All statements in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by words such as "believe," "intend," "expect," "may," "could," "would," "will," "should," "plan," "project," "contemplate," "anticipate" or similar statements. Because these statements reflect our current views concerning future events, these forward-looking statements are subject to risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to demand for our products and services; our ability to compete effectively and adjust to rapidly changing market dynamics; the timing of revenue recognition from significant contracts with schools and school districts; market acceptance of our newer products and services; continued federal and state focus on assessment and remediation in K-12 education; and the other factors described under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission ("SEC"). We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Overview

The Princeton Review provides integrated classroom-based, print and online products and services that address the needs of students, parents, educators and educational institutions. We offer one of the leading SAT preparation courses and are among the leading providers of test preparation courses for most major post-secondary and graduate admissions tests. The Company and its international franchisees provide test preparation courses and tutoring services for the SAT, GMAT, MCAT, LSAT, GRE and other standardized admissions tests to students throughout the United States and abroad. The Company currently operates through our Test Preparation Services and Supplemental Educational Services ("SES") divisions.

Test Preparation Services Division

The Test Preparation Services division derives the majority of its revenue from classroom-based and Princeton Review online test preparation courses and tutoring services. This division also receives royalties from its independent international franchisees, which provide classroom-based courses under the Princeton Review brand. As a result of the acquisitions of Test Services, Inc. ("TSI") in March 2008, the Princeton Review franchises in several southern California locations, Utah and New Mexico ("SoCal") in July 2008 and the Princeton Review Pittsburgh, Inc. ("Pittsburgh") in October 2008, we do not have any remaining domestic franchisees as of September 30, 2009. Additionally, this division receives royalties and advances from Random House for books authored by The Princeton Review.

The Test Preparation Services division accounted for 78% of our overall revenue for the nine months ended September 30, 2009, and historically has accounted for the majority of our overall revenue.

Supplemental Educational Services Division

The Supplemental Educational Services ("SES") division provides state-aligned research-based academic tutoring instruction to students in schools in need of improvement in school districts throughout the country which receive funding under the No Child Left Behind Act of 2001 ("NCLB"). We expect SES revenue and income from operations to continue to increase in 2009 as a result of the full year benefit of new markets entered over the course of 2008, increased demand in existing markets and expansion into new markets.

Former K-12 Services Division

The Company's former K-12 Services division provided a number of services to K-12 schools and districts, including assessment, professional development and intervention materials (workbooks and related products). Additionally, this division received college counseling fees paid by high schools. In March 2009, we sold our K-12 Services division to CORE Education and Consulting Solutions, Inc. ("CORE"). The Company received $9.5 million of cash from CORE at the close of the transaction and recognized a gain of $913,000. In connection with the sale of its K-12 Services division, financial results associated with this business have been reclassified as discontinued operations.

Results of Operations

Comparison of Three Months Ended September 30, 2009 and 2008




                                                Three Months Ended          Amount of         Percent
                                                   September 30,             Increase         Increase
                                                2009           2008         (Decrease)       (Decrease)
Revenue:
Test Preparation Services                     $  34,090      $ 34,050      $         40               0 %
SES Services                                        235           699              (464 )           (66 )%

Total revenue                                    34,325        34,749              (424 )            (1 )%

Cost of revenue:
Test Preparation Services                        11,237        10,634               603               6 %
SES Services                                        486           544               (58 )           (11 )%

Total cost of revenue                            11,723        11,178               545               5 %

Gross profit                                     22,602        23,571              (969 )            (4 )%


Operating expenses:
Selling, general and administrative              20,518        21,741            (1,223 )            (6 )%
Restructuring                                     1,131           482               649             135 %
Acquisition expenses                                285            -                285             N/A

Total operating expenses                         21,934        22,223              (289 )            (1 )%


Other income (expense) and other items:
Interest expense                                   (136 )        (510 )             374             (73 )%
Interest income                                       2           110              (108 )           (98 )%
Other income                                          1            -                  1             N/A
Provision for income taxes                         (391 )        (499 )             108             (22 )%

(Loss) income from continuing operations      $     144      $    449      $       (305 )           (68 )%

Revenue

For the three months ended September 30, 2009, total revenue decreased by $424,000, or 1%, to $34.3 million from $34.7 million in the three months ended September 30, 2008.

