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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 10-Q

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

For the period ended October 31, 2001

|      |  |                                                                                         
|----- |  | ----------------------------------------------------------------------------------------
|(   ) |  | 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
(State or other jurisdiction of
incorporation or organization)                |  | 33-0585210
(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 and Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X]    NO [   ]

Number of shares of registrants common stock outstanding as of November 30,
2001: 46,533,844



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TABLE OF CONTENTS



|                              |                                                                                           |                                            |  |  |  |  |  | 
|----------------------------- | ----------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Consolidated Financial Statements                                                
|                              |                                                                                           | CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                           | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                           | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                           | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Operating Results
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                       
|Part II OTHER INFORMATION    
|                              | Item 1. Legal Proceedings                                                                
|                              | Item 2. Changes in Securities and Use of Proceeds                                        
|                              | Item 3. Defaults Upon Senior Securities                                                  
|                              | Item 4. Submission of Matters to a Vote of Security Holders                              
|                              | Item 5. Other Information                                                                
|                              | Item 6. Exhibits and Reports on Form 8-K                                                 
|SIGNATURES                   



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##### Table of Contents



Lightspan, Inc
Quarterly Report on Form 10-Q
Table of Contents

|           |         |                                                                                              |  |  |    |      |  | 
|---------- | ------- | -------------------------------------------------------------------------------------------- |  |  | -- | ---- |  | 
|           |         |                                                                                              |  |  |    | Page
|           |         |                                                                                              |  |  |    |     
|PART I     |         |                                                                                              |  |  | 2  |     
|           | Item 1. | Consolidated Financial Statements and Notes to Consolidated Financial Statements (Unaudited) |  |  | 2  |     
|           | Item 2. | Managements Discussion and Analysis of Financial Condition and Operating Results            |  |  | 10 |     
|           | Item 3. | Quantitative and Qualitative Disclosures About Market Risk                                   |  |  | 21 |     
|PART II    |         |                                                                                              |  |  | 22 |     
|           | Item 1. | Legal Proceedings                                                                            |  |  | 22 |     
|           | Item 2. | Changes in Securities and Use of Proceeds                                                    |  |  | 22 |     
|           | Item 3. | Defaults Upon Senior Securities                                                              |  |  | 22 |     
|           | Item 4. | Submission of Matters to a Vote of Security Holders                                          |  |  | 22 |     
|           | Item 5. | Other Information                                                                            |  |  | 22 |     
|           | Item 6. | Exhibits and Reports on Form 8-K                                                             |  |  | 22 |     
|Signatures |         |                                                                                              |  |  | 24 |     

1



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PART I. FINANCIAL INFORMATION




Item 1. Consolidated Financial Statements




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

|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |          |    |         | 
|-------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------- | ------------------------------------------ | -------- | ----------- | ------- | ----------- | -------- | -- | ------- | 
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          | October 31, |         | January 31,
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          | 2001        |         | 2001       
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |            
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          | (Unaudited) |         |             |          |   
|Assets                                                                                                               |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|Current assets:                                                                                                      |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     | Cash and cash equivalents                                                                                        |                                                                                         | $                                          | 43,996   |             |         | $           | 45,566   |   
|                                                                                                                     | Short-term investments                                                                                           |                                                                                         |                                            | 9,730    |             |         |             | 32,683   |   
|                                                                                                                     | Accounts receivable, less allowance for doubtful accounts of
$932 (October 31, 2001) and $573 (January 31, 2001) |                                                                                         |                                            | 10,017   |             |         |             | 11,253   |   
|                                                                                                                     | Finished goods inventory                                                                                         |                                                                                         |                                            | 2,972    |             |         |             | 2,567    |   
|                                                                                                                     | Other current assets                                                                                             |                                                                                         |                                            | 1,580    |             |         |             | 2,379    |   
|                                                                                                                     | Restricted cash                                                                                                  |                                                                                         |                                            | 826      |             |         |             | 1,115    |   
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     |                                                                                                                  |                                                                                         | Total current assets                       |          |             | 69,121  |             |          |    | 95,563  | 
|Restricted cash                                                                                                      |                                                                                                                  |                                                                                         | 827                                        |          |             |         | 3,653       |         
|Property and equipment, net                                                                                          |                                                                                                                  |                                                                                         | 7,415                                      |          |             |         | 5,886       |         
|Goodwill, net of accumulated amortization of $19,085 (October
31, 2001) and $11,603 (January 31, 2001)               |                                                                                                                  |                                                                                         | 16,738                                     |          |             |         | 24,139      |         
|Other intangible assets, net of accumulated amortization of
$15,842 (October 31, 2001) and $9,604 (January 31, 2001) |                                                                                                                  |                                                                                         | 17,358                                     |          |             |         | 23,596      |         
|Deposits and other assets                                                                                            |                                                                                                                  |                                                                                         | 780                                        |          |             |         | 1,061       |         
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     |                                                                                                                  |                                                                                         | Total assets                               |          | $           | 112,239 |             |          | $  | 153,898 | 
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|Liabilities and Stockholders Equity                                                                                 |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|Current liabilities:                                                                                                 |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     | Accounts payable                                                                                                 |                                                                                         | $                                          | 5,834    |             |         | $           | 5,990    |   
|                                                                                                                     | Accrued liabilities                                                                                              |                                                                                         |                                            | 11,309   |             |         |             | 9,295    |   
|                                                                                                                     | Acquisition consideration payable                                                                                |                                                                                         |                                            | 2,000    |             |         |             | 2,000    |   
|                                                                                                                     | Deferred revenue                                                                                                 |                                                                                         |                                            | 11,670   |             |         |             | 8,122    |   
|                                                                                                                     | Other current liabilities                                                                                        |                                                                                         |                                            | 240      |             |         |             | 373      |   
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     |                                                                                                                  |                                                                                         | Total current liabilities                  |          |             | 31,053  |             |          |    | 25,780  | 
|Deferred revenue, less current portion                                                                               |                                                                                                                  |                                                                                         | 1,402                                      |          |             |         | 1,240       |         
|Other liabilities                                                                                                    |                                                                                                                  |                                                                                         | 338                                        |          |             |         | 563         |         
|Stockholders equity:                                                                                                |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     | Preferred stock, par value $0.001:                                                                               |                                                                                         |                                            |          |             |         |             |          |   
|                                                                                                                     |                                                                                                                  | Authorized shares  20,000                                                              |                                            |          |             |         |             |          |    |        
|                                                                                                                     |                                                                                                                  | No shares issued and outstanding                                                        |                                            |          |            |         |             |          |   |        
|                                                                                                                     | Common stock, par value $0.001:                                                                                  |                                                                                         |                                            |          |             |         |             |          |   
|                                                                                                                     |                                                                                                                  | Authorized shares  250,000                                                             |                                            |          |             |         |             |          |    |        
|                                                                                                                     |                                                                                                                  | Issued and outstanding shares  46,509 (October 31, 2001) and
46,044 (January 31, 2001) |                                            |          | 47          |         |             |          | 46 |        
|                                                                                                                     | Additional paid-in capital                                                                                       |                                                                                         |                                            | 354,616  |             |         |             | 354,415  |   
|                                                                                                                     | Deferred compensation                                                                                            |                                                                                         |                                            | (408     | )           |         |             | (1,314   | ) 
|                                                                                                                     | Accumulated other comprehensive income (loss)                                                                    |                                                                                         |                                            | 16       |             |         |             | (714     | ) 
|                                                                                                                     | Accumulated deficit                                                                                              |                                                                                         |                                            | (274,825 | )           |         |             | (226,118 | ) 
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     |                                                                                                                  |                                                                                         | Total stockholders equity                 |          |             | 79,446  |             |          |    | 126,315 | 
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         
|                                                                                                                     |                                                                                                                  |                                                                                         | Total liabilities and stockholders equity |          | $           | 112,239 |             |          | $  | 153,898 | 
|                                                                                                                     |                                                                                                                  |                                                                                         |                                            |          |             |         |             |         

