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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K



|[X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- | ------------------------------------------------------------------------------------
|    | For the fiscal year ended January 31, 2002                                          



|[  ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|---- | ----------------------------------------------------------------------------------------

For the transition period from ________ to ________

Commission File No. 000-29347

Lightspan, Inc.

(Exact name of registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 33-0585210                          
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                              
|10140 Campus Point Drive
San Diego, California                 |  | 92121-1520                          
|(Address of principal executive office)                        |  | (Zip Code)                          

(858) 824-8000
(Registrants telephone number, including area code)

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

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

Common Stock
(Title of Each Class)

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 periods 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 [  ]

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

As of March 31, 2002, the aggregate market value of registrants
voting and non-voting stock held by non-affiliates, based upon the
closing sales price for the registrants common stock, as reported
on the Nasdaq National Market, was approximately $22.7 million. To
determine this aggregate market value, the registrant has excluded
from the total number of shares outstanding as of March 31, 2002 shares of common stock held by each officer and director and by each
person who owns 5% or more of the outstanding common stock as such
persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for
any other purposes.

Number of shares of registrants common stock outstanding as of
March 31, 2002: 47,044,407

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants Proxy Statement for its 2002 Annual
Meeting of Stockholders, are incorporated by reference into Part III
of this Report.



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TABLE OF CONTENTS



|                              |                                                                                               |  |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                       
|                              | Item 1. Business                                                                             
|                              | Item 2. Properties                                                                           
|                              | Item 3. Legal Proceedings                                                                    
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                      
|                              | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|                              | Item 6. Selected Financial Data                                                              
|                              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 7a. Quantitative and Qualitative Disclosures About Market Risk                          
|                              | Item 8. Financial Statements and Supplementary Data                                          
|                              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III                     
|                              | Item 10. Directors and Executive Officers of the Registrant                                  
|                              | Item 11. Executive Compensation                                                              
|                              | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                              | Item 13. Certain Relationships and Related Transactions                                      
|PART IV                      
|                              | Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|SIGNATURES                   
|INDEX TO FINANCIAL STATEMENTS
|EXHIBIT 23.1                 



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Lightspan, Inc.2002 Annual Report on Form 10-K
Table of Contents

|           |  |          |    |                                                                                       |  |      |    | 
|---------- |  | -------- | -- | ------------------------------------------------------------------------------------- |  | ---- | -- | 
|           |  |          |    |                                                                                       |  | Page
|           |  |          |    |                                                                                       |  |     
|PART I     |  |          |    |                                                                                       |  |      | 2  | 
|           |  | Item 1.  |    | Business                                                                              |  |      | 2  | 
|           |  | Item 2.  |    | Properties                                                                            |  |      | 21 | 
|           |  | Item 3.  |    | Legal Proceedings                                                                     |  |      | 21 | 
|           |  | Item 4.  |    | Submission of Matters to a Vote of Security Holders                                   |  |      | 21 | 
|PART II    |  |          |    |                                                                                       |  |      | 22 | 
|           |  | Item 5.  |    | Market for Registrants Common Equity and Related Stockholder Matters                 |  |      | 22 | 
|           |  | Item 6.  |    | Selected Financial Data                                                               |  |      | 23 | 
|           |  | Item 7.  |    | Managements Discussion and Analysis of Financial Condition and Results
of Operations |  |      | 24 | 
|           |  | Item 7a  |    | Quantitative and Qualitative Disclosures About Market Risk                            |  |      | 35 | 
|           |  | Item 8.  |    | Financial Statements and Supplementary Data                                           |  |      | 35 | 
|           |  | Item 9.  |    | Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure  |  |      | 35 | 
|PART III   |  |          |    |                                                                                       |  |      | 36 | 
|           |  | Item 10. |    | Directors and Executive Officers of the Registrant                                    |  |      | 36 | 
|           |  | Item 11. |    | Executive Compensation                                                                |  |      | 36 | 
|           |  | Item 12. |    | Security Ownership of Certain Beneficial Owners and Management                        |  |      | 36 | 
|           |  | Item 13. |    | Certain Relationships and Related Transactions                                        |  |      | 36 | 
|PART IV    |  |          |    |                                                                                       |  |      | 37 | 
|           |  | Item 14. |    | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  |      | 37 | 
|SIGNATURES |  |          | 40 |                                                                                      

The following are trademarks or service marks of Lightspan, Inc.:

|                                   |  |                                   |  |                           
|---------------------------------- |  | --------------------------------- |  | --------------------------
| Academic.com                     |  |  Learning Search                 |  |  The Lightspan Network®  
| AcademicOnline 2000              |  |  Lightspan                       |  |  Lightspan Partnership   
| Academic Systems                 |  |  Lightspan.com                   |  |  Lightspan Reading Center
| Desktop Professional Development |  |  Lightspan Achieve Now           |  |  School Focus            
| Ed-mail®                         |  |  Lightspan Achieve Now Online    |  |  StudyWeb®               
| eduTest.com                      |  |  Lightspan Adventures            |  |  Your Class Online       
| Family Focus                     |  |  Lightspan Assessment Builder    |  |  Your School Online      
| Global Schoolhouse®              |  |  Lightspan Early Reading Program |  |                           
| LearningPlanet.com               |  |  Lightspan eduTest Assessment    |  |                           

All other trade names, trademarks and service marks appearing
in this Annual Report on Form 10-K are the property of their
holders.

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PART I




Item 1.Business

In addition to historical information, the discussion in this
Annual Report on Form 10-K contains forward-looking statements
including statements relating to our future financial performance
and operations. These forward-looking statements involve risks,
uncertainties and assumptions. The actual results may differ
materially from those stated in these forward-looking statements as
a result of many factors, including, but not limited to, those
discussed in the sections in this Annual Report entitled
Competition, Risk Factors and Managements Discussion and
Analysis of Financial Condition and Results of Operations and
elsewhere in this Annual Report and in any other documents
incorporated by reference into this Annual Report. Do not place
undue reliance on these forward-looking statements, which reflect
our opinions only as of the date hereof. We undertake no obligation
to update or revise any of these forward-looking statements. You
should carefully review the risk factors described in this document
as well as in other documents that we file from time to time with
the Securities and Exchange Commission, including the Quarterly
Reports on Form 10-Q that we will file during our 2003 fiscal year.

Introduction

Lightspan, Inc. provides curriculum-based educational software
and Internet products and services used both in school and at home.
We were founded in 1993 on the philosophy of using technology to
increase student achievement by providing exceptional curriculum
products that are used in classrooms and that are also used at home.
Our technology, delivery systems and content help increase student
interest in learning and assessment, parental involvement in their
childrens education, and productive interaction among teachers,
parents and students. More than 900 studies by schools that use our
products and services indicate that our products improve overall
student performance.

Lightspan Achieve Now, our product for students in kindergarten
through eighth grade, or K-8, is a series of media-rich, interactive
software programs that covers the core curriculum- language arts,
reading and math. We sell it exclusively to schools and school
districts for use in both the classroom and at home. As of January
31, 2002, the Lightspan Achieve Now curriculum has already been
purchased by over 1,200 school districts in 47 states and
implemented in approximately 4,000 schools and approximately 19,000
classrooms, representing a total of approximately 220,000 student
and teacher licenses. Our higher education products provide a series
of curriculum-based software that addresses the math and writing
needs of under-prepared college students. As of January 31, 2002,
these products are in use in over 350 colleges and universities
across the United States. Also as of January 31, 2002, we had over
3,400 subscriptions to our Internet products for students in
pre-kindergarten through grade twelve.

Our objective is to become a leading provider of
technology-delivered, curriculum-based supplemental study materials
and online assessment services in kindergarten through higher
education. To achieve this objective, we expect to draw on the
educational technology and Internet experience of our entire
management team to pursue the following strategies:



| |  |  | capitalize on our current market position and
leverage our existing suite of products;       
| | - |  | ---------------------------------------------------------------------------------------------
|
| |  |  | enhance our Lightspan Achieve Now curriculum through
new Internet and broadband technologies;
|
| |  |  | continue to promote and enhance our fee-based subscription Internet products; and            
|
| |  |  | evaluate strategic relationships.                                                            

Products Overview

Our products and services are technology-based educational
tools and resources that can be used by teachers, students and
families to increase student achievement.

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More than 900 studies by schools that use our products and
services indicate Lightspan programs increase student performance in
reading/language arts and mathematics. Assuming the average student
performs at the 50th percentile, and over the period of time
comprising school years 1998 to 2001, for every 100 students in
nationally representative samples, students at schools that
implemented Lightspan Achieve Now outperformed the control group by
27% in reading/language arts and outperformed the control group by
23% in mathematics, as described in Lightspans implementation
guidelines. The Lightspan Achieve Now curriculum, a
skill-and-content-based reform model eligible for funding by the
U.S. Department of Educations Comprehensive School Reform
Demonstration program, is among the top three reform models eligible
schools have selected over the past three years.

Several independent studies conducted by colleges that use our
higher education products have shown that our products which address
the math and writing needs of under-prepared college students,
compared to traditional lecture taught courses, increase pass rates,
keep more students enrolled in the courses covered and increase
students performance in follow-on course work.

K-8 Software

Lightspan Achieve Now is a standards-based curriculum program used by
students in kindergarten through eighth grade that is proven to increase
student achievement in reading, language arts and mathematics. Lightspan
Achieve Now includes interactive software, school and home learning
activities, teacher materials, on-site and technology-based professional
development and student assessment. Lightspan Achieve Now is aligned to
individual state standards, textbooks, standardized tests, and
professional association standards, and has been approved as a skill- and
content-based Comprehensive School Reform Model.

Lightspan Achieve Now is designed to help all students perform at
their best. The program addresses the key challenges faced by schools,
teachers, students, and families by providing a proven, cost-effective way
to:



| |  |  | increase the amount of time that students spend learning;        
| | - |  | -----------------------------------------------------------------
|
| |  |  | increase family involvement in their childrens learning;        
|
| |  |  | provide equitable access to educational tools and technology; and
|
| |  |  | increase student motivation and commitment to learning.          

Lightspan Achieve Now is a series of media-rich, interactive
software programs that covers the core curriculum of language arts,
reading and math, and is designed to enhance learning both in the
classroom and at home. Lightspan Achieve Now is a supplement to
textbooks and other materials used in K-8 schools and covers more
than 80% of the typical K-8 reading, language arts and mathematics
curricula. Lightspan Achieve Now incorporates a variety of
interactive formats and varying levels of difficulty to cover a
specific set of educational objectives and to address a diverse
range of learning styles, making it possible to reach each student
in a class more effectively. The Lightspan Achieve Now curriculum
features stories and original characters designed around an
interactive approach, which is intended to provide the student with
essential components of an effective learning environment, including
motivation to master a skill or concept, learning by doing, practice
and application of the skill or concept to another situation.

We deliver our reading and language arts and mathematics
curricula in imaginary worlds  episodic, interactive series with
a consistent set of characters that are designed to cover a broad
range of curriculum objectives. Generally, each world is contained
on a series of CD-ROMs, or titles, which are divided into multiple
Adventures. Our Adventures are developed with the assistance of an
advisory board of reading, language arts and mathematics educators,
an advisory board of video game developers, television writers and
commercial animators. The Lightspan Achieve Now curriculum was
developed using entertainment industry production techniques and
features full motion digital video and 3-D animation.

Our Lightspan Achieve Now language arts and reading curriculum
provides a variety of learning paths, all with a single objective -
improving literacy and communication  and is designed to ensure
that all students succeed in listening, speaking, reading, writing,
viewing and producing. The Adventures that compose our Lightspan
Achieve Now reading and language arts curriculum address vocabulary

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comprehension, critical thinking skills, study skills, the
writing process, print and text recognition, phonics, decoding, and
many other areas covered by the typical kindergarten through eighth
grade, or K-8 reading and language arts curriculum.

Our Lightspan Achieve Now math curriculum is designed to
provide a set of experiences that increase student confidence and
encourage students to solve problems, think mathematically and apply
and communicate their thoughts. The Adventures that comprise our
Lightspan Achieve Now mathematics curriculum address number sense,
critical thinking, number theory, estimation, geometry and many
other areas covered by the typical K-8 mathematics curriculum.

Lightspan Achieve Now licenses are sold on a perpetual license
basis at the student license and teacher license levels, including
materials and professional development. A complete Lightspan Achieve
Now program consists of teacher licenses containing up to 40 CD-ROM
titles appropriate to each grade level, instructional materials,
student licenses for each student containing the same CD-ROM titles
as those included with the teacher licenses, student pre-tests,
post-tests and progress checks, parenting and other materials,
professional development visits, and evaluation criteria to meet
accountability standards. There are a total of 79 separate CD-ROM
titles, some of which are included in more than one grade cluster.

Lightspan Achieve Nows curriculum runs on both PlayStation
game consoles® and on MPEG-capable, Windows-based personal
computers, though use at home is currently almost always on
PlayStation game consoles. We plan to continue development of new
titles to meet changing education trends, to refresh the product
over time and to continue to support both the PlayStation game
console and PC platforms.

Lightspan Achieve Now Online is available to schools that are
using both Lightspan Achieve Now and The Lightspan Network.
Lightspan Achieve Now Online provides students, teachers, and
families with online activities and resources that extend and
enhance the Lightspan Achieve Now program. With Lightspan Achieve
Now Online, schools can access curriculum content and tools that
assist in the effective implementation of Lightspan Achieve Now.

K-12 Internet

Our Internet products and services provide teachers, students
and parents with a wide array of online learning resources. We sell
these products on a subscription basis.

Lightspan.com

All of our Internet products and services can be accessed
through www.lightspan.com. We plan to maintain and provide moderate
level enhancements to the subscription products and services offered
through Lightspan.com.

Lightspan Early Reading Program

The Lightspan Early Reading Program, launched in the fall of
2001, was designed to enhance and extend balanced literacy
instruction in kindergarten through third grade, or K-3. The
program aligns with the No Child Left Behind Act of 2001by
supporting reading in the early grades. The program combines the
online Lightspan Reading Center and components of Lightspan Achieve
Now and includes curriculum CDs in reading and language arts
augmented by comprehensive assessment and curriculum support
materials. The Lightspan Early Reading Program is supported by
extensive professional development, based on an action research
model. Teachers who satisfy the specified conditions of the program
may be eligible to receive Continuing Education Units.

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The Lightspan Network

The Lightspan Network is our premium online subscription
service for classroom and home use. This product provides a rich
array of curriculum-based kindergarten though twelfth grade, or
K-12, content correlated to state academic standards in an
advertising-free environment.

The Lightspan Network is a suite of tools and resources that help simplify
a teachers instructional planning and supports ongoing professional
growth. This includes management and communication tools that bring
teachers together, and a variety of curriculum and learning activities
that promote student achievement. All of these features are designed to
help streamline the process of aligning and organizing curriculum to state
standards and assessment.

Teachers can plan and organize their instructional day and build
customized lesson plans with The Lightspan Networks learning activities,
Lesson Plan Library and Lesson Plan Builder. Teachers can access
ready-made virtual field trips in the Web Trip Library, or build their own
Web Trips. My File Cabinet provides an easy-to-use online tool that lets
teachers organize their lesson plans, Web trips and favorite links in one
location.

The Lightspan Network also encourages communication and collaboration
among teachers with our Curriculum Moderator and Publishing Tool, which
allows sharing of lesson plans and Web trips.

Lightspan Reading Center

In 2001, we released the Lightspan Reading Center, a component of the
Lightspan Early Reading Program. The Lightspan Reading Center is a
research-based Internet program that supports K-3 student achievement in reading. This add-on content module
integrates seamlessly into The Lightspan Network. This product is a
complete online reading program that supports student achievement and
provides tools to help educators make more informed instructional
decisions. The Lightspan Reading Center:



| |  |  | provides online, audio-supported multiple-choice
assessments addressing four levels: early, emergent, transitional,
and fluent;                                                                                                       
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | generates time-saving student assessment reports that
outline student learning needs and automatically list recommended
learning activities, lesson plans, and other resources to inform
instructional decisions in the classroom;    
|
| |  |  | accesses over 100 learning activities, lesson plans, and
printable worksheets in the key areas of reading mastery: phonemic
awareness, phonics and decoding, reading comprehension,
vocabulary, background knowledge, and fluency; and
|
| |  |  | responds quickly to additional learning needs by
administering post tests as students master each level of reading.                                                                                                                   

The Lightspan Reading Center provides rich, engaging literacy activities,
lesson plans and printables that help students understand phonemes, decode
unfamiliar words, become fluent readers, develop background knowledge and
increase vocabulary to construct meaning from print.

Instruction, content, and strategies in the Lightspan Reading Center have
been developed using the most current, scientifically based reading
research. Lightspan applies rigorous, systematic, and objective
procedures to obtain valid knowledge relevant to reading development,
reading instruction, and reading difficulties. The Lightspan Reading
Center is a developmental program that supplements and enriches classroom
instruction.

Online Assessment

Lightspan offers a combination of online assessment products, Lightspan
eduTest Assessment and Lightspan Assessment Builder, with proprietary test
questions covering language arts, mathematics and science.

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Lightspan eduTest Assessment is a comprehensive accountability and
assessment program that allows educators to quickly identify district,
school, class, and student strengths and needs relating to state and
national standards. By providing tools and reports that are tailored to
the needs of teachers and administrators in a particular school community,
Lightspan eduTest Assessment gives educators the power to implement
effective instruction that is targeted to students and the standards on
which they need the most improvement.

All Lightspan eduTest Assessment subscriptions provide immediate reporting
of student results and real-time aggregated reports up to the school and
district level. Lightspan eduTest Assessment enables educators to
schedule, create and administer assessments for all students in their
school or district.

Lightspan eduTest Assessment offers a combination of standards-based
tests, easy-to-use software, flexible options for benchmarking,
comprehensive reports at all levels, and professional development to
ensure that districts and schools are successful.

Lightspan Assessment Builder is a customizable assessment and
accountability solution that gives districts control over their
assessments. The program includes a template-based tool that guides
district-level assessment administrators through the process of creating
assessments specific to their district needs. They can include any
standards, objectives, and test parameters based on the assessment program
that their district has established.

Lightspan Assessment Builder allows districts to:



| |  |  | customize and design assessments to
meet district objectives;                 
| | - |  | ------------------------------------------------------------------------------
|
| |  |  | control assessment content and
delivery;                                      
|
| |  |  | access a powerful search engine
with over several thousand test items;        
|
| |  |  | create and add tailored test items;
and                                       
|
| |  |  | develop customized test items in additional languages and other subject areas.

Higher Education

Academic Systems (Academic), our higher education division,
has products that address the needs of under-prepared college
students, consisting of:



| |  |  | Interactive Mathematics, Pre-Algebra, Elementary
Algebra, Intermediate Algebra and College Algebra,which
cover topics ranging from whole numbers, proportional
reasoning, signed numbers and introductory geometry and
algebra to non-linear functions, equations, conic sections,
matrices, determinants, induction, sequences and counting;                                                                                                                                                                                                                    
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Interactive English,which prepares students for
academic writing, including narrative writing, data analysis,
text interpretation, and persuasive writing, and contains
concise grammar instructions on common college writing errors
and related reading and comprehension activities;                                                                                                                                                                                                                                                                          
|
| |  |  | Web-enhanced versions of Interactive Mathematics and
Interactive English which allow colleges to implement the
programs using client workstations that are located solely
within an intranet, on the Internet in a distance learning
configuration, or with a combination of intranet and
Internet-based workstations. Academic also offers fully
hosted versions of Interactive Mathematics and Interactive
English that enable colleges to offer courses to their
students without the costs associated with purchasing and
servicing computer server hardware;
|
| |  |  | Academic.com, a complete Web-based product offering
that helps faculty create, manage and teach interactive
courses online. With over 350 Learning Objects, Academic.com
offers a complete suite of Internet-based instructional
tools, content and services providing students with engaging,
interactive learning activities that can be accessed anytime
and anywhere; and                                                                                                                                                                                    

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| |  |  | The Interactive Companion Series which provides
exceptional quality supplemental instruction developed by
college level subject matter experts. Each Interactive
Companion focuses on a key concept, provides a model and
gives opportunities for review and self-assessment. Highly
interactive multimedia reinforces the content with sound
video and animation. The Interactive Companion Series
currently covers core subject areas in: Molecular Cell
Biology, Beginning Microbiology, Microbiology for Majors,
Genetics, General Chemistry, Biochemistry, Statistics,
Biostatistics, Precalculus, Calculus, College Algebra,
Principles of Microeconomics, Principles of Macroeconomics,
Intermediate Macroeconomics, Business Statistics, Operations
Management, Complete Nutrition and Essential Nutrition.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Academics products are media-rich with extensive graphics and
video components and are grounded in teaching techniques that focus
on students as individuals. Students can take the courses in a
computer lab or on a Windows-based PC at home or office, and work at
their own pace. Students review lessons and then practice the
concepts learned. Depending upon the students performance in the
practice session, the program prompts further review or moves the
student onto the next lesson. Wrong answers will prompt an
explanation of how to solve the question. In the Elementary Algebra
course, for example, there is a special help function featuring
student archetypes who represent different learning styles and offer
multiple approaches to solving the problem. These approaches range
from showing the method that can be used to solve the problem, to
explaining the solution with a picture or graph, to providing the
solution from a theoretical perspective. This often provides the
help that under-prepared college students need to pass the course
and succeed in school. Academic also offers printed practice
materials.

Academic provides management services to educators who use its
curriculum, typically by compiling and communicating information
about student time-on-task and performance while using the
curriculum. These management services can be accessed on the
Internet at Academic.com or a colleges Web site, and also on a
colleges local area network.

Academic curriculum products are licensed to colleges and then
sold by the licensing colleges to students on a student-by-student
basis for use with each class, instead of a textbook.

Segment and Geographic Information

Financial information about our K-12 and Higher Education
products and services is incorporated herein by reference to Note 10
Reportable Segments of the Notes to the Lightspan consolidated
financial statements included in Part II in this Annual Report on
Form 10-K. Since inception, substantially all of our revenues have
been attributable to, all of our long-lived assets have been located
in, and all of our operations have been conducted in the United
States and Puerto Rico.

Product Design and Development

We consider successful product development to be essential to
maintaining and growing our market position and have incurred $24.4
million, $25.8 million and $12.4 million in related technology and
development expenses for the years ended January 31, 2002, 2001 and
2000, respectively. We expect to continue enhancing our Lightspan
Achieve Now and higher education curricula and our fee-based
subscription Internet products and services.

Lightspan Achieve Now products include a diverse mix of media,
formats, and visual presentations. Every Lightspan Adventure is
built according to the following fundamental design principles,
which we believe differentiate our products from competitive
products:



| |  |  | we correlate each title to state and national
academic standards;                                                                                                                                                                  
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we create interesting characters in engaging stories
that unfold with the help of full-screen, full-motion video
and music, and with sophisticated interactivity representing
many of the techniques of the latest video games; and

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| |  |  | we develop assessment components for the teacher to
monitor students progress for each of the titles.
| | - |  | ------------------------------------------------------------------------------------------------------

All Lightspan Achieve Now programs are designed so they can be
used on a television via a PlayStation game console as well as on a
computer screen through desktop or laptop personal computers. Text
elements are rendered on the screen for clear visibility from across
the room. Live action video and animation segments are converted
from original footage to the MPEG software format, and then
digitally optimized for a sharp television picture. We believe these
design features offer a unique opportunity to be able to transition
our Lightspan Achieve Now curriculum to a digital set-top box once
broadband technology becomes widely available to cable television
subscribers. We also believe that our competitors who have designed
their educational technology for use only on a personal computer
will experience difficulties in converting their computer interfaces
to television interfaces, and that we are better positioned to move
our products to a digital set-top box platform.

Academics math and English products combine media-rich video
and graphics with teaching techniques that focus on students as
individuals and offer extensive help and reinforcement examples. The
Academic curriculum is reviewed each school year based on input from
user groups comprised of faculty from across the country, and
updated when appropriate.

Sales and Marketing

We sell our Lightspan Achieve Now curriculum, The Lightspan
Network and Lightspan eduTest Assessment directly to schools and
school districts. We identify and target school districts that
routinely implement new and innovative programs. Our programs are
generally sold top down, with the first presentations made to a
school districts key decision maker, who is often the
superintendent or assistant superintendent in charge of curriculum
or technology. Schools are becoming more involved in the decision
process as site-based management is implemented within school
districts. The sales cycle for the initial purchase of our Lightspan
Achieve Now curriculum is typically six to twelve months, sometimes
with shorter periods for The Lightspan Network and Lightspan eduTest
Assessment.

A school district will typically purchase the Lightspan Achieve
Now curriculum for a few classrooms in one school. Upon the
successful implementation of the Lightspan Achieve Now curriculum,
the school district will typically add the curriculum in other
schools within the district. The product is also often sold within
the original school, either in additional classrooms in a given
grade or to additional grade levels.

As of January 31, 2002, we employed 91 sales professionals
which include direct and internal salespeople and sales managers for
grades K-12. As of that date, this sales force was supported by a
87-person professional development team that provides pre- and
post-sales support and works with current Lightspan schools to
identify additional sales opportunities. While our sales force and
professional development team are focused on selling into new
accounts and increasing our presence in current accounts, they also
act as partners with implementing schools in identifying funding
sources. Each member of our sales force has substantial experience
as an educator, teacher, and/or administrator coupled with a
background in educational technology sales. The salesperson is
generally working in his or her home territory and has extensive
contacts in school districts within their region.

Our marketing efforts include:



| |  |  | hosting policy forums for education policy makers at industry events;  
| | - |  | -----------------------------------------------------------------------
|
| |  |  | keynote speeches and presentations at major education conventions;     
|
| |  |  | participating on the advisory boards of key organizations in education;
|
| |  |  | advertising in major education industry publications;                  

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| |  |  | direct marketing and direct mail activities;                                                                                                                                               
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | customizing marketing materials to target key
opportunities such as summer school and after school
programs, English as a Second Language, Migrant Education,
and Urban Education programs;
|
| |  |  | presenting at education trade shows and customer
conferences; and                                                                                                                          
|
| |  |  | pursuing focused media relations activities in the
national media, education trade press and in local media in
communities that are implementing our Lightspan Achieve Now
curriculum.     

Our 91 person sales force includes an inside sales organization
of 20 people to support our sales efforts in the field. This
operation, located in Denver, is staffed by sales people with
experience supporting institutional sales, via telemarketing
techniques. Their focus is on supporting the field sales team,
qualifying leads, selling and renewing our Internet subscription
products and performing on-line product demonstrations.

In addition to our 91 sales professionals that focus on selling
our Achieve Now curriculum and fee-based subscription Internet
products, at January 31, 2002, Academic employed 29 sales
professionals which include direct salespeople and sales mangers. As
of that date, this sales force was supported by a 12-person
professional development team that provides pre- and post-sales
support focusing primarily on the higher education market.
Academics sales and marketing efforts focus on statewide and
system-wide sales, and specifically target potential purchasers that
offer opportunities for the Academic Systems curriculum to multiple
college class sections. A typical initial sale of the Academic
curriculum will be for several sections in a college course. As the
faculty becomes familiar with the Academic curriculum and witnesses
improved results from sections that are using the curriculum,
Academics contracts are generally renewed and increased. Over 85%
of the institutions that have installed any portion of the Academic
curriculum since it was first offered remain as installed users.
Academics marketing efforts include print advertising in
periodicals directed at the higher education market, direct
marketing, participation at trade shows and hosting special seminars
and Continuous Improvement user conferences nationwide.

Professional Development and Support Services

Lightspan Achieve Now and Internet subscription products include
on-site professional development. Each school works with a Lightspan
Educational Consultant to examine instructional objectives and develop a
plan that demonstrates the key processes of the program to teachers,
staff, and families. Teachers learn how to use Lightspan Achieve Now and
our Internet subscription products to align curriculum, design lessons,
and analyze student progress. These professional development resources
help schools implement Lightspan Achieve Now and our Internet subscription
products in ways that lead to maximum student achievement and greater
family involvement.

