##### Table of Contents



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

(858) 824-8000
(Registrants telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:
 Common Stock
(Title of Each Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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 August 31,
2001:    46,498,375



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TABLE OF CONTENTS



|                              |                                                                                           |  |  |  |  |  |  | 
|----------------------------- | ----------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. 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  |  | 2   
|          
|          
|          
|          
|           | Item 2. | Managements Discussion and Analysis of Financial Condition and Operating Results |  | 9   
|          
|          
|          
|          
|           | Item 3. | Quantitative and Qualitative Disclosures About Market Risk                        |  | 13  
|          
|          
|          
|          
|PART II    |         | 14                                                                               
|          
|          
|          
|          
|           | Item 1. | Legal Proceedings                                                                 |  | 14  
|          
|          
|          
|          
|           | Item 2. | Changes in Securities and Use of Proceeds                                         |  | 14  
|          
|          
|          
|          
|           | Item 3. | Defaults Upon Senior Securities                                                   |  | 14  
|          
|          
|          
|          
|           | Item 4. | Submission of Matters to a Vote of Security Holders                               |  | 14  
|          
|          
|          
|          
|           | Item 5. | Other Information                                                                 |  | 15  
|          
|          
|          
|          
|           | Item 6. | Exhibits and Reports on Form 8-K                                                  |  | 15  
|          
|          
|          
|          
|Signatures |         | 16                                                                               



1



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##### Table of Contents









PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

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

|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |          |   |         | 
|------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | -------- | ----------- | ------- | ----------- | -------- | - | ------- | 
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          | July 31,    |         | January 31,
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          | 2001        |         | 2001       
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |            
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          | (Unaudited) |         |             |          |  
|Assets                                                                                                                         |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Current assets:                                                                                                                |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Cash and cash equivalents                                                                                                                                       |  | $                                          | 40,966   |             |         | $           | 45,566   |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Short-term investments                                                                                                                                          |  |                                            | 11,151   |             |         |             | 32,683   |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Accounts receivable, less allowance for doubtful accounts of
$933 (July 31, 2001) and $573 (January 31, 2001)                                                   |  |                                            | 20,605   |             |         |             | 11,253   |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Finished goods inventory                                                                                                                                        |  |                                            | 2,441    |             |         |             | 2,567    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Other current assets                                                                                                                                            |  |                                            | 1,372    |             |         |             | 2,379    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Restricted cash                                                                                                                                                 |  |                                            | 826      |             |         |             | 1,115    |  
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                               |                                                                                                                                                                 |  | Total current assets                       |          |             | 77,361  |             |          |   | 95,563  | 
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Restricted cash                                                                                                                |                                                                                                                                                                 |  | 1,653                                      |          |             |         | 3,653       |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Property and equipment, net                                                                                                    |                                                                                                                                                                 |  | 8,158                                      |          |             |         | 5,886       |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Goodwill, net of accumulated amortization of $16,585 (July 31,
2001) and $11,603 (January 31, 2001)                            |                                                                                                                                                                 |  | 19,236                                     |          |             |         | 24,139      |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Other intangible assets                                                                                                        |                                                                                                                                                                 |  | 19,438                                     |          |             |         | 23,596      |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Deposits and other assets                                                                                                      |                                                                                                                                                                 |  | 831                                        |          |             |         | 1,061       |         
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                               |                                                                                                                                                                 |  | Total assets                               |          | $           | 126,677 |             |          | $ | 153,898 | 
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|Liabilities and Stockholders Equity                                                                                           |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Current liabilities:                                                                                                           |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Accounts payable                                                                                                                                                |  | $                                          | 2,140    |             |         | $           | 5,990    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Accrued liabilities                                                                                                                                             |  |                                            | 11,295   |             |         |             | 9,295    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Acquisition consideration payable                                                                                                                               |  |                                            | 2,000    |             |         |             | 2,000    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Deferred revenue  services and other                                                                                                                           |  |                                            | 13,008   |             |         |             | 8,122    |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Other current liabilities                                                                                                                                       |  |                                            | 280      |             |         |             | 373      |  
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                               |                                                                                                                                                                 |  | Total current liabilities                  |          |             | 28,723  |             |          |   | 25,780  | 
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Deferred revenue  services and other, less current portion                                                                    |                                                                                                                                                                 |  | 1,176                                      |          |             |         | 1,240       |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Other liabilities                                                                                                              |                                                                                                                                                                 |  | 405                                        |          |             |         | 563         |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|Stockholders
equity:
Preferred stock, par value $0.001:
   Authorized shares  20,000,000
   No shares issued and outstanding |                                                                                                                                                                 |  |                                           |          |             |         |            |         
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Common
stock, par value $0.001:
Authorized shares  250,000,000
Issued and outstanding shares  46,498,375 (July 31, 2001) and
46,044,033
   (January 31, 2001) |  |                                            | 46       |             |         |             | 46       |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Additional paid-in capital                                                                                                                                      |  |                                            | 354,633  |             |         |             | 354,415  |  
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Deferred compensation                                                                                                                                           |  |                                            | (575     | )           |         |             | (1,314   | )
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Accumulated other comprehensive income (loss)                                                                                                                   |  |                                            | 24       |             |         |             | (714     | )
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                              
|                                                                                                                               | Accumulated deficit                                                                                                                                             |  |                                            | (257,755 | )           |         |             | (226,118 | )
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                               |                                                                                                                                                                 |  | Total stockholders equity                 |          |             | 96,373  |             |          |   | 126,315 | 
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         
|                                                                                                                               |                                                                                                                                                                 |  | Total liabilities and stockholders equity |          | $           | 126,677 |             |          | $ | 153,898 | 
|                                                                                                                               |                                                                                                                                                                 |  |                                            |          |             |         |             |         