See accompanying notes.

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

|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |         |        | 
|------------------------ | -------------------------------------------- | ------------------------ | ------- | ------------------------------ | ------ | ----------------------------- | ------- | ------- | ------ | ---- | ------- | ------- | ------ |  | ------- | ------- | ------ | 
|                         |                                              |                          |         | Three Months Ended October 31, |        | Nine Months Ended October 31,
|                         |                                              |                          |         |                                |        |                              
|                         |                                              |                          |         | 2001                           |        | 2000                          |         | 2001    |        | 2000
|                         |                                              |                          |         |                                |        |                               |         |         |        |     
|Revenues:                |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Software licenses                            |                          | $       | 7,231                          |        |                               | $       | 6,011   |        |      | $       | 26,862  |        |  | $       | 72,310  |       
|                         | Internet subscriptions                       |                          |         | 2,287                          |        |                               |         | 1,465   |        |      |         | 5,611   |        |  |         | 3,079   |       
|                         | Professional services                        |                          |         | 2,754                          |        |                               |         | 2,467   |        |      |         | 6,840   |        |  |         | 6,800   |       
|                         | Hardware and other                           |                          |         | 1,082                          |        |                               |         | 1,162   |        |      |         | 4,165   |        |  |         | 4,449   |       
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total revenues           |         |                                | 13,354 |                               |         |         | 11,105 |      |         |         | 43,478 |  |         |         | 86,638 | 
|Cost of revenues:        |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Software licenses                            |                          |         | 1,634                          |        |                               |         | 1,149   |        |      |         | 5,203   |        |  |         | 13,295  |       
|                         | Internet subscriptions                       |                          |         | 514                            |        |                               |         | 374     |        |      |         | 1,434   |        |  |         | 1,124   |       
|                         | Professional services                        |                          |         | 1,312                          |        |                               |         | 1,281   |        |      |         | 4,094   |        |  |         | 3,387   |       
|                         | Hardware and other                           |                          |         | 837                            |        |                               |         | 714     |        |      |         | 3,075   |        |  |         | 2,769   |       
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total cost of revenues   |         |                                | 4,297  |                               |         |         | 3,518  |      |         |         | 13,806 |  |         |         | 20,575 | 
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|Gross profit             |                                              |                          | 9,057   |                                |        |                               | 7,587   |         |        |      | 29,672  |         |        |  | 66,063  |        
|Operating expenses:      |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Sales and marketing                          |                          |         | 11,911                         |        |                               |         | 11,355  |        |      |         | 37,781  |        |  |         | 43,995  |       
|                         | Technology and development                   |                          |         | 6,015                          |        |                               |         | 6,246   |        |      |         | 19,294  |        |  |         | 18,280  |       
|                         | General and administrative                   |                          |         | 3,923                          |        |                               |         | 2,807   |        |      |         | 9,163   |        |  |         | 7,234   |       
|                         | Stock-based compensation                     |                          |         | 142                            |        |                               |         | 378     |        |      |         | 635     |        |  |         | 2,018   |       
|                         | Amortization of intangible assets            |                          |         | 4,577                          |        |                               |         | 4,521   |        |      |         | 13,720  |        |  |         | 11,475  |       
|                         | Restructuring                                |                          |         |                               |        |                               |         |        |        |      |         |        |        |  |         | 1,600   |       
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total operating expenses |         |                                | 26,568 |                               |         |         | 25,307 |      |         |         | 80,593 |  |         |         | 84,602 | 
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|Loss from operations     |                                              |                          | (17,511 | )                              |        |                               | (17,720 | )       |        |      | (50,921 | )       |        |  | (18,539 | )      
|Interest income          |                                              |                          | 475     |                                |        |                               | 1,622   |         |        |      | 2,285   |         |        |  | 4,938   |        
|Interest expense         |                                              |                          | (34     | )                              |        |                               | (53     | )       |        |      | (71     | )       |        |  | (85     | )      
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Net loss                                     |                          | $       | (17,070                        | )      |                               | $       | (16,151 | )      |      | $       | (48,707 | )      |  | $       | (13,686 | )     
|Preferred stock dividend |                                              |                          |        |                                |        |                               |        |         |        |      |        |         |        |  | (16,506 | )      
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Net loss attributable to common
stockholders |                          | $       | (17,070                        | )      |                               | $       | (16,151 | )      |      | $       | (48,707 | )      |  | $       | (30,192 | )     
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|Net loss per share:      |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Basic and diluted                            |                          | $       | (0.37                          | )      |                               | $       | (0.35   | )      |      | $       | (1.05   | )      |  | $       | (0.70   | )     
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        
|                         | Weighted average shares  basic
and diluted  |                          |         | 46,503                         |        |                               |         | 45,704  |        |      |         | 46,299  |        |  |         | 43,404  |       
|                         |                                              |                          |         |                                |        |                               |         |         |        |      |         |         |        |  |         |        

See accompanying notes.