Test Preparation Services revenue remained flat at $34.1 million for the three months ended September 30, 2009 as compared to the same period of 2008. Increases in revenue of $1.4 million from domestic franchises acquired subsequent to June 30, 2008 and $812,000 from increased institutional contract revenue were offset by a $2.2 million reduction attributed primarily to lower classroom-based and tutoring revenues. Increases in organic classroom-based enrollments were offset by lower prices charged for our classroom-based courses and a higher percentage of enrollments from lower-priced services. Organic tutoring revenues declined due to lower enrollments and a shift towards lower priced tutoring packages. We expect these pricing and enrollment trends to continue through the remainder of 2009.

SES Services revenues decreased $464,000, or 66%, to $235,000 from $699,000 in the three months ended September 30, 2008. SES Services revenue for the three months ended September 30, 2009 was derived primarily from new summer programs being offered in certain of our operating regions. SES Services revenue for the three months ended September 30, 2008 primarily related to positive billing adjustments from the 2007-2008 academic year, which ended in June 2008. There were no significant billing adjustments from the 2008-2009 academic year, which ended in June 2009.

Cost of Revenue

For the three months ended September 30, 2009, total cost of revenue increased by $545,000, or 5%, to $11.7 million from $11.2 million in the three months ended September 30, 2008.

Test Preparation Services cost of revenue increased by $603,000 or 6%, to $11.2 million from $10.6 million in the three months ended September 30, 2008 due primarily to incremental costs related to the 2008 acquisitions. Gross margin during the period for the Test Preparation Services division decreased from 69% to 67%, primarily as a result of the lower prices charged for our classroom-based courses, as costs per an instruction session are relatively fixed. We expect the impact of lower prices to continue to negatively impact gross margin through the remainder of 2009.

SES Services cost of revenue decreased by $58,000, or 11%, to $486,000 from $544,000 in the three months ended September 30, 2008 and gross margin during the same period decreased from 22% to (107%). The decrease in gross margin is primarily due to the lower revenue described above without a proportionate decrease in costs, as the majority of the costs per class are relatively fixed.

Selling, General and Administrative Expenses

For the three months ended September 30, 2009, selling, general and administrative expenses decreased by $1.2 million, or 6%, to $20.5 million from $21.7 million in the three months ended September 30, 2008.

Test Preparation Services selling, general and administrative expenses decreased by $1.4 million, or 9%, to $13.6 million from $15.0 million in the three months ended September 30, 2008. This decrease is primarily due to increased efforts to reduce expenses, including advertising, professional fees and facility expenses and lower compensation. This decrease is partially offset by incremental expenses related to the 2008 franchise acquisitions, including depreciation and amortization.

SES Services selling, general and administrative expenses increased by $530,000, or 20% to $3.1 million from $2.6 million in the three months ended September 30, 2008. The increase is primarily attributable to additional personnel, facility and other costs necessary to support entry into nine new markets during the 2008-2009 school year.

Corporate selling, general and administrative expenses decreased by $369,000, or 9%, to $3.8 million from $4.2 million in the three months ended September 30, 2008, due primarily to reductions in corporate headcount and reduced compensation expense. This decrease is partially offset by increased professional service fees attributed to our outsourced information technology function.

Restructuring

The Company's restructuring charges increased by $649,000 or 135%, to $1.1 million from $482,000 in the three months ended September 30, 2008. The restructuring charges incurred during the three months ended September 30, 2009 were attributed to the restructuring initiative announced and commenced in the first quarter of 2009 related to outsourcing the Company's information technology operations and simplifying management's structure following the sale of the K-12 Services division. The restructuring charges incurred during the three months ended September 30, 2008 were severance expenses related to restructuring activities initiated during 2007 to relocate the Company's finance and certain legal operations from New York City to offices located near Boston, Massachusetts.