See accompanying notes.



2



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##### Table of Contents



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

|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |         |        | 
|------------------------ | -------------------------------------------- | ------------------------ | ------- | --------------------------- | ------ | ------------------------- | ------- | ------- | ------ | ---- | ------- | ------- | ------ |  | ------- | ------- | ------ | 
|                         |                                              |                          |         | Three Months Ended July 31, |        | Six Months Ended July 31,
|                         |                                              |                          |         |                             |        |                          
|                         |                                              |                          |         | 2001                        |        | 2000                      |         | 2001    |        | 2000
|                         |                                              |                          |         |                             |        |                           |         |         |        |     
|Revenues:                |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                        
|                        
|                        
|                        
|                         | Software licenses                            |                          | $       | 13,274                      |        |                           | $       | 14,099  |        |      | $       | 19,631  |        |  | $       | 66,299  |       
|                        
|                        
|                        
|                        
|                         | Internet subscriptions                       |                          |         | 1,764                       |        |                           |         | 891     |        |      |         | 3,324   |        |  |         | 1,614   |       
|                        
|                        
|                        
|                        
|                         | Professional services                        |                          |         | 2,219                       |        |                           |         | 2,159   |        |      |         | 4,086   |        |  |         | 4,333   |       
|                        
|                        
|                        
|                        
|                         | Hardware                                     |                          |         | 2,116                       |        |                           |         | 1,744   |        |      |         | 2,989   |        |  |         | 2,897   |       
|                        
|                        
|                        
|                        
|                         | Other                                        |                          |         | 94                          |        |                           |         | 231     |        |      |         | 94      |        |  |         | 390     |       
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total revenues           |         |                             | 19,467 |                           |         |         | 19,124 |      |         |         | 30,124 |  |         |         | 75,533 | 
|                        
|                        
|                        
|                        
|Cost of revenues:        |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                        
|                        
|                        
|                        
|                         | Software licenses                            |                          |         | 2,113                       |        |                           |         | 2,621   |        |      |         | 3,569   |        |  |         | 12,146  |       
|                        
|                        
|                        
|                        
|                         | Internet subscriptions                       |                          |         | 329                         |        |                           |         | 445     |        |      |         | 920     |        |  |         | 750     |       
|                        
|                        
|                        
|                        
|                         | Professional services                        |                          |         | 1,546                       |        |                           |         | 1,197   |        |      |         | 2,782   |        |  |         | 2,106   |       
|                        
|                        
|                        
|                        
|                         | Hardware                                     |                          |         | 1,583                       |        |                           |         | 1,128   |        |      |         | 2,238   |        |  |         | 2,030   |       
|                        
|                        
|                        
|                        
|                         | Other                                        |                          |         |                            |        |                           |         | 25      |        |      |         |        |        |  |         | 25      |       
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total cost of revenues   |         |                             | 5,571  |                           |         |         | 5,416  |      |         |         | 9,509  |  |         |         | 17,057 | 
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|Gross profit             |                                              |                          | 13,896  |                             |        |                           | 13,708  |         |        |      | 20,615  |         |        |  | 58,476  |        
|                        
|                        
|                        
|                        
|Operating expenses:      |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                        
|                        
|                        
|                        
|                         | Sales and marketing                          |                          |         | 13,906                      |        |                           |         | 15,636  |        |      |         | 25,870  |        |  |         | 32,640  |       
|                        
|                        
|                        
|                        
|                         | Technology and development                   |                          |         | 6,521                       |        |                           |         | 6,900   |        |      |         | 13,279  |        |  |         | 12,034  |       
|                        
|                        
|                        
|                        
|                         | General and administrative                   |                          |         | 3,220                       |        |                           |         | 2,197   |        |      |         | 5,240   |        |  |         | 4,427   |       
|                        
|                        
|                        
|                        
|                         | Stock-based compensation                     |                          |         | 220                         |        |                           |         | 704     |        |      |         | 493     |        |  |         | 1,640   |       
|                        
|                        
|                        
|                        
|                         | Amortization of intangible assets            |                          |         | 4,575                       |        |                           |         | 3,615   |        |      |         | 9,143   |        |  |         | 6,954   |       
|                        
|                        
|                        
|                        
|                         | Restructuring                                |                          |         |                            |        |                           |         | 1,600   |        |      |         |        |        |  |         | 1,600   |       
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         |                                              | Total operating expenses |         |                             | 28,442 |                           |         |         | 30,652 |      |         |         | 54,025 |  |         |         | 59,295 | 
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|Loss from operations     |                                              |                          | (14,546 | )                           |        |                           | (16,944 | )       |        |      | (33,410 | )       |        |  | (819    | )      
|                        
|                        
|                        
|                        
|Interest income          |                                              |                          | 723     |                             |        |                           | 1,763   |         |        |      | 1,810   |         |        |  | 3,316   |        
|                        
|                        
|                        
|                        
|Interest expense         |                                              |                          | (21     | )                           |        |                           | (17     | )       |        |      | (37     | )       |        |  | (32     | )      
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         | Net income (loss)                            |                          | $       | (13,844                     | )      |                           | $       | (15,198 | )      |      | $       | (31,637 | )      |  | $       | 2,465   |       
|                        
|                        
|                        
|                        
|Preferred stock dividend |                                              |                          |        |                             |        |                           |        |         |        |      |        |         |        |  | (16,506 | )      
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         | Net loss attributable to common
stockholders |                          | $       | (13,844                     | )      |                           | $       | (15,198 | )      |      | $       | (31,637 | )      |  | $       | (14,041 | )     
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|Net loss per share:      |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                        
|                        
|                        
|                        
|                         | Basic and diluted                            |                          | $       | (0.30                       | )      |                           | $       | (0.34   | )      |      | $       | (0.68   | )      |  | $       | (0.33   | )     
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        
|                         | Weighted average shares  basic
and diluted  |                          |         | 46,284                      |        |                           |         | 44,828  |        |      |         | 46,196  |        |  |         | 42,207  |       
|                         |                                              |                          |         |                             |        |                           |         |         |        |      |         |         |        |  |         |        

