##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

WASHINGTON, D.C. 20549




---

Form 10-K

|  |  |                                                                                             
|- |  | --------------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the fiscal year ended January 31,
    2003                                              
| 
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| 
|  |  | For the transition period
    from           to                                             

Commission File 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(Address of principal executive
    office) |  | 92121-1520(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 þ         No o

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.    o

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

As of July 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 $43.6 million. To
determine this aggregate market value, the registrant has
excluded from the total number of shares outstanding as of July
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, 2003: 47,677,851

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants Proxy Statement
for its 2003 Annual Meeting of Stockholders, are incorporated by
reference into Part III of this Report.



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TABLE OF CONTENTS



|                  |                                                                                                         |  |  |  |  |  |  | 
|----------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|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 and Related Stockholder Matters
|                  | Item 13. Certain Relationships and Related Transactions                                                
|                  | Item 14. Controls and Procedures                                                                       
|PART IV          
|                  | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|SIGNATURES       
|EXHIBIT 23.1     
|EXHIBIT 99.1     
|EXHIBIT 99.2     



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##### Table of Contents



LIGHTSPAN, INC.

2003 ANNUAL REPORT ON FORM 10-K







TABLE OF CONTENTS


|           |           |  |    |                                                                                                    |  |  |    | 
|---------- | --------- |  | -- | -------------------------------------------------------------------------------------------------- |  |  | -- | 
|           |           |  |    | Page                                                                                              
|           |           |  |    |                                                                                                   
|PART I     |           |  |    |                                                                                                   
|           | 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    |           |  |    |                                                                                                   
|           | Item  5.  |  |    | Market for Registrants Common Equity and
    Related Stockholder Matters                          |  |  | 21 | 
|           | Item  6.  |  |    | Selected Financial Data                                                                            |  |  | 22 | 
|           | Item  7.  |  |    | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |  |  | 24 | 
|           | Item  7a  |  |    | Quantitative and Qualitative Disclosures About
    Market Risk                                     |  |  | 34 | 
|           | Item  8.  |  |    | Financial Statements and Supplementary Data                                                        |  |  | 34 | 
|           | Item  9.  |  |    | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure           |  |  | 35 | 
|PART III   |           |  |    |                                                                                                   
|           | Item  10. |  |    | Directors and Executive Officers of the Registrant                                                 |  |  | 35 | 
|           | Item  11. |  |    | Executive Compensation                                                                             |  |  | 35 | 
|           | Item  12. |  |    | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |  |  | 35 | 
|           | Item  13. |  |    | Certain Relationships and Related Transactions                                                     |  |  | 35 | 
|           | Item  14. |  |    | Controls and Procedures                                                                            |  |  | 35 | 
|PART IV    |           |  |    |                                                                                                   
|           | Item  15. |  |    | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                               |  |  | 36 | 
|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.

1



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##### Table of Contents






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 our Quarterly Reports on
Form 10-Q that we will file during our 2004 fiscal
year.

Introduction

Lightspan, Inc. provides curriculum-based
educational software and online 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 1,000 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 these
programs exclusively to schools and school districts for use in
both the classroom and at home. As of January 31, 2003, the
Lightspan Achieve Now curriculum has already been purchased by
over 1,500 school districts in 47 states and implemented in
approximately 4,400 schools and approximately 21,000 classrooms,
representing a total of approximately 250,000 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,
2003, these products are in use in over 350 colleges and
universities across the United States. Also as of
January 31, 2003, we had approximately 4,200 subscriptions
to our online products for students in pre-kindergarten through
grade twelve, or K-12.

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 online 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 online and broadband technologies;
|
| |  | continue to promote and enhance our fee-based
    subscription online 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.

More than 1,000 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

2



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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 is the #1 technology
program receiving federal Comprehensive School Reform
(CSR) funds and second overall. The CSR program was
established to help schools implement proven whole school reform
programs known to increase student achievement.


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 were
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 comprehension, critical

3



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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
81 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 Online

Our online subscription 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 online 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.



| |                      
| | ---------------------
| | 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.

4



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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 online subscription
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, science and social studies.

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.

5



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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 60,000
    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 online-based instructional tools,
    content and services providing students with engaging,
    interactive learning activities that can be accessed anytime and
    anywhere; and                                                                                                                                                                                                                                                                                                                                                    
|
| |  | 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

6



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| |  |                                                                                                            
| |  | -----------------------------------------------------------------------------------------------------------
| |  | 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, Puerto Rico and the U.S. Virgin Islands.

Product Design and Development

We consider successful product development to be
essential to maintaining and growing our market position and
have incurred $13.5 million, $24.4 million and
$25.8 million in related technology and development
expenses for the years ended January 31, 2003, 2002 and
2001, respectively. We expect to continue enhancing our
Lightspan Achieve Now and higher education curricula and our
fee-based online subscription 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
|
| |  | 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

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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, 2003, we employed
81 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 77 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;                                                                                                                                              
|
| |  | 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 81 person sales force includes an inside
sales organization of 19 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 online subscription products and performing online
product demonstrations.

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In addition to our 81 sales professionals
that focus on selling our Achieve Now curriculum and fee-based
online subscription products, at January 31, 2003, Academic
employed 25 sales professionals which include direct
salespeople and sales mangers. As of that date, this sales force
was supported by a 4-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. Approximately 80% 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 online subscription
products include on-site professional development. Certain
online subscription products also include professional
development delivered electronically, which is comprised of
archived lessons as well as real-time interactive sessions. 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 online subscription products to align curriculum, design
lessons and analyze student progress. These professional
development resources help schools implement Lightspan Achieve
Now and our online 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.

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, 2003, we maintained a
staff of 81 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 online
subscription products. Schools may purchase additional
professional development or support services. We believe that
the on-site training provided by our professional develop-

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ment 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 products acquired through
our acquisition of eduTest, Inc. and 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 online subscription 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.

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 online 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

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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,
2003, no one customer accounted for more than 10% of total
revenues for Lightspan.

Employees

As of January 31, 2003, we employed 386
persons, including 120 in technology and development, 50 in
general and administrative, 135 in sales and marketing and 81 in
professional development. On January 30, 2003, we announced
an overall reduction of approximately 16% of our employees
lowering our headcount to 324 persons at the beginning of
the first quarter of fiscal year 2004. 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.

We have adopted a code of ethics that applies to
all employees, including our principal executive officer,
principal financial officer, principal accounting officer or
controller, or persons performing similar functions. Our code of
ethics is available for review on our website at
www.lightspan.com in connection with our Investor
Relations materials. In addition, we intend to promptly
disclose (1) the nature of any amendment to our code of
ethics that applies to our principal executive officer,
principal financial officer, principal accounting officer or
controller, or persons performing similar functions and
(2) the nature of any waiver, including an implicit waiver
from a provision of our code of ethics that is granted to one of
these specified officers, the name of such person who is granted
the waiver and the date of the waiver on our website in the
future,

Our website address is www.lightspan.com. Our
filings with the SEC, including our Annual Report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to these reports are
available free of charge through our Internet website as soon as
reasonably practicable after being filed with or furnished to
the SEC.

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 online
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 online subscription 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 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-eight quarters ended January 31, 2003. In
addition, in fiscal year 1997 and 1998 we recognized license
revenue for

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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,
2004 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. 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 online subscription 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 online subscription 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, 2003 we have accumulated net
losses of $308.0 million. We incurred net losses of
$36.1 million for the fiscal year ended January 31,
2003; net losses of $62.2 million for the fiscal year ended
January 31, 2002; and $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. 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 online subscription 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 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. In May 2002, we engaged U.S.
Bancorp Piper Jaffray to evaluate those inquiries and strategic
alternatives for our business and to assist management and the
Board of Directors in maximizing shareholder value.

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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 type 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 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.

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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 online subscription
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 online subscription business. Our ability to
increase revenues from our fee-based online subscription
business depends on:



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

The future success of our fee-based online
subscription business is highly dependent on an increase in the
number of 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 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.

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If we are unable to substantially increase our
revenues from our online subscription 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 online
subscription 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 online subscription products and services as
planned. Enhancements and improvements to our fee-based online
subscription 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 online subscription 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 online subscription 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 online subscription products and their related
technology on a timely and cost-effective basis. If our
enhancements, improvements and adaptations of our fee-based
online subscription 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.

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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 online 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. 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 may continue to evaluate
other operating environments and computer platforms for our
software products as they become available.

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 lower 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 online
subscription businesses if the market for those businesses does
not develop.

The success of our fee-based online subscription
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

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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 online subscription
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 and Academic brands is critical to
attracting purchasers for our curriculum-based educational
software and subscribers and users of our fee-based online
subscription 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 and Academic
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 online subscription 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 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, online services, and management
departments. The loss of the services of any of our

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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. 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 make
potential acquisitions of assets or businesses. Moreover, as of
March 20, 2003, 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 180 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 53.4% of our common
stock.

As of March 31, 2003, executive officers,
directors and holders of 5% or more of our outstanding common
stock, in the aggregate, owned or controlled approximately 53.4%
of our outstanding common stock. These

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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, 2003:

|                    |  |     |    |          |  |                                                                            
|------------------- |  | --- | -- | -------- |  | ---------------------------------------------------------------------------
|Name                |  | Age |    | Position
|                    |  |     |    |         
|Executive Officers  |  |     |    |          |  |                                                                            
|John T. Kernan      |  |     | 57 |          |  | Chairman of the Board and Chief Executive Officer                          
|Carl E. Zeiger      |  |     | 60 |          |  | President, Chief Operating Officer and Director                            
|Michael A. Sicuro   |  |     | 44 |          |  | Senior Vice President, Chief Financial Officer,
    Treasurer and Secretary
|Sandra K. Fivecoat  |  |     | 54 |          |  | Senior Vice President of Sales                                             
|James M. Dredge     |  |     | 53 |          |  | Chief Executive Officer of Academic Systems                                
|Bernice Stafford    |  |     | 61 |          |  | Senior Vice President of School Marketing and
    Evaluation               
|Dr. Larry R. Vaughn |  |     | 64 |          |  | Senior Vice President of Professional Development                          

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,

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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 January 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 January 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
with Deloitte and Touche LLP and is a Certified Public
Accountant in California and Oregon. 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 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

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Corporation. Ms. Stafford is a former
teacher and early childhood administrator who has been involved
with marketing instructional technology to schools since 1984.
In addition to serving on the boards of Technology, Reading, and
Learning Disabilities, Agency for Instructional Technology, and
the National Educational Knowledge Industry Association, to
which she was recently appointed chair, she is also a member of
Californias Committee on Public Schools Accountability.
Ms. Stafford holds a Bachelor of Arts and Masters 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 sublease approximately
9,700 square feet. Warehouse facilities are located in Carlsbad,
California, where we currently lease on a month-to-month basis
approximately 12,000 square feet. Additional facilities are
located in Mountain View, California, where approximately 9,900
square feet are under a lease for Academic expiring in 2004.
This space was subleased for a portion of the year ended
January 31, 2003. In addition, we lease for Academic
approximately 4,500 square feet in Redwood City, California on a
month-to-month basis which expires in June 2004. We currently
maintain a facility that we have subleased in Richmond,
Virginia, for approximately 3,000 square feet under a lease
expiring in 2003. In Denver, Colorado, 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.




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.




PART II






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

The information required to be disclosed by
Item 201(d) of Regulation S-K Securities
Authorized for Issuance Under Equity Compensation
Plans is included under Item 12 of Part III
of this Annual Report on Form 10-K.

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

21



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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, 2003: |                |                    |   |      |  |  |   |     
|                                    | First Quarter  |                    | $ | 1.30 |  |  | $ | 0.86 | 
|                                    | Second Quarter |                    |   | 1.96 |  |  |   | 0.93 | 
|                                    | Third Quarter  |                    |   | 1.69 |  |  |   | 1.15 | 
|                                    | Fourth Quarter |                    |   | 1.30 |  |  |   | 1.00 | 

|                                    |                |      |   |      |  |  |   |      | 
|----------------------------------- | -------------- | ---- | - | ---- |  |  | - | ---- | 
|                                    |                | 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 | 

The closing sales price of our common stock on
March 31, 2003 was $0.65.