Lightspans Desktop Professional Development is a six-part CD program
included with Lightspan Achieve Now. This program provides teachers with
information on the latest teaching strategies to help them tailor their
instruction to meet the needs of each student. The program features
leading experts such as Dr. Carmelita Williams, former president of the
International Reading Association (IRA) and Dr. Douglas Reeves, director
of the Center for Performance Assessment. These experts guide teachers
through lessons on enhancing family involvement, assessing student
progress, and individualizing instruction. This series also helps
teachers to effectively implement Lightspan Achieve Now in the classroom.

Teachers can use this technology-based professional development tool
at their convenience from their home or school PC, saving valuable time
and giving teachers more control over when and where professional
development takes place. In addition, on-site professional development
sessions conducted by Lightspan Educational Consultants help to enhance
the Lightspan Desktop Professional Development content.

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We believe that successfully implementing our products and services in
schools and extending them to the home is necessary to realize potential
improvements in student achievement. We also believe that independently
validated improvements in student achievement differentiate the Lightspan
Achieve Now curriculum from products offered by our competitors and
generate further support at the district and school level for expanded
sales. Our goal is to become the partner of schools that implement our
products and services. Given the comprehensive nature of the Lightspan
Achieve Now curriculum, its connection of schools to homes, the rapid
technological changes resulting from the Internet, and educators needs
for ongoing technical training and mentoring, we have committed
substantial resources to train educators in the use of our products and
services.

As of January 31, 2002, we maintained a staff of 99 trained
professionals, most of whom are former educators, to provide
pre-sale planning and post-sale implementation, customer support,
training services and motivation for teachers, administrators and
parents in Lightspan schools. We also operate a toll-free, five-day
per week technical and curriculum support telephone help line that
is accessible to both teachers and parents. We include professional
development and telephone support services with the initial
purchase of Lightspan Achieve Now and certain Internet subscription
products. Schools may purchase additional professional development
or support services. We believe that the on-site training provided
by our professional development staff is a key factor in encouraging
school districts to implement Lightspan products in more schools
within the district and in additional classrooms within an
individual school.

We provide pre-sale and post-sale support for college campuses
that use our Academic curriculum in a manner similar to that
provided for our Lightspan Achieve Now curriculum, with a greater
emphasis on technical support and installation related to the
Web-based or local area networked student management system.
Installation and support are included with the software license and
additional services may be purchased.

Rights to Content

We rely principally upon a combination of copyright, trademark
and trade secret laws and contractual restrictions to protect our
proprietary rights.

We developed and own the rights to nearly all of the content
within the Lightspan Achieve Now curriculum, including the worlds,
characters, stories, educational content, and games. We hold
trademarks to all of our Lightspan Achieve Now worlds, our
individual CD-ROM titles, and many of our characters. We also hold
trademarks on our eduTest products included as part of Lightspan
eduTest Assessment.

Seasonality

Our operating results vary significantly from quarter to
quarter because of seasonal influences on demand for our Lightspan
Achieve Now, fee-based subscription Internet and Academic Systems
curricula products and services based on school calendars, budget
cycles, source and timing of school districts funding. Our
Lightspan Achieve Now license transactions have historically been
highest in our second fiscal quarter, and lowest in our first fiscal
quarter. In July 2000, we recognized the remaining Achieve Now
deferred software license revenue as the remaining titles were
completed and shipped during the second quarter. As a result, our
reported revenue for that quarter and previous quarters was not
indicative of our underlying business in those periods. See
Critical Accounting Policies in Managements Discussion and
Analysis of Financial Condition and Operating Results for further
discussion.

Competition

The market for educational technology content and services is
highly fragmented and competitive, with no company having
significant market penetration. We generally compete for school
instructional dollars with textbook publishers, software publishers,
supplemental print publishers, Internet content and service
providers, and training services, among others. We believe our
solution is unique and competes favorably with existing products in
these categories on a price and performance basis.

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In the instructional technology segment of this market, we
believe our existing and prospective competitors may be divided into
the following groups:



| |  |  | comprehensive curriculum software publishers which
offer various school-based computer-based learning systems;
| | - |  | --------------------------------------------------------------------------------------------------------------
|
| |  |  | edutainment software vendors, which principally
target the consumer market but also sell to schools;        
|
| |  |  | education-oriented Internet services and the
educational segments of general on-line service providers;       
|
| |  |  | distance learning providers; and                                                                              
|
| |  |  | programs that take over management of the school or provide substantial tutoring help.                        

As Internet and broadband services become more widely deployed
in K-12 and colleges, we believe new and unidentified competition
will enter the market. Traditional media companies and rapidly
expanding Internet companies are likely to present new competition.
Many of our current and potential competitors have longer operating
histories, larger customer or user bases, greater brand recognition
and significantly greater financial, marketing and other resources
than we do. In addition, many of these current and potential
competitors can devote substantially greater resources to product
development, marketing and promotional campaigns and Web site and
systems development than we can.

Customer Concentration Risk

During the fiscal year ended January 31, 2002, no one customer
accounted for more than 10% of total revenues for Lightspan.

Employees

As of January 31, 2002, we employed 540 persons, including 191
in technology and development, 72 in general and administrative, 178
in sales and marketing and 99 in professional development. Our
future success is substantially dependent on the performance of our
senior management team and our continuing ability to attract and
retain highly qualified technical and managerial personnel. See the
Risk Factors section below for a further discussion of certain
risks related to our employees. None of our employees is
represented by a labor union and we consider our employee relations
to be excellent.

On January 31, 2002, we announced a major cost control
initiative that included an overall reduction of approximately 15%
of our employees resulting in a post-staff reduction total headcount
of 451 persons.

Risk Factors

You should consider carefully the following risk factors,
together with all of the other information included in this Annual
Report on Form 10-K. Each of these risk factors could adversely
affect our business, operating results and financial condition, as
well as adversely affect the value of an investment in our common
stock.

We have a limited operating history that makes an evaluation of our
business difficult.

We began selling our Lightspan Achieve Now educational software
in January 1996 and entered the Internet market by launching The
Lightspan Network in January 1997. Academic began selling its
educational software in April 1994. Since early 1999, we have
significantly increased our efforts to expand our fee-based
subscription Internet businesses. As a result, our businesses have
only a limited operating history on which you can base your
evaluation of our business and prospects. In considering an
investment

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in our stock, you should evaluate the risks, uncertainties,
expenses and difficulties frequently encountered by early stage
companies.

Our quarterly results are volatile and difficult to forecast, which
could cause the price of our common stock to decline.

Our quarterly results have fluctuated significantly since our
inception, for various reasons. Our quarterly results have ranged
from a net loss of $21.0 million to a net income of $17.7 million
over the twenty-four quarters ended January 31, 2002. In addition,
in fiscal year 1997 and 1998 we recognized license revenue for our
Lightspan Achieve Now product of $5.6 million and $14.8 million,
respectively, in accordance with the accounting rules in effect at
that time; while in fiscal years 1999 and 2000, we did not recognize
any Lightspan Achieve Now license revenue, in accordance with new
accounting rules adopted February 1, 1998. In the quarter ended
April 30, 2000, we recognized $46.4 million in previously deferred
revenue, resulting in an operating profit of $16.2 million. In the
quarter ended July 31, 2000, we recognized the remaining $2.0
million of revenue previously deferred. The operating results for
these quarters are not indicative of our underlying business in
these quarters, and will not be indicative of results that may be
expected for any subsequent quarter, for the full year ending
January 31, 2003 or for any future years.

We expect significant fluctuations in our quarterly revenues
and operating results to continue. Demand for our products and
services is subject to seasonal influences based on school
calendars, budget cycles, and the sources and timing of school
districts funding. Moreover, our sales could be delayed from
quarter to quarter due partly to our need to assist school district
decision makers regarding the uses and benefits of our software, and
the lengthy multiple approval process that typically accompanies
significant expenditures by school districts. In addition, the
tragedies of September 11 have caused school districts to carefully
balance their focus on academics with concerns about health and
security. If a significant sale that we expect to occur in a
particular quarter is delayed until a future quarter, or does not
occur at all, our quarterly performance may be adversely affected to
a greater degree than expected. Further, our fee-based subscription
Internet efforts may contribute to fluctuations in our quarterly
operating results because the sales cycles and our ability to
recognize revenues derived from sales of our fee-based subscription
Internet products are different than the sales cycles and our
ability to recognize revenues derived from sales of our educational
software. Also, our quarterly results may be impacted to the extent
that outstanding warrants held by CINAR become exercisable upon
completion of certain performance criteria and we are required to
record a corresponding expense. If our financial results for one or
more quarters fall below the expectations of analysts and investors,
the trading price of our common stock may decline.

We expect net losses to continue for the foreseeable future and may
never achieve or sustain profitability, which may cause our stock
price to decline.

Since our inception, we have incurred significant net losses.
As of January 31, 2002 we have accumulated net losses of $271.9
million. We incurred net losses of $62.2 million for the fiscal year
ended January 31, 2002; $32.1 million in net losses for the fiscal
year ended January 31, 2001, including the recognition of $48.1
million in revenue previously deferred in fiscal years 1999 and
2000; and $55.7 million in net losses for the fiscal year ended
January 31, 2000. Our operating losses and negative cash flow could
continue as we incur costs and expenses related to, among other
things:



| |  |  | marketing and promotional activities;                                                                                                                                               
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | continued development and expansion of our fee-based
subscription Internet offerings and content; and                                                                               
|
| |  |  | amortization or impairment of intangible assets and
goodwill recorded in connection with our acquisitions of
eduTest, LearningPlanet.com, Academic, Global Schoolhouse and
StudyWeb.

Our ability to become profitable and maintain profitability
depends on our ability to generate and sustain substantially higher
revenues while maintaining reasonable expense levels. Although we
may continue our

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spending on the activities listed above, these efforts may not
result in increased revenues. We conduct operations using estimates
as to future expense levels based on our expectations of future
revenues. We cannot guarantee that we will be able to predict our
future revenues accurately or that we will be able to adjust
spending to compensate for any unexpected revenue shortfall. If we
achieve profitability, we may not be able to sustain or increase
profitability.

From time to time, we
receive inquiries from investors and other parties as to whether
Lightspan will remain an independent organization. We consider those
inquiries, along with our ongoing operations of the company, in
determining how to best maximize stockholder value. We have not,
however, formally engaged a financial advisor in connection with any
such inquiries.

Changes in funding for public school systems could reduce our
revenues and impede the growth of our business.

We derive a substantial portion of our revenues from public
school funding, which is heavily dependent on support from federal,
state and local governments. Government budget deficits may
adversely affect the availability of this funding. In addition, the
government appropriations process is often slow, unpredictable and
subject to factors outside of our control. Curtailments, delays or
reductions in the funding of schools or colleges, for example a
reduction of funds allocated to schools under Title I of the
Elementary and Secondary Education Act of 1965, could delay or
reduce our revenues, in part because schools may not have sufficient
capital to purchase our products or services. Funding difficulties
experienced by schools or colleges could also cause those
institutions to be more resistant to price increases in our
products, compared to other businesses that might better be able to
pass on price increases to their customers. The growth of our
business depends on continued investment by public school systems in
interactive educational technology and products. Changes to funding
of public school systems could slow this kind of investment.

We are heavily dependent upon our relationship with Sony Computer
Entertainment Inc. and termination of that relationship, potential
supply shortages of the PlayStation game consoles or unanticipated
changes in the game consoles could significantly reduce our
Lightspan Achieve Now sales or increase related expenses.

We are heavily dependent upon our relationship with Sony
Computer Entertainment Inc., which supplies the PlayStation game
console used by the students who use our Lightspan Achieve Now
educational software at home. Historically, and for the foreseeable
future, sales of Lightspan Achieve Now and PlayStation game consoles
have accounted for a majority of our revenue. Without incurring
significant additional expense, there currently is no readily
available operating platform for broad implementation of Lightspan
Achieve Now in the home other than the PlayStation game console.
Sony Computer Entertainment Inc. has rights to terminate their
agreement with us in various circumstances, including if it elects
to stop producing the PlayStation game console. If our agreement is
terminated, if the PlayStation game console loses popular appeal or
if we are unable to obtain an adequate supply of PlayStation game
consoles on a timely basis, our ability to sell our Lightspan
Achieve Now curriculum will be significantly reduced and we could
incur significant additional expenses or lose substantial revenues.

We may also experience disruption of supply of the original
PlayStation game console as Sony Computer Entertainment Inc.
balances its manufacturing capability between the PlayStation game
console and the PlayStation®2 computer entertainment system. If we
are unable to acquire PlayStation game consoles, our software
license revenue may be deferred, as our revenue recognition policy
requires that delivery of hardware along with the software is
required before we can fully recognize software license revenue.

Note: PlayStation and the
PS
Family logo are registered trademarks of Sony Computer Entertainment
Inc.

We may need additional financing to meet our strategic business
objectives, which may not be available and, if available, might
adversely impact our existing stockholders.

We may need to raise additional funds to continue to meet
operating demands or other strategic business objectives. In
addition, if we enter into new areas of business, we may incur
substantially increased expenses for which we do not expect
investment returns for months or years in the future. If we raise
additional funds through the issuance of equity or debt securities
that have rights senior to those of our current stockholders, these
stockholders may experience additional dilution or may lose other
rights. We cannot be certain that additional financing will be
available to us on favorable terms when required, if at all. Such
capital raising may be made more difficult if we are no longer
listed on the NASDAQ National Market

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as a result of our failure to continue to meet the listing
requirements required by NASDAQ, which is a risk we face. If we
cannot raise funds on acceptable terms, if and when needed, we may
not be able to take advantage of future opportunities, to continue
to operate or grow our business or respond to competitive pressures
or unanticipated developments.

Our continued growth will utilize our resources, and failure to
manage this growth effectively could disrupt our operations and
prevent us from generating the revenues we expect.

We expect that expansion of our customer and revenue base will
be required to successfully implement our business strategy. For
example, the development of our business continues to require sales
and marketing expenditures as well as increased development efforts
of certain products. This expansion may strain our management,
operational, financial and technological resources, as well as the
infrastructure for our Web sites and services. The growth of our
Lightspan Achieve Now educational software business may strain the
resources of our professional development staff during periods of
heavy implementation in purchasing school districts. Our growth
depends on our ability to attract and retain qualified employees
(including employees of businesses that we acquire), particularly
sales and marketing and product development personnel. Our failure
to manage our growth in a manner that minimizes these strains on our
resources could disrupt our operations and ultimately prevent us
from generating the revenues we expect.

Our curriculum-based educational software may be unable to achieve
or maintain broader market acceptance, which would cause our future
revenue growth and profitability to be adversely impacted.

We expect to continue to generate a substantial portion of our
revenues from our curriculum-based educational software products
such as Lightspan Achieve Now software licenses, and will need to
increase these revenues in order to more effectively grow other
areas of our business. Revenues from licenses will depend
principally on broadening market acceptance of that software, which
may not occur due to a number of factors, including:



| |  |  | teacher, parent and student preferences for
interactive educational technology are subject to changes in
popular entertainment and educational theory;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | some teachers may be reluctant to use interactive
educational technology to supplement their customary teaching
practices;                            
|
| |  |  | we may be unable to continue to demonstrate
improvements in academic performance at schools or colleges
that use our educational software; and        
|
| |  |  | our failure to detect bugs in our software could
result in product failures or poor product performance.                                              

If market acceptance of our curriculum-based educational
software is not broadened, our future revenue growth will be
adversely impacted and we may never become profitable.

The success of our business model requires us to increase our
revenues from our fee-based subscription Internet business, and we
may never become profitable if we are unable to do so.

To achieve our operating goals and objectives, we will need to
derive an increasing portion of our revenues from our fee-based
subscription Internet business. Our ability to increase revenues
from our fee-based subscription Internet business depends on:



| |  |  | our ability to increase the subscriber base of our
fee-based subscription Internet products while maintaining a
subscription fee; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | improvement of the accessibility and ease of use of
our Web sites.                                                                   

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The future success of our fee-based subscription Internet
business is highly dependent on an increase in the number of
Internet users who are willing to subscribe to The Lightspan
Network, Lightspan Reading Center, Lightspan eduTest Assessment and
Lightspan Assessment Builder subscription products. The number of
Internet users willing to pay for online educational products may
not continue to increase. If the market for subscription-based
online educational products develops more slowly than we expect, or
if our efforts to attract new subscribers are not successful or cost
effective our operating results and financial condition may be
materially and adversely affected.

If we are unable to substantially increase our revenues from
our Internet businesses, we will be unable to execute our current
business model. As a result, we may need to reevaluate that business
model, or we may never become profitable.

We rely on statistical studies to demonstrate the effectiveness of
our products, and our reputation and sales and marketing efforts
could be adversely impacted if the results of these studies are not
representative or if their integrity is questioned, which could lead
to lower than expected revenues.

We rely heavily on statistical studies, including those cited
in this Annual Report on Form 10-K, to demonstrate that our
curriculum-based educational software increase student achievement.
We believe that these studies accurately reflect the performance of
our products. However, these studies involve the following risks:



| |  |  | the limited sample sizes used in our studies may
yield results that are not representative of the general
population of students who use our products;                                                                                                                                                             
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the methods used to gather the information upon which
these studies are based depend on cooperation from students
and other participants and inaccurate or incomplete responses
could distort results; and                                                                                                         
|
| |  |  | schools studying the effectiveness of our Lightspan
Achieve Now curriculum administer different tests, and
colleges and universities studying the effectiveness of our
Academic Systems curriculum apply different methodologies and
data collection techniques, making results difficult to
aggregate and compare.

We are involved in the Lightspan Achieve Now studies in the
following ways:



| |  |  | we facilitate the collection and analysis of data for
these studies; and                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we select and pay researchers to aggregate and
present the results of these studies and, in some cases, to
conduct the studies.

Our sales and marketing efforts, as well as our reputation,
could be adversely impacted if the public, including our existing
and potential customers, perceives these studies to be biased due to
our involvement, or if the results of these studies are not
representative, which could lead to lower than expected revenues.

If we fail to enhance our fee-based subscription Internet products
and services without systems interruptions and adapt those products
and services to changes in technology, our future revenue growth and
profitability could be less than we expect.

We believe that a component of our future revenue growth will
depend on whether we are able to enhance and improve our fee-based
subscription Internet products and services as planned. Enhancements
and improvements to our fee-based subscription Internet products are
currently scheduled, but we cannot assure you that those
enhancements and improvements will gain market acceptance or be
launched on schedule and without systems interruptions. In addition,
the Internet is rapidly changing, and we expect that we will
continually need to adapt our fee-based subscription Internet
products and their related technology to emerging Internet standards
and practices, technological advances developed by our competition,
and changing subscriber and user preferences. Ongoing adaptation of
our fee-based subscription Internet

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products and their related technology will entail significant
expense and technical risk, and we may use new technologies
ineffectively or fail to adapt our fee-based subscription Internet
products and their related technology on a timely and cost-effective
basis. If our enhancements, improvements and adaptations of our
fee-based subscription Internet products and their related
technologies are delayed, result in systems interruptions or do not
gain market acceptance, our future revenue growth will be adversely
impacted and we may never become profitable.

We expect competition to increase significantly in the future, which
could prevent us from successfully implementing our business
strategy.

The educational technology market is intensely competitive and
subject to increasing commercial attention. Barriers to entering
Internet markets are relatively low, and we expect competition to
intensify in the future, as more businesses use the Internet to
enter the student, parent and teacher markets for education-oriented
products and services. We also may be adversely affected by pricing
and other operational decisions. For example, the decision of
several of our competitors that offer educational content on the
Internet to offer a free service rather than charge a fee, which
could adversely impact our subscription revenues.

Our competitors include:



| |  |  | comprehensive curriculum software publishers which
offer various school-based computer-based learning systems;
| | - |  | --------------------------------------------------------------------------------------------------------------
|
| |  |  | edutainment software vendors, which principally
target the consumer market but also sell to schools;        
|
| |  |  | education-oriented Internet services and the
educational segments of general on-line service providers;       
|
| |  |  | distance learning providers; and                                                                              
|
| |  |  | programs that take over management of the school or provide substantial tutoring help.                        

Many of our current and potential competitors have longer
operating histories, larger customer or user bases, greater brand
recognition and significantly greater financial, marketing and other
resources than we do. Many of these current and potential
competitors can devote substantially greater resources than we can
to product development, marketing and promotional campaigns and Web
site and systems development.

Our acquisitions of other businesses and involvement in strategic
relationships may not be successful, which could distract our
management or cause us to incur additional expenses.

We have acquired businesses and may continue to do so in the
future. Our integration of these acquisitions or any future
acquisitions could distract our management or cause us to incur
additional expenses, and could cause our business and operations to
be adversely impacted. We also may enter into strategic
relationships with complementary businesses.

If we do not successfully anticipate and adapt to changes in
computer platforms and other evolving technologies, our operating
results relating to sales of our software products could be
adversely impacted.

We must manage our software development efforts to anticipate
and adapt to changes in popular computer operating environments and
other evolving technologies. For example, we have improved the
existing Academic CD-ROM-based educational software product with
Internet-based enhancements. Our Lightspan Achieve Now
curriculum-based educational software is currently delivered in
CD-ROM format on PlayStation game consoles and on Windows-based
personal computers. We will continue to evaluate other operating
environments and computer platforms for our software products as
they become available.

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We may decide from time to time to make our software products
available in other operating environments or on other computer
platforms and our efforts to do so may involve substantial costs
without the realization of expected additional revenue from these
activities. Market acceptance of our software products and our
operating results relating to their sale could also be worse than we
expect if we are unable to anticipate and adapt to changes in
computer platforms and other evolving technologies in a timely and
cost-effective manner.

We will not be able to grow our Internet businesses if the market
for those businesses does not develop.

The success of our fee-based subscription Internet businesses
will depend in large part on the continued emergence and growth of a
market for Internet-based educational technology products. The
market for educational technology is characterized by rapid change
and product innovation, unpredictable product life cycles and
unpredictable preferences among students, teachers and parents.
Internet commercial businesses and services are evolving markets as
well, and it is difficult to estimate how and when growth or other
changes in those markets will occur. We therefore cannot predict
that the market for Internet-based educational technology products
will continue to expand.

Our business may not succeed without the continued development and
maintenance of the Internet.

Without the continued development and maintenance of the
Internet infrastructure, we could fail to generate the revenues
necessary for our fee-based subscription Internet business to
succeed. In addition, our Lightspan Achieve Now curriculum is very
media-rich and is not currently delivered over the Internet, due to
bandwidth and other limitations. The continued development of the
Internet includes maintenance of a reliable network with the
necessary speed, data capacity and security, as well as timely
development of complementary products for providing reliable
Internet access and services. Because the online exchange of
information and global commerce on the Internet is new and evolving,
we cannot predict whether the Internet will prove to be an effective
vehicle for delivering commercial content or will provide a viable
marketplace for electronic commerce in the long term.

As the number of Internet users continues to increase, and as
these users increase their frequency of use and bandwidth
requirements, the Internet infrastructure may be unable to support
the demands. In addition, increased users or bandwidth requirements
may adversely impact the performance of the Internet.

Unless we maintain a strong brand identity, our business may not
grow and our financial results may be adversely impacted.

We believe that maintaining and enhancing the value of our
Lightspan, Academic and eduTest brands is critical to attracting
purchasers for our curriculum-based educational software and
subscribers and users of our fee-based subscription Internet
businesses. Our success in maintaining brand awareness will depend
on our ability to continuously provide educational technology that
students enjoy using and teachers and parents consider beneficial to
the learning process. We cannot assure you that we will be
successful in maintaining our brand equity. In addition, to attract
and retain subscribers and users and to promote and maintain the
Lightspan, Academic and eduTest brands, we have spent, and may need
to continue spending significant resources on a brand-enhancement
strategy, which includes promotional programs and efforts by our
field sales team and professional development staffs. Revenues from
these activities may not be sufficient to offset associated costs.

Claims relating to data collection from our user base and content
available on or accessible from our Web sites may subject us to
liabilities and additional expense.

We currently collect only the names of teachers who are
registering for our Internet products. However, we may in the future
collect names and other personal information relating to students,
teachers and parents, and may sell our user information on an
aggregated, non-individual basis; though we do not intend to sell
information relating to children under the age of thirteen. We could
be subject to liability claims for misuses

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of information collected from our users, such as for
unauthorized marketing purposes, and could face additional expenses
to analyze and comply with increasing regulation in this area. The
Federal Trade Commission, for example, has enacted regulations
governing collection of personal information from children under the
age of thirteen and is expected to issue and enforce additional
regulations in this area. We could also be subject to liability
based on claims relating to content that is published on our Web
sites or that is accessible from our network through links to other
Web sites. In addition to subjecting us to potential liability,
claims of this type could require us to change our Web sites in a
manner that could be less attractive to our customers and divert our
financial and development resources.

Our business operations could be significantly disrupted if we lose
members of, or fail to properly integrate, our management team.

Our success depends on the continued contributions of the
principal members of our sales and marketing, product development,
Internet services, and management departments. The loss of the
services of any of our officers or senior managers could disrupt
operations in their respective departments and could cause our
overall financial results to be adversely impacted. We do not
maintain any key person life insurance policies other than on John
T. Kernan, our Chairman and Chief Executive Officer, and Carl E.
Zeiger, our President and Chief Operating Officer.

Several of our existing senior management personnel joined us
during fiscal 2001 and fiscal 2002. Some of these individuals have
not previously worked together as a management team. If our senior
managers are unable to work effectively as a team, our business
operations could be significantly disrupted.

We may not be able to prevent others from using our trademarks,
copyrights, software, characters and other intellectual property
assets. If others do use these assets, their value to us, and our
ability to use them to generate revenues, may decrease.

Our intellectual property includes our trademarks and
copyrights, proprietary software, characters and other proprietary
rights. We believe that our intellectual property is important to
our success and our competitive position, and we try to protect it.
However, our efforts may be inadequate. In addition, our ability to
conduct our business may be adversely impacted if others claim we
violate their intellectual property rights. If successful, claims of
this nature could adversely impact our business by requiring us to
cease using important intellectual property or pay monetary damages.
Even if unsuccessful, these claims could adversely impact our
business by damaging our reputation, requiring us to incur legal
costs and diverting managements attention away from our business.

Our stock price is highly volatile.

The market price of our common stock is likely to continue to
be highly volatile due to risks and uncertainties described in this
section of the Annual Report, as well as other factors, including:



| |  |  | conditions and publicity regarding the Internet or educational software industries generally;                   
| | - |  | ----------------------------------------------------------------------------------------------------------------
|
| |  |  | sales of substantial amounts of our stock by existing stockholders;                                             
|
| |  |  | price and volume fluctuations in the stock market at
large which do not relate to our operating performance; and
|
| |  |  | comments by securities analysts, or our failure to
meet analysts or investor expectations.                     

Furthermore, the stock market has from time to time experienced
extreme price and volume fluctuations that may be unrelated to the
operating performance of particular companies. In addition, class
action lawsuits have historically been initiated against Internet
and software companies following periods of volatility in the market
prices of these companies stock. In general, decreases in our stock
price would reduce the value of our stockholders investments and
could limit our ability to raise necessary capital or

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make potential acquisitions of assets or
businesses. Moreover, as of April 24, 2002, our common stock had
closed at less than $1.00 for thirty consecutive trading days. We
have received notification from NASDAQ of our non-compliance with the
exchange's minimum-price requirement; however we have a grace period
of 90 days to regain compliance with this requirement. If we are
unable to regain compliance, or if appeals to NASDAQ for relief from
compliance are unsuccessful, then we could be delisted from the
NASDAQ National Market, which could adversely affect our stock price
and the ability of our stockholders and investors to buy and sell our
common stock.

If
litigation were instituted on the basis of volatility or liquidity in
our stock price, it could result in substantial costs and would
divert managements attention and resources. This could have a
material adverse effect on our business, financial condition and
results of operations.

Our executive officers, directors and major stockholders control
approximately 44.5% of our common stock.

As of March 31, 2002, executive officers, directors and holders
of 5% or more of our outstanding common stock, in the aggregate,
owned or controlled approximately 44.5% of our outstanding common
stock. These stockholders are able to influence all matters
requiring approval by our stockholders, including the election of
directors and the approval of corporate transactions. This
concentration of ownership may also delay, deter or prevent a change
in control of our company and may make some transactions more
difficult or impossible to complete without the support of these
stockholders. See Part III, Item 12 for more detail regarding the
stockholdings of these stockholders.