Acquisition expenses

Acquisition expenses for the three months ended September 30, 2009 consist of legal and accounting fees associated with due diligence and other preparations for our anticipated acquisition of Penn Foster Education Group, Inc.

Interest Expense

Interest expense decreased by $374,000 to $136,000, from $510,000 in the three months ended September 30, 2008, primarily due to a decrease in our term loan outstanding under our credit facility. Since September 30, 2008, we have repaid approximately $12.0 million of principal under our credit facility term loan.

Interest Income

Interest income decreased by $108,000, or 98% from the three months ended September 30, 2008 due primarily to higher average cash balances during the three months ended September 30, 2008.

Provision for Income Taxes

The provision for income taxes decreased by $108,000 to $391,000, from $499,000 in the three months ended September 30, 2008. The income tax provision was recorded during the three months ended September 30, 2009 based on the estimated annual tax liability calculated using an annual effective tax rate for United States and foreign tax purposes. The effective rate differs from the federal statutory rate of 34% due to our inability to record a tax benefit on our losses generated in the United States, differences in foreign tax rates, and the effect of tax-deductible goodwill, for which a deferred tax liability has been recorded.

Comparison of Nine Months Ended September 30, 2009 and 2008




                                               Nine Months Ended           Amount of         Percent
                                                 September 30,              Increase         Increase
                                              2009           2008          (Decrease)       (Decrease)
Revenue:
Test Preparation Services                   $  86,673      $  85,472      $      1,201               1 %
SES Services                                   23,947         19,071             4,876              26 %

Total revenue                                 110,620        104,543             6,077               6 %
Cost of revenue:
Test Preparation Services                      30,719         28,492             2,227               8 %
SES Services                                   12,048          8,599             3,449              40 %

Total cost of revenue                          42,767         37,091             5,676              15 %

Gross profit                                   67,853         67,452               401               1 %


Operating expenses:
Selling, general and administrative            61,065         62,082            (1,017 )            (2 )%
Restructuring                                   5,179          2,233             2,946             132 %
Acquisition expenses                              285             -                285             N/A

Total operating expenses                       66,529         64,315             2,214               3 %


Other income (expense) and other items:
Interest expense                                 (681 )         (583 )             (98 )            17 %
Interest income                                    34            311              (277 )           (89 )%
Other income                                      255             (2 )             257         (12,850 )%
Provision for income taxes                       (512 )       (1,162 )             650             (56 )%

Income from continuing operations           $     420      $   1,701      $     (1,281 )           (75 )%

Revenue

For the nine months ended September 30, 2009, total revenue increased by $6.1 million, or 6%, to $110.6 million from $104.5 million in the nine months ended September 30, 2008.

Test Preparation Services revenue increased by $1.2 million, or 1%, to $86.7 million from $85.5 million in the nine months ended September 30, 2008. This increase is primarily due to incremental revenue of $9.1 million from domestic franchises acquired during 2008 as described above. This increase in revenue is partially offset by a $1.7 million reduction in franchise fees as a direct result of the same franchise acquisitions and a $0.8 million reduction in non-franchise licensing revenue due to the termination of a contract with a marketing partner that has filed for bankruptcy. The increase is further offset by a decrease of $5.4 million due primarily to lower classroom-based and tutoring revenues during the nine months ended September 30, 2009. Increases in classroom-based enrollments were offset by lower prices charged for our classroom-based courses and a higher percentage of enrollments from lower-priced services. Organic tutoring revenues declined due to lower enrollments and a shift towards lower priced tutoring packages. We expect these pricing and enrollment trends to continue through the remainder of 2009.

SES Services revenues increased $4.9 million, or 26%, to $24.0 million from $19.1 million in the nine months ended September 30, 2008. This increase is primarily due to expansion into nine new markets during the 2008-2009 school year.