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

|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |         |        |         |         |  
|-------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ------------------------------------------------- | ------------------------- | --------------------------------------------------------- | ------ | ----------------------------- | ------- | ------- | ------ | ------- | ------- | -
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        | Nine Months Ended October 31,
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |        
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        | 2001                          |         | 2000   
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|Operating activities:                                                |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Net loss                                                                                         |                                                   | $                         | (48,707                                                   | )      |                               | $       | (13,686 | )     
|                                                                     | Adjustments to reconcile net loss to net cash used in operating activities:                      |                                                   |                           |                                                           |        |                               |         |         |       
|                                                                     |                                                                                                  | Depreciation and amortization                     |                           |                                                           | 2,230  |                               |         |         | 1,230  |        
|                                                                     |                                                                                                  | Provision for doubtful accounts                   |                           |                                                           | 359    |                               |         |         | 313    |        
|                                                                     |                                                                                                  | Amortization of intangible assets                 |                           |                                                           | 13,720 |                               |         |         | 11,475 |        
|                                                                     |                                                                                                  | Amortization of deferred stock-based compensation |                           |                                                           | 635    |                               |         |         | 2,018  |        
|                                                                     |                                                                                                  | Change in deferred advertising expense            |                           |                                                           |       |                               |         |         | 400    |        
|                                                                     |                                                                                                  | Restructuring charge, non-cash portion            |                           |                                                           |       |                               |         |         | 1,038  |        
|                                                                     |                                                                                                  | Changes in operating assets and liabilities:      |                           |                                                           |        |                               |         |         |        |        
|                                                                     |                                                                                                  |                                                   | Accounts receivable       |                                                           |        | 877                           |         |         |        | 4,573   |        
|                                                                     |                                                                                                  |                                                   | Inventory                 |                                                           |        | (405                          | )       |         |        | (1,381  | )      
|                                                                     |                                                                                                  |                                                   | Deferred cost of revenue  |                                                           |        |                              |         |         |        | 8,709   |        
|                                                                     |                                                                                                  |                                                   | Deposits and other assets |                                                           |        | 1,080                         |         |         |        | (516    | )      
|                                                                     |                                                                                                  |                                                   | Accounts payable          |                                                           |        | (156                          | )       |         |        | (877    | )      
|                                                                     |                                                                                                  |                                                   | Deferred revenue          |                                                           |        | 3,710                         |         |         |        | (45,497 | )      
|                                                                     |                                                                                                  |                                                   | Accrued liabilities       |                                                           |        | 2,014                         |         |         |        | (3,750  | )      
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     |                                                                                                  |                                                   |                           | Net cash flows used in operating activities               |        |                               | (24,643 | )       |        |         | (35,951 | )
|Investing activities:                                                |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Purchase of short-term investments                                                               |                                                   |                           | (8,489                                                    | )      |                               |         | (21,085 | )     
|                                                                     | Maturities of short-term investments                                                             |                                                   |                           | 32,172                                                    |        |                               |         | 11,912  |       
|                                                                     | Purchase of property and equipment                                                               |                                                   |                           | (3,760                                                    | )      |                               |         | (2,067  | )     
|                                                                     | Release of restrictions on cash                                                                  |                                                   |                           | 3,115                                                     |        |                               |         |        |       
|                                                                     | Net cash paid for the acquisition of eduTest                                                     |                                                   |                           |                                                          |        |                               |         | (2,645  | )     
|                                                                     | Net cash paid for the acquisition of LearningPlanet.com                                          |                                                   |                           |                                                          |        |                               |         | (200    | )     
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     |                                                                                                  |                                                   |                           | Net cash flows provided by (used in) investing activities |        |                               | 23,038  |         |        |         | (14,085 | )
|Financing activities:                                                |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Proceeds from issuance of common stock                                                           |                                                   |                           | 393                                                       |        |                               |         | 114,740 |       
|                                                                     | Principal repayments on capital leases                                                           |                                                   |                           | (358                                                      | )      |                               |         | (369    | )     
|                                                                     | Principal repayments on notes payable                                                            |                                                   |                           |                                                          |        |                               |         | (172    | )     
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     |                                                                                                  |                                                   |                           | Net cash flows provided by financing activities           |        |                               | 35      |         |        |         | 114,199 |  
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Increase (decrease) in cash and cash equivalents                                                 |                                                   |                           | (1,570                                                    | )      |                               |         | 64,163  |       
|                                                                     | Cash and cash equivalents at beginning of period                                                 |                                                   |                           | 45,566                                                    |        |                               |         | 5,033   |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Cash and cash equivalents at end of period                                                       |                                                   | $                         | 43,996                                                    |        |                               | $       | 69,196  |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|Supplemental disclosure of cash flow information:                    |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Interest paid                                                                                    |                                                   | $                         | 71                                                        |        |                               | $       | 85      |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|Supplemental schedule of noncash investing and financing activities: |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Deferred stock-based compensation                                                                |                                                   | $                         | (271                                                      | )      |                               | $       | (1,096  | )     
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Conversion of convertible preferred stock into common stock                                      |                                                   | $                         |                                                          |        |                               | $       | 52      |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Issuance of common stock related to the acquisitions of Academic, eduTest
and LearningPlanet.com |                                                   | $                         | 80                                                        |        |                               | $       | 14,490  |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Issuance of common stock as preferred stock dividend                                             |                                                   | $                         |                                                          |        |                               | $       | 16,506  |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        
|                                                                     | Additional consideration related to the acquisition of eduTest                                   |                                                   | $                         |                                                          |        |                               | $       | 2,000   |       
|                                                                     |                                                                                                  |                                                   |                           |                                                           |        |                               |         |        

See accompanying notes.