It may be difficult for a third party to acquire our company, and
this could adversely impact our stock price.

Delaware corporate law and our certificate of incorporation and
bylaws contain provisions that could delay, defer or prevent a
change in control of our company or our management. These provisions
could also discourage proxy contests and make it more difficult for
you and other stockholders to elect directors and take other
corporate actions. As a result, these provisions could limit the
price that investors are willing to pay in the future for shares of
our common stock. These provisions:



| |  |  | authorize us to issue preferred stock that can be
created and issued by the board of directors without prior
stockholder approval, with rights senior to those of common
stock;       
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | provide for a staggered board of directors, so
that it would take three successive annual meetings to
replace all directors;                                                          
|
| |  |  | prohibit stockholder action by
written consent; and                                                                                                                                   
|
| |  |  | establish advance notice requirements for
submitting nominations for election to the board of
directors and for proposing matters that can be acted upon
by stockholders at a meeting.

Additionally,
in February 2002 we adopted a Share Purchase Rights Plan. Pursuant this plan,
each share of our outstanding common stock has an
associated preferred share purchase right. These rights will not
trade separately from our common stock until, and are exercisable
only upon, the acquisition or potential acquisition by a person or
group of, or the tender offer for, fifteen percent or more of our
common stock.

Executive Officers of the Registrant

The following table sets forth information about our executive
officers as of March 31, 2002:

|                    |  |     |  |                                                                        
|------------------- |  | --- |  | -----------------------------------------------------------------------
|Name                |  | Age |  | Position                                                               
|                    |  |     |  |                                                                        
|                   
|Executive Officers  |  |     |  |                                                                        
|                   
|John T. Kernan      |  | 56  |  | Chairman of the Board and Chief Executive Officer                      
|                   
|Carl E. Zeiger      |  | 59  |  | President, Chief Operating Officer and Director                        
|                   
|Michael A. Sicuro   |  | 43  |  | Senior Vice President, Chief Financial Officer,
Treasurer and Secretary
|                   
|Sandra K. Fivecoat  |  | 53  |  | Senior Vice President of Sales                                         
|                   
|James M. Dredge     |  | 52  |  | Chief Executive Officer of Academic Systems                            
|                   
|Bernice Stafford    |  | 60  |  | Senior Vice President of School Marketing and
Evaluation               
|                   
|Dr. Larry R. Vaughn |  | 63  |  | Senior Vice President of Professional Development                      

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John T. Kernanco-founded Lightspan and has served as our
Chairman and Chief Executive Officer since inception, September
1993. Prior to co-founding Lightspan, Mr. Kernan served as Chairman
and Chief Executive Officer of Jostens Learning Corporation, an
educational software company. Mr. Kernan developed Jostens Learning
from a start-up company in 1985 (then named Education Systems
Technology Corporation) to one of the largest educational software
businesses in the United States. Under Mr. Kernans leadership,
Jostens Learning was a leading supplier of pre-kindergarten through
adult educational software. Prior to founding Jostens Learning, Mr.
Kernan was an executive with Gill Cable Corporation, a Northern
California cable TV operator. He also was Vice President of Product
Development for DELTAK, Inc. (now NETg), then the nations largest
provider of video-based training for technical professionals. Mr.
Kernan was the President of the Software Publishers Association, has
been named Educator of the Decade by Electronic Learning Magazine
and regional Entrepreneur of the Year by Inc. Magazine, among
other distinctions. Mr. Kernan was a founder of Academic Systems,
which has since been acquired by Lightspan, and Elemental Software,
which has since been acquired by Macromedia. Mr. Kernan is a member
of the Board of Directors of TechNet and Varsity Group, Inc. Mr.
Kernan holds a Bachelor of Science from Loyola College.

Carl E. Zeigerco-founded Lightspan and has served as our
President and Chief Operating Officer and as a director since
September 1993. He also served as our Interim Chief Financial
Officer and Secretary from June 2000 to February 2001. Prior to
co-founding Lightspan, Mr. Zeiger served as the President and Chief
Operating Officer of Jostens Learning Corporation. Along with Mr.
Kernan, Mr. Zeiger developed Jostens Learning into a leading
supplier of pre-kindergarten through adult educational software.
Prior to joining Jostens Learning, Mr. Zeiger served as Senior Vice
President of Finance for Integrated Software Systems Corporation, a
leading provider of representation graphics software, and managed
its initial and secondary public offerings and its eventual sale to
Computer Associates. Mr. Zeiger is a certified public accountant in
the State of California and holds a Bachelor of Science from the
University of Denver.

Michael A. Sicurohas served as our Senior Vice President,
Chief Financial Officer, Treasurer and Secretary since February
2001. Previously, he was the Chief Executive Officer and Chief
Financial Officer for MediaDNA from May 2000 to September 2000.
From June 1996 to May 2000, he was the Managing Director and Chief
Financial Officer of ITLA Capital. From 1994 to 1996 Mr. Sicuro
served as the Vice President and Chief Financial Officer of Blue
Cross of California and Controller of WellPoint Health Networks.
Mr. Sicuro also served as the Senior Vice President and Chief
Financial Officer of U.S. Bancorp Mortgage from 1993 to 1994.
Previously, he was employed by Western Federal Savings and Loan
Association as Senior Vice President and Controller and was the
Deputy Controller for First Interstate Bancorp. He was an Audit
Manager and Certified Public Accountant with Deloitte and Touche
LLP. Mr. Sicuro holds a Bachelors degree in Business
Administration from Kent State University.

Sandra K. Fivecoathas served as our Senior Vice President of
Sales since February 1999. From April 1998 to January 1999, she
served as Regional Vice President for our South Central Region. From
1987 to April 1998, Ms. Fivecoat held various executive sales
management positions at Apple Computer, a manufacturer of computers
and software. Ms. Fivecoat had a career in public education, where
she was a teacher, administrator, university researcher, and from
1982 to 1986, the first Director of Educational Technology for the
State of Texas where she established, organized and managed the
division providing overall guidance and direction to public schools
in the effective uses of technology in instruction and
administration. Ms. Fivecoat has been published in the Journal of
Computers in Science and Math Teachingand Computers in Curriculum
and Instruction. Ms. Fivecoat holds a Bachelor of Science and a
Masters in Education from the University of Texas at Austin.

James M. Dredgehas served as our Chief Executive Officer of
Academic Systems since January 2001. From February 1999 to January
2001, Mr. Dredge served as senior vice president/general manager of
the School Division at The Learning Company, where he managed all
sales, marketing and product development of brands such as The
Learning Company, MECC, Broderbund and Mindscape. His
responsibilities also included operations of Learning Services, Inc.,
and of The Learning Companys Language Division. From 1993 to
February 1999, Mr. Dredge assumed a variety of positions including
President and Chief Operating

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Officer for Invest Learning/Mergent Technologies, a leader in
education technology solutions for the high school, college,
corporate and corrections markets. Mr. Dredge holds a Bachelor of
Arts and a Masters in Public Administration from the University of
Minnesota.

Bernice Staffordco-founded Lightspan and has served as our
Vice President of School Marketing and Evaluation since October
1993, and was promoted to Senior Vice President of School Marketing
and Evaluation in March 2002. From 1989 to 1993, she served as
Director of Sales Programs at Jostens Learning Corporation. Ms.
Stafford is a former teacher and early childhood administrator who
has been involved with marketing instructional technology to schools
for more than 10 years. In addition to serving on the boards of
Technology, Reading, and Learning Difficulties and the Agency for
Instructional Technology, she was recently appointed to a task force
that will advise the California Assembly Education Subcommittee on
Urban Education Quality. Ms. Stafford holds a Bachelor of Arts and
a Master of Arts from the University of California at Berkeley.

Dr. Larry R. Vaughn, Ed.D.has served as our Senior Vice
President of Professional Development since January 1999. From 1979
to 1998, he has served as superintendent of school districts
including Wichita Public Schools in Wichita, Kansas from January
1993 to July 1998, Pasadena Independent School Districts in
Pasadena, Texas from 1989 to 1993, Victoria Independent School
District in Victoria, Texas from 1985 to 1989, Alice Independent
School District in Alice, Texas from 1982 to 1985, and Hitchcock
Independent School District in Hitchcock, Texas from 1979 to 1982.
From 1967 to 1979, he served as Director of Curriculum and Secondary
Program Coordinator of Sheldon Independent School District in
Houston, Texas. Dr. Vaughn holds a Bachelor of Arts from Mississippi
State University and a Doctorate in Education from the University of
Houston.




Item 2.Properties

Our headquarters are located in San Diego, California, where we
currently lease approximately 65,000 square feet under a lease
expiring in 2003 and approximately 10,000 square feet under a lease
expiring in March 2002. Warehouse facilities are located in
Carlsbad, California, where we currently lease approximately 12,000
square feet under a lease expiring in August 2002. Additional
facilities are located in Mountain View, California, where
approximately 9,900 square feet are under a lease for Academic
expiring in 2004, in Richmond, Virginia, where approximately 14,700
square feet are under a lease for eduTest expiring in 2003, and in
Denver, Colorado, where approximately 3,400 square feet are under a
lease for our inside sales force expiring in 2004. These facilities
are adequate for our current operations. We currently maintain a
facility that we have subleased in Santa Monica, California, our
former West Los Angeles based operations, for approximately 4,300
square feet under a lease expiring in September 2002.




Item 3.Legal Proceedings

We are not currently involved in any material legal
proceedings.




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

None.

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##### Table of Contents






PART II




Item 5.Market for Registrants Common Equity and Related
Stockholder Matters

Market Information

The Common Stock of the Company is traded on the Nasdaq
National Market under the symbol LSPN. The Common Stock was
initially offered to the public on February 10, 2000 at $12 per
share. The following table sets forth the range of high and low
closing sales prices on the Nasdaq National Market of the Companys
Common Stock, for the periods indicated as reported by the Nasdaq.

|                                    |                                        |  |                    |       |     |  |   |      | 
|----------------------------------- | -------------------------------------- |  | ------------------ | ----- | --- |  | - | ---- | 
|                                    |                                        |  | Common Stock Price
|                                    |                                        |  |                   
|                                    |                                        |  | High               |       | Low
|                                    |                                        |  |                    |       |    
|Fiscal year ended January 31, 2002: |                                        |  |                    |       |     |  |   |     
|                                    | First Quarter                          |  | $                  | 3.03  |     |  | $ | 1.13 | 
|                                    | Second Quarter                         |  |                    | 2.36  |     |  |   | 0.97 | 
|                                    | Third Quarter                          |  |                    | 2.25  |     |  |   | 1.01 | 
|                                    | Fourth Quarter                         |  |                    | 1.72  |     |  |   | 1.12 | 
|                                   
|                                    |                                        |  | High               |       | Low
|                                    |                                        |  |                    |       |    
|Fiscal year ended January 31, 2001: |                                        |  |                    |       |     |  |   |     
|                                    | First Quarter (from February 10, 2000) |  | $                  | 25.38 |     |  | $ | 8.00 | 
|                                    | Second Quarter                         |  |                    | 10.00 |     |  |   | 4.88 | 
|                                    | Third Quarter                          |  |                    | 5.78  |     |  |   | 1.88 | 
|                                    | Fourth Quarter                         |  |                    | 3.03  |     |  |   | 0.84 | 

The closing sales price of our common stock on March 28, 2002
was $0.87.

Holders

As of March 31, 2002, there were approximately 417 record
holders of our common stock.

Dividends

We have never declared or paid any cash dividends on our
capital stock. We currently intend to retain any future earnings to
finance the growth and development of our business and therefore do
not anticipate paying any cash dividends in the foreseeable future.
Any future determination to pay cash dividends will be at the
discretion of the board of directors and will be dependent upon our
financial condition, results of operations, capital requirements,
general business conditions and other factors that the board of
directors may consider relevant.

Recent Sales of Unregistered Securities

On May 19, 2001, we issued 34,615 shares of our common stock to
the holder of a warrant upon the exercise of such warrant. For this
issuance we relied on the exemption provided by Section 4(2) of the
Securities Act of 1933.

Use of Proceeds

The effective date of our registration statement on Form S-1
(No. 333-90103) relating to our initial public offering was
February 9, 2000. A total of 8,155,150 shares of the Companys
common stock in the aggregate were sold at a price of $12.00 per
share to an underwriting syndicate led by Credit Suisse First
Boston, U.S. Bancorp Piper Jaffray Inc. and Thomas Weisel Partners
LLC. The offering commenced on February 9, 2000, and closed on
March 7, 2000. The initial public offering resulted in gross
proceeds of approximately $97.9 million, of which $6.9 million was
applied toward the underwriting discount. Expenses related to the
offering totaled approximately $2.2 million. Net proceeds to the
Company were

22



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$88.8 million. From the time of receipt through January 31,
2002, $0.2 million of the net proceeds were applied to repay debt,
$2.6 million were used to purchase eduTest, $5.0 million were used
to promote our Lightspan.com Web site and the remaining proceeds of
$81.0 million were used primarily to fund operations or invested in
short-term, interest-bearing securities rated AA or better.




Item 6. Selected Financial Data

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be
read in conjunction with the Lightspan consolidated financial
statements and the related notes thereto and Managements
Discussion and Analysis of Financial Condition and Results of
Operations. Our statement of operations data for the years ended
January 31, 2002, 2001, 2000, 1999 and 1998 and balance sheet data
as of January 31, 2002, 2001, 2000, 1999 and 1998 are derived from
our audited financial statements, which are included elsewhere in
this Form 10-K for the years ended January 31, 2002, 2001 and 2000
and as of January 31, 2002 and 2001. The following financial
information is in thousands, except per share data.

|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|-------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                             |  | Years Ended January 31,
|                                             |  |                        
|                                             |  | 2002                    |         | 2001 |  | 2000 |         | 1999 |  | 1998
|                                             |  |                         |         |      |  |      |         |      |  |     
|Consolidated Statement of
Operations Data:   |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Total revenues                               |  | $                       | 57,532  |      |  | $    | 99,074  |      |  | $    | 16,916  |   |  | $ | 10,870  |   |  | $ | 22,309  |  
|Total cost of revenues                       |  |                         | 17,729  |      |  |      | 25,286  |      |  |      | 9,734   |   |  |   | 7,660   |   |  |   | 11,433  |  
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Gross profit                                 |  |                         | 39,803  |      |  |      | 73,788  |      |  |      | 7,182   |   |  |   | 3,210   |   |  |   | 10,876  |  
|Total operating expenses                     |  |                         | 104,506 |      |  |      | 112,123 |      |  |      | 63,382  |   |  |   | 37,194  |   |  |   | 37,827  |  
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Loss from operations                         |  |                         | (64,703 | )    |  |      | (38,335 | )    |  |      | (56,200 | ) |  |   | (33,984 | ) |  |   | (26,951 | )
|Interest income (expense), net               |  |                         | 2,460   |      |  |      | 6,215   |      |  |      | 479     |   |  |   | 417     |   |  |   | (527    | )
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net loss                                     |  |                         | (62,243 | )    |  |      | (32,120 | )    |  |      | (55,721 | ) |  |   | (33,567 | ) |  |   | (27,478 | )
|Preferred stock dividend                     |  |                         |        |      |  |      | (16,506 | )    |  |      |        |   |  |   |        |   |  |   |        |  
|Net loss attributable to common
stockholders |  | $                       | (62,243 | )    |  | $    | (48,626 | )    |  | $    | (55,721 | ) |  | $ | (33,567 | ) |  | $ | (27,478 | )
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net loss per
share(1)  basic and diluted    |  | $                       | (1.34   | )    |  | $    | (1.10   | )    |  | $    | (13.61  | ) |  | $ | (9.91   | ) |  | $ | (8.65   | )
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Weighted average
shares  basic and diluted  |  |                         | 46,373  |      |  |      | 44,019  |      |  |      | 4,094   |   |  |   | 3,388   |   |  |   | 3,177   |  
|                                             |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  

|                                                            |  |                |        |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        | 
|----------------------------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------ | 
|                                                            |  | At January 31,
|                                                            |  |               
|                                                            |  | 2002           |        | 2001 |  | 2000 |         | 1999 |  | 1998
|                                                            |  |                |        |      |  |      |         |      |  |     
|Consolidated Balance Sheet Data:                            |  |                |        |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        | 
|Cash and cash equivalents                                   |  | $              | 35,033 |      |  | $    | 45,566  |      |  | $    | 5,033   |   |  | $ | 7,143   |   |  | $ | 4,422  | 
|Short-term investments                                      |  |                | 8,333  |      |  |      | 32,683  |      |  |      | 16,132  |   |  |   |        |   |  |   |       | 
|Deferred cost of revenues- Achieve Now                      |  |                |       |      |  |      |        |      |  |      | 8,709   |   |  |   | 3,555   |   |  |   |       | 
|Working capital (deficit)                                   |  |                | 31,978 |      |  |      | 69,783  |      |  |      | (25,994 | ) |  |   | (12,233 | ) |  |   | 454    | 
|Total assets                                                |  |                | 97,420 |      |  |      | 153,898 |      |  |      | 102,432 |   |  |   | 22,566  |   |  |   | 14,080 | 
|Deferred revenues-Achieve Now                               |  |                |       |      |  |      |        |      |  |      | 48,110  |   |  |   | 20,717  |   |  |   |       | 
|Deferred revenues-services and other, current and long-term |  |                | 11,964 |      |  |      | 9,362   |      |  |      | 7,022   |   |  |   | 3,444   |   |  |   | 2,494  | 
|Capital lease obligations, less current portion             |  |                | 39     |      |  |      | 268     |      |  |      | 443     |   |  |   | 394     |   |  |   | 775    | 
|Total stockholders equity (deficit)                        |  |                | 68,295 |      |  |      | 126,315 |      |  |      | 26,694  |   |  |   | (11,249 | ) |  |   | 1,682  | 



|(1) |  | See Note 1 to the Lightspan consolidated financial
statements for a description of the computation of the net
loss per share.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------

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

This information should be read in conjunction with the audited
consolidated financial statements and notes thereto contained
herein. Except for the historical information contained herein, the
following discussion contains forward-looking statements that
involve risks and uncertainties. Our future results could differ
materially from those discussed here. Factors that could cause or
contribute to such differences include risks detailed in Part I,
Item I under the caption Risk Factors and elsewhere in this Annual
Report on Form 10-K.

Overview

We were founded in 1993 on the philosophy of using technology
to increase student achievement by connecting the school to the
home. We develop, market and sell curriculum-based educational
software and fee-based subscription Internet products and services
used both in school and at home. Our curriculum-based educational
software consists of our Lightspan Achieve Now and Academic
software. Lightspan Achieve Now is our media-rich, interactive
CD-ROM-based software for students in schools in kindergarten
through eighth grade that covers the core curriculum of language
arts, reading and math. Our technology, delivery system and content
help increase student interest in learning, parental involvement in
their childrens education, and productive interaction among
teachers, parents and students. Our Academic software is also
CD-ROM-based and serves the college market with an English and
mathematics curriculum designed to meet the needs of under-prepared
college students. Our fee-based subscription Internet products
consist of The Lightspan Network, which provides curriculum based
content correlated to state academic standards, and the Lightspan
Reading Center, which is a complete online reading program that
supports student achievement and helps educators make more informed
instructional decisions. Assessment products are offered through
Lightspan eduTest Assessment, with proprietary test questions,
covering language arts, mathematics and science, allowing educators
to assess their students progress in the classroom. The results
can be analyzed at the school district and school levels, and the
classroom.

Our products and services are sold to school districts by a
direct field sales force, our internal sales organization and
supported by our professional development team who assist in
implementing our curricula in schools.

Critical Accounting Policies

The preparation of financial statements in conformity with
generally accepted accounting principles requires us to utilize
accounting policies and make estimates and assumptions that affect
our reported amounts. Our significant accounting policies are
described in Note 1 of the Notes to Consolidated Financial
Statements included elsewhere in this annual report. We believe
policies and estimates related to revenue recognition, intangible
assets and allowance for doubtful accounts represent our critical
accounting policies. Future results may differ from these estimates
under different assumptions or conditions.

Revenue Recognition

Software License Revenue. We recognize revenue from license
agreements when a non-cancelable, non-contingent license agreement
has been signed, the software product has been delivered, no
uncertainties exist surrounding product acceptance, fees from the
agreement are fixed and determinable, and collection is probable.
In software arrangements that include multiple elements, such as
those that include rights to software products, customer support and
product implementation and training services, Lightspan allocates
the total fee to each component of the arrangement based on
objective evidence of its fair value, which is specific to
Lightspan. The objective evidence for each element is based on the
sale price of each element when sold or offered for sale separately.
We use the residual method to recognize revenue when a license
agreement includes one or more elements to be delivered at a future
date if evidence of the fair value of all undelivered elements
exists. If evidence of the fair value of the undelivered elements
does not exist, all revenue is deferred until sufficient evidence
exists or all elements have been delivered.

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Internet Subscriptions.Revenue derived from fee-based
Internet subscriptions is recognized on a straight-line basis over
the term of the agreement, generally one year.

Professional Services. Revenue derived from professional
services, including product implementation and customer training is
recognized as the services are performed. Revenue derived from
telephone support and maintenance arrangements provided by the
professional development organization is recognized ratably over the
term of the support and maintenance period, generally one year.

We recognize our revenue in accordance with the Securities and
Exchange Commissions (SEC) Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements (SAB 101) and The
American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 97-2, Software Revenue Recognition,
and SOP 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions. We believe that
our revenue recognition policy is consistent with this guidance and
in accordance with generally accepted accounting principles.
However, the accounting profession continues to discuss various
provisions of these guidelines with the objective of providing
additional guidance on their future application. These discussions
and the issuance of new interpretations, once finalized, could lead
to unanticipated changes in recognized revenue. They could also
drive significant adjustments to our business practices that could
result in increased administrative costs, lengthened sales cycles
and other changes that could affect our results of operations.

Effective February 1, 1998, we adopted SOP 97-2, as described
in Note 1 of the Notes to Consolidated Financial Statements, which
caused a substantial change in the timing of when revenue was
recognized for Lightspan Achieve Now licenses. Under SOP 97-2, we
were unable to recognize any Lightspan Achieve Now license fees as
revenue until we shipped the final title which we planned to provide
to all existing customers for no additional charge. Therefore, we
deferred the recognition of revenue for all Lightspan Achieve Now
licenses shipped in the years ended January 31, 2000 and 1999. By
April 30, 2000, we had completed and shipped all Lightspan Achieve
Now titles in all grade clusters used on the PlayStation game
console and grade cluster K through 2 used on a PC platform,
resulting in the recognition in the first quarter of fiscal 2001 of
$46.4 million of revenue previously deferred. By July 31, 2000, we
had completed and shipped all remaining Lightspan Achieve Now titles
used on a PC platform, resulting in the recognition in the second
quarter of fiscal 2001 of the remaining $1.7 million of revenue
previously deferred. Subsequent to July 31, 2000, we did not defer
revenue relating to Lightspan Achieve Now licenses that were shipped
as we had completed the development of all Lightspan Achieve Now
titles.

To the extent that we deferred the Lightspan Achieve Now
license revenue until delivery of final titles, pursuant to SOP
97-2, we also deferred the costs of duplicating the product and
packaging it for distribution. In the three months ended April 30,
2000, we recognized $8.4 million in cost of license revenue when we
recognized the related $46.4 million in revenue. In the three
months ended July 31, 2000, we recognized $0.3 million in cost of
license revenue when we recognized the related $1.7 million in
revenue.

The following table shows the activity in software license
revenue and associated cost of revenue deferred pursuant to SOP 97-2
for the years ended January 31, 2001 and 2000, respectively (in
thousands):

|                                              |                              |  |                         |         |      |  |   |        | 
|--------------------------------------------- | ---------------------------- |  | ----------------------- | ------- | ---- |  | - | ------ | 
|                                              |                              |  | Years Ended January 31,
|                                              |                              |  |                         |         |     
|                                              |                              |  | 2001                    |         | 2000
|                                              |                              |  |                         |         |     
|Deferred license revenue- Achieve Now         |                              |  |                         |         |      |  |   |       
|                                              | Beginning balance            |  | $                       | 48,110  |      |  | $ | 20,717 | 
|                                              | Deferred during the period   |  |                         | 384     |      |  |   | 27,393 | 
|                                              | Recognized during the period |  |                         | (48,494 | )    |  |   |       | 
|                                              |                              |  |                         |         |      |  |   |       
|                                              | Ending balance               |  | $                       |        |      |  | $ | 48,110 | 
|                                              |                              |  |                         |         |      |  |   |       
|Deferred cost of license revenue- Achieve Now |                              |  |                         |         |      |  |   |       
|                                              | Beginning balance            |  | $                       | 8,709   |      |  | $ | 3,555  | 
|                                              | Deferred during the period   |  |                         | 70      |      |  |   | 5,154  | 
|                                              | Recognized during the period |  |                         | (8,779  | )    |  |   |       | 
|                                              |                              |  |                         |         |      |  |   |       
|                                              | Ending balance               |  | $                       |        |      |  | $ | 8,709  | 
|                                              |                              |  |                         |         |      |  |   |       

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Intangible Assets

We assess the potential for impairment of our goodwill based on the
provisions of SFAS 121. In assessing impairment, we made assumptions
regarding future cash flows and other factors to determine the fair value
of goodwill or impairment thereof. If these estimates or their related
assumptions change in the future, we may be required to recognize
impairment charges for our goodwill not previously recorded. For the year
ended January 31, 2002, the Company did not record any impairment loss
related to goodwill.

The Company will apply SFAS 142 beginning in the first quarter of
fiscal 2003. Beginning in that quarter, we will reclassify an
assembled workforce intangible asset with an unamortized balance of
$0.5 million to goodwill at the date of adoption and will no longer
amortize goodwill, thereby eliminating (subject to future impairment
charges) what would otherwise be an annual goodwill amortization of
approximately $9.8 million. In accordance with SFAS 142 the Company will test goodwill for
impairment using the two-step process prescribed in SFAS 142. The first
step is a screen for potential impairment, while the second step measures
the amount of the impairment, if any. We will complete an initial goodwill
impairment assessment during the first six months of fiscal 2003 to
determine if an impairment charge should be recognized under SFAS 142. We
cannot predict at this time whether a material impairment charge will be
recorded.

Our intangible assets were acquired as a result of our acquisitions of
Academic and Global Schoolhouse in September 1999, StudyWeb in October
1999 and eduTest in June 2000, and represent customer base, acquired
technology, trademarks and trade names. These intangibles are amortized
on a straight-line basis over the estimated economic life of the assets.
Lightspan continually evaluates the recoverability of the intangible
assets and considers any events or changes in circumstances that would
indicate that the carrying amount of an asset may not be recoverable. The
determination of the value of such intangible assets requires management
to make estimates and assumptions that affect our consolidated financial
statements. Any material changes in circumstances could require future
write-downs of our intangible assets and could have a material adverse
impact on our operating results for the periods in which such write-downs
occur.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts that we estimate to be
sufficient to provide adequate protection against losses resulting from
collecting less than full payment on our receivables. A considerable
amount of judgment is required when we assess the realization of
receivables, including assessing the probability of collection and the
current credit-worthiness of each customer. We determine the amount of the
reserve by analyzing known uncollectible accounts, aged receivables,
historical losses and our customers credit-worthiness. Amounts later
determined and specifically identified to be uncollectible are charged or
written off against this reserve. Should a customers account become past
due, we generally place a hold on the account and discontinue further
shipments to that customer, minimizing further risk of loss.
Additionally, our policy is to fully reserve for all accounts with aged
balances greater than one year. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability
to make payments, an additional provision for doubtful accounts may be
required.

Results of Operations

Operating Losses. We have incurred significant losses since
our inception and, as of January 31, 2002, have accumulated losses
of approximately $271.9 million. We expect to continue to incur
operating losses for the foreseeable future. In July 2000, we
recorded a $1.6 million restructuring charge related to a refocus of
our sales and marketing efforts from our free Internet products
towards our fee-based subscription Internet products. In addition,
in July 2000, we completed and shipped the remaining Lightspan
Achieve Now titles used on a PC platform and the PlayStation game
console, recognizing $48.1 million during the first two quarters of
fiscal year 2001 (ended July 31, 2000) in revenue previously
deferred pursuant to SOP 97-2, resulting in an operating loss of
$38.3 million for the year ended January 31, 2001 (fiscal 2001).
The operating results in fiscal 2001 are not indicative of our
underlying business in that year, and are not indicative of results
that may be expected for the foreseeable future.