Cost of Revenue

For the nine months ended September 30, 2009, total cost of revenue increased by $5.7 million, or 15%, to $42.8 million from $37.1 million in the nine months ended September 30, 2008.

Test Preparation Services cost of revenue increased by $2.2 million, or 8%, to $30.7 million from $28.5 million in the nine months ended September 30, 2008. This increase is primarily due to incremental costs of $3.7 million related to the 2008 acquisitions. Excluding the impact of franchises acquired, cost of revenue decreased by $1.5 million due to improved classroom operating efficiencies which lowered relative teacher, course material and facility costs required to deliver our services. Gross margin during the period for the Test Preparation Services division decreased from 67% to 65%, primarily as a result of lower prices charged for our classroom-based courses, as costs per an instruction session are relatively fixed. We expect the impact of lower prices to continue to negatively impact gross margin through the remainder of 2009.

SES Services cost of revenue increased by $3.4 million, or 40%, to $12.0 million from $8.6 million in the nine months ended September 30, 2008 as a direct result of the increase in revenue and the additional operating regions in the 2008-2009 school year that were not included in the results for the nine months ended September 30, 2008. Gross margin during the period for the SES Services division decreased from 55% to 50% due primarily to lower gross margins in new operating regions as average students per class were lower than existing regions as of the nine months ended September 30, 2008.

Selling, General and Administrative Expenses

For the nine months ended September 30, 2009, selling, general and administrative expenses decreased by $1.0 million, or 2%, to $61.1 million from $62.1 million in the nine months ended September 30, 2008.

Test Preparation Services selling, general and administrative expenses increased by $1.8 million, or 5%, to $41.0 million from $39.2 million in the nine months ended September 30, 2008. This increase is primarily due to incremental expenses related to the 2008 franchise acquisitions, partially offset by a reduction in expenses due to lower advertising and compensation expense.

SES Services selling, general and administrative expenses increased by $1.1 million, or 13%, to $9.5 million from $8.4 million in the nine months ended September 30, 2008. The increase is primarily attributable to additional personnel, facility and other costs necessary to support entry into nine new markets during the 2008-2009 school year.

Corporate selling, general and administrative expenses decreased by $4.0 million, or 28%, to $10.5 million from $14.5 million in the nine months ended September 30, 2008, due primarily to reductions in corporate headcount and reduced incentive compensation expense. This decrease is partially offset by increased professional service fees attributed to our outsourced information technology function.

Restructuring

The Company's restructuring charges increased by $3.0 million, or 132%, to $5.2 million from $2.2 million in the nine months ended September 30, 2008. The increase is attributed to the restructuring initiative announced and commenced in the first quarter of 2009 related to outsourcing the Company's information technology operations, transferring the majority of remaining corporate functions located in New York City to the offices located near Boston, Massachusetts, and simplifying management's structure following the sale of the K-12 Services division. The restructuring charges incurred during the nine months ended September 30, 2008 were severance expense related to restructuring activities initiated during 2007 to relocate the Company's finance and certain legal operations from New York City to offices located near Boston, Massachusetts.

Acquisition expenses

Acquisition expenses for the nine months ended September 30, 2009 consist of legal and accounting fees associated with due diligence and other preparations for our anticipated acquisition of Penn Foster Education Group, Inc.

Interest Expense

Interest expense increased by $98,000 to $681,000, from $583,000 in the nine months ended September 30, 2008 as a result of borrowings outstanding under the credit facility. The average outstanding balance under the credit facility during the nine months ended September 30, 2009 was lower than the prior period, but outstanding for the entire nine month period, resulting in the increase in interest expense over the prior period. The average outstanding balance under the credit facility during the nine months ended September 30, 2008 was higher but outstanding for only three months during this period.

Interest Income

Interest income decreased by $277,000, or 89%, to $34,000 from $311,000 in the nine months ended September 30, 2008 due primarily to higher average cash balances during the nine months ended September 30, 2008.

