee Stock Purchase Plan. (Filed as Exhibit 99.1 to Current Report on Form 8-K (File No. 001-34555) filed on June 9, 2010)

10.3		Share Purchase Agreement, dated as of June 9, 2010, by and among Archipelago Learning, Inc., Archipelago Learning Holdings UK Limited, Matt Drakard, Simon Booley and Tom Morgan. (Filed as Exhibit 10.1 to Current Report on Form 8-K (File No. 001-34555) filed on June 10, 2010)

10.4		Amendment No. 7 to Credit Agreement, dated as of June 9, 2010, by and among Archipelago Learning, LLC, the other credit parties party thereto, the lenders party thereto and General Electric Capital Corporation, as agent. (Filed as Exhibit 10.2 to Current Report on Form 8-K (File No. 001-34555) filed on June 10, 2010)

10.5		Service Agreement, dated as of June 9, 2010, by and between Matthew Drakard and Educationcity Limited. (Filed as Exhibit 10.3 to Current Report on Form 8-K (File No. 001-34555) filed on June 10, 2010)

10.6		Service Agreement, dated as of June 9, 2010, by and between Simon Booley and Educationcity Limited. (Filed as Exhibit 10.4 to Current Report on Form 8-K (File No. 001-34555) filed on June 10, 2010)

11.1*		Statement re computation of per share earnings (incorporated by reference to Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report).

31.1*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


*		Filed herewith.

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Litigous
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Archipelago Learning (ARCL) Inactive 10-Q2010 Q3 Quarterly report

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