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LIGHTSPAN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements of Lightspan,
Inc., which include the accounts of its wholly owned subsidiaries, Academic
Systems Corporation (Academic) and Edutest, Inc. (eduTest or
eduTest.com), have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments, consisting of normal recurring
items considered necessary for a fair presentation, have been included in the
accompanying unaudited consolidated financial statements. All significant
intercompany transactions and balances have been eliminated in consolidation.
Historically, the operating results for Lightspan, Inc., Academic and eduTest
(collectively Lightspan or the Company) have varied significantly from
quarter to quarter because of seasonal influences on demand for its Lightspan
Achieve Now, fee-based subscription Internet and Academic curricula products
and services based on school calendars, budget cycles, the sources and timing
of school districts funding. The Companys operating results are expected to
continue to vary significantly from quarter to quarter as a result of the same
influences. Operating results for the three and nine months ended October 31,
2001, or for any other interim period are not necessarily indicative of the
results that may be expected for the full year ending January 31, 2002. For
further information, refer to the consolidated financial statements and notes
thereto, included in the Companys Annual Report on Form 10-K for the fiscal
year ended January 31, 2001.

Organization and Business Activity

The Company was founded in 1993, as The Lightspan Partnership, Inc. and
changed its name to Lightspan, Inc. on April 10, 2000. The Company provides
curriculum-based educational software and Internet products and services to
schools and school districts that are used both in the 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.
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. AcademicOnline 2000 is the Web-enhanced Interactive
Mathematics and Interactive English product line which colleges may implement
using client workstations that are located solely within an intranet, on the
Internet (a distance learning configuration), or with a combination of intranet
and Internet-based workstations. Academic.com is a complete Internet-based
product offering that helps faculty create, manage and teach courses online and
offers a complete suite of instructional tools, content and services. EduTests
product, eduTest Online Assessment Center, offers 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. The results can be analyzed at the school district,
the individual school and the classroom levels.

Revenue

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

In software arrangements that include multiple elements, such as those
that include rights to software products, customer support and product
implementation and training services, the Company allocates the total revenue
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.

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Software Licenses

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 32 to 35 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.

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 Lightspan 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.

As of April 30, 2000, the Company 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 of $46.4 million of revenue previously deferred and the recognition
of $8.4 million of previously deferred expenses as cost of revenue, pursuant to
AICPA Statement of Position (SOP) 97-2 as discussed below. As of July 31,
2000, the Company 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, the Company did not defer revenue
relating to Lightspan Achieve Now licenses that were shipped as the Company had
completed the development of all Lightspan Achieve Now titles.

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.

Internet Subscriptions

Revenue derived from fee-based Internet subscriptions including The
Lightspan Network, eduTest Online Assessment Center and Academic.com is
recognized on a straight-line basis over the term of the agreement, generally
one year. Fees charged for building routine interfaces with fee-based Internet
subscriptions are treated as service elements and recognized in accordance with
standard implementation plans that Lightspan establishes for its customers.

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 technical
services that include adding specific content to Web sites is recognized upon
customer acceptance of agreed upon deliverables. Revenue derived from
telephone support and maintenance

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arrangements provided by the professional development organization is
recognized ratably over the term of the support and maintenance period,
generally one year.

Hardware

Hardware revenue derived from the sale of PlayStation game consoles and
related accessories is recognized upon shipment of the console and the related
software product.

Reclassifications

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

2. Stockholders Equity

Lightspan computes net loss per share in accordance with Statement of
Financial Accounting Standards (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 were
excluded from diluted loss per share for the three and nine months ended
October 31, 2001 and 2000 because the Company had a net loss for the period and
the inclusion of outstanding stock options and warrants would be anti-dilutive.

3. Comprehensive Income (Loss)

Included in the Companys cash equivalents for the year ended January 31,
2001 was an investment in short-term commercial paper of Pacific Gas and
Electric, which filed for Chapter 11 bankruptcy in April 2001. Accordingly,
the Company recorded an unrealized loss related to this investment in other
comprehensive loss in the statement of stockholders equity for the year ended
January 31, 2001. During April 2001, the Companys third-party investment
manager repurchased this security at par value. As a result, the Company
revised the unrealized loss included in comprehensive income (loss) in April
2001.

For the three months ended October 31, 2001 and 2000, comprehensive loss
was $17.1 million and $16.1 million, respectively. There were no net
unrealized holding gains or losses for the three months ended October 31, 2001
and 2000. For the nine months ended October 31, 2001 and 2000, comprehensive
loss was $48.0 million and $13.7 million, respectively. The difference between
net loss and comprehensive loss for the nine months ended October 31, 2001 was
due to net unrealized income on available-for-sale securities of $0.7 million.

4. Reportable Segments

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. It also establishes standards for related disclosures about products
and services, geographic areas and major customers.

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

Lightspan has two reportable segments: K-12 and Higher Education.
Revenues derived from the K-12 segment include the sale of Lightspan Achieve
Now software licenses, subscription fees for The Lightspan Network and
eduTest.com products, implementation, training and support services and
hardware and related accessories. Revenues derived from the Higher Education
segment, comprised solely of Academic, include the sale of curriculum

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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.