See accompanying notes.



3



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##### Table of Contents



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

|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |         |       |         |         |  
|-------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ------------------------------------------------- | ------------------------- | --------------------------------------------------------- | ----- | ------------------------- | ------- | ------- | ----- | ------- | ------- | -
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       | Six Months Ended July 31,
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                          
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       | 2001                      |         | 2000   
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|Operating activities:                                                |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Net income (loss)                                                                                |                                                   | $                         | (31,637                                                   | )     |                           | $       | 2,465   |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Adjustments to reconcile net income (loss) to net cash used in
operating activities:             |                                                   |                           |                                                           |       |                           |         |         |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Depreciation and amortization                     |                           |                                                           | 1,375 |                           |         |         | 772   |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Provision for doubtful accounts                   |                           |                                                           | (360  | )                         |         |         | 73    |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Amortization of intangible assets                 |                           |                                                           | 9,143 |                           |         |         | 6,954 |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Amortization of deferred stock-based compensation |                           |                                                           | 493   |                           |         |         | 1,640 |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Change in deferred advertising expense            |                           |                                                           |      |                           |         |         | 300   |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Restructuring charge, non-cash portion            |                           |                                                           |      |                           |         |         | 1,600 |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  | Changes in operating assets and liabilities:      |                           |                                                           |       |                           |         |         |       |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Accounts receivable       |                                                           |       | (8,992                    | )       |         |       | (2,698  | )      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Inventory                 |                                                           |       | 126                       |         |         |       | 2       |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Deferred cost of revenue  |                                                           |       |                          |         |         |       | 8,709   |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Deposits and other assets |                                                           |       | 1,237                     |         |         |       | (260    | )      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Accounts payable          |                                                           |       | (3,850                    | )       |         |       | (3,150  | )      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Deferred revenue          |                                                           |       | 4,822                     |         |         |       | (44,227 | )      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     |                                                                                                  |                                                   | Accrued liabilities       |                                                           |       | 2,000                     |         |         |       | (1,733  | )      
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                     |                                                                                                  |                                                   |                           | Net cash flows used in operating activities               |       |                           | (25,643 | )       |       |         | (29,553 | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Investing activities:                                                |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Purchase of short-term investments                                                               |                                                   |                           | (8,489                                                    | )     |                           |         | (13,946 | )    
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Maturities of short-term investments                                                             |                                                   |                           | 30,759                                                    |       |                           |         | 11,692  |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Purchase of property and equipment                                                               |                                                   |                           | (3,649                                                    | )     |                           |         | (1,328  | )    
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Release of restrictions on cash                                                                  |                                                   |                           | 2,289                                                     |       |                           |         |        |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | 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 |       |                           | 20,910  |         |       |         | (6,427  | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Financing activities:                                                |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Proceeds from issuance of common stock                                                           |                                                   |                           | 384                                                       |       |                           |         | 114,517 |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Principal repayments on capital leases                                                           |                                                   |                           | (251                                                      | )     |                           |         | (269    | )    
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Principal repayments on notes payable                                                            |                                                   |                           |                                                          |       |                           |         | (172    | )    
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                     |                                                                                                  |                                                   |                           | Net cash flows provided by financing activities           |       |                           | 133     |         |       |         | 114,076 |  
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                     | Increase (decrease) in cash and cash equivalents                                                 |                                                   |                           | (4,600                                                    | )     |                           |         | 78,096  |      
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Cash and cash equivalents at beginning of period                                                 |                                                   |                           | 45,566                                                    |       |                           |         | 5,033   |      
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                     | Cash and cash equivalents at end of period                                                       |                                                   | $                         | 40,966                                                    |       |                           | $       | 83,129  |      
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|Supplemental disclosure of cash flow information:                    |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Interest paid                                                                                    |                                                   | $                         | 37                                                        |       |                           | $       | 32      |      
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|Supplemental schedule of noncash investing and financing activities: |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Deferred stock-based compensation                                                                |                                                   | $                         | (246                                                      | )     |                           | $       | (406    | )    
|                                                                     |                                                                                                  |                                                   |                           |                                                           |       |                           |         |        
|                                                                     | 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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##### Table of Contents