Holders

As of March 31, 2003, there were
approximately 374 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.

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 $88.8 million. From the time
of receipt through January 31, 2003, $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

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January 31, 2003, 2002, 2001, 2000 and 1999
and balance sheet data as of January 31, 2003, 2002, 2001,
2000 and 1999 are derived from our audited financial statements,
which are included elsewhere in this Form 10-K for the
years ended January 31, 2003, 2002 and 2001 and as of
January 31, 2003 and 2002. The following financial
information is in thousands, except per share data.


|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                          |  |                        
|                                                          |  | Years Ended January 31,
|                                                          |  |                        
|                                                          |  | 2003                    |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                          |  |                         |         |      |  |      |         |      |  |     
|Consolidated Statements of Operations
    Data:           |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Total revenues                                            |  | $                       | 50,008  |      |  | $    | 57,532  |      |  | $    | 99,074  |   |  | $ | 16,916  |   |  | $ | 10,870  |  
|Total cost of revenues                                    |  |                         | 14,494  |      |  |      | 17,729  |      |  |      | 25,286  |   |  |   | 9,734   |   |  |   | 7,660   |  
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Gross profit                                              |  |                         | 35,514  |      |  |      | 39,803  |      |  |      | 73,788  |   |  |   | 7,182   |   |  |   | 3,210   |  
|Total operating expenses                                  |  |                         | 69,029  |      |  |      | 104,506 |      |  |      | 112,123 |   |  |   | 63,382  |   |  |   | 37,194  |  
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Loss from operations                                      |  |                         | (33,515 | )    |  |      | (64,703 | )    |  |      | (38,335 | ) |  |   | (56,200 | ) |  |   | (33,984 | )
|Interest income (expense), net                            |  |                         | 374     |      |  |      | 2,460   |      |  |      | 6,215   |   |  |   | 479     |   |  |   | 417     |  
|Cumulative effect of a change in accounting
    principle |  |                         | (3,000  | )    |  |      |        |      |  |      |        |   |  |   |        |   |  |   |        |  
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net loss                                                  |  |                         | (36,141 | )    |  |      | (62,243 | )    |  |      | (32,120 | ) |  |   | (55,721 | ) |  |   | (33,567 | )
|Preferred stock dividend                                  |  |                         |        |      |  |      |        |      |  |      | (16,506 | ) |  |   |        |   |  |   |        |  
|Net loss attributable to common stockholders              |  | $                       | (36,141 | )    |  | $    | (62,243 | )    |  | $    | (48,626 | ) |  | $ | (55,721 | ) |  | $ | (33,567 | )
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net loss per share(1)  basic and
    diluted             |  | $                       | (0.76   | )    |  | $    | (1.34   | )    |  | $    | (1.10   | ) |  | $ | (13.61  | ) |  | $ | (9.91   | )
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Weighted average shares  basic and
    diluted           |  |                         | 47,271  |      |  |      | 46,373  |      |  |      | 44,019  |   |  |   | 4,094   |   |  |   | 3,388   |  
|                                                          |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  

|                                                |  |                |        |      |  |      |        |      |  |      |         |  |  |   |         |   |  |   |         |  
|----------------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- |  |  | - | ------- | - |  | - | ------- | -
|                                                |  |               
|                                                |  | At January 31,
|                                                |  |               
|                                                |  | 2003           |        | 2002 |  | 2001 |        | 2000 |  | 1999
|                                                |  |                |        |      |  |      |        |      |  |     
|Consolidated Balance Sheets Data:               |  |                |        |      |  |      |        |      |  |      |         |  |  |   |         |   |  |   |         |  
|Cash and cash equivalents                       |  | $              | 18,497 |      |  | $    | 35,033 |      |  | $    | 45,566  |  |  | $ | 5,033   |   |  | $ | 7,143   |  
|Short-term investments                          |  |                | 5,055  |      |  |      | 8,333  |      |  |      | 32,683  |  |  |   | 16,132  |   |  |   |        |  
|Restricted cash                                 |  |                | 827    |      |  |      | 1,653  |      |  |      | 4,768   |  |  |   |        |   |  |   |        |  
|Deferred cost of revenues  Achieve Now         |  |                |       |      |  |      |       |      |  |      |        |  |  |   | 8,709   |   |  |   | 3,555   |  
|Working capital (deficit)                       |  |                | 10,662 |      |  |      | 31,978 |      |  |      | 69,783  |  |  |   | (25,994 | ) |  |   | (12,233 | )
|Total assets                                    |  |                | 59,546 |      |  |      | 97,420 |      |  |      | 153,898 |  |  |   | 102,432 |   |  |   | 22,566  |  
|Deferred revenues  Achieve Now                 |  |                |       |      |  |      |       |      |  |      |        |  |  |   | 48,110  |   |  |   | 20,717  |  
|Deferred revenues, current and long-term        |  |                | 12,324 |      |  |      | 11,964 |      |  |      | 9,362   |  |  |   | 7,022   |   |  |   | 3,444   |  
|Capital lease obligations, less current portion |  |                |       |      |  |      | 39     |      |  |      | 268     |  |  |   | 443     |   |  |   | 394     |  
|Total stockholders equity (deficit)            |  |                | 32,979 |      |  |      | 68,295 |      |  |      | 126,315 |  |  |   | 26,694  |   |  |   | (11,249 | )



---



|    |                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------
|(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 online
subscription 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 online
subscription 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 primarily by a direct field sales force, an 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, goodwill valuation,
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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Online Subscriptions.Revenue derived from fee-based online
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
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, 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). 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.

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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  | 
|                                                  |                              |                         |   |         |   |  |   |       



| |                      
| | ---------------------
| | Valuation of Goodwill

On February 1, 2002, we adopted Statement of
Financial Accounting Standards No. 142, or SFAS
No. 142, Goodwill and Other Intangible Assets
which required us to cease amortizing goodwill, and instead
perform a transitional review for impairment as of
February 1, 2002 and an annual review for impairment during
the fourth quarter of fiscal 2003. Goodwill is considered to be
potentially impaired if we determine the carrying value of the
reporting unit exceeds its fair value. During the second quarter
of fiscal 2003, we performed the transitional test by completing
the first step of this review and determined that there was a
potential impairment of goodwill relating to our higher
education division, Academic Systems. As a result, as required
by SFAS 142, we performed a second step utilizing an
independent appraisal firm combined with internal analyses and
other market and company information to measure the amount of
the potential impairment. As a part of this second step,
SFAS 142 requires the fair value of the reporting unit be
allocated to its assets and liabilities in the same manner used
in accounting for business combinations. These analyses were
judgmental in nature and included a significant amount of
estimates and assumptions in forecasting revenues, expenses,
growth rates and other relevant information in a discounted cash
flow model with discount rates reflecting the appropriate
inherent risk.

This transitional impairment review from the
second step of SFAS 142 resulted in a noncash charge of
$3.0 million to reduce the carrying value of the goodwill
associated with our higher education division, Academic Systems.
This charge is reflected as the cumulative effect of a change in
accounting principle in the first quarter of fiscal 2003 as
required by SFAS 142. Also in connection with the adoption
of SFAS 142 we reclassified $1.2 million and
$0.5 million of assembled workforce intangibles and related
accumulated amortization respectively as required by the
pronouncement.

During the fourth quarter of fiscal 2003, we also
performed our annual review for impairment as of
January 31, 2003 using many of the factors discussed below
and determined no impairment existed.

In addition to the annual review, an interim
review is required if an event occurs or circumstances change
that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. Examples of such
events or circumstances include:



| |   |                                                                                     
| | - | ------------------------------------------------------------------------------------
| |  | a significant adverse change in legal factors or
    in the business climate;       
|
| |  | a decline in our stock price or the stock price
    of comparable companies;        
|
| |  | a significant decline in our projected revenue or
    earnings growth or cash flows;
|
| |  | an adverse action or assessment by a regulator;                                     

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| |   |                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | unanticipated competition or the loss of key
    personnel                                                                                          
|
| |  | a more-likely-than-not expectation that a
    reporting unit or a significant portion of a reporting unit will
    be sold or otherwise disposed of;
|
| |  | the testing of recoverability under Statement 144
    of a significant asset group within a reporting unit; and                                     

We cannot assure you that when we complete our
annual or other periodic reviews for impairment of goodwill that
a material impairment charge will not be recorded. Goodwill
totaled $11.7 million at January 31, 2003.



| |                                   
| | ----------------------------------
| | Valuation of Intangible
    Assets

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. We periodically assess the impairment of intangible
assets which requires us to make assumptions and judgments
regarding the carrying value of these 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. At January 31, 2003, the net book value of
intangible assets that are subject to amortization totaled
$6.8 million.



| |                                    
| | -----------------------------------
| | 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. As of January 31, 2003, we have not incurred a
material write-off of accounts receivable since our inception.

Results of Operations

Operating Losses.We
have incurred significant losses since our inception and, as of
January 31, 2003, have accumulated losses of approximately
$308.0 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 online subscription 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 2003 vs.
    2002



| |         
| | --------
| | Revenues

The types of revenue we generate are fees from
the sale of software licenses, online subscriptions,
professional services and hardware. Our total revenues decreased
13 percent to $50.0 million in fiscal 2003 from
$57.5 million in fiscal 2002 due to a decrease in software
license and hardware revenues of $10.6 million, which was
partially offset by an increase of $2.6 million in our fee-based
online subscription products.

Software Licenses.Our software license revenues decreased to $26.6 million in
fiscal 2003 from $34.3 million in fiscal 2002. This
decrease was primarily due to a decrease in the number of
Lightspan Achieve Now licenses sold in fiscal 2003 of
approximately 30,000 as compared to approximately 42,000 sold in
fiscal 2002.

Online
Subscriptions.Our online subscription
revenues increased to $10.5 million in fiscal 2003 from
$7.9 million in fiscal 2002 primarily due to a modest price
increase and an increase in the subscriber base. The base of
customers subscribing to The Lightspan Network product increased
to approximately 2,400 at fiscal end 2003 from approximately
2,300 at fiscal end 2002. In addition, the base of customers
subscribing to the Lightspan Edutest Assessment product
increased to approximately 1,700 at fiscal end 2003 from
approximately 1,100 at fiscal end 2002.

Professional
Services.Our professional service
revenues increased to $9.9 million in fiscal 2003 from
$9.3 million in fiscal 2002 primarily due to the volume
increase in subscriber base for our online subscription products
and the related professional services sold with those products.

Hardware and Other.Our hardware and other revenues decreased to $3.0 million
in fiscal 2003 from $5.9 million in fiscal 2002 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. In addition, Sony
reduced the price of the PlayStation game console in the second
quarter to $49 from $99 resulting in an approximate
$1.8 million reduction in hardware revenue.



| |                 
| | ----------------
| | Cost of Revenues

Our total cost of revenues decreased to
$14.5 million for fiscal 2003 from $17.7 million for
fiscal 2002 primarily due to the decrease in software license
revenue and hardware revenue and their corresponding costs and a
decrease in the allocable costs to professional services and the
PlayStation price reduction.



| |         
| | --------
| | Expenses

Sales and Marketing.Our sales and marketing expenses decreased to $36.3 million
for fiscal 2003 from $49.4 million for fiscal 2002. This
was primarily due to a decrease in personnel and related
expenses, and a decrease in commissions related to lower sales.

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 online
subscription products, Lightspan Achieve Now curriculum and
Academic products.

Technology and
Development.Our technology and
development expenses decreased to $13.5 million for fiscal
2003 from $24.4 million for fiscal 2002. This was primarily
due to a decrease in personnel and related costs and consulting
fees related to projects that were completed.

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 online subscription products and
Academic online products, which we expensed as incurred.

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General and
Administrative.Our general and
administrative expenses decreased to $11.0 million for
fiscal 2003 from $11.7 million for fiscal 2002. This was
due primarily to decreases in personnel 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 $0.2 million and
$0.7 million for fiscal years 2003 and 2002, respectively.
Since the Companys IPO, all stock options granted have
been at fair market value and as a result no compensation
expense has been recorded. 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, 2003, there was approximately
$0.03 million to be amortized in future periods.