Financial Information for Lightspans Segments

The following information is for the K-12 and Higher Education segments
(in thousands):

|                                  |                                             |   |                                     |       |           |   |              |       |  |   |         |       |  
|--------------------------------- | ------------------------------------------- | - | ----------------------------------- | ----- | --------- | - | ------------ | ----- |  | - | ------- | ----- | -
|                                  |                                             |   | Three Months Ended October 31, 2001
|                                  |                                             |   |                                    
|                                  |                                             |   |                                     |       |           |   | Higher       |       |  |   |        
|                                  |                                             |   | K-12                                |       | Education |   | Consolidated
|                                  |                                             |   |                                     |       |           |   |             
|Revenues from external customers  |                                             | $ | 11,853                              |       |           | $ | 1,501        |       |  | $ | 13,354  |      
|Interest income, net              |                                             |   | 441                                 |       |           |   |             |       |  |   | 441     |      
|Depreciation and amortization     |                                             |   | 746                                 |       |           |   | 109          |       |  |   | 855     |      
|Segment loss from operations      |                                             |   | (11,934                             | )     |           |   | (5,577       | )     |  |   | (17,511 | )    
|Segment assets                    |                                             |   | 83,672                              |       |           |   | 28,567       |       |  |   | 112,239 |      
|Other significant non cash items: |                                             |   |                                     |       |           |   |              |       |  |   |         |      
|                                  | Deferred stock compensation                 |   |                                     | (25   | )         |   |              |      |  |   |         | (25   | )
|                                  | Amortization of deferred stock
compensation |   |                                     | 137   |           |   |              | 5     |  |   |         | 142   |  
|                                  | Amortization of intangible assets           |   |                                     | 1,582 |           |   |              | 2,995 |  |   |         | 4,577 |  

|                                  |                                             |   |                                     |       |           |   |              |       |   |   |         |       |  
|--------------------------------- | ------------------------------------------- | - | ----------------------------------- | ----- | --------- | - | ------------ | ----- | - | - | ------- | ----- | -
|                                  |                                             |   | Three Months Ended October 31, 2000
|                                  |                                             |   |                                    
|                                  |                                             |   |                                     |       |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                                |       | Education |   | Consolidated
|                                  |                                             |   |                                     |       |           |   |             
|Revenues from external customers  |                                             | $ | 9,417                               |       |           | $ | 1,688        |       |   | $ | 11,105  |      
|Interest income, net              |                                             |   | 1,569                               |       |           |   |             |       |   |   | 1,569   |      
|Depreciation and amortization     |                                             |   | 351                                 |       |           |   | 107          |       |   |   | 458     |      
|Segment loss from operations      |                                             |   | (11,922                             | )     |           |   | (5,798       | )     |   |   | (17,720 | )    
|Segment assets                    |                                             |   | 138,533                             |       |           |   | 29,975       |       |   |   | 168,508 |      
|Other significant non cash items: |                                             |   |                                     |       |           |   |              |       |   |   |         |      
|                                  | Deferred stock compensation                 |   |                                     | (665  | )         |   |              | (25   | ) |   |         | (690  | )
|                                  | Amortization of deferred stock
compensation |   |                                     | 374   |           |   |              | 4     |   |   |         | 378   |  
|                                  | Amortization of intangible assets           |   |                                     | 1,607 |           |   |              | 2,914 |   |   |         | 4,521 |  

|                                  |                                             |   |                                    |       |           |   |              |       |   |   |         |        |  
|--------------------------------- | ------------------------------------------- | - | ---------------------------------- | ----- | --------- | - | ------------ | ----- | - | - | ------- | ------ | -
|                                  |                                             |   | Nine Months Ended October 31, 2001
|                                  |                                             |   |                                   
|                                  |                                             |   |                                    |       |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                               |       | Education |   | Consolidated
|                                  |                                             |   |                                    |       |           |   |             
|Revenues from external customers  |                                             | $ | 35,900                             |       |           | $ | 7,578        |       |   | $ | 43,478  |       
|Interest income, net              |                                             |   | 2,211                              |       |           |   | 3            |       |   |   | 2,214   |       
|Depreciation and amortization     |                                             |   | 1,968                              |       |           |   | 262          |       |   |   | 2,230   |       
|Segment loss from operations      |                                             |   | (36,469                            | )     |           |   | (14,452      | )     |   |   | (50,921 | )     
|Segment assets                    |                                             |   | 83,672                             |       |           |   | 28,567       |       |   |   | 112,239 |       
|Other significant non cash items: |                                             |   |                                    |       |           |   |              |       |   |   |         |       
|                                  | Deferred stock compensation                 |   |                                    | (260  | )         |   |              | (11   | ) |   |         | (271   | )
|                                  | Amortization of deferred stock
compensation |   |                                    | 614   |           |   |              | 21    |   |   |         | 635    |  
|                                  | Amortization of intangible assets           |   |                                    | 4,735 |           |   |              | 8,985 |   |   |         | 13,720 |  

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|                                  |                                             |   |                                    |        |           |   |              |       |   |   |         |        |  
|--------------------------------- | ------------------------------------------- | - | ---------------------------------- | ------ | --------- | - | ------------ | ----- | - | - | ------- | ------ | -
|                                  |                                             |   | Nine Months Ended October 31, 2000
|                                  |                                             |   |                                   
|                                  |                                             |   |                                    |        |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                               |        | Education |   | Consolidated
|                                  |                                             |   |                                    |        |           |   |             
|Revenues from external customers  |                                             | $ | 79,994                             |        |           | $ | 6,644        |       |   | $ | 86,638  |       
|Interest income (expense), net    |                                             |   | 4,854                              |        |           |   | (1           | )     |   |   | 4,853   |       
|Depreciation and amortization     |                                             |   | 970                                |        |           |   | 260          |       |   |   | 1,230   |       
|Restructuring charge              |                                             |   | 1,600                              |        |           |   |             |       |   |   | 1,600   |       
|Segment loss from operations      |                                             |   | (3,217                             | )      |           |   | (15,322      | )     |   |   | (18,539 | )     
|Segment assets                    |                                             |   | 138,533                            |        |           |   | 29,975       |       |   |   | 168,508 |       
|Other significant non cash items: |                                             |   |                                    |        |           |   |              |       |   |   |         |       
|                                  | Deferred stock compensation                 |   |                                    | (1,050 | )         |   |              | (46   | ) |   |         | (1,096 | )
|                                  | Amortization of deferred stock
compensation |   |                                    | 1,968  |           |   |              | 50    |   |   |         | 2,018  |  
|                                  | Amortization of intangible assets           |   |                                    | 2,780  |           |   |              | 8,695 |   |   |         | 11,475 |  

5. Recently Issued Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Statement, or SFAS, No. 141, Business
Combinations. SFAS No. 141 addresses financial accounting and reporting for
business combinations and it requires business combinations in the scope of
this statement to be accounted for using the purchase method. The provisions of
this statement apply to all business combinations initiated after June 30,
2001. The Company does not believe that the adoption of this statement will
have a material impact on its results of operations, financial position or cash
flows.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other acquired assets. It addresses how intangible assets that are
acquired individually or with a group of other assets (but not those acquired
in a business combination) should be accounted for in financial statements upon
their acquisition. This statement also addresses how goodwill and other
intangible assets should be accounted for after they have been initially
recognized in the financial statements. With the adoption of this statement,
goodwill is no longer subject to amortization over its estimated useful life.
Goodwill will be assessed for impairment at least annually using
fair-value-based tests. This statement becomes effective for fiscal years
beginning after December 15, 2001. The Company is currently assessing the
impact of the adoption of this statement and, while the Company is not aware of
any impairment charges, an analysis will be done upon adoption of this
statement to determine if an impairment charge is necessary. As such, the
Company has not yet determined the effect SFAS No. 142 will have on its results
of operations or financial position.