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), are together defined as Lightspan or the Company and 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, they 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
Companys operating results are expected to vary 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, source and timing of
school districts funding. Operating results for the three and six months
ended July 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, incorporated 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 fee to
each component of the arrangement based on objective evidence of its fair
value, which is specific to Lightspan. The



5



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##### Table of Contents



objective evidence for each element is based on the sale price of each
element when sold or offered for sale separately.

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.

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.

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.

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.

Professional Services

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



6



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##### Table of Contents



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 six months ended July
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
adjusted the unrealized loss included in comprehensive income (loss) in April
2001.

For the three months ended July 31, 2001 and 2000, comprehensive loss was
$13.8 million and $15.2 million, respectively. There were no net unrealized
holding gains or losses for the three months ended July 31, 2001 and 2000. For
the six months ended July 31, 2001 and 2000, comprehensive income (loss) was
($30.9) million and $2.5 million, respectively. The difference between net
income (loss) and comprehensive income (loss) for the six months ended July 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 products
licensed to colleges and then sold by the licensing colleges to students on a
student-by-student basis for use with each class.



7



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##### Table of Contents



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 July 31, 2001
|                                  |                                             |   |                                 
|                                  |                                             |   |                                  |       |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                             |       | Education |   | Consolidated
|                                  |                                             |   |                                  |       |           |   |             
|Revenues from external customers  |                                             | $ | 15,122                           |       |           | $ | 4,345        |       |   | $ | 19,467  |      
|                                 
|                                 
|                                 
|                                 
|Interest income, net              |                                             |   | 702                              |       |           |   |             |       |   |   | 702     |      
|                                 
|                                 
|                                 
|                                 
|Depreciation and amortization     |                                             |   | 648                              |       |           |   | 71           |       |   |   | 719     |      
|                                 
|                                 
|                                 
|                                 
|Segment loss from operations      |                                             |   | (11,635                          | )     |           |   | (2,911       | )     |   |   | (14,546 | )    
|                                 
|                                 
|                                 
|                                 
|Segment assets                    |                                             |   | 92,568                           |       |           |   | 34,109       |       |   |   | 126,677 |      
|                                 
|                                 
|                                 
|                                 
|Other significant non cash items: |                                             |   |                                  |       |           |   |              |       |   |   |         |      
|                                 
|                                 
|                                 
|                                 
|                                  | Deferred stock compensation                 |   |                                  | (70   | )         |   |              | (1    | ) |   |         | (71   | )
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of deferred stock
compensation |   |                                  | 214   |           |   |              | 6     |   |   |         | 220   |  
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of intangible assets           |   |                                  | 1,580 |           |   |              | 2,995 |   |   |         | 4,575 |  