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Comparison of Fiscal 2002 vs. 2001

Revenues

The types of revenue we generate are fees from the sale of
software licenses, Internet subscriptions, professional services and
hardware. Our total revenues decreased 42 percent to $57.5 million
in fiscal 2002 from $99.1 million in fiscal 2001 due to the
recognition of $48.1 million in Lightspan Achieve Now revenue
previously deferred in fiscal years 2000 and 1999, see Critical
Accounting Policies. Excluding the previously deferred revenue for
fiscal 2001, total revenues of $57.5 million in fiscal 2002 were 13
percent higher than the total revenues of $51.0 million adjusted to
remove such previously deferred revenue. This increase was
primarily due to an increase in software license revenue of $2.9
million and an increase of $3.4 million from our fee-based Internet
subscription products.

Software Licenses.Our software license revenues decreased 57
percent to $34.3 million in fiscal 2002 from $79.6 million in fiscal
2001 primarily due to the recognition in fiscal 2001 of $48.1
million in Lightspan Achieve Now revenue previously deferred in
fiscal years 2000 and 1999. See Critical Accounting Policies.
Excluding the previously deferred revenue for fiscal 2001, software
license revenues of $34.3 million in fiscal 2002 were 9 percent
higher than software license revenues of $31.4 million adjusted to
remove such previously deferred revenue. This increase was
primarily due to a 9 percent price increase in our Lightspan Achieve
Now product, which offset a 2 percent decrease in the number of
Lightspan Achieve Now licenses sold in fiscal 2002 to approximately
42,000 as compared to approximately 43,000 sold in fiscal 2001.

Internet Subscriptions. Our Internet subscription revenues
increased 74 percent to $7.9 million in fiscal 2002 from $4.6
million in fiscal 2001 primarily due to a combination of a 17% price
increase on The Lightspan Network product and the inclusion of a
complete fiscal year of revenue from our Assessment products in
connection with our acquisition of eduTest in June 2000. In
addition, the base of customers subscribing to our fee-based
Internet subscription products increased 21 percent to approximately
3,400 at fiscal end 2002 from approximately 2,800 at fiscal end
2001.

Professional Services.Our professional service revenues
increased 2 percent to $9.3 million in fiscal 2002 from $9.2 million
in fiscal 2001 primarily due to the sale of additional professional
services that were sold with our software and Internet subscription
products, which reflect increases over the prior fiscal year.

Hardware and Other.Our hardware and other revenues increased
3 percent to $5.9 million in fiscal 2002 from $5.8 million in fiscal
2001 primarily due to the recognition of $1.0 million of other
revenue in fiscal 2002 relating to a non refundable fee collected
from a reseller of our Academic software product. This amount
reflects a 25 percent increase over the $0.8 million in other
revenue recognized in fiscal 2001 which related to website
sponsorship agreements. This increase in other revenue was offset
by a nominal decrease in hardware revenues that corresponds to the
decrease in Lightspan Achieve Now licenses sold.

Cost of Revenues

Our total cost of revenues decreased 30 percent to $17.7
million for fiscal 2002 from $25.3 million for fiscal 2001 primarily
due to the recognition in fiscal 2001 of $8.7 million in software
license cost of revenues related to the sale of Lightspan Achieve
Now licenses previously deferred in fiscal years 2000 and 1999, see
Critical Accounting Policies. Excluding the previously deferred
software license cost of revenues for fiscal 2001, cost of revenues
of $17.7 million in fiscal 2002 were 8 percent higher than cost of revenues
of $16.3 million adjusted to remove such previously deferred cost of
revenue. This increase is due primarily to the corresponding
increase in software license revenue and an increase in the
allocable costs to professional services, primarily the inclusion of
a complete fiscal year of costs from our Assessment products in
connection with our acquisition of eduTest in June 2000.

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Expenses

Sales and Marketing.Our sales and marketing expenses decreased
13 percent to $49.4 million for fiscal 2002 from $56.9 million for
fiscal 2001. This was primarily due to a decrease in personnel and
related expenses, and a decrease in promotional activities connected
to the launch of Lightspan.com in the first quarter of fiscal 2001
reflecting a refocus of our sales and marketing efforts toward
fee-based subscription Internet products and away from our free
Internet products.

Our sales and marketing expenses consist primarily of
compensation and related benefits, commissions, bonuses, travel,
advertising, promotional activities, customer incentive programs and
research and evaluation of our current customers and markets. We
continue to pursue marketing campaigns to retain and increase sales
to current customers, attract new customers, and broaden our markets
for our fee-based subscription Internet products, Lightspan Achieve
Now curriculum and Academic products.

Technology and Development.Our technology and development
expenses decreased 5 percent to $24.4 million for fiscal 2002 from
$25.8 million for fiscal 2001. This was primarily due to a decrease
in personnel and consulting fees related to our focus toward
fee-based Internet subscription products and away from the design of
free Internet products.

Our development costs consist primarily of compensation and
benefits for design, art, production, enhancement, maintenance and
testing of our Lightspan Achieve Now curriculum, fee-based
subscription Internet products and Academic Internet products, which
we expensed as incurred.

General and Administrative.Our general and administrative
expenses increased 24 percent to $11.7 million for fiscal 2002 from
$9.4 million for fiscal 2001. This was due primarily to non
recurring costs related to severance accruals for staff
reductions, additional reserves for doubtful accounts and
professional service fees.

Our general and administrative expenses consist primarily of
compensation and benefits for executive and administrative
personnel, professional service expenses and other general corporate
expenses.

Stock-Based Compensation.Stock-based compensation expense was
approximately $0.7 million and $2.4 million for fiscal years 2002
and 2001, respectively. During fiscal years 2002 and 2001, we
recorded zero and $0.1 million, respectively, in deferred
stock-based compensation as a result of our granting of stock
options to employees with exercise prices per share below the fair
values per share for our common stock on the dates those options
were granted prior to our initial public offering. The deferred
stock-based compensation is being amortized to expense on an
accelerated basis over the vesting period of the individual options,
generally four years. As of January 31, 2002, there was
approximately $0.3 million to be amortized in future periods.

Amortization of Intangible Assets.In connection with our
acquisitions of Academic, Global Schoolhouse and StudyWeb in the
third quarter of fiscal 2000, and LearningPlanet.com and eduTest in
the second quarter of fiscal 2001, we recorded intangible assets
totaling an aggregate of approximately $68.9 million, including
goodwill of $35.7 million. We amortize these intangible assets over
their respective useful lives, ranging from three to ten years. Our
amortization of goodwill and intangible assets totaled $18.3 million
and $16.0 million for fiscal years 2002 and 2001, respectively.
As a result of the application of SFAS 142, effective February 1,
2002 goodwill will no longer be amortized, but is required to be
assessed on an annual basis for impairment at the reporting unit
level (with a charge reported as appropriate) by applying a fair
value based test. Beginning in the first quarter of fiscal 2003, we
will reclassify an assembled workforce intangible asset with an
unamortized balance of $0.5 million to goodwill at the date of
adoption and will no longer amortize goodwill, thereby eliminating
(subject to future impairment charges) what would otherwise be an
annual goodwill amortization of approximately $9.8 million. In accordance with SFAS 142 the
Company will test goodwill for impairment using the two-step process
prescribed in SFAS 142. The first step is an analysis for potential
impairment, while the second step measures the amount of the
impairment, if any. We will complete an initial goodwill impairment
assessment during the first six months of fiscal 2003 to determine
if an impairment charge

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should be recognized under SFAS 142. We cannot predict at this
time whether a material impairment charge will be recorded.

Interest Income (Expense).Our net interest income decreased
to $2.5 million for fiscal 2002 from $6.2 million for fiscal 2001 as
a result of lower cash balances and a reduction in the market yield
on such investments.

Comparison of Fiscal 2001 vs. 2000

Revenues

Our total revenues increased 486 percent to $99.1 million in
fiscal 2001 from $16.9 million in fiscal 2000 primarily due to a
$77.3 million increase in software license revenues, a $2.8 million
increase in Internet subscription revenue and a $2.6 million
increase in professional services revenues, offset in part by a $0.6
million decrease in hardware revenues as described below.

Software Licenses.Our software license revenues increased
$77.3 million to $79.5 million in fiscal 2001 from $2.2 million in
fiscal 2000 due primarily to the recognition of $48.1 million in
Lightspan Achieve Now revenue previously deferred in fiscal years
2000 and 1999, see Critical Accounting Policies above, and $23.6
million in revenue relating to approximately 43,000 Lightspan
Achieve Now licenses sold in fiscal 2001.

Internet Subscriptions. Our Internet subscription revenues
increased 154 percent to $4.6 million in fiscal 2001 from $1.8
million in fiscal 2000 primarily due to an increase in the revenue
recognized from the annuity base relating to prepaid Internet
subscription fees for The Lightspan Network and the sale of Academic
Internet products that we offered beginning in the quarter ended
July 31, 2000. Customers subscribing to The Lightspan Network
increased 133 percent to approximately 2,800 at fiscal end 2001 from
approximately 1,200 at fiscal end 2000, resulting from an increased
focus of our sales force on promoting and selling The Lightspan
Network.

Professional Services.Our professional service revenues
increased 40 percent to $9.2 million in fiscal 2001 from $6.5
million in fiscal 2000 primarily due to an increase in the average
billing rates and an increase in software license and Internet
subscription sales.

Hardware and Other.Our hardware revenues decreased 9 percent
to $5.8 million in fiscal 2001 from $6.4 million in fiscal 2000
primarily due to an increase in the sales of our PC version of
Lightspan Achieve Now licenses which are not sold with any hardware.

Cost of Revenues

Our total cost of revenues increased 160 percent to $25.3
million for fiscal 2001 from $9.7 million for fiscal 2000 due
primarily to an $8.7 million increase in software license cost of
revenues related to the sale of Lightspan Achieve Now licenses
previously deferred in fiscal years 2000 and 1999, see Critical
Accounting Policies above, and the costs related to the 43,000
Lightspan Achieve Now licenses sold in fiscal 2001.

Expenses

Sales and Marketing.Our sales and marketing expenses increased
60 percent to $56.9 million for fiscal 2001 from $35.6 million for
fiscal 2000. This was primarily due to an increase in personnel and
related commissions, promotional activities connected to the launch
of Lightspan.com including a $5.0 million television campaign in the
first quarter of fiscal 2001, the continued promotion of Lightspan
Achieve Now and our fee-based subscription Internet products and a
full year of Academic sales and marketing expense of $8.0 million
for fiscal 2001, which was purchased in September 1999.

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Technology and Development.Our technology and development
expenses increased 108 percent to $25.8 million for fiscal 2001 from
$12.4 million for fiscal 2000. This was primarily due to additional
personnel and consulting costs related to the development of our
Lightspan Achieve Now version 2.0 and fee-based subscription
Internet products, and $5.9 million in expenses incurred by Academic
for fiscal 2001.

General and Administrative.Our general and administrative
expenses increased 42 percent to $9.4 million for fiscal 2001 from
$6.7 million for fiscal 2000. This was due primarily to personnel
and related costs resulting from our increased infrastructure,
system support, corporate expenses associated with being a public
company including legal and accounting fees, and $1.3 million in
expenses incurred by Academic in fiscal 2001.

Stock-Based Compensation.Stock-based compensation expense was
approximately $2.4 million and $3.7 million for fiscal years 2001
and 2000, respectively. During fiscal years 2001 and 2000, we
recorded $0.1 million and $8.7 million, respectively, in deferred
stock-based compensation as a result of our granting of stock
options to employees with exercise prices per share below the fair
values per share for our common stock on the dates those options
were granted prior to our initial public offering. The deferred
stock-based compensation is being amortized to expense on an
accelerated basis over the vesting period of the individual options,
generally four years.

Amortization of Intangible Assets.In connection with our
acquisitions of Academic, Global Schoolhouse and StudyWeb in the
third quarter of fiscal 2000, and LearningPlanet.com and eduTest in
the second quarter of fiscal 2001, we recorded intangible assets
totaling an aggregate of approximately $68.9 million, including
goodwill of $35.7 million. We amortize these intangible assets over
their respective useful lives, ranging from three to ten years. Our
amortization of goodwill and intangible assets totaled $16.0 million
and $5.0 million for fiscal years 2001 and 2000, respectively.

Restructuring.In July 2000, we recorded a $1.6 million
restructuring charge related to a refocus of our sales and marketing
efforts from our free Internet products towards our fee-based
subscription Internet products, which was fully implemented during
the quarter ended October 31, 2000. The restructuring charge
included $1.2 million of involuntary termination benefits relating
to the termination of 14 employees in August 2000. We also accrued
exit costs of $0.4 million in expenses relating to contractual
obligations for services associated with our free Internet site that
will no longer be used to generate revenue. As of January 31,
2001, we paid $1.0 million in involuntary termination benefits and
exit costs and the remaining involuntary termination benefits were
substantially paid during the year ended January 31, 2002.

Interest Income (Expense).Our net interest income increased
to $6.2 million for fiscal 2001 from $0.5 million for fiscal 2000 as
a result of investing the proceeds from our initial public offering
in February 2000 in short term, interest-bearing, securities rated
AA or better.

Acquisitions

eduTest, Inc.

On June 23, 2000, we acquired eduTest, Inc., a provider of
Internet-based educational testing and assessment products.

In connection with our acquisition of eduTest, we issued
1,028,543 shares of our common stock with a value at the measurement
date of $8.75 and paid approximately $2.4 million in cash, $1.3
million of which was paid to common shareholders, and the remaining
$1.1 million of which was paid in satisfaction of various
obligations of eduTest, in exchange for all of the outstanding shares of capital stock of eduTest. In addition, we issued 228,561 shares of our common stock on December 23, 2001, which had been held
back from the purchase price as security for indemnification and
other obligations of eduTest.

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The acquisition of eduTest was accounted for as a purchase. We
allocated the purchase price to the assets acquired, consisting
principally of goodwill and intangible assets, and amortize over
useful lives ranging from three to five years. The results of
operations including the related amortization of intangible assets,
have been included in our consolidated results of operations from
the date of acquisition. The assets, liabilities and operations
included in our K-12 business segment as described in Note 10,
Reportable Segments of the Notes to Consolidated Financial
Statements.

LearningPlanet.com

On May 26, 2000, we acquired LearningPlanet.com, a popular
education Web destination for children and their parents. The
acquisition was designed to augment the extensive collection of
preschool through high school curriculum-based learning activities
already available in our fee-based subscription Internet products
and services. LearningPlanet.com features creative and instructional
learning activities in mathematics and language arts. Launched in
June 1999, LearningPlanet.com has focused on creating activities for
kids that are both entertaining and educational. The transaction was
structured as an asset purchase, acquiring the LearningPlanet.com
Web site and related technology and assets in exchange for a
combination of approximately $0.15 million in our common stock and
$0.2 million in cash. The purchase price was allocated to goodwill
and amortized over a useful life of three years. The accompanying
consolidated financial statements include the results of operations
of LearningPlanet.com from the date of acquisition.

Other Strategic Relationships

CINAR Corporation

In October 1999, we agreed to pursue several potential
strategic initiatives with CINAR Corporation. As part of our
agreement, CINAR purchased 2,500,000 shares of our Series E
preferred stock at $5.00 per share, which converted into
1,250,000 shares of common stock upon completion of our initial public
offering. CINAR also purchased $10 million of our common stock, or
833,333 shares, in a private placement that occurred concurrently
with our initial public offering at the initial public offering
price of $12 per share. We also granted CINAR a warrant to purchase
500,000 shares of our Series E preferred stock at an exercise price
of $5.00 per share (which became a warrant to purchase 250,000 shares of common stock at an exercise price of $10.00 per share upon
completion of our initial public offering) that will vest upon the
achievement of various agreed-to strategic goals. As of January
31, 2002, CINAR has not achieved the strategic goals, and
accordingly, no expense has been recorded. This agreement
terminates on May 1, 2003.

Preferred Stock Dividends

Upon the completion of our initial public offering of common
stock in February 2000, warrants to purchase up to 2,760,160 shares
of Series D preferred stock at $0.02 per share converted into
warrants to purchase up to 1,380,080 shares of common stock and were
automatically exercised, resulting in the issuance of 1,377,762 shares of common stock (after application of certain net exercise
provisions that permitted exercise without additional cash payment
combined with the issuance of a reduced number of shares). As a
result, on February 15, 2000, we accounted for the intrinsic value
of these warrants as a preferred stock dividend of $16.5 million.
Such amount also increased the net loss per share applicable to
common stockholders for the fiscal year ended January 31, 2001.

Legal Matters

During 2000, a former employee commenced legal action against
us, alleging causes of action for fraud, breach of contract,
negligent misrepresentation and conversion. During fiscal 2002 we
entered into a settlement agreement and release with a former
employee, the terms of which are subject to confidentiality
provisions.

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Income Taxes

At January 31, 2002, Lightspan had federal and California net
operating loss carryforwards of approximately $251.9 million and
$52.3 million respectively. The difference between the federal and
California tax loss carryforwards is primarily attributable to
capitalization of research expenses and limitations on net operating
losses for California tax purposes. The federal tax loss
carryforwards will begin expiring in 2007 unless previously
utilized. Through January 31, 2002, California tax loss
carryforwards of $12.0 million have expired, and additional loss
carryforwards will continue to expire in fiscal 2003. A valuation
allowance has been recognized to offset the deferred tax assets
because management cannot conclude that it is more likely than not
that the deferred tax assets will be realized. Pursuant to Internal
Revenue Code Section 382 and 383, the use of Lightspans net
operating loss and credit carryforwards may be limited as a result
of a cumulative change in ownership of more than 50%.

Lightspans net operating loss carryforwards as of January 31, 2002,
will expire as follows (in millions):

|          |        |   |         |       |       |   |      |      | 
|--------- | ------ | - | ------- | ----- | ----- | - | ---- | ---- | 
|          |        |   | Federal |       | State
|          |        |   |         |       |      
|2003      |        |   |        |       |       | $ | 10.5 |     
|2004      |        |   |        |       |       |   | 3.3  |     
|2005      |        |   |        |       |       |   | 4.5  |     
|2006      |        |   |        |       |       |   | 8.8  |     
|2007      |        | $ | 0.1     |       |       |   | 25.2 |     
|Remaining |        |   | 251.8   |       |       |   |     |     
|          |        |   |         |       |       |   |      |     
|          | Totals |   | $       | 251.9 |       |   | $    | 52.3 | 
|          |        |   |         |       |       |   |      |     

Contractual Obligations

The
following summarizes our contractual obligations at January 31, 2002, and the effect these contractual obligations are expected
to have on our liquidity and cash flows in future periods (in
thousands).

|                 |  |       |       |                |  |                        |       |               |  |   |       |  |  |   |   | 
|---------------- |  | ----- | ----- | -------------- |  | ---------------------- | ----- | ------------- |  | - | ----- |  |  | - | - | 
|                 |  |       |       |                |  | Payments Due By Period |       |               |  |  
|                 |  |       |       |                |  |                        |       |               |  |  
|                 |  | Total |       | 1 Year or Less |  | 1  3 Years            |       | After 3 Years
|                 |  |       |       |                |  |                        |       |              
|Operating leases |  | $     | 5,079 |                |  | $                      | 2,512 |               |  | $ | 2,567 |  |  | $ |  | 
|Capital leases   |  |       | 282   |                |  |                        | 242   |               |  |   | 40    |  |  |   |  | 
|                 |  |       |       |                |  |                        |       |               |  |   |       |  |  |   |   | 
|Total            |  | $     | 5,361 |                |  | $                      | 2,754 |               |  | $ | 2,607 |  |  | $ |  | 
|                 |  |       |       |                |  |                        |       |               |  |   |       |  |  |   |   | 

Common Shares Outstanding and Reserved for Future Issuance

The following table summarizes common shares outstanding and reserved
for future issuance at January 31, 2002 (in thousands):

|                                                                 |  |  |       | 
|---------------------------------------------------------------- |  |  | ----- | 
|Common stock options outstanding, unexercised                    |  |  | 4,974 | 
|Common stock options reserved for future issuance                |  |  | 894   | 
|Employee stock purchase plan shares reserved for future issuance |  |  | 165   | 

Warrants

In connection with debt and equipment lease financing
agreements entered into at various dates, Lightspan issued a total
of 749,605 warrants to purchase: up to 150,000 shares of Series A
preferred stock at $1.00 per share, up to 150,000 shares of Series B
preferred stock at $3.00 per share, up to 96,625 shares and 57,564 shares of Series C preferred stock at $6.00 per share and $0.01 per
share, respectively, up to 183,105 shares and 127,659 shares of
Series D preferred stock at $3.76 and $4.70 per share, respectively,

32



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##### Table of Contents



and up to 42,216 shares of Series E preferred stock at $5.00 per
share. The warrants expire on various dates commencing in 2002
through 2006.

Upon completion of our initial public offering, and taking into
effect the reverse split in January 2000, all of the above 749,605
warrants to purchase Series A through E preferred stock were
converted, at their respective conversion rates, into warrants to
purchase 403,591 shares of common stock. As of January 31, 2002,
warrants to purchase 225,764 shares of common stock remained
outstanding.

Liquidity and Capital Resources

From inception through January 2002, we have financed our
operations and met our capital expenditure requirements primarily
from the net proceeds from private sales of equity securities, net
proceeds from our initial public offering and the collection of
revenues from the sales of our products and services. Currently,
we are not generating sufficient revenue to fund our operations.
We expect our operating losses and net operating cash outflows to
continue if we are unable to increase sales. If we are unable to
sufficiently increase our revenues, our ability to service and
maintain our products or fund our operations could be
significantly impaired. At January 31, 2002, we had $35.0 million
of unrestricted cash and cash equivalents, $8.3 million in
short-term investments and $1.7 million in restricted cash for a
total of $45.0 million. The expansion of our business will require
the use of our capital to fund operating losses, capital
expenditures and working capital needs. We have incurred
significant operating losses since our inception and may continue
to incur losses. We expect to continue to incur operating losses
for the foreseeable future.

Our working capital has fluctuated significantly since our
inception. This is due, in large part, to the timing of cash
payments to vendors, cash collections from customers, varying
resources required for development efforts on our product offerings,
as well as receipt of cash from our preferred stock financings,
initial public offering, private placements and other equity
offerings. We expect our working capital requirements and cash
position to fluctuate significantly from period to period for the
foreseeable future for the same reasons.

Net cash used in operating activities was $31.7 million, $49.7
million and $25.3 million for fiscal 2002, 2001 and 2000,
respectively. Net cash used during these periods was primarily to
fund technology and development, sales and marketing, including
promotion of Lightspan.com, and general and administrative costs
associated with the development and deployment of our Lightspan
Achieve Now, Academic curriculum and fee-based subscription Internet
products and services. We expect to begin to generate cash from
operations in our third fiscal quarter of fiscal 2003, however, our
negative operating cash flow may continue if we are unable to
increase our sales.

Net cash provided by investing activities was $20.8 million for
fiscal 2002 relating primarily to the maturities, offset by
purchases, of short-term investments purchased with proceeds from our
initial public offering and $4.2 million used in the purchase of
property and equipment. Net cash used in investing activities was
$24.3 million for fiscal 2001 relating primarily to the purchases,
offset by maturities, of short-term investments, $4.2 million used in
the purchase of property and equipment and $2.8 million in cash paid
for the acquisitions of eduTest and LearningPlanet.com. Net cash
used in investing activities was $22.8 million for fiscal 2000
relating primarily to the $16.1 million increase in short-term
investments and $4.3 million in cash paid for the acquisitions of
Academic, Global Schoolhouse and StudyWeb.

Net cash provided by
financing activities was $0.3 million for
fiscal 2002 relating primarily to proceeds from issuances of common
stock under the Employee Stock Purchase Plan and the exercise of
employee stock options. Net cash provided by financing activities
was $114.5 million for fiscal 2001, relating primarily to the
proceeds from our initial public offering, private placements and
the underwriters exercise of their overallotment option. Net cash
provided by financing activities was $46.0 million for fiscal 2000
relating primarily to the proceeds from the issuance of preferred
stock.

33



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##### Table of Contents



Our future capital requirements will depend on a variety of
factors, including market acceptance of our products and services
and the resources we devote to developing, marketing, selling and
supporting our products. We expect to devote capital resources in
connection with, marketing, promotional activities, maintaining and
selling our existing products and services, and continued
development, expansion and maintenance of our existing software and
Internet product offerings and content. In addition, we may devote
substantial capital resources to strategic acquisitions and
relationships.

As of January 31, 2002, we believe that our cash, cash
equivalents and short-term investments will be sufficient to fund
our operations and capital requirements through at least the next 12
months. However, the actual amount of funds that we will need
during or after the next 12 months will be determined by many
factors, some of which are beyond our control, and we may need funds
sooner than currently anticipated.

Recently Issued Accounting Standards

In June 2001, FASB issued Statement of Financial Accounting
Statement, or SFAS, No. 141, Business Combinations
(SFAS 141) and No.
142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141,
effective June 30, 2001, requires all business combinations initiated
after June 30, 2001 to be accounted for using the purchase method of
accounting. The pooling of interests method of accounting can no longer
be used for business combinations completed after June 30, 2001. The
provisions of SFAS 141 are similar to prior generally accepted accounting
principles (GAAP), although SFAS 141 requires additional disclosures for
transactions occurring after the effective date. We do not believe that
the adoption of this statement will have a material impact on our results
of operations, financial position or cash flows. SFAS 142 eliminates the
amortization of goodwill for business combinations completed after June
30, 2001. Effective February 1, 2002, goodwill will no longer be
amortized, but is required to be assessed on an annual basis for
impairment at the reporting unit level (with a charge recorded as
appropriate) by applying a fair value based
test. SFAS 142 also provides additional guidance on acquired intangibles
that should be separately recognized and amortized, which may result in
the recognition of additional intangible assets as compared with prior
GAAP. Beginning in the first quarter of fiscal 2003, we will reclassify
an assembled workforce intangible asset with an unamortized balance of
$0.5 million to goodwill at the date of adoption and will no longer
amortize goodwill, thereby eliminating (subject to future impairment
charges) what would otherwise be an annual goodwill amortization of
approximately $9.8 million. Unamortized goodwill was $14.2 million as of
January 31, 2002. We will complete an initial goodwill impairment
assessment during the first six months of fiscal 2003 to determine if an
impairment charge should be recognized under SFAS 142. We cannot predict
at this time whether a material impairment charge will be recorded.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period
in which it is incurred. When the liability is initially recorded, the
entity capitalizes a cost by increasing the carrying amount of the related
long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful
life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or
loss upon settlement. This statement becomes effective for fiscal years
beginning after June 15, 2002. Adoption of SFAS No. 143 is not currently
expected to have a material impact on our results of operations or
financial position.

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, in that it removes goodwill from its
impairment scope and allows for different approaches in cash flow
estimation. However, SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for (a) recognition and measurement of the impairment of
long-lived assets to be held and used and (b) measurement of long-lived
assets to be disposed of. SFAS No. 144 also supercedes the business
segment concept in APB Opinion No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, in that it permits presentation of a component of an
entity, whether classified as held for sale or disposed of, as a
discontinued operation. However, SFAS No. 144 retains the requirement of
APB Opinion No. 30 to report discontinued operations separately from
continuing operations. This statement becomes effective for fiscal years
beginning after December 15, 2001 with earlier application encouraged. We
believe that the implementation of this standard will not have a material
effect on our results of operations or financial position.

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Item 7a. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates
relates primarily to the increase or decrease in the amount of
interest income we can earn on our investment portfolio and on the
increase or decrease in the amount of interest expense we must pay
with respect to our various outstanding debt instruments. Our risk
associated with fluctuating interest expense is limited, however, to
the interest rates which are tied to market rates, and our
investments in interest sensitive financial instruments. Under our
current policies, we do not use interest rate derivative instruments
to manage exposure to interest rate changes and do not expect to in
the future. We ensure the safety and preservation of our invested
principal funds by limiting default risks, market risk and
reinvestment risk. We mitigate default risk by investing in
securities rated AA or better. A hypothetical 100 basis point
adverse move in interest rates along the entire interest rate yield
curve would not materially affect the fair value of our interest
sensitive financial instruments at January 31, 2002 or 2001.
Declines in interest rates over time will, however, reduce our
interest income.