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

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, in that it removes goodwill from its impairment
scope and allows for different approaches in cash flow estimation. However,
SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for (a)
recognition and measurement of the impairment of long-lived assets to be held
and used and (b) measurement of long-lived assets to be disposed of. SFAS No.
144 also supercedes the business segment concept in APB Opinion No. 30,
Reporting the Results of OperationsReporting the Effects of Disposal of a
Segment of a

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Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, in that it permits presentation of a component of an entity,
whether classified as held for sale or disposed of, as a discontinued
operation. However, SFAS No. 144 retains the requirement of APB Opinion No. 30
to report discontinued operations separately from continuing operations. This
statement becomes effective for fiscal years beginning after December 15, 2001
with earlier application encouraged. The Company believes that the
implementation of this standard will not have a material effect on the
Companys results of operations or financial position.




Item 2.Managements Discussion and Analysis of Financial Condition and
Operating Results

Statements in this document, other than the statements of historical
information, are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. We may identify these statements by the use of words such as will,
may, might, could, should, believe, expect, anticipate, intend,
plan, predict, project, estimate, potential, continue, and similar
expressions. These statements are only predictions. Actual events or results
may differ materially. Such forward-looking statements involve known and
unknown risks and other factors which may cause our actual results in future
periods to differ materially from those expressed in any forward-looking
statements. These risks and factors include those discussed below under the
headings Liquidity and Capital Resources and Risks and Uncertainties. You
should also carefully review the risks described in other documents we file
from time to time with the Securities and Exchange Commission. We caution that
the risks and factors discussed below and in such filings are not exclusive.
We do not undertake to update any forward-looking statement that may be made
from time to time by or on behalf of the Company. You are urged to carefully
review and consider the various disclosures in this report and in our other
reports filed with the Securities and Exchange Commission that attempt to
advise you of certain risks and factors that may affect our business. You are
cautioned not to place undue reliance on these forward-looking statements to
reflect events or circumstances occurring after the date hereof.

The following should be read in conjunction with our consolidated
financial statements and notes to these consolidated financial statements.

Results of Operations

We have incurred significant losses since our inception and, as of October
31, 2001, have accumulated losses of approximately $258.3 million. We expect to
continue to incur operating losses for the foreseeable future. In the nine
months ended October 31, 2000 we had 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 in the first and second
quarters of fiscal 2001 of $46.4 million and $2.0 million, respectively, of
revenue previously deferred pursuant to SOP 97-2 as described below. The
operating results in the first and second quarters of fiscal 2001 are not
indicative of our underlying business in those quarters, and are not indicative
of results that may be expected for any subsequent quarter.

Revenue

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 $2.0 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.

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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 nine
months ended October 31, 2000, we recognized $8.8 million in cost of license
revenue when we recognized the related $48.5 million in revenue.

The following table summarizes the activity in software license revenue
and associated cost of license revenue deferred pursuant to SOP 97-2 for the
nine months ended October 31, 2000 (in thousands):

|                                                         |                              |                |   |                   |   | 
|-------------------------------------------------------- | ---------------------------- | -------------- | - | ----------------- | - | 
|                                                         |                              |                |   | Nine Months Ended
|                                                         |                              |                |   | October 31, 2000 
|                                                         |                              |                |   |                  
|Deferred license revenue - Lightspan Achieve Now         |                              |                |   |                  
|                                                         | Beginning balance            |                | $ | 48,110            |  
|                                                         | Deferred during the period   |                |   | 384               |  
|                                                         | Recognized during the period |                |   | (48,494           | )
|                                                         |                              |                |   |                   |  
|                                                         |                              | Ending balance |   | $                 |  | 
|                                                         |                              |                |   |                   |  
|Deferred cost of license revenue - Lightspan Achieve Now |                              |                |   |                  
|                                                         | Beginning balance            |                | $ | 8,709             |  
|                                                         | Deferred during the period   |                |   | 70                |  
|                                                         | Recognized during the period |                |   | (8,779            | )
|                                                         |                              |                |   |                   |  
|                                                         |                              | Ending balance |   | $                 |  | 
|                                                         |                              |                |   |                   |  

Comparison of Three and Nine Months Ended October 31, 2001 and 2000

Revenues

We generate revenues from fees from the sale of software licenses,
Internet subscriptions, professional services and hardware. Our total revenues
increased 20 percent to $13.4 million in the three months ended October 31,
2001 from $11.1 million in the three months ended October 31, 2000 primarily
due to the increase in software licenses revenue from selling more licenses and
the increase in Internet subscription revenue relating to our increased
subscriber base. Our total revenues decreased 50 percent to $43.5 million in
the nine months ended October 31, 2001 from $86.6 million in the nine months
ended October 31, 2000 primarily due to the recognition in the nine months
ended October 31, 2000 of $48.1 million in previously deferred software license
revenue, as described in Revenue above.

Software Licenses.Our software license revenues increased 20 percent to
$7.2 million in the three months ended October 31, 2001 from $6.0 million in
the three months ended October 31, 2000 primarily due to an increase in
Lightspan Achieve Now licenses sold. Our software license revenues decreased
63 percent to $26.9 million in the nine months ended October 31, 2001 from
$72.3 million in the nine months ended October 31, 2000 primarily due to the
recognition of $48.1 million in Lightspan Achieve Now revenue previously
deferred in fiscal years 2000 and 1999, as described in Revenue above.