|                                  |                                             |   |                                  |      |           |   |              |       |   |   |         |       |  
|--------------------------------- | ------------------------------------------- | - | -------------------------------- | ---- | --------- | - | ------------ | ----- | - | - | ------- | ----- | -
|                                  |                                             |   | Three Months Ended July 31, 2000
|                                  |                                             |   |                                 
|                                  |                                             |   |                                  |      |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                             |      | Education |   | Consolidated
|                                  |                                             |   |                                  |      |           |   |             
|Revenues from external customers  |                                             | $ | 15,295                           |      |           | $ | 3,829        |       |   | $ | 19,124  |      
|                                 
|                                 
|                                 
|                                 
|Interest income, net              |                                             |   | 1,744                            |      |           |   | 2            |       |   |   | 1,746   |      
|                                 
|                                 
|                                 
|                                 
|Depreciation and amortization     |                                             |   | 335                              |      |           |   | 76           |       |   |   | 411     |      
|                                 
|                                 
|                                 
|                                 
|Restructuring charge              |                                             |   | 1,600                            |      |           |   |             |       |   |   | 1,600   |      
|                                 
|                                 
|                                 
|                                 
|Segment loss from operations      |                                             |   | (13,117                          | )    |           |   | (3,827       | )     |   |   | (16,944 | )    
|                                 
|                                 
|                                 
|                                 
|Segment assets                    |                                             |   | 149,535                          |      |           |   | 36,102       |       |   |   | 185,637 |      
|                                 
|                                 
|                                 
|                                 
|Other significant non cash items: |                                             |   |                                  |      |           |   |              |       |   |   |         |      
|                                 
|                                 
|                                 
|                                 
|                                  | Deferred stock compensation                 |   |                                  | (347 | )         |   |              | (15   | ) |   |         | (362  | )
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of deferred stock
compensation |   |                                  | 686  |           |   |              | 18    |   |   |         | 704   |  
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of intangible assets           |   |                                  | 792  |           |   |              | 2,823 |   |   |         | 3,615 |  

|                                  |                                             |   |                                |       |           |   |              |       |   |   |         |       |  
|--------------------------------- | ------------------------------------------- | - | ------------------------------ | ----- | --------- | - | ------------ | ----- | - | - | ------- | ----- | -
|                                  |                                             |   | Six Months Ended July 31, 2001
|                                  |                                             |   |                               
|                                  |                                             |   |                                |       |           |   | Higher       |       |   |   |        
|                                  |                                             |   | K-12                           |       | Education |   | Consolidated
|                                  |                                             |   |                                |       |           |   |             
|Revenues from external customers  |                                             | $ | 24,047                         |       |           | $ | 6,077        |       |   | $ | 30,124  |      
|                                 
|                                 
|                                 
|                                 
|Interest income (expense), net    |                                             |   | 1,770                          |       |           |   | 3            |       |   |   | 1,773   |      
|                                 
|                                 
|                                 
|                                 
|Depreciation and amortization     |                                             |   | 1,222                          |       |           |   | 153          |       |   |   | 1,375   |      
|                                 
|                                 
|                                 
|                                 
|Segment loss from operations      |                                             |   | (24,535                        | )     |           |   | (8,875       | )     |   |   | (33,410 | )    
|                                 
|                                 
|                                 
|                                 
|Segment assets                    |                                             |   | 92,568                         |       |           |   | 34,109       |       |   |   | 126,677 |      
|                                 
|                                 
|                                 
|                                 
|Other significant non cash items: |                                             |   |                                |       |           |   |              |       |   |   |         |      
|                                 
|                                 
|                                 
|                                 
|                                  | Deferred stock compensation                 |   |                                | (235  | )         |   |              | (11   | ) |   |         | (246  | )
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of deferred stock
compensation |   |                                | 477   |           |   |              | 16    |   |   |         | 493   |  
|                                 
|                                 
|                                 
|                                 
|                                  | Amortization of intangible assets           |   |                                | 3,153 |           |   |              | 5,990 |   |   |         | 9,143 |  



8



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##### Table of Contents



|                                      |                                             |   |                                |       |           |   |              |       |   |   |         |       |  
|------------------------------------- | ------------------------------------------- | - | ------------------------------ | ----- | --------- | - | ------------ | ----- | - | - | ------- | ----- | -
|                                      |                                             |   | Six Months Ended July 31, 2000
|                                      |                                             |   |                               
|                                      |                                             |   |                                |       |           |   | Higher       |       |   |   |        
|                                      |                                             |   | K-12                           |       | Education |   | Consolidated
|                                      |                                             |   |                                |       |           |   |             
|Revenues from external customers      |                                             | $ | 70,577                         |       |           | $ | 4,956        |       |   | $ | 75,533  |      
|                                     
|                                     
|                                     
|                                     
|Interest income (expense), net        |                                             |   | 3,285                          |       |           |   | (1           | )     |   |   | 3,284   |      
|                                     
|                                     
|                                     
|                                     
|Depreciation and amortization         |                                             |   | 619                            |       |           |   | 153          |       |   |   | 772     |      
|                                     
|                                     
|                                     
|                                     
|Restructuring charge                  |                                             |   | 1,600                          |       |           |   |             |       |   |   | 1,600   |      
|                                     
|                                     
|                                     
|                                     
|Segment income (loss) from operations |                                             |   | 8,705                          |       |           |   | (9,524       | )     |   |   | (819    | )    
|                                     
|                                     
|                                     
|                                     
|Segment assets                        |                                             |   | 149,535                        |       |           |   | 36,102       |       |   |   | 185,637 |      
|                                     
|                                     
|                                     
|                                     
|Other significant non cash items:     |                                             |   |                                |       |           |   |              |       |   |   |         |      
|                                     
|                                     
|                                     
|                                     
|                                      | Deferred stock compensation                 |   |                                | (385  | )         |   |              | (21   | ) |   |         | (406  | )
|                                     
|                                     
|                                     
|                                     
|                                      | Amortization of deferred stock
compensation |   |                                | 1,593 |           |   |              | 47    |   |   |         | 1,640 |  
|                                     
|                                     
|                                     
|                                     
|                                      | Amortization of intangible assets           |   |                                | 1,173 |           |   |              | 5,781 |   |   |         | 6,954 |  