Amortization of Intangible
Assets.Effective February 1,
2002, we adopted SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and
Other Intangible Assets, which eliminated the amortization
of goodwill. The adoption of these statements also resulted in
the reclassification of the net book value assigned to the
assembled workforce intangible at January 31, 2002, which
totaled $0.5 million, to goodwill. Our amortization of
goodwill and intangible assets totaled $18.3 million for
fiscal year 2002 which included $10.3 million of goodwill
amortization.

We performed a transitional review for impairment
of our goodwill as of February 1, 2002 in accordance with
SFAS No. 142, which resulted in the recording of a non-cash
charge of $3.0 million to reduce the carrying value of the
goodwill associated with our Higher Education segment. In
calculating the impairment charge, the fair value of the
impaired reporting unit was estimated using an independent
appraisal firm combined with a discounted cash flow methodology
as well as other corporate and market information. This charge
is reflected as the cumulative effect of a change in accounting
principle in the accompanying consolidated statements of
operations. We also completed our annual evaluation for
impairment of goodwill on January 31, 2003, and determined
that no impairment existed.

Amortization expense for other purchased
intangible assets was $8.0 million for the year ended
January 31, 2003 and $8.0 million for 2002.

Interest Income
(Expense).Our net interest income
decreased to $0.4 million for fiscal 2003 from
$2.5 million for fiscal 2002 as a result of lower cash
balances and a reduction in the market yield on such investments.



| |                                       
| | --------------------------------------
| | Comparison of Fiscal 2002 vs.
    2001



| |         
| | --------
| | Revenues

The types of revenue we generate are fees from
the sale of software licenses, online subscriptions,
professional services and hardware. Our total revenues decreased
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 online subscription
products.

Software Licenses.Our software license revenues decreased 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 higher than software license revenues of
$31.4 million adjusted to remove such previously deferred
revenue. This increase was primarily due to a price increase in
our Lightspan Achieve Now product, which

29



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##### Table of Contents



offset a 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.


Online
Subscriptions.Our online subscription
revenues increased to $7.9 million in fiscal 2002 from
$4.6 million in fiscal 2001 primarily due to a combination
of a 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 online subscription products
increased to approximately 3,400 at fiscal end 2002 from
approximately 2,800 at fiscal end 2001.

Professional
Services.Our professional service
revenues increased 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 online subscription products, which reflect
increases over the prior fiscal year.

Hardware and Other.Our hardware and other revenues increased 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
an 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 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 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.



| |         
| | --------
| | Expenses

Sales and Marketing.Our sales and marketing expenses decreased 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 online subscription 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 online
subscription products, Lightspan Achieve Now curriculum and
Academic products.

Technology and
Development.Our technology and
development expenses decreased 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 online 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 online subscription products and
Academic Internet products, which we expensed as incurred.

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General and
Administrative.Our general and
administrative expenses increased 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.

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.

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, 2003, 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.

31



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##### Table of Contents



Legal Matters

We are not currently involved in any material
legal proceedings.

Income Taxes

At January 31, 2003, Lightspan had federal
and California net operating loss carryforwards of approximately
$274.0 million and $43.3 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 utilized. Through January 31,
2003, California tax loss carryforwards of $26.5 million
have expired, and additional loss carryforwards will continue to
expire in fiscal 2004. 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%
during any given three-year period.

Lightspans net operating loss carryforwards
as of January 31, 2003, will expire as follows (in
millions):

|          |        |         |       |       |  |   |      |      | 
|--------- | ------ | ------- | ----- | ----- |  | - | ---- | ---- | 
|          |        | Federal |       | State
|          |        |         |       |      
|2004      |        |         |      |       |  | $ | 3.3  |     
|2005      |        |         |      |       |  |   | 6.0  |     
|2006      |        |         |      |       |  |   |     |     
|2007      |        | $       | 0.1   |       |  |   |     |     
|2008      |        |         | 0.9   |       |  |   |     |     
|Remaining |        | $       | 273.0 |       |  | $ | 34.0 |     
|          |        |         |       |       |  |   |      |     
|          | Totals |         | $     | 274.0 |  |   | $    | 43.3 | 
|          |        |         |       |       |  |   |      |     

Contractual Obligations

The following summarizes our contractual
obligations at January 31, 2003, 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
|                 |  |       |       |                        |  |            
|Operating leases |  | $     | 2,014 |                        |  | $           | 1,601 |  |  | $ | 413 | 
|                 |  |       |       |                        |  |             |       |  |  |   |     | 

Common Shares Outstanding and Reserved for
Future Issuance

The following table summarizes common shares
outstanding and reserved for future issuance at January 31,
2003 (in thousands):

|                                                                     |  |  |       | 
|-------------------------------------------------------------------- |  |  | ----- | 
|Common stock options outstanding, unexercised                        |  |  | 6,000 | 
|Common stock options reserved for future issuance                    |  |  | 1,209 | 
|Employee stock purchase plan shares reserved for
    future issuance |  |  | 239   | 

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.

32



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Upon completion of our initial public offering,
and after the effect of 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, 2003, warrants to purchase 21,108 shares
of common stock remained outstanding and expire on various dates
through 2004.

Liquidity and Capital Resources

From inception through January 31, 2003, 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 on a consistent basis.
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, 2003, we had
$18.5 million of unrestricted cash and cash equivalents,
$5.1 million in short-term investments and
$0.8 million in restricted cash for a total of
$24.4 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
$19.9 million, $31.7 million and $49.7 million
for fiscal 2003, 2002 and 2001, 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 online subscription
products and services.

Net cash provided by investing activities was
$3.0 million for fiscal 2003 relating primarily to the
maturities, offset by purchases, of short-term investments
purchased with proceeds from our initial public offering and
$0.3 million used in the purchase of property and
equipment. Net cash provided by investing activities was
$20.8 million for fiscal 2002 relating primarily to the
purchases, offset by maturities, of short-term investments,
$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 acquisition of
eduTest and LearningPlanet.com.

Net cash provided by financing activities was
$0.4 million for fiscal 2003 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 $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.

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 online subscription
product offerings and content. In addition, we may devote
substantial capital resources to strategic acquisitions and
relationships.

33



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##### Table of Contents



As of January 31, 2003, we had working
capital of $10.7 million and an accumulated deficit of
$324.5 million. The accompanying financial statements have
been prepared assuming that Lightspan will continue as a going
concern. This basis of accounting contemplates the recovery of
the Companys assets and the satisfaction of its
liabilities in the normal course of conducting business. Based
on a revenue and expense forecast, we believe our existing
capital resources will enable us to fund operations through
January 31, 2004. If revenue targets are not achieved as
contemplated by the forecast, we may determine that it is
necessary to delay, reduce the scope of or eliminate one or more
of our sales and marketing programs and reduce our expenditures
on infrastructure and headcount. If necessary, we believe we
have the ability to defer or eliminate certain sales, general
and administrative expenses to enable us to sustain our
operations through January 2004. 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 April 2002, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 145, Recission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections, which is effective
for the company beginning February 1, 2003. The Company
believes the adoption of SFAS No. 145 will not have a
material effect on the Companys consolidated financial
position or results of operations.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 requires that costs
associated with exit or disposal activities be recorded at their
fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon managements
commitment to an exit plan, which is generally before an actual
liability has been incurred. This Statement is effective for
exit or disposal activities that are initiated after
December 31, 2002 and will impact the timing of exit or
disposal costs reported by us after adoption.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. SFAS
No. 148 amends SFAS No. 123 by providing alternative
methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 expands the pro
forma disclosures of the effect of a companys accounting
for stock-based employee compensation required by SFAS
No. 123 and adds comparable disclosures to those required
by APB Opinion No. 28, Interim Financial
Reporting. SFAS No. 148 is effective for financial
statements of the Company beginning December 15, 2002.






|         |                                                               
|-------- | --------------------------------------------------------------
|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, 2003 or 2002. 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, 2003 and 2002 and the Report of
Ernst & Young LLP, Independent Auditors, are included
in this report on Form 10-K on pages 45 through 69.

34



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##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|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.




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 2003 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 and Related Stockholder
    Matters

The information under the caption Security
Ownership of Certain Beneficial Owners and Management in
the Proxy Statement is incorporated herein by this reference.
The remaining information called for by this item relating to
Securities Authorized for Issuance under Equity
Compensation Plans is incorporated herein by reference to
the Proxy Statement,






|         |                                                   
|-------- | --------------------------------------------------
|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.






|         |                        
|-------- | -----------------------
|Item 14. | Controls and Procedures

(a) Under the supervision and with the
participation of our management, including our principal
executive officer and principal financial officer, we conducted
an evaluation of the effectiveness of design and operation of
our disclosure controls and procedures, as such term is defined
under Rule 13a-14(c) promulgated under the Securities
Exchange Act of 1934, as amended, within the 90 days prior
to the filing date of this report. Based on their evaluation,
our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are
effective as of the evaluation date.

(b) There were no significant changes in our
internal disclosure controls or in other factors that could
significantly affect these controls after the date of our most
recent evaluation.

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##### Table of Contents






PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | 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                                                                                                                                                                             |  |      | 45 | 
|    |  | Consolidated Balance Sheets as of
    January 31, 2003 and 2002                                                                                                                                                                   |  |      | 46 | 
|    |  | Consolidated Statements of Operations for the
    years ended January 31, 2003, 2002 and 2001                                                                                                                                     |  |      | 47 | 
|    |  | Consolidated Statements of Stockholders
    Equity (Deficit) for the years ended January 31, 2003, 2002
    and 2001                                                                                                             |  |      | 48 | 
|    |  | Consolidated Statements of Cash Flows for the
    years ended January 31, 2003, 2002 and 2001                                                                                                                                     |  |      | 49 | 
|    |  | Notes to Consolidated Financial Statements                                                                                                                                                                                        |  |      | 50 | 
|(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 exhibits listed under Item 15(c) hereof
    are filed with or incorporated by reference into this report.
    Each management contract or compensatory plan or arrangement is
    identified separately in Item 15(c) herein. |  |      |    | 

(b) Current Reports on Form 8-K

On February 27, 2003, we filed a report on
Form 8-K announcing that on February 26, 2003, we issued a
press release regarding our financial results for the three and
twelve months ended January 31, 2003.

(c) Exhibits

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.                                                                                                                                                                      
|         | (7)     |         |  |             | 4.3  |  |  | Rights Agreement dated as of February 14,
    2002 among Lightspan, Inc. and Computershare Investor Services,
    LLC.                                                                           
|         | (7)     |         |  |             | 4.4  |  |  | Form of Rights 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.                                                        

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|         |         |         |  |             |       |  |  |                                                                                                                                                                                           
|-------- | ------- | ------- |  | ----------- | ----- |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Footnote |         | Exhibit |  |            
|Number   |         | Number  |  | Description
|         |         |         |  |            
|         | (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.                                                           
|         | (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.                                                                                                                                 

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|         |      |         |  |             |       |  |  |                                                                                                                                                                                     
|-------- | ---- | ------- |  | ----------- | ----- |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Footnote |      | Exhibit |  |            
|Number   |      | Number  |  | Description
|         |      |         |  |            
|         | (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.                                                                            
|         | (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.                                                                                                                                                     
|         | (8)  |         |  |             | 23.1  |  |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                                                                                             
|         | (8)  |         |  |             | 24.1  |  |  | Power of Attorney. See page 40.                                                                                                                                                     
|         | (8)  |         |  |             | 99.1  |  |  | Certification by the Chief Executive Officer of
    the Company pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002.                                                      
|         | (8)  |         |  |             | 99.2  |  |  | Certification by the Chief Financial Officer of
    the Company pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002.                                                      



---



| |   |                                                                     
| | - | --------------------------------------------------------------------
| |  | 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.         