Internet Subscriptions. Our Internet subscription revenues increased 56
percent to $2.3 million in the three months ended October 31, 2001 from $1.5
million in the three months ended October 31, 2000 and increased 82 percent to
$5.6 million in the nine months ended October 31, 2001 from $3.1 million in the
nine months ended October 31, 2000 primarily due to an increase in the base of
customers subscribing to our fee-based Internet subscription products.
Customers subscribing to our Internet subscription products, The Lightspan
Network and eduTest.com, increased 27 percent to approximately 3,400 at October
31, 2001 from approximately 2,700 at October 31, 2000.

Professional Services.Our professional service revenues increased 12
percent to $2.8 million in the three months ended October 31, 2001 from $2.5
million in the three months ended October 31, 2000 primarily due to the
increase in the billable hours for professional services. Our professional
service revenues reflect no significant change for the nine months ended
October 31, 2001 compared to the nine months ended October 31, 2000.

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Cost of Revenues

Our total cost of revenues increased 22 percent to $4.3 million for the
three months ended October 31, 2001 from $3.5 million for the three months
ended October 31, 2000, corresponding to the increase in total revenues. For
the nine months ended October 31, 2001, total cost of revenues decreased 33
percent to $13.8 million from $20.6 million for the nine months ended October
31, 2000 due primarily to an $8.6 million decrease in software license cost of
revenues related to the sale of Lightspan Achieve Now licenses previously
deferred in fiscal years 2000 and 1999, as described in Revenue above. For
the three months ended October 31, 2001 and 2000, gross margin as a percentage
of total revenues was 68 percent. Gross margin as a percentage of total
revenues decreased 8 percentage points to 68 percent in the nine months ended
October 31, 2001 from 76 percent in the nine months ended October 31, 2000
primarily due to the higher gross margin on revenues derived from sales of
Lightspan Achieve Now licenses, which were entirely deferred for fiscal years
2000 and 1999 and recognized in the first two quarters of the nine months ended
October 31, 2000.

Expenses

Sales and Marketing.Our sales and marketing expenses increased 5 percent
to $11.9 million for the three months ended October 31, 2001 from $11.4 million
for the three months ended October 31, 2000 primarily due to the increase in
commissions from the increase in sales. Our sales and marketing expenses
decreased 14 percent to $37.8 million for the nine months ended October 31,
2001 from $44.0 million for the nine months ended October 31, 2000 primarily
due to a decrease in promotional activities connected to the launch of
Lightspan.com in the first quarter of 2000 and a refocus of our sales and
marketing efforts toward fee-based subscription Internet products and away from
our free Internet products.

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

Technology and Development.Our technology and development expenses
decreased 4 percent to $6.0 million for the three months ended October 31, 2001
from $6.2 million for the three months ended October 31, 2000 due to our
continued refocus toward subscription based Internet products and away from the
design of free Internet products. Technology and development expenses
increased 6 percent to $19.3 million for the nine months ended October 31, 2001
from $18.3 million for the nine months ended October 31, 2000 primarily due to
increased development expenses associated with our fee-based Internet products.

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

General and Administrative.Our general and administrative expenses
increased 40 percent to $3.9 million for the three months ended October 31,
2001 from $2.8 million for the three months ended October 31, 2000 and
increased 27 percent to $9.1 million for the nine months ended October 31, 2001
from $7.2 million for the nine months ended October 31, 2000 primarily due to
certain non-recurring severance accruals relating to staff reductions and
increased 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 $0.1
million and $0.4 million for the three months ended October 31, 2001 and 2000,
respectively, and $0.6 million and $2.0 million for the nine months ended
October 31, 2001 and 2000, respectively. Stock-based compensation is the
result of our granting of stock options to

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employees with exercise prices per share below the fair values per share
for our common stock on the dates those options were granted. 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
October 31, 2001, there was approximately $0.4 million to be amortized in
future periods.

Amortization of Intangible Assets.We recorded intangible assets related
to our acquisitions in prior periods totaling an aggregate of approximately
$69.0 million, including goodwill of $35.8 million and amortize them over their
respective useful lives, ranging from three to ten years. Amortization expense
of goodwill and intangible assets increased to $13.7 million for the nine
months ended October 31, 2001 from $11.5 million for the nine months ended
October 31, 2000, due to the amortization expense relating to the purchase of
eduTest in July 2000. See note 5 to our consolidated financial statements for
a discussion of changes we will make in accounting for goodwill and intangible
assets.

Interest Income (Expense).Our net interest income decreased 72 percent
to $0.4 million for the three months ended October 31, 2001 from $1.6 million
for the three months ended October 31, 2000 and decreased 54 percent to $2.2
million for the nine months ended October 31, 2001 from $4.9 million for the
nine months ended October 31, 2000 as a result of lower cash balances and a
reduction in the market yield on such investments.

Liquidity and Capital Resources

From inception through October 2001, 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. At October 31, 2001, we had $44.0 million of cash and cash
equivalents, $9.7 million in short-term investments and $1.7 million in
restricted cash for a total of $55.4 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 losses
since our inception and expect to continue to incur losses for the foreseeable
future.

Our working capital has fluctuated significantly since our inception. This
is due 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.

Net cash used in operating activities decreased $11.3 million in the nine
months ended October 31, 2001 as compared to the nine months ended October 31,
2000 primarily due the decrease in sales and marketing expenses relating to our
refocus toward subscription based Internet products from our free Internet
products and services and our continued efforts to decrease our operating costs
offset in part of by our continued development of our fee-based subscription
Internet products and services. Net cash provided by investing activities
increased $37.1 million in the nine months ended October 31, 2001 as compared
to the nine months ended October 31, 2000 primarily due to an increase in the
maturities of our short-term investments used to fund operations. Net cash
provided by financing activities decreased $114.2 million in the nine months
ended October 31, 2001 as compared to the nine months ended October 31, 2000
primarily due to the receipt of net proceeds related to our initial public
offering, underwriters exercise of their overallotment option and private
placements in the first quarter of fiscal 2001.