5. Recently Issued Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, Business Combinationsand SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS 141 replaces APB 16 and eliminates pooling-of-interests
accounting prospectively. It also provides guidance on purchase accounting
related to the recognition of intangible assets and accounting for negative
goodwill. SFAS 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Under SFAS 142, goodwill will be tested
annually and whenever events or circumstances occur indicating that goodwill
might be impaired. SFAS Nos. 141 and 142 are effective for all business
combinations completed after June 30, 2001. Upon adoption of SFAS 142,
amortization of goodwill recorded for business combinations consummated prior
to July 1, 2001 will cease, and intangible assets acquired prior to July 1,
2001 that do not meet the criteria for recognition under SFAS 141 will be
reclassified to goodwill. Companies are required to adopt SFAS 142 for fiscal
years beginning after December 15, 2001. The Company will adopt SFAS 142 on
February 1, 2002, and it has not yet determined the impact, if any, that this
statement will have on its results of operations and financial position.

In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement 133. The statement defers the effective date of SFAS No. 133, which
establishes accounting and reporting standards for derivative instruments on
the Companys balance sheet at fair value. The Company adopted SFAS 133 in
February 2001. As of July 31, 2001, the Company did not hold any derivative
instruments or conduct any hedging activities. The adoption of SFAS Nos. 137
and 133 did not impact the Companys financial position or results of
operations.




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

This information should be read in conjunction with the unaudited
consolidated financial statements and the notes thereto included in Item 1 of
Part I of this Quarterly Report and the audited consolidated financial
statements and notes thereto and Managements Discussion and Analysis of
Financial Condition and Results of Operations for the year ended January 31,
2001 contained in our Annual Report on Form 10-K filed April 30, 2001 with the
SEC.

Except for the historical information contained herein, the following
discussion contains forward looking statements, including statements related to
our future financial performance and business trends that are subject to risks
and uncertainties, including, but not limited to, changes in economic
conditions in our market areas; changes in policies by regulatory agencies and
educational organizations; the volatility and seasonality of our expenses and
operating results; market acceptance of our curriculum based software and
Internet products; management of rapid growth; risks associated with expanding
our Internet business; changes in funding for public schools; technological
advances and risks related thereto and other risks detailed from time to time
in our filings with the Securities and Exchange Commission. We caution readers
not to place undue reliance on any forward-looking statements. We do



9



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##### Table of Contents



not undertake, and specifically disclaim any obligation, to revise any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements. These
risks could cause our actual results for fiscal 2002 and beyond to differ
materially from those expressed in any forward looking statements by us, or on
our behalf.

Results of Operations

We have incurred significant losses since our inception and, as of July
31, 2001, have accumulated losses of approximately $241.2 million. We expect to
continue to incur operating losses for the foreseeable future. In the six
months ended July 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.

To the extent that we deferred the Lightspan Achieve Now license revenue
until delivery of final titles, pursuant to SOP 97-2, we also deferred the
costs of duplicating the product and packaging it for distribution. In the
three and six months ended July 31, 2000, we recognized $0.4 million and $8.8
million, respectively in cost of license revenue when we recognized the related
$2.0 million and $48.5 million, respectively, 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
three and six months ended July 31, 2000 (in thousands):