38



---



##### Table of Contents





|    |                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------
|(6) | Filed as an 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 as an exhibit to the Companys Current
    Report on Form 8-K dated February 14, 2002, and
    incorporated herein by reference.            
|   
|(8) | Filed with this report.                                                                                                                           

39



---



##### Table of Contents






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,
2003.



| |                
| | ---------------
| | LIGHTSPAN, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ CARL E. ZEIGER

| |                                                    
| | ---------------------------------------------------
| |                                                    
| | Carl E. Zeiger,                                    
| | President, Chief Operating Officer and
    Director

April 29, 2003

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. KERNANJohn T. Kernan                 |  | Chief Executive Officer and Chairman(Principal Executive Officer)   |  | April 29, 2003
|                                                
|/s/ CARL E. ZEIGERCarl E. Zeiger                 |  | President, Chief Operating Officer,
    and Director                |  | April 29, 2003
|                                                
|/s/ MICHAEL A. SICUROMichael A. Sicuro           |  | Chief Financial Officer(Principal Financial and Accounting Officer) |  | April 29, 2003
|                                                
|/s/ JEFFREY W. BROWNJeffrey W. Brown             |  | Director                                                            |  | April 29, 2003
|                                                
|/s/ ELIZABETH R. COPPINGERElizabeth R. Coppinger |  | Director                                                            |  | April 29, 2003
|                                                
|/s/ DOUGLAS M. HOLTBYDouglas M. Holtby           |  | Director                                                            |  | April 29, 2003

40



---



##### Table of Contents



|                                         |  |          |  |                |  | 
|---------------------------------------- |  | -------- |  | -------------- |  | 
|                                         |  |          |  |               
|Signature                                |  | Title    |  | Date          
|                                         |  |          |  |               
|                                        
|/s/ HUGH M. TIETJENHugh M. Tietjen       |  | Director |  | April 29, 2003
|                                        
|/s/ BARRY J. SCHIFFMANBarry J. Schiffman |  | Director |  | April 29, 2003

41



---



##### Table of Contents



CERTIFICATIONS

I, John T. Kernan, Chairman of the Board and
Chief Executive Officer of Lightspan, Inc., certify that:

1. I have reviewed this Annual Report on
Form 10-K of Lightspan, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |     |                   
| | --- | ------------------
| | By: | /s/ JOHN T. KERNAN

| |                          
| | -------------------------
| |                          
| | John T. Kernan           
| | Chairman of the Board and
| | Chief Executive Officer  

Date: April 29, 2003

42



---



##### Table of Contents



I, Michael A. Sicuro, Senior Vice President,
Chief Financial Officer, Treasurer and Secretary of Lightspan,
Inc., certify that:

1. I have reviewed this Annual Report on
Form 10-K of Lightspan, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |     |                      
| | --- | ---------------------
| | By: | /s/ MICHAEL A. SICURO

| |                                                                            
| | ---------------------------------------------------------------------------
| |                                                                            
| | Michael A. Sicuro                                                          
| | Senior Vice President, Chief Financial
    Officer, Treasurer and Secretary

Date: April 29, 2003

43



---



##### Table of Contents



INDEX TO FINANCIAL STATEMENTS

|                                                                                                        |  |      |    | 
|------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                        |  | Page
|                                                                                                        |  |     
|Report of Ernst & Young LLP, Independent
    Auditors                                                   |  |      | 45 | 
|Consolidated Balance Sheets as of
    January 31, 2003 and 2002.                                        |  |      | 46 | 
|Consolidated Statements of Operations for the
    years ended January 31, 2003, 2002 and 2001.          |  |      | 47 | 
|Consolidated Statements of Stockholders
    Equity for the years ended January 31, 2003, 2002 and 2001 |  |      | 48 | 
|Consolidated Statements of Cash Flows for the
    years ended January 31, 2003, 2002 and 2001.          |  |      | 49 | 
|Notes to Consolidated Financial Statements                                                              |  |      | 50 | 

44



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##### Table of Contents



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, 2003
and 2002, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended January 31, 2003. 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, 2003 and 2002
and the results of its operations and its cash flows for each of
the three years in the period ended January 31, 2003, in
conformity with accounting principles generally accepted in the
United States.

As discussed in Note 2 to the consolidated
financial statements, Lightspan, Inc. changed its method of
accounting for purchased goodwill and other intangible assets in
accordance with Statement of Financial Accounting Standards
No. 142 during fiscal 2003.



| |                  
| | -----------------
| | ERNST & YOUNG LLP

San Diego, California


February 20, 2003


45



---



##### Table of Contents



LIGHTSPAN, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share
data)


|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |          |    |        | 
|---------------------------------------------------------------------------------------------- | ---------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------------ | -------- | -- | ------ | ------ | -------- | -- | ------ | 
|                                                                                               |                                                |                                                                    
|                                                                                               |                                                | January 31,                                                        
|                                                                                               |                                                |                                                                    
|                                                                                               |                                                | 2003                                                                |                                            | 2002    
|                                                                                               |                                                |                                                                     |                                            |         
|ASSETS                                                                                        
|Current assets:                                                                                |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               | Cash and cash equivalents                      |                                                                     | $                                          | 18,497   |    |        | $      | 35,033   |   
|                                                                                               | Short-term investments available for sale      |                                                                     |                                            | 5,055    |    |        |        | 8,333    |   
|Accounts receivable, less allowance for doubtful
    accounts of $1,652 and $930, respectively |                                                |                                                                     | 9,135                                      |          |    |        | 11,477 |         
|                                                                                               | Finished goods inventory                       |                                                                     |                                            | 1,829    |    |        |        | 2,432    |   
|                                                                                               | Restricted cash                                |                                                                     |                                            | 827      |    |        |        | 826      |   
|                                                                                               | Other current assets                           |                                                                     |                                            | 1,075    |    |        |        | 1,449    |   
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               |                                                |                                                                     | Total current assets                       |          |    | 36,418 |        |          |    | 59,550 | 
|Restricted cash                                                                                |                                                |                                                                     |                                           |          |    |        | 827    |         
|Property and equipment, net                                                                    |                                                |                                                                     | 4,060                                      |          |    |        | 6,839  |         
|Goodwill, net of accumulated amortization of
    $22,280 and $21,580, respectively             |                                                |                                                                     | 11,741                                     |          |    |        | 14,241 |         
|Intangible assets, net of accumulated
    amortization of $25,226 and $17,922, respectively    |                                                |                                                                     | 6,774                                      |          |    |        | 15,278 |         
|Deposits and other assets                                                                      |                                                |                                                                     | 553                                        |          |    |        | 685    |         
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               |                                                |                                                                     | Total assets                               |          | $  | 59,546 |        |          | $  | 97,420 | 
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                      
|Current liabilities:                                                                           |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               | Accounts payable                               |                                                                     | $                                          | 3,836    |    |        | $      | 4,421    |   
|                                                                                               | Accrued liabilities                            |                                                                     |                                            | 10,258   |    |        |        | 12,242   |   
|                                                                                               | Deferred revenues                              |                                                                     |                                            | 11,642   |    |        |        | 10,682   |   
|                                                                                               | Other current liabilities                      |                                                                     |                                            | 20       |    |        |        | 227      |   
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               |                                                |                                                                     | Total current liabilities                  |          |    | 25,756 |        |          |    | 27,572 | 
|Deferred revenues, less current portion                                                        |                                                |                                                                     | 682                                        |          |    |        | 1,282  |         
|Other liabilities                                                                              |                                                |                                                                     | 129                                        |          |    |        | 271    |         
|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  47,676 and
    47,029, respectively |                                            |          | 48 |        |        |          | 47 |       
|                                                                                               | Additional paid-in capital                     |                                                                     |                                            | 357,460  |    |        |        | 356,887  |   
|                                                                                               | Deferred compensation                          |                                                                     |                                            | (27      | )  |        |        | (278     | ) 
|                                                                                               | Accumulated deficit                            |                                                                     |                                            | (324,502 | )  |        |        | (288,361 | ) 
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               |                                                |                                                                     | Total stockholders equity                 |          |    | 32,979 |        |          |    | 68,295 | 
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         
|                                                                                               |                                                |                                                                     | Total liabilities and stockholders equity |          | $  | 59,546 |        |          | $  | 97,420 | 
|                                                                                               |                                                |                                                                     |                                            |          |    |        |        |         

See accompanying notes.

46



---



##### Table of Contents



LIGHTSPAN, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
data)


|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |        |         | 
|------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | ------------------------ | ------- | ------ | ------ | ---- | ------- | ------ | ------- | - | ------- | ------ | ------- | 
|                                                                    |                                                                                                   |                         
|                                                                    |                                                                                                   | Years Ended January 31, 
|                                                                    |                                                                                                   |                         
|                                                                    |                                                                                                   | 2003                     |         | 2002   |        | 2001
|                                                                    |                                                                                                   |                          |         |        |        |     
|Revenues:                                                           |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Software licenses                                                                                 |                          | $       | 26,604 |        |      | $       | 34,309 |         |   | $       | 79,553 |        
|                                                                    | Online subscriptions                                                                              |                          |         | 10,506 |        |      |         | 7,935  |         |   |         | 4,556  |        
|                                                                    | Professional services                                                                             |                          |         | 9,863  |        |      |         | 9,343  |         |   |         | 9,175  |        
|                                                                    | Hardware and other                                                                                |                          |         | 3,035  |        |      |         | 5,945  |         |   |         | 5,790  |        
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    |                                                                                                   | Total revenues           |         |        | 50,008 |      |         |        | 57,532  |   |         |        | 99,074  | 
|Cost of revenues:                                                   |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Software licenses                                                                                 |                          |         | 5,240  |        |      |         | 6,564  |         |   |         | 14,887 |        
|                                                                    | Online subscriptions                                                                              |                          |         | 1,854  |        |      |         | 1,952  |         |   |         | 2,004  |        
|                                                                    | Professional services                                                                             |                          |         | 5,030  |        |      |         | 5,411  |         |   |         | 4,780  |        
|                                                                    | Hardware and other                                                                                |                          |         | 2,370  |        |      |         | 3,802  |         |   |         | 3,615  |        
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    |                                                                                                   | Total cost of revenues   |         |        | 14,494 |      |         |        | 17,729  |   |         |        | 25,286  | 
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Gross profit                                                        |                                                                                                   |                          | 35,514  |        |        |      | 39,803  |        |         |   | 73,788  |       
|Operating expenses:                                                 |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Sales and marketing                                                                               |                          |         | 36,266 |        |      |         | 49,367 |         |   |         | 56,920 |        
|                                                                    | Technology and development                                                                        |                          |         | 13,535 |        |      |         | 24,424 |         |   |         | 25,775 |        
|                                                                    | General and administrative                                                                        |                          |         | 10,997 |        |      |         | 11,670 |         |   |         | 9,425  |        
|                                                                    | Stock-based compensation                                                                          |                          |         | 227    |        |      |         | 747    |         |   |         | 2,398  |        
|                                                                    | Amortization of intangible assets                                                                 |                          |         | 8,004  |        |      |         | 18,298 |         |   |         | 16,005 |        
|                                                                    | Restructuring                                                                                     |                          |         |       |        |      |         |       |         |   |         | 1,600  |        
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    |                                                                                                   | Total operating expenses |         |        | 69,029 |      |         |        | 104,506 |   |         |        | 112,123 | 
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Loss from operations                                                |                                                                                                   |                          | (33,515 | )      |        |      | (64,703 | )      |         |   | (38,335 | )     
|Interest income                                                     |                                                                                                   |                          | 461     |        |        |      | 2,571   |        |         |   | 6,315   |       
|Interest expense                                                    |                                                                                                   |                          | (87     | )      |        |      | (111    | )      |         |   | (100    | )     
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Loss before cumulative effect of change in
    accounting principle |                                                                                                   |                          | (33,141 | )      |        |      | (62,243 | )      |         |   | (32,120 | )     
|Cumulative effect of a change in accounting
    principle           |                                                                                                   |                          | (3,000  | )      |        |      |        |        |         |   |        |       
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Net loss                                                            |                                                                                                   |                          | (36,141 | )      |        |      | (62,243 | )      |         |   | (32,120 | )     
|Preferred stock dividend                                            |                                                                                                   |                          |        |        |        |      |        |        |         |   | (16,506 | )     
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Net loss applicable to common stockholders                          |                                                                                                   | $                        | (36,141 | )      |        | $    | (62,243 | )      |         | $ | (48,626 | )     
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|Net loss per share:                                                 |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Basic and diluted loss per share before
    cumulative effect of a change in accounting principle |                          | $       | (0.70  | )      |      | $       | (1.34  | )       |   | $       | (1.10  | )      
|                                                                    | Cumulative effect of a change in accounting
    principle                                         |                          | $       | (0.06  | )      |      |         |       |         |   |         |       |        
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Basic and diluted net loss per share                                                              |                          | $       | (0.76  | )      |      | $       | (1.34  | )       |   | $       | (1.10  | )      
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       
|                                                                    | Weighted average shares  basic and diluted                                                       |                          |         | 47,271 |        |      |         | 46,373 |         |   |         | 44,019 |        
|                                                                    |                                                                                                   |                          |         |        |        |      |         |        |         |   |         |       

See accompanying notes.

