UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

Commission file number: 0-22187

RENAISSANCE LEARNING, INC.

2911 Peach Street
P.O. Box 8036
Wisconsin Rapids, Wisconsin
(Address of principal executive offices)

54495-8036
(Zip Code)

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

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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

RENAISSANCE LEARNING, INC.

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

See accompanying notes to condensed consolidated financial statements.

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

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RENAISSANCE LEARNING, INC. AND SUBSIDIARIES

1. Consolidation

     The condensed consolidated financial statements include the financial results of Renaissance Learning, Inc. and our subsidiaries. Our significant subsidiaries include Renaissance Corporate Services, Inc. and Generation 21 Learning Systems, LLC. All significant intercompany transactions have been eliminated in the condensed consolidated financial statements.

2. Basis of Presentation

     The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in our opinion, necessary for a fair presentation of the results of the interim periods, and are presented on an unaudited basis. These financial statements should be read in conjunction with the financial information contained in our Annual Report on Form 10-K for the year ended December 31, 2003, which is on file with the U.S. Securities and Exchange Commission (“2003 Annual Report”).

     The results of operations for the three and six month periods ended June 30, 2004 and 2003 are not necessarily indicative of the results to be expected for the full year.

3. Earnings Per Common Share

     Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Shares issued and shares reacquired during the period are weighted for the portion of the period they were outstanding. Diluted earnings per common share has been computed based on the weighted average number of common shares outstanding, increased by the number of additional common shares that would have been outstanding if the potentially dilutive stock option shares had been issued.

     On April 17, 2002, our Board of Directors authorized a repurchase program which provides for the repurchase of up to 5,000,000 shares of our common stock. No time limit was placed on the duration of the repurchase program, nor is there any dollar limit on the program. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. During the six months ending June 30, 2004, we did not repurchase any shares under this program. The cumulative shares repurchased under this program remain at 4.0 million with an associated cost of $72.9 million.

     The weighted average shares outstanding are as follows:

     For the three months ended June 30, 2004 and 2003, 781,102 and 833,432 shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. For the six months ended June 30, 2004 and 2003, 774,536 and 902,542 shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. These options could be dilutive in the future.

4. Comprehensive Income

     Total comprehensive income was $13.6 million and $16.5 million in the first six months of 2004 and 2003, respectively. For the quarters ended June 30, 2004 and 2003, comprehensive income was $7.7 million and $8.9 million, respectively. Our comprehensive income includes foreign currency translation adjustments.

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5. Goodwill and Other Intangible Assets

     In accordance with SFAS No. 142 “Goodwill and Other Intangible Assets”, goodwill is not amortized but is tested at least annually for impairment. Our other intangible assets have finite lives and are amortized over their estimated useful lives of four years for algorithms and purchased software code, and five years for the non-compete agreement. Other intangibles with finite lives are scheduled to be fully amortized in 2005 with corresponding amortization estimated to be $139,000 for the remainder of 2004, and $192,000 for 2005.

     For the three months ended June 30, 2004 and 2003, we recognized amortization expense on other intangibles of $74,000 and $114,000, respectively. For the six months ended June 30, 2004 and 2003, we recognized amortization expense of $147,000 and $249,000, respectively. No goodwill or other intangibles were acquired or impaired during the six months ended June 30, 2004 or 2003. Other intangibles consisted of the following (in thousands):

6. Stock Option Plan

     We have established the 1997 Stock Incentive Plan for our officers, key employees, non-employee directors and consultants. The intrinsic value method as prescribed in APB 25, “Accounting for Stock Issued to Employees”, is used to account for stock based compensation arrangements. Had compensation cost been determined for our plan based on the fair value at the grant dates for awards consistent with the alternative method set forth under SFAS 123, our net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

     No options were granted during the second quarter of 2004 or 2003. The fair value of options granted in the first six months of 2004 and 2003 were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

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7. Segment Reporting

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

8. Dividends

     On March 1, 2004, we paid a special cash dividend of $2.15 per share and our first quarterly dividend of $.04 per share totaling $67.9 million. On June 1, 2004, we paid a quarterly cash dividend of $.04 per share totaling $1.2 million.

     On July 21, 2004, our Board of Directors declared a quarterly cash dividend of $.04 per share, payable September 1, 2004 to shareholders of record as of August 13, 2004.

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

Results of Operations

     Our results of operations can be affected by general economic factors and their related impact on state and federal budgetary decisions. The difficult funding environment existing in the 2003-2004 school year continued to impact the first half of 2004 including reduced attendance at our National Renaissance Conference. Another contributing factor was the delay in customer order decisions as they evaluate our new Renaissance Place product line.