|                                                        |                              |                |   |                    |   |                  |   |         |   | 
|------------------------------------------------------- | ---------------------------- | -------------- | - | ------------------ | - | ---------------- | - | ------- | - | 
|                                                        |                              |                |   | Three Months Ended |   | Six Months Ended
|                                                        |                              |                |   | July 31, 2000      |   | July 31, 2000   
|                                                        |                              |                |   |                    |   |                 
|Deferred license revenue-
Lightspan Achieve Now         |                              |                |   |                    |   |                  |   |        
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Beginning balance            |                | $ | 2,048              |   |                  | $ | 48,110  |  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Deferred during the period   |                |   |                   |   |                  |   | 384     |  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Recognized during the period |                |   | (2,048             | ) |                  |   | (48,494 | )
|                                                        |                              |                |   |                    |   |                  |   |        
|                                                        |                              | Ending balance |   | $                  | 0 |                  |   | $       | 0 | 
|                                                        |                              |                |   |                    |   |                  |   |        
|Deferred cost of license revenue-
Lightspan Achieve Now |                              |                |   |                    |   |                  |   |        
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Beginning balance            |                | $ | 371                |   |                  | $ | 8,709   |  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Deferred during the period   |                |   |                   |   |                  |   | 70      |  
|                                                       
|                                                       
|                                                       
|                                                       
|                                                        | Recognized during the period |                |   | (371               | ) |                  |   | (8,779  | )
|                                                        |                              |                |   |                    |   |                  |   |        
|                                                        |                              | Ending balance |   | $                  | 0 |                  |   | $       | 0 | 
|                                                        |                              |                |   |                    |   |                  |   |        



10



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Comparison of Three and Six Months Ended July 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 2 percent to $19.5 million in the three months ended July 31, 2001
from $19.1 million in the three months ended July 31, 2000 primarily due to the
increase in Internet subscription revenue relating to our increased subscriber
base, partially offset by the recognition in the three months ended July 31,
2000 of $2.0 million in previously deferred software license revenue, as
described in Revenue above. Our total revenues decreased 60 percent to $30.1
million in the six months ended July 31, 2001 from $75.5 million in the six
months ended July 31, 2000 primarily due to the recognition in the six months
ended July 31, 2000 of $48.1 million in previously deferred software license
revenue, as described in Revenue above.

Software Licenses.Our software license revenues decreased $0.8 million
to $13.3 million in the three months ended July 31, 2001 from $14.1 million in
the three months ended July 31, 2000 primarily due to the recognition of $2.0
million in Lightspan Achieve Now revenue previously deferred (see Revenue
above), partially offset by an increase in Lightspan Achieve Now licenses sold.
Our software license revenues decreased $46.7 million to $19.6 million in the
six months ended July 31, 2001 from $66.3 million in the six months ended July
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 98
percent to $1.8 million in the three months ended July 31, 2001 from $0.9
million in the three months ended July 31, 2000 and increased 106 percent to
$3.3 million in the six months ended July 31, 2001 from $1.6 million in the six
months ended July 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 31 percent to approximately 3,300 at July
31, 2001 from approximately 2,500 at July 31, 2000.

Professional Services.Our professional service revenues remained
relatively consistent for the three months ended July 31, 2001 compared to the
three months ended July 31, 2000, and decreased 6 percent to $4.1 million in
the six months ended July 31, 2001 from $4.3 million in the six months ended
July 31, 2000 primarily due to a decrease in the billable hours for
professional services in the first quarter of fiscal 2002.

Hardware.Our hardware revenues increased 21 percent to $2.1 million in
the three months ended July 31, 2001 from $1.7 million in the three months
ended July 31, 2000 and increased 3 percent to $3.0 million in the six months
ended July 31, 2001 from $2.9 million in the six months ended July 31, 2000
primarily due to an increase in the sale of PlayStation game consoles and
related hardware components sold with our Lightspan Achieve Now licenses.

Cost of Revenues

Our total cost of revenues increased 3 percent to $5.6 million for the
three months ended July 31, 2001 from $5.4 million for the three months ended
July 31, 2000, corresponding to the increase in total revenues. For the six
months ended July 31, 2001, total cost of revenues decreased 44 percent to $9.5
million from $17.1 million for the six months ended July 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. Gross margin as a percentage of
total revenues decreased 1 percentage point to 71 percent in the three months
ended July 31, 2001 from 72 percent in the three months ended July 31, 2000 and
decreased 9 percentage points to 68 percent in the six months ended July 31,
2001 from 77 percent in the six months ended July 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 six months ended July 31, 2000.



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Expenses

Sales and Marketing.Our sales and marketing expenses decreased 11 percent
to $13.9 million for the three months ended July 31, 2001 from $15.6 million
for the three months ended July 31, 2000 and decreased 21 percent to $25.9
million for the six months ended July 31, 2001 from $32.6 million for the six
months ended July 31, 2000. This was primarily due to a decrease in
promotional activities connected to the launch of Lightspan.com in the first
quarter of fiscal 2001, and a refocus of our sales and marketing efforts
toward fee-based subscription Internet
products 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. Although we have reduced our sales and
marketing expenses related to our free Internet products, we continue to pursue
branding and marketing campaigns to retain and increase sales to current
customers, attract new customers, and broaden our markets for our Lightspan
Achieve Now curriculum, fee-based subscription Internet products, and Academic
products.