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

As of October 31, 2001, we believe that our cash and cash equivalents and
short-term investments will be sufficient to fund our operations and capital
requirements through at least the next 12 months. However, the actual amount
of funds that we will need during or after the next 12 months will be
determined by many factors, some of which are beyond our control, and we may
need funds sooner than currently anticipated.

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Risks and Uncertainties

Additional risks not presently known to us, or that we currently deem
immaterial, may also impair our business operations. Our business, financial
condition or results of operations may be seriously harmed by any of these
risks. You should carefully read these risks and uncertainties in evaluating
our business.

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

We began selling our Lightspan Achieve Now educational software in January
1996 and entered the Internet market by launching The Lightspan Network in
January 1997 and through our purchase of eduTest in July 2000. Academic began
selling its educational software in April 1994. Since early 1999, we have
significantly increased our efforts to expand our fee-based subscription
Internet businesses. As a result, our businesses have only a limited operating
history on which you can base your evaluation of our business and prospects.

Our quarterly operating results are volatile and difficult to predict, and if
we fail to meet the expectations of investors or security analysts, the market
price of our common stock would likely 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-three quarters ended
October 31, 2001. In addition, in fiscal years 1997 and 1998 we recognized
license revenue for our Lightspan Achieve Now product of $5.6 million and $14.8
million, respectively, in accordance with the accounting rules in effect at
that time; while in fiscal years 1999 and 2000, we did not recognize any
Lightspan Achieve Now license revenue, in accordance with new accounting rules
adopted February 1, 1998. In the quarter ended April 30, 2000, we recognized
$46.4 million in previously deferred revenue, resulting in an operating profit
of $16.2 million. In the quarter ended July 31, 2000, we recognized the
remaining $2.0 million of revenue previously deferred. The operating results
for these quarters are not indicative of our underlying business in these
quarters, and will not be indicative of results that may be expected for any
subsequent quarter, for the full year ending January 31, 2002 or for any future
years.

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

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

Since our inception, we have incurred significant losses. As of October
31, 2001 we have accumulated net losses of $258.3 million. We incurred net
losses of $32.1 million 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, $55.7 million in net losses for the fiscal year ended January
31, 2000 and $33.6 million in net losses for the fiscal year ended January 31,
1999. We expect our operating losses and negative cash flow to continue for the
foreseeable future as we incur costs and expenses related to:
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| |  | marketing and promotional activities;                                                                                                                                 
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | continued development, expansion and maintenance of our existing software
and Internet product offerings and content; and                                             
| 
| |  | amortization 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.

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
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 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.

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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. 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. If we cannot raise
funds on acceptable terms, if and when needed, we may not be able to take
advantage of future opportunities, to continue to operate or grow our business
or respond to competitive pressures or unanticipated developments.

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

We expect that expansion of our customer and revenue base will be required
to successfully implement our business strategy. For example, the development
of our business continues to require sales and marketing expenditures as well
as increased development efforts of certain products. This expansion may strain
our management, operational, financial and technological resources, as well as
the infrastructure for our Web sites and services. The growth of our Lightspan
Achieve Now educational software business may strain the resources of our
professional development staff during periods of heavy implementation in
purchasing school districts. Our growth depends on our ability to attract and
retain qualified employees (including employees of businesses that we acquire),
particularly Internet systems, 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 may be adversely impacted and we may never
become profitable.

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

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

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

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

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

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

We rely heavily on statistical studies to demonstrate that our
curriculum-based educational software increase student achievement. We believe
that these studies accurately reflect the performance of our products. However,
these studies involve the following risks:



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

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



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

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

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

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

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

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

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

Our competitors include:



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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to subjecting us to potential liability, claims of this type could require
us to change our Web sites in a manner that could be less attractive to our
customers and divert our financial and development resources.

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

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

Several of our existing senior management personnel joined us during
fiscal 2001 and fiscal 2002. Some of these individuals have not previously
worked together and are currently being integrated 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 Form
10-Q, 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 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. If litigation
were instituted on this basis, 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
45% of our common stock.

As of October 31, 2001, executive officers, directors and holders of 5% or
more of our outstanding common stock, in the aggregate, owned or controlled
approximately 45% 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.

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.




Item 3. 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 October 31, 2001. Declines in interest rates over time will,
however, reduce our interest income.

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Part II. OTHER INFORMATION




Item 1.Legal Proceedings

We are not currently involved in any material legal proceedings.




Item 2.Changes in Securities and Use of Proceeds

Recent Sales of Unregistered Securities

None.

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
October 31, 2001, $2.6 million were used to purchase eduTest and the remaining
proceeds were used primarily to fund operations or invested in short-term,
interest-bearing securities rated AA or better.




Item 3.Defaults Upon Senior Securities

None.




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

None.




Item 5.Other Information

None.




Item 6.Exhibits and Reports on Form 8-K

(a)  Current Reports on Form 8-K

We did not file any current reports on Form 8-K for the quarter ended
October 31, 2001.

(b)  Exhibits

|         |  |         |     |             |  |                                                                            |  |  |  | 
|-------- |  | ------- | --- | ----------- |  | -------------------------------------------------------------------------- |  |  |  | 
|Footnote |  | Exhibit |     |             |  |                                                                            |  | 
|Number   |  | Number  |     | Description |  |                                                                            |  | 
|         |  |         |     |             |  |                                                                            |  | 
|(1)      |  |         | 3.1 |             |  | Amended and Restated Certificate of Incorporation, as currently in effect.
|(2)      |  |         | 3.2 |             |  | Bylaws, as currently in effect.                                           
|         |  |         | 4.1 |             |  | Reference is made to Exhibits 3.1 and 3.2.                                
|(2)      |  |         | 4.2 |             |  | Specimen Stock Certificate.                                               

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---

|(1) |  | Filed as an exhibit to the Companys 2000 Annual Report on
Form 10-K, or amendments thereto, and incorporated herein by
reference.                                         
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | 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.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized on the 14th day of
December, 2001.

|                  |                                            |                      
|----------------- | ------------------------------------------ | ---------------------
|                  | Lightspan, Inc.                           
|                 
|                  | By:                                        | /s/ MICHAEL A. SICURO
|                  |                                           
|December 14, 2001 | Michael A. Sicuro,
Chief Financial Officer

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