Item 8. Financial Statements and Supplementary Data

The Companys consolidated financial statements at January 31,
2002 and 2001 and the Report of Ernst & Young LLP, Independent
Auditors, are included in this report on Form 10-K on pages 41
through 64.




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

There have been no disagreements with accountants on any matter
of accounting principles and practices or financial disclosure.

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##### Table of Contents






PART III




Item 10. Directors and Executive Officers of the Registrant

Information regarding our directors is incorporated by
reference to the sections entitled Election of Directors and
Compliance with Section 16(a) of the Exchange Act in our Proxy
Statement to be filed with the Securities and Exchange Commission in
connection with our 2002 Annual Meeting of Stockholders (the Proxy
Statement). Information regarding our executive officers is
located in Part I, Item I of this Annual Report, under the caption
Executive Officers and Key Employees of the Registrant.




Item 11. Executive Compensation

The information required by this item is incorporated by
reference to the Proxy Statement under the heading Executive
Compensation.




Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required by this item is incorporated by
reference to the Proxy Statement under the heading Security
Ownership of Certain Beneficial Owners and Management.




Item 13. Certain Relationships and Related Transactions

The information required by this item is incorporated by
reference to the Proxy Statement under the headings Related-Party
Transactions and Compensation Committee Interlocks and Insider
Participation.

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##### Table of Contents






PART IV




Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)  The following documents are filed as part of the report:

|    |  |                                                                                                                                                                              |  |      |    | 
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|    |  |                                                                                                                                                                              |  | Page
|    |  |                                                                                                                                                                              |  |     
|(1) |  | Report of Ernst & Young LLP, Independent Auditors                                                                                                                            |  |      | 42 | 
|    |  | Consolidated Balance Sheets as of January 31, 2002 and 2001                                                                                                                  |  |      | 43 | 
|    |  | Consolidated Statements of Operations for the years ended January 31, 2002, 2001 and 2000                                                                                    |  |      | 44 | 
|    |  | Consolidated Statements of Stockholders Equity (Deficit) for the years ended January 31,
2002, 2001 and 2000                                                                |  |      | 45 | 
|    |  | Consolidated Statements of Cash Flows for the years ended January 31, 2002, 2001 and 2000                                                                                    |  |      | 46 | 
|    |  | Notes to Consolidated Financial Statements                                                                                                                                   |  |      | 47 | 
|   
|(2) |  | Financial statement schedules other than those listed
above have been omitted because they are either not required,
not applicable or the information is otherwise included. |  |      |    | 
|   
|(3) |  | The following exhibits are incorporated herein by
reference or are filed with this report as indicated below.                                                                |  |      |    | 

|         |  |         |       |             |  |                                                                                                                                                                                      
|-------- |  | ------- | ----- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Footnote |  | Exhibit |       |            
|Number   |  | Number  |       | Description
|         |  |         |       |            
|(5)      |  |         | 2.1   |             |  | Agreement and Plan of Merger and Reorganization among Lightspan, Inc., Educator Acquisition, Inc., eduTest,
Inc., and Certain Shareholders of eduTest, Inc. dated as of May 24, 2000.
|(3)      |  |         | 3.1   |             |  | Amended and Restated Certificate of Incorporation, as currently in effect.                                                                                                           
|(1)      |  |         | 3.2   |             |  | Bylaws, as currently in effect.                                                                                                                                                      
|         |  |         | 4.1   |             |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                           
|(1)      |  |         | 4.2   |             |  | Specimen Stock Certificate.                                                                                                                                                          
|(1)     |  |         | 10.1  |             |  | 1992 Stock Option Plan.                                                                                                                                                              
|(1)     |  |         | 10.2  |             |  | Forms of Incentive and Nonstatutory Stock Option Agreement under the 1992 Stock Option Plan.                                                                                         
|(6)     |  |         | 10.3  |             |  | 2000 Equity Incentive Plan.                                                                                                                                                          
|(1)     |  |         | 10.4  |             |  | Form of Stock Option Agreement pursuant to the 2000 Equity Incentive Plan.                                                                                                           
|(6)     |  |         | 10.5  |             |  | 2000 Employee Stock Purchase Plan and related offering documents.                                                                                                                    
|(1),(2)  |  |         | 10.6  |             |  | Office Lease by and between the Company and Insurance Company of the West dated as of May 28, 1996.                                                                                  
|(1)      |  |         | 10.7  |             |  | Lease by and between the Travelers Insurance Company and Academic Systems Corporation dated as of July 1, 1996
and amended December 3, 1996.                                         
|(1),(2)  |  |         | 10.8  |             |  | Office Sublease by and between the Company and Qualcomm Incorporated dated as of December 1, 1997 and amended
September 21, 1998.                                                    
|(1)      |  |         | 10.9  |             |  | Office Lease by and between the Company and McWin Corporation dated as of May 1, 1997.                                                                                               
|(1)      |  |         | 10.10 |             |  | Office Lease by and between the Company and Auerbach Plaza Limited Partnership and Goliac, Inc., dated as of
June 4, 1999.                                                           
|(1)      |  |         | 10.11 |             |  | Loan and Security Agreement by and between the Company and Silicon Valley Bank dated as of February 25,1997
and amended December 31, 1997, March 31, 1998 and March 26, 1999.        
|(1)      |  |         | 10.12 |             |  | Master Lease Agreement by and between the Company and Transamerica Business Credit Corporation dated as of
August 14, 1997, including Schedules 1, 2, 3, 4 and 5 thereto.            
|(1)      |  |         | 10.13 |             |  | Master Equipment Lease by and between the Company and Pentech Financial Services, Inc. dated as of July 25,
1999, including supplements 1, 2 and 3 thereto.                          
|(1)      |  |         | 10.14 |             |  | Equipment Financing Agreement by and between the Company and Pentech Financial Services, Inc. dated as of July
1, 1999.                                                              

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|         |  |         |       |             |  |                                                                                                                                                                             
|-------- |  | ------- | ----- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Footnote |  | Exhibit |       |            
|Number   |  | Number  |       | Description
|         |  |         |       |            
|(1)      |  |         | 10.15 |             |  | Amended and Restated Investor Rights Agreement by and among the Company and certain stockholders of the
Company dated July 8, 1999.                                         
|(1)      |  |         | 10.16 |             |  | Amendment and Waiver dated October 28, 1999.                                                                                                                                
|(1)      |  |         | 10.17 |             |  | Amendment to Investor Rights Agreement dated October 29, 1999.                                                                                                              
|(1)      |  |         | 10.18 |             |  | Form of Indemnity Agreement between the Company and its directors and officers.                                                                                             
|(1)      |  |         | 10.19 |             |  | Developer Agreement by and between the Company and Sony Computer Entertainment America dated as of January 26,
1996.                                                        
|(1),(2)  |  |         | 10.20 |             |  | Sale and License Agreement by and between the Company and Sony Computer Entertainment America dated as of
January 26, 1996.                                                 
|(1),(2)  |  |         | 10.21 |             |  | Letter Agreement by and between the Company and SmarterKids.com, Inc. dated as of July 12, 1999.                                                                            
|(1)      |  |         | 10.22 |             |  | Academic Systems Fulfillment Agreement by and between Academic Systems Corporation and FGI Print Management
dated as of June 12, 1998.                                      
|(1)      |  |         | 10.23 |             |  | Series E Stock Purchase Agreement by and between the Company and CINAR Corporation dated as of October 29,
1999.                                                            
|(1)      |  |         | 10.24 |             |  | Warrant Agreement to purchase Series A preferred stock by and between the Company and Comdisco, Inc. dated as
of March 15, 1994.                                            
|(1)      |  |         | 10.25 |             |  | Warrant Agreement to purchase Series B preferred stock by and between the Company and Comdisco, Inc. dated as
of May 30, 1995.                                              
|(1)      |  |         | 10.26 |             |  | Warrant Agreement to purchase Series B preferred stock by and between the Company and Comdisco, Inc. dated as
of April 26, 1996.                                            
|(1)      |  |         | 10.27 |             |  | Warrant to purchase Series C preferred stock by and between the Company and Silicon Valley Bank dated as of
March 24,1997.                                                  
|(1)      |  |         | 10.28 |             |  | Warrant Agreement to purchase Series C preferred stock by and between the Company and Comdisco, Inc. dated as
of April 26, 1996.                                            
|(1)      |  |         | 10.29 |             |  | Warrant to purchase Series D preferred stock by and between the Company and Montgomery Securities.                                                                          
|(1)      |  |         | 10.30 |             |  | Form of Warrant to purchase Series D preferred stock.                                                                                                                       
|(1)      |  |         | 10.31 |             |  | Form of Warrant to purchase Series D preferred stock.                                                                                                                       
|(1)      |  |         | 10.32 |             |  | Letter Agreement regarding strategic initiatives by and between the Company and CINAR Corporation dated as of
October 29, 1999.                                             
|(1)      |  |         | 10.33 |             |  | Amendment and Waiver dated October 28, 1999.                                                                                                                                
|(1)      |  |         | 10.34 |             |  | Warrant to purchase Series E preferred stock by and between the Company and Comdisco, Inc.                                                                                  
|(1)      |  |         | 10.35 |             |  | Form of Warrant to purchase Series E preferred stock.                                                                                                                       
|(1)      |  |         | 10.36 |             |  | Warrant to purchase Series D preferred stock by and between the Company and SZ Investments L.L.C. dated as of
June 6, 1997.                                                 
|(1)      |  |         | 10.37 |             |  | Oracle Reseller agreement, dated as of August 9, 1994, including Addendums.                                                                                                 
|(1)      |  |         | 10.38 |             |  | Form of Warrant to purchase common stock by and between the Company and Cox Communications Holdings, Inc.
issued concurrent with the closing of our initial public offering.
|(1)      |  |         | 10.39 |             |  | Stock Purchase Agreement by and between the Company and Cox Communications Holdings, Inc. dated as of January
11, 2000.                                                     
|(1)      |  |         | 10.40 |             |  | Stock Purchase Agreement by and between the Company and Gateway Companies, Inc. dated as of January 12, 2000.                                                               
|(3)      |  |         | 10.41 |             |  | Amendment to Warrant to purchase Series E preferred stock by and between the Company and CINAR Corporation
dated as of January 25, 2000.                                    
|(3)      |  |         | 10.42 |             |  | Office Lease by and between the Company and Lyon & Lyon LLP dated as of March 31, 2000.                                                                                     
|(4)      |  |         | 10.43 |             |  | Licensed Developer Agreement by and between the Company and Sony Computer Entertainment America dated as of
January 26, 2000.                                               
|(4)      |  |         | 10.44 |             |  | PlayStation®2 Development System Agreement by and between the Company and Sony Computer Entertainment America
dated as of March 7, 2000.                                    
|(4)      |  |         | 10.45 |             |  | Master Equipment Lease Extension Letter by and between the Company and Pentech Financial Services, Inc. dated
as of March 29, 2000.                                         
|(5)      |  |         | 10.46 |             |  | Lease Agreement by and between Global Partner Ventures, LLC and Koger Equity, Inc. dated as of October 16,
1998, as amended.                                                
|(5)      |  |         | 10.47 |             |  | Separation Agreement by and between Winifred B. Wechsler and the Company, dated as of July 31, 2000.                                                                        

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|         |                                                                  |         |       |             |  |                                                                                                      
|-------- | ---------------------------------------------------------------- | ------- | ----- | ----------- |  | -----------------------------------------------------------------------------------------------------
|Footnote |                                                                  | Exhibit |       |            
|Number   |                                                                  | Number  |       | Description
|         |                                                                  |         |       |            
|(6)     |                                                                  |         | 10.48 |             |  | Separation Agreement by and between Merritt D. Farren and the Company, dated as of January 31, 2001. 
|(6)     |                                                                  |         | 10.49 |             |  | Form of Employment Agreement  Tier I for John T. Kernan and Carl E. Zeiger                          
|(6)     |                                                                  |         | 10.50 |             |  | Form of Employment Agreement  Tier II for Michael A. Sicuro, Sandra K. Fivecoat and James M. Dredge.
|(5)      |                                                                  |         | 21.1  |             |  | Subsidiaries of the registrant.                                                                      
|(7)      |                                                                  |         | 23.1  |             |  | Consent of Ernst & Young LLP, Independent Auditors.                                                  
|(7)      |                                                                  |         | 24.1  |             |  | Power of Attorney. See page 40.                                                                      
|        | Denotes management contract or compensatory plan or arrangement.



---

|(1) |  | Filed as an exhibit to the Companys Registration Statement
on Form S-1, Registration Statement No. 333-90103, or amendments
thereto, and incorporated herein by reference.         
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Confidential treatment has been requested with respect to
certain portions of this exhibit. Omitted portions have been
filed separately with the Securities and Exchange Commission.
|   
|   
|   
|   
|(3) |  | Filed as an exhibit to the Companys 2000 Annual Report on
Form 10-K, or amendments thereto, and incorporated herein by
reference.                                                  
|   
|   
|   
|   
|(4) |  | Filed as an exhibit to the Companys Quarterly Report on Form
10-Q for the Three Months Ended April 30, 2000, and incorporated
herein by reference.                                 
|   
|   
|   
|   
|(5) |  | Filed as an exhibit to the Companys Registration Statement
on Form S-1, Registration Statement No. 333-42288, or amendments
thereto, and incorporated herein by reference.         
|   
|   
|   
|   
|(6) |  | Filed as on exhibit to the Companys Annual Report on Form
10-K for the year ended January 31, 2001, and incorporated herein
by reference.                                          
|   
|   
|   
|   
|(7) |  | Filed with this report.                                                                                                                                                             

(b) Current Reports on Form 8-K

On February 14, 2002 the Board of Directors of Lightspan, Inc.
approved the adoption of a share purchase rights plan. Terms of the
plan provide for a dividend distribution of one preferred share
purchase right for each outstanding share of common stock of the
Company. The dividend is payable on March 8, 2002 to the
stockholders of record on that date. Each right entitles the
registered holder to purchase from the Company one one-hundredth of
a share of Series A Junior Participating Preferred Stock, par value
$0.001 per share (the Preferred Shares), at a price of $10.00 per
one one-hundredth of a Preferred Share, subject to adjustment. Each
one one-hundredth of a share of Preferred Shares has designations
and powers, preferences and rights, and the qualifications,
limitations and restrictions which make its value approximately
equal to the value of a common share. The description and terms of
the rights are set forth in the rights agreement.

39



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized on the 29th day of April, 2002.

|               |                                                                 |                   
|-------------- | --------------------------------------------------------------- | ------------------
|               | Lightspan, Inc.                                                
|              
|               | By:                                                             | /s/ CARL E. ZEIGER
|               |                                                                
|April 29, 2002 | Carl E. Zeiger,
President, Chief Operating Officer
and Director

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints John T. Kernan and
Carl E. Zeiger and each of them, as his true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him and in his name, place, and stead, in any and
all capacities, to sign any and all amendments to this Annual Report
on Form 10-K and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents,
and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his
substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.

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

|                                                  |  |                                                                      |  |               
|------------------------------------------------- |  | -------------------------------------------------------------------- |  | --------------
|Signature                                         |  | Title                                                                |  | Date          
|                                                  |  |                                                                      |  |               
|                                                 
|/s/ JOHN T. KERNAN
John T. Kernan                 |  | Chief Executive Officer and Chairman(Principal Executive Officer)    |  | April 29, 2002
|                                                 
|/s/ CARL E. ZEIGER
Carl E. Zeiger                 |  | President, Chief Operating Officer,
and Director                     |  | April 29, 2002
|                                                 
|/s/ MICHAEL A. SICURO
Michael A. Sicuro           |  | Chief Financial Officer
(Principal Financial and Accounting Officer) |  | April 29, 2002
|                                                 
|/s/ JAMES W. BREYER
James W. Breyer               |  | Director                                                             |  | April 29, 2002
|                                                 
|/s/ BARRIE USHER
Barrie Usher                     |  | Director                                                             |  | April 29, 2002
|                                                 
|/s/ BARRY J. SCHIFFMAN
Barry J. Schiffman         |  | Director                                                             |  | April 29, 2002
|                                                 
|/s/ JEFFREY W. BROWN
Jeffrey W. Brown             |  | Director                                                             |  | April 29, 2002
|                                                 
|/s/ ELIZABETH R. COPPINGER
Elizabeth R. Coppinger |  | Director                                                             |  | April 29, 2002

40



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INDEX TO FINANCIAL STATEMENTS

|                                                                                                              |  |      |    | 
|------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                              |  | Page
|                                                                                                              |  |     
|Report of Ernst & Young LLP, Independent Auditors                                                             |  |      | 42 | 
|Consolidated Balance Sheets as of January 31, 2002 and 2001                                                   |  |      | 43 | 
|Consolidated Statements of Operations for the years ended January 31, 2002, 2001 and 2000                     |  |      | 44 | 
|Consolidated Statements of Stockholders Equity (Deficit) for the years ended January 31,
2002, 2001 and 2000 |  |      | 45 | 
|Consolidated Statements of Cash Flows for the years ended January 31, 2002, 2001 and 2000                     |  |      | 46 | 
|Notes to Consolidated Financial Statements                                                                    |  |      | 47 | 

41



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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Lightspan, Inc.

We have audited the accompanying consolidated balance sheets
of Lightspan, Inc. as of January 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders equity
(deficit), and cash flows for each of the three years in the period
ended January 31, 2002. These financial statements are the
responsibility of the Companys management. Our responsibility is
to express an opinion on these financial statements based on our
audits.

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

In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial
position of Lightspan, Inc. at January 31, 2002 and 2001 and the
results of its operations and its cash flows for each of the three
years in the period ended January 31, 2002, in conformity with
accounting principles generally accepted in the United States.

ERNST & YOUNG LLP

San Diego, California
February 22, 2002

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LIGHTSPAN, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |          |    |         | 
|------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------------ | -------- | ----------- | ------ | ------ | -------- | -- | ------- | 
|                                                                               |                                                                                          |                                                                 |                                            |          | January 31,
|                                                                               |                                                                                          |                                                                 |                                            |          |            
|                                                                               |                                                                                          |                                                                 |                                            |          | 2002        |        | 2001  
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |       
|Assets                                                                         |                                                                                          |                                                                 |                                            |          |             |        |        |         
|Current assets:                                                                |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               | Cash and cash equivalents                                                                |                                                                 | $                                          | 35,033   |             |        | $      | 45,566   |   
|                                                                               | Short-term investments available for sale                                                |                                                                 |                                            | 8,333    |             |        |        | 32,683   |   
|                                                                               | Accounts receivable, less allowance for doubtful accounts of
$930 (2002) and $573 (2001) |                                                                 |                                            | 11,477   |             |        |        | 11,253   |   
|                                                                               | Finished goods inventory                                                                 |                                                                 |                                            | 2,432    |             |        |        | 2,567    |   
|                                                                               | Restricted cash                                                                          |                                                                 |                                            | 826      |             |        |        | 1,115    |   
|                                                                               | Other current assets                                                                     |                                                                 |                                            | 1,449    |             |        |        | 2,379    |   
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               |                                                                                          |                                                                 | Total current assets                       |          |             | 59,550 |        |          |    | 95,563  | 
|Restricted cash                                                                |                                                                                          |                                                                 | 827                                        |          |             |        | 3,653  |         
|Property and equipment, net                                                    |                                                                                          |                                                                 | 6,839                                      |          |             |        | 5,886  |         
|Goodwill, net of accumulated amortization of $21,583 (2002)
and $11,603 (2001) |                                                                                          |                                                                 | 14,241                                     |          |             |        | 24,139 |         
|Intangible assets, net                                                         |                                                                                          |                                                                 | 15,278                                     |          |             |        | 23,596 |         
|Deposits and other assets                                                      |                                                                                          |                                                                 | 685                                        |          |             |        | 1,061  |         
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               |                                                                                          |                                                                 | Total assets                               |          | $           | 97,420 |        |          | $  | 153,898 | 
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|Liabilities and Stockholders Equity                                           |                                                                                          |                                                                 |                                            |          |             |        |        |         
|Current liabilities:                                                           |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               | Accounts payable                                                                         |                                                                 | $                                          | 4,421    |             |        | $      | 5,990    |   
|                                                                               | Accrued liabilities                                                                      |                                                                 |                                            | 12,242   |             |        |        | 9,295    |   
|                                                                               | Acquisition consideration payable                                                        |                                                                 |                                            |         |             |        |        | 2,000    |   
|                                                                               | Deferred revenues                                                                        |                                                                 |                                            | 10,682   |             |        |        | 8,122    |   
|                                                                               | Other current liabilities                                                                |                                                                 |                                            | 227      |             |        |        | 373      |   
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               |                                                                                          |                                                                 | Total current liabilities                  |          |             | 27,572 |        |          |    | 25,780  | 
|Deferred revenues, less current portion                                        |                                                                                          |                                                                 | 1,282                                      |          |             |        | 1,240  |         
|Other liabilities                                                              |                                                                                          |                                                                 | 271                                        |          |             |        | 563    |         
|Stockholders equity:                                                          |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               | Convertible preferred stock, par value $0.001:                                           |                                                                 |                                            |          |             |        |        |          |   
|                                                                               |                                                                                          | Authorized shares  20,000                                      |                                            |          |             |        |        |          |    |        
|                                                                               |                                                                                          | Issued and outstanding shares  0                               |                                            |          |             |        |        |          |    |        
|                                                                               |                                                                                          | Aggregate liquidation preference  $0                           |                                            |          |            |        |        |          |   |        
|                                                                               | Common stock, par value $0.001:                                                          |                                                                 |                                            |          |             |        |        |          |   
|                                                                               |                                                                                          | Authorized shares  250,000                                     |                                            |          |             |        |        |          |    |        
|                                                                               |                                                                                          | Issued and outstanding shares  47,029 (2002)
and 46,044 (2001) |                                            |          | 47          |        |        |          | 46 |        
|                                                                               | Additional paid-in capital                                                               |                                                                 |                                            | 356,887  |             |        |        | 354,415  |   
|                                                                               | Deferred compensation                                                                    |                                                                 |                                            | (278     | )           |        |        | (1,314   | ) 
|                                                                               | Accumulated other comprehensive loss                                                     |                                                                 |                                            |         |             |        |        | (714     | ) 
|                                                                               | Accumulated deficit                                                                      |                                                                 |                                            | (288,361 | )           |        |        | (226,118 | ) 
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               |                                                                                          |                                                                 | Total stockholders equity                 |          |             | 68,295 |        |          |    | 126,315 | 
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         
|                                                                               |                                                                                          |                                                                 | Total liabilities and stockholders equity |          | $           | 97,420 |        |          | $  | 153,898 | 
|                                                                               |                                                                                          |                                                                 |                                            |          |             |        |        |         

See accompanying notes.

43



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LIGHTSPAN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)

|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |        |        | 
|------------------------------------------ | ------------------------------------------- | ------------------------ | ------- | ----------------------- | ------- | ---- | ------- | ------ | ------- | - | ------- | ------ | ------ | 
|                                           |                                             |                          |         | Years Ended January 31,
|                                           |                                             |                          |         |                        
|                                           |                                             |                          |         | 2002                    |         | 2001 |         | 2000  
|                                           |                                             |                          |         |                         |         |      |         |       
|Revenues:                                  |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           | Software licenses                           |                          | $       | 34,309                  |         |      | $       | 79,553 |         |   | $       | 2,210  |       
|                                           | Internet subscriptions                      |                          |         | 7,935                   |         |      |         | 4,556  |         |   |         | 1,791  |       
|                                           | Professional services                       |                          |         | 9,343                   |         |      |         | 9,175  |         |   |         | 6,546  |       
|                                           | Hardware and other                          |                          |         | 5,945                   |         |      |         | 5,790  |         |   |         | 6,369  |       
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           |                                             | Total revenues           |         |                         | 57,532  |      |         |        | 99,074  |   |         |        | 16,916 | 
|Cost of revenues:                          |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           | Software licenses                           |                          |         | 6,564                   |         |      |         | 14,887 |         |   |         | 676    |       
|                                           | Internet subscriptions                      |                          |         | 1,952                   |         |      |         | 2,004  |         |   |         | 548    |       
|                                           | Professional services                       |                          |         | 5,411                   |         |      |         | 4,780  |         |   |         | 3,142  |       
|                                           | Hardware and other                          |                          |         | 3,802                   |         |      |         | 3,615  |         |   |         | 5,368  |       
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           |                                             | Total cost of revenues   |         |                         | 17,729  |      |         |        | 25,286  |   |         |        | 9,734  | 
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|Gross profit                               |                                             |                          | 39,803  |                         |         |      | 73,788  |        |         |   | 7,182   |       
|Operating expenses:                        |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           | Sales and marketing                         |                          |         | 49,367                  |         |      |         | 56,920 |         |   |         | 35,643 |       
|                                           | Technology and development                  |                          |         | 24,424                  |         |      |         | 25,775 |         |   |         | 12,400 |       
|                                           | General and administrative                  |                          |         | 11,670                  |         |      |         | 9,425  |         |   |         | 6,660  |       
|                                           | Stock-based compensation                    |                          |         | 747                     |         |      |         | 2,398  |         |   |         | 3,704  |       
|                                           | Amortization of intangible assets           |                          |         | 18,298                  |         |      |         | 16,005 |         |   |         | 4,975  |       
|                                           | Restructuring                               |                          |         |                        |         |      |         | 1,600  |         |   |         |       |       
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           |                                             | Total operating expenses |         |                         | 104,506 |      |         |        | 112,123 |   |         |        | 63,382 | 
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|Loss from operations                       |                                             |                          | (64,703 | )                       |         |      | (38,335 | )      |         |   | (56,200 | )     
|Interest income                            |                                             |                          | 2,571   |                         |         |      | 6,315   |        |         |   | 747     |       
|Interest expense                           |                                             |                          | (111    | )                       |         |      | (100    | )      |         |   | (268    | )     
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|Net loss                                   |                                             |                          | (62,243 | )                       |         |      | (32,120 | )      |         |   | (55,721 | )     
|Preferred stock dividend                   |                                             |                          |        |                         |         |      | (16,506 | )      |         |   |        |       
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|Net loss applicable to common stockholders |                                             | $                        | (62,243 | )                       |         | $    | (48,626 | )      |         | $ | (55,721 | )     
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|Net loss per share:                        |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           | Basic and diluted                           |                          | $       | (1.34                   | )       |      | $       | (1.10  | )       |   | $       | (13.61 | )     
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       
|                                           | Weighted average shares  basic and diluted |                          |         | 46,373                  |         |      |         | 44,019 |         |   |         | 4,094  |       
|                                           |                                             |                          |         |                         |         |      |         |        |         |   |         |       

See accompanying notes.