Other Income

Other income for the nine months ended September 30, 2009 primarily consists of additional proceeds received from the sale of stock in a private investment that occurred in September 2008 and a settlement payment received in conjunction with the termination of one of our international franchises. There was essentially no other income or expense for the nine months ended September 30, 2008.

Provision for Income Taxes

The provision for income taxes decreased by $650,000 to $512,000, from $1.2 million in the nine months ended September 30, 2008. The decrease is due to the utilization of the annual effective tax rate to calculate the current year provision and the amount of

income earned year to date in proportion to the expected income to be earned for the year. The effective rate differs from the federal statutory rate of 34% due to our inability to record a tax benefit on our losses generated in the United States, differences in foreign tax rates, and the effect of tax-deductible goodwill, for which a deferred tax liability has been recorded. For the nine months ended September 30, 2008, the discrete method was used to calculate the provision as the annual effective tax rate was not considered a reliable estimate of year to date income tax expense.

Liquidity and Capital Resources

Our primary sources of liquidity during the nine months ended September 30, 2009 were cash and cash equivalents on hand, cash flow generated from operations, cash proceeds from the sale of our K-12 Services division (a discontinued operation) and borrowings under our revolving line of credit. Our primary uses of cash during the nine months ended September 30, 2009 were capital expenditures, repayments of borrowings under our revolving line of credit and the required installment payment of a portion of the term loan under our credit facility in connection with the sale of our K-12 Services division. At September 30, 2009 we had $10.9 million of cash and cash equivalents (including $616,000 of restricted cash) and $5.0 million of unused borrowing capacity available under the revolving line of credit of our Wells Fargo credit facility. In addition, in September 2009 we filed a registration statement on Form S-3 with the SEC utilizing a shelf registration process whereby we may from time to time offer and sell common stock, preferred stock, warrants or units, or any combination of these securities, in one or more offerings up to a total amount of $75.0 million.

On October 16, 2009, we entered into the Purchase Agreement to purchase all of the issued and outstanding shares of Penn Foster's capital stock for $170.0 million in cash, subject to post-closing adjustments. We concurrently entered into commitment letters to raise approximately $155.0 million in debt financing and between $30.0 million and $40.0 million in equity financing to fund the cash consideration for the acquisition, pay certain fees and expenses in connection with the acquisition, repay the outstanding term loan under our existing credit facility and for general working capital purposes. The debt financing commitments include a $40.0 million senior secured credit facility term loan, a $40.0 million bridge loan, $50.0 million in senior subordinated notes and $25.0 million in junior subordinated notes. The equity financing commitments consist of a new Series E Non-Convertible Preferred Stock of the Company which, subject to and upon shareholder approval, will automatically convert into a new Series D Convertible Preferred Stock of the Company which will be convertible into shares of Company common stock. A substantial portion of the debt financing will require periodic cash interest payments and, in the case of the new senior secured credit facility term loan, scheduled principal payments. The new senior secured credit facility will also include a $10.0 million revolving line of credit. We expect the operating cash flows generated from our legacy business and Penn Foster, once acquired, and currently available cash on hand to be sufficient to fund our working capital needs, capital expenditures and the debt service obligations under the new financing arrangements over the next twelve months and beyond. However, there can be no assurance that the acquisition or related financings will be completed, or if completed, will be completed on a timely basis. In addition, our ability to generate positive cash flows from operations is dependent on our future financial performance, which is subject to many factors beyond our control as outlined in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008 and in Part II, Item 1A of this Quarterly Report on Form 10-Q.

In addition to generating positive income from operations, the timing of cash payments received under our customer arrangements is a primary factor impacting our sources of liquidity. Our Test Preparation Services division generates the largest portion of our cash flow from operations from its retail classroom and tutoring courses. These customers usually pay us in advance or contemporaneously with the services we provide, thereby supporting our short-term liquidity needs. Increasingly, however, across Test Preparation Services and SES, we are generating a greater percentage of our cash from contracts with institutions . . .