47



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##### Table of Contents



LIGHTSPAN, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

Years Ended January 31, 2003, 2002 and
2001


(In thousands)


|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |         |  
|---------------------------------------------------------------------------------------------------------------------------- | ----------------------------- | --------------- | ------- | ------------ |  | ---------- | --- | ----------- |  | -------- | ------ | ------------- |  | ------------ | -- | ------------- |  | ------- | ------- | --------- |  | - | ---- | - |  | - | ------ | - |  | - | ---- | ---- | - | - | -------- | ------- | - | - | ------- | ------- | -
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |        
|                                                                                                                             |                               | Convertible     |         |              |  |            |     |             |  |          |        |               |  |              |    | Total        
|                                                                                                                             |                               | Preferred Stock |         | Common Stock |  | Additional |     | Deferred    |  |          |        | Other         |  |              |    | Stockholders
|                                                                                                                             |                               |                 |         |              |  | Paid-in    |     | Advertising |  | Deferred |        | Comprehensive |  | Accumulated  |    | Equity       
|                                                                                                                             |                               | Shares          |         | Amount       |  | Shares     |     | Amount      |  | Capital  |        | Expense       |  | Compensation |    | Loss          |  | Deficit |         | (Deficit)
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |          
|Balance at January 31, 2000                                                                                                  |                               |                 | 52,231  |              |  | $          | 52  |             |  |          | 4,764  |               |  | $            | 5  |               |  | $       | 209,740 |           |  | $ | (400 | ) |  | $ | (5,211 | ) |  | $ |     |      |   | $ | (177,492 | )       |   | $ | 26,694  |        
|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  |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 88,819  |        
|Issuance of common stock in private placements,
    net of advisory fees of $930                                             |                               |                 |        |              |  |            |    |             |  |          | 2,125  |               |  |              | 2  |               |  |         | 24,568  |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 24,570  |        
|Issuance of common stock in connection with the
    purchase of eduTest and LearningPlanet.com, net of registration
    fees |                               |                 |        |              |  |            |    |             |  |          | 1,019  |               |  |              | 1  |               |  |         | 8,934   |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 8,935   |        
|Issuance of common stock                                                                                                     |                               |                 |        |              |  |            |    |             |  |          | 1,515  |               |  |              | 2  |               |  |         | 7,331   |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 7,333   |        
|Reduction to deferred compensation related to
    stock options                                                              |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         | (1,499  | )         |  |   |     |   |  |   | 1,499  |   |  |   |     |      |   |   |         |         |   |   |        |        
|Amortization of deferred compensation                                                                                        |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         |        |           |  |   |     |   |  |   | 2,398  |   |  |   |     |      |   |   |         |         |   |   | 2,398   |        
|Use of advertising credits                                                                                                   |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         |        |           |  |   | 400  |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 400     |        
|Preferred stock dividend                                                                                                     |                               |                 |        |              |  |            |    |             |  |          | 1,378  |               |  |              | 1  |               |  |         | 16,505  |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   | (16,506  | )       |   |   |        |        
|Comprehensive loss:                                                                                                          |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |        
|                                                                                                                             | Unrealized loss               |                 |         |              |  |            |     |            |  |          |        |              |  |              |    |              |  |         |         |          |  |   |      |  |  |   |        |  |  |   |      | (714 | ) |   |          |        |   |   |         | (714    | )
|                                                                                                                             | Net loss                      |                 |         |             |  |            |     |            |  |          |        |              |  |              |    |              |  |         |         |          |  |   |      |  |  |   |        |  |  |   |      |     |   |   |          | (32,120 | ) |   |         | (32,120 | )
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |        
|                                                                                                                             | Comprehensive loss            |                 |         |             |  |            |     |            |  |          |        |              |  |              |    |              |  |         |         |          |  |   |      |  |  |   |        |  |  |   |      |     |   |   |          |        |   |   |         | (32,834 | )
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |        
|Balance at January 31, 2001                                                                                                  |                               |                 |        |              |  |            |    |             |  |          | 46,044 |               |  |              | 46 |               |  |         | 354,415 |           |  |   |     |   |  |   | (1,314 | ) |  |   | (714 | )    |   |   | (226,118 | )       |   |   | 126,315 |        
|Issuance of common stock to Learning Planet.com
    and eduTest                                                              |                               |                 |        |              |  |            |    |             |  |          | 263    |               |  |              |   |               |  |         | 2,067   |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 2,067   |        
|Exercise of stock options                                                                                                    |                               |                 |        |              |  |            |    |             |  |          | 185    |               |  |              |   |               |  |         | 147     |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 147     |        
|Reduction to deferred compensation related to
    stock options                                                              |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         | (289    | )         |  |   |     |   |  |   | 289    |   |  |   |     |      |   |   |         |         |   |   |        |        
|Amortization of deferred compensation                                                                                        |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         |        |           |  |   |     |   |  |   | 747    |   |  |   |     |      |   |   |         |         |   |   | 747     |        
|Common Stock issued under Employee Stock Purchase
    Plan                                                                   |                               |                 |        |              |  |            |    |             |  |          | 537    |               |  |              | 1  |               |  |         | 548     |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 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                                                                                                  |                               |                 |        |              |  |            |    |             |  |          | 47,029 |               |  |              | 47 |               |  |         | 356,887 |           |  |   |     |   |  |   | (278   | ) |  |   |     |      |   |   | (288,361 | )       |   |   | 68,295  |        
|Exercise of stock options                                                                                                    |                               |                 |        |              |  |            |    |             |  |          | 198    |               |  |              |   |               |  |         | 170     |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 170     |        
|Reduction to deferred compensation related to
    stock options                                                              |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         | (24     | )         |  |   |     |   |  |   | 24     |   |  |   |     |      |   |   |         |         |   |   |        |        
|Amortization of deferred compensation                                                                                        |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         |        |           |  |   |     |   |  |   | 227    |   |  |   |     |      |   |   |         |         |   |   | 227     |        
|Common Stock issued under Employee Stock Purchase
    Plan                                                                   |                               |                 |        |              |  |            |    |             |  |          | 449    |               |  |              | 1  |               |  |         | 427     |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   |         |         |   |   | 428     |        
|Comprehensive and net loss                                                                                                   |                               |                 |        |              |  |            |    |             |  |          |       |               |  |              |   |               |  |         |        |           |  |   |     |   |  |   |       |   |  |   |     |      |   |   | (36,141  | )       |   |   | (36,141 | )      
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |        
|Balance at January 31, 2003                                                                                                  |                               |                 |        |              |  | $          |    |             |  |          | 47,676 |               |  | $            | 48 |               |  | $       | 357,460 |           |  | $ |     |   |  | $ | (27    | ) |  | $ |     |      |   | $ | (324,502 | )       |   | $ | 32,979  |        
|                                                                                                                             |                               |                 |         |              |  |            |     |             |  |          |        |               |  |              |    |               |  |         |         |           |  |   |      |   |  |   |        |   |  |   |      |      |   |   |          |         |   |   |         |        

See accompanying notes.

48



---



##### Table of Contents



LIGHTSPAN, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |         |         |  
|------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------- | ------ | ------- | ---- | ------- | -------- | ------- | - | ------- | ------- | ------- | -
|                                                                                |                                                                                                      |                                                              
|                                                                                |                                                                                                      | Years Ended January 31,                                      
|                                                                                |                                                                                                      |                                                              
|                                                                                |                                                                                                      | 2003                                                          |         | 2002   |         | 2001
|                                                                                |                                                                                                      |                                                               |         |        |         |     
|Operating activities:                                                           |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|Net loss                                                                        |                                                                                                      | $                                                             | (36,141 | )      |         | $    | (62,243 | )        |         | $ | (32,120 | )      
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Depreciation and amortization                                                                        |                                                               |         | 2,439  |         |      |         | 3,265    |         |   |         | 1,821   |        
|                                                                                | Provision for doubtful accounts                                                                      |                                                               |         | 724    |         |      |         | 357      |         |   |         | (78     | )      
|                                                                                | Amortization of intangible assets                                                                    |                                                               |         | 8,004  |         |      |         | 18,298   |         |   |         | 16,005  |        
|                                                                                | Amortization of deferred stock-based compensation                                                    |                                                               |         | 227    |         |      |         | 747      |         |   |         | 2,398   |        
|                                                                                | Loss on disposal of assets                                                                           |                                                               |         | 607    |         |      |         |         |         |   |         |        |        
|                                                                                | Change in deferred advertising expense                                                               |                                                               |         |       |         |      |         |         |         |   |         | 400     |        
|                                                                                | Restructuring charge, non-cash portion                                                               |                                                               |         |       |         |      |         |         |         |   |         | 533     |        
|                                                                                | Cumulative effect of a change in accounting
    principle                                            |                                                               |         | 3,000  |         |      |         |         |         |   |         |        |        
|                                                                                | Changes in operating assets and liabilities, net
    of effects of assets acquired:                  |                                                               |         |        |         |      |         |          |         |   |         |         |        
|                                                                                |                                                                                                      | Accounts receivable                                           |         |        | 1,618   |      |         |          | (581    | ) |         |         | 5,266   |  
|                                                                                |                                                                                                      | Finished goods inventory                                      |         |        | 603     |      |         |          | 135     |   |         |         | (1,451  | )
|                                                                                |                                                                                                      | Deferred cost of revenue                                      |         |        |        |      |         |          |        |   |         |         | 8,709   |  
|                                                                                |                                                                                                      | Restricted cash                                               |         |        | 826     |      |         |          | 3,115   |   |         |         | (4,768  | )
|                                                                                |                                                                                                      | Deposits and other assets                                     |         |        | 506     |      |         |          | 1,306   |   |         |         | (527    | )
|                                                                                |                                                                                                      | Accounts payable, accrued and other liabilities               |         |        | (2,672  | )    |         |          | 1,300   |   |         |         | 329     |  
|                                                                                |                                                                                                      | Deferred revenue                                              |         |        | 360     |      |         |          | 2,602   |   |         |         | (46,188 | )
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                |                                                                                                      | Net cash flows used in operating activities                   |         |        | (19,899 | )    |         |          | (31,699 | ) |         |         | (49,671 | )
|Investing activities:                                                           |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Purchases of short-term investments                                                                  |                                                               |         | (5,078 | )       |      |         | (121,845 | )       |   |         | (35,753 | )      
|                                                                                | Maturities of short-term investments                                                                 |                                                               |         | 8,356  |         |      |         | 146,909  |         |   |         | 18,488  |        
|                                                                                | Purchase of property and equipment                                                                   |                                                               |         | (267   | )       |      |         | (4,218   | )       |   |         | (4,204  | )      
|                                                                                | Net cash paid for acquisitions                                                                       |                                                               |         |       |         |      |         |         |         |   |         | (2,845  | )      
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                |                                                                                                      | Net cash flows provided by (used in) investing
    activities |         |        | 3,011   |      |         |          | 20,846  |   |         |         | (24,314 | )
|Financing activities:                                                           |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Proceeds from issuance of common stock                                                               |                                                               |         | 428    |         |      |         | 548      |         |   |         | 114,011 |        
|                                                                                | Principal repayments on capital leases                                                               |                                                               |         | (246   | )       |      |         | (375     | )       |   |         | (391    | )      
|                                                                                | Principal repayments on notes payable                                                                |                                                               |         |       |         |      |         |         |         |   |         | (257    | )      
|                                                                                | Net proceeds from exercise of stock options                                                          |                                                               |         | 170    |         |      |         | 147      |         |   |         | 1,155   |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                |                                                                                                      | Net cash flows provided by financing activities               |         |        | 352     |      |         |          | 320     |   |         |         | 114,518 |  
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|Increase (decrease) in cash and cash
    equivalents                            |                                                                                                      |                                                               | (16,536 | )      |         |      | (10,533 | )        |         |   | 40,533  |        
|Cash and cash equivalents at beginning of year                                  |                                                                                                      |                                                               | 35,033  |        |         |      | 45,566  |          |         |   | 5,033   |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|Cash and cash equivalents at end of year                                        |                                                                                                      | $                                                             | 18,497  |        |         | $    | 35,033  |          |         | $ | 45,566  |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|Supplemental disclosure of cash flow
    information:                           |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Interest paid                                                                                        |                                                               | $       | 87     |         |      | $       | 111      |         |   | $       | 100     |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|Supplemental schedule of noncash investing and
    financing activities:        |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Reduction in deferred stock-based compensation                                                       |                                                               | $       | 24     |         |      | $       | 289      |         |   | $       | (1,499  | )      
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | 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  |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Issuance of common stock as preferred stock
    dividend                                             |                                                               | $       |       |         |      | $       |         |         |   | $       | 16,506  |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        
|                                                                                | Additional consideration payable related to the
    acquisitions of Academic and eduTest             |                                                               | $       |       |         |      | $       | (2,000   | )       |   | $       | 2,000   |        
|                                                                                |                                                                                                      |                                                               |         |        |         |      |         |          |         |   |         |        

See accompanying notes.