44



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LIGHTSPAN, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
YEARS ENDED JANUARY 31, 2002, 2001 and 2000
(in thousands)



|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |        |   |  | 
|--------------------------- | -------------------------------------------------------------------------------------------------------------------- | ----------------------------- | ------ | ------- | --------------------------- | - | ------------ | --- | ---------- |  | ------ | ------ | ------- | - | -- | -- | - | - | ------- | ------ | - |  | 
|                            |                                                                                                                      |                               |        |         | Convertible
Preferred Stock |   | Common Stock |     | Additional
|                            |                                                                                                                      |                               |        |         |                             |   |              |     | Paid-in   
|                            |                                                                                                                      |                               |        |         | Shares                      |   | Amount       |     | Shares     |  | Amount |        | Capital
|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |        
|Balance at February 1, 1999 |                                                                                                                      |                               | 35,528 |         |                             | $ | 35           |     |            |  | 3,541  |        |         | $ | 4  |    |   | $ | 110,675 |       
|                            | Issuance of Series E convertible
preferred stock                                                                     |                               |        | 6,614   |                             |   |              | 7   |            |  |        |       |         |   |    |   |   |   |         | 33,018 |  
|                            | Issuance of Series E convertible
preferred stock in exchange
for future advertising                                  |                               |        | 80      |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | 400    |  
|                            | Series E convertible preferred
stock issued in connection
with the acquisition of
Academic Systems                   |                               |        | 7,192   |                             |   |              | 7   |            |  |        |       |         |   |    |   |   |   |         | 35,952 |  
|                            | Series E convertible preferred
stock issued in connection
with the acquisition of StudyWeb                           |                               |        | 217     |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | 1,085  |  
|                            | Issuance of common stock in
connection with the acquisition
of Academic Systems                                      |                               |        |        |                             |   |              |    |            |  |        | 570    |         |   |    |   |   |   |         | 4,711  |  
|                            | Issuance of options and warrants
in connection with the
acquisition of Academic Systems                              |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | 1,818  |  
|                            | Issuance of Series E preferred stock                                                                                 |                               |        | 2,600   |                             |   |              | 3   |            |  |        |       |         |   |    |   |   |   |         | 12,997 |  
|                            | Exercise of stock options                                                                                            |                               |        |        |                             |   |              |    |            |  |        | 653    |         |   |    | 1  |   |   |         | 361    |  
|                            | Deferred compensation related to
stock options                                                                       |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | 8,723  |  
|                            | Amortization of deferred compensation                                                                                |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         |       |  
|                            | Net loss and comprehensive net loss                                                                                  |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         |       |  
|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |       
|Balance at January 31, 2000 |                                                                                                                      |                               | 52,231 |         |                             |   | 52           |     |            |  | 4,764  |        |         |   | 5  |    |   |   | 209,740 |       
|                            | Conversion of convertible preferred
stock into common stock upon
completion of initial public
offering               |                               |        | (52,231 | )                           |   |              | (52 | )          |  |        | 27,088 |         |   |    | 27 |   |   |         | 25     |  
|                            | Issuance of common stock in
initial public offering, net
of offering costs, commissions
and discounts of $9,042      |                               |        |        |                             |   |              |    |            |  |        | 8,155  |         |   |    | 8  |   |   |         | 88,811 |  
|                            | Issuance of common stock in private
placements, net of advisory fees
of $930                                         |                               |        |        |                             |   |              |    |            |  |        | 2,125  |         |   |    | 2  |   |   |         | 24,568 |  
|                            | Issuance of common stock in
connection with the purchase
of eduTest and LearningPlanet.com,
net of registration fees |                               |        |        |                             |   |              |    |            |  |        | 1,019  |         |   |    | 1  |   |   |         | 8,934  |  
|                            | Issuance of common stock                                                                                             |                               |        |        |                             |   |              |    |            |  |        | 1,515  |         |   |    | 2  |   |   |         | 7,331  |  
|                            | Reduction to deferred compensation
related to stock options                                                          |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | (1,499 | )
|                            | Amortization of deferred compensation                                                                                |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         |       |  
|                            | Use of advertising credits                                                                                           |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         |       |  
|                            | Preferred stock dividend                                                                                             |                               |        |        |                             |   |              |    |            |  |        | 1,378  |         |   |    | 1  |   |   |         | 16,505 |  
|                            | Comprehensive loss:                                                                                                  |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |        |   | 
|                            |                                                                                                                      | Unrealized loss               |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      | Net loss                      |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      | Comprehensive loss            |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |       
|Balance at January 31, 2001 |                                                                                                                      |                               |       |         |                             |   |             |     |            |  | 46,044 |        |         |   | 46 |    |   |   | 354,415 |       
|                            | Issuance of common stock to Learning
Planet.com and eduTest                                                          |                               |        |        |                             |   |              |    |            |  |        | 263    |         |   |    |   |   |   |         | 2,067  |  
|                            | Exercise of stock options                                                                                            |                               |        |        |                             |   |              |    |            |  |        | 185    |         |   |    |   |   |   |         | 147    |  
|                            | Reduction to deferred compensation
related to stock options                                                          |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         | (289   | )
|                            | Amortization of deferred compensation                                                                                |                               |        |        |                             |   |              |    |            |  |        |       |         |   |    |   |   |   |         |       |  
|                            | Common Stock issued under Employee
Stock Purchase Plan                                                               |                               |        |        |                             |   |              |    |            |  |        | 537    |         |   |    | 1  |   |   |         | 547    |  
|                            | Comprehensive loss:                                                                                                  |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |        |  
|                            |                                                                                                                      | Net change in unrealized loss |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      | Net loss                      |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      | Comprehensive loss            |        |         |                            |   |              |     |           |  |        |        |        |   |    |    |  |   |         |        |  | 
|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |       
|Balance at January 31, 2002 |                                                                                                                      |                               |       |         |                             | $ |             |     |            |  | 47,029 |        |         | $ | 47 |    |   | $ | 356,887 |       
|                            |                                                                                                                      |                               |        |         |                             |   |              |     |            |  |        |        |         |   |    |    |   |   |         |       

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |         |         |   | 
|--------------------------- | -------------------------------------------------------------------------------------------------------------------- | ----------------------------- | ---- | ---- | ----------- | - | ------------ | ------ | ------------- | - | ----------- | - | --------- | - | -------- | ------- | ------------- | - | ------- | ------- | ------- | - | 
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |         | Total  
|                            |                                                                                                                      |                               |      |      | Deferred    |   |              |        |               |   | Other       |   |           |   |          |         | Stockholders'
|                            |                                                                                                                      |                               |      |      | Advertising |   | Deferred     |        | Comprehensive |   | Accumulated |   | Equity   
|                            |                                                                                                                      |                               |      |      | Expense     |   | Compensation |        | Loss          |   | Deficit     |   | (Deficit)
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |          
|Balance at February 1, 1999 |                                                                                                                      | $                             |     |      |             | $ | (192         | )      |               | $ |            |   |           | $ | (121,771 | )       |               | $ | (11,249 | )      
|                            | Issuance of Series E convertible
preferred stock                                                                     |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 33,025  |        
|                            | Issuance of Series E convertible
preferred stock in exchange
for future advertising                                  |                               |      | (400 | )           |   |              |       |               |   |             |  |           |   |          |        |               |   |         |        |        
|                            | Series E convertible preferred
stock issued in connection
with the acquisition of
Academic Systems                   |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 35,959  |        
|                            | Series E convertible preferred
stock issued in connection
with the acquisition of StudyWeb                           |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 1,085   |        
|                            | Issuance of common stock in
connection with the acquisition
of Academic Systems                                      |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 4,711   |        
|                            | Issuance of options and warrants
in connection with the
acquisition of Academic Systems                              |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |         |               |   |         | 1,818   |        
|                            | Issuance of Series E preferred stock                                                                                 |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 13,000  |        
|                            | Exercise of stock options                                                                                            |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 362     |        
|                            | Deferred compensation related to
stock options                                                                       |                               |      |     |             |   |              | (8,723 | )             |   |             |  |           |   |          |        |               |   |         |        |        
|                            | Amortization of deferred compensation                                                                                |                               |      |     |             |   |              | 3,704  |               |   |             |  |           |   |          |        |               |   |         | 3,704   |        
|                            | Net loss and comprehensive net loss                                                                                  |                               |      |     |             |   |              |       |               |   |             |  |           |   |          | (55,721 | )             |   |         | (55,721 | )      
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        
|Balance at January 31, 2000 |                                                                                                                      |                               | (400 | )    |             |   | (5,211       | )      |               |   |            |   |           |   | (177,492 | )       |               |   | 26,694  |        
|                            | Conversion of convertible preferred
stock into common stock upon
completion of initial public
offering               |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         |        |        
|                            | Issuance of common stock in
initial public offering, net
of offering costs, commissions
and discounts of $9,042      |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 88,819  |        
|                            | Issuance of common stock in private
placements, net of advisory fees
of $930                                         |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 24,570  |        
|                            | Issuance of common stock in
connection with the purchase
of eduTest and LearningPlanet.com,
net of registration fees |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 8,935   |        
|                            | Issuance of common stock                                                                                             |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 7,333   |        
|                            | Reduction to deferred compensation
related to stock options                                                          |                               |      |     |             |   |              | 1,499  |               |   |             |  |           |   |          |        |               |   |         |        |        
|                            | Amortization of deferred compensation                                                                                |                               |      |     |             |   |              | 2,398  |               |   |             |  |           |   |          |        |               |   |         | 2,398   |        
|                            | Use of advertising credits                                                                                           |                               |      | 400  |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 400     |        
|                            | Preferred stock dividend                                                                                             |                               |      |     |             |   |              |       |               |   |             |  |           |   |          | (16,506 | )             |   |         |        |        
|                            | Comprehensive loss:                                                                                                  |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |         |        
|                            |                                                                                                                      | Unrealized loss               |      |      |            |   |              |        |              |   |             |   | (714      | ) |          |         |               |   |         |         | (714    | )
|                            |                                                                                                                      | Net loss                      |      |      |            |   |              |        |              |   |             |   |          |   |          |         | (32,120       | ) |         |         | (32,120 | )
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        
|                            |                                                                                                                      | Comprehensive loss            |      |      |            |   |              |        |              |   |             |   |          |   |          |         |              |   |         |         | (32,834 | )
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        
|Balance at January 31, 2001 |                                                                                                                      |                               |     |      |             |   | (1,314       | )      |               |   | (714        | ) |           |   | (226,118 | )       |               |   | 126,315 |        
|                            | Issuance of common stock to Learning
Planet.com and eduTest                                                          |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 2,067   |        
|                            | Exercise of stock options                                                                                            |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 147     |        
|                            | Reduction to deferred compensation
related to stock options                                                          |                               |      |     |             |   |              | 289    |               |   |             |  |           |   |          |        |               |   |         |        |        
|                            | Amortization of deferred compensation                                                                                |                               |      |     |             |   |              | 747    |               |   |             |  |           |   |          |        |               |   |         | 747     |        
|                            | Common Stock issued under Employee
Stock Purchase Plan                                                               |                               |      |     |             |   |              |       |               |   |             |  |           |   |          |        |               |   |         | 548     |        
|                            | Comprehensive loss:                                                                                                  |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |         |        
|                            |                                                                                                                      | Net change in unrealized loss |      |      |            |   |              |        |              |   |             |   | 714       |   |          |         |               |   |         |         | 714     |  
|                            |                                                                                                                      | Net loss                      |      |      |            |   |              |        |              |   |             |   |          |   |          |         | (62,243       | ) |         |         | (62,243 | )
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        
|                            |                                                                                                                      | Comprehensive loss            |      |      |            |   |              |        |              |   |             |   |          |   |          |         |              |   |         |         | (61,529 | )
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        
|Balance at January 31, 2002 |                                                                                                                      | $                             |     |      |             | $ | (278         | )      |               | $ |             |   |           | $ | (288,361 | )       |               | $ | 68,295  |        
|                            |                                                                                                                      |                               |      |      |             |   |              |        |               |   |             |   |           |   |          |         |               |   |         |        

See accompanying notes.

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##### Table of Contents



LIGHTSPAN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |        |         |   |         |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------- | ------- | --------------------------------------------------------- | -------- | ----------------------- | ------- | ------ | ------- | ---- | ------- | ------ | ------- | - | ------- | -
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          | Years Ended January 31,
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          | 2002                    |         | 2001   |         | 2000
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |     
|Operating activities:                                                       |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|Net loss                                                                    |                                                                                                  | $                                                                               | (62,243 | )                                                         |          | $                       | (32,120 | )      |         | $    | (55,721 | )     
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  | Depreciation and amortization                                                   |         |                                                           | 3,265    |                         |         |        | 1,821   |      |         |        | 1,193   |  
|                                                                            |                                                                                                  | Provision for doubtful accounts                                                 |         |                                                           | 357      |                         |         |        | (78     | )    |         |        | 188     |  
|                                                                            |                                                                                                  | Amortization of intangible assets                                               |         |                                                           | 18,298   |                         |         |        | 16,005  |      |         |        | 4,975   |  
|                                                                            |                                                                                                  | Amortization of deferred stock-based compensation                               |         |                                                           | 747      |                         |         |        | 2,398   |      |         |        | 3,704   |  
|                                                                            |                                                                                                  | Change in deferred advertising expense                                          |         |                                                           |         |                         |         |        | 400     |      |         |        |        |  
|                                                                            |                                                                                                  | Restructuring charge, non-cash portion                                          |         |                                                           |         |                         |         |        | 533     |      |         |        |        |  
|                                                                            |                                                                                                  | Changes in operating assets and liabilities, net of effects of assets acquired: |         |                                                           |          |                         |         |        |         |      |         |        |         |  
|                                                                            |                                                                                                  |                                                                                 |         | Accounts receivable                                       |          |                         | (581    | )      |         |      | 5,266   |        |         |   | (7,099  | )
|                                                                            |                                                                                                  |                                                                                 |         | Finished goods inventory                                  |          |                         | 135     |        |         |      | (1,451  | )      |         |   | 434     |  
|                                                                            |                                                                                                  |                                                                                 |         | Deferred cost of revenue                                  |          |                         |        |        |         |      | 8,709   |        |         |   | (5,154  | )
|                                                                            |                                                                                                  |                                                                                 |         | Restricted cash                                           |          |                         | 3,115   |        |         |      | (4,768  | )      |         |   |        |  
|                                                                            |                                                                                                  |                                                                                 |         | Deposits and other assets                                 |          |                         | 1,306   |        |         |      | (527    | )      |         |   | (1,670  | )
|                                                                            |                                                                                                  |                                                                                 |         | Accounts payable, accrued and other liabilities           |          |                         | 1,300   |        |         |      | 329     |        |         |   | 4,383   |  
|                                                                            |                                                                                                  |                                                                                 |         | Deferred revenue                                          |          |                         | 2,602   |        |         |      | (46,188 | )      |         |   | 29,485  |  
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  |                                                                                 |         | Net cash flows used in operating activities               |          |                         | (31,699 | )      |         |      | (49,671 | )      |         |   | (25,282 | )
|Investing activities:                                                       |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  | Purchases of short-term investments                                             |         |                                                           | (121,845 | )                       |         |        | (35,753 | )    |         |        | (16,132 | )
|                                                                            |                                                                                                  | Maturities of short-term investments                                            |         |                                                           | 146,909  |                         |         |        | 18,488  |      |         |        |        |  
|                                                                            |                                                                                                  | Purchase of property and equipment                                              |         |                                                           | (4,218   | )                       |         |        | (4,204  | )    |         |        | (2,353  | )
|                                                                            |                                                                                                  | Proceeds from sale of property and equipment                                    |         |                                                           |         |                         |         |        |        |      |         |        | 5       |  
|                                                                            |                                                                                                  | Net cash paid for acquisitions                                                  |         |                                                           |         |                         |         |        | (2,845  | )    |         |        | (4,302  | )
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  |                                                                                 |         | Net cash flows provided by (used in) investing activities |          |                         | 20,846  |        |         |      | (24,314 | )      |         |   | (22,782 | )
|Financing activities:                                                       |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  | Proceeds from issuance of common stock                                          |         |                                                           | 548      |                         |         |        | 114,011 |      |         |        |        |  
|                                                                            |                                                                                                  | Proceeds from issuance of preferred stock                                       |         |                                                           |         |                         |         |        |        |      |         |        | 46,025  |  
|                                                                            |                                                                                                  | Proceeds from capital leases                                                    |         |                                                           |         |                         |         |        |        |      |         |        | 683     |  
|                                                                            |                                                                                                  | Principal repayments on capital leases                                          |         |                                                           | (375     | )                       |         |        | (391    | )    |         |        | (1,064  | )
|                                                                            |                                                                                                  | Principal repayments on notes payable                                           |         |                                                           |         |                         |         |        | (257    | )    |         |        | (52     | )
|                                                                            |                                                                                                  | Net proceeds from exercise of stock options                                     |         |                                                           | 147      |                         |         |        | 1,155   |      |         |        | 362     |  
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  |                                                                                 |         | Net cash flows provided by financing activities           |          |                         | 320     |        |         |      | 114,518 |        |         |   | 45,954  |  
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|Increase (decrease) in cash and cash equivalents                            |                                                                                                  |                                                                                 | (10,533 | )                                                         |          |                         | 40,533  |        |         |      | (2,110  | )     
|Cash and cash equivalents at beginning of year                              |                                                                                                  |                                                                                 | 45,566  |                                                           |          |                         | 5,033   |        |         |      | 7,143   |       
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|Cash and cash equivalents at end of year                                    |                                                                                                  | $                                                                               | 35,033  |                                                           |          | $                       | 45,566  |        |         | $    | 5,033   |       
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|Supplemental disclosure of cash flow information:                           |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            |                                                                                                  | Interest paid                                                                   |         | $                                                         | 111      |                         |         | $      | 100     |      |         | $      | 173     |  
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|Supplemental schedule of noncash investing and financing activities:        |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Reduction in deferred stock-based compensation                                                   |                                                                                 | $       | 289                                                       |          |                         | $       | (1,499 | )       |      | $       | 8,723  |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Conversion of convertible preferred stock into common stock                                      |                                                                                 | $       |                                                          |          |                         | $       | 52     |         |      | $       |       |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Issuance of common stock related to the acquisitions of
Academic, eduTest and LearningPlanet.com |                                                                                 | $       | 67                                                        |          |                         | $       | 14,490 |         |      | $       | 4,711  |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Issuance of common stock as preferred stock dividend                                             |                                                                                 | $       |                                                          |          |                         | $       | 16,506 |         |      | $       |       |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Series E preferred stock issued in connection with the Acquisition of
Academic                   |                                                                                 | $       |                                                          |          |                         | $       |       |         |      | $       | 35,959 |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Valuation of options and warrants issued in connection with the acquisition
of Academic          |                                                                                 | $       |                                                          |          |                         | $       |       |         |      | $       | 1,818  |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Additional consideration payable related to the acquisitions of Academic and
eduTest             |                                                                                 | $       | (2,000                                                    | )        |                         | $       | 2,000  |         |      | $       | 5,341  |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Series E preferred stock issued for future advertising                                           |                                                                                 | $       |                                                          |          |                         | $       |       |         |      | $       | 400    |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       
|                                                                            | Series E preferred stock issued in connection with the acquisition of
StudyWeb                   |                                                                                 | $       |                                                          |          |                         | $       |       |         |      | $       | 1,085  |        
|                                                                            |                                                                                                  |                                                                                 |         |                                                           |          |                         |         |        |         |      |         |       

See accompanying notes.

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LIGHTSPAN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Organization and Business Activity

Lightspan, Inc. (Lightspan) was founded in 1993. Lightspan was
incorporated as The Lightspan Partnership, Inc. and changed its name to
Lightspan, Inc. on April 10, 2000. Lightspan provides curriculum-based
educational software and Internet products and services to schools and
school districts that are used both in school and at home. Lightspan
Achieve Now is an interactive CD-ROM-based software product for
kindergarten through eighth grade schools, or K-8, that covers the core
curriculum of language arts, reading and math. The Lightspan Achieve Now
program typically includes the Lightspan Achieve Now software and a
PlayStation® game console that the student uses to operate the program at
home throughout the school year. The Lightspan Network is an online
subscription service that provides curriculum-based content for classroom
and home use. The Lightspan Reading Center is a complete online reading
program that supports student achievement and helps educators make more
informed instructional decisions. Lightspan eduTest Assessment is a
comprehensive accountability and assessment online subscription program
that allows educators to quickly identify district, school, class, and
student strengths and needs relating to state and national standards.
Academic software is a CD-ROM-based product that serves the college
market with an English and mathematics curriculum designed to meet the
needs of under-prepared students. Web-enhanced versions of Academics
Interactive Mathematics and Interactive English which allow colleges to
implement the programs using client workstations that are located solely
within an intranet, on the Internet in a distance learning configuration,
or with a combination of intranet and Internet-based workstations.

Principles of Consolidation

The consolidated financial statements include the accounts of
Lightspan and its wholly-owned subsidiaries, Academic Systems Corporation
(Academic) and Edutest, Inc. (eduTest or eduTest.com). All
intercompany accounts and transactions have been eliminated in
consolidation.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and highly liquid
investments which include debt securities with original maturities when
acquired of three months or less. Restricted cash consists of
certificates of deposit that are used as collateral against lines of
credit.

Short-term investments

Short-term investments consist of fixed income investments with an
original maturity of greater than three months such as United States
treasury securities, obligations of the United States government agencies
and other investment grade securities such as commercial paper and
corporate bonds rated AA or better. The Company applies Statement of
Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities to its investments in
short-term investments. Short-term investments classified as
available-for-sale are recorded at estimated fair value with unrealized
gains or losses reported in stockholders equity.

Accounts Receivable

Substantially all of Lightspans accounts receivable are from school
districts and colleges located throughout the United States and Puerto
Rico. The company maintains an adequate level of accounts receivable
reserves in order to minimize the risk of loss due to uncollectible
accounts. Management periodically assesses the adequacy of these reserves
based on various business risk factors that include availability of
customer funding and customer delinquency trends. Historically,
uncollected accounts have been minimal and have not exceeded managements
expectations.

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Inventory

Inventory consists primarily of hardware and software and is stated
at the lower of cost (first in, first out basis) or market.

Property and Equipment

Property and equipment is stated at cost and depreciated or amortized
over the shorter of the estimated useful life of the related asset (two to
five years) or the term of the lease, using the straight-line method.

Amortization of Intangible Assets

Intangible assets consist of customer base, core technology,
trademark and trade name, assembled workforce and goodwill and are
amortized over useful lives ranging from three to ten years. See Recently
Issued Accounting Standards below.

Deferred Revenues

Payments received in advance of amounts earned are recorded as
deferred revenue in the accompanying financial statements.

Impairment of Long-Lived Assets

The Company evaluates the recoverability of its long-lived assets in
accordance with SFAS No. 121, Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of.SFAS 121 requires
recognition of impairment of long-lived assets in the event the net book
value of these assets exceeds the future undiscounted cash flows
attributable to these assets. The Company assesses potential impairment
to its long-lived assets when there is evidence that events or changes in
circumstances have made recovery of the assets carrying value unlikely.
Should an impairment exist, the impairment loss would be measured based on
the excess of the carrying value of the assets over the assets fair value
or discounted estimates of future cash flows. The Company has not
identified any such impairment losses to date.

Revenue

Lightspan derives its revenues from the licensing of software,
product implementation, materials, training services, customer support
services, Internet subscriptions, and the sale of PlayStation game
consoles and accessories.

Software Licenses

We recognize revenue from license agreements when a non-cancelable,
non-contingent license agreement has been signed, the software product
has been delivered, no uncertainties exist surrounding product
acceptance, fees from the agreement are fixed and determinable, and
collection is probable. In software arrangements that include multiple
elements, such as those that include rights to software products,
customer support and product implementation and training services,
Lightspan allocates the total fee to each component of the arrangement
based on objective evidence of its fair value, which is specific to
Lightspan. The objective evidence for each element is based on the sale
price of each element when sold or offered for sale separately. We use
the residual method to recognize revenue when a license agreement
includes one or more elements to be delivered at a future date if
evidence of the fair value of all undelivered elements exists. If
evidence of the fair value of the undelivered elements does not exist,
all revenue is deferred until sufficient evidence exists or all elements
have been delivered.

Lightspan sells its Lightspan Achieve Now licenses in three distinct
grade clusters  grades K through 2; grades 3 through 4; and grades 5
through 8. Each grade cluster includes up to 40 separate Lightspan
Achieve Now titles, with each title consisting of one distinct CD-ROM.
As of January 31, 2000, there were a total of 77 separate titles, some of
which were included in more than one grade cluster. From fiscal 1997
through fiscal 2000, certain

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titles were under development at various stages in the development
cycle. Lightspan considers titles that have completed the development
cycle and have been released for shipment to customers to be completed,
and considers titles still in the development cycle to be as-yet
uncompleted. As of January 31, 2000, 72 of the 77 titles had been
completed and five of the 77 titles were still as-yet uncompleted.

In July 2000, the Company completed and shipped all Lightspan
Achieve Now titles in all grade clusters used on the PlayStation game
console and on a PC platform, resulting in the recognition of $48.1
million of revenue previously deferred, and the recognition of $8.7
million of previously deferred expenses as cost of revenue, pursuant to
SOP 97-2 as discussed below.

On February 1, 1998, Lightspan adopted the provisions of SOP 97-2,
Software Revenue Recognition,as amended by SOP 98-4, Deferral of the
Effective Date of Certain Provisions of SOP 97-2.Under SOP 97-2,
Lightspan recognizes software license revenue when (i) an agreement has
been executed or a definitive purchase order has been received; (ii) the
product has been shipped or services have been performed; (iii) the fee
has become fixed and determinable; (iv) the collection of the fee is
considered probable; (v) the related hardware, if applicable, has been
shipped, and (vi) when all titles for a given grade cluster have been
delivered to its customers. In early 1998, Lightspan began providing
customers with a specific list of titles which were planned to be
eventually provided to the customers, as well as the projected delivery
dates for these titles. Prior to April 30, 2000, Lightspan deferred the
recognition of all revenue for Achieve Now licenses, since objective fair
values of individual as-yet uncompleted titles could not be determined
and used to allocate the license fee to the individual titles as they
were shipped.

In December 1999, the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin No. (SAB) 101, Revenue Recognition in
Financial Statements. The Company adopted SAB 101 in the fourth quarter
of fiscal 2001. SAB 101 requires, among other things, that license and
other up-front fees be recognized over the term of the agreement, unless
the fees are nonrefundable and in exchange for products delivered or
services performed that represent the culmination of a separate earnings
process. The Company currently recognizes revenue in accordance with SAB
101, and the adoption in fiscal 2001 did not have a material effect on
the Companys financial position and results of operations.

Academic curriculum products are licensed to colleges and then sold
by the licensing colleges to students on a student-by-student basis for
use with each class, instead of a textbook. As Lightspan is not
contractually obligated to provide further service after delivery of the
license, Lightspan recognizes the full sales value of Academic license
revenue generally upon delivery.

Historically, Lightspan has experienced minimal customer
cancellations, forfeitures or discontinuations of licenses.

Internet Subscriptions

Revenue derived from fee-based Internet subscriptions recognized on a
straight-line basis over the term of the agreement, generally one year.

Professional Services

Revenue derived from professional services, including product
implementation and customer training provided by the professional
development organization, is recognized as the services are performed in
accordance with the standard implementation, training, service, and
evaluation plans that Lightspan establishes for its customers. Revenue
derived from telephone support and maintenance arrangements provided by
the professional development organization is recognized ratably over the
term of the support and maintenance period, generally one year.

Hardware

Revenue derived from hardware revenue, including the sale of
PlayStation game consoles and related accessories, is recognized upon
delivery of the console and the related software product.

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Advertising Costs

Advertising costs are expensed as incurred and were $0.2 million,
$5.7 million, and $0.4 million for the years ended January 31, 2002, 2001
and 2000, respectively.

Technology and Development Expenses

Technology and development expenses include software development
costs which are expensed as incurred until technological feasibility has
been established and a definitive decision has been made to proceed with
the commercial launch of the title. To date, these factors have not been
met until substantial completion of the title, and therefore costs
associated with software development have been expensed as incurred.

Web Site Development Costs

Technology and development expenses also include Web site
development costs which are evaluated under Emerging Issues Task Force
(EITF) 00-2 Accounting for Web Site Development Costs. Web site
development costs for which a plan exists to market the Web-site
externally are accounted for pursuant to SFAS 86, Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketedand
are expensed as incurred until technological feasibility has been
established and a definitive decision has been made to proceed with the
commercial launch of the Web site. To date, technological feasibility has
not been met until substantial completion of the Web site, and therefore
costs associated with Web site development costs have been expensed as
incurred.

Web site development costs relating to software (which includes Web
site application, infrastructure and graphics) used to operate a web site
internally and for which a plan to market the Web site externally does
not exist are accounted for in accordance with SOP 98-1 Accounting for
the Cost of Computer Software Developed or Obtained for Internal Use.
According to SOP 98-1, once capitalization criteria of SOP 98-1 have been
met, the Company capitalizes costs such as external direct costs of
materials and services, payroll and payroll related costs for employees
who are directly associated with developing the internaluse software or
upgrades and enhancements that result in additional functionality.
Training costs, data conversion costs and operating expenses are expensed
as incurred. As of January 31, 2002, the Company had not incurred any
Web site development costs meeting the criteria for capitalization.