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

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Three Months Ended June 30, 2004 and 2003

     Net Sales. Our net sales decreased by $2.4 million, or 7.2%, to $31.2 million in the second quarter of 2004 from $33.6 million in the second quarter of 2003. Revenues were down, partly as a result of the on-going state budgetary concerns and their impact on funding for K-12 schools during the 2003-2004 school year. Product sales declined by $2.4 million, or 8.3%, to $26.3 million in the second quarter of 2004 from $28.7 million in the second quarter of 2003. Lower product sales were partially due to our customers delaying their purchase decisions to evaluate the benefits of the new Renaissance Place versions of Accelerated Reader and Accelerated Math, which we began to ship during May. Product revenues were also impacted by sales of Renaissance Place which, unlike our earlier perpetually licensed versions, is a subscription based product that requires the sale to be initially recorded as deferred revenue and then recognized into income over the subscription period, typically 12 months. Sales of our six new products, which were introduced in 2002 or 2003, continued at similar levels to the past two quarters.

     Service revenue for the second quarter of 2004 was $4.9 million, declining by $52,000, or 1.1%, from the second quarter 2003. This decline was lower than the 8 to 9% declines of the past three quarters due to increased district sales that included more services. Our new academic coaching service began to gain some momentum in the second quarter. This coaching service, offered at a list price of $499 per teacher, per year, is subscription based which requires the revenue to be deferred and recognized over the 12-month subscription period. We expect coaching to be an important growth area for us and expect that, to some extent, it will replace on-site and hotel training sessions. This shift from our single events training to deferred service revenues is expected to result in at least a short term decline in recognition of service revenue.

     As a result of the declines in sales and earnings experienced in the first half of 2004, we expect sales and earnings for the full year 2004 to be down from the 2003 levels.

     Cost of Sales. The cost of sales of products decreased by $1.1 million, or 37.0%, to $1.8 million in the second quarter of 2004 from $2.9 million in the second quarter of 2003. As a percentage of product sales, the cost of sales of products decreased to 6.8% in the second quarter of 2004 from 9.9% in the second quarter of 2003. This decrease is due, in part, to lower scanner warranty and shipping costs, cost efficiencies in our custom assessment products business in 2004, and to the sales mix this year compared to last with proportionally lower sales of scanners, which is a lower gross profit margin product than our core software products.

     The cost of sales of services increased by $146,000, or 7.1%, to $2.2 million in the second quarter of 2004 from $2.0 million in the second quarter of 2003. As a percentage of sales of services, the cost of sales of services increased to 45.0% in the second quarter of 2004 from 41.6% in the second quarter of 2003. This increase in the cost of sales of services is partially a result of incurring costs to ramp up our new service offerings prior to their full utilization and the expected future revenues.

     Product Development. Product development expenses were $4.2 million in the second quarter of 2004, which was up by $46,000 from the second quarter of 2003. As a percentage of net sales, product development costs increased to 13.6% in the second quarter of 2004 from 12.5% in the second quarter of 2003 primarily due to the decline in sales. We capitalized product development expenses of $285,000 this quarter compared to $151,000 in the second quarter of 2003. No significant changes in product development initiatives are planned in the short term, but since very little costs are expected to be capitalized in the near term, we expect reported product development expense to be slightly higher in the second half of the year than they were in the first half.

     Selling and Marketing. Selling and marketing expenses were $7.7 million in the second quarter of 2004 an increase of $919,000, or 13.6%, from $6.7 million in the second quarter of 2003. As a percentage of net sales, selling and marketing expenses increased to 24.6% in the second quarter of 2004 from 20.1% in the second quarter of 2003. The increase in selling and marketing expenses is primarily due to the field sales force expansion. We expect selling and marketing costs to continue to exceed the amount incurred in the comparable prior year period due to the continued expansion of our field sales force. At June 30, 2004, we had 42 professionals on our field sales team with a goal to have approximately 60 within the next six to nine months.

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     General and Administrative. General and administrative expenses were $3.4 million for the second quarter of 2004, a decrease of $577,000 from the $3.9 million in the second quarter of 2003. This decrease is primarily due to a one-time executive severance charge incurred in the second quarter of 2003. No significant change in general and administrative expenses is expected in the second half of 2004 compared to the first half. As a percentage of net sales, general and administrative expenses decreased to 10.8% from 11.7%.

     Operating Income. Operating income was $11.9 million, or 38.2% of net sales in the second quarter of 2004, compared to $13.8 million, or 41.1% of net sales in the second quarter of 2003.

     Income Tax Expense. Income tax expense of $4.5 million was recorded in the second quarter of 2004 at an effective income tax rate of 37.0% of pre-tax income, compared to $5.6 million, or 38.3% of pre-tax income in the second quarter of 2003. We do not expect significant changes to our effective tax rate for the balance of 2004.

Six Months Ended June 30, 2004 and 2003

     Net Sales. Our net sales of $62.7 million in the first six months of 2004 were $5.1 million less than the $67.8 million in the first six months of 2003. Revenues were down, partly as a result of the on-going state budgetary concerns and their impact on funding for K-12 schools during the 2003-2004 school year. Product sales declined by $4.5 million, or 8.0%, to $51.4 million in the first six months of 2004 from $55.9 million in the same period in 2003. Lower product sales were partially due to our customers delaying their purchase decisions to evaluate the benefits of the new Renais