49



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##### Table of Contents



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 online 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.



| |                      
| | ---------------------
| | Basis of Presentation

As of January 31, 2003, Lightspan had
working capital of $10.7 million and an accumulated deficit
of $324.5 million. The accompanying financial statements
have been prepared assuming that Lightspan will continue as a
going concern. This basis of accounting contemplates the
recovery of the Companys assets and the satisfaction of
its liabilities in the normal course of conducting business.
Based on a revenue and expense forecast, management believes
that Lightspans existing capital resources will enable
them to fund operations through January 31, 2004. If
revenue targets are not achieved as contemplated by the
forecast, Lightspan may determine that it is necessary to delay,
reduce the scope of or eliminate one or more of its sales and
marketing programs and reduce the cost of its infrastructure and
personnel. If necessary, management believes it has the ability
to defer or eliminate certain sales, general and administrative
expenses to enable Lightspan to sustain its operations through
January 2004.



| |                            
| | ---------------------------
| | 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 of three months or less when acquired.
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

50



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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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. The Company has not recorded a material write-off of
receivables since inception.



| |          
| | ---------
| | 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.

Depreciation expense for the years ended
January 31, 2003, 2002 and 2001 was $2.4 million,
$3.1 million and $1.8 million, respectively.



| |                                         
| | ----------------------------------------
| | Goodwill and Other Intangible
    Assets

On February 1, 2002, the Company adopted
Statement of Financial Accounting Standards No. 142, or
SFAS No. 142, Goodwill and Other Intangible
Assets which eliminated amortization of goodwill and
certain other intangible assets and requires annual testing for
impairment. SFAS No. 142 prescribes a two-phase process for
impairment testing of goodwill. The first phase identifies
impairment, if any, of goodwill by comparing the reporting
units carrying amount, including goodwill, to the fair
value of the reporting unit. The fair values of the reporting
units are estimated using a discounted cash flow model and other
corporate and market information. If the carrying amount of the
reporting unit exceeds its fair value, goodwill is considered
impaired and a second step is performed to measure the amount of
impairment loss, if any.

Intangible assets consist of customer base, core
technology, trademark and trade name and are amortized over
useful lives ranging from three to ten years.



| |                  
| | -----------------
| | 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 reviews the recoverability of the
carrying value of long-lived assets, primarily property, plant
and equipment, intangible assets, and software development
costs, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be fully recoverable. Should indicators of impairment exist,
the carrying values of the assets are evaluated in relation to
the operating performance and future undiscounted cash flows of
the underlying business. The net book value of an asset is

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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

adjusted to fair value if its expected future
undiscounted cash flow is less than its book value. The Company
has identified no such impairment losses as of January 31,
2003 and 2002.



| |        
| | -------
| | 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

Lightspan recognizes 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. Lightspan uses
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 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

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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.



| |                     
| | --------------------
| | Online Subscriptions

Revenue derived from fee-based online
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.



| |                  
| | -----------------
| | Advertising Costs

Advertising costs are expensed as incurred and
were $0.1 million, $0.2 million and $5.7 million for
the years ended January 31, 2003, 2002 and 2001,
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 and Software 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

53



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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 Statement of Position
(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, 2003, 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.

Pro forma information regarding net loss is
required by SFAS No. 123, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation 
Transition and Disclosure, 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, 2003, 2002 and 2001, respectively: ten year
risk-free interest rates of 4.02%, 4.90% and 6.51%,
respectively; dividend yields of 0%; weighted-average expected
life of the options of four to five years; and expected
volatility of 77% for the year ended January 31, 2003. In
determining pro forma amounts, the estimated fair value of the
options is amortized to expense over the vesting period of such
options. The following table compares net loss as reported in
Lightspans financial statements to pro forma amounts that
would be reported had compensation expense been recognized for
Lightspans stock-based

54



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

compensation plans using the fair value method of
SFAS No. 123, as amended by SFAS No. 148 (in
thousands, except per share data):

|                                                                                                                                           |  |                         |         |      |  |      |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                                                           |  |                        
|                                                                                                                                           |  | Years Ended January 31,
|                                                                                                                                           |  |                        
|                                                                                                                                           |  | 2003                    |         | 2002 |  | 2001
|                                                                                                                                           |  |                         |         |      |  |     
|Net loss, as reported                                                                                                                      |  | $                       | (36,141 | )    |  | $    | (62,243 | ) |  | $ | (48,626 | )
|Add: Stock-based compensation expense included in
    reported net income, net of related tax effects                                      |  |                         | 227     |      |  |      | 747     |   |  |   | 2,398   |  
|Deduct: Total Stock-based compensation expense
    determined under fair value based method for all awards, net of
    related tax effects |  |                         | (1,013  | )    |  |      | (1,755  | ) |  |   | (5,980  | )
|                                                                                                                                           |  |                         |         |      |  |      |         |   |  |   |         |  
|Pro forma net loss                                                                                                                         |  | $                       | (36,927 | )    |  | $    | (63,251 | ) |  | $ | (52,208 | )
|                                                                                                                                           |  |                         |         |      |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share:                                                                                                      |  |                         |         |      |  |      |         |   |  |   |         |  
|As reported                                                                                                                                |  | $                       | (0.76   | )    |  | $    | (1.34   | ) |  | $ | (1.10   | )
|                                                                                                                                           |  |                         |         |      |  |      |         |   |  |   |         |  
|Pro forma                                                                                                                                  |  | $                       | (0.78   | )    |  | $    | (1.36   | ) |  | $ | (1.19   | )
|                                                                                                                                           |  |                         |         |      |  |      |         |   |  |   |         |  



| |                   
| | ------------------
| | 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 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, 2003.



| |                  
| | -----------------
| | 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
0.2 million, 1.2 million and 1.4 million for the
years ended January 31, 2003, 2002 and 2001, respectively,
and were excluded from the diluted earnings per share because of
their antidilutive effect.

55



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                 
| | ----------------
| | 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 April 2002, the FASB issued SFAS No. 145,
Recission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections, which is effective for the Company beginning
February 1, 2003. The Company believes the adoption of SFAS
No. 145 will not have a material effect on the
Companys consolidated financial position or results of
operations.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 requires that costs
associated with exit or disposal activities be recorded at their
fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon managements
commitment to an exit plan, which is generally before an actual
liability has been incurred. This Statement is effective for
exit or disposal activities that are initiated after
December 31, 2002 and will impact the timing of exit or
disposal costs reported after adoption.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. SFAS
No. 148 amends SFAS No. 123 by providing alternative
methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 expands the pro
forma disclosures of the effect of a companys accounting
for stock-based employee compensation required by SFAS
No. 123 and adds comparable disclosures to those required
by APB Opinion No. 28, Interim Financial
Reporting. SFAS No. 148 is effective for financial
statements of the Company beginning December 15, 2002.

56



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2.     Detailed
Balance Sheet Information (In thousands)

Cash and cash equivalents consist of the
following:

|                      |                                            |             |        |      |  |   |        |     | 
|--------------------- | ------------------------------------------ | ----------- | ------ | ---- |  | - | ------ | --- | 
|                      |                                            |            
|                      |                                            | January 31,
|                      |                                            |            
|                      |                                            | 2003        |        | 2002
|                      |                                            |             |        |     
|Cash                  |                                            | $           | 2,028  |      |  | $ | 1,344  |    
|Money market accounts |                                            |             | 16,469 |      |  |   | 33,689 |    
|                      |                                            |             |        |      |  |   |        |    
|                      |                                            | $           | 18,497 |      |  | $ | 35,033 |    
|                      |                                            |             |        |      |  |   |        |    
|Restricted cash       |                                            |             |        |      |  |   |        |    
|                      | Certificates of deposit, current portion   |             |        | 826  |  |   |        | 826 | 
|                      | Certificates of deposit, long term portion |             |        |     |  |   |        | 827 | 
|                      |                                            |             |        |      |  |   |        |    
|Total restricted cash |                                            | $           | 826    |      |  | $ | 1,653  |    
|                      |                                            |             |        |      |  |   |        |    

At January 31, 2003, short-term investments
consisted of the following.

|                          |                                                                |                |        |             |  |              |   |   |  |   |        |        | 
|------------------------- | -------------------------------------------------------------- | -------------- | ------ | ----------- |  | ------------ | - | - |  | - | ------ | ------ | 
|                          |                                                                |                |        | Unrealized  |  | Fair        
|                          |                                                                | Amortized Cost |        | Gain (Loss) |  | Market Value
|                          |                                                                |                |        |             |  |             
|U.S. agency               |                                                                | $              | 5,055  |             |  | $            |  |   |  | $ | 5,055  |       
|                          |                                                                |                |        |             |  |              |   |   |  |   |        |       
|Cash and cash equivalents |                                                                | $              | 18,497 |             |  | $            |  |   |  | $ | 18,497 |       
|                          |                                                                |                |        |             |  |              |   |   |  |   |        |       
|                          | Total cash and cash equivalents and short-term
    investments |                | $      | 23,552      |  |              | $ |  |  |   | $      | 23,552 | 
|                          |                                                                |                |        |             |  |              |   |   |  |   |        |       

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 | 
|                           |                                                                |                |        |             |  |              |   |   |  |   |        |       

Property and equipment consist of the following:

|                                               |  |             |         |      |  |   |         |  
|---------------------------------------------- |  | ----------- | ------- | ---- |  | - | ------- | -
|                                               |  |            
|                                               |  | January 31,
|                                               |  |            
|                                               |  | 2003        |         | 2002
|                                               |  |             |         |     
|Computer equipment                             |  | $           | 11,003  |      |  | $ | 12,506  |  
|Software                                       |  |             | 3,145   |      |  |   | 2,718   |  
|Office furniture and equipment                 |  |             | 1,807   |      |  |   | 2,045   |  
|                                               |  |             |         |      |  |   |         |  
|                                               |  |             | 15,955  |      |  |   | 17,269  |  
|Less accumulated depreciation and amortization |  |             | (11,895 | )    |  |   | (10,430 | )
|                                               |  |             |         |      |  |   |         |  
|                                               |  | $           | 4,060   |      |  | $ | 6,839   |  
|                                               |  |             |         |      |  |   |         |  

Goodwill and
Other Intangible Assets

On February 1, 2002, we adopted Statement of
Financial Accounting Standards No. 142, or SFAS
No. 142, Goodwill and Other Intangible Assets
which required us to cease amortizing goodwill, and instead

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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

perform a transitional review for impairment as
of February 1, 2002 and an annual review for impairment
during the fourth quarter of fiscal 2003. Goodwill is considered
to be potentially impaired if we determine the carrying value of
the reporting unit exceeds its fair value. During the second
quarter of fiscal 2003, we performed the transitional test by
completing the first step of this review and determined that
there was a potential impairment of goodwill relating to our
higher education division, Academic Systems. As a result, as
required by SFAS 142, we performed a second step utilizing
an independent appraisal firm combined with internal analyses
and other market and company information to measure the amount
of the potential impairment. As a part of this second step,
SFAS 142 requires the fair value of the reporting unit be
allocated to its assets and liabilities in the same manner used
in accounting for business combinations. These analyses were
judgmental in nature and included a significant amount of
estimates and assumptions in forecasting revenues, expenses,
growth rates and other relevant information in a discounted cash
flow model with discount rates reflecting the appropriate
inherent risk.