Stock-Based Compensation

As permitted by SFAS No. 123, Accounting for Stock-Based
Compensation,Lightspan has elected to follow Accounting Principles Board
Opinion (APB) No. 25, Accounting for Stock Issued to Employees,and
related Interpretations in accounting for stock-based employee
compensation. Under APB No. 25, if the exercise price of Lightspans
employee and director stock options equals or exceeds the fair value of
the underlying stock on the date of grant, no compensation expense is
recognized. When the exercise price of the employee or director stock
options is less than the fair value of the underlying stock on the grant
date, Lightspan records deferred stock compensation for the difference
and amortizes this amount to expense in accordance with FASB
Interpretation No. 28, (FIN 28), over the vesting period of the
options. Options or stock awards issued to non-employees are recorded at
their fair value as determined in accordance with SFAS No. 123 and EITF
96-18, and recognized over the related service period.

Comprehensive Loss

The Company has adopted the provisions of SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes standards for reporting
comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net
assets) during a period from non-owner sources. Net loss and other
comprehensive loss, including foreign currency translation adjustments
and unrealized gains and losses on investments shall be reported, net of
their related tax effect, to arrive at comprehensive loss. The Companys
net loss and its total comprehensive loss are included in a supplementary
schedule in the statement

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of stockholders equity for the years ended January 31, 2002 and
2001. Total comprehensive loss was equivalent to reported net loss for
the year ended January 31, 2000.

Segment Reporting

SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information,establishes standards for disclosure about operating
segments in annual financial statements and selected information in
interim financial reports. This establishes standards for related
disclosures about products and services, geographic areas and major
customers. See Note 10.

Net Loss Per Share

Lightspan computes net loss per share in accordance with SFAS No.
128, Earnings Per Share.Under the provisions of SFAS No. 128, basic net
income (loss) per share is computed by dividing the net income (loss) for
the period by the weighted average number of common shares outstanding
during the period. Diluted net income (loss) per share is computed by
dividing the net income (loss) for the period by the weighted average
number of common and common equivalent shares outstanding during the
period. Potentially dilutive securities composed of incremental common shares issuable upon the exercise of stock options and warrants, and
common shares issuable on conversion of preferred stock, were excluded
from historical diluted loss per share because of their anti-dilutive
effect. Dilutive common stock equivalents would include the dilutive
effects of common stock options, convertible preferred stock (as if
converted), warrants for common stock, and restricted stock that has not
yet fully vested. Potentially dilutive securities totaled 1.2 million,
1.4 million, and 29.5 million for the years ended January 31, 2002, 2001
and 2000, respectively, and were excluded from the diluted earnings per
share because of their antidilutive effect.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires Lightspan management to make
estimates and assumptions that affect the amounts reported in the
financial statements and disclosures made in the accompanying notes to
the financial statements. Actual results could differ from those
estimates.

Fair Value of Financial Instruments

Financial instruments, including cash and cash equivalents, accounts
receivable, accounts payable, accrued liabilities, and capital lease
obligations, are carried at cost, which management believes approximates
fair value because of the short-term maturity of these instruments.
Short-term investments, consisting primarily of U.S. Agency securities
that mature within one year, are carried at fair value, which is based on
quoted market prices for such securities.

Reclassifications

Certain amounts in prior year financial statements have been
reclassified to conform with the current period presentation.

Recently Issued Accounting Standards

In June 2001, FASB issued Statement of Financial Accounting
Statement, or SFAS, No. 141, Business Combinations
(SFAS 141) and No.
142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141,
effective June 30, 2001, requires all business combinations initiated
after June 30, 2001 to be accounted for using the purchase method of
accounting. The pooling of interests method of accounting can no longer
be used for business combinations completed after June 30, 2001. The
provisions of SFAS 141 are similar to prior generally accepted accounting
principles (GAAP), although SFAS 141 requires additional disclosures for
transactions occurring after the effective date. We do not believe that
the adoption of this statement will have a material impact on our results
of operations, financial position or cash flows. SFAS 142 eliminates the
amortization of goodwill for business

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combinations completed after June 30, 2001. Effective February 1,
2002, goodwill will no longer be amortized, but is required to be assessed
on an annual basis for impairment at the reporting unit level by applying
a fair value based test. SFAS 142 also provides additional guidance on
acquired intangibles that should be separately (with a charge
recorded as appropriate) recognized and amortized,
which may result in the recognition of additional intangible assets as
compared with prior GAAP. Beginning in the first quarter of fiscal 2003,
we will reclassify an assembled workforce intangible asset with an
unamortized balance of $0.5 million to goodwill at the date of adoption
and will no longer amortize goodwill, thereby eliminating (subject to
future impairment charges) what would otherwise have been an annual goodwill
amortization of approximately $9.8 million. Unamortized goodwill was
$14.2 million as of January 31, 2002. We will complete an initial
goodwill impairment assessment during the first six months of fiscal 2003
to determine if an impairment charge should be recognized under SFAS 142.
We cannot predict at this time whether a material impairment charge will
be recorded.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period
in which it is incurred. When the liability is initially recorded, the
entity capitalizes a cost by increasing the carrying amount of the related
long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful
life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or
loss upon settlement. This statement becomes effective for fiscal years
beginning after June 15, 2002. Adoption of SFAS No. 143 is not currently
expected to have a material impact on our results of operations or
financial position.

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, in that it removes goodwill from its
impairment scope and allows for different approaches in cash flow
estimation. However, SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for (a) recognition and measurement of the impairment of
long-lived assets to be held and used and (b) measurement of long-lived
assets to be disposed of. SFAS No. 144 also supercedes the business
segment concept in APB Opinion No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, in that it permits presentation of a component of an
entity, whether classified as held for sale or disposed of, as a
discontinued operation. However, SFAS No. 144 retains the requirement of
APB Opinion No. 30 to report discontinued operations separately from
continuing operations. This statement becomes effective for fiscal years
beginning after December 15, 2001 with earlier application encouraged. We
believe that the implementation of this standard will not have a material
effect on our results of operations or financial position.

2. Detailed Balance Sheet Information (In thousands)

Cash and cash equivalents consist of the following:

|                           |                                            |   |             |     |      |   |        |       | 
|-------------------------- | ------------------------------------------ | - | ----------- | --- | ---- | - | ------ | ----- | 
|                           |                                            |   | January 31,
|                           |                                            |   |            
|                           |                                            |   | 2002        |     | 2001
|                           |                                            |   |             |     |     
|Cash                       |                                            | $ | 1,344       |     |      | $ | 893    |      
|Money market accounts      |                                            |   | 33,689      |     |      |   | 27,880 |      
|Commercial paper           |                                            |   |            |     |      |   | 9,296  |      
|U.S. government securities |                                            |   |            |     |      |   | 7,457  |      
|Certificates of deposit    |                                            |   |            |     |      |   | 40     |      
|                           |                                            |   |             |     |      |   |        |      
|                           |                                            | $ | 35,033      |     |      | $ | 45,566 |      
|                           |                                            |   |             |     |      |   |        |      
|Restricted cash            |                                            |   |             |     |      |   |        |      
|                           | Certificates of deposit, current portion   |   |             | 826 |      |   |        | 1,115 | 
|                           | Certificates of deposit, long term portion |   |             | 827 |      |   |        | 3,653 | 
|                           |                                            |   |             |     |      |   |        |      
|Total restricted cash      |                                            | $ | 1,653       |     |      | $ | 4,768  |      
|                           |                                            |   |             |     |      |   |        |      

Included in unrealized losses for the year ended January 31, 2001 is
$0.8 million related to an investment in Pacific Gas and Electric. This
investment had an original maturity of less than ninety days and was
therefore classified in cash and cash equivalents, and the unrealized loss
was included in other comprehensive income in the statement of
stockholders equity. During April 2001, the Companys third-party
investment manager repurchased this security at par value and the Company
adjusted the unrealized loss accordingly.

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At January 31, 2002, short-term investments consisted of the
following.

|                           |                                                            |   |                |        |             |   |              |   |      |   |        |        | 
|-------------------------- | ---------------------------------------------------------- | - | -------------- | ------ | ----------- | - | ------------ | - | ---- | - | ------ | ------ | 
|                           |                                                            |   |                |        |             |   | Unrealized   |   | Fair
|                           |                                                            |   | Amortized Cost |        | Gain (Loss) |   | Market Value
|                           |                                                            |   |                |        |             |   |             
|U.S. government securities |                                                            | $ | 8,333          |        |             | $ |             |   |      | $ | 8,333  |       
|                           |                                                            |   |                |        |             |   |              |   |      |   |        |       
|Cash and cash equivalents  |                                                            | $ | 35,033         |        |             | $ |             |   |      | $ | 35,033 |       
|                           |                                                            |   |                |        |             |   |              |   |      |   |        |       
|                           | Total cash and cash
equivalents and short-term
investments |   | $              | 43,366 |             |   | $            |  |      |   | $      | 43,366 | 
|                           |                                                            |   |                |        |             |   |              |   |      |   |        |       

At January 31, 2001, short-term investments consisted of the
following.

|                           |                                                            |   |                |        |             |   |              |      |      |   |        |        | 
|-------------------------- | ---------------------------------------------------------- | - | -------------- | ------ | ----------- | - | ------------ | ---- | ---- | - | ------ | ------ | 
|                           |                                                            |   |                |        |             |   | Unrealized   |      | Fair
|                           |                                                            |   | Amortized Cost |        | Gain (Loss) |   | Market Value
|                           |                                                            |   |                |        |             |   |             
|Commercial paper           |                                                            | $ | 19,819         |        |             | $ |             |      |      | $ | 19,819 |       
|U.S. Corporate bonds       |                                                            |   | 6,077          |        |             |   | 35           |      |      |   | 6,112  |       
|Certificates of deposit    |                                                            |   | 4,212          |        |             |   | 12           |      |      |   | 4,224  |       
|U.S. government securities |                                                            |   | 2,527          |        |             |   | 1            |      |      |   | 2,528  |       
|                           |                                                            |   |                |        |             |   |              |      |      |   |        |       
|                           | Total short-term investments                               |   | $              | 32,635 |             |   | $            | 48   |      |   | $      | 32,683 | 
|                           |                                                            |   |                |        |             |   |              |      |      |   |        |       
|Cash and cash equivalents  |                                                            | $ | 46,328         |        |             | $ | (762         | )    |      | $ | 45,566 |       
|                           |                                                            |   |                |        |             |   |              |      |      |   |        |       
|                           | Total cash and cash
equivalents and short-term
investments |   | $              | 78,963 |             |   | $            | (714 | )    |   | $      | 78,249 | 
|                           |                                                            |   |                |        |             |   |              |      |      |   |        |       

Intangible assets consist of the following:

|                              |  |             |         |      |  |   |        |  
|----------------------------- |  | ----------- | ------- | ---- |  | - | ------ | -
|                              |  | January 31,
|                              |  |            
|                              |  | 2002        |         | 2001
|                              |  |             |         |     
|Customer base                 |  | $           | 17,500  |      |  | $ | 17,500 |  
|Core technology               |  |             | 10,400  |      |  |   | 10,400 |  
|Trademark and trade name      |  |             | 4,100   |      |  |   | 4,100  |  
|Assembled workforce           |  |             | 1,200   |      |  |   | 1,200  |  
|                              |  |             |         |      |  |   |        |  
|                              |  |             | 33,200  |      |  |   | 33,200 |  
|Less accumulated amortization |  |             | (17,922 | )    |  |   | (9,604 | )
|                              |  |             |         |      |  |   |        |  
|                              |  | $           | 15,278  |      |  | $ | 23,596 |  
|                              |  |             |         |      |  |   |        |  

Property and equipment consist of the following:

|                                               |  |             |         |      |  |   |        |  
|---------------------------------------------- |  | ----------- | ------- | ---- |  | - | ------ | -
|                                               |  | January 31,
|                                               |  |            
|                                               |  | 2002        |         | 2001
|                                               |  |             |         |     
|Computer equipment                             |  | $           | 12,506  |      |  | $ | 9,871  |  
|Software                                       |  |             | 2,718   |      |  |   | 1,242  |  
|Office furniture and equipment                 |  |             | 2,045   |      |  |   | 1,938  |  
|                                               |  |             |         |      |  |   |        |  
|                                               |  |             | 17,269  |      |  |   | 13,051 |  
|Less accumulated depreciation and amortization |  |             | (10,430 | )    |  |   | (7,165 | )
|                                               |  |             |         |      |  |   |        |  
|                                               |  | $           | 6,839   |      |  | $ | 5,886  |  
|                                               |  |             |         |      |  |   |        |  

Accrued liabilities consist of the following:

|                                          |  |             |        |      |  |   |       | 
|----------------------------------------- |  | ----------- | ------ | ---- |  | - | ----- | 
|                                          |  | January 31,
|                                          |  |            
|                                          |  | 2002        |        | 2001
|                                          |  |             |        |     
|Accrued compensation and related expenses |  | $           | 10,876 |      |  | $ | 7,311 | 
|Other accrued liabilities                 |  |             | 1,366  |      |  |   | 1,984 | 
|                                          |  |             |        |      |  |   |       | 
|                                          |  | $           | 12,242 |      |  | $ | 9,295 | 
|                                          |  |             |        |      |  |   |       | 

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3. Business Combinations and Strategic Relationships

Acquisition of Academic Systems Corporation

On May 10, 1999, Lightspan entered into a merger agreement with
Academic, which sells and supports interactive multimedia learning
systems, principally to colleges and universities. In connection with the
merger agreement which was consummated on September 20, 1999, Lightspan
issued 7,191,839 shares of Series E convertible preferred stock, 570,356 shares of common stock, options to purchase 263,404 shares of common
stock, and warrants to purchase 42,216 shares of Series E convertible
preferred stock, (which became warrants to purchase 21,108 shares of
common stock upon closing of the Offering) and agreed to pay $1.7 million
in cash, in exchange for all of the outstanding common and preferred shares of Academic and all outstanding Academic options and warrants. The
acquisition was accounted for as a purchase.

The Series E convertible preferred stock was valued at $5.00 per
share (the same price that such shares were sold for cash in July,
September and October 1999). The merger agreement included a put right
whereby Academic common shareholders could elect to receive cash of $1.00
per Academic common share ($8.26 per Lightspan common share on an
as-converted basis) in lieu of shares of Lightspan common stock.
Shareholders approximating 21% of Academics common shares and outstanding
options exercised the put right, resulting in an aggregate cash payment
of $1.7 million. The remaining Academic common shares and options to
purchase common shares were converted to Lightspan common stock and
options to purchase common stock at a ratio of .12121-to-1. The 570,356
common shares to be issued were valued at $8.26 per share (the same price
on an as-converted basis that Academic common shareholders and
optionholders were paid upon election of the put right). The 263,404
options to purchase Lightspan common stock that were issued to Academic
optionholders were recorded at their fair value of $6.82 per share in
accordance with APB 16 with the fair value determined by the minimum value
method.

Subsequent to September 20, 1999, the date the acquisition was
consummated, Lightspan issued additional consideration in the amount of
$5.3 million, representing 1,068,015 shares of Series E preferred stock
(which converted into 534,008 shares of common stock upon completion of
the Offering) in early 2000 to certain Academic stockholders and recorded
this amount as a liability at January 31, 2000. In March 2000, Lightspan
issued these shares to such stockholders.

The aggregate purchase price totaled $49.9 million as follows
(in thousands):

|                                                                                                                         |  |   |        | 
|------------------------------------------------------------------------------------------------------------------------ |  | - | ------ | 
|Valuation of Series E convertible preferred stock issued                                                                 |  | $ | 35,959 | 
|Valuation of common stock issued                                                                                         |  |   | 4,711  | 
|Issuance of cash pursuant to exercise of put right                                                                     |  |   | 1,734  | 
|Valuation of options and warrants exchanged for Academic options and warrants                                            |  |   | 1,818  | 
|Acquisition costs                                                                                                        |  |   | 369    | 
|Additional consideration issuable in Series E convertible preferred stock (common
stock upon completion of the Offering) |  |   | 5,342  | 
|                                                                                                                         |  |   |        | 
|Aggregate purchase price                                                                                                 |  | $ | 49,933 | 
|                                                                                                                         |  |   |        | 

The purchase price was allocated to the assets acquired, consisting
principally of intangible assets and goodwill, which are being amortized
over useful lives ranging from four to ten years. The accompanying
consolidated financial statements include the results of operations of
Academic since September 20, 1999, the date the acquisition was
consummated.

Acquisition of Global Schoolhouse

On September 2, 1999, Lightspan acquired certain assets of The Global
SchoolNet Foundation, principally consisting of the Web site
GlobalSchoolhouse.com, an education Web site designed to help teachers
develop and manage collaborative learning projects online, and related
intellectual property, for $2.5 million in cash. The acquisition was
accounted for as a purchase. The purchase price was allocated to the
assets acquired, principally intangible assets related to the Web site,
which are being amortized over a three-year useful life. The accompanying

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consolidated financial statements include the results of operations
of Global Schoolhouse since September 2, 1999. On September 25, 2001
Lightspan and Global SchoolNet Foundation entered into a licensing agreement
whereby Global SchoolNet Foundation agreed to operate and maintain the
Global Schoolhouse website, and was granted the right to use certain
content assets acquired by Lightspan in the initial acquisition that
enable Global SchoolNet Foundation to continue to pursue its charitable educational
endeavors. This transaction will ensure that the Global Schoolhouse
educational content and activities remains available to customers of
Lightspans The Lightspan Network online educational subscription service.

Acquisition of StudyWeb

On October 28, 1999, Lightspan acquired certain assets of American
Computer Resource, principally consisting of the Web site StudyWeb.com, a
research website designed to help parents, teachers and students find
online educational resources, and related intellectual property, for
consideration of $1.0 million in cash and 217,000 shares of Series E
convertible preferred stock, valued at $5.00 per share. The aggregate
purchase price was $2.1 million. The acquisition was accounted for as a
purchase. The purchase price was allocated to the assets acquired,
principally intangible assets related to the Web site, which are being
amortized over a three-year useful life. The accompanying consolidated
financial statements include the results of operations of StudyWeb since
October 28, 1999, the date the acquisition was consummated.

Acquisition of eduTest, Inc.

On May 24, 2000, Lightspan entered into a merger agreement with
eduTest, which offered a combination of online assessment products and
proprietary test questions covering language arts, mathematics, history
and science, allowing educators to assess their students progress in the
classroom. In connection with the merger agreement, which was consummated
on June 23, 2000, Lightspan paid $2.2 million in cash, $1.3 million of
which was paid to eduTest common shareholders and the remaining $1.1
million of which was paid in satisfaction of various obligations of
eduTest. Lightspan also issued 1,028,543 shares of common stock with a
value at the measurement date of $8.75 per share valued at $9.0 million,
with a potential for up to an additional 228,561 hold-back shares valued
at $2.0 million over the next 18 months and up to an additional $2.0
million in stock over the subsequent 12 months based upon certain revenue
based performance criteria, in exchange for all of the outstanding common
and preferred shares of eduTest. The acquisition was accounted for as a
purchase.

In December 2001 we issued 228,561 shares of our common stock which
had been initially held back from the purchase price as security for
indemnification and other obligations of eduTest. The aggregate purchase
price, including the 228,561 hold-back shares valued at $2.0 million, but
excluding the $2.0 million in potential earnout payments, totaled $13.6
million as follows (in thousands):

|                                                         |  |   |        | 
|-------------------------------------------------------- |  | - | ------ | 
|Valuation of common stock issued                         |  | $ | 9,000  | 
|Valuation of hold-back shares                            |  |   | 2,000  | 
|Acquisition costs                                        |  |   | 287    | 
|Cash paid to eduTest shareholders                        |  |   | 1,309  | 
|Cash paid in satisfaction of certain eduTest liabilities |  |   | 1,054  | 
|                                                         |  |   |        | 
|Aggregate purchase price                                 |  | $ | 13,650 | 
|                                                         |  |   |        | 

The purchase price was allocated to the assets acquired, consisting
principally of intangible assets and goodwill, which are being amortized
over useful lives of three to five years. The accompanying consolidated
financial statements include the results of operations of eduTest since
June 23, 2000, the date the acquisition was consummated.

Acquisition of LearningPlanet.com

On May 26, 2000, Lightspan acquired LearningPlanet.com, a
popular education Web destination for children and their parents.
LearningPlanet.com features creative and instructional learning
activities in mathematics and language arts. Launched in June 1999,
LearningPlanet.com has focused on creating activities for kids that
are both entertaining and educational. The transaction was
structured as an asset

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purchase, with Lightspan acquiring the LearningPlanet.com Web
site and related technology and assets in exchange for a combination
of approximately $0.15 million in our common stock and $0.2 million
in cash. The purchase price was allocated to goodwill and amortized
over a useful life of three years. The accompanying consolidated
financial statements include the results of operations of
LearningPlanet.com since May 26, 2000, the date the acquisition was
consummated.

Pro forma financial information

The following unaudited pro forma financial information assumes the
acquisitions of Academic, Global Schoolhouse, Study Web, eduTest and
LearningPlanet.com were consummated on February 1, 2000 (in thousands,
except per share data):

|                                      |  |                         |         |      |  |   |         |  
|------------------------------------- |  | ----------------------- | ------- | ---- |  | - | ------- | -
|                                      |  | Years Ended January 31,
|                                      |  |                        
|                                      |  | 2002                    |         | 2001
|                                      |  |                         |         |     
|Revenues                              |  | $                       | 57,532  |      |  | $ | 99,607  |  
|Net loss                              |  | $                       | (62,243 | )    |  | $ | (51,607 | )
|Net loss per share, basic and diluted |  | $                       | (1.34   | )    |  | $ | (1.19   | )
|                                      |  |                         |         |      |  |   |         |  

4. Restructuring

Restructuring.In July 2000, we recorded a $1.6 million
restructuring charge related to a refocus of our sales and marketing
efforts from our free Internet products towards our fee-based
subscription Internet products, which was fully implemented during
the quarter ended October 31, 2000. The restructuring charge
included $1.2 million of involuntary termination benefits relating
to the termination of 14 employees in August 2000. The Company also
accrued exit costs of $0.4 million in expenses relating to
contractual obligations for services associated with our free
Internet site that will no longer be used to generate revenue. As
of January 31, 2001, the Company had paid $1.0 million in
involuntary termination benefits and exit costs and the remaining
involuntary termination benefits were substantially paid during the
year ended January 31, 2002.

5. Letter of Credit and Financing Facility

In October 2000, Lightspan entered into a $2.5 million letter of
credit with a financial institution related to a three-year contract with
a customer whereby in the event of cancellation of the contract, the
customer can draw an amount equivalent to the value of any non-delivered
services, not to exceed the value of the letter of credit. The amount of
this letter of credit will decrease to $0.8 million on September 30, 2002
and will expire on September 30, 2003. The letter of credit is
collateralized by a $1.7 million certificate of deposit and the face value
of the certificate of deposit is recorded as restricted cash. As of
January 31, 2002, the contract has not been cancelled and no amount has
been drawn against the letter of credit.

6. Commitments and Contingencies

Lightspan leases its facilities under operating lease agreements
subject to annual escalation provisions based upon the Consumer Price
Index. Facilities rent and operating lease expenses were $2.4 million,
$1.9 million and $1.2 million, for the years ended January 31, 2002, 2001
and 2000, respectively.

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At January 31, 2002, future minimum lease payments for all leases
with initial terms of one year or more are as follows for each fiscal year
ending January 31 (in thousands):

|                                                  |  |           |       |         |  |   |      |  
|------------------------------------------------- |  | --------- | ----- | ------- |  | - | ---- | -
|                                                  |  | Operating |       | Capital
|                                                  |  | Leases    |       | Leases 
|                                                  |  |           |       |        
|2003                                              |  | $         | 2,512 |         |  | $ | 242  |  
|2004                                              |  |           | 2,093 |         |  |   | 40   |  
|2005                                              |  |           | 402   |         |  |   |     |  
|2006                                              |  |           | 72    |         |  |   |     |  
|                                                  |  |           |       |         |  |   |      |  
|Total minimum lease payments                      |  | $         | 5,079 |         |  |   | 282  |  
|                                                  |  |           |       |         |  |   |      |  
|Less amounts representing interest                |  |           |       |         |  |   | (16  | )
|                                                  |  |           |       |         |  |   |      |  
|Present value of future minimum lease payments    |  |           |       |         |  |   | 266  |  
|Less current portion of capital lease obligations |  |           |       |         |  |   | (227 | )
|                                                  |  |           |       |         |  |   |      |  
|Long-term capital lease obligations               |  |           |       |         |  | $ | 39   |  
|                                                  |  |           |       |         |  |   |      |  

Capital lease obligations are included in other liabilities on the
balance sheet at January 31, 2002. Amortization on assets under capital lease is included with
depreciation expense in property and equipment.

In addition, Lightspan subleases a portion of their facilities for a
period of one year subject to one-year renewal options. Sublease income
was $0.2 million, $0.5 million and $0.4 million for the years ended
January 31, 2002, 2001 and 2000, respectively.

7. Stockholders Equity

Initial Public Offering

On February 15, 2000, Lightspan completed its initial public offering
(the Offering) of 7,500,000 shares of common stock at $12 per share.
Lightspan also issued 2,125,000 shares at the same price in private
placements that occurred concurrently with the Offering. In March 2000 the
underwriters exercised a portion of their overallotment option and
purchased 655,150 additional shares at the Offering price. Total net
proceeds as a result of the Offering, private placements and overallotment
exercise after deducting the underwriting discount and commissions,
offering expenses and financial advisory fees was approximately $113.4
million.

Convertible Preferred Stock

All series of preferred stock automatically converted into 27,087,810 shares of common stock at the then effective conversion price upon the
closing of the Offering on February 15, 2000.

Upon the completion of the Offering, warrants to purchase up to
2,760,160 shares of Series D preferred stock at $.02 per share converted
into warrants to purchase up to 1,380,080 shares of common stock and were
automatically exercised, resulting in the issuance of 1,377,762 shares of
common stock (after application of certain net exercise provisions that
permitted exercise without additional cash payment combined with the
issuance of a reduced number of shares). As a result, on February 15,
2000, Lightspan accounted for the intrinsic value by charging retained
earnings an additional $16.5 million and increasing the carrying amount of
common stock by a corresponding amount. Such amount increased the net loss
per share applicable to common stockholders for the year ended January 31,
2001.

Stock Option Plan

In 1993, Lightspan adopted its 1993 Stock Option Plan, which was
renamed the 2000 Equity Incentive Plan (the Plan) upon the close of the
Offering. Upon the closing of its acquisition of Academic, Lightspan
assumed Academic's 1992 Stock Option Plan. All options outstanding
under the 1992 Stock Option Plan were converted into options to
purchase shares of Lightspan common stock, and are included in the
summary below. Options for common stock may be incentive stock options or
non-statutory stock options and are granted at the discretion of the Board
of Directors. The Plan permits immediate exercise of options with the
unvested portion subject to repurchase by Lightspan at the original
exercise price, in the event of termination of employment. Non-statutory
stock options may be granted to employees, directors and consultants
whereas incentive stock options may be granted to employees and directors
only. The option price for incentive stock

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options shall not be less than 100% of the fair value on the date of
grant, and the option price of non-statutory options shall not be less
than 85% of the fair value on the date of grant. The maximum term of
options granted under the Plan is ten years. Incentive stock options
granted under the Plan generally vest at the rate of 25% after one year
from the vesting commencement date and 1/36 of the remaining shares every
month thereafter. Non-statutory stock options generally vest at the rate
of 50% after one year from the vesting commencement date and the remaining
50% after two years from such date.

At January 31,
2002, Lightspan was authorized to issue 8,164,940 shares of common stock to eligible employees, officers, directors and
consultants under the Plan, of which options to purchase 893,937 shares
were available for future grant at January 31, 2002.