Technology and Development.Our technology and development expenses
decreased 5 percent to $6.5 million for the three months ended July 31, 2001
from $6.9 million for the three months ended July 31, 2000 due to our refocus
toward subscription based Internet products from the design of free Internet products, and increased 10 percent to
$13.3 million for the six months ended July 31, 2001 from $12.0 million for the
six months ended July 31, 2000 primarily due to the inclusion of additional
subscription-based Internet development expenses associated with eduTest.com,
which we acquired in the second quarter of fiscal 2001.

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. We believe that continued investment in fee-based
subscription Internet product development is critical to attaining our
strategic objectives.

General and Administrative.Our general and administrative expenses
increased $1.0 million or 47 percent to $3.2 million for the three months ended
July 31, 2001 from $2.2 million for the three months ended July 31, 2000 and
increased $0.8 million or 18 percent to $5.2 million for the six months ended
July 31, 2001 from $4.4 million for the six months ended July 31, 2000
primarily due to a net increase in our accounts receivable reserve relating to
our increased sales and certain severance accruals relating to staff
reductions.

Our general and administrative expenses consist primarily of compensation
and benefits for executive and administrative personnel, professional service
expenses and other general corporate expenses. We expect that general and
administrative expenses may increase as our business expands.

Stock-Based Compensation.Stock-based compensation expense was $0.2
million and $0.7 million for the three months ended July 31, 2001 and 2000,
respectively, and $0.5 million and $1.6 million for the six months ended July
31, 2001 and 2000, respectively, as a result of our granting of stock options
to employees with exercise prices per share below the fair values per share for
our common stock on the dates those options were granted. 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
July 31, 2001, there was approximately $0.6 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 $4.6 million and $9.1
million for the three and six months ended July 31, 2001, respectively from



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$3.6 million and $7.0 million for the three and six months ended July 31,
2000, respectively, due to the amortization expense relating to the purchase of
Edutest in July 2000. See Note 5 above.

Interest Income (Expense).Our net interest income decreased 60 percent
to $0.7 million for the three months ended July 31, 2001 from $1.7 million for
the three months ended July 31, 2000 and decreased 46 percent to $1.8 million
for the six months ended July 31, 2001 from $3.3 million for the six months
ended July 31, 2000 as a result of lower cash balances.

Liquidity and Capital Resources

From inception through July 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 July 31, 2001, we had $41.0 million of cash and cash equivalents,
$11.1 million in short-term investments and $2.5 million in restricted cash for
a total of $54.6 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, in large part, to the timing of cash payments to vendors, cash
collections from customers, varying resources required for development efforts
on our product offerings, as well as receipt of cash from our preferred stock
financings, initial public offering, private placements and other equity
offerings. We expect our working capital requirements and cash position to
fluctuate significantly from period to period for the foreseeable future.

Net cash used in operating activities decreased $3.9 million in the six
months ended July 31, 2001 as compared to the six months ended July 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 offset in part of by
our continued development of our fee-based subscription Internet products and
services. Net cash provided by investing activities increased $27.3 million in
the six months ended July 31, 2001 as compared to the six months ended July 31,
2000 primarily due to an increase in the maturities of our short-term
investments used for operations. Net cash provided by financing activities
decreased $113.9 million in the six months ended July 31, 2001 as compared to
the six months ended July 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 substantial capital resources in connection with brand maintenance,
marketing, promotional activities, maintaining and selling our existing
products and services, and continued development and expansion of our fee-based
subscription Internet offerings and content. In addition, we may devote
substantial capital resources to strategic acquisitions and relationships.

As of July 31, 2001, we believe that our cash and cash equivalents and
short-term investments will be sufficient to fund our operations for at least
the next 12 months.




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



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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 July 31, 2001. Declines in interest rates over time will,
however, reduce our interest income.




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
July 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

We held our Annual Meeting of Stockholders on June 28, 2001.

At the meeting, the following nominees were elected as directors to hold
office until the 2004 Annual Meeting of Stockholders or until their successors
are elected and qualified:

|               |  |           |            |               |  |  |         | 
|-------------- |  | --------- | ---------- | ------------- |  |  | ------- | 
|Nominee        |  | Votes For |            | Votes Against
|               |  |           |            |              
|Carl E. Zeiger |  |           | 36,813,004 |               |  |  | 105,138 | 
|              
|              
|              
|              
|John E. Kole   |  |           | 36,808,489 |               |  |  | 109,653 | 

Also at the meeting, the appointment of Ernst & Young LLP as the Companys
independent public accountants for the fiscal year ending January 31, 2002 was
ratified. The voting for the proposal was as follows:

For- 36,880,346
     Against- 31,873
     Abstain- 5,923

There were no other proposals.



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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 July
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.                                               



---

|(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
September, 2001.

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



16