This transitional impairment review from the
second step of SFAS 142 resulted in a noncash charge of
$3.0 million to reduce the carrying value of the goodwill
associated with our higher education division, Academic Systems.
This charge is reflected as the cumulative effect of a change in
accounting principle in the first quarter of fiscal 2003 as
required by SFAS 142. Also in connection with the adoption
of SFAS 142 we reclassified $1.2 million and $0.5
million of assembled workforce intangibles and related
accumulated amortization respectively as required by the
pronouncement.

During the fourth quarter of fiscal 2003, we also
performed our annual review for impairment as of
January 31, 2003 and determined no impairment existed.

We cannot assure you that when we complete our
annual or other periodic reviews for impairment of goodwill that
a material impairment charge will not be recorded. Goodwill
totaled $11.7 million at January 31, 2003.

The following table presents a reconciliation of
net income (loss) and per share data to what would have
been reported had the new rules been in effect during the years
ended January 31, 2003, 2002 and 2001.

|                                                           |  |             |         |      |  |      |         |   |  |   |         |  
|---------------------------------------------------------- |  | ----------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                           |  |            
|                                                           |  | January 31,
|                                                           |  |            
|                                                           |  | 2003        |         | 2002 |  | 2001
|                                                           |  |             |         |      |  |     
|Reported net loss                                          |  | $           | (36,141 | )    |  | $    | (62,243 | ) |  | $ | (48,626 | )
|Cumulative effect of change in accounting
    principle    |  |             | 3,000   |      |  |      |        |   |  |   |        |  
|Add back goodwill and assembled workforce
    amortization |  |             |        |      |  |      | 10,295  |   |  |   | 9,188   |  
|                                                           |  |             |         |      |  |      |         |   |  |   |         |  
|Adjusted net loss                                          |  | $           | (33,141 | )    |  | $    | (51,948 | ) |  | $ | (39,438 | )
|                                                           |  |             |         |      |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share:                      |  |             |         |      |  |      |         |   |  |   |         |  
|Reported net loss per share                                |  | $           | (0.76   | )    |  | $    | (1.34   | ) |  | $ | (1.10   | )
|Cumulative effect of change in accounting
    principle    |  |             | 0.06    |      |  |      |        |   |  |   |        |  
|Goodwill amortization                                      |  |             |        |      |  |      | 0.22    |   |  |   | 0.21    |  
|                                                           |  |             |         |      |  |      |         |   |  |   |         |  
|Adjusted net loss per share                                |  | $           | (0.70   | )    |  | $    | (1.12   | ) |  | $ | (0.90   | )
|                                                           |  |             |         |      |  |      |         |   |  |   |         |  

58



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Detail of intangible assets subject to
amortization at January 31, 2003 was as follows:

|                         |  |           |   |          |  |              |        |          |  |   |        |  |  |   |       | 
|------------------------ |  | --------- | - | -------- |  | ------------ | ------ | -------- |  | - | ------ |  |  | - | ----- | 
|                         |  | Remaining |   |          |  |              |        |         
|                         |  | Useful    |   | Gross    |  |              |        | Net     
|                         |  | Life (in  |   | Carrying |  | Accumulated  |        | Carrying
|                         |  | years)    |   | Value    |  | Amortization |        | Value   
|                         |  |           |   |          |  |              |        |         
|Customer base            |  |           | 4 |          |  | $            | 17,500 |          |  | $ | 14,787 |  |  | $ | 2,713 | 
|Core technology          |  |           | 4 |          |  |              | 10,400 |          |  |   | 8,858  |  |  |   | 1,542 | 
|Trademark and trade name |  |           | 9 |          |  |              | 4,100  |          |  |   | 1,581  |  |  |   | 2,519 | 
|                         |  |           |   |          |  |              |        |          |  |   |        |  |  |   |       | 
|                         |  |           |   |          |  | $            | 32,000 |          |  | $ | 25,226 |  |  | $ | 6,774 | 
|                         |  |           |   |          |  |              |        |          |  |   |        |  |  |   |       | 

Comparison of intangible assets between years:

|                              |  |             |         |      |  |   |         |  
|----------------------------- |  | ----------- | ------- | ---- |  | - | ------- | -
|                              |  |            
|                              |  | January 31,
|                              |  |            
|                              |  | 2003        |         | 2002
|                              |  |             |         |     
|Customer base                 |  | $           | 17,500  |      |  | $ | 17,500  |  
|Core technology               |  |             | 10,400  |      |  |   | 10,400  |  
|Trademark and trade name      |  |             | 4,100   |      |  |   | 4,100   |  
|Assembled workforce           |  |             |        |      |  |   | 1,200   |  
|                              |  |             |         |      |  |   |         |  
|                              |  |             | 32,000  |      |  |   | 33,200  |  
|Less accumulated amortization |  |             | (25,226 | )    |  |   | (17,922 | )
|                              |  |             |         |      |  |   |         |  
|                              |  | $           | 6,774   |      |  | $ | 15,278  |  
|                              |  |             |         |      |  |   |         |  

Amortization expense for intangible assets for
the years ended January 31, 2003, 2002 and 2001 was
$8.0 million, $8.0 million and $7.1 million,
respectively.

The estimated annual amortization expense for
amortized intangible assets owned as of January 31, 2003
for each of the five succeeding fiscal years is as follows:

|                                  |  |   |       | 
|--------------------------------- |  | - | ----- | 
|Years Ending January 31,
    2004 |  | $ | 4,774 | 
|2005                              |  |   | 520   | 
|2006                              |  |   | 392   | 
|2007                              |  |   | 300   | 
|2008                              |  |   | 300   | 
|Thereafter                        |  |   | 488   | 
|                                  |  |   |       | 
|                                  |  | $ | 6,774 | 
|                                  |  |   |       | 

Accrued liabilities consist of the following:

|                                          |  |             |        |      |  |   |        | 
|----------------------------------------- |  | ----------- | ------ | ---- |  | - | ------ | 
|                                          |  |            
|                                          |  | January 31,
|                                          |  |            
|                                          |  | 2003        |        | 2002
|                                          |  |             |        |     
|Accrued compensation and related expenses |  | $           | 8,728  |      |  | $ | 10,876 | 
|Other accrued liabilities                 |  |             | 1,530  |      |  |   | 1,366  | 
|                                          |  |             |        |      |  |   |        | 
|                                          |  | $           | 10,258 |      |  | $ | 12,242 | 
|                                          |  |             |        |      |  |   |        | 

59



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.     Business
Combinations and Strategic Relationships



| |                             
| | ----------------------------
| | 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
$2.6 million in cash, $1.3 million of which was paid
to eduTest common shareholders, $1.1 million of which was
paid in satisfaction of various obligations of eduTest and
$.2 million of transaction costs. 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. The intangible assets 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 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.

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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                    
| | -----------------------------------
| | Pro forma financial
    information

The following unaudited pro forma financial
information assumes the acquisitions of 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, the Company 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 would 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 decreased to $0.8 million on
September 30, 2002 and will expire on September 30,
2003. The letter of credit is collateralized by a
$0.8 million certificate of deposit and the face value of
the certificate of deposit is recorded as restricted cash. As of
January 31, 2003, 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 $2.2 million, $2.4 million and
$1.9 million, for the years ended January 31, 2003, 2002
and 2001, respectively.

At January 31, 2003, 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
|                             |  | Leases   
|                             |  |          
|2004                         |  | $         | 1,601 | 
|2005                         |  |           | 339   | 
|2006                         |  |           | 74    | 
|                             |  |           |       | 
|Total minimum lease payments |  | $         | 2,014 | 
|                             |  |           |       | 

61



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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,
$0.2 million and $0.5 million for the years ended
January 31, 2003, 2002 and 2001, 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 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, 2003, Lightspan was
authorized to issue 9,711,991 shares of common stock to eligible
employees, officers, directors and consultants under the Plan,
of which options to purchase 1,208,510 shares were available for
future grant at January 31, 2003.

62



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |          |   |   |      |      |  |   |       |        |   |   |      |      | 
|------------------------------------------------------------------ | --------- | ----------------------- | ----- | -------- | - | ------- | ---- | -------- |  | ------- | ----- | -------- | - | - | ---- | ---- |  | - | ----- | ------ | - | - | ---- | ---- | 
|                                                                   |           |                        
|                                                                   |           | Years Ended January 31,
|                                                                   |           |                        
|                                                                   |           |                         |       |          |   |        
|                                                                   |           | 2003                    |       | 2002     |   | 2001   
|                                                                   |           |                         |       |          |   |        
|                                                                   |           |                         |       | Weighted |   |         |      | Weighted |  |         |       | Weighted
|                                                                   |           |                         |       | Average  |   |         |      | Average  |  |         |       | Average 
|                                                                   |           |                         |       | Exercise |   |         |      | Exercise |  |         |       | Exercise
|                                                                   |           | Options                 |       | Price    |   | Options |      | Price    |  | Options |       | Price   
|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |         
|Outstanding  beginning of year                                    |           |                         | 4,974 |          |   | $       | 3.06 |          |  |         | 4,420 |          |   | $ | 4.28 |      |  |   | 3,782 |        |   | $ | 4.16 |     
|                                                                   | Granted   |                         |       | 2,347    |   |         | $    | 0.96     |  |         |       | 2,024    |   |   | $    | 1.19 |  |   |       | 2,494  |   |   | $    | 4.89 | 
|                                                                   | Exercised |                         |       | (207     | ) |         | $    | 0.82     |  |         |       | (185     | ) |   | $    | 0.79 |  |   |       | (597   | ) |   | $    | 1.94 | 
|                                                                   | Forfeited |                         |       | (1,114   | ) |         | $    | 3.27     |  |         |       | (1,285   | ) |   | $    | 4.68 |  |   |       | (1,259 | ) |   | $    | 6.23 | 
|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |          |   |   |      |      |  |   |       |        |   |   |      |     
|Outstanding  end of year                                          |           |                         | 6,000 |          |   | $       | 2.27 |          |  |         | 4,974 |          |   | $ | 3.05 |      |  |   | 4,420 |        |   | $ | 4.28 |     
|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |          |   |   |      |      |  |   |       |        |   |   |      |     
|Exercisable at end of year                                         |           |                         | 2,023 |          |   |         |      |          |  |         | 1,624 |          |   |   |      |      |  |   | 1,115 |        |   |   |      |     
|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |          |   |   |      |      |  |   |       |        |   |   |      |     
|Weighted average fair value of Options granted
    during the year |           | $                       | 0.96  |          |   |         |      |          |  | $       | 1.19  |          |   |   |      |      |  | $ | 4.84  |        |   |   |      |     
|                                                                   |           |                         |       |          |   |         |      |          |  |         |       |          |   |   |      |      |  |   |       |        |   |   |      |     