A summary of Lightspans stock option activity and related
information is as follows (in thousands, except per share data):

|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |          |   |      |      |  |   |          |       |   |   |      |      | 
|-------------------------------------------------------------- | --------- | - | ----------------------- | ------ | ----- | - | -------- | ---- | ----- | - | ------- | ------ | -------- | - | ---- | ---- |  | - | -------- | ----- | - | - | ---- | ---- | 
|                                                               |           |   | Years Ended January 31,
|                                                               |           |   |                        
|                                                               |           |   | 2002                    |        | 2001  |   | 2000    
|                                                               |           |   |                         |        |       |   |         
|                                                               |           |   |                         |        |       |   | Weighted |      |       |   |         |        | Weighted |   |      |      |  |   | Weighted
|                                                               |           |   |                         |        |       |   | Average  |      |       |   |         |        | Average  |   |      |      |  |   | Average 
|                                                               |           |   |                         |        |       |   | Exercise |      |       |   |         |        | Exercise |   |      |      |  |   | Exercise
|                                                               |           |   | Options                 |        | Price |   | Options  |      | Price |   | Options |        | Price   
|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |         
|Outstanding  beginning of year                                |           |   | 4,420                   |        |       | $ | 4.28     |      |       |   | 3,782   |        |          | $ | 4.16 |      |  |   | 1,783    |       |   | $ | .78  |     
|                                                               | Granted   |   |                         | 2,024  |       |   | $        | 1.19 |       |   |         | 2,494  |          |   | $    | 4.89 |  |   |          | 2,986 |   |   | $    | 5.48 | 
|                                                               | Exercised |   |                         | (185   | )     |   | $        | 0.79 |       |   |         | (597   | )        |   | $    | 1.94 |  |   |          | (653  | ) |   | $    | .54  | 
|                                                               | Forfeited |   |                         | (1,285 | )     |   | $        | 4.68 |       |   |         | (1,259 | )        |   | $    | 6.23 |  |   |          | (334  | ) |   | $    | 2.09 | 
|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |          |   |      |      |  |   |          |       |   |   |      |     
|Outstanding  end of year                                      |           |   | 4,974                   |        |       | $ | 3.05     |      |       |   | 4,420   |        |          | $ | 4.28 |      |  |   | 3,782    |       |   | $ | 4.16 |     
|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |          |   |      |      |  |   |          |       |   |   |      |     
|Exercisable at end of year                                     |           |   | 1,624                   |        |       |   |          |      |       |   | 1,115   |        |          |   |      |      |  |   | 896      |       |   |   |      |     
|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |          |   |      |      |  |   |          |       |   |   |      |     
|Weighted average fair value of
Options granted during the year |           | $ | 1.19                    |        |       |   |          |      |       | $ | 4.84    |        |          |   |      |      |  | $ | 3.96     |       |   |   |      |     
|                                                               |           |   |                         |        |       |   |          |      |       |   |         |        |          |   |      |      |  |   |          |       |   |   |      |     

The following table summarizes information about stock options
outstanding as of January 31, 2002 (in thousands, except per share
data):

|                        |  |        |                     |                  |                     |                   |     |                  |  |                |       |  |  |                  |       |  |  |   |       | 
|----------------------- |  | ------ | ------------------- | ---------------- | ------------------- | ----------------- | --- | ---------------- |  | -------------- | ----- |  |  | ---------------- | ----- |  |  | - | ----- | 
|                        |  |        | Options Outstanding |                  | Options Exercisable
|                        |  |        |                     |                  |                    
|                        |  |        |                     |                  |                     | Weighted          |     |                  |  |                |       |  |  |                  |       |  |  |  
|                        |  |        |                     |                  |                     | Average Remaining |     | Weighted Average |  |                |       |  |  | Weighted Average
|Range of Exercise Price |  | Number |                     | Contractual Life |                     | Exercise Price    |     | Number           |  | Exercise Price
|                        |  |        |                     |                  |                     |                   |     |                  |  |               
|$0.01    $  1.90       |  |        | 2,276               |                  |                     |                   | 8.0 |                  |  | $              | 1.09  |  |  |                  | 395   |  |  | $ | 1.00  | 
|$1.91    $  3.80       |  |        | 1,252               |                  |                     |                   | 6.5 |                  |  | $              | 2.47  |  |  |                  | 493   |  |  | $ | 2.47  | 
|$3.81    $  5.70       |  |        | 480                 |                  |                     |                   | 2.8 |                  |  | $              | 4.07  |  |  |                  | 265   |  |  | $ | 4.05  | 
|$5.71    $  7.60       |  |        | 420                 |                  |                     |                   | 7.4 |                  |  | $              | 5.79  |  |  |                  | 178   |  |  | $ | 5.78  | 
|$7.61    $  9.50       |  |        | 259                 |                  |                     |                   | 4.5 |                  |  | $              | 8.34  |  |  |                  | 137   |  |  | $ | 8.33  | 
|$9.51    $11.40        |  |        | 265                 |                  |                     |                   | 2.3 |                  |  | $              | 10.09 |  |  |                  | 145   |  |  | $ | 10.09 | 
|$13.30  $15.20         |  |        | 3                   |                  |                     |                   | 3.9 |                  |  | $              | 14.25 |  |  |                  | 1     |  |  | $ | 14.25 | 
|$17.10  $19.00         |  |        | 19                  |                  |                     |                   | 7.3 |                  |  | $              | 19.00 |  |  |                  | 10    |  |  | $ | 19.00 | 
|                        |  |        |                     |                  |                     |                   |     |                  |  |                |       |  |  |                  |       |  |  |   |       | 
|                        |  |        | 4,974               |                  |                     |                   | 6.6 |                  |  | $              | 3.05  |  |  |                  | 1,624 |  |  | $ | 4.01  | 
|                        |  |        |                     |                  |                     |                   |     |                  |  |                |       |  |  |                  |       |  |  |   |       | 

Pro forma information regarding net loss is required by SFAS No. 123,
Accounting for Stock-Based Compensation, and has been determined as if
Lightspan had accounted for its employee stock options under the fair
value method of that statement. The fair value of these options was
estimated at the date of grant using the Black-Scholes option pricing
model for options subsequent to Lightspans initial public offering and
using the minimum value method for nonpublic entities for options prior to
Lightspans initial public offering, with the following weighted average
assumptions for each of the years ended January 31, 2002, 2001 and 2000,
respectively: ten year risk-free interest rates of 4.90%, 6.51% and 5.75%,
respectively; dividend yields of 0%; weighted-average expected life of the
options of four to five years; and expected volatility of 121% for the
year ended January 31, 2002. The minimum value option pricing model used
for the year ending January 31, 2000 excludes the factor of volatility.

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For purposes of pro forma disclosures, the estimated fair value of
the options is amortized to expense over the vesting period of such
options. Lightspans pro forma information is as follows (in thousands,
except per share data):

|                                                |  |                         |         |      |  |      |         |   |  |   |         |  
|----------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                |  | Years Ended January 31,
|                                                |  |                        
|                                                |  | 2002                    |         | 2001 |  | 2000
|                                                |  |                         |         |      |  |     
|Pro forma net loss                              |  | $                       | (63,251 | )    |  | $    | (52,208 | ) |  | $ | (57,236 | )
|                                                |  |                         |         |      |  |      |         |   |  |   |         |  
|Pro forma net loss per share, basic and diluted |  | $                       | (1.36   | )    |  | $    | (1.19   | ) |  | $ | (13.98  | )
|                                                |  |                         |         |      |  |      |         |   |  |   |         |  

2000 Employee Stock Purchase Plan

In October 1999, Lightspan adopted the 2000 Employee Stock Purchase
Plan (the Purchase Plan) whereby a total of 500,000 shares of common
stock were reserved for issuance under the Purchase Plan. This share
reserve shall automatically increase each year, based upon a formula, by
an amount not to exceed 1% of our total outstanding common stock at the
time of the automatic increases. The Purchase Plan is intended to qualify
as an employee stock purchase plan within the meaning of Section 423 of
the Internal Revenue Code. Under the Purchase Plan, the board may
authorize participation by eligible employees, including officers, in
periodic offerings following the commencement of the Purchase Plan. For
the years ended January 31, 2002 and 2001, employees purchased 536,999 and
305,163 shares, respectively, under the Purchase Plan. As of January 31,
2002, 164,738 shares remained available for issuance prior to the
automatic increase.

Unless otherwise determined by the board, employees are eligible to
participate in the Purchase Plan only if they are employed by Lightspan
for at least 20 hours per week and are customarily employed by Lightspan
for at least 5 months per calendar year. Employees who participate in an
offering may have up to 15% of their earnings withheld pursuant to the
Purchase Plan. The amount withheld is then used to purchase shares of
common stock equal to 85% of the lower of the fair market value of the
common stock at the commencement date or the end of each offering period.
Employees may end their participation in the offering at any time during
the offering period, and participation ends automatically on termination
of employment.

In the event of a merger, reorganization, consolidation or
liquidation, the board has discretion to provide that each right to
purchase common stock will be assumed or an equivalent right substituted
by the successor corporation or the board may provide for all sums
collected by payroll deductions to be applied to purchase stock
immediately prior to such merger or other transaction. The board has the
authority to amend or terminate the Purchase Plan, provided, however, that
no such action may adversely affect any outstanding rights to purchase
common stock.

Common Shares Reserved for Future Issuance

The following table summarizes common shares reserved for future
issuance at January 31, 2002:

|                             |                                           |  |         |           | 
|---------------------------- | ----------------------------------------- |  | ------- | --------- | 
|Common stock options         |                                           |  | 893,937 |          
|Employee stock purchase plan |                                           |  | 164,738 |          
|                             |                                           |  |         |          
|                             | Total common shares reserved for issuance |  |         | 1,058,675 | 
|                             |                                           |  |         |          

Warrants

In connection with debt and equipment lease financing agreements
entered into at various dates, Lightspan issued a total of 749,605
warrants to purchase: up to 150,000 shares of Series A preferred stock at
$1.00 per share, up to 150,000 shares of Series B preferred stock at $3.00
per share, up to 96,625 shares and 57,564 shares of Series C preferred
stock at $6.00 per share and $0.01 per share, respectively, up to 183,105 shares and 127,659 shares of Series D preferred stock at $3.76 and $4.70
per share, respectively, and up to 42,216 shares of Series E preferred
stock at $5.00 per share. The warrants expire on various dates commencing
in 2002 through 2006.

The warrants to purchase Series A through D preferred stock were
valued at an aggregate of $0.2 million and were recorded as debt discounts
and accreted into interest expense over the life of the applicable
financing agreements. The fair value of the warrants were estimated at the
dates of grant using the minimum value method with the following
assumptions: risk free interest rate at the date of grant of 6.00%; an expected warrant life of
two years; and no annual

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dividends. There were no such amounts included in interest expense
for the years ended January 31, 2002, 2001 and 2000.

In connection with the acquisition of Academic Systems Corporation
(Academic), Lightspan converted 50,000 warrants to purchase Academic
Series C preferred stock originally issued in connection with lease
financing into 8,000 warrants to purchase Lightspan Series E preferred
stock; and 34,216 warrants to purchase Academic Series F preferred stock
originally issued in connection with debt financing into 34,216 warrants
to purchase Lightspan Series E preferred stock. These warrants were valued
at $1.25 per share and $.33 per share, respectively, in accordance with
APB 16, using the minimum value method, and were accounted for as a part
of the purchase price of Academic.

Upon completion of the Offering, and taking into effect the reverse
split in January 2000, all of the above 749,605 warrants to purchase
Series A through E preferred stock were converted, at their respective
conversion rates, into warrants to purchase 403,591 shares of common
stock. As of January 31, 2002, warrants to purchase 225,764 shares of
common stock remained outstanding.

Agreement with CINAR Corporation

In October 1999, Lightspan agreed to pursue several potential
strategic initiatives with CINAR Corporation. As part of the agreement,
CINAR purchased 2,500,000 shares of Series E preferred stock at $5.00 per
share, which converted into 1,250,000 shares of common stock upon
completion of Lightspans initial public offering. CINAR also purchased
$10 million of common stock, or 833,333 shares, in a private placement
that occurred concurrently with Lightspans initial public offering at the
initial public offering price of $12 per share. Lightspan also granted
CINAR a warrant to purchase 500,000 shares of Series E preferred stock at
an exercise price of $5.00 per share (which became a warrant to purchase
250,000 shares of common stock at an exercise price of $10.00 per share
upon completion of our initial public offering) that will vest upon the
achievement of various agreed-to strategic goals.

Lightspan has accounted for the warrants in accordance with EITF
96-18, Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling Goods or Services.
Specifically, the shares that could be issued pursuant to the warrant will
be valued the earlier of a) the date at which a commitment for performance
is reached or b) the date at which CINARs performance is complete (the
measurement date).

Lightspan believes that it is unlikely that a performance commitment,
as described in EITF 96-18, will be reached until performance is complete.
Therefore, the measurement date will be the date of completion of
performance and accordingly, no expense had been recorded through January
31, 2002.

Agreement with Cox Communications Holdings, Inc.

In January 2000, Lightspan agreed to pursue strategic initiatives
with Cox Communications Holdings, Inc. Cox Communications provides a wide
variety of services to schools in their cable communities through its
Cable in the Classroom initiative which provides public schools with
free basic cable service and learning guides. As part of the agreement,
Cox Communications purchased $12.5 million of Lightspan common stock, or
1,041,667 shares, in a private placement that occurred concurrently with
the Offering. Lightspan also granted Cox Communications a warrant to
purchase 750,000 shares of common stock at an exercise price of $10.00 per
share upon the closing of our initial public offering.

Lightspan has accounted for the warrant in accordance with EITF
96-18.Specifically, the shares that could be issued pursuant to the
warrant were valued the earlier of a) the date at which a commitment for
performance is reached or b) the earlier of the date at which Cox
Communications performance is complete or February 15, 2001 (the
measurement date). On February 15, 2001, Lightspan measured the value
of the warrant in accordance EITF 96-18, and deferred $0.1 million in
stock based compensation expense that was recognized over the remaining
six-month life of the warrant, which expired on August 15, 2001.

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Deferred Advertising Expense

On October 29, 1999, Lightspan issued 160,000 shares of Series E
convertible preferred stock to Liberty Digital Corporation in exchange for
$0.4 million in cash and $0.8 million in future Internet advertising
credits. Lightspan determined that the fair value of the shares issued
($5.00 per share) was more readily determinable than the fair value of the
advertising credits.

As a result, Lightspan recorded the 160,000 shares issued at $0.8
million and recorded deferred advertising expense of $0.4 million. During
the year ended January 31, 2001, Lightspan remeasured the value of the shares in accordance with EITF 96-18 and expensed $0.3 million, as the
advertising credits were utilized.

Deferred Compensation

Lightspan recorded deferred stock-based compensation of $0.1 million
and $8.7 million for the years ended January 31, 2001 and 2000,
respectively, in connection with the grants of certain stock options to
employees and consultants with exercise prices per share below the fair
values per share for our common stock on the dates those options were
granted prior to the initial public offering. Lightspan also reduced
deferred stock-based compensation by $0.3 million due to the cancellation
of unvested options associated with the termination of employees during
the year ended January 31, 2002. Amortization of deferred stock
compensation was $0.8 million, $2.4 million and $3.7 million during the
years ended January 31, 2002, 2001 and 2000, respectively.

8. Income Taxes

Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for tax purposes.
Significant components of Lightspans deferred tax assets are shown below
(in thousands):

|                          |                                             |   |             |          |      |   |        |         |  
|------------------------- | ------------------------------------------- | - | ----------- | -------- | ---- | - | ------ | ------- | -
|                          |                                             |   | January 31,
|                          |                                             |   |            
|                          |                                             |   | 2002        |          | 2001
|                          |                                             |   |             |          |     
|Deferred tax assets:      |                                             |   |             |          |      |   |        |        
|                          | Net operating loss carryforwards            |   | $           | 91,206   |      |   | $      | 79,148  |  
|                          | Capitalized research expenses               |   |             | 1,955    |      |   |        | 1,336   |  
|                          | Research and development credits            |   |             | 8,358    |      |   |        | 6,614   |  
|                          | Other                                       |   |             | 5,898    |      |   |        | 2,525   |  
|                          |                                             |   |             |          |      |   |        |        
|Total deferred tax assets |                                             |   | 107,417     |          |      |   | 89,623 |        
|                          | Valuation allowance for deferred tax assets |   |             | (100,849 | )    |   |        | (80,013 | )
|                          |                                             |   |             |          |      |   |        |        
|Net deferred tax assets   |                                             |   | 6,568       |          |      |   | 9,610  |        
|                          |                                             |   |             |          |      |   |        |        
|Deferred tax liabilities: |                                             |   |             |          |      |   |        |        
|                          | Acquired intangibles                        |   |             | (6,568   | )    |   |        | (9,610  | )
|                          |                                             |   |             |          |      |   |        |        
|Net deferred tax assets   |                                             | $ |            |          |      | $ |       |        
|                          |                                             |   |             |          |      |   |        |        

A valuation allowance has been recognized to offset the deferred tax
assets because management cannot conclude that it is more likely than not
that the deferred tax assets will be realized.

At January 31, 2002, Lightspan had federal and California net
operating loss carryforwards of approximately $251.9 million and $52.3
million respectively. The difference between the federal and California
tax loss carryforwards is primarily attributable to capitalization of
research expenses and limitations on net operating losses for California
tax purposes. The federal tax loss carryforwards will begin expiring in
2007 unless previously utilized. Through January 31, 2002, California tax
loss carryforwards of $12.0 million have expired, and additional loss
carryforwards will continue to expire in fiscal 2003. Lightspan also has
federal and California research and development tax credit carryforwards
of $5.8 million and $3.8 million respectively, which will begin expiring
in fiscal 2008 unless previously utilized.

Pursuant to Internal Revenue Code Section 382 and 383, the use of
Lightspans net operating loss and credit carryforwards may be limited as
a result of a cumulative change in ownership of more than 50%.

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Lightspans net operating loss carryforwards as of January 31, 2002,
will expire as follows (in millions):

|          |        |   |         |       |       |   |      |      | 
|--------- | ------ | - | ------- | ----- | ----- | - | ---- | ---- | 
|          |        |   | Federal |       | State
|          |        |   |         |       |      
|2003      |        | $ |        |       |       | $ | 10.5 |     
|2004      |        |   |        |       |       |   | 3.3  |     
|2005      |        |   |        |       |       |   | 4.5  |     
|2006      |        |   |        |       |       |   | 8.8  |     
|2007      |        |   | 0.1     |       |       |   | 25.2 |     
|Remaining |        |   | 251.8   |       |       |   |     |     
|          |        |   |         |       |       |   |      |     
|          | Totals |   | $       | 251.9 |       |   | $    | 52.3 | 
|          |        |   |         |       |       |   |      |     

9. Retirement Plan

Lightspan has a 401(k) defined contribution savings and retirement
plan (the Retirement Plan). The Retirement Plan is for the benefit of
all qualifying employees and permits employees voluntary contributions up
to 20% of base salary limited by the IRS imposed maximum. On January 1,
1999, Lightspan began matching in cash 10% of employee contributions up to
4% of eligible compensation. Employer contributions were $0.09 million,
$0.1 million and $0.04 million for the years ended January 31, 2002, 2001
and 2000, respectively.

10. Reportable Segments

Description of the Types of Products from Which Each Reportable Segment
Derives its Revenues

Lightspan has two reportable segments: K-12 and Higher Education.
Revenues derived from the K-12 segment include the sale of Lightspan
Achieve Now software licenses, subscription fees for The Lightspan Network
and eduTest products, implementation, training and support services and
hardware and related accessories. Revenues derived from the Higher
Education segment, comprised solely of Academic which was acquired in
September 1999, include the sale of curriculum products licensed to
colleges and then sold by the licensing colleges to students on a
student-by-student basis for use with each class.

Measurement of Segment Profit or Loss and Segment Assets

Lightspan evaluates performance and allocates resources based on
profit or loss from operations before income taxes. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies.

Factors Management Used to Identify Lightspans Reportable Segments

Lightspans reportable segments are business units that offer
different products and services. Prior to the end of fiscal year 2001,
and due to the Companys restructuring in July 2000 and as the Company has
focused on selling its software and fee-based subscription Internet
products and services together, Lightspan re-evaluated its reportable
segments and combined the Achieve Now and K-12 Internet segments,
previously reported as separate segments, into the K-12 segment.

Financial Information for Lightspans Segments

The Companys Higher Education segment remains solely comprised of
Academic. The following information is for the K-12 and Higher Education
segments (in thousands):

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|                                  |                                             |   |                             |       |           |   |              |        |   |   |         |        |  
|--------------------------------- | ------------------------------------------- | - | --------------------------- | ----- | --------- | - | ------------ | ------ | - | - | ------- | ------ | -
|                                  |                                             |   | Year Ended January 31, 2002
|                                  |                                             |   |                            
|                                  |                                             |   |                             |       |           |   | Higher       |        |   |   |        
|                                  |                                             |   | K-12                        |       | Education |   | Consolidated
|                                  |                                             |   |                             |       |           |   |             
|Revenues from external customers  |                                             | $ | 47,154                      |       |           | $ | 10,378       |        |   | $ | 57,532  |       
|Interest income (expense), net    |                                             |   | 2,460                       |       |           |   |             |        |   |   | 2,460   |       
|Depreciation and amortization     |                                             |   | 2,857                       |       |           |   | 408          |        |   |   | 3,265   |       
|Restructuring charge              |                                             |   |                            |       |           |   |             |        |   |   |        |       
|Loss from operations              |                                             |   | (46,130                     | )     |           |   | (18,573      | )      |   |   | (64,703 | )     
|Assets                            |                                             |   | 71,679                      |       |           |   | 25,741       |        |   |   | 97,420  |       
|Other significant non cash items: |                                             |   |                             |       |           |   |              |        |   |   |         |       
|                                  | Deferred stock compensation                 |   |                             | (264  | )         |   |              | (25    | ) |   |         | (289   | )
|                                  | Amortization of deferred stock compensation |   |                             | 747   |           |   |              |       |   |   |         | 747    |  
|                                  | Amortization of intangible assets           |   |                             | 6,316 |           |   |              | 11,982 |   |   |         | 18,298 |  

|                                  |                                             |   |                             |        |              |   |              |        |   |   |         |        |  
|--------------------------------- | ------------------------------------------- | - | --------------------------- | ------ | ------------ | - | ------------ | ------ | - | - | ------- | ------ | -
|                                  |                                             |   | Year Ended January 31, 2001
|                                  |                                             |   |                            
|                                  |                                             |   |                             |        |              |   | Higher       |        |   |   |        
|                                  |                                             |   | K-12                        |        | Education    |   | Consolidated
|                                  |                                             |   |                             |        |              |   |             
|Revenues from external customers  |                                             | $ | 91,052                      |        |              | $ | 8,022        |        |   | $ | 99,074  |       
|Interest income (expense), net    |                                             |   | 6,219                       |        |              |   | (4           | )      |   |   | 6,215   |       
|Depreciation and amortization     |                                             |   | 1,486                       |        |              |   | 335          |        |   |   | 1,821   |       
|Restructuring charge              |                                             |   | 1,600                       |        |              |   |             |        |   |   | 1,600   |       
|Loss from operations              |                                             |   | (16,944                     | )      |              |   | (21,391      | )      |   |   | (38,335 | )     
|Assets                            |                                             |   | 116,362                     |        |              |   | 37,536       |        |   |   | 153,898 |       
|Other significant non cash items: |                                             |   |                             |        |              |   |              |        |   |   |         |       
|                                  | Deferred stock compensation                 |   |                             | (1,437 | )            |   |              | (62    | ) |   |         | (1,499 | )
|                                  | Amortization of deferred stock compensation |   |                             | 2,344  |              |   |              | 54     |   |   |         | 2,398  |  
|                                  | Amortization of intangible assets           |   |                             | 4,314  |              |   |              | 11,691 |   |   |         | 16,005 |  
|                                 
|                                  |                                             |   | Year
Ended January 31, 2000
|                                  |                                             |   |                            
|                                  |                                             |   |                             |        |              |   | Higher       |        |   |   |        
|                                  |                                             |   | K-12                        |        | Education(1) |   | Consolidated
|                                  |                                             |   |                             |        |              |   |             
|Revenues from external customers  |                                             | $ | 14,706                      |        |              | $ | 2,210        |        |   | $ | 16,916  |       
|Interest income (expense), net    |                                             |   | 493                         |        |              |   | (14          | )      |   |   | 479     |       
|Depreciation and amortization     |                                             |   | 1,093                       |        |              |   | 100          |        |   |   | 1,193   |       
|Loss from operations              |                                             |   | (49,115                     | )      |              |   | (7,085       | )      |   |   | (56,200 | )     
|Assets                            |                                             |   | 54,534                      |        |              |   | 47,898       |        |   |   | 102,432 |       
|Other significant non cash items: |                                             |   |                             |        |              |   |              |        |   |   |         |        |  
|                                  | Deferred stock compensation                 |   |                             | 8,499  |              |   |              | 224    |   |   |         | 8,723  |  
|                                  | Amortization of deferred stock compensation |   |                             | 3,649  |              |   |              | 55     |   |   |         | 3,704  |  
|                                  | Amortization of intangible assets           |   |                             | 538    |              |   |              | 4,437  |   |   |         | 4,975  |  
|                                  | (1) Partial year                            |   |                             |        |              |   |              |        |   |   |         |        |  

11. Legal Matters

During 2000, a former employee (the Plaintiff) commenced legal
action against Lightspan, alleging causes of action for fraud, breach of
contract, negligent misrepresentation and conversion. In fiscal 2002 the
Plaintiff and Lightspan entered into a settlement agreement and release,
the terms of which are subject to confidentiality provisions.

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12. Unaudited Selected Quarterly Financial Data

The following is a summary of the quarterly results of operations
for the years ended January 31, 2002 and 2001.

|                                                      |                   |          |               |         |   |            |         |            |   |   |         |       |   |   |         |       |  
|----------------------------------------------------- | ----------------- | -------- | ------------- | ------- | - | ---------- | ------- | ---------- | - | - | ------- | ----- | - | - | ------- | ----- | -
|                                                      |                   |          | Quarter Ended
|                                                      |                   |          |              
|2002                                                  |                   | April 30 |               | July 31 |   | October 31 |         | January 31
|                                                      |                   |          |               |         |   |            |         |           
|Total revenues                                        |                   | $        | 10,657        |         |   | $          | 19,467  |            |   | $ | 13,354  |       |   | $ | 14,054  |      
|Total cost of revenues                                |                   |          | 3,938         |         |   |            | 5,571   |            |   |   | 4,297   |       |   |   | 3,923   |      
|Gross margin                                          |                   |          | 6,719         |         |   |            | 13,896  |            |   |   | 9,057   |       |   |   | 10,131  |      
|Total operating expenses                              |                   |          | 25,583        |         |   |            | 28,442  |            |   |   | 26,568  |       |   |   | 23,913  |      
|Net loss attributable to
common stockholders          |                   |          | (17,793       | )       |   |            | (13,844 | )          |   |   | (17,070 | )     |   |   | (13,536 | )    
|Net loss per share:                                   |                   |          |               |         |   |            |         |            |   |   |         |       |   |   |         |      
|                                                      | Basic and diluted |          | $             | (0.39   | ) |            | $       | (0.30      | ) |   | $       | (0.37 | ) |   | $       | (0.29 | )
|                                                     
|2001                                                  |                   |          |               |         |   |            |         |            |   |   |         |       |   |   |         |      
|Total revenues                                        |                   | $        | 56,409        |         |   | $          | 19,124  |            |   | $ | 11,105  |       |   | $ | 12,436  |      
|Total cost of revenues                                |                   |          | 11,641        |         |   |            | 5,416   |            |   |   | 3,518   |       |   |   | 4,711   |      
|Gross margin                                          |                   |          | 44,768        |         |   |            | 13,708  |            |   |   | 7,587   |       |   |   | 7,725   |      
|Total operating expenses                              |                   |          | 28,643        |         |   |            | 30,652  |            |   |   | 25,307  |       |   |   | 27,521  |      
|Net income (loss)
attributable to common
stockholders |                   |          | 1,157         |         |   |            | (15,198 | )          |   |   | (16,151 | )     |   |   | (18,434 | )    
|Net income (loss) per share:                          |                   |          |               |         |   |            |         |            |   |   |         |       |   |   |         |      
|                                                      | Basic and diluted |          | $             | 0.03    |   |            | $       | (0.34      | ) |   | $       | (0.35 | ) |   | $       | (0.40 | )

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