The following table summarizes information about
stock options outstanding as of January 31, 2003 (in
thousands, except per share data):

|                        |  |                     |       |                     |  |                  |     |        |  |                |       |  |  |  |       |  |  |   |       | 
|----------------------- |  | ------------------- | ----- | ------------------- |  | ---------------- | --- | ------ |  | -------------- | ----- |  |  |  | ----- |  |  | - | ----- | 
|                        |  |                     |       |                    
|                        |  | Options Outstanding |       | Options Exercisable
|                        |  |                     |       |                    
|                        |  |                     |       | Weighted            |  |                  |     |        |  | Weighted      
|                        |  |                     |       | Average Remaining   |  | Weighted Average |     |        |  | Average       
|Range of Exercise Price |  | Number              |       | Contractual Life    |  | Exercise Price   |     | Number |  | Exercise Price
|                        |  |                     |       |                     |  |                  |     |        |  |               
|$ 0.01  $ 1.90         |  |                     | 3,831 |                     |  |                  | 8.8 |        |  | $              | 1.02  |  |  |  | 498   |  |  | $ | 1.13  | 
|$ 1.91  $ 3.80         |  |                     | 1,032 |                     |  |                  | 6.0 |        |  | $              | 2.45  |  |  |  | 676   |  |  | $ | 2.43  | 
|$ 3.81  $ 5.70         |  |                     | 458   |                     |  |                  | 1.9 |        |  | $              | 4.06  |  |  |  | 363   |  |  | $ | 4.05  | 
|$ 5.71  $ 7.60         |  |                     | 312   |                     |  |                  | 7.4 |        |  | $              | 5.80  |  |  |  | 197   |  |  | $ | 5.80  | 
|$ 7.61  $ 9.50         |  |                     | 200   |                     |  |                  | 3.7 |        |  | $              | 8.34  |  |  |  | 157   |  |  | $ | 8.33  | 
|$ 9.51  $11.40         |  |                     | 150   |                     |  |                  | 2.2 |        |  | $              | 10.09 |  |  |  | 120   |  |  | $ | 10.09 | 
|$13.30  $15.20         |  |                     | 1     |                     |  |                  | 7.2 |        |  | $              | 14.25 |  |  |  | 1     |  |  | $ | 14.25 | 
|$17.10  $19.00         |  |                     | 16    |                     |  |                  | 7.2 |        |  | $              | 19.00 |  |  |  | 11    |  |  | $ | 19.00 | 
|                        |  |                     |       |                     |  |                  |     |        |  |                |       |  |  |  |       |  |  |   |       | 
|                        |  |                     | 6,000 |                     |  |                  | 7.3 |        |  | $              | 2.27  |  |  |  | 2,023 |  |  | $ | 3.74  | 
|                        |  |                     |       |                     |  |                  |     |        |  |                |       |  |  |  |       |  |  |   |       | 

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, 2003, 2002 and 2001,
respectively: ten year risk-free interest rates of 4.02%, 4.90%
and 6.51%, respectively; dividend yields of 0%; weighted-average
expected life of the options of four to five years; and expected
volatility of 77% for the year ended January 31, 2003.

63



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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,
|                                                |  |                        
|                                                |  | 2003                    |         | 2002 |  | 2001
|                                                |  |                         |         |      |  |     
|Pro forma net loss                              |  | $                       | (36,927 | )    |  | $    | (63,251 | ) |  | $ | (52,208 | )
|                                                |  |                         |         |      |  |      |         |   |  |   |         |  
|Pro forma net loss per share, basic and diluted |  | $                       | (0.78   | )    |  | $    | (1.36   | ) |  | $ | (1.19   | )
|                                                |  |                         |         |      |  |      |         |   |  |   |         |  



| |                                      
| | -------------------------------------
| | 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
and common stock equivalents 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, 2003 and 2002, employees purchased 448,570 and
536,999 shares, respectively, under the Purchase Plan. As of
January 31, 2003, 238,676 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, 2003:

|                             |                                           |  |           |           | 
|---------------------------- | ----------------------------------------- |  | --------- | --------- | 
|Common stock options         |                                           |  | 1,208,510 |          
|Employee stock purchase plan |                                           |  | 238,676   |          
|                             |                                           |  |           |          
|                             | Total common shares reserved for issuance |  |           | 1,447,186 | 
|                             |                                           |  |           |          



| |         
| | --------
| | 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

64



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 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
dividends. There were no such amounts included in interest
expense for the years ended January 31, 2003, 2002 and 2001.

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 after the
effect of 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, 2003, warrants to purchase 21,108 shares
of common stock remained outstanding and expire on various dates
through 2004.



| |                                     
| | ------------------------------------
| | 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, 2003.



| |                             
| | ----------------------------
| | 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.

65



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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
$0.4 million.



| |                      
| | ---------------------
| | 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, 2003. Amortization of deferred stock
compensation was $0.2 million, $0.8 million and
$2.4 million during the years ended January 31, 2003,
2002 and 2001, 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,
|                          |                                             |            
|                          |                                             | 2003        |         | 2002    
|                          |                                             |             |         |         
|Deferred tax assets:      |                                             |             |         |          |   |   |         |         
|                          | Net operating loss carryforwards            |             | $       | 98,843   |   |   | $       | 91,206   |  
|                          | State capitalized research expenses         |             |         | 1,955    |   |   |         | 1,955    |  
|                          | Federal research and development credits    |             |         | 8,910    |   |   |         | 8,358    |  
|                          | Deferred revenue                            |             |         | 5,021    |   |   |         | 2,672    |  
|                          | Other                                       |             |         | 5,207    |   |   |         | 3,226    |  
|                          |                                             |             |         |          |   |   |         |         
|Total deferred tax assets |                                             |             | 119,936 |          |   |   | 107,417 |         
|                          | Valuation allowance for deferred tax assets |             |         | (116,842 | ) |   |         | (100,849 | )
|                          |                                             |             |         |          |   |   |         |         
|Net deferred tax assets   |                                             |             | 3,094   |          |   |   | 6,568   |         
|                          |                                             |             |         |          |   |   |         |         
|Deferred tax liabilities: |                                             |             |         |          |   |   |         |         
|                          | Acquired intangibles                        |             |         | (3,094   | ) |   |         | (6,568   | )
|                          |                                             |             |         |          |   |   |         |         
|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, 2003, Lightspan had federal
and California net operating loss carryforwards of approximately
$274.0 million and $43.3 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, 2003, California tax loss carryforwards of
$26.5 million have expired, and additional loss carryforwards
will continue to expire in fiscal 2004. Lightspan also has
federal and California research and development tax credit
carryforwards of $6.0 million and $4.4 million
respectively, which will begin expiring in fiscal 2008 unless
previously utilized.

66



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##### Table of Contents



LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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%
during any given three-year period.

Lightspans net operating loss carryforwards
as of January 31, 2003, will expire as follows (in
millions):

|          |        |         |       |       |  |   |      |      | 
|--------- | ------ | ------- | ----- | ----- |  | - | ---- | ---- | 
|          |        | Federal |       | State
|          |        |         |       |      
|2004      |        |         |      |       |  | $ | 3.3  |     
|2005      |        |         |      |       |  |   | 6.0  |     
|2006      |        |         |      |       |  |   |     |     
|2007      |        | $       | 0.1   |       |  |   |     |     
|2008      |        |         | 0.9   |       |  |   |     |     
|Remaining |        | $       | 273.0 |       |  | $ | 34.0 |     
|          |        |         |       |       |  |   |      |     
|          | Totals |         | $     | 274.0 |  |   | $    | 43.3 | 
|          |        |         |       |       |  |   |      |     

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 $0.08 million,
$0.09 million and $0.1 million for the years ended
January 31, 2003, 2002 and 2001, 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 Lightspan
eduTest Assessment 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 online subscription products
and services together, Lightspan re-evaluated its reportable
segments and combined the Achieve Now and K-12 online segments,
previously reported as separate segments, into the K-12 segment.

67



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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                   
| | --------------------------------------------------
| | 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):

|                                  |                                             |                             |         |           |   |              |        |       |  |   |         |       |  
|--------------------------------- | ------------------------------------------- | --------------------------- | ------- | --------- | - | ------------ | ------ | ----- |  | - | ------- | ----- | -
|                                  |                                             |                            
|                                  |                                             | Year Ended January 31, 2003
|                                  |                                             |                            
|                                  |                                             |                             |         | Higher    |   |             
|                                  |                                             | K-12                        |         | Education |   | Consolidated
|                                  |                                             |                             |         |           |   |             
|Revenues from external customers  |                                             | $                           | 40,932  |           |   | $            | 9,076  |       |  | $ | 50,008  |      
|Interest income (expense), net    |                                             |                             | 374     |           |   |              |       |       |  |   | 374     |      
|Depreciation and amortization     |                                             |                             | 2,069   |           |   |              | 370    |       |  |   | 2,439   |      
|Loss from operations              |                                             |                             | (24,406 | )         |   |              | (9,109 | )     |  |   | (33,515 | )    
|Assets                            |                                             |                             | 42,949  |           |   |              | 16,597 |       |  |   | 59,546  |      
|Other significant non cash items: |                                             |                             |         |           |   |              |        |       |  |   |         |      
|                                  | Deferred stock compensation                 |                             |         | (24       | ) |              |        |      |  |   |         | (24   | )
|                                  | Amortization of deferred stock compensation |                             |         | 227       |   |              |        |      |  |   |         | 227   |  
|                                  | Amortization of intangible assets           |                             |         | 2,254     |   |              |        | 5,750 |  |   |         | 8,004 |  

|                                  |                                             |                             |         |           |   |              |         |        |   |   |         |        |  
|--------------------------------- | ------------------------------------------- | --------------------------- | ------- | --------- | - | ------------ | ------- | ------ | - | - | ------- | ------ | -
|                                  |                                             |                            
|                                  |                                             | 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   |       
|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 |  

68



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LIGHTSPAN, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

11.     Legal
Matters

We are not currently involved in any material
legal proceedings.

12.     Unaudited
Selected Quarterly Financial Data

The following is a summary of the quarterly
results of operations for the years ended January 31, 2003
and 2002.

|                                                                      |                                                                                                       |               |         |         |   |            |         |            |   |   |         |       |   |   |         |       |  
|--------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- | ------------- | ------- | ------- | - | ---------- | ------- | ---------- | - | - | ------- | ----- | - | - | ------- | ----- | -
|                                                                      |                                                                                                       |              
|                                                                      |                                                                                                       | Quarter Ended
|                                                                      |                                                                                                       |              
|                                                                      |                                                                                                       | April 30      |         | July 31 |   | October 31 |         | January 31
|                                                                      |                                                                                                       |               |         |         |   |            |         |           
|2003                                                                  |                                                                                                       |               |         |         |   |            |         |            |   |   |         |       |   |   |         |      
|Total revenues                                                        |                                                                                                       | $             | 10,270  |         |   | $          | 14,115  |            |   | $ | 12,577  |       |   | $ | 13,046  |      
|Total cost of revenues                                                |                                                                                                       |               | 3,216   |         |   |            | 3,774   |            |   |   | 3,912   |       |   |   | 3,592   |      
|Gross margin                                                          |                                                                                                       |               | 7,054   |         |   |            | 10,341  |            |   |   | 8,665   |       |   |   | 9,454   |      
|Total operating expenses                                              |                                                                                                       |               | 19,594  |         |   |            | 18,458  |            |   |   | 16,729  |       |   |   | 14,248  |      
|Loss before cumulative effect of a change in
    accounting principle |                                                                                                       |               | (12,406 | )       |   |            | (7,984  | )          |   |   | (7,940  | )     |   |   | (4,811  | )    
|Cumulative effect of a change in accounting
    principle             |                                                                                                       |               | (3,000  | )       |   |            |        |            |   |   |        |       |   |   |        |      
|Net loss attributable to common stockholders                          |                                                                                                       |               | (15,406 | )       |   |            | (7,984  | )          |   |   | (7,940  | )     |   |   | (4,811  | )    
|Net loss per share:                                                   |                                                                                                       |               |         |         |   |            |         |            |   |   |         |       |   |   |         |      
|                                                                      | Basic and diluted net loss per share before
    cumulative effect of a change in accounting principle |               | $       | (0.26   | ) |            | $       | (0.17      | ) |   | $       | (0.17 | ) |   | $       | (0.10 | )
|                                                                      | Cumulative effect of a change in accounting
    principle                                             |               | $       | (0.06   | ) |            |         |           |   |   |         |      |   |   |         |      |  
|                                                                      | Basic and diluted                                                                                     |               | $       | (0.32   | ) |            | $       | (0.17      | ) |   | $       | (0.17 | ) |   | $       | (0.10 | )
|2002                                                                  |                                                                                                       |               |         |         |   |            |         |            |   |   |         |       |   |   |         |      
|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 | )

69